Greece is evidently going to hit the financial skids next week. The EU appears to have stopped bargaining (as have the Greeks, who now want to put the issue of austerity in exchange for another EU bailout to their voters). Without bargaining, there won't be a deal.
How did things end up this way? One perspective is that, by entering the Euro Zone, Greece gave up a lot of power and put itself under the control of the EU. When a country issues its own currency (i.e., fiat currency), it has considerable control over its currency's value in relation to other currencies. If the country slides downhill economically speaking, it can devalue its currency and export its way out of trouble. The Japanese have done this for decades, and the Chinese and other developing nations are endeavoring to emulate the Japanese.
But what if the country, instead of issuing its own currency, uses another medium of exchange? Historically, gold and silver, and sometimes copper, served such a role. But a country that uses an independent medium of exchange can't devalue its way out of a recession. It has to find another way; and sometimes it can't. That's why the industrialized West moved off the gold standard in the 20th Century. It prevented them from using central bank policies to recover from economic downturns.
Fiat currencies have a very bad image among many in the political right. Gold standard conservatives fear that governments will inflate the wealth of citizens away for reasons of political expediency. They rightly point to the morass of post-World War I Germany, when the Weimar Republic did that, resulting in widespread malaise and paving the way for fascism.
But gold standard adherents forget a basic principle of economics: goods become widespread in the market because people demand them. Fiat currency is simply another good, and people demand a lot of it. It serves as a medium of exchange, and no major economy can exist without a copious supply of the medium of exchange. Gold was extremely scarce in Colonial America, and deer skins (i.e., buck skins, from whence came the term "buck"), tobacco and other goods served as an alternative to gold. Various commercial promises to pay, such as drafts, promissory notes, banker's notes, and the like, also came to be used in lieu of gold. Fiat currency was government's way of simplifying the problem of lack of gold and silver that could be used as media of exchange.
Fiat currency also conferred power. When the American Revolution began, the Continental Congress issued paper money in order to finance the rebellion. This paper was subject to inflation, and considerable controversy eventually surrounded its use. Nevertheless, the Continental Congress' ability to issue fiat currency helped to sustain the Revolution.
The U.S. government in the 19th Century outlawed the issuance of bank notes and other private currency and substituted the greenback in their stead. Although the U.S. government clung to the gold standard, it devalued the dollar against gold once the Great Depression began, and took the dollar off the gold standard during the economic difficulties of the early 1970's. In other words, gold wasn't really the standard. The dollar was worth what the government said it was worth, not what the market price of gold happened to be.
The power of fiat currency became vividly clear during the Great Depression and World War II. The U.S. government began to borrow in large amounts (i.e., engage in deficit spending) in order to alleviate the Depression. Then, it borrowed enormous amounts to finance the war and defeat fascism. After World War II, the U.S. government flooded the free world with dollars, so that there would be a currency to replace the British pound as the world's reserve currency. The U.S. government derives enormous power from the fact that the dollar is the world's reserve currency. People in other countries have to pay attention to America, because America's currency keeps the world's economy going. Even in the Communist bloc, the dollar mattered. As Communist economies flagged, the dollar became the underground, but de facto real, currency in many Communist nations. Communism's legitimacy was in part undermined by the strength of America's fiat currency.
Greece is in a real fix, because its citizens don't want austerity, but they want to remain part of the EU. Reality is that they are damned if they do and damned if they don't. Staying in the EU will require agreement to the EU's demands for more austerity, which will probably worsen Greece's depression. Leaving the EU will also likely mean that the Greek depression will worsen. Who's at fault for this mess is a complicated question, but the answer, in short, is like Agatha Christy's novel, Murder on the Orient Express. Everyone involved in and with the EU is responsible. And there's no easy way out of the mess, for anyone.
But a larger point is that fiat currencies aren't good or evil. They are a tool, one that can be used productively or counter-productively. We need to watch what the Fed is doing--closely. But let us recognize that much of America's strength comes from its fiat currency.
Showing posts with label economics. Show all posts
Showing posts with label economics. Show all posts
Saturday, June 27, 2015
Monday, September 3, 2012
Ignore the Election. Try a Little Science.
As far as economic growth goes, forget about the Presidential election. Neither party is focused on what really matters: basic scientific research. All great surges in economic growth have resulted from scientific advancement. When humans acquired enough scientific knowledge to engage in agriculture, they were able to grow large surpluses of food. These surpluses were used to support the development of settled societies, with cities, specialized workers, the centralization of knowledge through educational institutions, and control over resources like rivers and their floods. Human populations increased exponentially, as did human wealth.
The leap from a largely agricultural world to an industrialized world began with the development of the steam engine at the end of the 18th Century. The steam engine allowed humans to harness very large quantities of power derived by burning wood, and later fossil fuels. The vast increase in power offered by the steam engine led the way to the railroad, steam ships, giant factories that provided economies of scale, and even a few early cars.
In the 19th Century, the harnessing of electricity led to the telegraph, telephone, small and large scale lights and lighting systems, and all manner of machinery and equipment. New technologies for extracting and utilizing fossil fuels like coal, oil and natural gas vastly increased the amount of power available to humans, especially through the use of the internal combustion engine that powers almost all motor vehicles today. With that great increase in power came an enormous improvement in living standards.
In the 20th Century, advances in knowledge of electromagnetic radiation gave rise to the radio, television, cell phones and the wireless computers used today (variously called smart phones, tablets, etc.). Advances in agriculture have eliminated a great deal of the hunger that plagued much of the world before World War II. Developments in material sciences led to the semiconductor revolution, which is the foundation of all modern computers. The Internet, invented by [fill in the name of your favorite politician], has revolutionized communication.
In short, the big score comes when humans make major scientific advances and find ways to exploit them. Money printing and interest rate manipulation by the Fed, supply side tax cutting, deficit spending, scorched earth treatment for Medicare and Medicaid, and just about all the other hooey that politicians can't stop talking about don't amount to jack compared to the effectiveness of scientific advance in fostering economic growth. Much and perhaps most of today's political debate revolves around how to split up a seemingly inadequate pie. But the supposed conflicts between the 1% vs. the 99%, older folks vs. younger ones, taxpayers vs. beneficiaries of the social safety net, and so on all become less consequential if the pie expands at a faster rate.
