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November 2, 2007

A Review of The Age of Turbulence

Rand of course believed in the wisdom of the individual to act in his or her self-interest in ways that ultimately improved the lot of everyone, while Smith (in Greenspan’s words) believed that individuals “trading freely with one another following their own self-interest leads to a growing, stable economy.” Greenspan goes on to write that market perfection results from people “free to act in their self-interest, unencumbered by external shocks or economic policy.” What’s striking then is how Greenspan often strayed from this simple logic given his desire to tame economic growth along with markets he deemed frothy. If they’d been around to witness Greenspan’s time at the Fed, would Rand, Smith and Schumpeter have been fans of his work? Maybe not.

From the book’s introduction and well beyond, Greenspan frequently errs on the side of limiting individual economic activity; in particular arguing post-9/11 that excessive tax cuts “would overstimulate the economy and cause interest rates to rise.” The latter view, that growth is inflationary, and as such should be managed from Washington, is a major theme throughout.

Upon taking over in 1987, Greenspan felt the need to “raise rates soon” based on reports from other Fed presidents who said they were “seeing good growth, high optimism, and full employment—all reasons to be leery of inflation.” Apparently more oriented in Phillips Curve thinking than was assumed at the time, Greenspan justifies rate increases with his view that, “the long Reagan-era boom had maxed out: factories were full, and joblessness was at its lowest level in eight years.”

For a self-professed free trader and free marketer, Greenspan’s words seem strange and contradictory, and worse, speak to someone very much taken in by the prestige of his office such that he feels justified to opine on, and at times manage, the infinite decisions and inputs that were the marketplace. At various points in the book he writes of the happy process of globalization that leads to greater and greater work specialization through access to the worldwide labor force, yet in attempting to slow the Reagan economy, he reverted to thinking suggesting that the U.S. was isolated in such a way that perceived labor shortages stateside would somehow be inflationary. That inflation is always and everywhere a monetary phenomenon is never mentioned, because had it been, the folly of his actions would be more apparent. If it has any effect, growth serves to soak up excess liquidity, so that efforts to bring about “soft” economic landings if anything exacerbate real inflationary pressures.

Moving to the Clinton years, a large factor in Greenspan’s seeking higher rates in 1994 had to do with what he deems the Fed’s desire to be pre-emptive “before the economy had a chance to seriously overheat.” And while Clinton Treasury Secretary Robert Rubin had made plain to him that a federal official should never talk about the stock market in public, Greenspan aggregated to himself the role of stock-market commentator too. The most prominent instance of this is a speech he planned in the bathtub one morning which asked, “how do we know when irrational exuberance has unduly escalated asset values?”

If even the most skilled investors fail at times to understand markets, how could Greenspan have assumed he was somehow different? Worse, given Greenspan’s brilliant articulation of the Schumpeterian view that rapid economic change results in positive, efficiency-enhancing creative destruction, what purpose did it serve to distort this process with “soft landing” policies that by definition would have slowed the aforementioned change? In short, even if one accepted the flawed logic suggesting labor shortages can cause inflation, wouldn’t it be best to let the markets solve this problem through innovation (the ATM, the Internet, foreign outsourcing to name three) rather than with ham-handed governmental policies meant to put people out of work?

Greenspan points to the happy fall of communism and the subsequent addition of hundreds of millions of workers into the worldwide labor pool as a helpful factor when it came to keeping inflationary pressures down during most of his tenure. He adds that future central bankers won’t be so lucky once the world digests the formerly unfree workforce additions from the former Soviet Union, China and India.

But even there he violates the basic classical principle that supply is demand. While we’re very definitely the lucky beneficiaries of cheap goods from overseas, the reality is that there never can be a broad glut or dearth of goods such that the general price level moves at all. Workers offering up new goods will by definition be demanding goods (the price level thus remaining unchanged), and to the extent that workers save the gains from their output, those savings will merely fund the creation of new companies who will employ workers demanding goods from the world supply. In choosing to ignore the truth that all inflation/disinflation is monetary in nature, Greenspan further misrepresents what inflation actually is.

