Savings vs. Consumption

Politicians polarize issues so can distinguish themselves from the other party. However, the public would be better served if they would use logic and common sense to arrive at solutions. It is actually disgusting to think that a politician would use a crisis as a means to gain political advantage but all too often this seems to be the case. There are some ideological differences between politicians as well as economists. One of these is these is the notion of Supply Side Economics. This became a Republican mantra since the days of Ronald Reagan. Maybe someone else has a different take on this but my impression is it promotes – consumption; deregulation; bigger companies and fewer of them; pure unconstrained capitalism, lower taxes on the wealthy and loose credit.

The funny part about Supply Side Economics is that is was sold as a conservative principle. The reality is that anything on the extremes is hardly conservative. Conservative by definition is careful and measured. A balanced budget is conservative. Saving for your future is conservative. Stabilizing the Markets is conservative. Transparency is conservative. Supply Side implies creating demand in the market by lowering taxes on the wealthy. This in turn means lowering the cost of capital and taxes on businesses as well. Granted, we live in a competitive world. Communities, states and countries compete to attract business to locate in their jurisdiction. So there is some validity to the argument. There is validity to most arguments; the real measure of success is the balance between all the cause and effect factors that are at play.

Consumption is constrained by the availability of credit. Either you save for what you want to buy or you use credit to shortcut that process. Obtaining credit leverages your ability to grow and expand. The net result is you pass risk onto someone else and offer them a return on their investment. The higher the leverage the greater the risks that you may not be able to service the debts while you pay all your other expenses. Having an inventory of cash on hand provides a shock absorber to a downturn in business. There must be enough cash to pay the bills during the entire downturn. Otherwise you are forced in terms that will probably kill your business. The same is true for businesses and personal finance. Savings is vitally important in the real world and needs to be encouraged.

I have used one economic principle all my life from a biblical story about Joseph in Egypt where he convinced the Pharaoh to save up grain for the upcoming famine. He simply knew that there is always a cycle of drought and famine and it was prudent to save. Over-consumption and lack of savings meant disaster in the future. Savings is therefore a moral and a conservative principle.

Encouraging consumption is the absence of encouraging savings is like telling someone it is healthy to over eat all the time. It feels good while you are doing it but a practice of over eating will kill you. This hopefully, illustrates the balance that is needed in economics. Further this is a process issue. The process of capital formation and debt servicing has to be balanced by appropriate risks that recognize business cycles.

At the end of the day, it would appear the promotion of Supply Side Economics was used more as political devise than a legitimate argument for sound economic policy. It did in fact set the stage for the abuses that we currently see by financial institutions, large businesses and executive compensation. Worse yet it promoted an attitude where the employees are mere commodities for business to use in the name of short term profits and shareholder value.


As previously described, leverage is a way to invest for the future. Individuals taking out loans for college may in fact permit more students to get college degrees and earn higher salaries down the road. A business borrowing to purchase equipment gives them the ability to service increased demand and actually make the business healthier. The supposition is, in both cases, they can repay the loans in reasonable time frame.

Time is a critical factor in debt servicing. The longer the time it takes to repay a loan the greater the risk of a downturn in the business cycle or keeping a job. Unfortunately, the general economy is getting more volatile for both businesses and individuals. We are now a global economy. US dominance in the global economy is waning and translates to greater competition for businesses and labor. The sheer size of the world population means that there is downward pressure on wages, especially when labor is globalized. Businesses have to react faster and be able to leverage capital more efficiently than the next guy. That next guy is anybody in the world and you may not know who they are. The only way you can win at this game is to use time to your advantage. Keep debt low enough so that is can be paid off as quickly as possible. Therefore only fund the best ROI projects.

