Your Economic Future

Economics as Ecology

2012-11-04T12:20:00.000-08:00

The economy can be thought of as one type of ecosystem. There are many different participants, each with their own goals and their own ways of reacting. They all share information in one way or another. Sometimes small groups of entities will cooperate for their mutual benefit (corporations or hives). The gestalt of all participants behaves in ways that wouldn’t be obvious from knowing the behavior of individual elements.

Chaotic Systems

Scientists are aware that changes to an ecosystem can have unpredictable and damaging consequences far beyond the area that was changed. Wiping out a predator might seem like a good idea at the time but then the prey population can explode leading to starvation and disease. Small changes can lead to large effects and “unintended consequences”. People have gradually learned to be careful with the natural environment in order to protect all of the participants. However politicians have not learned to show similar restraint with regard to their destruction of the economy.

State Planning

The great Supreme Court justice Louis Brandeis said “The greatest dangers to liberty lurk in insidious encroachment by men of zeal, well-meaning but without understanding.” History is full of well-meaning social experiments that went horribly awry. Maybe the biggest and most destructive such failure would be communism in China and Russia. Historians estimate that Mao’s Cultural Revolution killed around 60 million Chinese. The famines caused by Stalin similarly killed millions of Russians, Ukrainians and others.

Prohibition

Even the US is not immune to the destruction wrought by well-meaning social experiments. We have endured Prohibition as well as the ill-informed semi-socialism started by Hoover and amplified by FDR. Even now we have the huge financial bailouts and Obamacare that threaten to take over huge portions of our economy, purportedly to cure some past evil. And the experimenters, playing with OMP (other people’s money), are so out of touch with the suffering of the little people that they actually think that they’re helping. These experiments wouldn’t be as destructive if the experimenters would admit when something doesn’t work and so abandon it. Instead, any admission of error is politically impossible, and we end up stuck with the same failed policies for generations.

Some common-sense principles that should be extended from ecological science to economic science.

- Any major change to the economy (taxes, regulation) should be studied carefully by independent scientists using case studies and computer modeling. In general, only governments and government-backed entities are likely to be large enough to disrupt the economic-ecology. For this reason most of the initial focus should be on the largest and most disruptive entities. Later, it would make sense to focus on those who have explicit or implicit government backing such as FNMA, FMAC and the too-big-to-fail banks.

- Crack down on the major polluters. In the economic ecosystem everyone depends upon information. The most egregious polluters can damage millions and stunt growth of others. For example, a government agency who gives out rosy yet bogus information one month then quietly retracts the number next month should be reined in. Perhaps we need a government agency who can police other government agencies and penalize them with staff cuts when they damage the economy through intention or negligence.

- Any changes should be small, slow and incremental.

A Path Forward

As we have learned more about nonlinear systems and complex dynamics, we have turned our attention to the natural world and the study of ecology. It is completely natural that we should use some of the same methods in our study of economics since the latter is similarly complex and fragile. Let us be careful about making large changes to the natural economic landscape risking much needless suffering or the extinction of many small businesses.

Naturally there will be old, established institutions (governmental and associated members of the parasitic class) who will fight against even the smallest incursion into their ability to control or change the economy. Just as in the 60’s when environmental laws made it harder for the large polluters, so too will entrenched interests fight against modest and common sense reforms. To quote Cicero: follow the money.

Stalingrad all over again.

2012-10-08T17:20:00.001-07:00

In World War 2 (or the Great Patriotic War for our friends to the east) Hitler overrode the good advice of his Generals Manstein, Guderian, Paulus, and chose to stay and fight for Stalingrad from about August 1942 until February 1943, exactly 70 years ago. Rather than conduct a strategic withdrawal and save their forces to fight another day under far more advantageous conditions, Hitler ordered that no one would take even one step backwards. Had the madman not thrown away his forces in that meat-grinder, he could have possibly made a separate peace with Stalin and put all of his forces into fighting the Americans in the west, delaying the war much longer. In the US we’re grateful for his bad decisions and all of the lives spared.

Many times in history, kings have chosen to fight against long odds rather than suffer the humiliation of a strategic withdrawal, and lost because by definition it’s unlikely to win against long odds. Hitler desperately wanted to win Stalingrad, largely for propaganda purposes to capture the city named after his arch-nemesis, but also because it had great regional importance as a gateway to the Caucasus oilfields. These days Germany doesn’t want Europe to break up because of the embarrassment and because they would lose the large market for German production, so we see them giving repeated bailouts to Greece in an effort to keep them in the Eurozone, or at least to keep the ball rolling until after the German election of September, 2013.