When it came to taxes and government revenues, Greenspan’s soul mate was George W. Bush’s first Treasury Secretary, Paul O’Neill. He and O’Neill agreed that when it came to tax cuts, there should be “tripwires” in case revenues fell substantially. Though he softly acknowledged the incentive/revenue effect of tax cuts, Greenspan fails to note that if tax rates are uncertain, there would be a chilling effect on economic actors such that the latter would be more reluctant to engage in profitable activity given the knowledge that rates could change at any time. So in a sense, the tripwires that Greenspan advocated would have been self-fulfilling for the certainty that they would have stimulated less in the way of production.

Greenspan’s assertion that “a sound budget will bring long-term rates down” made him very much at home with the “Rubinomics” crowd of the Clinton Administration, and sure enough, he says he “had an unusually fruitful and harmonious working relationship” with both Rubin and his successor, Lawrence Summers. Impressive company for sure, though it should be remembered that long-term rates actually fell amidst rising deficits in the ‘80s, that the 30-year Treasury was yielding 5.8% when the Clinton tax increases passed in ’93 versus an 8% yield by 1994, and that long rates rose during the surplus years only to fall again with the return to deficit spending in the new millennium.

Commenting on the Asian currency crisis of the late ‘90s, Greenspan reduces it to an inevitable event that came about when “shrewd market players who didn’t believe in the tooth fairy realized that the developing countries could maintain the fixed-exchange rate regime only so long.” No mention was made that his failure to accommodate the 1997 cut in the capital gains rate led to a rising dollar such that the aforementioned fixed exchange rates were made tenuous by his very own policies.

In much the same way Greenspan glosses over inflationary mistakes made at the Federal Reserve while discussing the rising oil price over the last few years. Foreign demand is once again blamed, while the truth that oil is up 190% in dollars since 2001 (versus 85% in euros) is never mentioned. Greenspan bemoans the lack of an inventory cushion and lagging investment on the part of oil producers as the other main reasons for expensive oil today, but never mentions how the gyrating dollar has made large petroleum inventories and heavy capital investment things of the past.

Seeking to explain the often secretive nature of FOMC meetings, Greenspan says that if the discussions were made public, the meetings would have become “a series of bland, written presentations.” Hard to argue with, but then maintaining a stable dollar should be a very bland process, which begs the question of why the FOMC would need to meet at all to maintain dollar-price stability. In Greenspan’s defense he merely inherited a position that had gotten too powerful, but given his free-market leanings, it would have been nice to have learned that once in power, he sought to greatly reduce the Fed’s mission. Sadly, he did not.

So while many will be disappointed to learn the extent to which Greenspan tried to manage the economy, worked against tax cuts, and generally glossed over mistakes of his own making, the Age of Turbulence is still very much a worthwhile read. Greenspan’s writing is very lively and insightful on a variety of subjects.

A strong free trader, tariffs in his view lead to the unhappy “reversal of the international division of labor.” Having lived a long time, Greenspan’s application of Schumpeter’s vision of creative destruction to manufacturing, communications and Soviet-era tractors was positively riveting.

Addressing our current-account deficit, Greenspan says he would place worries over it “far down the list.” Instead, he attributes its rise to a reduced “home bias” when it comes to foreign investment, along with the increasing worldwide specialization of labor that has enriched workers such that they have money to invest. Greenspan makes plain that the world’s “current account balance is zero,” and while U.S. companies may more and more be the recipients of foreign sources of capital, this affects “international balance-of-payments bookkeeping but arguably not economic stress.”

For gold-standard advocates, though, Greenspan suggests there is “no likelihood of its return” due to constant political pressures for cheap money, he acknowledges that he has “always harbored a nostalgia for the gold standard’s inherent price stability.” He also points out that “the average inflation rate under gold and earlier commodity standards was essentially zero.”

In a sense, his laudatory comments about gold are what made the Age of Turbulence most disappointing. While the book would suggest he targeted the economy to the detriment of the dollar throughout his tenure, Greenspan fingered the dollar price of gold as a major determinant in his conduct of monetary policy in a 1994 congressional statement, and from 1989 to 1997, gold fluctuated in a relatively tight range of $320-$400. It’s been said that Greenspan had us on an implicit gold standard during the ‘90s; and measured by the stock market, those were great economic times.