Ensure that there is always adequate reserve cash to cover the time to get you through a downturn. Forecast conservatively sales and growth in market-share. Understand your internal costs and capabilities as best you can. Match your supply to the forecasted demand so that they are balanced. The more often this is reviewed and balanced the better. The sheer exercise of going through the process of balancing supply to demand gives a clearer picture of the risks that are being made. The numbers don’t lie, just the people that try to distort them. In other words you have to realistically gather your best information and analyze it in the most unbiased way as possible.

You may in fact be able to service more debt when you have a clearer idea of your own supply / demand situation (like a balanced budget process). However, the reverse is true. If you don’t have a clear idea of your situation then the prudent thing is to have more savings, less debt and lower overall leverage. Transparency in this context, are both external and internal. Most people may think of the external implications but many times the processes are not in place for a business or a family to know their own financial situation and inherent risk factors. Our educational system should include a program that teaches the fundamentals of economics, personal finance, savings, investing, leverage and risk management. It seems like the only thing being taught on a massive scale today is how to rack up more credit card debt.

There is a moral question here. Should there be any limit to how much leverage an individual or a company can take on? The fact that so many people are regularly servicing 24% plus credit card debt is testimony to how little they understand finances or their own financial situation. The blame for this situation goes further than the consumer. The financial institutions know very well how onerous this burden is on those people and use their own greed to justify it because they know the amount of profit they reap. However, the moral hazard is unconscionable. So in their mind if they can take advantage of people’s ignorance then they should be allowed to do this. Similarly, if a company officer of a company takes on more debt then the company can service – all the employees, suppliers and stock holders get hurt from this single action.

The problem in a nutshell on the limits to leverage is two-fold – transparency of information and responsibility for the longer term. Of these two, responsibility for the long term is more important. The lender must bare the responsibility for risks taken on over the long term. The individuals within the financial institution will act in self serving ways if they are not held responsible. So within the financial institution the individuals have to be held responsible but the institution must be held responsible for their performance metrics, compensation policies and monitoring of behavior. All the information in the world is not going to matter if there is no accountability for behavior.

If the process was in place to promote proper lending behavior then the next major issue is the availability of timely information about the borrower’s ability to pay and monitoring that as long as they have that debt. The heavy lifting aspect of this process is the “will” to gather the information and provide it on a continual basis. Computers and networks make this process a cake walk. It is a poor excuse to justify higher interest rates to cover the lack of desire to determine and monitor a borrower’s ability to pay. If a lender can get away with charging exorbitant interest rates then they mask their lack of desire or competence to determine and monitor a borrower’s ability to pay.

There is no doubt, that limits have to be placed on leverage. When interest rates are capped, it forces lenders to check viability of borrowers more carefully. So caps are necessary. Only people that believe in unconstrained capitalism believe that interest rates should be completely market driven. That kind of thinking promotes more greed and corruption. It also leads to more risk taking, higher leverage and less stability of the financial system.

Strong Middle Class

If the goal is to polarize the population then unconstrained capitalism is the fast path to accomplishing it. If the goal is to raise the standard of living that most people enjoy then there should be a strong middle class. The intention is not necessarily to create a middle class. Having a large middle class is an indication of a flourishing healthy economy. It denotes a society that is participating in a competitive environment where people have a chance to succeed if they work hard and/or are innovative. So the idea is to promote an environment for a strong middle class. The question is, what does that entail?

We have a unique challenge now in the U.S. Our average standard of living is so far above the world’s average that our definition of middle class is not reality in the context of the world. We need to frame the bounds of what is middle class for this discussion. Lower class will be referred to as a group of people that can not regularly provide for their basic needs – housing, food, health care and heating. Middle class are those that can provide for their immediate needs and a reasonable amount of future needs. The upper classes are those people that have excess capability to provide for their basic needs and other luxuries.

The phrase that adeptly sets the stage for a balanced economic society is “Life, Liberty and the Pursuit of Happiness”. The characterization does not imply that we owe everyone a specific standard of living, just the opportunity to improve their current level. Should there be a minimum standard of living in a modern industrialized country? If that is the case then there should also be limits to the upper end. Welfare and social entitlement programs are intended to set a minimum standard and estate taxes and graduated taxes were mechanisms to control the upper end.

