Tuesday, March 1, 2011

Dynamics away from and to prosperity

I am not an economist. I know by admitting to these five words, some of you have your finger poised to click away from the rest of what follows. Others might have a few invectives ready to fling, “Well then why the &*#$^% should I read the rest," and still others might read just so to validate in their minds the stupidity that I might expose through it all. It will be fodder at those late night parties. And some souls might persist and read it. To all these and other accidental visitors, welcome to my unsophisticated economic planet!

Richard Feynman

Richard Feynman once said in an interview that he took the Martian viewpoint to think. For instance he wondered that as the earth rotates in its daily orb that at twilight hitting the large part of the earth at the same time would find a lot of households employed in the similar game of brushing their teeth. An interesting concept to explore since he was not convinced about cavities and brushing of the teeth. But the premise was the Martian view. So I have decided to take one of those lofty viewpoints regarding the economy.

Imagine you are in a spacecraft waiting for the thrust to overcome the gravitational pull on liftoff.

Let us start with the debacle that was and is. The “Liquidity, Subprime, Housing and Debt crisis.”
Back in the summer of 2006, when everything was endless vista of rosy fortunes. What lay ahead was anyone’s dream. None, save a few ventured into the dour world of what “could be.”  To those we heed in this hour of need. For it was their prescient thinking that heralded this hour of recognition.

In 2007, money was plentiful. The banks awash with loaned capital had but to throw it at anyone with a thought or a premise of potential return. No collaterals were needed, nothing save a signature. As the sub-prime debacle started to unfold and uncollateralized mortgages began to default, the liquidity solidified into a slow freeze. The train of hunched over men in long raincoats could be seen walking home to give the bad news to their families that they had been “let go.” Meanwhile the small boat carrying the true thinkers was coming to dock. One of the thinkers on that boat was Nassim Taleb who wrote “The Black Swan.” This book detailed the growing perfect storm that  would lead to an economic collapse. He was in retrospect right. What followed was the housing crisis where the unsustainable prices  became unsustainable. The “bubble” of there is “only limited land where to build upon,” suddenly became awash with “the land that had unoccupied buildings built upon.” 
Desired Home

The sub-prime disaster was erected on a premise of affordable housing for all, idea that oddly resembles the Affordable Health care for all. The problem in getting to housing for all was human ingenuity of creating derivatives like the CDOs , CLOs and the CDSs. These derivatives in simplistic terms were products composed of multiple mortgages packaged into one. The good, the bad and the ugly all buttoned up in one tiny portfolio. The investors who put up the money based on a false , by any of the several rating agencies who were paid by the product creator. Once the package had been bought by the investors it was repackaged and sold to someone else for a fraction of a profit for the next one and then the next one till the end result was that the initial lending agency nor the investor had no idea who actually was left holding the bag in case of default. 
IMF data on Housing Booms

Meanwhile a lot of ordinary citizens were in a similar game of "flipping homes" for quick capital gains. some of the homeowners and speculators now having lost their jobs were left under a roof, holding the mortgage that they could not afford.  Thus, the housing sector slowed to a crawl and then finally seized motion. Construction companies started laying off large numbers of people, sending unemployment rates through the 10% roof. New hiring stopped as companies took a momentary pause to assess the damage. Other giant economic powerhouses had to unload inventories and workers to maintain solvency. The real unemployment rate ticked upwards into stratospheric territory for a matured highly developed economy. Onwards through the process, new hiring came to a standstill. A large population of workers was busy trying to liquidate unnecessary gizmos they had become fond of during the “wealthy period,” but found no buyers. A large generation of wistful, hunched and depressed folk walked through once bustling departmental malls looking at some fortunate few pursue the dream of acquisition that they had been forced out of. The political bells of "disenfranchisement," rang wild with frenzy roiling the emotions of the depressed lot.

Sometime during that turbulent period a man driving a Cadillac Escalade stopped in front of a pawnshop. His pinstriped suit was wrinkled and his face over grown with stubble. He walked into the shop and removed a Movado Fiero (listed at $4,000) watch 

from his wrist wanting $2,500 to cover his mortgage payment. The shopkeeper had no demand for the watch.  The man looked disappointed and said, “I don’t know what I am going to do,” and walked away. The body of that man was found hours later in the river.
Unemployment lines in the Great Depression

These unfortunate, stuffed envelopes with their resumes, to get jobs but most were too qualified and others were less so. The lost wages of more than 10 percent of the unemployed and an equal number of underemployed lower waged earners resulted in fewer sales of the discretionary products. Companies continued to tighten their belts until there was no income to be squeezed and companies had to shutter their doors. Thus more were evicted from the labor force, licking their chops. Auto makers like GM who could not sustain the union sponsored entitlements had to reorganize. This had a chilling effect on the suppliers to GM and also those workers that lost their employment. Again the government fearing a contagion bailed out GM with billions of taxpayer dollars. It is doubtful that the movers and shakers of the auto industry learned the lesson of fiscal prudence. The Main Streets in Detroit and all across Michigan have seen the worse scenario come alive with shuttered doors of small businesses everywhere.
$787 Billion US Stimulus Package

