Current Commentary

A fundamentally revolutionary economic theory

I’m in the midst of working on my own economic theories/beliefs system.  Much of economics is a cut and dry science, but much of it is a values-based pseudo religion.  I see programs like Cash for Clunkers, welfare-style transfer payments being called “stimulative,” and even talk of bulldozing housing to drive prices higher and it is clear that our goals are wrong.  The chief mission of the Federal Reserve Board is full employment and stable prices.  I contend that, if we really think about it, we want neither.  What we really want is minimum employment with maximum prosperity. Tthink about it: you don’t want to work, you want the goods and services that your work allows you to purchase.  Leisure time is actually what makes most people the happiest, yet people sacrifice great amounts of leisure time in the traditional “full employment” model.  We also want falling prices.  Deflation is good.  Falling prices are the natural result of increased productivity brought about by improvements in technology and actual, real progress. Monetary policy manipulation keeps prices artificially high and that combined with multiple levels of bureaucratic red tape, inane regulations, and multiple government agencies and actions necessitates the “full employment.”  I contend that in the absence of monetary policy manipulation and most government rules and regulations, we would trend to an economy marked by relatively high wages and low prices where the average person could support himself comfortably on a 2-3 day work week.  The labor force would migrate away from “non-essential” and certainly non-beneficial productivity to essential/beneficial productivity, and that would lighten the workload for everyone involved in essential/beneficial productivity.  Another contention I have is the over emphasis on GDP; it’s a measure of output, not a measure of wealth. That’s why destroying stuff that works can lead to an increase in GDP even though no one is really any better off.

Jobs are not scarce resources, qualified labor is.  Jobs are easy to create; valuable output, not so much.  No one is any better off if -- as Keynes advocated in extreme times -- you pay a man to dig a hole and fill it in again.  The concept is definitely different, but very much rooted in common sense. The idea is based on thoughts I had after a group camping trip of 25 people total where only 7 were engaged in essential-to-the-camp activities such as fire building, cooking, and cleaning.  In a nutshell, I’m no worse off and the camp is no worse off if someone who had been sitting on his ass drinking beer gets off it and helps me chop wood.  The only thing that happens is we get more wood with a fresh set of hands, and I get more leisure time.  I wrote about it back in 2007, and I'll reproduce here what I wrote earlier.  Bottom line:  We have no chance of real peace and prosperity if we keep aiming at the wrong targets and basing all of our actions on hugely flawed foundational theories.

Here is what I wrote in 2007:

Monday, October 26, 2009

How can a 2% increase in the unemployment insurance rate put companies out of business?

Today I got a letter from DLLR (Department of Labor Licensing and Regulation) telling me that, because of increased filings and costs, my unemployment insurance (UI) rate will be increasing to 2.2% in 2010.

I'm getting off lucky: the letter says that some other employers will have their rates increased to 13.5%. The increase is based on my 2009 rate of 0.9%, but my 2009 rate was 3 times my 2008 rate of 0.3%. I'm a small company; I've never laid off or even fired anyone so I get the lowest possible rate. (A few years ago I raised the bar and had a bunch of people quit on me, and I took an independent contractor off a website development, but I've never fired or laid off a W-2 employee.) Companies that have fired or laid off people and have UI benefits claims get the higher rates. (Hint: If you are ever fired, don't sign anything that your employer asks you to sign because it is a CYA form that your employer will use to try to deny your UI claim.) 

But back to the question: How is such a small increase going to cut my profits by at least 10%? Payroll is my #1 cost, making up a little more than half of my total costs. My actual profit margin floats around 5-10%. This means an increase in payroll costs of 10-20% would put me completely in the red (10-20% of half=5-10% of the whole). It also means that a 2% increase in payroll costs will cut my profit margin from 5-10% to 4-9%. That's a 10-20% reduction attributed solely to the UI rate increase. 

So what does that really mean? It means 10-20% less growth. 10-20% less new hiring. 10-20% less new equipment purchasing. 10-20% less savings (remember that one man's loan is another man's savings). What does it mean to a company that is already at break even? It means the company is now in the red. What does it mean to a company that is already in the red? It means the company is now giving very serious consideration to closing up shop and laying off EVERYONE. The magic of the payroll tax is that it taxes GROSS PAYROLL, NOT NET PROFITS and thus can push a company on the edge over the edge, or drop an anvil on a company that already has fallen. 

Does anyone know anyone who has been on unemployment for an extended period of time and admitted that if it were not for their UI benefits they would be looking for a job harder? I do. Does anyone see an Atlas Shrugged parallel here? I do. 