On the face of things, Germany is not asking for anything unreasonable in exchange for granting big bailouts. The only strings attached are that the recipients live within their means and either raise taxes or cut bloated expenditures in order to create a sustainable economy. Naturally, neither of these are popular with Greek voters, so they fight against this “meddling”. The hard left coalition panders to voters who want everything, portraying the Germans as neo-Nazis trying to keep Greece down. But without the German largess Greece will very quickly fall apart.

France too is happy to jump on the bandwagon and portray Germany as greedy and mean-spirited. Recently the French president Hollande gave his support to Europe-wide bonds. This doesn’t fool anyone though, since it is obvious that this means that Germany (and maybe Finland and a handful of other tiny players) promises to back any bonds issued by other European country without these mean-spirited strings attached. Greece, Spain, Italy and others would love the opportunity to borrow a lot more money and then act all surprised when they weren’t able to pay it back, leaving Germany to pay it off, or more likely total default. To her credit, Angela Merkel is having none of this, nor is it all that popular with German voters who can see through the guise of friendship and team play.

But Germany is in a quandary and would like to see this normality last at least until after the US election in November of this year, or preferably until the German election in September, 2013. If Germany lets Greece default and leave the Euro, then other countries are likely to follow and Berlin will lose a large market for their good. But a full scale bailout and blank check for future bailouts with no sustainable Greek budget deal is very expensive. Furthermore a blank check has the moral hazard of letting the other weak countries ask for equal terms.

One big problem in letting Greece default is that investors will start to reconsider the bonds of Spain, Italy, and eventually even France. Investors remember a year ago when the Greek finance minister was saying that default would never occur, but then the hard left was voted in and default was imminent. Such things can change quickly, so investors are starting to avoid the bonds of these weak countries, leading the ECB to break their own rules and buy up bonds in an effort to keep interest rates low. This is an expensive way to go but letting Greece fall could be viewed as the first domino. For such a small country (GDP=$300 billion, debt=$360 billion), it seems to command a huge amount of aid and attention from the rest of Europe, precisely because they are the first domino. Spain is now on the brink, but their GDP and debt are about 5 times as much as Greece, making them prohibitively expensive even for the mighty German taxpayer to carry.

So we see Germany, the ECB and the US (acting through the IMF) trying to help keep Greece from going under until November 2012 for Obama or September 2013 for Merkel. It has been hugely difficult and expensive for the Germans to even prop up this small country. It is the opinion of this author that Angela may be out of luck because the game is likely to fall apart in early 2013. It is only a matter of time until the waves emanating outward from Europe wash up on our shores, leading our own bond buyers to demand higher rates, leading the Fed to be the buyer of last resort, and leading to crushing inflation in the US.

We Need More Bad Examples

2012-10-06T13:51:00.002-07:00

During the Cold War we could count on Russia, and to a lesser extent China, so serve as bad examples. Whenever the communist parties of Greece or France would start acting up people could look at the poverty and misery of the Eastern Bloc and say “We don’t want to be like that”, and the popularity of communism would wane in the West. But then Russia imploded and China became much more capitalistic (though not democratic), so our bad examples became harder to find.

Even in the US we have some states that are on the rise and others that are clearly sinking. As a resident of Arizona I’ve watched over the past decade as businesses fled the high taxes and punitive regulations of California. A big part of the growth of Arizona has come, not from AZ getting better, but rather from CA getting progressively worse. So whenever my West Coast lefty friends talk about the wisdom of increasing taxes to pay for shoes for the dead or maybe raising the minimum wage to $20/hour in Frisco, I encourage them. “Yeah, go for it! That’s a great idea! “ It’s good that we have competition between states so that people can see what works best and also so that really bad policies are revealed.

Societies seem to oscillate like a pendulum between more state control and more free enterprise, with a period of 30-40 years. In the 1930’s we had FDR imposing crushing new taxes and regulation upon the US economy which served to lengthen the Depression, but in the 1950’s we had Ike loosening things up. Then in the 1970’s we had the Nixon price controls and Carter tax increases dragging the US back into recession, and in the 1980’s the time was ripe for Reagan to slash taxes, reduce regulation and get the US economy on the upswing. Now in the teens we have Obama’s socialized medicine and the Fiscal Cliff threatening enormous tax increases that will surely crush the economy.

