In this post I attempt to respond to some comments that were written concerning my post of August 25. (http://seekingalpha.com/article/92648-the-reign-of-uncertainty-in-financial-markets) The comments specifically related to the fact that uncertainty always exists and whether or not markets work. I wrote the post of August 25 because I believe that uncertainty is greater now than it has been for a very long time. As a consequence, the volatility of markets is extreme and will continue to be extreme as long as this level of uncertainty continues to exist. I believe that this should be a consideration in the current business and investment decisions being made.
Uncertainty exists because humans make decisions based upon incomplete information. That is, if a decision maker had complete information there would be no uncertainty about what action that individual should take because the decision maker would know precisely the outcome that would result from any action that was available. The decision maker would, therefore, take the action that would be the ‘best’ in terms of the outcome that is being sought.
Uncertainty is defined in terms of variance. That is, because a decision maker has only incomplete information to work with, he/she will not know before the decision is made exactly what the outcome of that decision will be. Usually, there is a range of possible outcomes that can occur given the choice of a particular decision. Uncertainty, therefore, is relative in the sense that a situation in which the range of possible outcomes is somewhat narrow would be considered to be less risky than a situation in which the range of possible outcomes was much broader.
Generally one argues that if the decision maker has less information, the range of possible outcomes will be greater than if there is more information available. With less information available and a consequently larger range of possible outcomes, the situation is said to be riskier than when the decision maker has more information and a resultant narrower range of possible outcomes.
Therefore, to add to my post of August 25 I would state that we are currently working with less information relative to the possible outcomes that we have to deal with than we have in quite some time. From this I infer that in the current environment that businesses and investors are facing greater risk relative to their decisions than they have in a long time. And, as a consequence of this greater risk I would argue that markets will continue to be more volatile in the foreseeable future than they have been in recent history.
There is another issue that is being stressed relative to the current uncertainty. Nassim Nicholas Teleb, in his book “The Black Swan”, writes about two kinds of situations in which a decision maker has incomplete information. The first is what most people are more familiar with. This is a situation which uses the historical information available to create statistics that people can use to make better decisions. These statistics include probability distributions, means, standard deviations, and so on. These statistics can be used in routine, repeatable cases of decision making to help the decision maker incorporate what he or she does not know into their decision making process. Gathering more information in these situations help us to refine the probability distribution related to the specific case under review and its attributes.
The second type of situation, the one that Taleb is most interested in presenting to us, depends upon what we don’t know. That is, this kind of decision does not lend itself to the use of ordinary statistical analysis because these decisions relate to situations in which we have little or no experience relating to the information we don’t know, hence nothing to guide us in our decision making. Taleb tells of the turkey being fattened up to become a Thanksgiving dinner. For 1000 days the turkey is fed very well and treated like royalty. The 1001st day, the turkey is prepared for the Thanksgiving dinner. If the only information one has is the information from the first 1000 days, the prediction for the 1001st day would be to be fed very well and to be treated like royalty. Gathering more of the same kind of information helps very little. What is needed is not known and unless one knows what types of information are missing one can gain little to help in improving one’s ability to make a prediction.
In terms of this latter type of uncertainty, one can argue that in the current situation we don’t know what questions we should be asking or what kinds of information we need. In Taleb’s terms we are in the arena of the Black Swan.
Another question has been asked about whether or not I believe that markets work. The answer to this is yes, I believe that markets work and I have long argued that one must be careful in interfering with markets because, even though the intent of the person wanting to interfere with the working of the market may be the very best, humans, by and large have done much damage to markets, and to people, by interfering with the workings of markets. If one fusses around with markets, one must be very careful, and one must attempt to work with the processes related to markets and not to the outcomes achieved by markets.
Still, I believe that it is necessary to work with markets in order to help the markets function. There are many reasons for this. One of them has to do with incomplete information and the fact that some participants in markets may have more information than other participants do. Also, the existence of asymmetric information in markets in the short run can result in things like a liquidity crises that can cumulate in a dramatic downward spiral of prices. Another reason has to do with the existence of transaction costs and the fact that due to the existence of transaction costs markets may not function as efficiently and effectively as they could, especially with respect to the time it takes for the market to work out of a disruptive situation. Furthermore, incentives can exist that lead to behavior that is dishonest and harmful to others. Human beings are vulnerable to such incentives when the apparent marginal benefit of cheating seems to exceed the marginal cost of getting caught cheating.
Human beings are problem solvers and when they see situations that have seemingly undesirable consequences they attempt to fix them. This characteristic of human beings is what makes them especially unique among living species. It is a characteristic that has substantial survival value. But, humans must be careful when attempting to apply their problem solving skills to markets. First, as I mentioned above, in working with markets, humans need to focus on processes and not outcomes. They need to focus on rules about how individuals are to perform…such as rules pertaining to the importance of full disclosure and openness…and not what results they attain…such as the amount of people that someone hires. This cannot always be done, but it is a methodology that should be strived for.
Second, the crucial issue always has to do with the balance of interference that is achieved. My belief is that humans are always going to try and make things better…help markets operate more efficiently…and so it is a question of the balance between the two extreme goals that is important. If has always been my practice to try and err on the side of less interference with markets than more interference. Furthermore, it is always the case that this balance will change with time as we learn more and as the market adjusts to any interference imposed.
Dubner and Levitt state very clearly in “Freakonomics” that anytime any kind of incentive system (rules and regulations) is set up, there will be numerous people attempting to take advantage of the new system. This, to me, is another major argument for minimizing interference in markets…interference causes people to focus on beating the new rules and regulations imposed on the market. Thus, any new rules and regulations that are set up need to minimize the payoff for beating the new system so that more people keep their focus on making the market work rather than taking advantage of the new system. The more restrictive or the greater the interference of any new rules and regulations the more benefit that can be gained from “breaking” the system. Thus, I feel that there will be interferences with markets…with the best of intentions…but extreme care must be taken when interferences are imposed.
I hope these responses help readers understand a little bit more of where I am coming from.
Friday, August 29, 2008
Monday, August 25, 2008
The Reign of Uncertainty
The most dominant factor operating in markets at this time, domestic and international, is uncertainty. Yes, the price of oil is down. The price of gold and other commodities is down. The dollar is stronger. And, question have been raised…like has the dollar reached a bottom in value and now will recover (“Historical Trends Suggest That the Buck Is Back”, http://online.wsj.com/article/SB121961240718867281.html?mod=todays_us_money_and_investing.) Is inflation going to drop as the economy weakens so that interest rates don’t need to be raised? And so on, and so on.
What I see in world markets these days is not a “trend” here or a “trend” there. What I see is uncertainty. I see volatility with no clear direction, one way or the other. And, the uncertainty that exists is not connected to events, but to fundamental issues.
Three international issues immediately come to mind. The first of these has to do with Russia, the more active role it now seems to be playing, and the response of the rest of the world to the new feeling of power being exerted by Russia. The United States has expended a lot of its good will over the past seven years or so and is, at present, in no position to lead others against this exertion of will.
The second has to do with the other BRIC countries and the role they are going to play in the world economy in the future. China, of course, coming off the successful execution of the Olympic Games, is gaining in confidence every day. India, although it has its problems, is going to play a major role in the world economy going forward. And, Brazil seems to be growing stronger every day. The United States has little or no influence over the direction these nations move since it forfeited it’s ability to work with them when they were, economically, just emerging countries.
And, of course, there is the uncertainty related to world energy sources and the role that the Middle East plays within these markets. Although the demand for oil seems to have dropped off in the United States due to Americans driving less, the overall demand for energy in the world continues to climb. And, there is always the uncertainty relating to supply…we just don’t know what might happen here in terms of leaders and in terms of cultures. Of course, the militant forces of terrorism play a role in how this issue works itself out.
This just represents a start. We can remain at the world level and talk about the unraveling of the global consensus on trade. (http://www.ft.com/cms/s/0/111b33e6-71ff-11dd-a44a-0000779fd18c.html) Current economic relationships have been built upon the efforts of many people and nations to build a more global economy. This consensus is showing signs of weakness now and is in danger of collapsing. A world with more restricted trade and greater emphasis upon nationalism would certainty have major economic and financial ramifications for the world at this time.
There are other factors causing uncertainty internationally, but let’s take this discussion into the national level and focus on the United States. First, there is great uncertainty concerning the health of the financial system. The number one concern at this time is what is going to happen to Fannie Mae and Freddie Mac. Is the Federal Government going to have to step in and do something about them and if so what is going to be the resultant structure of the companies and what is such a bailout going to cost the American people? But, there is still concern about the health of investment banks and how large the additional write offs are going to be. There is concern about the commercial banking industry, whether or not there will be more bank failures and whether or not there will be a failure of one or more “major” banks. The fact that the FDIC is pulling back former employees that worked in bank examination and bank closures and workouts to augment its current staff is a source of some concern. Furthermore, there is no good estimate of the amount of charge offs that financial institutions will face…first in terms of mortgages, then credit cards, then…
Then there is the housing industry. How much further down will it go and how long will it take before the industry bottoms out and construction really begins again?
What about unemployment? The unemployment rate hit 5.7% last month and the projection is for this number to go higher and higher. But, how much higher? It seems as if layoffs and firings are just beginning. Many industries are going through major restructurings and we don’t know, as yet, what the final effect will be in terms of the employment numbers. Companies are going into bankruptcy. Other companies are reducing the number of retail outlets they have retrenching for the growth at any cost efforts of the past. The auto companies are asking the government for major dollars to help them make adjustments to the changing nature of the industry. And, in this environment, would you be terribly aggressive in expanding output or hiring new employees?