Don't expect private financing sources to support basic scientific research. Private capital wants to reap its profit within a few years, and concentrates on applied science. But applied science doesn't provide lasting prosperity (ask the Japanese, masters of applied science, about this point). Support for basic scientific research is essential to long term prosperity. If there's one item in the federal budget that should be boosted, this is it.
The leap from a largely agricultural world to an industrialized world began with the development of the steam engine at the end of the 18th Century. The steam engine allowed humans to harness very large quantities of power derived by burning wood, and later fossil fuels. The vast increase in power offered by the steam engine led the way to the railroad, steam ships, giant factories that provided economies of scale, and even a few early cars.
In the 19th Century, the harnessing of electricity led to the telegraph, telephone, small and large scale lights and lighting systems, and all manner of machinery and equipment. New technologies for extracting and utilizing fossil fuels like coal, oil and natural gas vastly increased the amount of power available to humans, especially through the use of the internal combustion engine that powers almost all motor vehicles today. With that great increase in power came an enormous improvement in living standards.
In the 20th Century, advances in knowledge of electromagnetic radiation gave rise to the radio, television, cell phones and the wireless computers used today (variously called smart phones, tablets, etc.). Advances in agriculture have eliminated a great deal of the hunger that plagued much of the world before World War II. Developments in material sciences led to the semiconductor revolution, which is the foundation of all modern computers. The Internet, invented by [fill in the name of your favorite politician], has revolutionized communication.
In short, the big score comes when humans make major scientific advances and find ways to exploit them. Money printing and interest rate manipulation by the Fed, supply side tax cutting, deficit spending, scorched earth treatment for Medicare and Medicaid, and just about all the other hooey that politicians can't stop talking about don't amount to jack compared to the effectiveness of scientific advance in fostering economic growth. Much and perhaps most of today's political debate revolves around how to split up a seemingly inadequate pie. But the supposed conflicts between the 1% vs. the 99%, older folks vs. younger ones, taxpayers vs. beneficiaries of the social safety net, and so on all become less consequential if the pie expands at a faster rate.
Don't expect private financing sources to support basic scientific research. Private capital wants to reap its profit within a few years, and concentrates on applied science. But applied science doesn't provide lasting prosperity (ask the Japanese, masters of applied science, about this point). Support for basic scientific research is essential to long term prosperity. If there's one item in the federal budget that should be boosted, this is it.
Thursday, April 19, 2012
Predicting China's Economic Performance From Political Scandal
China's political scandal du jour is the downfall of Bo Xilai, former top government official in the southwestern city of Chongjing. (That's the modern spelling of Chungking, the capital of free China during World War II.) Bo, formerly an upwardly mobile political star, was abruptly removed from power when his wife, Gu Kailai, was arrested on suspicion of murdering a British businessman named Neil Heywood. Heywood reportedly was a close associate of Bo and Gu, but apparently had a falling out and may have been eliminated because he knew too much and might reveal it. Good airport novel stuff, and there no doubt already are at least several commissioned (and numerous uncommissioned) film scripts about the scandal being written in Hollywood.
Bo appears like a throwback to Maoist days, promoting populist programs such as affordable housing for the masses and government directed spending to build infrastructure, thus fostering job creation. He also encouraged the singing of revolutionary songs from the Communist era, ordered students and government employees to work stints in rural areas (shades of the Cultural Revolution) and made the local TV station stop running commercials and broadcast revolutionary programming. Bo wasn't a pure Communist. He encouraged foreign investment and tried to attract manufacturing away from its established bases on China's coastline. But his overall approach revived notions of egalitarianism, and his popularity among average Chinese blossomed.
That made Bo a dangerous man--dangerous to the central government in Beijing, which is in the process of trying to engineer a transfer of power to a new generation of leaders. It's unclear that the differences between Bo and his adversaries are ideological; many of his policies are consonant with Beijing's expressed priorities. One suspects that this fight is over power. Bo is the son of Bo Yibo, one of the most exalted doyens of the Communist Party in its early days, and seemed destined by family legacy to rise to national prominence. As his popularity among the masses increased, his ascendency to top leadership could have become inexorable. Evidently, there were some people in Beijing who didn't cotton to that notion.
One of the oddest things about the Bo Xilai scandal is how it's being publicized by the Chinese government. This is basically a bare-fisted brawl in the smoke-filled rooms and back alleys of China's political power structure. In the past, such struggles were conducted in the utmost secrecy. Even today, the civil war that was the Cultural Revolution remains heavily shrouded in mystery. But the Beijing government has publicly announced Gu Kailai's arrest. And interesting details of the scandal--the kind of information that would likely be known by government investigators--seem to have found their way into the Western press. Why would the Party air its dirty laundry?
Most likely, to sway public opinion in China. Democracy, as the term is understood in the West, doesn't exist in China. But Chinese governments since the times of the earliest dynasties have understood that they need the loyalty of the populace. Emperors who lost the support of the people risked being overthrown by peasant rebellions, which had a tendency to flare up if government officials were corrupt and overbearing, and harvests were bad. In such circumstances, charismatic leaders would rise up, acquire popular followings and inspire uprisings. Often, they would embellish their appeals by harking back to the supposed moral uprightness and economic security of earlier times. The bad harvests, they would pronounce, were a sign that the emperor had lost the mandate of heaven, which justified rebellion.
Today's equivalent of a bad harvest is an economic downturn. And the economy has been slowing in China. Employment levels have fallen as Chinese exports faltered after the 2008 financial crisis. Real estate values are beginning to drop, and price inflation is disquieting. China's rapid shift to capitalism has removed most of the social safety net that existed in Communist days, leaving hundreds of millions who grew up with the security of the Iron Rice Bowl in the uncomfortable of role of fending for themselves in the mystifying harshness of the capitalist system.
Bo Xilai might have become a rallying point for China's discontented. Indeed, the press has reported that many in Chongqing continue to support him, if not for attribution. The Party's public destruction of Bo's political career would appear to be a message to the Chinese people that there ain't gonna be no change in the mandate of heaven, at least not if the power brokers in Beijing have anything to say about it (and they have a lot to say about it).
Why would they feel so threatened by Bo? Very possibly because they know that China's economy is headed for a downturn, one that could destabilize the fragile political compromise that holds China together today. Most Chinese don't care for Communism. But they also aren't ardent about fostering Western style democracy. They just want economic stability and an opportunity for a better life. As long as the government in Beijing delivers good harvests, most Chinese won't rock the boat. But if the economy starts to circle the drain, a charismatic leader like Bo Xilai, particularly if located far from the dour bureaucrats in the capital, could take advantage of the hard times in a gambit to seize power. Beijing's public exploitation of the scandal is, among other things, a pretty good indication that it expects China's economy to weaken. Hedge your bets if you're invested in the Central Kingdom.
