Economic Meltdown

Negative Yield on German Debt

2012-01-09T07:46:00.000-05:00

This week, Germany sold €3.9 billion of six-month Federal T-bills at an average yield of -0.0122%%. This has good and bad implications. It reinforces the fact that Germany continues to be a safe haven for investors and a bulwark economy against the effects of the Euro Crisis. Germany's conservative approach to monetary and fiscal policy in recent years is paying off. The bad news is that investors' safekeeping money under the pillow suggests a general bleakness in expectations. Such beliefs quickly translate into the real economy because when risk capital drys up, so does entreprenuerial opportunity and the possibility of new job creation. A similar phenomenon occurred in Japan in the 1990s. Record high household savings rates, reflected in negative yields on Japanese Federal bonds exacerbated years of zero job creation.

Central Banks' Efforts to Cheapen US$ Swaps

2011-11-30T20:23:00.000-05:00

Today's move by central banks around the world to increase the liquidity of the US$, by reducing the transactions costs of currency swaps, effectively lowers the 'price' of the US$ to European banks that are now under pressure to serve as lenders of last resort to the public purse. It is not quite a debasement of the US$, but the move can potentially wiped out billions of dollar denominated public debt. It's akin to printing a lot of money to pay the bills. It does not address any of the structural problems caused by runaway government spending. But it is a clever move with the potential long term consequence of domestic U.S. price inflation. It's payback for the European worker's funding of the U.S. consumer's spending habit. Merry Christmas!

Fiscal Union in the Eurozone

2011-11-28T12:00:00.000-05:00

Today, Eurozone leaders took a major step to bolster the union by agreeing to negotiate a legally binding package of rules to reduce sovereign control over domestic fiscal policies. This 'doubling down' will either strengthen the EU or take it down faster. It might strengthen the EU because Brussels will now have the right to intervene directly in national fiscal policies to enforce austerity measures. It might work in the opposite direction because strong ties in a networked organization, of which the EU is, work to propogate shocks across the system with greater fidelity and speed.

In order to mitigate the impact of these shocks, a networked organization will require more slack resources (e.g., national reserve requirements will have to go up) and higher barriers against exogenous sources of uncertainty (e.g., limits on currency movement in and out of the zone).

What appears to be a desperate attempt to stave off the break up of the EU may reduce global trade by slowing down the movement of capital across regions. In order to protect themselves, one can imagine similar measures by ASEAN, APEC, NAFTA, and so on.

Technology Driven Jobless Recovery

2011-11-21T12:59:00.000-05:00

Through the previous century and into the last decade, GDP per capita has grown an average 2.5% compounded a year. This has largely resulted from the increased use of technologies to boost productivity. But the relationship between productivity and real wages has weakened. On an inflation-adjusted basis, median income today is about the same as that in 1999, at the beginning of the Internet boom. Put another way, if wages had kept up with the rate of GDP growth in the last decade, median household income would be $30k higher than they are currently.

The history of technological change can be described as an evolutionary process punctuated by discontinuous leaps in innovation. Traditionally, firms invest in innovation to increase production capacity. These investments are staged so that an organization can adapt to the introduction of new methods. The controlled rate of adoption allowed horse carriage makers to become automobile manufacturers, and retail banks to become integrated financial service providers.

Skilled jobs based on routines that can be deconstructed into discrete steps were most suited to technological augmentation. Even those jobs that involve complex routines requiring the adroit manipulation of instruments can be augmented by the combination of fine motor robotics and intelligent visual recognition systems. We see this in the development of minimally invasive surgical techniques that was largely technology (rather than practice) driven. However, the increasing complexity of innovation is outstripping the human and organizational capacity to learn on the fly. These shifts create winners and losers overnight so that the technology augmentation of work has become the technology displacement of workers.

This jobless recovery is not a temporary phenomenon. It is embedded in the type of innovation we are experiencing. Platform technologies that can compute, analyze, recognize patterns and perform increasingly complex routines with greater accuracy and speed is being introduced at an increasing rate. Moore’s Law exacerbates the scale effects, creating even more powerful incentives to speed up the invention and deployment of such technologies. They have globalized the market for services such as radiology, chronic disease consultation, psychological counseling, and college and technical instruction. In addition to companies, entire classes of work are being displaced by technology.

The prognosis of this situation is not good for social or political stability. One commonly proposed solution, wealth redistribution, is not because it does not fix the fundamental problem of a workforce unable to exploit the latest technologies or whose value added is being displaced by the same technologies they relied on. Instead, solutions should focus on the technology and work relationship.

In the short term, organizations should be encouraged to accelerate the pace of innovation, not decelerate it. Why? Job loss results from the exit of companies and the technological displacement of entire classes of work. In terms of the first, U.S. companies compete on the global stage where innovation in emerging markets mean that if they do not keep up the impact of job losses will be more severe in the relatively higher wage U.S.

In the long term, the most resilient economies are those that display high levels of entrepreneurial bias. Fostering an entrepreneurial economy requires policies that reward risk taking while buffering the community from the inevitable shocks of failure. Closing the knowledge gap can aid a culture of risk taking. We can teach individuals how to assess risk and identify business opportunities. Business and engineering programs that emphasize opportunity recognition and creation, design-centric thinking, and the commercialization of discoveries can fireproof the next generation of workers from the economic vicissitudes of technological change.

Italy is not Greece. But...

2011-11-09T22:16:00.000-05:00

The financial shockwave caused by Italian government bond yields hitting 7.48% is causing speculation of a pan-European meltdown and the possible end of the Euro single currency union. Italy is the 4th largest sovereign borrower after the U.S., Japan and Germany, with debt exceeding those of Portugal, Ireland, Greece and Spain, combined.

By all accounts, Greece's troubles, already the cause of a low grade migraine for the European Central Bank and the governments of Germany and France, is child's play, compared to the possibility of a run on Italian debt obligations. Credit Default Swaps, the cost of insuring Italian debt, is at a record high. Already, sovereign debt yields across Europe are rising in tandem with the situation in Italy.