Higher unemployment means higher payments for unemployment compensation. The government will almost certainly give the auto companies financial help. The government is promising relief to people facing foreclosure on their homes. The bailout of “Fannie” and “Freddie” could run up to $200 billion. And, what if commercial bank failures, let alone the possible failure of another investment banking firm, put pressure on the FDIC’s insurance fund requiring the government to set aside more funds, how would that add to the deficit? And, these potentials demands for government monies are just a few of the possibilities along with the worldwide problems that could cause the Federal deficit to become even larger. What price will the United States Government pay to finance all the debt that could be amassed in the near future to handle the multitude of potential crises that could unfold?
Then there is the leadership concern. The Bush Administration is history…yet, it still is in office for almost five months. There are still members of the administration trying to leave some positive legacy behind them. There have been several recent articles discussing the efforts of Condoleezza Rice and Henry Paulson to do something positive before they leave office. The “big one” for Paulson is, of course, the Fannie Mae/Freddie Mac bailout. Everyone else seems to have just disappeared into the woodwork.
And, there is the case of the presidential candidates. I won’t go into that again…you can read my thoughts written in my blog for August 18, 2008 (http://maseportfolio.blogspot.com/). All I will say right now is that I don’t believe that either of the two candidates have given us a clear idea of what we can expect from them in the economics or financial arena if they are elected President.
The world is a highly uncertain place today. Given the nature of many of the factors contributing to this uncertainty, I don’t see how the uncertainty can be resolved in the short run. Because of this uncertainty, the risk associated with any business or investment decision will be higher than it has been for quite some time. Over the past several months we have seen this risk being built into market relationships, especially into the interest rate spreads that exist on financial markets. However, we are also seeing changes in relative pricing in the “real” economy as businesses adjust for the changing assessment of risk that exists within these markets. These re-evaluations, obviously, are not very encouraging for the stock market.
The prognosis for the future, therefore, is for volatility. Markets are going to go up and markets are going to go down, but it is going to be very difficult to determine longer term trends in such markets. There is just too much noise.
What will get us out of this mess? The answer to this dilemma is time, information, and leadership. Nationally, as well as internationally, we don’t have a vision of where we need to go. There is still much “pain” to be felt in the United States. Someone is going to have to “own up” to this pain and provide a map for getting through it, helping those hurt where possible. Until we get some idea of what is going to be done…uncertainty will reign in financial and economic markets.
What I see in world markets these days is not a “trend” here or a “trend” there. What I see is uncertainty. I see volatility with no clear direction, one way or the other. And, the uncertainty that exists is not connected to events, but to fundamental issues.
Three international issues immediately come to mind. The first of these has to do with Russia, the more active role it now seems to be playing, and the response of the rest of the world to the new feeling of power being exerted by Russia. The United States has expended a lot of its good will over the past seven years or so and is, at present, in no position to lead others against this exertion of will.
The second has to do with the other BRIC countries and the role they are going to play in the world economy in the future. China, of course, coming off the successful execution of the Olympic Games, is gaining in confidence every day. India, although it has its problems, is going to play a major role in the world economy going forward. And, Brazil seems to be growing stronger every day. The United States has little or no influence over the direction these nations move since it forfeited it’s ability to work with them when they were, economically, just emerging countries.
And, of course, there is the uncertainty related to world energy sources and the role that the Middle East plays within these markets. Although the demand for oil seems to have dropped off in the United States due to Americans driving less, the overall demand for energy in the world continues to climb. And, there is always the uncertainty relating to supply…we just don’t know what might happen here in terms of leaders and in terms of cultures. Of course, the militant forces of terrorism play a role in how this issue works itself out.
This just represents a start. We can remain at the world level and talk about the unraveling of the global consensus on trade. (http://www.ft.com/cms/s/0/111b33e6-71ff-11dd-a44a-0000779fd18c.html) Current economic relationships have been built upon the efforts of many people and nations to build a more global economy. This consensus is showing signs of weakness now and is in danger of collapsing. A world with more restricted trade and greater emphasis upon nationalism would certainty have major economic and financial ramifications for the world at this time.
There are other factors causing uncertainty internationally, but let’s take this discussion into the national level and focus on the United States. First, there is great uncertainty concerning the health of the financial system. The number one concern at this time is what is going to happen to Fannie Mae and Freddie Mac. Is the Federal Government going to have to step in and do something about them and if so what is going to be the resultant structure of the companies and what is such a bailout going to cost the American people? But, there is still concern about the health of investment banks and how large the additional write offs are going to be. There is concern about the commercial banking industry, whether or not there will be more bank failures and whether or not there will be a failure of one or more “major” banks. The fact that the FDIC is pulling back former employees that worked in bank examination and bank closures and workouts to augment its current staff is a source of some concern. Furthermore, there is no good estimate of the amount of charge offs that financial institutions will face…first in terms of mortgages, then credit cards, then…
Then there is the housing industry. How much further down will it go and how long will it take before the industry bottoms out and construction really begins again?
What about unemployment? The unemployment rate hit 5.7% last month and the projection is for this number to go higher and higher. But, how much higher? It seems as if layoffs and firings are just beginning. Many industries are going through major restructurings and we don’t know, as yet, what the final effect will be in terms of the employment numbers. Companies are going into bankruptcy. Other companies are reducing the number of retail outlets they have retrenching for the growth at any cost efforts of the past. The auto companies are asking the government for major dollars to help them make adjustments to the changing nature of the industry. And, in this environment, would you be terribly aggressive in expanding output or hiring new employees?
Higher unemployment means higher payments for unemployment compensation. The government will almost certainly give the auto companies financial help. The government is promising relief to people facing foreclosure on their homes. The bailout of “Fannie” and “Freddie” could run up to $200 billion. And, what if commercial bank failures, let alone the possible failure of another investment banking firm, put pressure on the FDIC’s insurance fund requiring the government to set aside more funds, how would that add to the deficit? And, these potentials demands for government monies are just a few of the possibilities along with the worldwide problems that could cause the Federal deficit to become even larger. What price will the United States Government pay to finance all the debt that could be amassed in the near future to handle the multitude of potential crises that could unfold?
Then there is the leadership concern. The Bush Administration is history…yet, it still is in office for almost five months. There are still members of the administration trying to leave some positive legacy behind them. There have been several recent articles discussing the efforts of Condoleezza Rice and Henry Paulson to do something positive before they leave office. The “big one” for Paulson is, of course, the Fannie Mae/Freddie Mac bailout. Everyone else seems to have just disappeared into the woodwork.
And, there is the case of the presidential candidates. I won’t go into that again…you can read my thoughts written in my blog for August 18, 2008 (http://maseportfolio.blogspot.com/). All I will say right now is that I don’t believe that either of the two candidates have given us a clear idea of what we can expect from them in the economics or financial arena if they are elected President.
The world is a highly uncertain place today. Given the nature of many of the factors contributing to this uncertainty, I don’t see how the uncertainty can be resolved in the short run. Because of this uncertainty, the risk associated with any business or investment decision will be higher than it has been for quite some time. Over the past several months we have seen this risk being built into market relationships, especially into the interest rate spreads that exist on financial markets. However, we are also seeing changes in relative pricing in the “real” economy as businesses adjust for the changing assessment of risk that exists within these markets. These re-evaluations, obviously, are not very encouraging for the stock market.
The prognosis for the future, therefore, is for volatility. Markets are going to go up and markets are going to go down, but it is going to be very difficult to determine longer term trends in such markets. There is just too much noise.
What will get us out of this mess? The answer to this dilemma is time, information, and leadership. Nationally, as well as internationally, we don’t have a vision of where we need to go. There is still much “pain” to be felt in the United States. Someone is going to have to “own up” to this pain and provide a map for getting through it, helping those hurt where possible. Until we get some idea of what is going to be done…uncertainty will reign in financial and economic markets.
Saturday, August 23, 2008
The "Inflation Threat" and the Strength of the Economy
Today's article in the Wall Street Journal reporting on the speech of Federal Reserve Chairman Ben Bernanke at the Jackson Hole conference (http://online.wsj.com/article/SB121941429990263697.html?mod=hps_us_whats_news) contains this paragraph:
"Some Fed officials have called for raising rates before long to address worries about inflation. Consumer prices rose 5.6% in July from a hear earlier, a 17-year high. However, most officials believe a weak economy will lessen the inflation threat, and they want to keep rates lower for now to offset tightening credit conditions."
This speaks precisely to the point I made in my post of August 22, 2008, "It's the Supply Side, St....". If you believe that the problem being faced by the policy makers is one of insufficient aggregate demand, then there certainly should be pressure for inflation to weaken.
However, if you believe that the weakness in economic growth comes because of a shift in aggregate supply then there WILL NOT be pressure on the general rate of inflation to decline.
Of course, both aggregate demand and aggregate supply shift. Thus, it is a question of which one of the two dominates. If shifts in aggregate demand dominate then the economy will weaken and inflation will lessen. However, if the shifts in aggregate supply dominate then the economy will weaken but inflation will not lessen.
How the current situation is interpreted is IMPORTANT both for the policymakers in Washington, D. C., but also for business leaders and investors!
"Some Fed officials have called for raising rates before long to address worries about inflation. Consumer prices rose 5.6% in July from a hear earlier, a 17-year high. However, most officials believe a weak economy will lessen the inflation threat, and they want to keep rates lower for now to offset tightening credit conditions."
This speaks precisely to the point I made in my post of August 22, 2008, "It's the Supply Side, St....". If you believe that the problem being faced by the policy makers is one of insufficient aggregate demand, then there certainly should be pressure for inflation to weaken.
However, if you believe that the weakness in economic growth comes because of a shift in aggregate supply then there WILL NOT be pressure on the general rate of inflation to decline.