Bo appears like a throwback to Maoist days, promoting populist programs such as affordable housing for the masses and government directed spending to build infrastructure, thus fostering job creation. He also encouraged the singing of revolutionary songs from the Communist era, ordered students and government employees to work stints in rural areas (shades of the Cultural Revolution) and made the local TV station stop running commercials and broadcast revolutionary programming. Bo wasn't a pure Communist. He encouraged foreign investment and tried to attract manufacturing away from its established bases on China's coastline. But his overall approach revived notions of egalitarianism, and his popularity among average Chinese blossomed.
That made Bo a dangerous man--dangerous to the central government in Beijing, which is in the process of trying to engineer a transfer of power to a new generation of leaders. It's unclear that the differences between Bo and his adversaries are ideological; many of his policies are consonant with Beijing's expressed priorities. One suspects that this fight is over power. Bo is the son of Bo Yibo, one of the most exalted doyens of the Communist Party in its early days, and seemed destined by family legacy to rise to national prominence. As his popularity among the masses increased, his ascendency to top leadership could have become inexorable. Evidently, there were some people in Beijing who didn't cotton to that notion.
One of the oddest things about the Bo Xilai scandal is how it's being publicized by the Chinese government. This is basically a bare-fisted brawl in the smoke-filled rooms and back alleys of China's political power structure. In the past, such struggles were conducted in the utmost secrecy. Even today, the civil war that was the Cultural Revolution remains heavily shrouded in mystery. But the Beijing government has publicly announced Gu Kailai's arrest. And interesting details of the scandal--the kind of information that would likely be known by government investigators--seem to have found their way into the Western press. Why would the Party air its dirty laundry?
Most likely, to sway public opinion in China. Democracy, as the term is understood in the West, doesn't exist in China. But Chinese governments since the times of the earliest dynasties have understood that they need the loyalty of the populace. Emperors who lost the support of the people risked being overthrown by peasant rebellions, which had a tendency to flare up if government officials were corrupt and overbearing, and harvests were bad. In such circumstances, charismatic leaders would rise up, acquire popular followings and inspire uprisings. Often, they would embellish their appeals by harking back to the supposed moral uprightness and economic security of earlier times. The bad harvests, they would pronounce, were a sign that the emperor had lost the mandate of heaven, which justified rebellion.
Today's equivalent of a bad harvest is an economic downturn. And the economy has been slowing in China. Employment levels have fallen as Chinese exports faltered after the 2008 financial crisis. Real estate values are beginning to drop, and price inflation is disquieting. China's rapid shift to capitalism has removed most of the social safety net that existed in Communist days, leaving hundreds of millions who grew up with the security of the Iron Rice Bowl in the uncomfortable of role of fending for themselves in the mystifying harshness of the capitalist system.
Bo Xilai might have become a rallying point for China's discontented. Indeed, the press has reported that many in Chongqing continue to support him, if not for attribution. The Party's public destruction of Bo's political career would appear to be a message to the Chinese people that there ain't gonna be no change in the mandate of heaven, at least not if the power brokers in Beijing have anything to say about it (and they have a lot to say about it).
Why would they feel so threatened by Bo? Very possibly because they know that China's economy is headed for a downturn, one that could destabilize the fragile political compromise that holds China together today. Most Chinese don't care for Communism. But they also aren't ardent about fostering Western style democracy. They just want economic stability and an opportunity for a better life. As long as the government in Beijing delivers good harvests, most Chinese won't rock the boat. But if the economy starts to circle the drain, a charismatic leader like Bo Xilai, particularly if located far from the dour bureaucrats in the capital, could take advantage of the hard times in a gambit to seize power. Beijing's public exploitation of the scandal is, among other things, a pretty good indication that it expects China's economy to weaken. Hedge your bets if you're invested in the Central Kingdom.
Friday, August 19, 2011
Should We Bring Back the Leisure Suit?
The economy in America and Europe is stagnant. Gas prices have risen sharply in recent years, and the Bureau of Labor Statistics reports rising inflation. The job market stinks. Business investment has ground to a halt. America is unwinding from unpopular wars. Young people just entering the labor force believe they face a lifetime of limited opportunity and lower living standards. They envy their parents, who seem to have had it so good. Prospects for the future seem like a blurred swirl in a porcelain bowl. Whether you believe history repeats itself or simply rhymes, the times are looking a lot like the 1970s. Maybe we should bring back the leisure suit.
The leisure suit had many attributes. It was casual, a rejection of the stuffy old formality of the 1950s. It usually came in pastel colors, brightening things up as the lights dimmed for electricity conservation mandated by rising energy prices. It was made of polyester, which thankfully led us to rethink the whole idea of better living through chemistry. It was flashy, ideal for mindlessly dissipating evenings in artificially fogged discos. Considering today's pervasive gloom, a bit of self-referential, sartorial frivolity might be just the thing we need.
But thinking of the 1970s reminds us of how glad we were to escape the malaise of those times. What is worth examining is how we made the escape. The fundamental economic problem then was price inflation. Already a nagging problem in the 3% range at the beginning of the decade, inflation was aggravated by OPEC oil price fixing, which escalated it to 13% by the end of the decade. Wages tended to keep fairly close pace with inflation, but the value of savings was eroded as interest rates lagged (does this sound familiar?). The stock market stunk, worth much less after inflation than it was worth at the beginning of the decade.
As students of economic history know, then Fed Chairman Paul Volcker raised interest rates sharply at the beginning of the 1980s to stabilize prices. In the process, the U.S. economy belly flopped into recession, with unemployment rising above 10% and stocks falling. Despite a tidal wave of criticism from the left, right, Democrats, Republicans, and just about everyone else standing on or about a bully pulpit, Volcker held firm, like a latter day Rock of Chickamauga. And prevailed. The recession of 1981-82 wrung inflation out of the economy, and it has never returned at any level approaching the confidence sapping double digits of the 70s. With inflation whipped, real economic growth resumed, employment levels rebounded, and the stock market took off on an 18-year bull run. The bond market, even more amazingly, took off on a bull run that hasn't ended even today.
