12/2/12

US Economic Growth


US Economic Growth

Economic growth—basically, increasing sales per person[1]—underlies improvements in the standard of living. Technological innovation is the primary driver of economic growth today, particularly in developed countries with stable or declining populations. [2] As a recent World Economic Forum report concludes, “In the long run, standards of living can be enhanced only by technological innovation.”[3] This is good news for the US, which has long led the world’s technological growth, and remains in excellent position to continue its economic growth through technological innovation.
For most of human history population growth was the primary driver, because as the ancient Greek writer Xenophon observed, with more people there can be more specialization, and “[o]f necessity he who pursues a very specialized task will do it best.[4] Although fortuitous discoveries and transfers of information sometimes also boosted growth,[5] the long-term rate of economic growth in pre-industrial societies remained gradual at best.
European growth rates quickened with the Industrial Revolution, starting in the late 18th century. Steam and, later, electric power triggered many innovations. There was a flood of new goods—railroads, threshing machines, refrigerators, etc.—and of new manufacturing processes that sharply reduced costs by simplifying labor, substituting machinery, or having machines perform previously inconceivable tasks. Such changes rendered traditional cost structures and productive capabilities obsolete, and produced a cornucopia of new or newly affordable goods.
The Industrial Revolution also made manufacturing and commercial exchange the dominant sectors of modern economies. Technological innovation proved crucial for their profitability and economic survival,[6] as well as for military power.
Underlying technological innovation were growing communities of scientists, engineers, and mechanics who employed scientific discoveries that had been accumulating since the days of Galileo and Newton. Accordingly, by the late 19th century businesses, universities, and militaries in advanced nations built new institutions, or expanded traditional ones, to train scientific personnel and perform research: institutes of technology, research laboratories, secular universities, night schools, and vocational schools.
But technological innovation alone cannot generate economic growth. To increase sales, innovations must be desired, and those who desire them need purchasing power to buy them. Only the combination of desire with purchasing power, known as economic demand, can turn technological innovations into economic growth.
In other words, there are three ingredients necessary for economic growth: technological innovation, a desire for that innovation, and the purchasing power to buy it. The US is extremely well situated to supply all three.

Technological Innovation

As of recent reports, the US has as many people with a college or higher degree as China, India, and Russia combined, 26% of the world’s total.[7] The US also continues to enjoy a substantial influx of science and engineering students, of whom more than two thirds remain here 10 years after graduation.[8]
More than 700 US universities do serious research at a 2009 cost of $54 billion.[9] US corporations employ more than 800,000 scientists and engineers, primarily in the US.[10] Of the top universities in the category of Engineering/Technology and Computer Sciences, ranked by papers published or cited in major scientific journals and number of Nobel or Fields medalists, the US has the top 15 universities, 20 of the top 25, and 52 of the top 100, and 154 of the top 500 universities in the world,[11] only 4 fewer than Japan, Germany, the UK, France, China, and India combined.[12]
The US spends a third of all the R&D expenditures by countries spending $1 billion or more, and at $405.3 billion US R&D expenditures exceed those of China, the second largest spender, by 260 percent. In aerospace and defense, US public and private R&D will total $88.8 billion in 2012, compared to $26.2 billion for the rest of the world. US R&D for defense alone exceeds total R&D expenditures in every other country but China, Japan, and Germany.[13]  In energy R&D, US public and private spending in 2012 will be 37% of global spending, in life sciences R&D, 49.7%, in information and communication technologies, 58%, and in chemicals and materials 27.5%.[14]
Although most US expenditures on R&D come from the private sector, unlike many other countries, even in governmental R&D the US predominates. The National Science Foundation’s annual report, Science and Engineering Indicators: 2012, which uses 2009 data on government expenditures estimates that US governmental R&D expenditures totaled $164.3 billion in 2009, compared to $110.2 billion for the EU, and $31.1 billion for Japan. Totals for China were unknown.[15] As I think this small selection of statistics clearly indicates, the bottom line is that the US R&D effort remains far greater than any other nation’s, and remains by far the largest in the world.

Demand

The Industrial Revolution’s preeminent current historian Robert C. Allen states, “the frenetic pursuit of income to buy novel consumer goods, many imported from abroad as the [British] economy globalized in the seventeenth century, was a cultural basis of the Industrial Revolution.”[16] In other words, the Industrial Revolution came in response to economic demand. Economic demand consists of desire coupled with purchasing power. Marketing is the discipline of stimulating desire; finance, of generating purchasing power.

Desire

Marketing creates desire by shaping innovations to maximize their allure, introducing them to potential buyers, communicating their value, and alleviating concerns that might inhibit their sale. Modern marketing uses a well-developed infrastructure for advertising and promotion, and increasingly uses technology and statistical tools to gather, organize, and analyze information about potential consumers.
As the leading market in the world since the end of World War I, if not before, the US has long since built a huge and highly sophisticated marketing sector. It is safe to assume that unlike many smaller, less developed, or more highly regulated markets, the US has long trained and deployed a plethora of highly skilled marketers, primarily US firms. No data directly indicates US superiority in marketing, but there are certainly indirect indications. For example, the US appears to have many more business schools, most of which stress marketing, than any comparable region. The Princeton Review lists 296 US business schools, whereas the Financial Times’ listing of European business schools includes only 75.[17] A ranking of the top 200 business schools in the world includes 82 in the US, 67 in Europe, and 36 in Asia and the Pacific. Rated by their marketing programs, this ranking lists 8 of the top 10 as US schools; 14 of the top 20; 18 of the top 30, and 22 of the top 40.[18] In other words, US capabilities in marketing are clearly equal if not superior to those of any other nation.

