IN THE BEGINNING
1974 was a watershed year and a good year to pick as the beginning of our current crisis. This was the year I graduated from college. Aside from the obvious coincidence, this was the year that the U.S. got the oil embargo shock of its life. For the first time the abstract of dependence on foreign oil became a reality as cars waited on gas lines for their allotment a limited supply. The average American had the luxury of thinking of oil and gasoline as such an ordinary commodity that was plentiful and part of our culture, prior to the embargo. All at once reality settled in. The price and supply could be manipulated. The U.S. was vulnerable to foreign countries and they were willing to use their resources to blackmail us.
The situation has not changed although the awareness of our dependence drifts to the back of the mind as blind optimism hopes that it won’t have more negatives consequences as in the past. Of course this is an illusion. This event had much greater significance. The global supply of natural resources is limited and the demand for them is growing faster than global ability to bring on increased supply. When this imbalance occurs, prices will naturally spike and may cause serious political consequences even wars. What is certain is that the frequency and severity of these events will only increase with time particularly as natural resources are depleted and the world’s population increases.
The second thing that happened around the same time was much touted efforts of the Nixon administration to engage China. A population of over a billion people is hard to ignore especially when they want to exert their influence on the other countries in their own self interests. China joined the nuclear club regardless of U.S. desire to prevent it. The follow-up policy decision was to find a way to engage them if we can’t beat them in Viet Nam. Maybe economic engagement is better then military engagement. Time will only tell. The stage was set regardless, for opening up trade with China. It became quickly apparent to multi-national corporations that China offered cheap labor and a potential new market for their products. The new global market model took shape.
Stepping back, there is no shortage of people that are writing about the current financial crisis and many of them focus on what I feel is a fairly narrow context. I humbly acknowledge other writers’ treatment of the crisis, where they probably have superior understanding of historical precedents but it appears to miss the point that the current crisis is unprecedented in the world’s history. We are entering in a new age where the interdependence of people and institutions from around the world is inescapable. This is the context that I feel needs to be addressed in order to understand and treat the crisis. This is both the magnitude of the problem thereby the magnitude where the solution must be found. Anything short of that is self serving on a national context and can actually lead to devastating results.
PHILOSOPHY / PRAGMATISM
Life is a journey. You hope that over the years that our perception of the world would get clearer. The sad reality is that right and wrong can change with time at a profound level. What might seem right in the short term may set the stage for monumental change that hurts millions of people. Take unemployment as an example. If the politicians find a way to put people back to work then most people would agree that is a good thing. However, would it be so good if the way they did it was by declaring war on neighboring countries? At one level this is the age old argument of the ends justifying the means or the other way around.
The beauty of economics is that it embraces other discussion areas – values; short and long term goals; metrics of success; philosophy vs. pragmatism. Life is not static. Values can change with age and situation. Goals are driven by ambition and circumstance. The definition of success can be defined in so many ways. A set of ideas can all sound good and logical but then there can be a problem of scope. Success in the short term may be illusionary, disappearing in the future. The success of the Nazis in revitalizing the economy of Germany during World War II led to the death of millions and the destruction of their country.
We have now seen the results of an economy that was pumped up by leveraging debt. More people became home owners and were instantly wealthier in the short term. This led to a bubble and ultimately led to the collapse of the real estate market. Companies grew and acquired other companies but then they could not service the debt and went bankrupt. The Masters of Wall St. created new and exciting financial instruments. They extracted huge salaries and bonuses in the short term and now the economy is collapsed to the point where the banks are being nationalized.
Human nature cannot be ignored. Simply, this is why we have laws and regulations. If human nature was always benevolent or benign, at minimum, in its impact then there would be no crime. The truth is human nature is characterized by more than just virtuous acts. Human nature is also defined by – a competitive spirit, survival instincts and sometimes deprived acts against other humans & the rest of nature.
Short term pragmatism needs to be bound by a long term philosophical constraints. Philosophical constraints would ensure that there are goals that benefit the entire human condition. There would be an understanding of causality that would anticipate cause and effect relationships. There would be metrics that help us evaluate what works and does not. Most importantly, there has to be a common agreement that we do need to be equally concerned about the long term as well as the short term. Also, the “means” are as important as the “ends”. And there needs to be an appreciation that a long term philosophical view is needed to bound short term pragmatism.