Education is probably by far the single biggest factor to enabling a strong middle class. Therefore the trick is to provide affordable high quality education to everyone is of paramount importance. There is much debate how to achieve that but I’ll leave that discussion to others.

The more difficult issue is the physics of the global economy which I see as the Big Sucking Sound. The middle class in America is threatened in profound ways. Free trade on the surface may sound good. But it is sapping the standard of living from the U.S. very rapidly. There are elements of Free Trade that are valid inevitable but the way that it is being implemented only favors the corporations without regard for the average worker here. It has been great for the third world.

The greatest concern here is the pace in which the jobs are being lost. There is no time or adequate processes in place to provide enough new jobs to replace those being lost. Worse yet highly skilled jobs are being lost at a faster pace too. No one seriously made the effort to determine the displacement of the jobs by the Free Trade Agreements. The most notable area being affected by this is the Middle Class. Its one thing to have a dam holding back water and let some go by in a controlled way. But imagine the dam bursting and all the water rushing down the valley at the same time. This is virtually what has been happening.

The process steps needed are obvious. Pass legislation to limit the amount of outsourcing that can be done without imposing significant taxes on the corporations. If they want to sell here then they need to staff here appropriately.

Stabilization then Growth
We are going through a truly transformational period of time. We have witnessed a broken process that was allowed to grow and continue without regard to the consequences. Then suddenly it hit the wall and devastated the world’s economy. Credit froze up like crazy. Major corporations and countries went bankrupt in a matter of months. Of course there needed to be the foresight that certain policies would inevitably lead to this consequence. It is recognized but there is too incestuous relationship between our elected officials and corporations. This was caused by our election process of campaign contributions and revolving doors, where elected officials that help corporations get big ticket jobs after they leave government.
Even more fundamental, there needs to be processes put in place for dealing with extraordinary events and situations. It is not acceptable to not know who is responsible for allowing dangerous situations to evolve to a crisis level. Natural events occur regularly that remind us that we need an emergency plan. Despite the rarity of any particular catastrophe, the magnitude of the devastation warrants investing in mitigation procedures to protect life and property. These procedures are contingent processes that are designed to help during the crises and help the recovery process.
The financial system is no different, it is too important to everyone; to ignore the need for processes to protect it, deal with developing crises and map out what is needed to recover as quickly as possible. Nothing was worse than to witness the abhorrent way the government dealt with the financial crisis of 2009. The TARP program was formulated so fast that the representatives voting on it didn’t even have time to read the document and understand the implications. The public was given no time for comment despite the enormous size of the package. As of June, 2009, AIG has received $180 billion from the government and its still growing as a result of TARP. Basically this was a conduit for funneling US taxpayer money to bail out foreign companies and governments. Yet nothing was said or discussed about how the TARP money was to be used. The U.S. debt burden has and will continue to grow as a result of institutions that for years squeezed huge salaries out of overly leveraged, risky investments. Ultimately they were not penalized for their behavior.
This abysmal situation screams for processes to prevent this from occurring again and to better deal with its development in a more proactive way. My take-away from witnessing this crisis unfolds is that performance metrics drive behavior.
A normal balanced market would operate well under free trade / free market principles. The process that supports these principles would dictate one set of rules that would simply define how the market works. The dislocation of natural economics that was brought on by Free Trade is far from a normal market. The winners are the executives and those on the receiving end within the third world.
An examination Free Market dynamics yields a number of processes that result in various impacts on different groups of people. Selling to a large untapped market would normally be very attractive. What happens if that market dumps products & services on your market while you are hamstrung and limited in how much you can sell to them? Regardless of what label you put on it, this is not “free” or fair trade. We have an underlying problem that accelerates the transfer of wealth and standard of living to third world countries. The continual increasing trade deficit bares this out. There needs to be a metric of who benefits and wins under this policy.
One metric should be unemployment by industry, by region. There have been waves of economic dislocation over the past decades. The first wave was the loss of simple manufactured products, like clothing and basic materials. The second wave was the loss of more complex manufactured products like computers and automobiles. Remember how the politicians use to brush aside the impact by saying, “look at the service industry and how much it has grown”.
The customer service jobs were subsequently exported, aided by advances in communications and the Internet. So the lower expertise service jobs were exported followed by the higher skilled programming jobs. Especially during the Tech Bubble, there was general euphoria about the number of programmer jobs that were being created. A programmer might get stock options and salaries over $100,000/year. Not any more. The rate these jobs being lost to India and China is accelerating and already acute.
Therefore, abnormal processes need to be designed & implemented to mitigate this situation. The unbalanced trade arrangement is even more insidious then the financial crisis of 2008. It’s not as obvious and will have an even larger impact on the U.S. economy to where there may be no recovery. Critical industries will continually be lost, U.S. dollar will be devalued and inflation will increase sharply. The earlier this set of circumstances is recognized and acted on, the less the eventual impact on the general economy. Abnormal processes need to be designed to bring the trade imbalances back in to normal operating conditions. The question is how?