Purchasing Power

Any valuable widely acceptable as payment constitutes purchasing power. Today, it’s usually cash, of which central banks usually maintain a consistent supply, or credit, whose supply is quite variable. Credit is the purchasing power provided in return for a promise of repayment, and in developed nations now constitutes most of the purchasing power. It comes in various forms, including goods furnished on account, secured or unsecured loans, and equity investments. The cost and availability of credit depends on creditors’ trust in repayment, which means that the quantity of purchasing power likewise depends primarily on the trustworthiness of promised repayment.
 The financial industry arranges most credit transactions, and in the developed world has steadily improved systems for making promises of repayment trustworthier. These improvements have included advances in the rule of law; better processes for finding, securing, and if necessary taking possession of property that has been pledged as security; increasing the types of property that could be used as security by developing markets where such properties could be valued and sold; and the systematic gathering of information about borrowers.
Recent financial innovations, many based on computer power, have greatly increased the trustworthiness of repayment promises. Credit cards are a US mid-20th century invention based on rapid and easy communications, computerized systems for evaluating credit records, and more sophisticated understandings of credit portfolios. New financial understandings like portfolio theory and how to value options, new credit instruments, and ever-expanding information systems have further assured repayment, or allowed investors to protect against perceived risks.
These financial creations have supported a considerable expansion of credit in recent decades, one that has helped finance technological innovation through venture capital, and provided purchasing power to those who desire the fruits of that innovation.[19] In this way, purchasing power grows apace with technological innovation, supporting the demand that drives economic growth.
As with technological innovation and marketing, the US has long been a world leader in finance, and seems well positioned to continue providing the purchasing power necessary for economic growth from innovation. The US financial system is the most fully developed in the world, with by far the largest number of commercial banks.[20] At the end of 2010, the capital value of US credit securities, both debt and equity, was $67 trilliion. Western Europe’s market capitalization was, by the same measure, $63 trillion, while China’s totaled $16 trillion.[21]  In the area of venture capital and private equity, however—the type of credit most oriented to innovation—a list of 50 leading private equity/venture capital firms, which “control the bulk of all capital committed to private equity,”[22] indicated that those in the US raised $548 billion for investment purposes during the preceding 5 years as compared to $251 billion raised by those based elsewhere. The fact that US firms control 68.5% of the money raised indicates the overwhelming nature of the US advantage in venture capital.

Conclusion

The concept of technological growth that underlies my optimism about the US economic future derives from my study of ancient business history, particularly the astonishing story of classical Athens.[23] This great city-state, known as the cradle of western civilization, was a dirt-poor town until about 600 BC. It had a barter market on the Acropolis, and some silver mines, but most Athenians were sharecroppers who produced only enough food to subsist after paying a fixed rent to clan leaders.
Soon after the nearby Anatolian kingdom of Lydia pioneered coinage, however, this technological innovation began to enliven the Athenian market. Coins simplified sales, sped up transactions, and gave everyone better information about prices. The market became more central to Athenian life and attracted traders selling previously unknown goods. A desire for these appealing foods and wares motivated many Athenians to increase their purchasing power by working harder, having fewer children, devoting food-growing land to cash crops like olives and grapes, and sending young men into mercenary service in foreign wars.
Democracy, although limited, prevented the aristocrats from capturing all of the resulting purchasing power. As ordinary Athenians gained wealth they deposited cash with bankers, who could consolidate many small savings into commercial investments in ships and trade goods as well as consumer loans. Trade increased wealth further, allowing this small city-state to bequeath us a legacy of great literature, magnificent sculptures, and beautiful monuments.
As with coins, technological innovation has generated economic growth in advanced modern nations, especially the US, and the growth has occurred much as it did in Athens. Innovation stoked new desires. To satisfy those desires, people pursued purchasing power. Democracy protected them from rapacious elites, so that the resulting wealth got widely distributed. My suggestion here is that with the now deliberate pursuit of technological innovation we are excellently positioned to continue economic growth into the future. To be sure, the current mal-distribution of wealth in the US and other countries calls the wide distribution of benefits into question. But if democracy does prevail, we should continue to enjoy robust economic growth.


[1] The measurement is “the total of spending on finished goods and services within that territory over the course of a period, plus the net of exports and imports.” See Bureau of Economic Advisors, “A Guide to the NIPAs,” p. 5 http://www.bea.gov/national/pdf/nipaguid.pdf referenced July 19, 2012. We usually speak in terms of “real” or “chained” GDP, using the inflation-adjusted value of money. Thus, GDP as of January 1, 2012 stood at $15.468 trillion, whereas “chained” GDP was $13.429 trillion. For GDP see Federal Reserve Bank of St. Louis at http://research.stlouisfed.org/fred2/data/GDP.txt, For chained GDP see http://research.stlouisfed.org/fred2/series/GDPC1?cid=106
[2] As when the ancients learned to make iron tools, military expeditions and traders found new agricultural stock, Archimedes invented his pump, Roman engineers created deep soil plows, and European colonists unearthed new goods and treasure.
[3] Sadly, the rapidity of these innovations and the political power of creditors and financial intermediaries have allowed irresponsible and unscrupulous financial behavior to do great harm. But such wrongs are no more inherent to finance than lawlessness was inherent to the west during its frontier days.
[4] The Origins of Business, Money, and Markets (Columbia University Business School, 2011)


[5] World Economic Forum, The Global Competitiveness Report 2012-2013, p.7. See also Table 2: Countries/economies at each stage of development, p. 10
[6] World Economic Forum, The Global Competitiveness Report 2012-2013, p. 7
[7]  quoted in Finley, Early Greece, 135
[8] David C. Mowery, Nathan Rosenberg, Technology and the Pursuit of Economic Growth, 1989: Cambridge University Press, p. 37
[9] Fig. 3-49, National Science Foundation, National Center for Science and Engineering Statistics, Science and Engineering Indicators: 2010, available at http://www.nsf.gov/statistics/seind10/c3/c3s5.htm
[10] Ibid.
[11] The Center for Measuring University Performance, The Top American Research Universities, 2011 Annual Report, available at http://mup.asu.edu/research.html
[12] National Science Foundation, op. cit.
[13] Shanghai Ranking Consultancy, http://www.arwu.org/FieldENG2010.jsp
[14] op. cit., http://www.arwu.org/ARWUStatistics2010.jsp
[15]  “Battelle R&D Magazine Annual Global Funding Forecast Predicts R&D Spending Growth will Continue While Globalization Accelerates,” http://www.battelle.org/media/news/2011/12/16/battelle-r-d-magazine-annual-global-funding-forecast-predicts-r-d-spending-growth-will-continue-while-globalization-accelerates
[16] Ibid.
[17] Ibid.
[18] Robert C. Allen, The British Industrial Revolution in Global Perspective (2009), Cambridge University Press.
[19] http://rankings.ft.com/businessschoolrankings/european-business-school-rankings-2011
[20] QS Global 200 Business Schools Report 2012, at http://www.topmba.com/mba-rankings/global-200/2011/region/asia. This ranking rates schools on a variety of characteristics.
[21] As of July, 2012 the US had 7,246 bank and thrift firms with $7.5 trillion in outstanding loans (including international loans). FDIC, Statistics at a Glance as of June 30, 2012, http://www.fdic.gov/bank/statistical/stats/2012jun/industry.pdf A fairly comprehensive list of all the banks in the world, not including thrifts, totals 1,290 banks. Of these approximately 93 are in the euro zone, and most of the rest are US banks. See Allbanks, “Banks of the World, at http://www.allbanks.org/main/list/
[22] McKinsey & Co., Mapping global capital markets 2011, Exhibit E2, p. 6 and Wikipedia, “List of Countries by GDP (nominal), List by United Nations.
[23] Dealogic, The Largest Private Equity Firms in the World: Anatomising the impact of the PEI 50,” http://www.peimedia.com/productimages/Media/000/179/537/Sample_pages_PEI50book.pdf