However, Italy's debt level, though high at 2 trillion Euro or 120% of GDP, is still manageable due to a much smaller operating budget deficit. Therefore, unlike Greece, where even structural reforms are unlikely to create investor confidence, Italy can still extricate itself by embracing serious fiscal reform. She should take a page from New Zealand's bold reforms in the mid-2000s, which led to a resurgence of the latter's economy.

Italy still boasts robust manufacturing and agriculture export based industries. Her service industries related to tourism continue to garner healthy inflows of foreign exchange. By defanging the unions, reducing public expenditures, lowering taxes on investments, reducing the distortions caused by undue business influene on public affairs, taking visible and concrete steps to collect what is owed to the public purse, Italy can restore investor confidence and halt the run on its debt.

What it should not do is follow Greece's example of financial re-engineering, such as calling for an ECB bailout before domestic reforms are taken, forcing holders of her debt to take haircuts, and blaming outsiders for its financial troubles. Such strategies serve to reduce confidence, not increase it, as they externalize problems caused by the country's political class.

The crash of Italian debt quality is a global referendum on the current Italian government, not its core economy. Prime Minister Berlusconi's offer to resign at some later date, only to annoint a successor, does nothing to instill investor confidence. Instead, he should dissolve Parliament, and call for elections without endorsing any candidate. Unfortunately, like Greece, self-interest will likely trump patriotism. I'm selling Euros, for now.

Fed Involvement in Economy

2011-09-28T15:31:00.001-04:00

On September 22, the Fed announced that it will re-weight its $2.65 trillion securities portfolio to favor long term debt holdings and mortgages. This will have the effect of lowering short term borrowing rates while increasing the government's exposure to (and backstopping) housing market risks. It is hoped that lower interest rates will encourage more borrowing while simultaneously sending a signal of the Fed's confidence in the future of the country.

The activism of the central bank, using monetary policy to influence consumption, rather than to simply regulate capital flows in the economic system, is breathtaking. More critically, these moves ignore a basic problem. That depressed capital investments is not the result of low interest rates or the lack of cash (both are at historic lows and highs, respectively), nor because of a lack of long term optimism (corporations have maintained or increased R&D). It is that entrepreneurs and corporations have lost confidence in the ability of the government (right and left) to protect the conditions for wealth creation. The mounting weight of new regulations, uncertainty over taxes, anti-capitalism rhetoric, and takeover of the free market demonstrate an arrogance that belies the ineptitude on display in D.C.

The Fed's Interest Rate Policy

2011-08-22T15:48:00.002-04:00

Two weeks ago, in an attempt to engineer the country's way out of the current debt crisis, the Fed announced a low (almost zero) interest rate policy for the next two years. This did not stablize the stock market. Worse, it had the effect of announcing a weak dollar policy, which pre-empts the monetary policies of foreign trade partners. This is an unprecedented move away from the free trade and capital market principles that have kept the economic engine of this country robust.

The debt problem in America is not the result of expensive money but cheap money leading to over-consumption. Therefore, keeping interest rates artificially low discounts the cost of consumption and exacerbates the debt problem in the long run. Over the last 2 decades, U.S. households and governments at all levels have financed their over-consumption by selling debt obligations to such countries as China, Brazil, Russia, Germany, and Japan.

Whether we realize it or not, U.S. consumers have been paid by Chinese and German workers to keep their jobs in the factory. When the U.S. deflates its currency by keeping interest rates low for an extended period of time, regardless of future economic conditions, this implied deal is broken.

It's anybody's guess where all this will lead. Rumblings from sovereigns about moving away from the U.S. dollar as a reserve currency to a basket suggests that the outcome is not likely to be pretty for us.

Financial Stability and the Healthcare System

2011-07-26T10:16:00.002-04:00

This post is a little off the beaten track for me. But it is important because in the debate over financial responsibility, we must remember the social obligations that we owe each other as members of the same community..

On Sunday, my wife was warded to critical care in a Baltimore hospital where I met some of the most wonderful doctors and nurses. These individuals, especially the nurses, perform their very difficult duties in the midst of human devastation, maintaining a composure with a compassion that is very difficult to comprehend (I was a total wreck). I also witnessed similar things in the ER, where she was first admitted.

Throughout this experience, I have come to see the incredible technological and human capital resident in the U.S. healthcare system. It is no exaggeration that it is the best in the world. In part, I believe it is the high value that Americans place on human life, hence the willingness to spare no expense, even at personal sacrifice, to preserve it.

I believe that in the long term continuing technological innovation, business process re-engineering, and increases in medical knowledge will allow the U.S. healthcare system to continue being the best in the world without the predicted financial burden that many have suggested (forecasts of future states almost always do not consider future innovation).

In the short term, however, given limited resources, trade-offs are inevitable. This is a very difficult thing to discuss because I wanted, and in fact did receive, the very best care for my wife, regardless of expense.

While the trade-offs should always be honestly recognized and discussed by our lawmakers, I believe that citizens should have direct voice in the making of such tradeoffs within their communities. For Americans, healthcare is too personal for decisions to be made only at the top. For example, the healthcare reform package passed by Congress was not the result of an exhaustive national conversation but the product of special interests and sales pitches by politicians and lobbyists. If there ever was a time for a national referendum on an issue affecting future generations, it is now.

The Debt Problem

2011-07-24T12:19:00.001-04:00

The current fiasco surrounding the debt crisis is more than just a clash of ideologies. There is a real possibility that tax rates will become so high (by some estimates, top marginal rates will hit 70%) in order for the U.S. to service the interest that capital flight (disinvestment in the country's wealth producing assets) will occur. Consider the U.K. in the 1950s and 60s.

More critically, the lost of credit worthiness will damage the country's geopolitical influence, which depends on moral suasion. It will become difficult to rally allies to global health, environment, and security causes. Hence, the drive to reduce the size of government and future entitlement is more than just a fight over how household wealth is allocated but has to do with the sustainability of the U.S. as a world leader.