Of course, both aggregate demand and aggregate supply shift. Thus, it is a question of which one of the two dominates. If shifts in aggregate demand dominate then the economy will weaken and inflation will lessen. However, if the shifts in aggregate supply dominate then the economy will weaken but inflation will not lessen.
How the current situation is interpreted is IMPORTANT both for the policymakers in Washington, D. C., but also for business leaders and investors!
Friday, August 22, 2008
It's The Supply Side...
This is the third of three posts in which I aim to present the outline of my vision of where the economy is going into the fall. The first, “The Candidates and Economic Leadership” (August 18, 2008) framed the political environment, and the second,” The Most Important Price in the Economy” (August 20. 2008) presented my view of where the focus needs to be centered for economic policy making. This third post will be more specific as it tries to define the dilemma the policy makers are facing within the current environment.
In my view the implicit model of aggregate economic activity that we default to is one in which the aggregate supply of goods and services is assumed to be fixed or constant. That is, the aggregate supply curve is perfectly inelastic with respect to the aggregate price level. (This, of course, is a very simple picture and does not take into account the potential growth of the economy. Both of these points can be addressed. I am just trying to KISS the analysis for reasons of space and exposition.)
In this simple model, the only way that one can get a fluctuation in output is when the aggregate demand curve shifts. If output is observed as less than ‘full employment output’ (or growth is less than “full employment growth’) the only explanation that can be given for such performance is that aggregate demand must be less than is needed to achieve ‘full employment output.’ That is, demand is deficient.
If demand is less than supply at a given price level shouldn’t the price level fall?
Here we face another assumption, pervasive in modern macroeconomics, which sneaks into our analysis without our really realizing it. This is the assumption that prices either do not fall in a modern economy or at least adjust downwards at a very slow pace.
Our basic instincts tell us, therefore, that the only way we can avoid unemployment and unused resources is to “juice up” aggregate demand. We must create an economic stimulus package that will “goose” the economy so that it will achieve full employment once again. This is what the tax stimulus package enacted earlier this year was all about.
But, what if the drop in economic output (or the slowdown in economic growth) is not due to deficient aggregate demand but due to a shift in the aggregate supply curve?
In this case, with no reduction in aggregate demand, we would face a decline in aggregate output AND a rise in prices!
And, in such a case, what would happen it the economy was stimulated through an economic stimulus package? Possibly economic output would increase a little bit, but the stimulus package would certainly put more pressure on prices! This seems like the situation called STAGFLATION, a replay of the 1970s!
Stagflation is a situation in which there has been a backward shift in the aggregate supply curve combined with economic stimulus. The supply curve shift has resulted from factors, independent of demand, that impact producers…like an energy shortage or changing trade patterns or difficulties in the financial sector or government policies…and cannot, therefore, be offset by an economic stimulus package. Any government efforts in such a situation must be directed at overcoming the things that are causing businesses to produce fewer products and services at given prices.
The attempt to stimulate aggregate demand at such times does very little in the way of creating much additional output. The demand pressures that are created go into price increases that help producers to weather the difficulties they are facing in terms of their output decisions. It is a fact of life that the factors that impact the producers at this time create greater uncertainty for their businesses. Changes in the future of motor vehicles using alternative fuels as energy sources are having a major effect on auto makers. Uncertainty about the structure and regulation of the financial industry cloud the decisions of bankers. The lack of a clear vision of the future economic policy of the government affects us all. In such an environment businesses will take fewer chances with respect to increasing their output but will gladly take any increase in cash flow that they can get from increases in prices. This is the less risky strategy at this time.
How is one to get out of such a bind?
Well, my first response to this is that we need good leadership. No one likes uncertainty. But, uncertainty is rampant in the United States at this time. We see this on the evening news broadcasts. Families are cutting back on school supplies for the fall because of the uncertainty they face with respect to their budgets. What is going to happen to gas prices? What is going to happen to food prices? What is going to happen to employment? And so on, and so on. How should producers respond to this? A tax break to these families is not going to get them to spend more on school supplies. So businesses are uncertain about their future.
What about energy policy? Off-shore drilling or reducing oil reserves is not going to solve our problems. Regardless of the short term responses of the presidential candidates, uncertainty is going to hang over businesses concerning what they should be doing about their future energy sources. Solar panels on all malls or strip centers? Wind sources for electrical energy companies? Companies focusing on these big issues are not focusing on output.
What about the financial system? What about the infrastructure? What about…?
We need a leader who provides us with a vision we can believe in and in whom we can develop trust in to deliver on that vision. We need a leader who can help reduce the uncertainty that exists in the United States at this time.
My second response is that we need to get away from an emphasis on stimulus, stimulus, stimulus. What does such an attitude do? First, is that it creates an atmosphere of go, go, go. Everything is up, bailouts will be given for making mistakes, but, after any short crisis, the emphasis will always be to push the limits. This is the kind of environment in which inflation flourishes. Why should I worry about a slowdown? Inflation will be back and I can let prices buy me out of any mistakes I make. Why should I worry about over-leveraging a position? I will just be bailed-out and the process will start over again. In such situations we concentrate more on financial outcomes rather than on real production and creation.
And, finally, I believe that we need economic policies and regulations that are based upon process and not upon outcomes. An unemployment policy based upon a target number for unemployment, say 5%, is one based upon an outcome. An employment policy based providing education and transition support is a policy based upon process. Anti-trust regulation based upon market statistics and market structure is regulation based upon outcomes. Business oversight based upon openness and full disclosure is regulation based upon process. Taxing corporations that creates incentives to “go offshore” so as to avoid taxes is a tax policy based upon outcomes. Taxing corporations so as to change behavior or to punish those earning “excess profits” is a tax policy based upon outcomes. The tax system that creates incentives to focus on creative accounting and ingenious corporate structure distracts businesses from what they really should be doing. Taxing businesses must be based upon processes…and not outcomes.
I could go on…and I probably will in the future…but, at this time, I firmly believe that we need to focus on what is impacting the supply side of the economy and not the demand side. If we do not focus on the supply side at this time I believe that we are in for continued volatility in the markets and continued fragility of our financial institutions and consequently our whole economic system.
In my view the implicit model of aggregate economic activity that we default to is one in which the aggregate supply of goods and services is assumed to be fixed or constant. That is, the aggregate supply curve is perfectly inelastic with respect to the aggregate price level. (This, of course, is a very simple picture and does not take into account the potential growth of the economy. Both of these points can be addressed. I am just trying to KISS the analysis for reasons of space and exposition.)
In this simple model, the only way that one can get a fluctuation in output is when the aggregate demand curve shifts. If output is observed as less than ‘full employment output’ (or growth is less than “full employment growth’) the only explanation that can be given for such performance is that aggregate demand must be less than is needed to achieve ‘full employment output.’ That is, demand is deficient.
If demand is less than supply at a given price level shouldn’t the price level fall?
Here we face another assumption, pervasive in modern macroeconomics, which sneaks into our analysis without our really realizing it. This is the assumption that prices either do not fall in a modern economy or at least adjust downwards at a very slow pace.
Our basic instincts tell us, therefore, that the only way we can avoid unemployment and unused resources is to “juice up” aggregate demand. We must create an economic stimulus package that will “goose” the economy so that it will achieve full employment once again. This is what the tax stimulus package enacted earlier this year was all about.
But, what if the drop in economic output (or the slowdown in economic growth) is not due to deficient aggregate demand but due to a shift in the aggregate supply curve?
In this case, with no reduction in aggregate demand, we would face a decline in aggregate output AND a rise in prices!
And, in such a case, what would happen it the economy was stimulated through an economic stimulus package? Possibly economic output would increase a little bit, but the stimulus package would certainly put more pressure on prices! This seems like the situation called STAGFLATION, a replay of the 1970s!
Stagflation is a situation in which there has been a backward shift in the aggregate supply curve combined with economic stimulus. The supply curve shift has resulted from factors, independent of demand, that impact producers…like an energy shortage or changing trade patterns or difficulties in the financial sector or government policies…and cannot, therefore, be offset by an economic stimulus package. Any government efforts in such a situation must be directed at overcoming the things that are causing businesses to produce fewer products and services at given prices.
The attempt to stimulate aggregate demand at such times does very little in the way of creating much additional output. The demand pressures that are created go into price increases that help producers to weather the difficulties they are facing in terms of their output decisions. It is a fact of life that the factors that impact the producers at this time create greater uncertainty for their businesses. Changes in the future of motor vehicles using alternative fuels as energy sources are having a major effect on auto makers. Uncertainty about the structure and regulation of the financial industry cloud the decisions of bankers. The lack of a clear vision of the future economic policy of the government affects us all. In such an environment businesses will take fewer chances with respect to increasing their output but will gladly take any increase in cash flow that they can get from increases in prices. This is the less risky strategy at this time.
How is one to get out of such a bind?
Well, my first response to this is that we need good leadership. No one likes uncertainty. But, uncertainty is rampant in the United States at this time. We see this on the evening news broadcasts. Families are cutting back on school supplies for the fall because of the uncertainty they face with respect to their budgets. What is going to happen to gas prices? What is going to happen to food prices? What is going to happen to employment? And so on, and so on. How should producers respond to this? A tax break to these families is not going to get them to spend more on school supplies. So businesses are uncertain about their future.
What about energy policy? Off-shore drilling or reducing oil reserves is not going to solve our problems. Regardless of the short term responses of the presidential candidates, uncertainty is going to hang over businesses concerning what they should be doing about their future energy sources. Solar panels on all malls or strip centers? Wind sources for electrical energy companies? Companies focusing on these big issues are not focusing on output.