7/24/12

Class War

The NY Times head for its National section today (July 24, 2012) tells it all: "GOP PLAN WOULD RAISE TAXES. Senate Republicans will press a plan to extend tax cuts for affluent families scheduled to expire Jan. 1, but allow a series of cuts for the working poor and the middle class to end."

I am currently reading Francis Fukuyama's excellent The Origins of Political Order in which he describes the recurring struggle in China between aristocrats and commoners. Anyone familiar with my book about The Origins of Business, Money, and Markets will recognize the same pattern as it befell the late Roman Empire. A powerful central government bases its legitimacy on popular support. But elites gradually capture the government, and extract favors and exemptions from common obligations. The government ends up helping them gain power over the rest of the population, using it to impose onerous burdens and restrictions. In the end, either revolution or invasion destroy the weakened central government, and a period of chaos and warfare follows until a new cycle begins.

7/9/12

Corporate Crime

I agree with Mark that "draconian and emotional responses to these problems [of corporate crime], if allowed to take hold, will lead to explosive collateral damage and far worse problems in the future." But I am not proposing either draconian or emotional responses. Nor am I suggesting RICO prosecutions.


When I speak of corporate crime, I am speaking as a lawyer, and I mean behavior that has been defined to a constitutionally valid degree of clarity, declared to be criminal through legislation or judicial construction, and punishable in proportionate and suitable ways if guilt is found under the normal "proof beyond a reasonable doubt" standard.


In a corporate case, whilst the standard of proof is the same as for individuals, what we mean by intentionality, and how we show it, may well be different. The difficulty in prosecuting corporate officials has been in showing that they actually knew that decisions they made within their scope of responsibility would result in crime. To know about the decisions does not go far enough; for conviction, the prosecutor must show that they knew about the criminal result. And proof of that knowledge has been very hard to collect. Indeed, serious doubts have been raised even about the convictions of Enron's leaders.


On the other hand, convicting an organization would not necessarily require showing guilty knowledge by any particular person. Take, for example, a bribery case. Megacorp wants to drill for oil in Xistan, and hires a consultant named Smith. Smith helps the oil minister's son get admitted to Eton, and consultant Jones pays his tuition there. At some point during the boy's first year, Megacorp gets the concession. Smith and Jones were independently on retainer to Megacorp, but each claims that Eton was merely a favor for an old friend. There's no evidence to the contrary. Could either of them be convicted of violating the laws against bribery? Probably not. Could any Megacorp executive? No. Could Megacorp itself? Possibly yes. It paid money to Smith and Jones. They were its agents, seeking the concession. They did favors for the oil minister, and Megacorp got its concession.


Mark properly notes that the misdeeds of Enron's higher level executives cost nearly 100,000 people to lose their jobs. That is a result to be avoided. Would it not have suited the Enron case better to order the corporation to withhold bonuses and stock options from the "C" level executives there for a period of years? Or to have devised some other punishment that would fall on the stockholders and executives, rather than the workers? 

7/7/12

Corporate Punishment: We Need Surgery Rather than Shotguns

          Keith implicitly raises a couple of important issues in his tirade against corporate crime: (1) First, how can we design fair and effective punishments to fit crimes deemed to have been committed by corporations, and (2) how can we do so without triggering rafts of unintended consequences? Underlying both of these questions is the more fundamental one of what exactly is a corporation? Despite the legalistic facade of "personhood", a corporation is in fact an association of persons collaborating around a collective purpose. Are a corporation's misdeeds, once proven,  then somehow the collective responsibility of all these people? Only those "at the top"? Only those directly party to the misdeeds? The difficulty in answering any of these questions with much precision explains why prosecution of corporate crime is often a slippery slope.

          One of the most sensational cases of corporate malfeasance in fairly recent memory would be the Enron saga, which climaxed with the firm's 2001 bankruptcy. More than 20,000 people lost their jobs, and  several of the firm's senior executives - including its president and its Chief Financial Officer - went to prison, where the president - Jeff Skilling - resides to this day. Creditors took huge loses and stockholders were wiped out. The company's 64-year old CEO Kenneth Lay was convicted of fraud and would have spent the remainder of his life behind bars were it not for the fact that he died of heart failure a couple of months after his trial. Enron's auditor, Arthur Anderson was deemed complicit in Enron's wrongdoing and stripped of the licenses necessary for it to continue in business. Another 28,000 people lost their jobs, and one of the world's largest and most highly respected accounting firms disappeared forever.

          It's hard to imagine a more unsparing set of punishments for corporate crime. Yet at the time, so intense was the anti-Enron and anti-corporate bloodlust that it seemed no punishment was going to be severe enough to satisfy people. Before Ken Lay's ultimate demise, California's Attorney General said at a press conference that he would like personally to escort him to a small prison cell that he would share with a "tattooed dude" who would "call him honey" and proceed to do to him what leering tattooed dudes in prison can be expected to do. And this from a liberal Democrat on record for his staunch opposition to hate crimes, environmental pollution, and all manner of bad things. Even more troubling, he was the state's highest legal officer charged with enforcing the laws of the land.

          The point is that otherwise rational people can become emotional and quite irrational on the subject of corporate crime. Large corporations often appear out of touch and out of reach and thus emerge as natural targets for popular resentment. This is true even among Republicans, who at times regard them as unholy extensions of Big Government. Reading news reports about possible corporate misdeeds, people often assume the worst and clamor for maximum punishments “for the guilty” before gaining a clear picture, or even any picture, of what has actually occurred.