Yet, America and Americans are known for compassion, pragmatism and generosity. Such qualities are also the basis for her moral authority in world affairs. Therefore, in cutting entitlements, we must be sensitive to how we are seen to treat the less fortunate, the less able, and the less well endowed. The cure would be worse than the disease if we ignore this defining American quality. In short, a middle ground needs to be carefully navigated. To do so will require a depth of humility never seen in politics and personal sacrifice experienced only twice or thrice in this country's short history.

The good news is that America has shown time and again that it is capable of innovating its way to a brighter future, as long as it remains an open country and able to attract the most talented to her shores.

Unemployment Not Declining

2011-07-10T21:32:00.002-04:00

The latest jobs report puts unemployment at 9.2%, up from the last quarter. This is not surprising given anaemic consumer spending and hence, perceptions of revenue uncertainty by companies. We may be entering an era of structural higher unemployment as companies permanently adapt to doing more with less by down scaling, outsourcing, and employing more technology. The long term solution is to foster more entreprenuership. To do so, the tax burden has to decrease in order to support those who are willing to take the risks of starting businesses. Instead, talk by leaders in Congress and the White House to raise taxes on the 'wealthy (read entreprenuers)' does nothing to inspire risk taking.

Portugal's Debt at Junk Status

2011-07-05T16:25:00.002-04:00

Today, Moody's downgrades Portugal's national debt to junk status. This means a number things, foremost of which is that it closes large sectors of the debt market to Portugal, including pension funds, sovereign funds, value funds, and those investors that cannot, by virtue of their rules or strategies take on the types of risks implied by junk status. More critically, this means that it will now be very costly for Portugal to restructure its public debt either by assets sales or the rewriting of covenants.

In some ways, the downgrade is not surprising. Portugal, Ireland, Greece and Spain are struggling to realign public spending entitlement, existing debt obligations, and tax revenue with the realities of slower consumption, lower productivity, and international competition from the emerging economies.

The U.S. has many of the structural problems (both private debt and public entitlements) currently experienced by the PIGS. Its still large domestic economy has allowed a delay of the critical fixes. It's not a good idea, however, to hope that the problems will go away if the economy re-inflates since the causes of the problems are not going to disappear.

The U.S. Dollar

2011-05-21T18:42:00.003-04:00

I've been going on about about the dangers of Greece's and Ireland's (now Spain's) debt problems to the stability of the Euro . A more immediate concern is the impact of the ever spiralling U.S. debt on the value of the dollar. We are seeing historic lows in the exchange rates of the greenback against the Euro, Pound, Yen, and even the Canadian Dollar (!) Gone are the days when one could take for granted the stability of the U.S. dollar because of the domesticity of its national debt and consumption economy. The U.S. consumption economy is now globally exposed (imports, excluding energy, far exceed exports) and foreign governments such as China, Britain, Russia, and Japan hold an ever larger share of U.S. Treasuries, relative to domestic holders. The lack of confidence in Washington's resolve to cut entitlement spending (the 'Gang of 6' on Capital Hill has failed) has given foreign holders of Treasuries more reason to hedge against the dollar. The weak dollar will lead to inflation, which, when triggered, will be very difficult to tame because there is already no appetite for austerity measures. Inflation will further attenuate domestic consumption, employment will remain anemic, and the threat of stagflation will become a reality.

Obama on Immigration

2011-05-10T17:40:00.001-04:00

Today the President made a case for revamping the approach to immigration in this country. By all accounts, it may be too late in the political season to matter. However, on this issue, he is absolutely right. The creative future of this country depends on a continual freshening of the gene pool through immigration. Job creation rests on those who are hungry, entreprenuerial, and unafraid to take risks by founding new companies and growing existing ones. The history of this country is replete with immigrants that have contributed their talents, effort, and resources to build the economic powerhouse that is the USA. Unfortunately, the short sightedness of party leaders on both sides will slow our recovery from this most recent economic disaster.

Cut in Greek Debt Rating

2011-05-09T22:30:00.000-04:00

S&P cut the rating of Greek sovereign debt to single-B (moving it closer to junk status) today, sparking a selloff off in government bonds of similarly highly indebted Eurozone nations - the sign of a 1997-type Asian Contagion. What the Germans and French do next will determine if the Euro falls off the cliff. Germany would like nothing more than jettison Greece from the zone. Of course this is not possible since it will worsen the contagion and take down Germany with it. The problem with economic integration is that there is no such thing. Without being able to directly intervene in a member country's fiscal policy, there is nothing Brussels can do to impose the kind of discipline needed to maintain the value of the currency. In the U.S., if states like California and New York do not begin to seriously impose Wisconsin and New Jersey-type fiscal discipline (by rewriting public labor contracts and reining in taxes), we will have our own Greek crisis.

The Continuing Lesson from Greece

2011-04-17T22:34:00.002-04:00

The International Monetary Fund warned on Friday that Greece may have to restructure its debt (i.e., extend its schedule of repayment), which it owes to the European Central Bank (ECB) and the IMF. The German Finance Minister said earlier in the week that he believes Greece needs to restructure for Europe to prevent another round of capital flight. The problem is that restructuring will increase the debt load, which the Greeks are unwilling to bear, and hence the protestations by the Greek Finance Minister over the idea. By most accounts, the Greeks are likely to default and a restructuring will only delay it.

This week's discussions on Capital Hill to raise the debt limit on the country's borrowing is a lot like the restructuring the ECB wants Greece to do. It merely kicks the can down the road and makes it easier to not do anything about the severely underfunded social security program that is coming due in the next decade.

Contrast this to the austerity measures undertaken by Thailand in the post-1997 Asian currency crisis. The result is a shrunken government sector and an economy that, after a short 18 months of pain, continues to grow at a steady clip.

The Obama Budget Plan

2011-04-14T00:14:00.003-04:00

Here is the plan fielded by the President today at GWU: $4T in cuts over 10 years with the goal of bringing the deficit to 3% of GDP by 2014.