One of my pet peeves in this area is that a company exists and acts to create shareholder value. This became a mantra in major corporations several decades ago and still survives as an argument for behavior of CEO’s. This is a philosophical point that sounds good. A company is owned by shareholders. They have put their money at risk. They should be the primary beneficiaries. The basic problem is shareholders are as fungible as currency. Stock can be bought then sold in minutes. Modern technology and electronic trading has enabled more rapid transactions and thereby less emotional connection with the lives that are impacted by their actions. This attitude has empowered corporate leaders to extract even larger salaries and bonuses to the point they rape the companies. Corporations are bought and sold, consolidated and destroyed in very short time frames. Is it right that a company that grew over decades and provided good incomes for its employees can be destroyed by executives that just seek to enrich themselves? And destroy the pensions and livelihoods of tens of thousands of people in the process, all in the name of shareholder value.
I am a capitalist and a libertarian. It doesn’t sound like it does it? Social responsibility is good business. We put aside reserves to pay for the deterioration of equipment and buildings. We have allowances in our tax code to acknowledge that this deterioration should be credited against a company’s cost of business. The same principle holds that a company should not pollute because it destroys a valuable resource that belongs to other people (than those that own the company). Further it will cost other people money, which they should not have to spend, due to another’s transgressions. A company should not be allowed to make low quality products that are harmful to the people that either buy it or those impacted later by its disposal. These are long term principles.
When corporate executives are incentivized by short term compensation then the concepts of saving for deterioration, pollution and quality mean nothing and are just an added liability against their goal of making more money for themselves. Worse, if they can profit by destroying the company, then they will find a way. This mentality will destroy capitalism and gives capitalism a bad name. Capitalism should encourage a company to grow, make better products and help all employees and stakeholders earn more from their efforts and risk. All employees should be incentivized the same as executives to share in the benefits of doing a good job and being creative & productive.
Competition is the common principle between capitalism & democracy. The primary argument for capitalism is that private ownership is a more competitive driver for innovation and productivity than government ownership. Without this argument everything ought to be state-owned with its risks and rewards shared by everyone. The argument is only valid if the stakeholders in an enterprise are motivated to participate in improvements. Management might be argued to be the only participants in improvements but it really depends on compensation. If only the management is compensated for improvements then what can be expected? Don’t blame the rank and file if the system was set up that way for compensation. The more variable pay is tied to improvement then the more you can expect improvement from all groups that that get variable incentive pay. Further, if rank and file was compensated more by variable pay then management would not be as important. Less management would be needed. The cost of business would be lower. Under no circumstance should management be disconnected from employees relative to compensation.
Similarly with democracy, the theory is that competition for office holders will yield leaders that are more capable and motivated to act in the general welfare of the population. Democracy depends on free and fair elections. When elections processes lose their freedom and fairness then democracy is destroyed and the value of democracy as a political system is minimized when compared to other systems. Democratic principles may sound noble when explained in terms like “fair and free” but the reality is the strength of the system comes from the competition it encourages and protects. The competition must be protected. Private ownership is therefore consistent with competition. A government monopoly has no inherent structure to foster competition. An industry controlled by one major player, a monopoly, may as well be run by a government.
In the perfect world the optimal arrangement would be minimal government interference in industry and the maximum amount of services provided by private industry. This concept describes the extreme democratic system of Libertarianism. The hallmark of Libertarianism is less government. Consider this. Government cannot interfere with businesses or individuals if there is less of it. People tend to think of Libertarianism as the far right wing. I don’t agree. It is the far-left because these people have to have ultimate faith that people will cooperate and act in the best interests of the greater population. This is an overly optimistic view of Human Nature. The far-right tends to want to dictate and control the greater population based on their notion of what is right and wrong without a democratic vote. Conversely this is a very negative view of Human Nature where the few do not trust the masses to do the right thing. Anything that causes more government is ring wing to me! The result is the same – less competition and suppression of innovation.
The way democracy is practiced as a political system is a mere shadow of what might be defended as a specific political philosophy. It seems more like an aberration of something else or mutt concept with elements of many ideas without coherent principles. In the worst case democracy is used as a label without any substance behind it. To make matters worse, the political parties of today having waning central core values that no one can articulate what this party is about. It would be a waste of time to try to describe them or try to make sense of their principles. Please don’t extrapolate my comments to be commentary about any one party today. One political party may only partially adhere to a hierarchical political system. Other parties might completely undermine that same system.
Regardless, all political parties should be held accountable for their core principles and how well they serve the country as a whole. Individual politicians are responsible for the greater good, not for specific interest groups. Our entire system today of parties and the way campaigns are run corrupts the fundamental principles of democracy (as described above) and fundamentally makes us less competitive as a country.