          Which brings me back to Keith’s intemperate screed and the news of more current events. He complains about “malefactors walking free” and hiding behind “screens of deniability." Then he speculates boldly about how easy it should be to prove “beyond reasonable doubt” the culpability of corporations. While he doesn’t really explain himself, and while I’m surely not a lawyer, what he seems to be suggesting is a sweeping new field of application for the federal RICO law, or something like it, whereby ordinary corporations could be decreed criminal enterprises. Indeed, what a powerful weapon this would be in the hands of ambitious prosecutors! After gaining such judgments, they could bring all manner of retribution to bear on targeted corporations and the “malefactors” employed by them. Our heroic avengers could go about their good work unencumbered by pesky distractions like the burden of proof. Trial lawyers too could have a field day feeding on anything that remained alive afterwards.

          The only two companies that Keith mentions by name, because they are in the news currently, are Glaxo and Barclays. Both are, of course, British companies, although their operations are global as are the issues in question.  I don’t know much about the pharmaceutical industry and won’t comment on Glaxo, but I do pay some attention to the banks and fully understand the importance of the LIBOR index Barclays has now admitted to having of manipulated, along with the analogous EURIBOR in Europe.  Notional value of trillions of dollars of contracts are potentially affected, including interest-rate swaps, home mortgages, and numerous other types of instruments. Selective release of emails from traders apparently involved the affair casts an even more disturbing light over it, since the attitude of amoral and puerile aggression so common among traders is there for all to see. For those perhaps previously unaware of it,  our banking system entrusts massive amounts of investment money to people who emotionally never matured much past their early adolescence.

          But then again, what has really been going on here? For one thing, this is not a new issue. Four years ago, the Wall Street Journal - hardly a leftwing muckraking rag - raised serious questions about LIBOR and the subjective judgments that underlie its daily calculation. It was obviously a system seriously prone to abuse, although since the apparent manipulation at that time appeared systematically downward, the WSJ's investigation elicited a collective yawn from the markets and the Government.  After all, homeowners with adjustable rate mortgages were benefiting, and central banks  around the world at the time were laboring  to bring all rates down anyway. The already-deposed CEO of Barclays has even alleged that the Governor of the Bank of England encouraged him in the endeavor.

          This latest spate of news, however, is different. The Barclays traders appeared to have been collaborating with traders at other banks to advantage specific trading positions. Keeping this in perspective, we're talking about minute distortions to the index - probably no more than a basis point or two - but enough presumably to make a P&L difference for large and highly leveraged trades. While an effort will be made to dramatize this story with tales of destruction wrought on long-suffering homeowners and the like, nothing of the sort is likely to be possible. The victims will be institutional investors on the losing end of the manipulated trades.

          Having said that, this is nonetheless a very serious scandal that in some way strikes at the heart of what has become a grotesquely complicated and vulnerable financial system around the world. The case will not, and should not,  go away quickly.  There will be more investigations, law suits, sackings, and so forth, at Barclays and other banks,  followed undoubtedly by a major revamping to the archaic procedures for by which these indices are produced. And this should be all for the better. What there is not a place for, in my opinion, is a highly-charged moralistic crusade led by posturing politicians with no practical ideas of their own, backed by armies of self-dealing trial lawyers.

          I realize that I am exaggerating the position that Keith took in his brief letter, and I'm making unfair sport of it to some degree.  I'm actually in more sympathy than I probably sound with his underlying attitude, which is a deep frustration with the corruption, immaturity and breathtakingly short-term orientation that characterizes our current financial system, not to mention our political system. I do feel, however, that draconian and emotional responses to these problems, if allowed to take hold, will lead to explosive collateral damage and far worse problems in the future.

7/3/12

Punishment for Corporate Crime

I replied to the NY Times editorial about Barclay's Bank this morning, July 3 2012, as follows:
The mounting levels of corporate crime, such as those of Barclay's and Glaxo, when combined with the apparent immunity of responsible officials from personal criminal liability, suggests that we need to fix the criminal laws and sentences that apply to corporations. We have an aggressive Dept. of Justice, but it just can't penetrate the screens of deniability that top corporate officials maintain. It can't prove guilty knowledge beyond a reasonable doubt, so these malefactors walk free, and continue to enjoy the trappings of respect and wealth. 

What we can prove beyond a reasonable doubt, however, is the criminal guilt of the corporations themselves. Since they are now "persons," and like Glaxo can plead guilty to crimes, we need a corporate version of jail. Fines are just a "cost of doing business," like paying bribes in Nigeria. But why not require criminally convicted firms to suspend the payment of dividends, or of executive bonuses and stock options? There are many creative possibilities for punishing criminal concerns that fall well short of injuring the least responsible employees. We need to pursue this option, because a society that does not punish its criminals cannot claim to have a rule of law.

6/21/12

I agree with much of what Mark says, actually.  I don't think money is all-determinative. For one thing, if the less well financed party has enough money to get itself heard, that should suffice if it has a potent message. But in past elections, whatever the party messages, both had enough money--including, probably, the Republicans in 2008. Now, however, the Citizens United decision allows heavy private and corporate thumbs to tip the scales to a previously unknown extent, and I think that the Democrats can overcome the resulting disadvantage only with a clearly superior message.

Unfortunately, Obama has a virtually impossible task because of the economy. I also agree with Mark that both Obama care and Dodd-Frank are highly imperfect bills. But who is actually responsible for these problems? I submit that the blame falls largely on the Republicans, who stonewalled Obama from the beginning. Their refusal to let him fully pursue the Keynesian solution that virtually all knowledgeable economists advocated has mired the economy in its present stasis. They are not responsible for Europe, but Obama would not be so badly hurt by Europe if unemployment were a point or two lower and our growth was better. Both Obamacare and Dodd-Frank incorporated many Republican ideas, and the party's stonewalling on those bills made sensible compromises and evaluations essentially impossible.

One point on which I do strongly disagree with Mark is his prioritizing the national debt, along with his claim, which I think is false, that Obama does not care about it. Obama and all the other national Democratic leaders have repeatedly said that we need to spend now in order to restart an economy whose growth can then pay off the debt, hopefully starting in 2014. Again, virtually all economists, apart from the partisan right, agree, and so do the lenders. So demanding that growth-promoting measures be trimmed or shelved in order to pay off the debt is self-defeating. By doing that, as has happened, we simply stop the economic growth that is the only sane way to escape the current situation.