What about the financial system? What about the infrastructure? What about…?
We need a leader who provides us with a vision we can believe in and in whom we can develop trust in to deliver on that vision. We need a leader who can help reduce the uncertainty that exists in the United States at this time.
My second response is that we need to get away from an emphasis on stimulus, stimulus, stimulus. What does such an attitude do? First, is that it creates an atmosphere of go, go, go. Everything is up, bailouts will be given for making mistakes, but, after any short crisis, the emphasis will always be to push the limits. This is the kind of environment in which inflation flourishes. Why should I worry about a slowdown? Inflation will be back and I can let prices buy me out of any mistakes I make. Why should I worry about over-leveraging a position? I will just be bailed-out and the process will start over again. In such situations we concentrate more on financial outcomes rather than on real production and creation.
And, finally, I believe that we need economic policies and regulations that are based upon process and not upon outcomes. An unemployment policy based upon a target number for unemployment, say 5%, is one based upon an outcome. An employment policy based providing education and transition support is a policy based upon process. Anti-trust regulation based upon market statistics and market structure is regulation based upon outcomes. Business oversight based upon openness and full disclosure is regulation based upon process. Taxing corporations that creates incentives to “go offshore” so as to avoid taxes is a tax policy based upon outcomes. Taxing corporations so as to change behavior or to punish those earning “excess profits” is a tax policy based upon outcomes. The tax system that creates incentives to focus on creative accounting and ingenious corporate structure distracts businesses from what they really should be doing. Taxing businesses must be based upon processes…and not outcomes.
I could go on…and I probably will in the future…but, at this time, I firmly believe that we need to focus on what is impacting the supply side of the economy and not the demand side. If we do not focus on the supply side at this time I believe that we are in for continued volatility in the markets and continued fragility of our financial institutions and consequently our whole economic system.
Wednesday, August 20, 2008
The Most Important Price in an Economy
In my post of August 18, 2008, I argued that neither of the presidential candidates had really staked out a well defined position as far as their economic vision was concerned. The pronouncements of the candidates, I wrote, were either too general or were bogged down in ‘wonkish’ minutia. As a consequence, an uncertainty has resulted that has left people and markets without direction and has fueled a greater volatility in prices.
Given this criticism, the question must be asked, “What is the basis for a sound economic vision?”
I believe that the foundation of a sound economic vision begins with the value of the United States dollar. I continually go back to the statement of Paul Volcker: “a nation’s exchange rate is the single most important price in the economy.” (Paul Volcker and Toyoo Gyohten, “Changing Fortunes: the World’s Money and the Threat to American Leadership, (New York: Times Books, 1992), p. 232.)
The reason the exchange rate is the single most important price in the economy is because it reflects the viewpoint of the rest of the world about how an economy is being managed relative to how other nations are managing their economies. In essence, the value of a country’s currency is related to relative rates of expected inflation…the expected inflation of the country in question relative to the expected inflation in other nations in the world.
And, it is expected inflation that is important, not actual inflation as measured by current price indices. Calculated measures of inflation do not always immediately capture what is going on in the world and, as a consequence, do not always pick up economic dislocations that will be reflected in prices at some time in the future.
For example, in the consumer price index, estimates are made of the rental price a home owner would pay for the housing services received from the owned home. These are not directly related to the prices that homes are being sold for. Thus, prices of houses may be rising at a very rapid rate while the estimated rental price of the housing services may be rising very slowly. Since the component of the consumer price index related to housing is quite large, the “measured” consumer price index may rise only modestly whereas the prices of housing might be rising quite rapidly. (Note: this, of course, relates to the situation several years ago and not right now.)
Furthermore, with all the Federal government debt being exported, the nations having investors that have purchased large amounts of this debt face a peculiar situation. Many of these nations have their currencies tied to the value of the United States dollar. The low interest rate policy in the United States has forced these countries to also maintain a low interest rate policy and this has resulted in higher rates of inflation in these countries. The inflation experienced in these countries is now finding its way back into the United States.
Thus, there are many ways that inflation or the possibility of inflation can work its way through the world economy without being captured in currently measured price indices. It would be silly for investors to wait for inflation to show up in the published price indices before they made their investment decisions. Investors must make decisions based on what they “expect” to happen. These inflationary expectations are therefore reflected in current market prices such as a nation’s exchange rate.
It can be strongly argued that if investors believe that a government is acting independently of the rest of the world and behaving in an imprudent and undisciplined manner they will sell the currency of that country and this will result in a decline in the value of that country’s currency. In essence, the market is reflecting the fact that this government is acting in a way that will cause higher relative rates of inflation in the future even thought the explicit evidence of this inflation is not present in currently measured figures.
This, I believe, is what has happened in to the United States dollar over the past six years or so. And, at the present time, no evidence has been given that the economic policy of the United States government has changed and there is little or no evidence that either of the presidential candidates will do anything to correct this situation. This is the cloud of uncertainty that is hanging over international financial markets at the present time. Until this position is clarified, uncertainty will remain and financial markets will remain quite volatile.
Of course, there is more to a vision of economic policy than that related to the nation’s exchange rate. But, the crux of such a policy is the trust that market participants place in the willingness of an administration to keep “expectations of inflation” under control. And, this goes backs to the basic fundamentals…fiscal discipline and conservative monetary management. For monetary policy to focus upon keeping inflation and inflationary expectations low, fiscal policy must be conducted in a way that does not put undue pressure on the conduct of the central bank. When deficits are too large the historical evidence suggests that sooner or later the monetary authorities will have to come in and “monetize” a substantial portion of the debt. This monetization of the debt is, of course, inflationary. Thus, even though a central bank may claim to be focused on keeping inflation low, a lack of fiscal discipline will be translated by market participants as potentially inflationary. Historically, the market participants have not been proven wrong.
Thus, fiscal discipline goes along with conservative monetary management. Again, no evidence has been forthcoming that either presidential candidate has advocated such control.
Economic growth is another facet of economic policy. However, the historical evidence shows that what is done to support long term economic growth is not directly connected with monetary policy or fiscal deficits. Loose monetary policy may spur on economic growth in the short run, but in the longer term, inflation created by fiscal deficits and loose monetary policy stifle initiative and innovation and lead to slower rates of economic expansion. Emphasis upon demand side stimulus (which tends to be inflationary over time) has not been the elixir for a dynamic and growing economy. What is needed is encouragement for a shift in the supply side of the economy. But, this will take an extended period of time.
I believe that a vision of future economic growth must be based upon three factors. First, organizations, both financial and non-financial, must stop focusing on financial methods as their key to performance and return to a focus on the products and services they produce as their strength. When the government emphasizes demand side policies, companies, unfortunately, seem to de-emphasize their “core competencies” and turn to financial leverage and added financial risk-taking as sources of exceptional performance.
Second, economic policy must support a “bottom-up” approach to economic creation and development. Real economic vitality comes about when entrepreneurial energy is released in an economy. Organizational conglomeration and size ultimately seem to primarily benefit the executives that build such giants. Why? Executive salaries, bonuses, and other benefits are related to size…because the system bases executive remuneration on comparables…and this has a cumulative effect that only encourages more inefficient mergers and efforts to achieve growth for growth’s sake. This area needs to be examined more thoroughly in order to create a supply side shift in aggregate economic performance.
Finally, in my view, the current world is a world of life-time education. To me, a safety-net begins by creating a world in which everyone, in a real sense, is trained for and participates in transition. The world is constantly changing. Major problems occur when people, companies, unions, and others want to “protect” people, companies, unions, and others from change. Government, at all levels, is going to have to play a role in creating this safety-net. But, the safety-net should begin and end with education…not just to start out…but throughout ones life.
Given this criticism, the question must be asked, “What is the basis for a sound economic vision?”
I believe that the foundation of a sound economic vision begins with the value of the United States dollar. I continually go back to the statement of Paul Volcker: “a nation’s exchange rate is the single most important price in the economy.” (Paul Volcker and Toyoo Gyohten, “Changing Fortunes: the World’s Money and the Threat to American Leadership, (New York: Times Books, 1992), p. 232.)
The reason the exchange rate is the single most important price in the economy is because it reflects the viewpoint of the rest of the world about how an economy is being managed relative to how other nations are managing their economies. In essence, the value of a country’s currency is related to relative rates of expected inflation…the expected inflation of the country in question relative to the expected inflation in other nations in the world.
And, it is expected inflation that is important, not actual inflation as measured by current price indices. Calculated measures of inflation do not always immediately capture what is going on in the world and, as a consequence, do not always pick up economic dislocations that will be reflected in prices at some time in the future.
For example, in the consumer price index, estimates are made of the rental price a home owner would pay for the housing services received from the owned home. These are not directly related to the prices that homes are being sold for. Thus, prices of houses may be rising at a very rapid rate while the estimated rental price of the housing services may be rising very slowly. Since the component of the consumer price index related to housing is quite large, the “measured” consumer price index may rise only modestly whereas the prices of housing might be rising quite rapidly. (Note: this, of course, relates to the situation several years ago and not right now.)
Furthermore, with all the Federal government debt being exported, the nations having investors that have purchased large amounts of this debt face a peculiar situation. Many of these nations have their currencies tied to the value of the United States dollar. The low interest rate policy in the United States has forced these countries to also maintain a low interest rate policy and this has resulted in higher rates of inflation in these countries. The inflation experienced in these countries is now finding its way back into the United States.
Thus, there are many ways that inflation or the possibility of inflation can work its way through the world economy without being captured in currently measured price indices. It would be silly for investors to wait for inflation to show up in the published price indices before they made their investment decisions. Investors must make decisions based on what they “expect” to happen. These inflationary expectations are therefore reflected in current market prices such as a nation’s exchange rate.