It would be fair to say that a political party should be a living organism that grows and changes as the environment changes. However a core set of characteristics, value system and principles should survive changes in political party leadership. It is best to forget about the dogma that they espouse and concentrate more on the system or process. The issue of political parties had to be mentioned because the political fighting and arguments you hear are so convoluted that they would confuse the ideas discussed here. I cannot see how they add value to the discussion. The most important issue for the party members appears to be how to protect and enhance their party with the good of society being secondary. That attitude is bankrupt and dangerous to the survival of our way of life.
Theory and practice are very different things. I believe the goal is to be as Libertarian as possible but that goes with the understanding that it is an inherently unobtainable goal due to Human Nature. Therefore the theory is to create an environment where we tap the potential of the entire workforce in a highly competitive way. Capitalism can be good if taken in the context described earlier. The laws and rules need to be developed that protect and enables the competitive environment. This is a serious issue because the same competitive spirit causes people to use the system to maximize the benefits that they personally get at the sacrifice of others.
A political system has to be complementary to the economic system. Here in lays one of the more difficult challenges that a free society faces. Where are the bounds and limits to where one does not corrupt the other? How can a “competitive” environment be protected while we encourage people to be more competitive. The illusion is that the performance pay has to be individual. It can be set up to reward the team effort. First, the political system has to recognize its Raison d’être. You probably see where this is going. Fundamentally the political system should establish the framework to ensure that society functions economically in a healthy manner. This includes education, training; setting priorities for infrastructure projects, maintaining critical functions and utilities; protecting our sovereignty. The political philosophy should be: encourage and promote competition. At the same time, they also need to set the bounds to protect the competitive environment from abuse. If it is not protected, abuse of the system will lead to the destruction of it.
The economic system has to provide stability, rewards for innovation and improved productivity. The goals of the political system and economic system should coincide. Innovation is necessary. Competition comes from motivated people. Therefore incentives are fundamentally a good thing because it motivates people. The economic collapse currently underway is pushing people to look for scape-goats and ways to get out of the situation. The greatest fear I have is that good principles will be blamed for the crisis when it was the abuse of the system that caused it. If you don’t understand the cause then you cannot solve it and you will probably make it worse. This is too important to be left to chance.
So now we need to examine the most significant issues that have contributed to this economic crisis. Then we will try to offer some ideas on how to solve it.
“FREE TRADE”
Expansion of markets is essential for economic growth. The alternative is simply competition over the same size market. The industrialized countries reached a saturation point in the early ‘70’s. It would seem logical that in order for these countries to expand their economies they had to try to remove the barriers to trade.
But this is not a simple one dimensional formula. There are winners and losers in all transactions. Unencumbered trade would normally make the stronger party a winner and the weaker party the loser. The industrialized countries for many years took advantage of the strength to gain access to cheap resources. What happens when the industrialized countries are no longer the stronger party?
Free trade might be better termed as Fair Trade. Translating terminology is a precarious art. My interpretation of Free trade is the enabling of multi-national companies to chase the lowest cost supplier of raw materials and labor anywhere in the world.
Trade is never free. The whole idea of setting up free trade agreement is to give an advantage to the parties that make the agreement and disadvantage those that are not part of it. Therefore there are still winners and losers. More so it depends on how well the agreement was drafted whether the agreement gives an advantage to one of the parties over the other. For argument sake let’s call such an agreement as “Fair Trade” Agreement.
I am not sure of all the reasons why the European countries formed the European Union (EU). It did seem to be a response to the mounting imbalance of trade with the developing countries such as China and India. The formation of the EU lowered the cost of doing business between its member countries. The collective result was to make them more competitive globally. Internally, the dynamic redistributed national balance sheets. Poorer countries had their standard of living improved while richer countries had to help fund the leveling of the standard of living.
The need to respond to the EU formation and the emergence of increasing trade with emerging countries motivated the drafting of NAFTA by the Clinton administration. Unfortunately, it did little to improve our competitiveness relative to the huge difference in labor costs between industrialized countries and emerging countries. In case there is some dispute about this statement. The metric used is our trade imbalances with these countries.
The mantra from the Bush Administration is we need more Free Trade agreements. What started with Canada and Mexico is being expanded to all of Central and Latin America. Fundamentally this direction is different than what Europe did with the EU. There has been no talk about currency consolidation, work standards or environmental standards. In contrast, the formation of the EU was constructed in a way that addressed the monetary issues involved in making participating countries more competitive. There were also implied changes that were intended to stabilize the interrelationships between countries and the new currency.
Who are the winners and losers? Within the countries that participate in Nafta, multi-nationals and poorer economies will win. The next question is, will this expansion of free trade within Nafta countries be more competitive with countries outside our free trade zone? All this maneuvering between countries avoids the larger question. Does the current monetary system serve us well?