It may well be that conservatives like Mark actually understand this, but have another reason for emphasizing the debt. Worrying about debt makes sense to most people, and therefore legitimizes in the public mind an attack on pension liabilities and public employee unions. There is definitely some merit to using the crisis to cut those problem areas down to size, but I would have more sympathy if the attack were carried out more straightforwardly, and without undercutting recovery.

I also, obviously, differ with Mark about the importance of the election. I think Romney's prescriptions will do tremendous damage, and that he will in fact carry out most of what he said he would.

The Exhaustion of American Ideologies

         There is an air of defeatism and desperation to Keith's "After November" piece. The tone reflects what seems to have become the attitude of a growing number of Democrats who give the impression of having already written off their chances for holding their political ground in the upcoming elections. This is a massive come-down from their self-assurance a mere four years ago when Barak Obama swept into Washington and drove Republicans before him like a broken army. At the time, Democrats talked confidently about a possibly permanent progressive realignment in America along the lines of FDR's post-Depression coalition.

So what alien counterforce is it that has now emerged? To hear Keith and his fellow Democrats tell it, the main problem is Big Money, which Republican plutocrats can always bring to bear and which they are now pouring in like hot fire against President Obama and the other honest progressives in government.  Keith has even carried the argument so far as to claim media bias against them, resurrecting a favorite bugbear of the Right and turning it on its head.

This narrative, however, doesn’t run very deep.  The Democrats too are funded by Big Money, and in the last presidential election cycle by even more of it generally than that which backed the Republicans. In my own home state,  for example, Representative Chris Shays, who had for many years represented the Fourth District of Connecticut as a moderately conservative Republican, lost to a former Goldman Sachs executive, who outspent him several times over.  This pattern played itself out on a grand scale as Democrats concentrated abundant financial resources on tightly contested races across the country.  On a national level – Fox News aside – the mainstream media covered the Obama campaign as though it harkened back to some wondrous combination of FDR’s brain-trust, JFK’s glamour, and  MLK’s moral gravitas.

Yet only those Republicans in the most extreme state of denial would have imagined they lost elections because of money and media bias. They lost because their ideology had run out of steam. Ronald Reagan's program of lower taxes and lighter regulation of business had been a constructive formula for addressing the serious  economic problems the country faced during the 1970's and early 80's. Giddy with success, however, Republicans allowed this formula to harden into an ideology. They behaved as though they believed the American economy had reached a state of permanent prosperity that could sustain momentum forever if supported by ever-lower taxes and ever-lower interest rates. Remarkably, Republicans even stopped worrying so much about the growth of Government, which continued its relentless pace during the Bush years, so long as higher taxes weren't necessary to pay for it.

There were warning signs along the way. One was the 1998 collapse of Long-Term Capital Management, a hedge-fund following an investment strategy governed by two Nobel-laureate economists who were on the on the LTCM payroll. Their quasi-mystical faith in the accuracy of free-market pricing lured them into a disastrous cul-de-sac. Another danger sign was the 2001 bankruptcy of Enron,  a company whose founder Kenneth Lay was also an apostle of free-market dogma. The Enron failure was part of a much bigger breakdown at the time,  as puffed-up technology stocks, having fed on free markets, suddenly deflated. This spectacle exposed,  as market crashes always do, the weakness in the "efficient market" thinking favored by right-leaning economists.

As prosperity and rising markets resumed in the early years of the new century, these problems for a while appeared to be little more than blips in the receding past. The blips, however, were revealed as foreshadows in 2008,  when our financial markets came crashing down and threatened to take with them our banks and our general economy. People's livelihoods were at risk now,  and the general public took notice. Since 2008 was also a presidential election year, voters did their jobs and threw out the people in power. More than that, the general public seemed to have picked up an intuitive grasp of where the crisis came from.  While the Democrats had been active collaborators in much that had gone wrong, it was Republican ideology that had fueled the immediate triggers to the crisis. Big Money and media bias did little more than exaggerate what would have been a landslide victory for the Democrats in any event. They came to power fairly and with an indisputable mandate.

Unfortunately, it became immediately clear that the Democrats had learned very little over preceding decades.  Interpreting the election results as proof that  they had been entirely right all along about the powers of Government, and their political enemies entirely wrong,  they developed a romantic and atavistic obsession with FDR's legendary "First Hundred Days". They set about designing a complex of the new government programs, economic stimulus and regulation that emulated the policies of  the 32nd President, albeit dressed up now with a modernistic focus on Green Energy and environmental science.  Like FDR's people, Obama's administration was determined to drive their work home quickly while they still had the power.  The two hallmark pieces of legislation to emerge from their two years of virtually undisputed control over government were the Patient Protection and Affordable Care Act and the Dodd–Frank Wall Street Reform and Consumer Protection Act, overhauling health care and finance respectively. While both of these Acts addressed genuinely glaring problems, both were massively over-engineered and were from the start doomed to bog down in a minefield of unintended consequences. More ominously, the money to pay for it all drove the federal budget deficit, already arguably at unsustainable levels, to unprecedented heights.

 And just as the Republicans in better days had their ideological apostles, so do the Democrats now. The most visible of these in the economic sphere probably is Paul Krugman, yet another Nobel Laureate ruined by fame. He has labored mightily to convince his party, and all of us, that the only problem with our current outsized budget deficit is that it isn't outsized enough. His most recent book entitled "End This Depression Now!", complete with exclamation point, sounds as though it could be the work of a self-help guru promising all good things to anyone bold enough to follow the formula and not ask stupid questions. We’re being instructed to keep pounding the fiscal pumps like real men and abandon worrywart concerns about deficits.

The voting public, however, isn’t having much of this and is asking lots of questions, many of them not as stupid Dr. Krugman would have us believe. With their momentum now stalled, the Democrats have good reason to worry about the coming election. Campaign finance is a legitimate issue for discussion,  but it is largely a red herring in the current environment. If the Democrats lose more ground, it will be not because any financial disadvantage, but because,  as with the Republicans last time around, their policies are failing and they’ve run out of ideas.

I suspect the Democrats, having over-estimated their standard-bearer in the last election, may be underestimating him now. He is, in my opinion, one of the most gifted politicians and orators of our era and is likely to overwhelm Mitt Romney in debates. Obama may have a weak record to defend, but so does Romney,  who cannot escape answering for the dysfunction of his own Party. There is a very good chance the President will regain the loyalty of his wavering followers, even if not their bright-eyed enthusiasm,  and that he will win over a fair number of Independents.