Whether or not he targeted a stable dollar, Greenspan’s reputation rose in such a way that he alone had the capital to tell Congress that the Fed should move in a new direction of not targeting the economy, and instead seeking a stable dollar price. He didn’t, and to some degree this could be explained as the certain result of his having morphed from sober central banker to “Maestro.” Maestros wouldn’t let “barbarous relics” be their guide, and partially to his discredit, the S&P 500 fell 13% from the time Bob Woodward’s book was released to Greenspan’s departure from the Fed. From the late ‘90s to 2006 when he left, the dollar/gold price became highly volatile as Greenspan tried to manage the economy while placing much less emphasis on the dollar’s singular value.

In a way, the prestige that accrued to Greenspan as a result of his previously good works put the future of central banking in a precarious position. Leaving no template for future Fed chairmen to follow other than engaging in the impossible task of guiding the economy, Greenspan’s account elevates the Fed Chairman’s prosaic role to one of prestige such that the vainer among us will surely aspire to the post in the future. As Bagehot noted, such men are dangerous.

November 19, 2007

Buffett's Estate-Tax Vision Isn't Charitable

Notably, the benefits didn’t end there. When Page and Brin founded Google, Stanford’s flush endowment, one funded largely by donations from its graduates, stepped up with a portion of the seed capital that they used to start the business. That Google’s creation was even a possibility is directly related to previous technological innovations that enabled them to build a computer-search concept that is presently a market behemoth.

Scientist Isaac Newton is well-known to have said, “If I have seen further than others, it is by standing on the shoulders of giants.” Today’s billionaire entrepreneurs, be they replicators or innovators, very certainly stand tall for what yesterday’s successes bequeathed to them in terms of knowledge and capital.

Buffet argues that in the last twenty years the tax-laws have helped the “super-rich” get richer, while “the average American went exactly nowhere on the economic scale.” Good rhetoric for sure, but the “super-rich” of today were for the most part not pictured in any snapshot of the super-wealthy 20 years ago. Proof of the latter comes from the latest Forbes 400, which showed that of its initial 400 members, only 32 remain.

Buffett suggests that we should re-phrase what some call the “death tax” to what he would term the “death present,” but rich and poor alike should not let Buffett’s revised definition confuse the issue. When we tax the surplus wealth of the rich, we put a bull’s-eye on the not-yet-rich. Those still eager to reach millionaire (or in Buffett’s case billionaire) status rely on the savings of others in the form of higher wages, plus when they seek to do as Brin and Page did and start a company, they rely on the savings of the Warren Buffetts of the world to fund their economy-enhancing ideas.

Too often today it’s said that the rich “give back” only when they hand over their money to all manner of charities. Taking nothing away from the obvious good that comes from charitable giving, even if both the new and old rich were to hoard every cent earned or inherited free of the greedy hand of government, they’d be giving back in spades for the certainty that their capital would serve as investment in tomorrow’s entrepreneurial ideas; ones that will potentially enrich tomorrow’s visionaries in ways that will make today’s wealthy seem small by comparison.

Though Buffett’s motives are perhaps pure in suggesting that, “We need to raise about 20 percent of GDP to fund the programs the American people want from the federal government,” and that we need to do this while removing the tax burden on those making less than $20,000 per year, in making this assertion he seems to be saying aid, rather than incentives, is what drives economic advancement. That the underclass he champions grew so substantially in the 1960s once government aid became a greater reality doesn’t seem to concern him.

Ignoring for now the often enervating impact of government handouts, to the extent that marginal rates of taxation on estates and income must rise to fund the governmental generosity he desires, they negatively impact the capital reliant economic advances that improve the opportunities of tomorrow’s entrepreneurs. Incentives matter, so any discussion of taxpayer-funded handouts should be analyzed in light of how long the productive class will work and reveal its income just to see it redistributed in unproductive ways.