It can be strongly argued that if investors believe that a government is acting independently of the rest of the world and behaving in an imprudent and undisciplined manner they will sell the currency of that country and this will result in a decline in the value of that country’s currency. In essence, the market is reflecting the fact that this government is acting in a way that will cause higher relative rates of inflation in the future even thought the explicit evidence of this inflation is not present in currently measured figures.
This, I believe, is what has happened in to the United States dollar over the past six years or so. And, at the present time, no evidence has been given that the economic policy of the United States government has changed and there is little or no evidence that either of the presidential candidates will do anything to correct this situation. This is the cloud of uncertainty that is hanging over international financial markets at the present time. Until this position is clarified, uncertainty will remain and financial markets will remain quite volatile.
Of course, there is more to a vision of economic policy than that related to the nation’s exchange rate. But, the crux of such a policy is the trust that market participants place in the willingness of an administration to keep “expectations of inflation” under control. And, this goes backs to the basic fundamentals…fiscal discipline and conservative monetary management. For monetary policy to focus upon keeping inflation and inflationary expectations low, fiscal policy must be conducted in a way that does not put undue pressure on the conduct of the central bank. When deficits are too large the historical evidence suggests that sooner or later the monetary authorities will have to come in and “monetize” a substantial portion of the debt. This monetization of the debt is, of course, inflationary. Thus, even though a central bank may claim to be focused on keeping inflation low, a lack of fiscal discipline will be translated by market participants as potentially inflationary. Historically, the market participants have not been proven wrong.
Thus, fiscal discipline goes along with conservative monetary management. Again, no evidence has been forthcoming that either presidential candidate has advocated such control.
Economic growth is another facet of economic policy. However, the historical evidence shows that what is done to support long term economic growth is not directly connected with monetary policy or fiscal deficits. Loose monetary policy may spur on economic growth in the short run, but in the longer term, inflation created by fiscal deficits and loose monetary policy stifle initiative and innovation and lead to slower rates of economic expansion. Emphasis upon demand side stimulus (which tends to be inflationary over time) has not been the elixir for a dynamic and growing economy. What is needed is encouragement for a shift in the supply side of the economy. But, this will take an extended period of time.
I believe that a vision of future economic growth must be based upon three factors. First, organizations, both financial and non-financial, must stop focusing on financial methods as their key to performance and return to a focus on the products and services they produce as their strength. When the government emphasizes demand side policies, companies, unfortunately, seem to de-emphasize their “core competencies” and turn to financial leverage and added financial risk-taking as sources of exceptional performance.
Second, economic policy must support a “bottom-up” approach to economic creation and development. Real economic vitality comes about when entrepreneurial energy is released in an economy. Organizational conglomeration and size ultimately seem to primarily benefit the executives that build such giants. Why? Executive salaries, bonuses, and other benefits are related to size…because the system bases executive remuneration on comparables…and this has a cumulative effect that only encourages more inefficient mergers and efforts to achieve growth for growth’s sake. This area needs to be examined more thoroughly in order to create a supply side shift in aggregate economic performance.
Finally, in my view, the current world is a world of life-time education. To me, a safety-net begins by creating a world in which everyone, in a real sense, is trained for and participates in transition. The world is constantly changing. Major problems occur when people, companies, unions, and others want to “protect” people, companies, unions, and others from change. Government, at all levels, is going to have to play a role in creating this safety-net. But, the safety-net should begin and end with education…not just to start out…but throughout ones life.
The Most Important Price in an Economy
In my post of August 18, 2008, I argued that neither of the presidential candidates had really staked out a well defined position as far as their economic vision was concerned. The pronouncements of the candidates, I wrote, were either too general or were bogged down in ‘wonkish’ minutia. As a consequence, an uncertainty has resulted that has left people and markets without direction and has fueled a greater volatility in prices.
Given this criticism, the question must be asked, “What is the basis for a sound economic vision?”
I believe that the foundation of a sound economic vision begins with the value of the United States dollar. I continually go back to the statement of Paul Volcker: “a nation’s exchange rate is the single most important price in the economy.” (Paul Volcker and Toyoo Gyohten, “Changing Fortunes: the World’s Money and the Threat to American Leadership, (New York: Times Books, 1992), p. 232.)
The reason the exchange rate is the single most important price in the economy is because it reflects the viewpoint of the rest of the world about how an economy is being managed relative to how other nations are managing their economies. In essence, the value of a country’s currency is related to relative rates of expected inflation…the expected inflation of the country in question relative to the expected inflation in other nations in the world.
And, it is expected inflation that is important, not actual inflation as measured by current price indices. Calculated measures of inflation do not always immediately capture what is going on in the world and, as a consequence, do not always pick up economic dislocations that will be reflected in prices at some time in the future.
For example, in the consumer price index, estimates are made of the rental price a home owner would pay for the housing services received from the owned home. These are not directly related to the prices that homes are being sold for. Thus, prices of houses may be rising at a very rapid rate while the estimated rental price of the housing services may be rising very slowly. Since the component of the consumer price index related to housing is quite large, the “measured” consumer price index may rise only modestly whereas the prices of housing might be rising quite rapidly. (Note: this, of course, relates to the situation several years ago and not right now.)
Furthermore, with all the Federal government debt being exported, the nations having investors that have purchased large amounts of this debt face a peculiar situation. Many of these nations have their currencies tied to the value of the United States dollar. The low interest rate policy in the United States has forced these countries to also maintain a low interest rate policy and this has resulted in higher rates of inflation in these countries. The inflation experienced in these countries is now finding its way back into the United States.
Thus, there are many ways that inflation or the possibility of inflation can work its way through the world economy without being captured in currently measured price indices. It would be silly for investors to wait for inflation to show up in the published price indices before they made their investment decisions. Investors must make decisions based on what they “expect” to happen. These inflationary expectations are therefore reflected in current market prices such as a nation’s exchange rate.
It can be strongly argued that if investors believe that a government is acting independently of the rest of the world and behaving in an imprudent and undisciplined manner they will sell the currency of that country and this will result in a decline in the value of that country’s currency. In essence, the market is reflecting the fact that this government is acting in a way that will cause higher relative rates of inflation in the future even thought the explicit evidence of this inflation is not present in currently measured figures.
This, I believe, is what has happened in to the United States dollar over the past six years or so. And, at the present time, no evidence has been given that the economic policy of the United States government has changed and there is little or no evidence that either of the presidential candidates will do anything to correct this situation. This is the cloud of uncertainty that is hanging over international financial markets at the present time. Until this position is clarified, uncertainty will remain and financial markets will remain quite volatile.
Of course, there is more to a vision of economic policy than that related to the nation’s exchange rate. But, the crux of such a policy is the trust that market participants place in the willingness of an administration to keep “expectations of inflation” under control. And, this goes backs to the basic fundamentals…fiscal discipline and conservative monetary management. For monetary policy to focus upon keeping inflation and inflationary expectations low, fiscal policy must be conducted in a way that does not put undue pressure on the conduct of the central bank. When deficits are too large the historical evidence suggests that sooner or later the monetary authorities will have to come in and “monetize” a substantial portion of the debt. This monetization of the debt is, of course, inflationary. Thus, even though a central bank may claim to be focused on keeping inflation low, a lack of fiscal discipline will be translated by market participants as potentially inflationary. Historically, the market participants have not been proven wrong.
Thus, fiscal discipline goes along with conservative monetary management. Again, no evidence has been forthcoming that either presidential candidate has advocated such control.
Economic growth is another facet of economic policy. However, the historical evidence shows that what is done to support long term economic growth is not directly connected with monetary policy or fiscal deficits. Loose monetary policy may spur on economic growth in the short run, but in the longer term, inflation created by fiscal deficits and loose monetary policy stifle initiative and innovation and lead to slower rates of economic expansion. Emphasis upon demand side stimulus (which tends to be inflationary over time) has not been the elixir for a dynamic and growing economy. What is needed is encouragement for a shift in the supply side of the economy. But, this will take an extended period of time.
I believe that a vision of future economic growth must be based upon three factors. First, organizations, both financial and non-financial, must stop focusing on financial methods as their key to performance and return to a focus on the products and services they produce as their strength. When the government emphasizes demand side policies, companies, unfortunately, seem to de-emphasize their “core competencies” and turn to financial leverage and added financial risk-taking as sources of exceptional performance.
Second, economic policy must support a “bottom-up” approach to economic creation and development. Real economic vitality comes about when entrepreneurial energy is released in an economy. Organizational conglomeration and size ultimately seem to primarily benefit the executives that build such giants. Why? Executive salaries, bonuses, and other benefits are related to size…because the system bases executive remuneration on comparables…and this has a cumulative effect that only encourages more inefficient mergers and efforts to achieve growth for growth’s sake. This area needs to be examined more thoroughly in order to create a supply side shift in aggregate economic performance.
Finally, in my view, the current world is a world of life-time education. To me, a safety-net begins by creating a world in which everyone, in a real sense, is trained for and participates in transition. The world is constantly changing. Major problems occur when people, companies, unions, and others want to “protect” people, companies, unions, and others from change. Government, at all levels, is going to have to play a role in creating this safety-net. But, the safety-net should begin and end with education…not just to start out…but throughout ones life.
Given this criticism, the question must be asked, “What is the basis for a sound economic vision?”
I believe that the foundation of a sound economic vision begins with the value of the United States dollar. I continually go back to the statement of Paul Volcker: “a nation’s exchange rate is the single most important price in the economy.” (Paul Volcker and Toyoo Gyohten, “Changing Fortunes: the World’s Money and the Threat to American Leadership, (New York: Times Books, 1992), p. 232.)