Currency Exchange
An examination of the all global currencies as a basket revels that there is great volatility in their relative volatility. The strongest of them all, the U.S. dollar has seen swings of over 40% within one year. At varying points in time the oil rich countries have seriously questioned denominating their oil in terms of the U.S. dollar.
The more a country uses ignores monetary stability the more it will get devalued. At this time the U.S. deficit is $11 trillion dollars. The unfunded liabilities are projected to be $53 trillion dollars. China is projected to be sitting on $2 trillion dollars in reserves, generated by the trade imbalances. This clearly paints a picture of a country that has lost control of its monetary policy. Projecting the trend forward is a disaster. The economy is spiraling downward with the politicians resorting to stimulus packages plus bailouts in the range of another $4 trillion dollar. The servicing of the debts will leave future generations with no ability to dig themselves out this hole without declaring bankruptcy.
Countries that have no leverage on the world stage due to their overwhelming debt have little ability to influence foreign policy or help keep the world safe. The U.S. can not afford its military at this point. The point is – the perception of strength in a currency stems from the underlying perception of the strength of the country’s economy. If the U.S. lost the perception of strength then which currency could replace it? Would another national currency be better?
The Value of Commodities
The value of work actually is not a constant. It varies by the laws of supply and demand. And we will deal with that more, later. It is easier to recognize that commodities vary in value based on the laws of supply and demand. There is an inherent cost to extract natural resources from the ground and similarly produced other commodities cost a certain amount. Sometimes the market value of a commodity is close to the cost of production. That is where it ends. The market value may swing wildly due to the supply and demand.
The elasticity of commodity prices can be viewed at different levels. Local fluctuations in prices are fairly minor. Prices at the local level tend to be due to perceived quality of the commodity carried by a specific vendor or dealer. Consider that commodities use to be more regionally priced. Now everything from water, metals, chemicals and oil have been “globalized”. This phenomenon is a major shift. Commodity prices and their relationship to a supply demand balance use to be more regional. The shift results in a global supply demand balance. The commodities are easily marketed, shipped and sold worldwide.
The enabling factors to commodity prices being due to global supply demands balances are technology, global distribution channels, multi-national companies, global financial markets and global marketing. This genie is out of the bottle. We will be dependent on global supply and demand unless there is a major destruction of any one of these enabling factors.
If commodities are more plentiful then the prices would not support the extra transportation to ship it. We create our own dependencies in how we think about our society. The illusion of wealth is symbolized by single family residents, larger houses, bigger cars and boats. The result is housing gets spread out over larger land areas and people commute to work further and further. Oil converted to gasoline is wasted just for people to get to work. People striving to get ahead measure their success by the symbols that denote their success. It’s a value system.
Sustainability of Planet
The world is getting smaller. On the one hand, people measure success by increased use of commodities. Adding to demand, the global population keeps increasing. However, the availability of natural resources, the most basic commodity, is finite. The finite availability is obvious from the extent of drilling and mining that companies are willing to go to in order to find new supplies. The underlying cost of production keeps going up. This is the underlying cause of inflation.
At some point in time the imbalance of supply and demand creates stress on the entire system. It could even lead to social unrest and wars. If income does not keep up with the prices of commodities and essential goods then people in that income level cascade into poverty. Increased numbers of people are likely to fall into this category as time passes. We would all like to think that the pie can be expanded forever. Is this realistic? The evidence clearly point to a global pie contracting. If we view the world from only our narrow regional perspective then we can dismiss the view that the pie is contracting.
Two of the most precious natural resources are water and productive farmland. A simple thing like water is so limited now that people believe that their only source of safe water is bottled water. What does that say? Bottles water is now shipped around the world. That is more bizarre. Food use to be a regional commodity but now food is shipped around the world. This movement and extra shipping of food and water increases fuel consumption but becomes more necessary when it’s not available locally.
What happens when there is not enough fuel to move the commodities any more? Food and water are necessary for life. Shelter and heat are the next level up. These depend on other commodities. Practically all commodities are already showing signs of imbalances. Eventually, the imbalances will reach a crisis stage. Our choices are either to prepare for this eventuality or destine ourselves for chaos and wars. A viable preparation means that we mitigate the affects of the problem or solve it entirely. The best we could hope for is mitigation.
The world population would have to be significantly reduced and a majority of the world’s population would have to have a cooperative respect for the finite world resources to truly solve the supply demand imbalance. Since neither is likely to happen, solutions must be found that significantly help to mitigate the imbalance. Significant is the operative word. It is easy to find lots of solutions but the vast majority of them will have no significant impact on solving the fundamental supply demand imbalance in basic commodities.