Since new and innovative ideas are ultimately funded by capital and past advances, it’s almost tautological to say that the surest way to lift all boats is to remove the barriers to wealth formation that already exist. Done right, productive work effort will rise in a way that expands a capital and knowledge base that will allow the next generation to accomplish even more.

Wealth creation is ultimately the result of hard work and knowledge being matched with capital. So to the extent that Buffett is correct about the less fortunate being on what he deems a “treadmill to nowhere,” the surest way to halt such a trend would be to reduce the penalties on wealth in a way that would make more investment available to more people. Buffett could, of course, hand all of his wealth over to the federal government, but if he does, no one should mistake his actions for charity.

Fault the Fed for the Falling Dollar, Not Gold

This need for constant value in currency is the essence of gold’s relevance to the responsibilities of central bankers in 2007. As ever has been the case, people who use dollars the world over want to rely on its value constancy over extended periods. Yet, the dollar is at or near its lowest value in U. S. history relative to gold, and trust in the dollar’s stability appears to be waning rather than building as 2007 nears its end. This was not always the case, as for most of U. S. history the dollar was termed “honest” and “good as gold,” because dollars could, in fact, be exchanged for gold at a guaranteed price if the holder preferred to have gold rather than dollars.

For today’s users of dollars, which include people and governments globally, the absence of a link between the dollar’s value and gold is clearly apparent. The Federal Reserve and the U. S. Treasury regularly declare that the dollar’s value “floats” and is to be determined from day to day “by the markets.” In this environment, a rational person expects prices of goods and services to change inversely to the change in currency value. Still, Fed officials act surprised that their floating dollar causes changes in prices and wages, and they insist they are “fighting inflation” while managing the dollar so it loses value almost daily.

The Fed certainly does not use the unchanging nature of gold to provide stable value for the dollar. Banks, governments and central banks have done so throughout history, but the Fed has not since 1971. Instead, the Fed prefers to manage domestic interest rates. Doing so stifles competition among banks and costs borrowers more for credit, and it causes the prices of assets to rise and fall inversely as interest rates are manipulated. Worse, as the Fed moves interest rates artificially, it separately adds dollars to the economy without a reliable guide to the number needed for real growth. The result has been a volatile, rocky road to a devalued dollar, which has lost about 96% of its purchasing power relative to gold since 1971. In certain intervals, the Fed has added too few dollars, causing severe deflation and collapse of business and financial markets, as occurred in 1996-2002.

Some observers insist gold is an “ancient relic” unusable by contemporary central banks for any beneficial purpose. If that is true, then why does every major government and central bank hold so much gold? Surely gold must have some relevance to financial stability, because the U. S. Treasury holds about 8,000 metric tons in its vaults and declines to exchange it for dollars. With Treasury taking that stance, producers of crude oil and manufactured products in other countries could hardly be criticized for doing the same.

Others complain that gold is useful in monetary management only if gold mining produces precisely the same amount of new gold annually as all others produce in goods and services. Otherwise, they claim, the “gold standard” can only cause inflation (if too much new gold is mined) or deflation (if mining production falls behind), because gold-backed currency must be issued only in strict proportion to gold held by the central bank. These ideas are, in truth, the “ancient relics” of monetary theory. Like manipulation of domestic interest rates and other mercantilist theories, they are tied to the constricted thinking of the Middle Ages with much less excuse for being so.

Exchanging gold for currency through bank teller windows is not the one and only means by which gold might serve the interests of central banks seeking to achieve stable currency value. Gold may be used, for example, as the “measuring stick” of currency value rather than as the substitute for it. Gold can be looked to for its constant nature, and its value may be assigned by all market participants rather than by central authority. Since the markets presently determine that something more than $800 are equal in value to an ounce of gold, the Federal Reserve or the U. S. Treasury as a matter of policy can decide that the dollar ought to be worth $500/oz in perpetuity, and liquidity will be managed to achieve that end.

Under this policy, the markets would continue to determine the dollar’s value on a daily basis, and no stresses or dislocations will build. As events change the need for liquidity, the Fed can be confident in every injection or draining of liquidity that the policy objective will be met – the dollar will remain at $500/oz – meaning that all users of dollars can trust in that fair outcome. The currency grows in exact proportion with economic expansion and the demand for dollars, showing perfect elasticity without inflation or deflation.