We need another 4 years of Obama to thoroughly discredit socialism for another generation. Most young people don’t remember the misery of the Nixon-Carter years, and so we need to relive those in a big way. I say bring it on! Bring on The Collapse, with double-digit unemployment, interest rates and inflation. History frequently shows examples of how, after major destruction, there is a rebirth and renewed vigor. In the Hindu religion it is recognized that the destroyer (Shiva) is necessary for the creator (Brahma) to exist. We are now on the verge of creation/destruction. They are the same.

Where to Hide From the Coming Tsunami of Money

2012-10-03T10:21:00.000-07:00

Everyone always likes to say "it can't happen here". But the US is not immune to the laws of nature nor is the US economy immune to the laws of economics. When too much money is created, either by printing press or electronically, then that extra money will necessarily drive up prices. We have already witnessed the large increases in stock prices, gold, oil and food in the past 2 years as the US Federal Reserve has embarked on multiple rounds of quantitative easing, ZIRP, TARP and Operation Twist. All of these actions by the US central bank are designed to increase liquidity, i.e. increase the amount of money in circulation. Plenty of other countries have gone down this path in the past and it always ends badly with high inflation, requiring even more money creation in a vicious circle of exponentially increasing money supply.

Thus far we have only had relatively subdued increases in the consumer price index, the official measure calculated by our masters in DC. Arguably, the official measure is too low since food and energy are excluded and they take credit for increases in technology (e.g. a 486 computer costs only 1/100th what it did in 1993, offsetting large gains in other areas). A less biased measure of inflation can be found at www.shadowstats.com. Shadowstats uses an older measure of inflation, before the books were doctored to make things look more rosy, and they arrive at an inflation number in the 6-8% range rather than the officially reported 2.5-3%. Whatever measure you use, prices are getting worse and appear to be accelerating due to the recent money created. So the important question is: where can I put my money so that inflation doesn't evaporate my savings over the next decade?

To start with, let's rule out places that will perform poorly in an inflationary environment. Anything fixed income is especially bad, doubly so at this time because the Federal Reserve is exercising price controls on interest rates, holding rates near zero. A 5-year CD at your local bank will yield about 1.4% per year. Corporate bonds and government bonds have even worse interest rates with the 7-year treasury currently yielding 1.04%, easily less than even the official change in CPI, with no compensation for the risk of rising inflation.

Stocks are slightly better than bonds but historically they have performed poorly during times of sustained inflation. While it's true that revenue will be higher, so too will all of the costs associated with doing business. Furthermore businesses that have high debt loads will see their interest costs soar. The real cost of holding inventory goes up a lot too. One small positive effect is that taxes will be helped because businesses will pay taxes later, with inflated dollars, on earnings that were made with dollars while they were more dear. However inflation also has the effect of pushing up taxes because of the time lag between when a business has an expense and when it has revenue. So buying inventory for $100 and then selling the final product for $200 a year later appears (to the IRS) as a gain of $100, requiring a tax of $30. But in real terms that gain of $100 is really a gain of (let's say) $50 due to inflation, so taxes have taken a much larger percentage of the profit.

Generally things that have enduring value are the best investments to shield yourself from the effects of inflation. Land, gold, oil and other commodities at least retain their value. As David Stockman remarked about what he would invest in given Ben Bernanke's promise to print dollars: "My investment model is ABCD: Anything Bernanke Can't Destroy, flashlight batteries, canned beans, bottled water, gold, a cabin in the mountains."

Price Controls: This Movie Ends Badly Every Time I See It

2012-10-03T10:18:00.000-07:00

Central planners are always trying new tricks and recycling old ones in their efforts to control economies in ways that benefit their friends and punish their enemies. Of course they will never admit that they have made an error, so if their financial schemes cause "unexpected consequences" they merely create a new scheme to solve the problem, and blame the situation on speculators, hoarders, profiteers, Jews or whomever else the general public can be tricked into hating.

Wage and price controls are as old as paper money. Governments are always tempted to take the easy way out and create extra paper money to cover a war or increase the (perceived) wealth of the populace and garner good will toward the king, oligarchy or other masters. The extra money thus created does not lead to any actual increase in wealth of the overall economy, though it might bestow some unearned wealth onto those who are closest to the seat of power. As the extra money flows through the economy it dilutes the value of the old bills circulating, leading to higher prices, or "inflation" as many call it. For the purpose of this blog entry I'll ignore the distinction between inflation meaning the increase in money supply and it's effect (higher prices).