An essential, virtually forgotten lesson from the disco era is that real pain had to be endured before the economy could be set on the right track. Investors, workers, businesses, savers, and homeowners all made sacrifices. There was no easy way out. Inflation had created economic distortions that had to eliminated. The relatively lax Fed of the 1970s was replaced by a stern, unyielding inflation slayer who wielded a mighty halberd.
Such is the path America must take today if it is to end today's dreary replay of the 1970s. The economy is distorted by asset bubbles, the leverage that made them possible, the fantasy mortgage loans that can't be collected but haven't been written off by the banks, Fed-prescribed low interest rates that encourage speculation while discouraging savings, and the dependence of the private sector on federal stimulus. Private businesses won't hire or invest unless there is a prospect of more federal intervention. Everyone wants a risk-free environment, or absent that, a federal bailout. Free enterprise, which means taking risk, barely exists any more and can usually be found only in the small business sector, where federal manna is scarce.
If the Fed wants to stimulate risk taking, what it must do is reverse the tide of moral hazard and stop the endless stream of largely futile accommodations. It should force business executives to take risk, not force savers to gamble their hard-earned retirement funds on dodgy financial instruments. When businesses realize that they will have to make their profits the old fashioned way--by taking risks and managing those risks to attain profitability--then we will see organic economic recovery. No amount of Fed coddling of corporate interests, and no amount of Fed punishment of savers and holders of capital, will achieve the spontaneous and self-sustaining growth that produces lasting prosperity.
Before there was a Federal Reserve, there were recessions, and bad ones at that. There were also recoveries from those recessions that led to sparkling prosperity. It's not like America endured an unrelenting stream of recessions followed by more recessions until the clouds parted and the Federal Reserve System was handed down to someone on Mount Sinai. The Fed has a legitimate role in stabilizing the financial system, and has done yeoman's duty in that respect. But it isn't and can't be the progenitor of all prosperity in America. In a free enterprise system, private enterprise must take on that job, and if corporate interests hold back in hope of yet another federal bailout, they must be made to understand it won't be forthcoming.
America is becoming like Japan, moribund and without a vision of the future. We don't want to take risks any more, and we don't want to accept pain. Blame and culpability are denied by the most powerful, even though their responsibility is greatest. The less powerful and the powerless are made to suffer the worst consequences of the Great Recession, even though their ability to cope is the least. Capitalism requires that blame and responsibility be assessed, and that losses be imposed appropriately. Without right and wrong, there can be no morality. And without losses as well as gains, there can be no free enterprise. We can have all gains only if we become one big government enterprise (and those gains would ultimately prove ethereal). We can't escape our current predicament by having the federal government (and, even worse, the EU) artificially support or inflate assets that are in reality worthless. There won't be a revival of sustained economic growth as long as the government holds out the promise of yet another bailout, yet more accommodation. While there remains a legitimate role for government in taking on tasks for which the private sector isn't well-suited, like building and maintaining infrastructure, and funding and conducting basic research (recall that the Internet started off as a Defense Department project), the government should stop trying to alleviate general business risk.
Otherwise, we might as well bring back the leisure suit. A dose of self-delusion as we circle the drain will numb the process of decay and decline. If we're going to stop thinking about tomorrow, we might as well have fun while we can.
The leisure suit had many attributes. It was casual, a rejection of the stuffy old formality of the 1950s. It usually came in pastel colors, brightening things up as the lights dimmed for electricity conservation mandated by rising energy prices. It was made of polyester, which thankfully led us to rethink the whole idea of better living through chemistry. It was flashy, ideal for mindlessly dissipating evenings in artificially fogged discos. Considering today's pervasive gloom, a bit of self-referential, sartorial frivolity might be just the thing we need.
But thinking of the 1970s reminds us of how glad we were to escape the malaise of those times. What is worth examining is how we made the escape. The fundamental economic problem then was price inflation. Already a nagging problem in the 3% range at the beginning of the decade, inflation was aggravated by OPEC oil price fixing, which escalated it to 13% by the end of the decade. Wages tended to keep fairly close pace with inflation, but the value of savings was eroded as interest rates lagged (does this sound familiar?). The stock market stunk, worth much less after inflation than it was worth at the beginning of the decade.
As students of economic history know, then Fed Chairman Paul Volcker raised interest rates sharply at the beginning of the 1980s to stabilize prices. In the process, the U.S. economy belly flopped into recession, with unemployment rising above 10% and stocks falling. Despite a tidal wave of criticism from the left, right, Democrats, Republicans, and just about everyone else standing on or about a bully pulpit, Volcker held firm, like a latter day Rock of Chickamauga. And prevailed. The recession of 1981-82 wrung inflation out of the economy, and it has never returned at any level approaching the confidence sapping double digits of the 70s. With inflation whipped, real economic growth resumed, employment levels rebounded, and the stock market took off on an 18-year bull run. The bond market, even more amazingly, took off on a bull run that hasn't ended even today.
An essential, virtually forgotten lesson from the disco era is that real pain had to be endured before the economy could be set on the right track. Investors, workers, businesses, savers, and homeowners all made sacrifices. There was no easy way out. Inflation had created economic distortions that had to eliminated. The relatively lax Fed of the 1970s was replaced by a stern, unyielding inflation slayer who wielded a mighty halberd.
Such is the path America must take today if it is to end today's dreary replay of the 1970s. The economy is distorted by asset bubbles, the leverage that made them possible, the fantasy mortgage loans that can't be collected but haven't been written off by the banks, Fed-prescribed low interest rates that encourage speculation while discouraging savings, and the dependence of the private sector on federal stimulus. Private businesses won't hire or invest unless there is a prospect of more federal intervention. Everyone wants a risk-free environment, or absent that, a federal bailout. Free enterprise, which means taking risk, barely exists any more and can usually be found only in the small business sector, where federal manna is scarce.
If the Fed wants to stimulate risk taking, what it must do is reverse the tide of moral hazard and stop the endless stream of largely futile accommodations. It should force business executives to take risk, not force savers to gamble their hard-earned retirement funds on dodgy financial instruments. When businesses realize that they will have to make their profits the old fashioned way--by taking risks and managing those risks to attain profitability--then we will see organic economic recovery. No amount of Fed coddling of corporate interests, and no amount of Fed punishment of savers and holders of capital, will achieve the spontaneous and self-sustaining growth that produces lasting prosperity.