In this mode, the Federal Reserve would provide every dollar demanded by the global economy at a uniformly stable value. Nothing more and nothing less should be asked of any central bank or currency.

With the return of the “honest” dollar would come elimination of “moral hazards” in the nature of expectations that large enterprises will be bailed out by the Fed if its financial undertakings prove unsuccessful. At the same time, however, such enterprises will no longer be caught in crises brought on by currency with unpredictable future value. That is a trade-off that every enterprise and worker ought to be eager to make.

November 24, 2007

Inside The Income Statistics

Since most of us get our income by earning it, it might seem that any difference between income and earnings would just be some technicality that only economists or accountants would bother with.

In reality, the difference can be huge, depending on the income bracket and the age of the individual.

Most of the income received by people 65 years old and up is not counted statistically as earnings. Only 24 percent of their incomes are earnings. Most of their incomes are from pensions or other sources known as "unearned income," such as returns on investments.

It should hardly be surprising that people who have been around a long time would have accumulated more money in the bank and maybe have a little nest egg in a mutual fund, each of which provides a stream of income during their retirement years, even if that income does not get counted as earnings.

Despite a drumbeat of political rhetoric depicting the elderly as being in dire economic conditions, the actual incomes of the elderly are more than four times what their earnings statistics might suggest -- or what politicians can claim, citing those statistics.

When it comes to wealth, the average net worth of people 65 years old and up is several times that of people under the age of 45. The highest average net worth in any age bracket belongs to households headed by people aged 70 to 74.

Although income is often confused with wealth, as when people currently in high income brackets are referred to as "rich," the elderly average lower income than middle-aged people, but more wealth.

Since 80 percent of the people who are 65 and up are either homeowners or home buyers, their housing costs tend to be lower. Among those 80 percent, their median monthly housing costs in 2001 averaged just $339 a month.

That includes property taxes, utilities, maintenance costs, condominium and association costs for people with such living arrangements, and mortgage payments for those who do not own their homes outright.

There are of course some elderly people who are poor, just as there are some poor people in every age bracket. But statistics cited by politicians, journalists and others who inflate the number of the poor need both scrutiny and skepticism.

The elderly are not the only people whose standard of living is grossly understated by those who cite statistics on earnings or income.

Those statistics do not include income received by low-income people as transfer payments from the government, such as welfare checks, much less various in-kind transfers, such as subsidized housing and subsidized medical care.

As of 2001, about 78 percent of the economic resources used by people in the bottom 20 percent of income recipients were in the form of either cash transfers or in-kind transfers.

To judge the standard of living of low-income people by income statistics is to leave out more than three-quarters of the economic resources used by them.

It is understandable that those who have either a political or an ideological vested interest in exaggerating the numbers of "the poor" would use statistics that greatly understate the standard of living of low-income people, as well as that of the elderly.

But that is all the more reason for the rest of us to be aware of what statistics do and do not mean -- and beware of those who want us to believe the worst, whether for their own political advantage or because that fits their ideological vision.

November 27, 2007

Economic Dichotomy in the Democratic Party

Tenets of Mercantilism

Three tenets of mercantilist economic policy are: (1) high tariffs (to keep foreign competitors out of domestic markets); (2) high marginal tax rates (to provide social safety net entitlements to those unemployed due to high tariffs); and (3) controlled domestic interest rates (to subsidize domestic production). These have been policy objectives of mercantilism since the 15th Century. They sound familiar because, in the 21st Century, they are central planks in the Democratic Party platform.

Call them populist, protectionist or Keynesian – these policies comprise the contemporary face of ancient mercantilism. They find broad political support among Democrats led by Senator Charles Schumer (D-NY) and occasional Republicans such as Senator Lindsey Graham (R-SC). For the past three years, these senators have threatened to impose a 27.5% tariff against Chinese products unless China’s central bank discontinues a more than decade-old peg of its currency’s value to the dollar.