An artificial stimulus by the United States government of “flow of easy money” was delivered to help stop the dire non-lending practices of the banks and allow resumption of easier lending. The banks, however had other objectives in mind. They wanted to survive the economic disaster. Their easy lending practices had created a large uncollectible debt where their own book value was seeing red. The banks started to hoard the easy federal money so as to shore up their own books. They did not want to be a statistic. The collapse of giants like Lehman Brothers, Bear Sterns and Washington Mutual along with more than 170 small and intermediate sized banks that got chewed up in the process and closed doors, had taught them a lesson or two. To ease the burden on depositors, FDIC jazzed up the printing press and offered protection of up to $100,000 for their savings. The small companies meanwhile continued to languish with no ability to borrow. These small companies could not afford the raw material to produce their product for their customers. People willing to pay 50 cents on the dollar for the products slowly depleted the inventory. The lack of cash and the lean labor force forced large numbers of small businesses to finally succumb to lack of new orders and the stark reality of chapter 7. Part of the stimulus money was used up to bail out businesses that were “Too big to fail.” The government bought out the assets and became shareholders in the process. Given that the government was able to govern the board of directors and to make decision regarding the company’s future outcome, made for an unholy union. The public sector was fully enmeshed and dictating to the private sector. The slow crush of the regulators had started to break the back of the  free-wheeling-self-governing private sector of the United States of America.

The rocket is now climbing out into space and the earth is shrinking in dimension beneath us. The eastern and western shores are visible at the same time and there just now the western shores of Europe come into view.

A similar crisis was brewing in Europe. Countries that had recently been the “darlings” of the money world now stood at the brink of an abyss. First was Iceland that had loaned an exorbitant amount of money as government loan to Ireland and faced with Irish inability to pay back had to declare insolvency. Ireland meanwhile had been resting on the housing bubble that continued to expand and enlarge. The astronomical home prices plus the easy money realized by prospectors with untold gains. Irish construction companies were paying heavily to import workers from Poland on these construction projects. The unfinished ruins now mark the landscape in Ireland. They broadcast the sad testimony of the sudden embarrassment of riches and equally sudden fall from grace. As quickly had the flood of wealth entered the shores of Ireland, it quickly exited. The dreams vanished. The unmoved parked cars in the short-term parking lot at the Dublin airport depicted the sudden exodus of the migrant workers. Times had changed.
Irish Countryside

The economic debacle of Ireland, against all proclamations by the stuffed financial shirts and new age mathematical geniuses, came to pass and herald an age similar to the potato famine with massive migration to other lands of opportunity. This harsh reality will take years to unfold until a product or two become available for sale. Meanwhile, Ireland will lay claim to tourism and hope and pray. Other countries in the throes of fiscal stranglehold are Greece, Portugal and possibly Spain. The PIIGS as they are called all oink to the same beat today. All have debt burdens incurred for rejoicing in their free money. Now the debt holders are calling their debt and there is no where to hide except pay by borrowing some more, or do the most dreaded thing called sovereign default.

Over by the juggernaut of the European Union, Germany seems to prosper on the slimmest of margins. Its workers are tied to the bailouts meted out to Greece, Ireland and Portugal. The thinking continues to be that sovereign defaults will become a contagion and take EU down into a brink of financial collapse or at minimum break the European Union. Some have the belief “if not now- when?”  A better question is how long is the German tax payer going to take it.

There are welts of anger bubbling in the European society from the mass immigration policies of the past. Large population of Algerian and other African and Middle Eastern Immigrants reside in poor housing projects in France, with upwards of 35% of those in the unemployed registers.  That powder keg has an exposed fuse. 

Germany on the other hand has the most to lose for continuing the bailout supports to the other non-productive nations. It is akin to the taxpaying worker paying the unemployed and underemployed non-productive public sector entitlements from their earnings. In global terms that would mean, meting out entitlements to countries with lack of productivity, waste and poor fiscal management. Germany, a country that absorbed its Eastern neighbor in the unification process turned itself into a powerhouse of productivity, now she lies exposed to its band of entitled brothers.

From PIIGS to BRICs! What about China and India, the two nations from the BRIC economically healthy nations? We can deal with them one by one. India first.
A street in India

India is a nation of over 1 billion. They have piggy-backed themselves to the technological revolution with large conglomerates employing thousands of workers. This revolution was spawned due to the outsourcing that benefited the West and India jointly. One side did not want to pay high wages to employ, while the other side paid minimal by Western standards but quite bountifully by Indian standards to work the same job. That lucrative period is at an end. Most companies that had outsourced have limited such use of workforce due to their own balance sheet contraction. Meanwhile the new age technology worker in India, has raised his own demands for better working condition and higher pay. No longer are they happy with having a job, they want equanimity in pay scale and a say about the job status. It seems, prosperity does things to people for better or worse, that ripple through and haunt over time. This will raise the cost of doing business on the Indian shores. To continue the prosperity, India will have to innovate and export, besides having a digital sourced workforce, a product of quality that the rest of the world seeks.  Innovation, will likely breed the future of that nation, should innate fraud and corruption not overtake such goals. To her advantage 50% of India’s population is below the age of 25, thus holds a tremendous potential.