Before there was a Federal Reserve, there were recessions, and bad ones at that. There were also recoveries from those recessions that led to sparkling prosperity. It's not like America endured an unrelenting stream of recessions followed by more recessions until the clouds parted and the Federal Reserve System was handed down to someone on Mount Sinai. The Fed has a legitimate role in stabilizing the financial system, and has done yeoman's duty in that respect. But it isn't and can't be the progenitor of all prosperity in America. In a free enterprise system, private enterprise must take on that job, and if corporate interests hold back in hope of yet another federal bailout, they must be made to understand it won't be forthcoming.
America is becoming like Japan, moribund and without a vision of the future. We don't want to take risks any more, and we don't want to accept pain. Blame and culpability are denied by the most powerful, even though their responsibility is greatest. The less powerful and the powerless are made to suffer the worst consequences of the Great Recession, even though their ability to cope is the least. Capitalism requires that blame and responsibility be assessed, and that losses be imposed appropriately. Without right and wrong, there can be no morality. And without losses as well as gains, there can be no free enterprise. We can have all gains only if we become one big government enterprise (and those gains would ultimately prove ethereal). We can't escape our current predicament by having the federal government (and, even worse, the EU) artificially support or inflate assets that are in reality worthless. There won't be a revival of sustained economic growth as long as the government holds out the promise of yet another bailout, yet more accommodation. While there remains a legitimate role for government in taking on tasks for which the private sector isn't well-suited, like building and maintaining infrastructure, and funding and conducting basic research (recall that the Internet started off as a Defense Department project), the government should stop trying to alleviate general business risk.
Otherwise, we might as well bring back the leisure suit. A dose of self-delusion as we circle the drain will numb the process of decay and decline. If we're going to stop thinking about tomorrow, we might as well have fun while we can.
Friday, June 17, 2011
Why Your Kid(s) Should Study Math
The unemployment rate among recent college graduates is about twice the 9% rate for the labor force as a whole. Many a recent recipient of a very expensive sheepskin has returned to the nest, bearing truckloads of debt and earning no regular income to repay it. Much has been written about their disillusionment; perhaps not enough has been written about those of their generation who found good jobs. Where are the high-paying jobs for holders of 4-year degrees? In engineering, computer programming and other science-oriented fields. What do these fields have in common? The need for good math skills.
Engineers can command starting salaries of $70,000 or more a year. People taking jobs in, say social work, earn half that or less. But they may have comparable debt loads. These statistics tell you who's going to be better off five, ten, twenty and more years after college.
Many liberal arts grads try to bail themselves out by taking on more student loans and going to law school or business school. Those with a facility for numbers will have the advantage. Most areas of law practice involve numbers. That's obviously so for those specializing in business, tax, trusts and estates, or torts. But math skills pay off even in areas like family law (try doing a prenup or a divorce without an understanding of money and finance), or criminal law (DNA matching is statistical, not literal, and sentencing issues can sometimes devolve into numerical arguments). As for finance and other business school subjects, take a look at options pricing models, and then bounce over to the math underlying a CDO, and then a CDO squared. If that's not enough fun, look at the modelling underlying high speed stock trading algorithms. Those who struggled with middle school algebra won't have a chance.
Even if you're not a college grad, math skills can be very important. Skilled blue collar work is increasingly computerized (look in the service bays of any car dealership, or the work stations in a machine tool shop). The manager of any franchise or retail business needs to keep track of sales, inventory, and employee schedules and hours worked. Even with computers, you can't do the work right unless you have a grasp of numbers.
All the nations that seem economically strong today emphasize math in their educational systems--China, South Korea, Singapore, and Germany are examples. America's state and locally controlled school systems don't place the same priority on math. That leaves only you as a parent. Too many students and parents focus on what it takes to get into the best college possible--being well-rounded, and having public service, internships, foreign travel and impressive references. Not enough focus on the step that follows: getting a freaking job.
Advanced economies become advanced through the application of science and math. Without science and math, we'd still be living in caves. People who understand the basis for advancement will do better as the future unfolds. Make sure your kids take as much math as they can stand. Not everyone needs to take calculus in high school, but the more mathematical facility a person has, the better that person is likely to do.
Engineers can command starting salaries of $70,000 or more a year. People taking jobs in, say social work, earn half that or less. But they may have comparable debt loads. These statistics tell you who's going to be better off five, ten, twenty and more years after college.
Many liberal arts grads try to bail themselves out by taking on more student loans and going to law school or business school. Those with a facility for numbers will have the advantage. Most areas of law practice involve numbers. That's obviously so for those specializing in business, tax, trusts and estates, or torts. But math skills pay off even in areas like family law (try doing a prenup or a divorce without an understanding of money and finance), or criminal law (DNA matching is statistical, not literal, and sentencing issues can sometimes devolve into numerical arguments). As for finance and other business school subjects, take a look at options pricing models, and then bounce over to the math underlying a CDO, and then a CDO squared. If that's not enough fun, look at the modelling underlying high speed stock trading algorithms. Those who struggled with middle school algebra won't have a chance.
Even if you're not a college grad, math skills can be very important. Skilled blue collar work is increasingly computerized (look in the service bays of any car dealership, or the work stations in a machine tool shop). The manager of any franchise or retail business needs to keep track of sales, inventory, and employee schedules and hours worked. Even with computers, you can't do the work right unless you have a grasp of numbers.
All the nations that seem economically strong today emphasize math in their educational systems--China, South Korea, Singapore, and Germany are examples. America's state and locally controlled school systems don't place the same priority on math. That leaves only you as a parent. Too many students and parents focus on what it takes to get into the best college possible--being well-rounded, and having public service, internships, foreign travel and impressive references. Not enough focus on the step that follows: getting a freaking job.
Advanced economies become advanced through the application of science and math. Without science and math, we'd still be living in caves. People who understand the basis for advancement will do better as the future unfolds. Make sure your kids take as much math as they can stand. Not everyone needs to take calculus in high school, but the more mathematical facility a person has, the better that person is likely to do.
Sunday, February 13, 2011
The New York Stock Exchange-Deutsche Boerse Derivatives Merger
The proposed merger between the New York Stock Exchange and Deutsche Boerse would reportedly create a combination that earns at least half of its net income from trading derivatives. See http://www.bloomberg.com/news/2011-02-11/nyse-deutsche-boerse-merger-is-free-with-derivatives.html. The derivatives trading is probably concentrated in financial derivatives, like futures and options for U.S. Treasury securities or stock indexes. (Commodities futures are a relatively small part of the derivatives business.) The stock trading business, facing competition from smaller, faster dark pools and other operators, is evidently in decline.