The Value of Work – Standard of Living
Remember that a currency is used in two ways – by the people within the country that issued it and to facilitate trade between countries. As discussed earlier, the currency of a particular country represents work by an individual. More specifically, the value of work was established on an individual in that particular country. Value was placed on that work – given the laws, economy and standard of living of that country. The pay scales may vary with competitive factors, taxes and cost of living in various areas. Compare this variation in value with the same work performed in countries like China or India. The value proposition of the same work is not even close. Within a country, the variation of work value may be 30%. Between countries, that same variation may be a factor of 10 fold. The minimum wage in the U.S. will be over $4.00 per hour soon. There is no minimum wage in many countries. The average per capita wage for a week’s may be $4.00 in these countries.
These discrepancies did not matter to U.S. citizens so long as their jobs could not be exported to these other countries. Free Trade policies and technology have enabled the exporting of jobs around the world. Manufacturing and service jobs alike have been exported. Practically, any type of job can now be exported, even engineering, legal services, information technology, design and management can easily be done. Management can be globally centralized and have been by multi-national corporations. The Internet, broadband speeds, wireless technologies and readily available devices make all higher order work completely portable and fungible around the world.
The exchange rate between countries is disconnected from the value of work between the same countries. If there was a connection then there would have similar pay scales. When it comes to exchange rates, there are many other factors at play. Each factor adds to the volatility in exchange rates. Maybe the worst factor that contributes to exchange rate volatility is that currencies now get traded like other commodities and stocks. Further, traders are allowed to hedge and short currencies. Meaning they are betting on whether currencies will go down in value relative to other currencies. Again the net result is less stability in the system.
Forecasting the direction of exchange rates is an art form based on multiple factors that judge the performance of an economy in the past, present and future. Basically put, it’s a measure of competition between countries, which country is better managing their economy. Each government acutely knows that they have to protect their economy from outside influences. In order to do that they impose tariffs and subsidize farming, manufacturing and other industries. In other words they manipulate their economy to their advantage. Their responsibility is to their people. So, the comment is not a negative remark. It is simply a reality. The European Union is an interesting case study due to the change in mentality that the people within the member country have towards each other. They are no longer as competitive between themselves. They are more competitive with countries outside the Union. The formation of the EU is a fundamental change in the competitive dynamic.
There are similarities between the EU and the former Soviet Union. There are also major differences. The differences are more noteworthy. The member countries on the EU elected to be partners in it. The Soviet Union did it by military force, whereby subsequently the member countries were treated as second class members to Russia. It is a matter of perspective. The resurgence of Russia’s economic strength has led to resurgence in thinking that their strength lays in their ability to control others. The EU perspective is that their strength lays in their ability to cooperate on multi-levels. The first level was on currency and trade.
The levels of cooperation are destined to expand over time to other forms of governance and security.
The success of the EU formation will be better judged over a longer period of time than has passed already. However, the fact that other countries want to join is a fairly clear indication that they believe that cooperation leads to stability and a higher standard of living for its people. Quite an amazing thing that a country’s people would believe that loss of sovereignty is out weighed by economic stability. Its seems, not to be such a hard sell to a country that is economically weak whereby their economy is strengthen by belonging to a larger group that is already stronger. Military alliances are more common for this reason. Trade agreements are also common. The big difference here is a major shift in governance. They must share certain political values and agree to certain economic policies. Once they agree to do that then they agree to be governed by a larger entity.
The experiment in cooperation by such culturally diverse countries will be tested as difference circumstances arise. Recently the global financial crisis and economic downturn may well be the first real test of that cooperation between EU countries. But this is the whole point. Which way are they individually more stable and have a better chance at protecting the standard of living for their people?
The sad reality is competition is normally a good thing and there has always been competition for basic needs and wealth. Innovation and progress have been a measure of the health of a society. A country’s Gross Domestic Product (GDP) is another form of measurement. Taken together we think of ourselves as part of a community as long as it benefits us. Do you care about GDP or technological progress if all it leads to is war and famine?
An individual cares about their standard of living. (Principle #1) Progress is best described as an improvement in standard of living by a greater percentage of people.
Competition
Competition motivates people to work. Now we have a dilemma. Why would you want to motivate people to work harder if the accumulation of wealth leads to an accelerating imbalance in commodity supply and demand? Fundamental changes are needed in our values system and beliefs. These are some of the central questions that surround political systems.
As wealth becomes too concentrated among too few people, then the economic system stops working. People start to believe that they can’t get ahead then they become disenfranchised and de-motivated. Capitalism is a cornerstone of a democratic system. The foundation of capitalism is competition. There has to be a basic belief that people can get ahead through their innovation and hard work. Well if we want to preserve democracy and capitalism then we should also act to preserve the principles of competition.