The reason the exchange rate is the single most important price in the economy is because it reflects the viewpoint of the rest of the world about how an economy is being managed relative to how other nations are managing their economies. In essence, the value of a country’s currency is related to relative rates of expected inflation…the expected inflation of the country in question relative to the expected inflation in other nations in the world.
And, it is expected inflation that is important, not actual inflation as measured by current price indices. Calculated measures of inflation do not always immediately capture what is going on in the world and, as a consequence, do not always pick up economic dislocations that will be reflected in prices at some time in the future.
For example, in the consumer price index, estimates are made of the rental price a home owner would pay for the housing services received from the owned home. These are not directly related to the prices that homes are being sold for. Thus, prices of houses may be rising at a very rapid rate while the estimated rental price of the housing services may be rising very slowly. Since the component of the consumer price index related to housing is quite large, the “measured” consumer price index may rise only modestly whereas the prices of housing might be rising quite rapidly. (Note: this, of course, relates to the situation several years ago and not right now.)
Furthermore, with all the Federal government debt being exported, the nations having investors that have purchased large amounts of this debt face a peculiar situation. Many of these nations have their currencies tied to the value of the United States dollar. The low interest rate policy in the United States has forced these countries to also maintain a low interest rate policy and this has resulted in higher rates of inflation in these countries. The inflation experienced in these countries is now finding its way back into the United States.
Thus, there are many ways that inflation or the possibility of inflation can work its way through the world economy without being captured in currently measured price indices. It would be silly for investors to wait for inflation to show up in the published price indices before they made their investment decisions. Investors must make decisions based on what they “expect” to happen. These inflationary expectations are therefore reflected in current market prices such as a nation’s exchange rate.
It can be strongly argued that if investors believe that a government is acting independently of the rest of the world and behaving in an imprudent and undisciplined manner they will sell the currency of that country and this will result in a decline in the value of that country’s currency. In essence, the market is reflecting the fact that this government is acting in a way that will cause higher relative rates of inflation in the future even thought the explicit evidence of this inflation is not present in currently measured figures.
This, I believe, is what has happened in to the United States dollar over the past six years or so. And, at the present time, no evidence has been given that the economic policy of the United States government has changed and there is little or no evidence that either of the presidential candidates will do anything to correct this situation. This is the cloud of uncertainty that is hanging over international financial markets at the present time. Until this position is clarified, uncertainty will remain and financial markets will remain quite volatile.
Of course, there is more to a vision of economic policy than that related to the nation’s exchange rate. But, the crux of such a policy is the trust that market participants place in the willingness of an administration to keep “expectations of inflation” under control. And, this goes backs to the basic fundamentals…fiscal discipline and conservative monetary management. For monetary policy to focus upon keeping inflation and inflationary expectations low, fiscal policy must be conducted in a way that does not put undue pressure on the conduct of the central bank. When deficits are too large the historical evidence suggests that sooner or later the monetary authorities will have to come in and “monetize” a substantial portion of the debt. This monetization of the debt is, of course, inflationary. Thus, even though a central bank may claim to be focused on keeping inflation low, a lack of fiscal discipline will be translated by market participants as potentially inflationary. Historically, the market participants have not been proven wrong.
Thus, fiscal discipline goes along with conservative monetary management. Again, no evidence has been forthcoming that either presidential candidate has advocated such control.
Economic growth is another facet of economic policy. However, the historical evidence shows that what is done to support long term economic growth is not directly connected with monetary policy or fiscal deficits. Loose monetary policy may spur on economic growth in the short run, but in the longer term, inflation created by fiscal deficits and loose monetary policy stifle initiative and innovation and lead to slower rates of economic expansion. Emphasis upon demand side stimulus (which tends to be inflationary over time) has not been the elixir for a dynamic and growing economy. What is needed is encouragement for a shift in the supply side of the economy. But, this will take an extended period of time.
I believe that a vision of future economic growth must be based upon three factors. First, organizations, both financial and non-financial, must stop focusing on financial methods as their key to performance and return to a focus on the products and services they produce as their strength. When the government emphasizes demand side policies, companies, unfortunately, seem to de-emphasize their “core competencies” and turn to financial leverage and added financial risk-taking as sources of exceptional performance.
Second, economic policy must support a “bottom-up” approach to economic creation and development. Real economic vitality comes about when entrepreneurial energy is released in an economy. Organizational conglomeration and size ultimately seem to primarily benefit the executives that build such giants. Why? Executive salaries, bonuses, and other benefits are related to size…because the system bases executive remuneration on comparables…and this has a cumulative effect that only encourages more inefficient mergers and efforts to achieve growth for growth’s sake. This area needs to be examined more thoroughly in order to create a supply side shift in aggregate economic performance.
Finally, in my view, the current world is a world of life-time education. To me, a safety-net begins by creating a world in which everyone, in a real sense, is trained for and participates in transition. The world is constantly changing. Major problems occur when people, companies, unions, and others want to “protect” people, companies, unions, and others from change. Government, at all levels, is going to have to play a role in creating this safety-net. But, the safety-net should begin and end with education…not just to start out…but throughout ones life.
Monday, August 18, 2008
The Candidates and Economic Leadership
I have just returned from two weeks of vacation in the mountains and lakes of New England. More than enough rain…but a magnificent two weeks of vacation, anyway.
Catching up is always the price one pays for taking some time off and with two weeks off, the price is quite high. But, it was hopeful to see the decline in the price of oil, the price of gold, and the strength in the dollar. I see that even Barack Obama took some time off in Hawaii, proving that he is human as well.
I have found in the past that it is always helpful in beginning to write again to discuss something that is more general in nature so as to attempt to gain a focus that might be lost if one starts out with something very specific. (I know, one commentator has stated that my perspective is one of 40,000 feet above the fray anyway.) Therefore, I would like to write about two major issues that I believe are going to provide the background for economic activity, not only in the near term, but also for the foreseeable future. These issues both have to do with Presidential leadership.
As many readers of this blog know, I am very interested in leadership…political leadership, business leadership, social leadership, cultural leadership…. Leadership is important because the leader defines the cultural of his or her administration, the world view and the operating procedure that lies behind all that the leader hopes to achieve. I have found that it is imperative that the leader of an organization reflect this culture in everything that he or she does or says or breathes. Only in this way can the leader galvanize his or her troops to accomplish what is being attempted.
The first issue that strikes me in getting back to the “real world” is that neither candidate for the presidency seems to be presenting us with their world view when it comes to the economic and financial affairs of the country. (The ‘operating policies’ of the candidates are another story…maybe for another time.) Returning to the battle I see little beyond vague generalities on the one hand and the facts and figures of ‘policy wonks’ on the other. In terms of Obama I see vague claims that he is moving toward “Rubinomics” (http://www.bloomberg.com/apps/news?pid=20601070&sid=aJ.pKsYB_DfU&refer=home) and other claims that he lacks “passion” when it comes to presenting his program (http://www.nytimes.com/2008/08/18/opinion/18krugman.html?hp). In terms of McCain, Ben Stein has been particularly brutal in claiming that McCain has no systematic thinking at all behind his statements about economic policy. According to a New York Times article this past week, McCain’s campaign leadership attempts to keep McCain off his cell-phone because many of his statements tend to reflect the last person he has talked with.
In my estimation, both candidates are currently lacking in leadership when it comes to the realm of economic policy. The United States…and the world…are facing some very serious economic problems…problems that will carry over for many years to come. And, we have little or no idea about what the economic ‘culture’ would be forthcoming from either candidate.
Robert Rubin states that Obama is focusing on “competitiveness and economic growth on the one hand, and distribution and fairness on the other.” (See the Bloomberg article cited above.) But, what does this mean?
The value of the dollar has declined for the last six years or so. Inflation seems to be picking up. Although commodity prices have declined recently, many see this as just a pause. What about the financial system and regulatory reform? Just what is the world view that Obama is presenting.
Unfortunately, I see nothing on the McCain side that can lead to any specific comments. Here I don’t know when I have seen such inconsistency in what has been presented.
This leadership void bothers me because it does not allow those of us that must operate in the economy any sense of direction. (Mason’s Rule # 5 is that markets hate uncertainty!) Even if we disagree with the world vision that a leader presents, we have something to go on by which we can make decisions. All decisions are based upon our forecast of possible future outcomes. A leadership void implies that the distribution of future outcomes is larger than it would be if there was a better idea of what policies might be implemented. A greater distribution of future outcomes portends greater volatility in business and financial markets. That is, it implies that the future will be quite risky!
So, the first thing that concerns me upon returning to civilization is that no economic leadership currently exists in Washington, D. C. and that the presidential candidates are not stepping up to the plate and providing a vision of economic leadership for when they are elected. This is bad for economic and financial markets because volatility is not conducive to either “competitiveness and economic growth” or to “distribution and fairness.” It is downright horrible for innovation and productivity.
The second issue of concern derives from the recent unpleasantness created by Russia and Georgia. It is not often that I quote Paul Krugman twice in something I write, but he has presented a viewpoint that I think must be taken very seriously. His column on August 15 (http://www.nytimes.com/2008/08/15/opinion/15krugman.html) discusses the possibility that we could be entering an age in which the world becomes more fragmented, economically as well as politically, leading to greater political and economic instability, slower economic growth, and more war. Krugman points out that into the 1910s the world seemed to be approaching a time of real global interconnectivity and peace. There was real optimism that this could be achieved. And, this collapsed into a lengthy period of revolution, war, and depression.