The $4T is divided into $1T in tax increases (goodbye, growth), $2T in spending cuts from defense and Obamacare (by bringing 33 million people into the healthcare system?), and $1T from ‘savings in interest due to lower spending’. That last is about as magical as fairy dust in budgeting terms.

How does $1T in tax increases, which translates into lower potential investments and growth and less future tax revenues from corporate and individual income, square with $1T in 'interest savings from less spending' when none of the entitlement programs are significantly touched?

If Sarbanes-Oxley was applied to the leaders of this country, many will be jailed or at least tarred and feathered. Imagine a CEO and CFO signing off on financial statements with justifications like that.

This is the local used car dealer saying.‘Come in and spend your money to save it’ or better, 'Vote for this Bill and you'll see what's in it.'

The Real Impact of TARP

2011-03-17T20:41:00.002-04:00

In this excellent WSJ piece by Atkins, McWatters and Troske, TARP is revealed as a shell game of numbers. All this goes to suggest that government bailouts should never be sold as good for the taxpayers on the strength of their economic benefits. It is misleading. Bailouts are costly and never economically efficient. The only efficient, albeit cold, solution is for the market to sort out the winners and losers. Bailouts should be recognized for what they are - programs to a. reduce the impact of a system in discontinuous change on social welfare, and/or b. to protect a political obligation resulting from earlier deals made to facilitate some type of social program (i.e., payback). In the case of TARP and related bailout measures, the government and Congress are paying back the banks for facilitating the Community Reinvestment Act and other programs to put more voters in homes and/or finance their lavish lifestyles.

The Asian miracle continues

2011-02-28T21:29:00.004-05:00

I'm in Hong Kong, SAR, China. The flexibility of the economies in Asia never cease to amaze me. Except for a blip in 2007, Hong Kong, China, Taiwan, India, and Singapore continue to grow unabated (the last reported 15% GDP growth in 2010) in the midst of continuing malaise in Europe and the U.S. Previously, such a situation was unlikely because the economies of the West and East were interlocked. The export-oriented Asian economies emerged with the rise of the European and U.S. consumer. This simple calculus is no longer true.

Just like the U.S., the foundation for these economies was built a generation ago. For example, the importance placed on education and the great respect for teachers form the bedrock of a society's innovative capacity. It is therefore no accident that the transition between low cost manufacturing to high value innovation in these economies occurred within 3 decades. Today, the purchasing power parity of the economies in the largest Chinese cities approaches that of the U.S.

Why should we care? Because we can no longer depend on the fact that these economies rely on the U.S. consumer and will indefinitely pay for his excesses through the purchase of U.S. Treasuries. The growth engines of these economies are increasingly domestic. Add to this, the per capita public and household debt burden in the U.S. is at a historical high and highest among the G8. The opportunity cost represented by the interest payments is the seed corn for the education of future generations and thereby, the country's standard of living.

Unless we seriously wrestle with public and household spending, we will have nothing to sow for the future.

Muni Bonds and Wisconsin

2011-02-25T22:13:00.000-05:00

Today, AIG announced that its Chartis unit faces a significant default risk in its municipal bond holdings, putting its parent company in danger of a liquidity crisis. Municipal bonds, sold to finance everything from schools to traffic lights, have been the way towns and cities across the country have funded their infrastructure. The pricing of many muni bonds are pegged to the credit ratings of the states in which they are located. The credit ratings of many states have taken a beating because the costs of public employee obligations and legislated entitlements have outstripped revenue production. When the credit rating of a bond deteriorates, institutional holders may be obligated, under their investment rules, to trigger an early redemption call, putting the municipality in danger of default, and possibly bankruptcy. If Wisconsin, Ohio, and other states trying to control the cost of public employee obligations do not succeed, the implication is not just unsustainable state budgets. A series of muni bond defaults may result, sending a lot of towns and cities to the poor house.

The Resilience of the Family Enterprise

2011-02-16T19:31:00.004-05:00

Elsewhere, I have written on the resilience of the family enterprise as the most basic unit of economic organization in a country. My good friend, Gideon Markman, has written a nice piece in an upcoming issue of the Strategic Management Journal that traces and compares the origins of long lived family enterprises and the state of Rome since antiquity. The point of the article is that those organizations that are resource constrained tend to be more innovative, flexible, adaptable, and ultimately long lived. Rome's decline occured at its peak. It had grown fat with its own success and ossified in its ways, unable to see beyond its own parochial interests and internal petty strifes.

Same with economic organizations. Those most resource constrained are forced to be inventive, if they want to survive. Those that ultimately make it tend to survive for long periods of time. The sitting government in the U.S. should take a page from this lesson. Budget cuts are unlikely to hurt the country as much as it will help force difficult decisions that can lead to inventive solutions to our ailments. Throwing money at the problem, a simple minded and easy way to manage is usually the worse thing that a conscientious manager, family founder, or government leader can do. Cut social security, cut Medicaid and Medicare, cut defense, make across the board deep cuts in government departments, and one would be surprised how innovative the citizens of this country and what is left of government can be.

Unemployment in a recovery

2011-02-09T13:56:00.001-05:00

The White House, in a recent address by the President, called on corporations to use the $2 trillion in cash to resume hiring. Indeed, the pressure for corporations to hire workers is increasing because markets around the world are recovering. TATA Consultancy reports that it needs to hire more than 1000 workers this year to meet growing demand for their services. However, the jobs report released last week combined with the continuing rise in corporate revenues and profits point to a complicated and long term problem.

U.S. corporations are adaptable, quick on their feet, and aggressively competitive. To compete in the global economy, they have had to migrate up the value curve in terms of human capital value added. However, corporations find themselves turning to the global market for labor because they are unable to find all the workers with the technical training and education they need in this country. To the extent that tight immigration rules prevent the hiring of foreign skilled workers, corporations find themselves setting up shop in other countries. The rub is that these divisions are increasingly doing high value added functions such as design, research and development. As these functions move to foreign locations, the domestic demand for workers with these skills will diminish over time, leading to the permanent hollowing out of the corporate headquarters.