A monopoly is corporation that has an overwhelming market share and/or can control the available supply to a point where they can control the price. The corporation may have created that monopoly by fair and acceptable business practices but the net result is still the same – they are now in an anti-competitive position to stifle competitive companies in unfair ways. This is not a clear point in time or situation. The U.S. government has recently made decisions that some corporations are too big to fail. Defacto, these corporations are at an anti-competitive point if the government believes that it is necessary to bail them out. Why should just a few companies get preferential treatment in a free democratic society? Preferential treatment is anti-competitive.
Wealth can become too concentrated by either an individual or a corporation. In either case the entity is positioned when it is too concentrated, to affect the standard of living for vast amounts of people, far beyond which would be healthy for continued economic stability. The tightening of natural resources will call into question how will the control, allocation and pricing of the resources be handled.
The accumulation of wealth is a good thing because the prospect of being able to participate in that activity promotes innovation and more work. The excessive concentration of wealth is an evil thing because it can lead to freezing people out of the possibility of participating in the same activity. If you try to over simplify the activity without recognizing that there needs to be bounds on the activity then you will not understand any of my arguments. (Principle #2) Every activity needs to have boundaries and constraints.
Taking aspirin or vitamin C is good for your health but taking too much will kill you. Creating housing for people is a good thing but creating too much in any one area where there is not enough water or roadways to support it is also exceeding necessary bounds. Burning fossil fuels helps to provide warmth and growth to a country but too much poisons the air and kills people. Maybe that’s ok in some people’s mind. Do we have to grow the society and kill people in the name of growth? Of course not unless you believe that then we are no further ahead than the caveman. Let’s assume that we do understand that a modern advanced society acts by principles that lead to cooperation and within constraints.
We must also believe that we have a common goal. I am suggesting that stabilizing our standard of living is a modest goal under the circumstances. A more ambitious goal would be to improve the standard of living for more people than enjoy it today. Competition, capitalism and democracy can be a formula for improving the standard of living. However, unconstrained capitalism is a formula for disaster. Any political system that promotes growth without recognizing constraints is like encouraging a driver to go faster down a hill when they have no brakes.
A point needs to be made. There is a common belief that things run by the government are less efficient and that private enterprises are better suited for practically every task. Companies fail and governments let their people down. This is no reason to abandon the thought that one or the other might be better at handling a situation or performing a specific task. Each must be evaluated on its own merits. But the critical thing is to set up a system that will work in the short and long term. For all its faults the U.S. postal service has been a huge success for many years. Social security is the same way. However, it is always about management. It is not about which entity runs it. If politicians continue to ignore the demographics of an aging society and under fund Social Security then they write its epitaph and misery for millions of people.
Corporate America today is far more short-sighted than they use to be. Basic research is a mere fraction of what use to be common, for most multi-national companies. Ten years ago capital projects were funded when they had a 3 year pay-back. Now only projects that pay back within 18 months are funded. The point is, do you want a corporation to manage a program that has to last for generations when their motivation and structure is short term minded only? The recent bailouts of largest financial and insurance companies are stark proof that corporations have adopted riskier short term goals while paying their executives exorbitant salary that drained cash from these companies. It is almost impossible to trust private companies having this kind of mentality with long term investments that we depend on for our future. Corporations may want to promote their social responsibility but that is only marketing to help sell their products and services. The reality is, it is irrational to expect any company to act on behalf of the community or the country when their only obligation is to their shareholders. This is especially true of multinational corporations. Shareholders can now be anyone in the world. Of course there are philanthropic people out there but that is the exception rather than the rule and if push came to shove their first obligation is always the survival of the company (or their own self interests).
We have to be intelligent enough to separate out which things would be better managed by a government or by the private sector. Even more intelligent would be to create a formula on how the two entities can work together to come up with the best short and long term results. This is basically an engineering task. We can design a car to go very fast and get the short term satisfaction that it is wonderful how fast it goes. The long term consequence is the on busy roads going too fast is dangerous and that a braking system needs to be developed to match the power and speed of the car. This is a good illustration of how the amount of expected traffic should be a constraint on the car design and the braking system is designed to balance short term with long term realities.