What ever happened to personal pride? I remember billionaire Ross Perot saying he'd cut grass before he'd take a handout. I have to agree. I'd push a lawnmower and knock on doors, rent my entire house out and move into my own basement (backyard if need be), eat Ramon Noodles every night, and sell everything I owned before I took a handout. So much has become so big and so faceless that I guess people don't stop and think of who is actually paying for it. How many people are getting foreclosed on with 50-inch plasma screens, a closet full of fancy clothes, cable TV, internet access, and cell phones? How many people are drawing some sort of government check with the same?

Friday, October 23, 2009 

'Pay Czar caps bailed-out banks' pay':
the story behind the headline

(from Yahoo news)

While I'd commend it as a good start, the story coming out leaves much to be desired. It's a political cover to attempt to quell populist furor. 

First, it only applies to the most bailed out companies -- BOA, Citi, AIG, Ford, GM, Ford Credit, GM Credit. This 100% DOES NOT APPLY to every other company that received public money. 

Second, GOLDMAN SACHS and their top heavy $700k/employee average 2009 pay is 100% exempted from this. Why? Because officially Goldman didn't get much public help. Goldman got their bailout money from AIG who of course got it from the public so the Goldman boys can say with a straight face they didn't get public help when counter party contracts they had with AIG that would have been worth somewhere between ZERO and 10 cents on the dollar in the event of an AIG collapse got paid at 100 cents on the dollar. About 12 billion dollars of the AIG bailout went straight into Goldman Sachs. 

Finally, with the exception of the dirty AIG division that was directly responsible for most of their Las Vegas style credit default swaps and derivatives who are capped at $200k, bank execs will still be making in the millions. Ken Lewis is going to make a 50 million dollar pension courtesy of Joe Taxpayer. 

I recognize that the subject of having the government control and cap pay at private is quite sensitive. While normally I would never support such a thing, given the fact that -- for all practical purposes -- these are no longer private companies, it needs to be done, and more of it needs to be done than is happening now. The first mistake was to bail these guys out, but to allow them to make millions on the taxpayer dime compounds the mistake and the extreme immorality of it.

Thursday, October 8, 2009

Is gold's price rise a speculative bubble,
or is it fundamentally supported?

Some key historical points on gold, summarized from this data.

1833-1932: FLAT at about $20/ounce.
1932-1934: doubled to $35/ounce.
1934-1971: FLAT at about $35/ounce.
***Then, in 1971, Great Britain was told "no" when they tried to trade in 3 billion USD for the equivalent in gold, and there was the collapse of Bretton Woods.***
1971-1980: increase by a factor of almost 25, to a high of $887.
1980-1982: cools off by half to about $400.
1982-2002: FLAT at about 300-400.
2002-2009: 400-1000.

Interesting additional facts:

• The US government has approximately 260 million ounces of physical gold reserves.
• The Chinese government has approximately 1 trillion dollars of USD reserve currency.
• If we returned to a Bretton Woods system, gold would have to trade at $3800/ounce just to satisfy China. Throw in Japan and the oil exporting nations, and the figure quickly approaches $10,000 per ounce.
• There is an argument that the REAL 1980 inflation-adjusted high is more around $5000-$6000 per ounce as the often reported $2400 inflation adjusted high-inflation adjusts using the often questioned CPI.

Key points to take from this summary:

1. When there is a real loss of confidence in the dollar, gold has a relatively recent (modern day, post WW2) precedent of moving exponentially.
2. Even if you got in "late" in the 1970s and bought at 3-4 times the price it started at (buying at 100-140) and then sold way after missing the 1980 high, you'd still be doubling or tripling your money at $300/ounce.
3. Excluding the 2002 to present run up, prior big gold moves have coincided with extremely high inflation (technically reflation in the 1930s).

The ultimate, bottom line conclusion boils down to this: If you think the Fed is somehow going to avoid severe 1970s-style inflation or worse, then gold is an overbought, speculative market primed for collapse. On the other hand, if you believe as Friedman said that the real effects of inflation are felt sometimes a year after the monetary policy that creates it and the dollar's reserve currency status will be a resistance to inflation but not a certain vaccine against it, then gold still has a long way to go.

I happen to think we will experience severe inflation and therefore gold is still a good buy because, to quote Edward Harrison, "There is only one direction the government is headed: increase asset prices."

[Published at seekingalpha.com.]