Going forward, we see that the jobs returning to the economy bifurcate into two categories (very low skilled jobs such as food service workers; and very high skilled jobs such as information security experts). Low skilled jobs, which accounted for much of the jobs created in the last quarter, tend to be location bound. High skilled jobs are portable and these have been slower to return because there is now a global labor market for them. The only way out is for the overall skill level of the economy to increase, which will require tough minded education reform and a very light hand of the government on the economic engine.

Illinois Tax Increase

2011-01-12T07:44:00.002-05:00

According to the Wall Street Journal, in order to close a $13 billion deficit, the Illinois House of Representatives today increased personal income tax from 3% to 5% and the corporate rate from 4.8% to 7%. Spending growth is capped at 2% annually. The measure is expectd to pass the Senate and signed into law by the governor.

Setting aside discussion of the fiscal exigencies and managerial shortcomings that led to this, it would be interesting to observe the resulting change in gross state product a year from now, in comparison to Virignia and New Jersey which took the opposite route of reducing government spending while keeping taxes static. Such natural experiments are occuring all over the country. My guess is a faster recovery for Virginia and New Jersey while Illinois experiences a hollowing out of the middle class as mid-sized companies and entrepreneurs move out of state.

2010 Year of Contradictions

2010-12-23T11:08:00.001-05:00

2010 will be remembered as the year of contradictions. Many corporations will end the year with the largest cash hoard in their histories and yet unemployment remains near 10%. Banks have been given billions of dollars in bailout money and yet credit remains historically tight. Interest rates are near zero and yet consumer spending remains tepid. 2010 has seen the largest amount of government spending on social programs in history but citizens are the angriest they have been in decades.

For all the good intentions in Washington, we must now accept that the economic principle of supply and demand cannot be indefinitely manipulated. Politicians and their agents cannot make people trade with one another, buy what they do not wish to consume, and act against their own self interests.

Happy New Year

The US Dollar

2010-12-07T13:55:00.002-05:00

The Bloomberg U.S. Dollar Index was reported to have increased by 5.08% in the month of November. This refers to the value of the dollar against a basket of widely traded currencies. What's happening? In an earlier blog, I wrote that the Fed's purchase of $600million of Treasury bills is inflationary and debasing, even though the money came from reserves and was not 'printed', as some have incorrectly claimed.

Given the rise in the Index, the temptation is to concolude that the Fed's action will therefore positively pump consumption without inflation, notwithstanding the fact that fear of the future is damping consumption, regardless of the amount of money in circulation. While inflation in the immediate future does not look likely, pouring that much money into an economy will have two effects: increase the cost of national borrowing as lenders risk adjust their rates to account for the increase in money supply, and reduce the incentives to get tough on government spending, the only sustainable way to reduce budget deficits.

Regardless, the rise in the dollar index is unlikely due to sentiment that the U.S. economy is strong but rather fears of a Euro meltdown given by Ireland's, and possibly Spain's, economic crises. As we have learned from the Asian currency crisis, contagion is real and that justifiable fears of contagion in the EU, stemming from Ireland, are likely the sources of the flight from Euros to Dollars. All this to say that policymakers need to maintain vigilance on non-productive domestic (i.e., government) spending and not use the relative weakness of the Euro as a hedge against wrong headed monetary policies.

Reversal in Job Creation

2010-12-03T17:23:00.000-05:00

The latest jobs report is another sign that the economy is not recovering, despite early leading positive indicators of stock market activity, consumer sentiments, and manufacturers' inventory. The data tells us that job creation, a lagging indicator of recovery, is still a long way off. It is unlikely to reach pre-recession levels due to the realignment of work processes and organziational structure to reduce headcount. Combined with the anticipated financial burden from the healthcare bill, employers are likely to balk at adding jobs, prefering rather to control capacity and raise prices.

What to do?

The continuing debate in Congress over tax cuts should end. The tax cuts should be made permanent, combined with serious permanent reductions in government entitlement programs. This will make more money available for investments and consumption, the primary drivers of job creation.

Second, rules and regulations at the Federal, State and County levels that slow the registration of companies, the creation of factories, and the distribution of products and services should be permanently eliminated. These include scientifically questionable environmental legislation, restrictions on mining and other natural resource extraction activities, legislation that limit labor mobility, and non-production related taxes on small and medium size enterprises.

Why these changes?

Production begins with investment. Such moves send strong signals to would-be investors from around the world that the U.S. is once again serious about wealth creation, and free market capitalism that rewards individual and corporate risk taking.

America needs to reopen for business. America needs to stop flirting with that unfaithful mistress called socialism.

Ireland's Meltdown: America's Lesson

2010-11-11T13:10:00.000-05:00

The inability for the Irish government to prevent a total collapse of the country's financial system by pumping 68 billion Euros into her banks is an object lesson on the limits of government power and creativity. The Fed is making the same mistake by pouring another $600billion into the economy.

There seems to have now developed among officials at the highest levels of our government a contempt for market mechanisms and private enterprise. Bashing big business and denying the consequences of individual choice in a free market by the same tired tax and spend policies is, at the very least, ignorant. More likely, such thinking shows hubris of the worse kind.

Printing Money

2010-11-04T23:26:00.000-04:00

The Fed's recent decision to buy $600 billion of Treasury bills amounts to printing vast sums of money. It is also a thinly disguished attempt to manipulate the dollar. Despite assurances to the European Central Bank that currency weakening is not the primary intention of the move, it has already resulted in currencies around the world rising to new highs against the dollar. To its credit, the ECB practiced restraint in its response rather than retaliate.

Such moves not only undermine the already lackadaisal financial cleanup at the banks (by pouring money into a system already flushed with cash - corporate cash reserves are at historical highs), it completely mis-reads the reasons why unemployment is still so high. Confidence in the government's ability to restrain itself no longer exists. Hence, like Japan in the 1990s, households and corporations are hoarding cash to counter government policies that punish investment and wealth creation. Small companies are not being created at the rate needed to boost employment because the reward for risk taking is low and large companies are not hiring for much the same reasons.