Similarly a political system that depends on raising millions of dollars to get candidates elected plus allows intense lobbying by special interests can not be expected to serve its people well. The same kind of self serving short term thinking removes accountability from the individuals for long term systems that we depend on. Motivation is a key driver of behavior. (Principle #3) Accountability and transparency are the best constraints on behavior. If you remove either, political and financial systems get corrupted. Unfortunately, it is fairly evident that the US political system has been corrupted. Public opinion of the Congress is about 26%. I feel the problem stems from the way they get elected and are not held to account for the performance. So there is some truth that the U.S. government cannot be expected to manage important systems for the public, any better than a corporation as long as it is corrupted by special interests. The greed and lack of accountability has also showed that private corporations are no better than government nor trust-worthy.
So we are left with the dilemma that both the corporate structure and the government have inherent problems. So the debate should not be which is better, rather how can we improve the accountability and transparency of both? The public needs to have faith that these institutions are acting ethically and in the public’s interest. Similarly, we need to focus on the natural behavior of humans and find ways to motivate them to act in responsible ways. This means we should incentivize them to act this way. And punish those that don’t.
It will be repeated several times that the issues we face today are not limited to our country. The size of our economy has a major impact on the rest of the world. The world looks at the U.S. as some kind of massive experiment where they are never sure what will be the result. The relative percentage of the U.S. economy to the world is shrinking rapidly and has already gotten to the point where our position as a world leader is in doubt, especially if we look out ten years. The fundamentals of our country – manufacturing, finance, agriculture, commodities, exports and currency stability are significantly challenged by other countries where it was unthinkable twenty years ago. Therefore, the causes and solutions to our current economic crisis can only be found in a global context. The next topic illustrates why there are global implications to the current crisis.
It also illustrates another major consideration – the difference between a variable and a constraint. A variable is something that can be changed to solve a problem. A constraint is something that limits the possible solutions and is fixed. Trying to solve a problem by changing a constraint is irrational and a waste of time, energy and money. We will be much further ahead in any discussion we have on our economic problems if we recognize the constraints we live under. Then we can maximize our efforts by focusing on those variables that are available to us to solve the problems before us.
The Big Sucking Sound
There is a law of physics that describes what happens when you put to containers together each with a different amount of gas in each. Once connected the pressure of gas (the amount) will equalize between the two of them. The U.S. and other developed countries have relatively small populations with a high standard of living. The emerging countries have large populations with low standards of living. For years people from the emerging countries have tries to immigrate to the industrialized countries in order to have a better life.
The result is population pressures have created stress on the receiving countries on their services such as health care, security and education. This situation becomes more acute when the economy of the recipient country declines. The flow of people from one country to another is somewhat constrained provided that immigration policies are enforced.
Consider now what has happened with Free Trade. Suddenly the constraints of exporting goods and services are removed. Jobs and commodities move more readily around the world. Jobs valued in the U.S. are many times more expensive to a company than those in emerging markets. The natural and immediate reaction by any businessman is to move the jobs overseas as quickly as possible.
All I hear is the Big Sucking Sound of the U.S. Standard of Living going to Third World Countries. Gradual change and equalization was inevitable. However, what the advocates of Free Trade have created is an acceleration of the growth of China and India with their huge populations. The equalization is happening at a rate that is unprecedented and very disruptive. The flood gates are now open. There has been no control or constraint on it. U.S. citizens have found themselves in a very disadvantaged situation. Their standard of living and that of all industrialized countries are now at risk. Further, a backlash is occurring with protectionism on the rise.
People refer to exports as a variable to help us out with the local economic crisis. The inevitable deterioration of the industrial countries’ standard of living is a constraint. This should be obvious by the continual trade imbalances that the U.S. has with the rest of the world. Of course it helps certain industries and companies but in aggregate the trend is that we are not going to see that trend reverse. We may mitigate it to some degree but that is the best we can expect. The ironic truth is that we did more to help global poverty by instituting free trade than with all the charities and grants we have given to impoverished countries combined. The difference is that our standard of living was not impacted by past giving. Also, the past giving was a matter of choice. The current trade imbalances are systemic, institutionalized and not a choice. We have lost control over that situation. Therefore trade imbalances (standard of living deterioration) acts as a constraint to our ability to solve our own economic problems.
The size of the trade imbalances has a much more sinister impact on our country – the loss of control over our foreign policy. Unfortunate as it is, financial situations dictate behavior at many levels – personal, group, corporate, governmental and nationally. The more debt that China buys (as U.S. Treasuries) the more they have a right to dictate U.S. foreign policy. We subsequently have no one to blame but ourselves. Anyone that thinks that solving a financial problem by creating more debt is delusional. Simply the debt has to be serviced. If you can’t service the debt you currently have then how can adding more debt help? (Principle #4) – Live within your means!