Only two weeks ago, America’s new best friend in Europe, President Sarkozy of France, solemnly advised the U. S. Congress that the Fed’s severe weakening of the dollar threatens a global trade war. Sarkozy’s message is all too true, and reveals that currency devaluation is simply the other side of the protective tariff coin.

China’s Peg to the Dollar

Ordinarily, a foreign central bank’s decision to peg its currency to the dollar is the highest compliment (short of dollarization) that can be paid the Fed. A dollar peg means that foreign central bank is ceding its monetary policy to the Fed. Responding to the U. S. tariff threat in 2005, China dropped its dollar peg and began a process of allowing the dollar to devalue slowly against the yuan. While the yuan-dollar peg endured, it provided China currency stability with its largest market – the U. S. – an entirely rational motive inconsistent with “manipulation.” At the same time, America received a reliable source of goods at stable prices. The Treasury Department of the Bush administration professes free trade policy, but pressures China to accept dollar devaluation so as to avoid instabilities in global trade that might precipitate from Schumer’s China tariff.

Mercantilism’s Political Home

Tariffs and high tax rates did not always find political support in the Democratic Party. Mercantilism achieved its American resurgence during the one term of President Herbert Hoover. When Hoover allowed tariff protection for farmers to be placed in the 1928 Republican platform, Democrats were the party of farmers and free trade.

Republicans passed the Smoot-Hawley Tariff Act in the U. S. Senate by a two-vote margin, with only four votes provided by Democrats, producing the Great Crash of 1929 and 25% unemployment by 1932. Hoover then asked for increases in tax rates to balance the severe federal budget deficit Smoot-Hawley had produced. Democrats and Republicans in Congress obliged with a quadrupled lowest bracket and trebled highest bracket retroactive to January 1, 1932.

After Hoover’s two historically tragic errors, Franklin D. Roosevelt was elected president in a landslide and both houses of Congress went strongly Democratic in 1932. Inexplicably, rather than reverse Hoover’s wrongs, Roosevelt kept the tariffs, added excise taxes on imports, and raised tax rates every year except 1939 during his four terms as president.

From the inception of the Republican Party until 1932, mercantilism’s political home was there. From 1932 to the present, mercantilism has reached its greatest influence through the Democratic Party. Building on Roosevelt’s business relationships with Wall Street during his earlier career there, mercantilism found its new home among Democrats, where it remains today.

Keynes’ Assist to Mercantilism

In 2007, the Democratic Party remains devoted to Keynesian economic theory and rhetoric, despite obvious detriments to Democrat constituencies. Most egregious of all is outright Democratic support for Federal Reserve monetary policy designed to manipulate domestic interest rates.

In The General Theory of Employment, Money and Interest (1936), Cambridge University professor of classical economics John Maynard Keynes wrote that he had been misled in his youth to have no appreciation for the merits of mercantilism. Keynes undertook to fill an intellectual void by providing a theoretical model capable of advancing mercantilist objectives. He advised that governments should be preoccupied with achieving a positive balance of trade and controlling domestic interest rates. The latter objective could aid the former, Keynes opined, by subsidizing employment while protecting workers from “bankers’ whims.”

Mercantilism Rules the Federal Reserve

Riding Keynes’ advice while turning it on its head, mercantilists persuaded a Republican president, Richard M. Nixon, to place control of domestic interest rates in the hands of bankers at the Federal Reserve System. Nixon voided by executive order the money rule in effect under the Bretton Woods Protocol that had required the dollar’s value to be kept stable relative to gold. The dollar’s value henceforth would “float” in the market so the Fed could manage domestic interest rates.

Since that fateful decision, the dollar’s value relative to gold has dropped 96%. Intermittently (1980-1982 and 1996-2001), the dollar has soared to deflationary peaks, causing damage at least as bad as inflation by means even more difficult to detect. No one suffers more at the hands of Federal Reserve Keynesianism than traditional Democrats: the common people.