The derivatives business is about risk management and risk transfer. When the leading exchange in America and the premier exchange in continental Europe join together to form a big risk management market, things are changing and not in a good way.
The fundamental role of the financial markets has historically been to facilitate capital formation. Capital formation consists first and foremost of the sale of stocks and bonds issued by business ventures to savers who want to share in the hoped for profits of those ventures. In other words, capital formation is about taking risks: investors taking risks to help entrepreneurs and established businesses take risks. When major financial markets combine to seek their futures in trading risk management products, one wonders how much capital is being sidetracked from growth oriented investment to speculation.
There is a historically valid role for commodities futures contracts in mitigating the risks of farmers, producers and manufacturers. But when Western financial markets focus more on swapping or selling risks, and less on facilitating capital formation, it's not that hard to understand why Asia is becoming an economic powerhouse while North America and Europe lag. Capital formation is booming in Asia. Fortunes are being made (and sometimes lost). Asia will do well over the next 50 years and perhaps longer because a lot of business risks are being taken, and surely some of those risks will pay off. (After 50 years, Asia's demographic profile will begin to resemble the industrialized world's--more older people and fewer younger people--and no one knows how that will play out.)
Very possibly, the combined NYSE-Deutsche Boerse will be stronger than the two exchanges individually. But its success doesn't necessarily signal prosperity for Western economies as a whole. Economic growth doesn't come from swapping risks. It comes from taking them. The Dutch didn't attain lasting prosperity from trading tulip bulbs. And the combination of the NYSE and Deutsche Boerse is ultimately, not that big a deal. What matters much more is boosting the flow of capital to pimply-faced kids huddled over computers in garages and college dorm rooms, nimble, tech-oriented machine tool companies, specialty steel companies, and other tinkerers and entrepreneurs from sea to shining sea.
The derivatives business is about risk management and risk transfer. When the leading exchange in America and the premier exchange in continental Europe join together to form a big risk management market, things are changing and not in a good way.
The fundamental role of the financial markets has historically been to facilitate capital formation. Capital formation consists first and foremost of the sale of stocks and bonds issued by business ventures to savers who want to share in the hoped for profits of those ventures. In other words, capital formation is about taking risks: investors taking risks to help entrepreneurs and established businesses take risks. When major financial markets combine to seek their futures in trading risk management products, one wonders how much capital is being sidetracked from growth oriented investment to speculation.
There is a historically valid role for commodities futures contracts in mitigating the risks of farmers, producers and manufacturers. But when Western financial markets focus more on swapping or selling risks, and less on facilitating capital formation, it's not that hard to understand why Asia is becoming an economic powerhouse while North America and Europe lag. Capital formation is booming in Asia. Fortunes are being made (and sometimes lost). Asia will do well over the next 50 years and perhaps longer because a lot of business risks are being taken, and surely some of those risks will pay off. (After 50 years, Asia's demographic profile will begin to resemble the industrialized world's--more older people and fewer younger people--and no one knows how that will play out.)
Very possibly, the combined NYSE-Deutsche Boerse will be stronger than the two exchanges individually. But its success doesn't necessarily signal prosperity for Western economies as a whole. Economic growth doesn't come from swapping risks. It comes from taking them. The Dutch didn't attain lasting prosperity from trading tulip bulbs. And the combination of the NYSE and Deutsche Boerse is ultimately, not that big a deal. What matters much more is boosting the flow of capital to pimply-faced kids huddled over computers in garages and college dorm rooms, nimble, tech-oriented machine tool companies, specialty steel companies, and other tinkerers and entrepreneurs from sea to shining sea.
Tuesday, October 26, 2010
The 21st Century Global Economics Experiment
Not since the days of the Cold War has there been such a clash of national economics policies. The UK has made an abrupt U-turn away from deficit spending, embracing the hair shirt of austerity. Elsewhere in Europe, big spending EU governments have followed suit, although not with the fervor of true believers. Keynesian economics may be disproved, or not.
America is caught in political crosscurrents, with fiscal policy stifled by a prairie fire of populism. The Federal Reserve is the only show in town, and the financial markets believe the Fed will put on a dazzling performance. Stock, commodities and bond valuations all presume that the Fed is going to walk into the joint and be a real big spender. Monetary policy is at the plate, and no one is on deck. The Austrian school of economics may be disproved, or not.
In China, an ad hoc amalgam of state controlled enterprise and fiercely capitalistic forces has propelled the Chinese economy into a meteoric rise. The Communist Party in China has craftily exploited market forces to raise living standards, thereby legitimizing its continued control while it gradually jettisons a failed ideology. The Chinese are wittingly or unwittingly recreating an updated version of dynastic China, where government played a large role in the economy but allowed private trade and commerce to spark growth. Imperial China was for over 1,000 years the wealthiest nation in the world, so this model has a history of success. If China continues its upward trajectory, free market ideologues may be discombobulated. Or not, if the heavy hand of state control of the economy and political freedoms smothers the individual initiative needed for lasting prosperity.
Since economists can't conduct controlled experiments, the world today is about as good as it gets for students of comparative economics. Ten or twenty years from now, tentative conclusions might be possible. Or not, since nothing in economics is ever truly resolved. Schools of thought mostly go in and out of fashion.
But what if they're all wrong? What if austerity in the Old World produces stagnation or even recession? What if the Fed's forthcoming liquidity dump fails? The financial system already has a trillion dollars of unused liquidity on deposit at Federal Reserve banks. More liquidity is likely to be just the proverbial push on a string, while stagnation continues. And what if China's real estate and credit bubbles burst, pushing China into the stagnation experienced by Japan and now America? With China's severe demographic problem of too many old and not enough young, any slowdown in China's growth could upset the entire apple cart the government is trying to push along.
If all models and all schools of thought are wrong, we have a problem. There wouldn't be any credible paradigm in which to find solutions. We might find ourselves mired in slumps and malaise, with struggling to muddle through the only strategy. But Americans are good at muddling. Every major crisis in American history, from the Revolution to the Civil War to World War II to the Cold War, was a painful muddle. Even if all the economists are confounded, Americans can still have faith in themselves, and that's always proven to be enough.