Purpose of a Monetary System
A monetary system permits the exchange of goods and services without requiring a barter system. A currency is used in lieu of contracting a similar value in another form of goods or service. In order for a currency to work as another form of exchange, the currency itself must have some inherent stability and value associated with it.
Major chemical and oil companies actually do physical exchanges of goods on a regular basis without the exchange of currency. Say for example a shipment of ethylene is heading towards Europe owned by company A and another is docked in the US for company B. Both companies have customers in Europe and the U.S. The two companies agree to provide ethylene to their respective customer in the two different areas. This saves each company the cost of shipping to their customers in both areas.
Similarly, there has to be trust that each party will provide the goods as they agreed to do and in a timely manner. Any one breach of confidence might destroy the relationship to work with the other company in the future. The importance of trust in any monetary system can not be understated. The concept just described introduced characteristics of the trust relationship. One characteristic is the agreement of value. The other was timely delivery. Further, there may have been additional costs associated with company A’s delivery over company B’s delivery to service the customers in question. This added complexity means a determination of the cost difference must be calculated and agreed to for this one exchange (transaction) to occur. The negotiation may be between uneven partners in the deal. One might be more limited in their overall supply availability or the world market may be short anyway. The additional shipping cost might then be waived or additional goods might be used to offset the difference.
There can be no limit to the complexity introduced given different circumstances. However, once the complexity gets to be too much for either party they may as well do a regular buy-sell agreement and exchange currencies to execute the transaction. That is too simplistic! Time and securitization also complicate the situation. Countries that suffer high inflation rates understand this all too well. The currency will be worth less over time in an inflationary environment. An individual worked “x” number of hours and received an appropriate amount of currency for that work. Today the currency and the work associated with it could buy a one unit of some good or service. But the longer they hold onto that currency in an inflationary environment, the less the currency is worth and worse, the more their work was devalued. Let’s say that same individual went out immediately upon earning that same amount of currency and bought a contract to receive the goods at a later time. They in essence just secured the value of their work. They hedged their bets about the value of their work into the future.
Changing Demands on Monetary Systems
Regulators and government officials that have responsibility for the country’s currency can’t resist the temptation to use the monetary system for other things than the original intention. The act of printing money beyond a fixed currency supply causes inflation and the devaluing of work performed in the past. Pegging the currency to a commodity like gold constrained the ability of a government to create additional currency. This did not completely eliminate the ability to print additional currency because additional gold could be mined and stockpiled in the Treasury. Still this was too constraining. Most, if not all governments have removed the pegging of their currency to gold.
Once the printing constraint was removed, governments funded additional spending far in excess of what would otherwise be allowed. There has been so much deficit spending that there is very little correlation left between the currency and work performed. This raises a fundamental question, Should a currency supply be tied to anything?
What the world is left with is a struggle to determine which currency has the greatest stability. The U.S. has literally accelerated their deficit spending internally and their account balances with other countries. Frankly, it is almost irrational to believe that the world has any faith in the U.S. dollar any more. The only reason it does continue, seems to be – what is the alternative? Now we come to the reason for this book. We desperately need to find a stable global currency, one that cannot be manipulated for any particular national interest.
Building a Strong Foundation
The ultimate desire of everyone is to have confidence that their work today has the same value into the future. If people loose that confidence then they are de-motivated to work in the first place. The heart of a good monetary system is to act as a surrogate for work, which can be exchanged for other goods and services. Value is implied in the currency related to the type and amount of work performed. Distortions in the marketplace are caused by past events and the expectation of future events. These distortions are reflected in the currency of any one particular country, with the exception now of the European Union and the Euro.
In this case, the distortions are relative to the collective events of the countries that belong to the Union. This is particularly interesting. The net result of the formation of this cooperative Union is that the events of any one country is dampened (mitigated) and adds stability to the currency in the process. More interesting is the fact that now, no one country can manipulate the currency according to their own self interests.
The heart of the dilemma is in the reduction of control by any one government to a larger entity. The individual states in the U.S. could theoretically each print their own currency and control their own currency supply. There has not been any debate that this is necessary or desirable. So in essence the U.S. has 50 states that have agreed to cooperate to have a common currency, similar to what the European Union has now done. The model that the EU has formed provides for an expansion of this collective, whereby other countries can join their Union provided they agree to certain conditions and terms. Non-member states are anxious to join due the perception that they will greatly benefit by this arrangement.
If the U.S. was part of a larger collective of countries that had a common currency, then the U.S. government would not be able to increase the size of the deficit by printing money as they are now doing with the bailouts and stimulus packages. Protection of the currency’s stability is more important than the internal economic problems. This is not to say that the central bank can not do this at all but it has to be done in a more cooperative manner.