The question that the Russia-Georgia conflict raises along with the world wide battle against terrorism is whether or not we are now at the crest of another period when world connectivity seems possible and globalization seems ready to make us all world citizens. Could this edifice all come crashing down in another round of regionalism, protectionism, isolation, and war? Krugman presents us with this possibility.
This possibility directs me to another subplot in the upcoming election. This is the stance that organized labor is taking with respect to global trade, government regulation, and sound economic policies. We see this stance presented in the article “Obama Tilt Toward Rubinomics Stirs Warning From Organized Labor” (http://www.bloomberg.com/apps/news?pid=20601070&sid=aJ.pKsYB_DfU&refer=home). To me the worst economic scenario for labor is one in which globalization collapses, a world in which nations cut themselves off from other nations, where economic growth is dismal, and where war and terrorism are a part of daily lives. To me, organized labor is taking a stance that it believes will help the ordinary worker in the United States but is, at a minimum, very, very shortsighted.
Organized labor in the United States is in a bad way. Over the past forty years or so it has become mostly irrelevant and, as a consequence, has lost a lot of its power. It is now attempting to exert itself once again. However, the more power it regains, the less well off will be the worker it is trying to help. Certainly the American worker needs an advocate. That advocate is not currently organized labor.
Here again, leadership is needed on a national scale. The world must avoid a return to protectionism, isolationism, and turmoil. The United States President must support globalization, integration, and inter-connectivity. The United States President must promote communication, education, mutual respect, and worldwide economic growth. Here again, it is time for one candidate or the other to step up to the task and present us with a vision we can buy on to.
Catching up is always the price one pays for taking some time off and with two weeks off, the price is quite high. But, it was hopeful to see the decline in the price of oil, the price of gold, and the strength in the dollar. I see that even Barack Obama took some time off in Hawaii, proving that he is human as well.
I have found in the past that it is always helpful in beginning to write again to discuss something that is more general in nature so as to attempt to gain a focus that might be lost if one starts out with something very specific. (I know, one commentator has stated that my perspective is one of 40,000 feet above the fray anyway.) Therefore, I would like to write about two major issues that I believe are going to provide the background for economic activity, not only in the near term, but also for the foreseeable future. These issues both have to do with Presidential leadership.
As many readers of this blog know, I am very interested in leadership…political leadership, business leadership, social leadership, cultural leadership…. Leadership is important because the leader defines the cultural of his or her administration, the world view and the operating procedure that lies behind all that the leader hopes to achieve. I have found that it is imperative that the leader of an organization reflect this culture in everything that he or she does or says or breathes. Only in this way can the leader galvanize his or her troops to accomplish what is being attempted.
The first issue that strikes me in getting back to the “real world” is that neither candidate for the presidency seems to be presenting us with their world view when it comes to the economic and financial affairs of the country. (The ‘operating policies’ of the candidates are another story…maybe for another time.) Returning to the battle I see little beyond vague generalities on the one hand and the facts and figures of ‘policy wonks’ on the other. In terms of Obama I see vague claims that he is moving toward “Rubinomics” (http://www.bloomberg.com/apps/news?pid=20601070&sid=aJ.pKsYB_DfU&refer=home) and other claims that he lacks “passion” when it comes to presenting his program (http://www.nytimes.com/2008/08/18/opinion/18krugman.html?hp). In terms of McCain, Ben Stein has been particularly brutal in claiming that McCain has no systematic thinking at all behind his statements about economic policy. According to a New York Times article this past week, McCain’s campaign leadership attempts to keep McCain off his cell-phone because many of his statements tend to reflect the last person he has talked with.
In my estimation, both candidates are currently lacking in leadership when it comes to the realm of economic policy. The United States…and the world…are facing some very serious economic problems…problems that will carry over for many years to come. And, we have little or no idea about what the economic ‘culture’ would be forthcoming from either candidate.
Robert Rubin states that Obama is focusing on “competitiveness and economic growth on the one hand, and distribution and fairness on the other.” (See the Bloomberg article cited above.) But, what does this mean?
The value of the dollar has declined for the last six years or so. Inflation seems to be picking up. Although commodity prices have declined recently, many see this as just a pause. What about the financial system and regulatory reform? Just what is the world view that Obama is presenting.
Unfortunately, I see nothing on the McCain side that can lead to any specific comments. Here I don’t know when I have seen such inconsistency in what has been presented.
This leadership void bothers me because it does not allow those of us that must operate in the economy any sense of direction. (Mason’s Rule # 5 is that markets hate uncertainty!) Even if we disagree with the world vision that a leader presents, we have something to go on by which we can make decisions. All decisions are based upon our forecast of possible future outcomes. A leadership void implies that the distribution of future outcomes is larger than it would be if there was a better idea of what policies might be implemented. A greater distribution of future outcomes portends greater volatility in business and financial markets. That is, it implies that the future will be quite risky!
So, the first thing that concerns me upon returning to civilization is that no economic leadership currently exists in Washington, D. C. and that the presidential candidates are not stepping up to the plate and providing a vision of economic leadership for when they are elected. This is bad for economic and financial markets because volatility is not conducive to either “competitiveness and economic growth” or to “distribution and fairness.” It is downright horrible for innovation and productivity.
The second issue of concern derives from the recent unpleasantness created by Russia and Georgia. It is not often that I quote Paul Krugman twice in something I write, but he has presented a viewpoint that I think must be taken very seriously. His column on August 15 (http://www.nytimes.com/2008/08/15/opinion/15krugman.html) discusses the possibility that we could be entering an age in which the world becomes more fragmented, economically as well as politically, leading to greater political and economic instability, slower economic growth, and more war. Krugman points out that into the 1910s the world seemed to be approaching a time of real global interconnectivity and peace. There was real optimism that this could be achieved. And, this collapsed into a lengthy period of revolution, war, and depression.
The question that the Russia-Georgia conflict raises along with the world wide battle against terrorism is whether or not we are now at the crest of another period when world connectivity seems possible and globalization seems ready to make us all world citizens. Could this edifice all come crashing down in another round of regionalism, protectionism, isolation, and war? Krugman presents us with this possibility.
This possibility directs me to another subplot in the upcoming election. This is the stance that organized labor is taking with respect to global trade, government regulation, and sound economic policies. We see this stance presented in the article “Obama Tilt Toward Rubinomics Stirs Warning From Organized Labor” (http://www.bloomberg.com/apps/news?pid=20601070&sid=aJ.pKsYB_DfU&refer=home). To me the worst economic scenario for labor is one in which globalization collapses, a world in which nations cut themselves off from other nations, where economic growth is dismal, and where war and terrorism are a part of daily lives. To me, organized labor is taking a stance that it believes will help the ordinary worker in the United States but is, at a minimum, very, very shortsighted.
Organized labor in the United States is in a bad way. Over the past forty years or so it has become mostly irrelevant and, as a consequence, has lost a lot of its power. It is now attempting to exert itself once again. However, the more power it regains, the less well off will be the worker it is trying to help. Certainly the American worker needs an advocate. That advocate is not currently organized labor.
Here again, leadership is needed on a national scale. The world must avoid a return to protectionism, isolationism, and turmoil. The United States President must support globalization, integration, and inter-connectivity. The United States President must promote communication, education, mutual respect, and worldwide economic growth. Here again, it is time for one candidate or the other to step up to the task and present us with a vision we can buy on to.
Friday, August 1, 2008
Investment strategies in this time of transition (I)
In my post of July 29, 2008, “Understanding the Economy” I discussed two possible interpretations of the current economic situation. One interpretation concentrated upon demand side changes in the economy whereas the other interpretation concentrated upon supply side changes. I argued that it was important to get the correct interpretation because the policy prescriptions would be different in each case and would produce substantially different results.
I gave two reasons for focusing upon the latter explanation as the cause of the business cycle and stated that it was important to create policies that provided supply side stimulus rather than policies that just attempted to stimulate demand. If the United States focuses on demand side stimulation, the argument is that this will just exacerbate inflationary pressures with little or no response in terms of increased output. Any governmental efforts need to be aimed at stimulating supply so that output can increase without undue pressure on prices.
A similar proposal has been presented by Kenneth Rogoff of Harvard University on Wednesday July 30 in the Financial Times, “The world cannot grow its way out of this slowdown.” (See http://www.ft.com/cms/s/29a40a90-5d6f-11dd-8129-000077b07658,Authorised=false.html?_i_location=http%3A%2F%2Fwww.ft.com%2Fcms%2Fs%2F0%2F29a40a90-5d6f-11dd-8129-000077b07658.html&_i_referer=http%3A%2F%2Fsearch.ft.com%2Fsearch%3FqueryText%3Dthe%2Bworld%2Bcannot%2Bgrow%26aje%3Dtrue%26dse%3D%26dsz%3D.)
Rogoff argues that “if all regions attempt to maintain high growth through macroeconomic stimulus, the main result is going to be higher commodity prices and ultimately a bigger crash in the not-too-distant future.” He goes on to say, “In the light of the experience of the 1970s, it is surprising how many leading policymakers and economic pundits believe that policy should aim to keep pushing demand up.”
Furthermore, Rogoff states, “Commodity constraints will limit the real output response globally, and most of the excess demand will spill over into higher inflation.”
In other words, pumping up aggregate demand at this time is not going to get a supply response and hence almost all of the increase in aggregate demand will go into prices increases. Not a very pretty view of the future.
My description of this scenario was presented in the earlier post. In this post I want to examine investment strategies for the two different scenarios. Since we started on the demand side responses and believe that policies aimed at spurring on aggregate demand have the highest probability of occurring, let’s begin here.
Demand side programs, according to the scenario presented by Rogoff (and myself), will have more impact on increasing inflation than they will on increasing output. As a consequence, investor focus should be on protecting oneself from rising prices. (Sounds like the seventies doesn’t it!)