Contrary to the usual most-important-election-ever rhetoric now emanating from both sides, however,  I personally don't think it makes a great deal of difference who wins in November. Whoever emerges with the Presidency and control of Congress will face the same set of intractable problems that exists now. And since both parties remain beholden to tired ideologies, our next crop of leaders will find themselves mostly trying to re-shuffle a deck of weak cards that have already been played.

Keith mentions the possibility of a third party emerging in the U.S.  There's surely no comfort in the prospect of a third party on the extreme right or left. Such a development would lead us even further down the road than we already are towards a mass-scale version of the morass now enveloping Greece. I agree, however, that a different kind of third party could be welcome. This would be not so much a bland "centrist" party as one that  would pick and choose strong but non-ideological core values and then take bold steps to address problems. Such a party would be genuinely committed to financial prudence and fairness at the same time. It would embody the spirits of pragmatism, efficiency and innovation, and would have no affinity for political grudges, dogmas or grandstanding. While there seems little immediate prospect for such a force materializing, we can all hope that the "better angels" of American democracy are still secretly at work somewhere, ready to exert a benign influence when the time is right. Unfortunately, an extreme crisis may prove to be the necessary catalyst. 


6/15/12

After November

The overwhelming financial advantage of the Republicans, their ability to undermine Obama by sabotaging the US recovery, the weak Democratic political campaign, and the grinding problems of Europe ensure a Republican sweep in November. Romney will be the new President, and he will have a majority in the Senate as well as overwhelming control of the House--and they of him. The question, then, is what will happen over the next 3-4 years.

The Republicans believe that economic recovery requires, first, an unpleasant period during which we get our fiscal house in order by cutting back on entitlements and government spending, and second, government support for private investment. They do not believe in government investment as such, apart from the military and police sectors. Consequently, a dramatic remake of the federal budget will be enacted, as they forthrightly promise. A balanced budget without tax increases on the investor class--that is, corporations and the wealthy--will be the goal, and will include increased defense spending. The Obama healthcare bill will be repealed, and the Republicans will seek to replace Medicaid and Medicare with a voucher system whose levels are geared to reducing federal deficits. Most other social programs, including the EPA, welfare, and industrial regulation will also face drastic financial reductions or total elimination. Farm welfare and tax incentives for carbon-based energy production will survive, however, and probably even increase.

Although Democrats will protest and use parliamentary maneuvers to block what they can, and the surviving liberal press will likewise fuss and fume, they will be talking only to themselves, and a continuing din of right wing advertising and media favoritism will largely drown out their objections. Nor can Democrats at local, State, or federal levels realistically hope to regain office, because the Republicans have a permanent and overwhelming monetary advantage, which has been demonstrated to be highly effective with the electorate, and they will also continue to benefit from voter eradication strategies in the States, of which they will control many more in the Romney sweep.

As  economic theory predicts, and the experience of Europe is now demonstrating, the austerity program that Romney promises will not actually restore fiscal order, and it will very clearly increase disparities of wealth. We can expect an increasing number of Americans to become jobless, members of the underground economy, dispirited, disqualified for 21st century jobs, and, in more and more cases, very angry. Although similar trends will grow throughout the world, the highest performing levels of the US economy should be able to sustain their sales and increase profits through their international operations. Similarly, those businesses that cater to the wealthy should thrive, and a flood of people moving down the income ladder might sustain sales and profits at the businesses like Walmart or Dollar Stores that cater to those with low income.

I say that US corporations should be able to sustain international sales, but that possibility would disappear if Romney pursues the beligerant foreign policy he has suggested. Even if he does not start a shooting war with Iran, however, anything like a return to the W. Bush policies would probably trigger international trade wars that could go far toward dismantling the free trade measures that have prevailed since World War II. Since that would, of course, be very problematic for the corporate world I tend to discount the possibility that a Romney foreign policy would resemble his campaign positions.

Some writers have posited that Romney's election and a sweeping Republican triumph in November would lead to something like permanent oligopolistic rule, with the only significant disagreements being within the ruling class. That does seem to me a possible endpoint of what must be a devolution that takes several election cycles. Several conceivable scenarios could seriously derail that development, such as warfare, civil chaos, Democratic resurgence, the formation of an effective new political party, plague or other cataclysmic natural disasters, or technological breakthroughs that overturn the existing economic structure.  So there is always hope.

6/11/12

The Wisconsin Recall - Another View

           Keith below presents a well-reasoned and fairly balanced discussion of the recent recall election in Wisconsin. His main purpose seems to be to chide his fellow Democrats against misconstruing the political significance of this development. The circumstances surrounding the recall, however, I think reveal a problem more fundamental than partisan political strategy.

          At the risk of sounding like the kind of idiot who quotes himself, I’m going to quote myself here. The excerpt is from a review I did of Michael Lewis's Boomerang, a recent compilation of his earlier reportages on several of the world's financial flashpoints. He writes on Greece, Ireland, and Iceland, but it's his take on the American state of California that has the most direct relevance to the present imbroglio in Wisconsin. This is the way in which I attempted to summarize the picture that Lewis paints.

“I'm pretty sure that Michael Lewis is a Democrat, but he writes without ideological blinders. He obviously admires the Republican Schwarzenegger (Lewis reports on  a bicycle jaunt and meeting he has had with the former California governor) for his intellectual honesty, optimism and relentless energy. However, even the redoubtable strongman, by his own admission, proved helpless against the problems of California. The state's voters embraced him initially and then eight years later threw him out of office, his approval ratings having crashed through the bottom of the floor. In Lewis's rendition, the travails of California sound depressingly like those of Greece. A land of shallow idealism mired in administrative incompetence, California promises everything but is willing to pay for little. The state's perpetual budget crisis seems to be without the slightest hope of being resolved at any point in the foreseeable future. Arnold seems disappointed but has taken it all in stride and moved on with his life. He says he had fun trying.

"Lewis realizes he could visit just about any city in the state and find a relevant crisis to observe, so he picks a few. The mayor of one of them - San Jose
-  (a Democrat by the way) sums up pretty well the problems of his city and most of the others when he points out that he could terminate every single current employ in his government and not save enough money to pay the pensions and post-retirement benefits of the former employees. He could then tax his wealthy citizens into oblivion and, having thus destroyed his tax base, still not put much of a dent in the problem. Apparently believing themselves much richer than they were - particularly during the Fin de si├Ęcle boom years - government officials had fecklessly backed away from confrontation with the public service unions, who were thus able to assume a largely free hand in crafting pay and benefit packages. The day of reckoning came much sooner than even pessimists had imagined.