The Fed is supposed to be independent of the government. It is supposed to protect the integrity of the nation's financial system. Instead, it is determined to support the White House's political agenda. Quite unbecoming of the guardian of free market capitalism.

The New Chevy Volt

2010-10-24T00:31:00.001-04:00

Chevy Volt = $40,280; Range 40 miles, 150 HP

BMW 335i = $40,600; Range 445 miles, 300 HP

'nuff said

The Next Currency Crisis

2010-10-19T18:20:00.004-04:00

In 1997, a sudden devaluation of the Thai baht triggered the Asian economic crisis that enveloped Asia, Russia, Brazil, and nearly brought the global financial system to ruin with the collapse of Long Term Capital Management (LTCM). At the time Malaysia imposed controls to stem the outflow of its currency that, it was argued, would no doubt have led to a freeze up of internal capital flows. The resulting 'beggar thy neighbor' effects in ASEAN were largely ignored, in part because Malaysia's economy was tiny by comparison to the region. That little experiment, however, did not go unnoticed by central bankers and activist governments. Fast forward 13 years.

In 2010, governments in China, Japan, Asia and South America have in recent months increasingly turned to currency manipulation (there is no other way to characterize it) to cushion the effects of the global meltdown on exports, domestic spending and debt obligations. Such countries comprise a large share of the global economy. The race to beggar thy neighbor is likely to result in a massive cycle of revaluations that will leave even the healthier economies of the world locked in a state of stagnation.

The value of financial assets and contracts will be worth much less than when they were formed, drastically upending the careful risk/return analyses that went into their creation. Domestic spending is likely to slow significantly for exporting countries and kept artificially high in importing ones. The U.S., already saddled with debt spanning several generations, will see its dollar weaken significantly, which will put greater pressure on domestic prices, further slowing, even halting, its economic recovery.

The exchange rates of currencies reflect the relative productivity of the economies they represent. Artifically inflating or deflating the currency of a country distorts the 'pricing' mechanism of its value creating assets and that of consumption and production decisions. This is not a good thing.

The real lesson from 1997 is that the Thai government and Thai companies allowed themselves to be seduced by cheap hot money. Therefore, governments, companies and households should impose strict discipline on their fiscal affairs to avoid future crises. Unfortunately, in 2010 the lesson that appeared to have been learned is that governments can manipulate their way out of the consequences of drunken spending and poor fiscal management by pushing the problem to their neighbors. This dangerous game of musical chairs can only end in tragedy. Governments should stay out of the business of managing their currencies.

Exit of AIG. Model for Govt Rescue Programs?

2010-10-01T13:58:00.004-04:00

This article from the NYTimes reports the impending exit of AIG from TARP (the $700 mil U.S. Government's Trouble Asset Relief Program). By the government's account, TARP prevented the meltdown of the U.S. financial system, caused by lousy bets on credit default insurance and loose financial management controls in the nations largest banks and insurers, of which AIG was the poster child. The problem with this view is two fold. The 'exit' strategy does not actually put money back in the hands of the taxpayers. The proposal consists of a package consisting of debt for equity swaps, senior to common equity swaps, and a proposed IPO of the AIA (AIG's Asian Unit) business. The entire package depends on only one thing - the state of the capital markets, and hence, the eventual ability of the government to unload its positions without riling the markets. Regardless, there will still be policymakers and activists that point to AIG as the model child for government rescues. This is a concern because AIG was unique and its lessons are not broadly applicable to other industries or circumstances.

AIG was kept alive because it was seen as a lynchpin to the entire financial system. They owned a vast majority of the credit insurance obligations that underpinned the mortgages and mortgage derived instruments held by governments and institutions. Having said this, it is not clear to me still why allowing the contracts to collapse, while wiping out billions of dollars in value and sending a lot of people to the poor house, would necessarily lead to the end of the global financial system. The system will simply adjust to a new, slower growth state. We will never know. In any case, even if we accepted the argument, very few institutions have the status of an AIG at the time of the crisis (LTCM is probably the closest analog - during the Asian Currency Crisis - except that LTCM was rescued by industry, not government).

AIG, as a company, had many parts that were sound, in particular their Asian and European units. The industry in which they competed, notable China, is still in high growth state. Hence, the restructuring that occured in the post-rescue period had a good chance of success, so that the there was some implied collateral backing the loans from the Fed. If, for example, the deal between Prudential and AIA had gone through, the resulting cash infusion would have allowed AIG to exit TARP last year. This is not the case with the automobile or airline industries. The sick companies in those industries have either hived off their crown jewels (e.g., the leasing companies of the automakers) or do not have much assets that can back a proper restructuring. Moreover, with reference to a prior point, the criticality of the survival of those companies are not the same as AIG. If any company in those industries failed, there would still be many competitors to produce the same, if not superior, products and re-employ the workers.

In sum, because the final chapter on AIG is not yet written - the U.S. government will still continue to be its largest shareholder for many years to come, and because AIG was unique, we should not allow ourselves to be persuaded by arguments on the 'success' of the rescue as justification for future 'too big to fail' rescue operations.

1978 in 2010

2010-09-06T13:24:00.003-04:00

Economist Paul Krugman, in his latest NY Times opinion piece, suggests that the reason the economic stimulus is not working (unemployment is still high, consumer spending is muted, and new capital investments continue to be low) is because not enough has been spent by the government. Comparing 2010 to 1938, he argues for the kind of stimulus spending equivalent to the deficit spending brought on by World War II or 30 trillion in today's dollars. In the light of the new $50 billion prime pump campaign just announced by the President in his Wisconsin labor day address, largely against the will of the people, such opinion must be encouraging to the White House.

The problem with this type of thinking is found in the fourth to the last paragraph of the piece, 'it is possible — indeed, necessary — for the nation as a whole to spend its way out of debt: a temporary surge of deficit spending, on a sufficient scale, can cure problems brought on by past excesses." [italics are mine] The reason we landed in this predicament is precisely, as Mr. Krugman notes, our past excesses. The idea that by creating more excess we will magically balance the books not only defies good sense but is morally irresponsible.