What to look for? More tax rebates (already being discussed); support for housing (already being discussed); keeping interest rates low (already being discussed); and other programs and policies being presented by presidential candidates and Congress.
Investment strategy? Where are your inflation hedges? Gold…commodities…housing seems to be out this time (it was a great hedge in the 1970s)…inventories…paintings…rare coins…
Obviously, these types of investment do not do a great deal to contribute to increasing output or stimulating productivity. This is what happened in the 1970s as the focus changed and people pulled back from investing in innovations and capital that resulted in increases in productivity and which also created positive externalities that spurred on the economy.
Demand side strategies at a time like this divert attention away from productive investment and toward investments that hedge against inflation and contribute little to resolving the underlying economic problems that plague the United States (and the world). But, demand side strategies are very popular with politicians because they can allow the candidate to talk about help to the ‘disadvantaged’ and the ‘little guy’ and beating up the ‘bad guys’. And, they promise faster results. Furthermore, when investors hedge against the inflation that is created, these same politicians can blast the ‘wealthy speculators’ for driving up prices which additionally harm the less well off. And, this is what happened during the years of the Carter administration.
Rogoff concludes his analysis with this warning: “In policymaker’s zealous attempts to avoid a plain vanilla supply shock recession, they are taking excessive risks with inflation and budget discipline that may ultimately lead to a much greater ad more protracted downturn.”
What about supply side policies? Not as easy to do and certainly not as easy to sell! First off, the fiscal authorities must take pressure off the monetary authorities by exerting discipline over the government’s budget. The irresponsible behavior of the current administration must be overcome by bringing the deficit under control. Doing this will help strengthen the value of the dollar, something that will help the performance of the United States economy in the longer run.
The attention of the monetary authorities must be focused on keeping inflation at a low level. What finally got the United States out of the malaise of the 1970s? Some tough policy actions on the part of Paul Volcker and the Federal Reserve that broke the back of inflation (even though this is not what Jimmy Carter really wanted). Inflation is counter-productive to economic growth, productivity, and innovation. We cannot get a supply side response as long as businesses and investors focus on inflation. Keeping inflation at a low level will also contribute to the strength of the dollar. (See Fred Mishkin’s last lecture before leaving the Fed: http://online.wsj.com/article/SB121726587261090311.html?mod=todays_us_page_one; and http://www.federalreserve.gov/newsevents/speech/mishkin20080728a.htm.)
Other supply side policies are still needed to spur on a recovery, but these will not result in programs that generate a short term payoff, something, of course, that politicians do not like. But, it must be remembered…it took us a long time to get where we are now and it will take a long time for us to get back ‘on track’. People must remind the politicians that they turned their heads aside for a long time allowing this economic dilemma to arise…and they are not going to be able to get us out of this mess with a wave of a magic wand!
It seems to me that there are at least two aspects to creating the platform for the next period of expansion. First, we must go through the economic transition to get our financial legs back under us, both in our financial institutions, but also in non-financial areas as well. Second, we must go through the technological transition that will result from the advent of new sources of energy. And, this transition will impact almost every sector of the economy. The important thing here is that the government must introduce policies and programs that will support the PROCESS of transition and which will not impede that process by shooting for specific OUTCOMES.
What to invest in given a supply side response by the government? Well, this is a time of transition and that means we must look into areas in which the transition is going to take place. One possible source for investment is in companies that are getting back to basics and bringing their focus back into the areas that they have or can establish sustainable competitive advantage. Here we can look for turnarounds, restructuring firms, and acquisitions to gain scale, customer captivity, or create barriers to entry. Second, we look toward those innovators that are working in the energy field to construct technologies or market structures that might create sustainable competitive advantage. This means that the scope of potential investments may be quite large, but the focus will be on future market structure. I will write more on these in the next two posts.
I gave two reasons for focusing upon the latter explanation as the cause of the business cycle and stated that it was important to create policies that provided supply side stimulus rather than policies that just attempted to stimulate demand. If the United States focuses on demand side stimulation, the argument is that this will just exacerbate inflationary pressures with little or no response in terms of increased output. Any governmental efforts need to be aimed at stimulating supply so that output can increase without undue pressure on prices.
A similar proposal has been presented by Kenneth Rogoff of Harvard University on Wednesday July 30 in the Financial Times, “The world cannot grow its way out of this slowdown.” (See http://www.ft.com/cms/s/29a40a90-5d6f-11dd-8129-000077b07658,Authorised=false.html?_i_location=http%3A%2F%2Fwww.ft.com%2Fcms%2Fs%2F0%2F29a40a90-5d6f-11dd-8129-000077b07658.html&_i_referer=http%3A%2F%2Fsearch.ft.com%2Fsearch%3FqueryText%3Dthe%2Bworld%2Bcannot%2Bgrow%26aje%3Dtrue%26dse%3D%26dsz%3D.)
Rogoff argues that “if all regions attempt to maintain high growth through macroeconomic stimulus, the main result is going to be higher commodity prices and ultimately a bigger crash in the not-too-distant future.” He goes on to say, “In the light of the experience of the 1970s, it is surprising how many leading policymakers and economic pundits believe that policy should aim to keep pushing demand up.”
Furthermore, Rogoff states, “Commodity constraints will limit the real output response globally, and most of the excess demand will spill over into higher inflation.”
In other words, pumping up aggregate demand at this time is not going to get a supply response and hence almost all of the increase in aggregate demand will go into prices increases. Not a very pretty view of the future.
My description of this scenario was presented in the earlier post. In this post I want to examine investment strategies for the two different scenarios. Since we started on the demand side responses and believe that policies aimed at spurring on aggregate demand have the highest probability of occurring, let’s begin here.
Demand side programs, according to the scenario presented by Rogoff (and myself), will have more impact on increasing inflation than they will on increasing output. As a consequence, investor focus should be on protecting oneself from rising prices. (Sounds like the seventies doesn’t it!)
What to look for? More tax rebates (already being discussed); support for housing (already being discussed); keeping interest rates low (already being discussed); and other programs and policies being presented by presidential candidates and Congress.
Investment strategy? Where are your inflation hedges? Gold…commodities…housing seems to be out this time (it was a great hedge in the 1970s)…inventories…paintings…rare coins…
Obviously, these types of investment do not do a great deal to contribute to increasing output or stimulating productivity. This is what happened in the 1970s as the focus changed and people pulled back from investing in innovations and capital that resulted in increases in productivity and which also created positive externalities that spurred on the economy.
Demand side strategies at a time like this divert attention away from productive investment and toward investments that hedge against inflation and contribute little to resolving the underlying economic problems that plague the United States (and the world). But, demand side strategies are very popular with politicians because they can allow the candidate to talk about help to the ‘disadvantaged’ and the ‘little guy’ and beating up the ‘bad guys’. And, they promise faster results. Furthermore, when investors hedge against the inflation that is created, these same politicians can blast the ‘wealthy speculators’ for driving up prices which additionally harm the less well off. And, this is what happened during the years of the Carter administration.
Rogoff concludes his analysis with this warning: “In policymaker’s zealous attempts to avoid a plain vanilla supply shock recession, they are taking excessive risks with inflation and budget discipline that may ultimately lead to a much greater ad more protracted downturn.”
What about supply side policies? Not as easy to do and certainly not as easy to sell! First off, the fiscal authorities must take pressure off the monetary authorities by exerting discipline over the government’s budget. The irresponsible behavior of the current administration must be overcome by bringing the deficit under control. Doing this will help strengthen the value of the dollar, something that will help the performance of the United States economy in the longer run.
The attention of the monetary authorities must be focused on keeping inflation at a low level. What finally got the United States out of the malaise of the 1970s? Some tough policy actions on the part of Paul Volcker and the Federal Reserve that broke the back of inflation (even though this is not what Jimmy Carter really wanted). Inflation is counter-productive to economic growth, productivity, and innovation. We cannot get a supply side response as long as businesses and investors focus on inflation. Keeping inflation at a low level will also contribute to the strength of the dollar. (See Fred Mishkin’s last lecture before leaving the Fed: http://online.wsj.com/article/SB121726587261090311.html?mod=todays_us_page_one; and http://www.federalreserve.gov/newsevents/speech/mishkin20080728a.htm.)
Other supply side policies are still needed to spur on a recovery, but these will not result in programs that generate a short term payoff, something, of course, that politicians do not like. But, it must be remembered…it took us a long time to get where we are now and it will take a long time for us to get back ‘on track’. People must remind the politicians that they turned their heads aside for a long time allowing this economic dilemma to arise…and they are not going to be able to get us out of this mess with a wave of a magic wand!
It seems to me that there are at least two aspects to creating the platform for the next period of expansion. First, we must go through the economic transition to get our financial legs back under us, both in our financial institutions, but also in non-financial areas as well. Second, we must go through the technological transition that will result from the advent of new sources of energy. And, this transition will impact almost every sector of the economy. The important thing here is that the government must introduce policies and programs that will support the PROCESS of transition and which will not impede that process by shooting for specific OUTCOMES.
What to invest in given a supply side response by the government? Well, this is a time of transition and that means we must look into areas in which the transition is going to take place. One possible source for investment is in companies that are getting back to basics and bringing their focus back into the areas that they have or can establish sustainable competitive advantage. Here we can look for turnarounds, restructuring firms, and acquisitions to gain scale, customer captivity, or create barriers to entry. Second, we look toward those innovators that are working in the energy field to construct technologies or market structures that might create sustainable competitive advantage. This means that the scope of potential investments may be quite large, but the focus will be on future market structure. I will write more on these in the next two posts.
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