    Step 1: Recognize the magnitude of the problem. Have honest communications to the citizens as to impact of the job losses and the projections as to what will happen over the next 5 – 10 years.
    Step 2: Prioritize all the industries in terms of national defense and vital to the long term health of the U.S. economy. Determine which industries have the highest priority and work on them first.
    Step 3: Review all trade agreements and dates that affect the prioritized list. Explore the agreements for latitude to modify agreements to protect critical U.S. Industries and determine wiggle room within agreements when possible to minimize international ramifications. The U.S. still has global responsibilities and that can not be ignored. But is does need to e recognized that we will not be able to help anyone if we don’t help ourselves now!
    Step 4: Impose import restrictions on countries that place restrictions on our products and/or services.
    Step 5: Resources and money need to be provided by the government to promote research to U.S. companies and institutions. Priority should be given to those entities where their workforce is US based and make funds contingent upon providing US jobs.

Limitations on Growth

Relative to the discussion herein, there are two kinds of Growth, population and economic growth (like GDP, growth domestic product). There is a great deal of overlap between these two areas and they are interdependent. This means that one can drive the other. A growing population will add to GDP, providing the standard of living stays the same for all. Economic growth will encourage educated people to have larger families because they can better afford to take care of more children. An uneducated population may have looked at family size as a way to have more employees for a family business. That model worked on a family farm where they were self-sufficient. However, in our industrialized over-crowded world this is no longer viable. Matter of fact small family farms are declining rapidly and replaced by commercial farms that are more efficient and can produce more food for the excessive population. Without that efficiency then more people would starve.
Economic growth sounds good for investors looking for greater returns on their investments. Politicians like growth so tax revenues increase to support the multitude of projects they would like to promote and show their accomplishments. Growth sounds good for workers when more jobs are created and wages are increased. If we stopped here then it would be natural to believe that economic growth is always good. Life is not so simple.
Improvements in productivity can provide an improved standard, of living, therefore economic growth, while everything else stays the same. Technology improvements have led the way for productivity improvements for decades. Admittedly the pace of technology advances has exceeded other limitations to economic growth. Consider this, technology advances have benefited only those countries that have had access to it and deployed it effectively. In the past technology advances in one country took years to migrate to other countries. As long as one country could continue to keep the pace of new technology advances up then it was a competitive advantage on a global scale.
The deployment of new technologies is more amorphous today. The educational levels in other industrialized countries are out-pacing the U.S. This is translating to more innovations coming from these other areas. Further, the access to the technologies is available over the web and can be deployed much faster in any part of the world. The more educated a population the faster they will deploy technologies to improve productivity. Again the U.S. is loosing it leadership in this area with the relative gap in education.
The quality and access to education affects the limitations on economic growth. This has always been the case and will become increasingly important in the global competitive arena.
The mantra of growth, as good, stems from an ever increasing population. Is growth good when the resources, to support an adequate standard of living, are depleted? Advocating growth under this scenario is insanity. It’s like saying “let’s accelerate how many people should starve to death, or let’s go to war faster”.
Many people would deplore the action by the Chinese Central Government to impose birth restrictions on its population. However, the majority of that population was already starving to death. If we have some moral dilemma with that policy then we better reconcile what that country should have done with its existing population and how to improve their standard of living.
The moral question should be who has more rights, the living or those that are not even conceived yet. This is a truly universal question at this point in history.

