Fundamentals 101

Mase: Economics and Finance. September 15, 2008

Fundamentals 101

The United States (and the world) is in a crisis mode. It will continue to stay in a crisis mode for some time. In working through this transition period it is crucial to remember…that fundamentals are important.

Americans are always ones for sports analogies. Let’s start with the need to develop fundamentals. We emphasize the fundamentals of the golf swing in golf. We emphasize the fundamentals of hitting a baseball in baseball. We emphasize the fundamentals in football…and so on and so on.

But, in finance and economics we constantly reflect upon a new economics, a new era in finance, and a new…whatever. We keep finding reasons to believe that we have entered some new period that negates part or all that we have learned. And, when we follow this path, we always end up finding out that…well…that the fundamentals really do still apply.

We can certainly blame the leaders of the corporate world of finance and industry for their putting the fundamentals of finance aside in their quest to become the biggest and “the best”. (What “the best” means we will save for another time.) All I will say here and now is that they were followers…not leaders…and that led to the downfall of those that have failed or will fail.

The leaders I have most scorn for at the present time are those leaders that created the atmosphere…the culture…in which others had to operate. These leaders completely ignored the economic and financial fundamentals that have, over time, proven to be so important in performance. And, the leaders I am talking about here are the political leaders that “set the table” for the period of upheaval that we are now going through.

The number one fundamental that must be adhered to is the one that relates to the value of the currency of a country. The leaders of a country must not…let me repeat…must not…let the value of its currency decline precipitously. I am not talking about slavishly keeping the value of a currency at a particular price. History has shown that this kind of policy does not work either.

Focus upon the value of ones currency causes one to focus upon what your country is doing relative to what other countries are doing. Many people do not like this thought because it seems to make the economic and financial policy of our country dependent upon what everyone else is doing. These people do not want to give up their sovereignty.

The problem with acting independently of everyone else is…we are not independent of everyone else! We live in a world where everyone else is dependent upon everyone else…whether we like it or not!

First finger pointed in blame…the Bush 43 administration. It came into office believing that the United States was so special that it could act unilaterally on anything it chose…it acted that way.

Second finger pointed in blame…Alan Greenspan and the Federal Reserve System. Whether or not they claim that they were paying attention to the value of the United States Dollar they did not act as if the value of the dollar was of any interest to them. They allowed the dollar to decline in value for about seven years. The value of a country’s foreign currency is the NUMBER ONE price that a central bank needs to focus upon!

Why, does a central bank need to focus on the value of its currency in foreign exchange markets? It is because the value of the currency provides information about how market participants are perceiving the economic policy of a specific country vis-à-vis other countries. Sure, the markets can be wrong in the short term, but over seven years the markets must contain some pieces of information that are not totally off-the-charts in terms of what is going on.

This is an important fundamental...pay attention to the value of your currency in foreign exchange markets.

But, Greenspan has argued that the Federal Reserve HAD to keep interest rates low because WITH THE BUSH TAX CUTS, FINANCING OF THE DEFICITS WOULD HAVE FORCED INTEREST RATES UP AND THIS WOULD HAVE CAUSED SLOWER ECONOMIC GROWTH!

But, that is why central banks are supposedly independent of the government of a nation.

Greenspan acted as if the Federal Reserve was nothing but a lackey of the Bush Administration!

If the Federal Reserve had acted as a real independent central bank…

Well, it didn’t…and see where it got us.

I am writing these things because we are currently in the midst of a presidential campaign. My concern is that not one of the candidates is addressing the real economic issues that the country faces. Furthermore, I don’t believe that they will before the election in November. This is due to the fact that neither of the major candidates wants to discuss the fundamentals that need to be re-addressed if the country is to get back on its feet. People want to hear what the candidates are going to do for them and not what fundamentals need to be re-established.

First, let me say that I believe that we are going to get through the current period of financial dislocations…there will still be failures, maybe even some large ones…but, we will get through this adjustment in the next eighteen months or so.

The concern seems to be growing that the economic problem will be one of stagflation. Let me just say here that the fundamentals of supply and demand analysis has not been surpassed. The problem with stagflation is that economic growth is slower than desired and that inflation is higher than desired.

NOTE: this is not a DEMAND-SIDE problem, IT IS A SUPPLY SIDE PROBLEM! ! !

Just goosing up aggregate demand with popular economic stimulus programs will not overcome the problem. Focusing just on demand-side solutions will only exacerbate, and not relieve the situation.

So, here is a fundamental teaching that we must not ignore.

Second, we live in an inter-dependent world. The United States cannot…repeat, cannot…just go off on its own and act unilaterally. We must talk with others. We must devise out programs, both economic and financial, within the context of what other nations are doing. Yes, this sacrifices some of our valued independence, but that is the way the world is. We must plan and live in such an inter-dependent world.

Here is another fundamental teaching that we must not ignore.

Third, the Federal Reserve must regain its independence once again. It must focus on what it should focus upon, the value of the United States dollar, and if other areas of the government cannot do what they want to do…then sorry, but this is the discipline that a real central bank bring to its nation.

This fundamental teaching cannot…let me repeat…cannot be ignored!