China, the second largest economy in the world recently dethroned Japan for that coveted position. China has seen a boom for all ages. Yet as all things run hot they will turn cold too. Their dependence on the West for desire of their low cost products is losing favor; a) due to the economic turndown there and b) lack of quality control. Correcting such debacles in a state run society can be rapid but faulty, decision makers reckless in their lofty positions mandate changes that may have little to do with the reality. The ensuing change will favor market pressures both on productivity, quality control and eventually on currency-balancing, that will make products on either side of buy and sell, reasonably priced. Unfortunately for the Chinese, the demographics dictate an aging population with a large gender bias from population control policies of the past.

Chinese Workers

During these “interesting-times” as the Chinese are wont to call difficult times, a restructuring of ideology will be undertaken. No more can China afford to revel on the low-priced, substandard quality products of the yesteryears. She has to produce her own quality products. To that effect the Communist Party has recently undertaken a government-sponsored program to offer $10 million to each PhD in science and mathematics to emigrate to China. The thinking goes, “If you cant grow them, buy them.” This reversal of brain drain to the West is employed as a safeguard for the future of the nation. The success of that depends ultimately on the regulatory bounds upon the private sector. An experiment of the public sector enforcing rules on the private sector has transient and limited benefits. (Read: the Eastern European Olympic athletes that excelled and then vanished. Only now in the private sector development the Tennis stars of today are athletes from the Russian states that have been unhampered by the governmental influence. So more than money will entice a nation into excelling).

Economies start and grow with an impetus of real demand. These economies are sustained till the demand is met or the collective desire for the products weaken. Such weaknesses lead to economic collapses (Ireland. Iceland, Greece and Portugal) If countries sustain themselves, blindfolded into a sense of security by politically ambitious people or despots (Tunisia, Egypt, Libya, Bahrain), they will and always pay a price. As will other nations dependent on the needs of the oil produced by outside sources. So where will this new chasm of revolutionary takeovers by the people, yearning for freedom, lead the entire oil enslaved world ? We don’t know yet. 
Global Oil Output 

But there are indications that countries like China and India have economic slow downs too thus leading to diminishing needs for energy. The overall decline in economies will soften the oil shock. Inventory surpluses will regulate the price per barrel lower and that might soften the landing for the matured economies.

So where does that leave us. It is quite simple when you think about it. A country will thrive because of its desires to innovate, develop and create saleable items. Living in the luxury of the past will collapse that historical grandeur (Roman Empire). Rome fell because of expansionistic tendency and abundance of forfeited wealth. 
Hadrian Wall

The Hadrian Wall stands as a testimony to that failure. A country that has softened in the middle with constant needs and desires but without the want to create and develop is surely at the brink of an economic abyss. Equally a government tying the hands of its most productive citizens, will, by virtue of that force destroy its capabilities to produce and prosper. Governments must unencumber its citizens to produce capital for all to enjoy. The US has lived in an Adam Smith world for along time and seen unlimited growth and progress. Now it seems that the train has taken a detour towards a Keyensian philosophy of tying the public sector to the private sector to soften the bumps on the undulating roads of economic uncertainty. Economies are like species, living by the creed of "the survival of the fittest." 

An economy can withstand shocks. But a weathered economy without foundational resources to create new products cannot and will not survive.

So back from the flight in our spaceship, the earth becomes a manageable concept. Doesn’t it? Nations need their governments to unencumber its citizens to create and manage the wealth and provide guidance towards such aims.

Scaled economies blossom by force of demand for products not by entitled citizenry. Invoking such disciplines requires leadership and a dedicated freed promise of a realizable good future.

In the end as in the beginning economics is about barter between parties for product or services. The price is based on supply and demand, nothing more or less. “Create a product sell and reap the benefit.”

The political rhetoric not withstanding, the data on the economic outlook for the United States and especially for the emerging markets is pretty good and on solid grounds. The US is still by far and wide the largest economy in the world. It has the most earnings per capita. It has the third best entrepreneurial spirit behind Denmark and Canada. It is still the most innovative country in the world although the gap is narrowing.

The risk the US faces is the growing public debt to the GDP which as of Q4 of 2010 stood close to 60%. Here it is important to note that economies stop growing or stagnate when the debt increases past 90% of GDP. The case in point being Japan which was recently dethroned as the second largest economy of the world due to its public debt of 180% of GDP. Japan is still reeling from a deflationary shock of almost two decades and faced with an aging population the prospects look bleak.

So all in all as go the economies of the households so do those of the countries. Productivity is the way to prosperity.

(All graph data is obtained from the IMF or the OECD)

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