"On his way out of the Mayor's office, Lewis asks as couple of his aids for suggestions about where, given his investigative focus, he should go next. Without hesitation they both point him to Vallejo, and Lewis makes a beeline for the place. Three years earlier, Vallejo became one of the few municipalities in the United States ever to file for bankruptcy, overwhelmed by reckless promises made in happier times to its public employees. By the time Lewis gets there, the city has few active public employees left and is a shell of itself. Many of its homes are in foreclosure and its taxable population is drifting away. Street maintenance is non-existent, and crime is rising.

"Paradoxically, though, it's in reporting on Vallejo that Lewis discovers more glimmers of hope than he has managed to find elsewhere, for much the same reason that former drug addicts can sometimes be inspirational: hitting absolute rock bottom creates a certain clear-sightedness about problems and a motivation to correct them. Lewis meets the recently-hired city manager, Phil Batchelor, who has come reluctantly out of retirement to take the job. A sober, unassuming man, his one precondition for doing so was that the city council members all sign a written pledge to him they will start behaving in a civil manner towards one another. It seems someone had recently thrown a severed pig's head onto the floor at one of their meetings. Having been able to discharge most of their debt in bankruptcy and renegotiate their labor contracts, Vallejo has the chance for a fresh start, and Batchelor is determined to make the best of it. He's not interested is apportioning blame to anyone for past failures and is pragmatically focused on solving problems one at a time.

"Lewis also spends time with a 41-year-old Vallejo fireman named Paige Meyer. Meyer has seen his compensation and benefits cut sharply, but is nonetheless still passionate about his work. He treats fighting fires as though it were a calling, and is re-inventing the job to make do with fewer resources, even though Vallejo apparently has many more fires than other comparable communities. He seems to have no bitterness and to enjoy his life despite the financial devastation around him.

"Putting all these stories together, it's not hard to get Lewis's vision of what has happened to our developed Western economies. He doesn't preach, but rather like Dickens' Ghost of Christmas Future, he lets the grim facts unfold and speak for themselves. The common denominator here is the illusion of easy money, which our modern financial markets have conjured up for us and which has fooled everyone from multi-millionaire bankers to municipal street cleaners into thinking that everything they want is there for the taking. Lewis doesn't say it directly, but he appears to regard the problems of places like Greece and Vallejo as indicative of what lies in store for all of us who fall prey to illusions that life is easy and money is free."

          Certain American commentators nowadays seem never to tire of pointing out sagely that the United States is not Greece. They might also remind us, fairly enough,  that Wisconsin is not California. Nonetheless, all of these crises have common roots, and all are symptomatic of a global breakdown in the model governing the world's developed economies.  This model is neither "capitalist" nor "socialist", in the nineteenth-century lingo that economists sometimes still employ, but a hybrid in which market-oriented production entities co-exist with monopolistic government service providers. And while market forces still provide a degree of restraint over the private sector (with banking a partial exception), no such organic discipline exists to reshape ineffective and inefficient government services. As a result, following the course of least resistance, politicians continue to fund old programs even as they create new ones, and they tend readily to accede to employee demands for growing compensation and benefits. All of this ensures that government's share of the economy will grow relentlessly, as indeed it has throughout most of the last century.

          Various Catch-22 problems ensue. The most obvious one is that the growing tax burden needed to pay for government  weakens the private sector, contributing to unemployment and other private-sector failures which in turn increase the demand for more government spending. The less noted Catch-22 is the problem that the essential services of government itself become squeezed as money is diverted towards non-essential and wasteful ends. As Keith points out, the anger that many people feel towards government stems less from a belief that they are spending too much money on government than from a knowledge that they are receiving inadequate services in return. I would suggest that this problem in general does not result from incompetence  among of people in government, but rather is inherent in the nature of government monopoly.  And the problem would seem only to get worse as time progresses.

          Analyzing such a system on a theoretical level, it would seem inevitably inclined towards a terminal breakdown at some stage in its existence. To borrow a Marxian notion, the system would appear doomed by an inescapable internal contradiction. In the United States, the most serious long-term problem exists at the federal level. Here, however,  a temporary safety valve is provided by the ability to incur debt-financed deficits, and the concurrent ability the support this debt with unconstrained quantities of fiat money. Our powerful Federal Reserve Bank has now learned how to utilize "quantitative easing" and other monetary gimmicks to repress the rise in long-term interest rates normally be expected from such practices. All this may well postpone the day of reckoning for a while longer at the federal level.

          It is, however, our state and local governments that sit on the cutting edge of the current crisis. Like Greece, they lack control over their own currency, and additionally many of them face hardwired legal constraints on most forms of deficit financing. Hence, unlike their federal brethren, they must face reality and either cut services or raise taxes. And increasing taxes in many cases risks undermining the economic basis on which even existing taxes might be paid in the future.

          Scott Walker has applied a blunt instrument in attempting to grapple with the problems of Wisconsin. The impact of what he has done is indeed cruel and unfair to those people who have built their lives around the honest assumption that they could count on a certain level of financial well-being for their lives. But is the fault his, or that of earlier politicians who made unsustainable promises in the first place?  He has won his victory operating through democratic channels and has overcome an opposition that has been every bit as vicious as the rightwing "lunacy" that Keith decries.

          I certainly have not studied the problems in Wisconsin in any depth, but I suspect that Scott Walker may be protecting his people from a much more painful resolution at some point in the future. We might soon see a cautionary foreshadow in what's probably about to happen to the people of Greece.

6/6/12

Meaning of Wisconsin Recall Vote

The Wisconsin vote for Scott Walker should make liberals think. Democratic commentators, as on MSNBC, try to dismiss this vote as due entirely to the funding differences, which will not be as great in the Presidential race. But the WI voters are among the most union-friendly and progressive of all in the US, Walker is a certifiable villain, and despite Walker's 71/2:1 spending advantage the ground campaign that the Democrats waged surely provided all voters with plenty of information. I think, therefore, that the result accurately expresses an actual voter preference--not just a triumph of rhetoric, framing, or advertising.