Fruits of Mercantilism

During periods of inflation, the Fed raises the funds rate to cause greater unemployment so workers will not have bargaining power to insist on higher wages to maintain their standard of living. Workers and the unemployed are most likely to own only cash rather than hard assets (such as real estate, equipment, etc.) that rise in price with inflation. Thus, inflation produced by interest rate manipulation hurts middle and lower income groups worse than those with greater capital and hard assets.

Deflation treats Democratic constituencies even more harshly than inflation. Deflation means the dollar’s value is increasing. This requires prices of products and services to be reduced, thus reducing revenues and profits. Lower profits mean less capital to invest in hiring workers and buying equipment that increases productivity (and wages) of workers. Marginal (sub-prime) workers are the first fired during deflation, just as they are the first fired during inflation when the Fed hikes interest rates.

Why the Fed Manipulates Interest Rates

With these economic scenarios so readily discernible, why does the Fed persist in its cyclical routines of hiking and cutting its “funds rate target,” while attempting explanations in only the most abstract and obtuse terms? There is no alternative answer: mercantilist influence.

Mercantilists benefit from the Fed’s manipulation of the funds rate in two primary ways. First, the funds rate “target” serves as a benchmark for all commercial banks by which they adjust interest rates charged on loans to their customers. This greatly relieves bank executives of the stress and strain of doing the same thing by a private arrangement in violation of anti-trust (price-fixing) laws.

Second, and importantly to investment banks and hedge funds, predictable moves of interest rates provide cyclical investment opportunities for those with closest knowledge of the Fed’s operations. As interest rates are ratcheted up, asset prices decline and collapse (the “buy low” opportunity). Then interest rates are cut, usually sharply, and asset prices rise (the “sell high” opportunity). Sitting on the boards that select Federal Reserve regional bank presidents, who meet with and sometimes vote on the Federal Open Market Committee, has its prerogatives.

Whence from here?

More difficult to fathom is how long Democratic Party faithful will continue their devotion to mercantilist objectives or, as it is contemporarily known, Keynesian economic policy. The common people benefit from jobs and an honest dollar, not from buying and selling opportunities. ~

November 28, 2007

Free Trade and the Rattling of Alan Blinder

Blinder argues that electronic innovations and the influx of Russians, Chinese and Indians into the worldwide labor force will lead to job destruction stateside, not to mention that this new competition from both humans and machines will “put a damper” on U.S. wages. In assuming this, he ignores the certainty that if U.S. industry did not access cheaper labor and machines, our wages would truly be low for the investment outflow that would result from our companies not operating in the most efficient way possible. That there exists an incentive to mechanize or outsource that which used to be done by American workers is a sure sign that the U.S. remains a magnet for capital such that foreign workers and machines are a cheaper option. We don’t lose jobs in the U.S. because our wages are falling, but due to the fact that we’re becoming more and more specialized such that our labor is more expensive.

Also not accounted for is the truth that when companies of any geographical origin pursue their specialty more inexpensively, the money they save hardly lies dormant. It either directly funds the creation of new job-creating concepts within the existing corporate entity, or, if saved, it is lent to other entrepreneurs whose economy-enhancing ideas are only limited by a lack of capital. Money saved means money for new, productive ideas.

Blinder opines that globalization means jobs in the fields of science and math will be offshorable in the future, but somewhat contradicts himself with the admission that we can’t “foresee exactly which jobs will go and which will stay.” Certainly not, but even if we could, this should not be a concern either way. Knowledge circulates with ease, and if scientific innovations occur overseas, Americans will be the immediate beneficiaries if our markets are open and free as Blinder believes they should be. Importantly, innovation without execution is only innovation. What Americans have proven time and again is their ability to grasp the significance of an idea, and build a business around it. We should heartily embrace scientific advances elsewhere knowing full well that the entrepreneurial spirit here will perfect those advances in ways that will be highly remunerative, and a source of new jobs and capital.