As prices rise the oligarchy is often tempted to crack down on the so-called price gougers and decree that a loaf of bread can only sell for $1 or that wages must remain at a certain level. Wouldn't it be nice if things were this easy? Just command what things will cost and it will be so. But economists are quite aware that price controls lead to either surpluses or (more likely) shortages. If a farmer is paying higher and higher prices for gasoline, tractors, fertilizer and other things necessary for his business, but is constrained to sell his wares at a fixed price, then many farmers will stop bringing their wares to market. Fewer loaves of bread means that some consumers will have to walk away without bread, even though he holds the decreed number of dollars to buy it, i.e. a shortage develops. The same shortages occur in gasoline, shoes and anything else if the price is forced to artificially low. Naturally black markets spring up to supply the desired items at a higher price, since many consumers are willing to pay more than the decreed price rather than hold onto to otherwise-worthless paper currency.

Even in this country, with its history of a semi-free market, we have examples of wage and price controls. In world wars I and II the US had price controls, and as recently as 1971-73 then-president Nixon instituted wage and price controls in response to the high inflation caused by Johnson's "guns and butter" program. Nixon continued the Vietnam war and the resulting budget deficits and money printing created the inflation. The effect of the Nixon price controls were the same as always: shortages. Eventually the controls were lifted in a tacit admission of defeat for state planning.

Fast forward 40 years to the present day. The US federal government (and most of Europe) have a crushing debt load. In an effort to shield the government from paying crushing interest loads the US central bank (Federal Reserve) has instituted multiple quantitative easing measures and artificially set the interest rate (the price of money) at extremely low levels. Like all price controls, this one too will fail. For the moment everything seems fine, with the officially calculated inflation rate relatively low (laughably excluding food and energy). Just as a reservoir behind a damn looks peaceful and calm, our present glut of money has the potential energy to do enormous destruction. Our masters in DC are content to merely hold back the inevitable until after the 2012 election and the incumbents are safely locked in. After that the tsunami of money will become too difficult to hold back and eventually will engulf those who are unprepared.

Next post: how to hide from the coming money tsunami.

Fiscal Cliff: Pick Your Poison

2012-10-02T16:45:00.000-07:00

The Fiscal Cliff refers to a large group of tax increases and smaller budget cuts that are due to take effect in January, 2013, conveniently after the presidential election. The tax increases would be due to the expiration of a patch in the Alternative Minimum Tax, social security tax cuts and the Bush child tax credits. The spending cuts would be considerably smaller than the tax increases and would be divided evenly between defense and non-defense. The Fiscal Cliff was part of a deal worked out by Congress in August, 2011 as part of the bill to increase the federal debt limit. It was agreed that increasing the federal debt would have dire financial impact, as it did in Greece when the debt/GDP ratio exceeded about 120%. Republicans wanted larger cuts and Democrats wanted even larger tax increases so they settled on this. Unless repealed, the net effect will be to increase taxes for the average family by $3,500 (estimate by the non-partisan Tax Policy Center). Single people and those with larger incomes would pay considerably more.

It is generally accepted by most economists and financial experts that the huge tax increases would cause a severe recession in the US. The spending cuts, though relatively small, would also reduce GDP and increase unemployment. Conventional wisdom is that Congress will kick the can down the road and delay implementation of these effects, increasing the total federal debt. Already the Federal Reserve is forced to buy something like 40% of all bonds issued because there are not enough buyers. This monetization of the debt is equivalent to printing money (electronically) and surely leads to inflation. Pundits believe that Congress will take the inflationary way out rather than the recessionary way out. I disagree.

Let's look at what is likely to happen politically if Congress comes to come sort of deal whereby they cancel (or infinitely delay) the tax increases and spending cuts. If they do vote on any sort of deal, whether it is to cancel the tax increases and blow up the deficit, or allow some tax increases and cancel others, then there will be responsibility. Surely either way (tax increases or monetizing the ever-increasing debt) the economy will suffer. Those who voted in favor will be on the hook. Those who voted against can always claim that they had a magical solution that would have made things so much better. Many people like to believe in magic and happy endings, so these claims have a strong appeal. Since Congressmen are very sensitive to perceptions, the risk of doing anything is that they will be blamed for the inevitable economic decline. It's better to do nothing and hide behind the false claims that they would have done it so much better. The lessons of Greece are not lost on US Congressmen; the Greek politicians who voted for "austerity" were mostly thrown out by the voters and a hard-left faction voted in who promised to restore all of the great perks. For this reason, I think that Congress will do nothing and everyone will retain plausible deniability.