The little detail Mr. Krugman did not mention is that spending in WWII was redirected from butter to guns. Households tightened belts and factories made tanks instead of cars. Household debt was a tiny fraction of the colossus that now faces every man, woman and child in this country. In 1938, the relative potential of the economy's productive capacity, from recent innovations in manufacturing and mining, meant that we could borrow freely from our future; which we did through the massive issuance of war bonds. Today, our relative productivity advantage is small and the national capacity to sustain additional debt, which would be necessary to fund Mr. Krugman's program, is essentially zero.

Fundamentally, Mr. Krugman and his ilk think that we can out get of this mess without sacrifice - spend our way out of debt. They do not call for the kind of national sacrifice and unified response to reduce consumption as in 1938. Instead, they believe quite the opposite. They want our government to print more money, or worse, borrow from the Chinese or Arabs, to forcefeed us trillions of dollars. For what? More cars, houses, calories...?

No, this is not 1938 in 2010. This is more like 1978 in 2010. We know what happened then.

Unemployment Insurance and the Meltdown

2010-08-30T14:52:00.003-04:00

As signs of the economic recovery become fainter and as mid-term elections draw near, the tenmptation to continue prime pumping the economy will increase. The most obvious target for new government spending is unemployment insurance. Proposals to extend unemployment insurance to an unprecedented 99 weeks (almost 2 years!) are circulating Congress, and supported by the White House. As respected economist Robert Barro notes, handouts from the public purse of this size can only lead to further deteriotation in wealth creation, killing any little momentum left in the economic recovery.

I do not suggest that we do away with unemployment insurance; the current 26 weeks is generous by first world standards, let alone global standards. However, as with any spending program, which cannot be killed, thought must be given to the long term effects.

In this case, the government has two ways it can go. It can put more money into the hands of people who are unemployed, which means taking it out of the hands of those who are or it can keep more money in the hands of people who are currently employed. Both programs will lead to more consumer spending. However, only one program, the latter, will have the additional effect of encouraging investments and innovation. The former program will reduce investment and innovation, hence, compromise the nation's capacity to create wealth. It will reduce the incentive for individuals to return to the labor market or for those currently underemployed to stay employed. The former program will effectively retard the necessary restructuring in the labor market.

As we struggle to rid ourselves of this painful mess we must keep a weather eye for our children's future.

The End of the Fourth Estate?

2010-08-16T11:53:00.002-04:00

In a recent Wall Street Journal story, it was reported that state of New Hampshire guaranteed a $200k loan to a local newspaper. While this is not the same as government funded and controlled media in places like Russia, China, and Cuba, it is not a stretch to imagine what such subsidies could do to the editorial independence of the local media. How does an editor select what to publish, say a report on corrupt local politicians, when he knows his paycheck comes from that same source?

Taxes and Prosperity

2010-08-02T19:03:00.001-04:00

This is one of the most cogent articles on the relationship between taxes and prosperity that I have read in a while.

Dr. Arthur Laffer, Stanford PhD and tenured professor at the University of Chicago, best known for the Laffer curve, explains, again, in simple terms why Congress and the White House are badly mistaken about the effect of a tax on government revenues and economic wealth.

He recognizes, as most economists do, that income elasticity with respect to tax rates are disproportionate at the higher end of the tax spectrum. This is because of a greater incentive for individuals to expend resources to reduce tax liabilities at that level, and because they can. The people who really get hurt from higher taxes are the middle and lower middle classes. They have less incentive, because the tax avoidance strategies they might use are costly relative to the gains, and less ability to do so, because they have fewer shelters available to them (less assets, access to clever tax lawyers and accounts, and situations in which they can take deductions).

Bottom line, whenever government has reduced taxes, revenues have increased because the incentive to avoid is attenuated, and more wealth is created because the resources are put to productive use, founding and growing companies. Whenever government has increased taxes, revenues have decreased because the incentive to avoid is heightened, and less money is available for wealth creation. More critically, when tax rates increase at the top end, more money goes into the non-productive part of the economy (tax lawyers, accountants, and financial products engineered specifically to reduce taxes), not in the making and selling of goods and services that increase social welfare.

The way to exit this economic meltdown is to cut taxes as quickly and as drastically as we can while maintaining a strong internal and external national security.

The Trouble with Job Preservation

2010-07-30T21:19:00.004-04:00

In a recent speech in Detroit, the President lauded the government's $60 billion bailout of GM and Chrysler, stating that inaction would have resulted in the loss of thousands of jobs. This statement claims a proof for a negative. It cannot be done.

Bailouts are like bandaids on a gangreneous body part. It may hide the rot but without fundamental surgery, the rot is still there, and spreading. To capitalize on the White House's PR move, the CEO of GM announced an increase in the number of Volt electric cars (from 30,000 to 45,000) planned for the year's production. The Volt is the product of a political sleight of hand to get the bailout money. It was a concept that never generated market enthusiasm, which is why the project was more than ten years old and moth balled at the time of the bailout. It was the best card GM had in its hand with which to cut a deal with the ATM called Congress. 'Give us the money and we'll give you something to wave in front of the environmentalists (wink wink, nod nod).' Why? Without the distribution infrastructure to fuel the car and without significant advances in battery storage, the Volt is an overpowered, overpriced golf cart. No one, including GM, knows who will buy these cars but don't be surprise if you see a few in the government car pool.

In 2001, Bill Ford Jr. came charging back to rescue the business that bears his name. His legacy at stake, Ford cut product lines, began tough negotiations with the unions, invested aggressively in new technologies (first U.S. automaker to introduce a hybrid), and cut deals with some of the most unlikely partners (Microsoft's SYNC). A decade later, it sat on the sidelines to watch GM and Chrysler go hat in hand to the government, both egged on by their union masters.

Only in a real crisis are tough decisions that reveal true intentions made.