Friday, October 2, 2009

Moore's 'Capitalism':
right diagnosis but wrong prescription

Michael Moore capitalizes on our current economic malaise to launch a broad attack against capitalism in general and close out his film with a full fledged endorsement of socialism. While many of his complaints about banking and insurance are spot on, his failure to distinguish them from the good parts of capitalism and his failure to identify the real primary causes of our current problem have the potential to march some lemmings off a cliff. Spoiler warning for anyone who reads further: I saw this movie last night at the Charles Theater (for FREE). 

Moore spends much of the movie railing against derivatives, credit default swaps, questionable types of insurance, and the public bailout that capped it all. He also points out how for about a decade our best and brightest were financial engineering instead of real engineering, and there was an immeasurable loss to productivity and humanity by having smart people figure out exotic finance rather than curing cancer, creating cellulosic ethanol, or working with cold fusion. These are good and valid points. We can all agree that taking money from those with median incomes of 45k and giving it to those who are millionaires is wrong. As to how we got here and as to the suggested solution, Moore is clueless, but so are many people, so allow me to enlighten you. 

We got here principally because of three legislative acts. These are three legislative acts that can be undone, but no one in any position of power is talking seriously about undoing them. I will first concede that, as with any complex problem, there were many causes, but the following are the three primary causes: 

(1) In 1973 the SEC revised its capital rules for broker-dealers. The revision mandated that any firm dealing in securities (fancy word for bundled loans) had to get them rated by a rating agency and if they didn't they would be penalized by not being able to do as much business as a firm that did get their securities rated. The SEC then went on to say that to get a qualified rating it had to come from one of five existing companies at the time. Those five have since consolidated to three: Moody's, Fitch, and S&P. This effectively barred any new ratings agencies from forming and turned the existing five into a government sponsored oligopoly (small group of monopolies). It also made the ratings that those agencies assigned critical to investment banking. Today the ratings agencies run 50% profit margins, a margin unheard of in any competitive market and clearly indicative of a monopoly. The bogus AAA ratings given to bundled garbage were absolutely necessary to get the big institutional money from pension funds, insurance companies, 401ks and sovereign wealth funds, most of which are BARRED from investing in anything not rated AAA. Were it not for the bogus AAA ratings, this would have been an interesting academic study, and probably even made front page for a while, but would not have been a black swan or six-sigma event. [A six-sigma event is characterized by a price drop of six times the volatility (or standard deviations) of the asset.] Competing ratings agencies must be allowed. Further, the payment structure must be reversed. Currently ratings agencies are paid by the company that comes up with the securities. This is a HUGE conflict of interest. They must be paid by the company buying/investing in the security.

(2) The repeal of the Glass-Steagall Act in 1999 allowed the bank you have your checking and savings account at to get involved in the risky securities ratings that agencies rate. From 1933 to 1999 this was disallowed for the very reason that we have witnessed: allowing traditional depository banks to expose themselves to that much risk exposes the average person and the entire economy to too much risk. Glass-Steagall MUST be restored if there is to be any hope of real change and preventing this from happening in the future. 

(3) The Commodity Futures Modernization Act of 2000 turned Wall Street into a Vegas Casino. It too undid a long standing law that barred banks from highly risky/questionable activity. From 1907 to 2000 there was no such thing as a credit default swap or a modern derivative (they had been allowed for future agricultural delivery contracts). I will repeat: 
FOR 93 YEARS THERE WAS NO SUCH THING AS A CREDIT DEFAULT SWAP OR A DERIVATIVE.

They weren't regulated; they were illegal, as they should be. The majority of the CFMA 2000 must be repealed, but there is no talk of this. There is only talk of how to regulate CDS's and derivatives. That's like talking about how to regulate fraud and deceit. You don't regulate such activity; you ban it outright. 

The movie closes with some powerful scenes of Chicago factory workers having a successful sit in, and some former homeowners in Miami who broke back into their foreclosed home, had the bank come out to repo it again, had the cops called out, and a huge group of community protesters turned them all away and reportedly the family is still in the home 8 months after the fact. It then goes on to endorse FDR's "Second Bill of Rights" which would have guaranteed a job with a living wage, freedom from unfair competition, a home, medical care, education, and recreation. FDR died less than a year after proposing this, and then Truman took over. While everything on the list is quite noble, the logical and difficult question is from whom do you take to make it happen and how do you take it from them? 

It is deeply concerning that there is no discussion of reforming the ratings agencies, restoring Glass-Steagall, and repealing the CFMA 2000. A few million people will form their opinion of what went wrong and how to fix it after watching Moore's movie, and I fear the actions that could result. Moore makes a good point that a significant portion of government is controlled by big business and also acts in the interest of big business. The corollary to Moore's good point is that undoing two relatively recent laws that passed at the behest of big business would be a logical start for getting back on the right path.