But what is that preference? Let me suggest that many voters are siding with Republicans because they don't think government is giving value for their money. It's not that they object to most government programs, but that they don't think government carries out any programs very well (except for military and, perhaps, police functions, for which they have little information). They question Obamacare not for insuring people, but because it's a government program, and while few people have had a bad experience with a health insurer, almost everyone has experienced frustration and waste when dealing with a government agency.

In saying this I do not mean to minimize the role of Republican propaganda and policy. Since Reagan, Republicans have starved the government of the money it needs to do its job well, and then blamed government bureaucrats for functioning badly. I am sure this trickery, along with propaganda, has played a substantial role in the public perception that the government isn't performing well. But there is also a real problem of government accountability. Government is a monopoly, and we all know how difficult it is to deal with such an entity. With only one mayor, governor, or President, and hundreds or thousands of government departments, the problem of making government truly responsive and accountable is a very difficult one to solve. In the experience of most voters, it hasn't been solved, and Republican propaganda takes care of any doubts.

Bottom line: I think the vote in Wisconsin, and the amazing support that Republicans have gained despite the lunacy of their ideology and the horrible track record of their leadership, owes more to the fact that only Republicans are saying "enough" about government, and less to any support of their actual policy objectives.

5/18/12

Overburdened Linchpins And The Rest Of 2012

          It's odd that so many people in the financial community seem already to have lost track of what really happened in 2008. The reason perhaps is that the year has by now been politicized and over-analyzed to where most of us are tired of the commentary and are no longer paying attention. Yet 2008 is still with us in a very immediate way, as is 2001, 1998, 1994 and all the other points of sharp market inflection that have occurred within the career-spans contemporary players. Financial historians will want to look back still further to at least the 1913 founding the American Federal Reserve system, a development that would over time give rise to the dollar-based international monetary system. The institution that was supposed put an end to financial panics, as they were called in those days, instead helped lay the groundwork for systemic instability, a more contemporary term-of-art for roughly the same thing unfolding through high-speed modern markets.

         I want to focus on 2012 and not torture history any more than necessary. Past chains of events, however, always suggest clues to the future and are thus usually worth the time to consider. Several common factors have percolated through past crises, but the one that stands out to my mind above all others is the existence of linchpin events. These are small developments that seem minimally significant upon first appearance, but that spin out of control and, through obscure interconnections, trigger improbably large events.

          Looking back to a couple of years prior to 2008, for example, mortgage analysts will remember that the default rates for subprime mortgages began creeping upward and were soon outside the "worst case" boundaries established by the investment bankers who were structuring mortgage securities. Insiders began taking note, but few people on Wall Street or in Washington were overly concerned, because the problem appeared to be manageable. It was only manageable, of course, until it wasn't, when projected financial losses began to extend beyond the relatively small sub-prime mortgage sector. Then suddenly awareness dawned about how leveraged the entire financial system had become. The succeeding chain of events needs no recounting here, but the end result after a couple of years was the virtual nationalization of supposedly indomitable banks in the U.S. and Europe, political realignments on both continents, and the dawn of what journalists later dubbed the "Great Recession".

         For the past three years the search for new linchpin events has been a favorite dinner-party sport among retired financial types, and a survivalist challenge for people still on the front lines. Now in May of 2012 a couple of developments have appeared that to my mind suggest themselves as serious candidates.

         First is the latest devolution of the situation in Greece. This crisis, of course, has been with us for the past three years. Hardly a slow news day has gone by without pundits attributing either small market upticks to new optimism that a Greek resolution is in the works, or else downticks to erosion of optimism that had supposedly been there the day before. As with a slow-moving cancer, Greece has found its way to the periphery of consciousness for most of us, but will not to go away. The news now is that new elections will be necessary due to the evaporation of whatever frail national consensus there had been to go on collaborating with the northern Europeans. We should remember that what we're dealing with here is not a normal country, however pretty its Aegean islands may be. Greece faced a communist insurgency in the years following WWII, suffered a fascist coup d'etat in 1967, and was living under military dictatorship as late as the 1970's. Political turbulence is not street theater for these people but serious business. The thought of elections in the current climate, with extremist parties gaining strength again, is unsettling.

         I'm no sovereign expert, but it doesn't take a weatherman to know which way the wind blows here. The Greeks and the Germans can no longer tolerate one another, and at the very least it seems we can expect that Greece will exit the eurozone. At that point a couple of ugly genies will be out of the bottle. First, the ties that bind the eurozone together will no longer appear sacrosanct to other member states who might be quietly considering the same option. Secondly, once they have their own currency back, we can expect the Greeks quickly to exercise their new prerogative to debase it. That, after all, is the point of monetary sovereignty for a failed nation. To a continent, and a world, overburdened with debt, little Greece will have demonstrated how easily fiat money can lighten the load. The re-appearance of hyperinflation in Europe, even in a small country, will reverberate loudly.

         The second potential linchpin event currently in the news is the J.P Morgan situation. In a matter of a few days, there has already been too much commentary about this from people with little information about it, and I'll try not to add to the noise here. However, the sudden announcement that even Jamie Dimon's bank doesn't know how to execute a hedge is devastating news for market participants who had been hoping that adults were back in the room and that our modern capital markets were regaining their equilibrium. As Dimon knows, he will now be compelled to hand over his sword to the politicians who, in a presidential election year, are more eager than ever to demonstrate their zeal in punishing Wall Street.

        And for anyone who takes comfort in the prospect of increased regulation, I can only point to the dog's breakfast that still sits largely uneaten on the table in the form of the 2010 Dodd Frank legislation. Paradoxically both over-engineered and unfinished, this body of law arms regulators with powers that are as vague as they are powerful. Implementation will now proceed with a renewed directionless vigor. Regulators will find themselves operating in waters that are dark and over their heads, but they will nonetheless feel compelled to act boldly. None of this bodes well for financial stability.

         For investors, the main lesson of 2008 was that in the midst of systemic instability, a decade's worth of hard-earned gains can be wiped out in a matter of weeks. In my view, the conditions are now in place for another collapse of equal magnitude, perhaps without the sovereign willpower this time to engineer another quick recovery. Investors, however, have no clear safe havens. Gold, the classic panacea for dangerous times, lost money in 2008 and, after big gains during the recovery, is losing money again now. Inflation and low interest rates are eating away at cash and bonds. Short strategies can be disastrous if the timing is wrong, and obvious trends rarely follow obvious timetables. Problems could easily come to a head by the end of this year, but could still drag on, depending mainly on political variables.