On what Blinder deems the “low end” of the labor market, he says economic advances will make “telephone operators, clerks and typists” superfluous. Aside from this being a wonderful development, Blinder seems a little bit late here. Nowadays most of us talk to voice-activated operators when we call all manner of businesses, while a computer age that’s long been with us has already destroyed copious amounts of jobs of the secretarial and clerk variety. He might have added that thanks to the proliferation of ATM machines, self-serve ticket kiosks at movie theaters, and the Internet, we now for the most part no longer deal with live human beings when we go to the bank, the movies or buy airline tickets. Life is cheaper and easier, and with labor being finite while jobs are infinite, U.S. workers continue to rise up the labor and wage scale thanks to past technological advances.

In citing certain legal and accounting disciplines that globalization will drive overseas, Blinder mistakes facilitation for true productivity. What he forgets is that in every society, there are producers and facilitators. Millions of Americans are employed in accounting and the law not because a truly free economy would need so many, but because in an economy burdened by an ever-growing tax and regulatory apparatus, lots of lawyers and accountants are a very necessary, but dead-weight cost to businesses. To the extent that this work can be sent overseas, the cost of doing business will be much cheaper here such that U.S. companies will become more profitable. We should heartily embrace an offshoring process that will allow more Americans to engage in truly productive work; work bolstered by new flows of capital seeking to invest in our growing profitability.

Blinder’s main solution to the job churn that has always been with us is for Americans to seek work that is harder to move overseas. If this is in fact possible, Americans would be wise to do otherwise. Again, without capital there are no jobs, and if workers seek what Adam Smith called “stationary” work free of the discipline that competition brings, they’ll soon enough be in jobs to which markets will attach a low value. Investors don’t pay for stable production, but for constant re-invention of work such that the productive process becomes more and more efficient. That the United States has evolved from an agrarian economy to one that is largely information-based is a positive rather than a negative. Indeed, rather than impoverish us, the job-destroying nature of machines and new labor-force entry has only served to make us wealthier, with a much higher standard of living.

Along the lines of the above, Blinder argues that, “we need to rethink our education system so that it turns out more people who are trained for jobs that will remain in the United States.” Ignoring for a moment his own point that we can’t “foresee exactly which jobs will go and which will stay,” if private economic interests can’t foresee with any certainty what professions markets desire, it’s a fair bet that our educational system, no matter its structure, will prove even less skillful when it comes to predicting how the economy will evolve. It is said today by many, including Blinder, that we don’t have enough engineers, but the fact that the Soviet Union produced ten times as many engineers as we did in the ‘70s did not arrest its eventual demise. Successful enterprise is that way for businesses meeting previously unmet needs and unknown needs. Unless governments or educational institutions possess a previously unknown hotline to the future, it seems folly to rely on either now.

Blinder also decries our “poor social safety net” that fails “to cushion the blow for displaced workers.” It could be said that a country like ours with plentiful jobs does not require robust unemployment insurance, but assuming the latter were more generous, it’s hard to make the case that this would create the necessary incentives for displaced workers to find new employment. Furthermore, the costs involved in creating a better safety net alongside the job-retraining programs he desires would have to come from somewhere; specifically from a finite capital stock that according to him must also fund “more spending on R&D.” He writes that we should avoid “letting ourselves get locked into ‘sunset’ industries,” but capitalism can once again never be stationary, and when economies boom, that’s when industries are most likely to be made obsolete by new entrants stateside and around the world.

Importantly, Blinder’s free trade instincts don’t so much have him decrying the future as much as he would like to warn us of an economic evolution that could be unsettling. History says his fears are overdone. That economic change is presently accelerating means that we should be optimistic about the higher living standards that will soon be within our grasp. Just as we all presently outsource to others here and overseas the creation of the food we eat, the clothes we wear, and the cars we drive, an expansion of the worldwide labor force will serve to make life’s necessities even cheaper, all the while expanding the range of goods we can access thanks to the greater economic specialization that will result, and that invariably accrues to the individual consumer.

The only risk here is in closing ourselves off to what’s ahead. If we do, the capital that has always cushioned economic change and made us more efficient will rapidly exit. Rather than outsourcing jobs, we’ll be the sad beneficiaries of low-wage insourcing from the countries that choose to embrace rather than turn away from the promising economic future before us.

About November 2007

This page contains all entries posted to RealClearMarkets - Articles in November 2007. They are listed from oldest to newest.

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