America is caught in political crosscurrents, with fiscal policy stifled by a prairie fire of populism. The Federal Reserve is the only show in town, and the financial markets believe the Fed will put on a dazzling performance. Stock, commodities and bond valuations all presume that the Fed is going to walk into the joint and be a real big spender. Monetary policy is at the plate, and no one is on deck. The Austrian school of economics may be disproved, or not.
In China, an ad hoc amalgam of state controlled enterprise and fiercely capitalistic forces has propelled the Chinese economy into a meteoric rise. The Communist Party in China has craftily exploited market forces to raise living standards, thereby legitimizing its continued control while it gradually jettisons a failed ideology. The Chinese are wittingly or unwittingly recreating an updated version of dynastic China, where government played a large role in the economy but allowed private trade and commerce to spark growth. Imperial China was for over 1,000 years the wealthiest nation in the world, so this model has a history of success. If China continues its upward trajectory, free market ideologues may be discombobulated. Or not, if the heavy hand of state control of the economy and political freedoms smothers the individual initiative needed for lasting prosperity.
Since economists can't conduct controlled experiments, the world today is about as good as it gets for students of comparative economics. Ten or twenty years from now, tentative conclusions might be possible. Or not, since nothing in economics is ever truly resolved. Schools of thought mostly go in and out of fashion.
But what if they're all wrong? What if austerity in the Old World produces stagnation or even recession? What if the Fed's forthcoming liquidity dump fails? The financial system already has a trillion dollars of unused liquidity on deposit at Federal Reserve banks. More liquidity is likely to be just the proverbial push on a string, while stagnation continues. And what if China's real estate and credit bubbles burst, pushing China into the stagnation experienced by Japan and now America? With China's severe demographic problem of too many old and not enough young, any slowdown in China's growth could upset the entire apple cart the government is trying to push along.
If all models and all schools of thought are wrong, we have a problem. There wouldn't be any credible paradigm in which to find solutions. We might find ourselves mired in slumps and malaise, with struggling to muddle through the only strategy. But Americans are good at muddling. Every major crisis in American history, from the Revolution to the Civil War to World War II to the Cold War, was a painful muddle. Even if all the economists are confounded, Americans can still have faith in themselves, and that's always proven to be enough.
Monday, June 21, 2010
What If the Economy is a Creature?
What if the economy is a creature? What if the financial system is a critter, perhaps a type of varmint? What do we do then?
The doyennes of economic orthodoxy hold that the economy can be understood and explained by identifying fixed relationships between a number of variables. To legitimize their field as science, and themselves as experts, they prefer that these relationships be susceptible to mathematical expression. They secure for their research vast amounts of computer power, and hunt endlessly for reliable data. (The latter is by far the harder to get.) Statistical analysis and robust results well-buttressed by high confidence levels engender the belief that economists might actually know something. Peer review by others equally enamored of tidy regression analyses validate the assumptions made and the banishment of data points deemed outliers in the pursuit of statistically significant confidence levels. The seeming clarity of the results is comforting, not only to professional economists, but also government officials, legislators and the general public.
Then how could economists have missed the real estate and credit bubbles so badly? How could they have misunderstood the tech stock bubble of the late 1990s? What if the baseline assumption of economics--that there are fixed relationships between and among relevant variables that can be uncovered and mathematicized--is wrong? The economy and financial system proved to be a lot less predictable than the doyennes expected. The only thing that is clear is that economists, as a profession, know a lot less than they, and many of the rest of us, believed.
Perhaps the economy, being the combined interaction of large numbers of organic beings (i.e., people), is itself organic. Instead of a constant set of fixed relationships, it may consist of a swirling vortex of dynamically changing interactions that never precisely repeat themselves. People change and adjust the ways they live as the world around them changes. The Boomer generation learned to read and write with paper and pencil, and did its high school research using printed encyclopedias. Yet in a few decades, it has transitioned from Gutenberg's technology to Bill Gates' and Steve Jobs' technology. Information is much more readily available and relationships between people have changed as e-mail, social networking, and more have rendered distance irrelevant and downtime (i.e., time for yourself) a thing of the past.
Isn't it possible, and indeed probable, that the economy has similarly changed? The Phillips Curve, a supposed inverse relationship between inflation and unemployment, was once deemed by economists to be virtually engraved in stone. And for a short period of time, it appeared that way. But after leisure suits ceased to be fashionable, the Phillips Curve became increasingly more difficult to discern in the real world. Conventional economic thought holds that the Phillips Curve was too simplistic. Maybe the truth is that it once had explanatory power but the economy mutated away from it.
Similarly, the gold standard of monetary policy, the lowering of interest rates to stimulate economic activity, seems to have had limited efficacy in recent times. Perhaps changes in and the greatly increased complexity of the financial system has undermined the efficacy of monetary policy. A salient feature of the financial system of the 1990s and the early 2000s was the shadow banking system created with mortgage-backed and other asset-backed securities. A large portion of the economy's credit flowed through this unregulated market. The regulated banks and brokerage firms turned away from extending credit to earning fee income and speculating in proprietary trading. They became less significant as conduits of credit. The shadow banking system collapsed with the financial crisis of 2007-08, and has largely not been replaced. Thus, lowering interest rates has had limited stimulative efficacy because the true conduits for credit have to a large degree ceased to exist.
A visitor from Mars, unburdened by the dogma of conventional economics, would conclude that the economy and financial system aren't driven by fixed relationships, but are dynamic processes whose only constancy is change. The economy, simply put, is a creature that is always changing and evolving. The financial system, infused with Wall Street's voracious appetite for ever-new, high-margin financial engineering, mutates even more rapidly than the economy as a whole, and can sometimes be a nasty varmint if not handled properly.
The notion that the economy is a creature would be disquieting to many economists, as it would cast them into the tar pits of behavioral economics and other potentially mushy bodies of thought. But human relationships and human interactions are mushy. Indeed, they often are blobs. Understanding the economy and the financial system is a never-ending, sometimes Sisyphean struggle to discern changes in economic relationships and interactions. Risk managers in financial institutions and financial regulators have to understand that creative destruction doesn't simply apply to businesses and industries. It also applies to asset classes and the very relationships and processes of the economy and financial system. The Flash Crash wouldn't have happened a few years ago. But it's happened now and can happen again. Monitoring risk, and especially systemic risk, requires knowing not only what's going on, but what's changing and what's likely to change and how. Government officials might have to delve deep into the financial engineering of the big banks and the major trading firms, even as it's evolving and notwithstanding the protests of influential executives about proprietary secrets and preserving competitive advantages.