Excesses and Limits of Capitalism

Let’s illustrate a point. If there were no regulations on companies, companies would eventually follow only one rule “Survival of the Fittest”. It happens over and over. One company grows to corner the market, manipulates prices and creates a monopoly. Under this scenario this one company engages in anticompetitive practices to eliminate all competition. This is the unwritten goal of every major company. The CEO’s have publicly stated that their companies’ reason for being is shareholder value. This is a clear statement about their intent to continue to grow by whatever means is necessary.
The legitimate question is whether the above scenario is fictional or a matter of fact. The shear fact that regulations have been created implies that there is real concern about the abuses of pure capitalism. If this can be assumed then the important question is how much regulation is needed and which regulations are effective? The regulations themselves can be too onerous. If they apply only to U.S. companies it defeats the intent of having them also. We live a in a globally competitive world. Unfortunately, the issue of fair competition much more complicated. Governments subsidize companies and industries that they deem as critical to their national interests. By the way, national interests may simply mean the protection of jobs in that country. Take the case of building commercial airlines. There are really only two companies competing in this arena – Boeing and Airbus. Airbus seemingly gets much more subsidies than Boeing. Placing additional regulations or taxes on just Boeing would compound the ability of that company to compete against Airbus by raising the cost of doing business.
One might point to this airline building industry as an example of a monopoly already. This example also illustrates the situation of the cost of research, developing and building different kinds of marketable goods. The cost and risk may be just too high for most companies to afford. The level of sophistication of developing and building commercial airlines is already more expensive than most countries can even afford. If it is in the national interests for the government to help the development of a technology for the general public good then it would be appropriate for that government to subsidize that research. The government still has a responsibility to ensure that that public’s interests are truly served and not just the interests of that one company. Think about the balancing act of this one and you should be getting a good sized headache about how difficult it is to balance that act. The key point is the world has gotten very complicated and there are no easy one-sided answers. All aspects of unintended consequences need to be explored before we just plow ahead and impose additional regulations and taxes on people and companies. “Good engineering” would be an appropriate phrase to remember.
This is not the forum for debating how to draft and enforce regulations. What should be understood though is that the strength of capitalism is the competition it fosters. Creating a competitive environment creates opportunity for people, promotes innovation, and motivates people to work harder. If wealth gets too concentrated then that environment gets destroyed. Furthermore if a company is allowed to monopolize a market then the competitive environment in that market is destroyed. This can be even more insidious because that one market may impact many others that are in related industries. Large and rapid price increases in critical commodities due to manipulation of their markets may even send shock waves through the broader economy and send it into a recession.

Pace and Step Changes

All processes go through changes. The changes can be either positive or negative. Even positive changes can have an averse affects when the changes happen too suddenly or magnitude of the change is too large. Normal processes can absorb changes provided they are managed in a responsible way. That may mean that other steps may be needed to implement the changes in a process,
The formation of the European Community illustrated this point when they recognized that some of the countries that were to join had a significantly lower standard of living than other countries joining. Investments were made in the infrastructure of the poorer countries so that the transition would be easier.

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