The Federal Reserve appears likely, under the financial regulatory reform now moving toward enactment, to end up with the greatest share of the responsibility for monitoring systemic risk. Thus, it will have the greatest responsibility for casting aside doctrine and diving into the unknown. Most significantly, regulators may have to apply an element of judgment even when statistically significant analyses aren't easily obtained. Problems can't always be avoided simply because they can't readily be quantified. Regulatory agencies are given, by law, a measure of discretion and they should bring common sense, as well as statistical technique, to bear. That won't be easy, as the Fed's governors and staff sometimes seem more inclined toward stalwartly manning the Maginot Line of economic orthodoxy than anticipating a blitzkrieg through the Ardennes. But financial panics and crises are like the flu virus, constantly mutating and appearing in unexpected forms that existing preventive measures weren't meant to address. Recognizing the organic nature of the economy and financial system, and reacting quickly, before all desired information is available, may well be crucial to ensuring that the financial crisis of 2007-08 and other painful disruptions don't happen again.
The doyennes of economic orthodoxy hold that the economy can be understood and explained by identifying fixed relationships between a number of variables. To legitimize their field as science, and themselves as experts, they prefer that these relationships be susceptible to mathematical expression. They secure for their research vast amounts of computer power, and hunt endlessly for reliable data. (The latter is by far the harder to get.) Statistical analysis and robust results well-buttressed by high confidence levels engender the belief that economists might actually know something. Peer review by others equally enamored of tidy regression analyses validate the assumptions made and the banishment of data points deemed outliers in the pursuit of statistically significant confidence levels. The seeming clarity of the results is comforting, not only to professional economists, but also government officials, legislators and the general public.
Then how could economists have missed the real estate and credit bubbles so badly? How could they have misunderstood the tech stock bubble of the late 1990s? What if the baseline assumption of economics--that there are fixed relationships between and among relevant variables that can be uncovered and mathematicized--is wrong? The economy and financial system proved to be a lot less predictable than the doyennes expected. The only thing that is clear is that economists, as a profession, know a lot less than they, and many of the rest of us, believed.
Perhaps the economy, being the combined interaction of large numbers of organic beings (i.e., people), is itself organic. Instead of a constant set of fixed relationships, it may consist of a swirling vortex of dynamically changing interactions that never precisely repeat themselves. People change and adjust the ways they live as the world around them changes. The Boomer generation learned to read and write with paper and pencil, and did its high school research using printed encyclopedias. Yet in a few decades, it has transitioned from Gutenberg's technology to Bill Gates' and Steve Jobs' technology. Information is much more readily available and relationships between people have changed as e-mail, social networking, and more have rendered distance irrelevant and downtime (i.e., time for yourself) a thing of the past.
Isn't it possible, and indeed probable, that the economy has similarly changed? The Phillips Curve, a supposed inverse relationship between inflation and unemployment, was once deemed by economists to be virtually engraved in stone. And for a short period of time, it appeared that way. But after leisure suits ceased to be fashionable, the Phillips Curve became increasingly more difficult to discern in the real world. Conventional economic thought holds that the Phillips Curve was too simplistic. Maybe the truth is that it once had explanatory power but the economy mutated away from it.
Similarly, the gold standard of monetary policy, the lowering of interest rates to stimulate economic activity, seems to have had limited efficacy in recent times. Perhaps changes in and the greatly increased complexity of the financial system has undermined the efficacy of monetary policy. A salient feature of the financial system of the 1990s and the early 2000s was the shadow banking system created with mortgage-backed and other asset-backed securities. A large portion of the economy's credit flowed through this unregulated market. The regulated banks and brokerage firms turned away from extending credit to earning fee income and speculating in proprietary trading. They became less significant as conduits of credit. The shadow banking system collapsed with the financial crisis of 2007-08, and has largely not been replaced. Thus, lowering interest rates has had limited stimulative efficacy because the true conduits for credit have to a large degree ceased to exist.
A visitor from Mars, unburdened by the dogma of conventional economics, would conclude that the economy and financial system aren't driven by fixed relationships, but are dynamic processes whose only constancy is change. The economy, simply put, is a creature that is always changing and evolving. The financial system, infused with Wall Street's voracious appetite for ever-new, high-margin financial engineering, mutates even more rapidly than the economy as a whole, and can sometimes be a nasty varmint if not handled properly.
The notion that the economy is a creature would be disquieting to many economists, as it would cast them into the tar pits of behavioral economics and other potentially mushy bodies of thought. But human relationships and human interactions are mushy. Indeed, they often are blobs. Understanding the economy and the financial system is a never-ending, sometimes Sisyphean struggle to discern changes in economic relationships and interactions. Risk managers in financial institutions and financial regulators have to understand that creative destruction doesn't simply apply to businesses and industries. It also applies to asset classes and the very relationships and processes of the economy and financial system. The Flash Crash wouldn't have happened a few years ago. But it's happened now and can happen again. Monitoring risk, and especially systemic risk, requires knowing not only what's going on, but what's changing and what's likely to change and how. Government officials might have to delve deep into the financial engineering of the big banks and the major trading firms, even as it's evolving and notwithstanding the protests of influential executives about proprietary secrets and preserving competitive advantages.
The Federal Reserve appears likely, under the financial regulatory reform now moving toward enactment, to end up with the greatest share of the responsibility for monitoring systemic risk. Thus, it will have the greatest responsibility for casting aside doctrine and diving into the unknown. Most significantly, regulators may have to apply an element of judgment even when statistically significant analyses aren't easily obtained. Problems can't always be avoided simply because they can't readily be quantified. Regulatory agencies are given, by law, a measure of discretion and they should bring common sense, as well as statistical technique, to bear. That won't be easy, as the Fed's governors and staff sometimes seem more inclined toward stalwartly manning the Maginot Line of economic orthodoxy than anticipating a blitzkrieg through the Ardennes. But financial panics and crises are like the flu virus, constantly mutating and appearing in unexpected forms that existing preventive measures weren't meant to address. Recognizing the organic nature of the economy and financial system, and reacting quickly, before all desired information is available, may well be crucial to ensuring that the financial crisis of 2007-08 and other painful disruptions don't happen again.
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