GM and Chrysler were never really in a 'crisis'. With no possibility of a bailout, they may have taken bolder action against the unions and made cars that consumers would buy. We will never know. Instead, we know that GM took the bailout money to buy market share with their 'friends and family' sales gimmick, effectively paying consumers to use their products. The government was more than happy to jump in with 'cash for clunkers', which resulted in record sales of Toyotas.

The bottom line is that the government's focus on job preservation is simply wrong. After more than a trillion dollars of 'stimulus' money and eighteen months, the latest GDP report still shows little hope of a robust recovery. The White House knows that government spending does not create jobs so instead it touts job preservation.

An honest government focuses on job creation. Job creation is tough. It requires a great deal of humility on the part of lawmakers and respect for the individual. You can't buy job creation like you buy job preservation. Sustained job creation can only come from companies that make products people want to buy. Job creation requires the public burden borne by individuals and companies to be light so resources can go to innovation, risk taking, and venture creation.

There's an old Indian saying that when the horse you are riding drops dead, you dismount. This government insists on flogging it harder to make it run faster.

President Obama's Address

2010-06-17T00:24:00.004-04:00

The recent speech President Obama gave was a tour-de-force of the government's agenda for righting the listing ship that is the U.S. economy.

Read carefully and its obvious that the agenda pits government against private interests.

Europe has demonstrated the economic costs of a large government, relative to the productive capacity of its economy. It has also shown how the social philosophy of 'business bad, government good' leads to complacency among individuals and arrogant lawmakers.

The strength of the U.S. political economy lies in the ability for individuals to take personal responsibility for their economic wellbeing. It stems from the willingness to take risks to reap the benefits. This is not simply a belief but an experience of everyday life in America.

The continual willingness of this government to paint private interests with nefarious intentions and the rejection of any attempt at partnership flies against economic history and against common sense. Unless I am wrong, private enterprise still creates the jobs and employs the voters that the White House seems eager to please in November.

The largest employers and globally most competitive companies - Microsoft, Walmart, General Electric, Google, Goldman Sachs... - started in the proverbial garage. I wonder how many garage start ups are now stillborn because of the speech?

The $1 Trillion Rescue Package

2010-05-10T12:15:00.001-04:00

It is a well known fact that as a network becomes tightly coupled, shocks felt in one node are quickly propogated throughout, and may even have disproportionate impact because the effects are cumulated. The current crisis in the Eurozone, which threatens the financial stability of the world, provides a classic example. The rescue package being put together to stablize the region (Spain, Portugal, and possibly Italy are under credit watch) can be interpreted as a network response to this principle and/or an exerbation of the core problem.

The movement toward economic integration is driven by the belief that integration will create efficiencies (lower barriers to trade and commerce) and thus generate greater levels of growth and welfare. The cost is exposure to moral hazard and the resulting shock to the system. When the U.S. military built the Internet, it was designed with redundancies to make communications lines robust against a nuclear attack. These redundacies have the effect of loosening the tight integration in the network, so that shocks (such as a nuclear attack) in one part of the system will be absorbed locally, rather than propogated systemwide. Such redundancies are inefficient but robust.

A similar principle needs to be applied to the current situation in Europe. Rather than commit more resources from the Zone to rescue packages, thus tightening the coupling between the healthy parts to the sick parts of the system, Greece, Span, Portugal and, possibly, Italy, need to be quanrantined from the Zone, for example by indexing their costs of sovereign borrowing to market rates and raising revenue production (i.e., taxes) to more sustainable levels. The effect will be very painful and politically costly. However, a little blood letting may be necessary in order for the entire body to recover.

The long term solution is of course to de-integrate Europe or to adopt fiscal policies that more transparently reveal the costs of domestic governmental decisions. It is not to further tighten the screws that lock down France and Germany to the rest of their neighbors.

Update: A Greek Tragedy

2010-04-13T09:33:00.003-04:00

In an interim measure to stem its debt crisis, Greece sold $2 billion of 3-month treasury bills at 3.65%. In an era of low interest rates, the yield is considerable. Greece is expected to cover its April obligations but little else beyond. The good news for Europe in all this is Germany's surprising strength in the last quarter. Exports have risen and household debt remains under control. However, I reiterate that until clear and bold steps are taken to reduce public sector spending, short term bond sales to cover upcoming obligations merely shift the problem to future generations. The hope that a stronger Euro/Greek economy will reduce current obligations in the future is the type of financial roulette that Greek and European taxpayers should not have to endure. The lesson: governments around the word need to take affirmative steps to encourage private capital accumulation and production.

Another mortgage bailout

2010-04-01T18:37:00.002-04:00

The Administration's announcement of a new plan to bailout mortgagees' whose properties are underwater does little to add jobs to the economy. Instead, the plan will prolong the already anaemic recovery by keeping the market from discovering real prices.

Anticipating the government's actions, banks are now less likely to conduct short sales, rewrite mortgage terms, and rebase the value of their asset portfolios. This will result in lower lending, inflated interest rates, and less capital accumulation overall. Business investment in future capacity and R&D will trend lower, delaying increases in productivity.

The Administration's dismissal of economic reality is not surprising. This announcement coming on the heels of the healthcare vote (which guarantees a thumping for incumbents in November) is an attempt to sway public opinion of the governing party. For the people, the price is too high.

And the child shall lead them...

2010-03-22T18:52:00.001-04:00

I seldom agree with Tom Friedman (New York Times columnist). I am, however, with him a hundred percent on this one. Immigration is the lifeblood of America from its founding. It is even more critical today, given the low birth rates and aging population, and perennially poor showing in math and science competitions.

Job retraining and organizational restructuring can help mitigate the productivity gap in the short run but have limits. Economic growth demands endogenous innovation. Immigration of all types and from all socioeconomic classes is the only way out of the talent and financial deficits confronting us.

We need to remind ourselves that immigation is a multi-generational phenomenon. The fruit picker's child may be the next discoverer of the cure for cancer. Immigration reform should move only in one direction, which is to ensure that the doors remain wide open, permanently.

Financial REform?

2010-03-20T14:30:00.002-04:00

On March 18, 2010, Christopher Dodd, Democrat Chairman of the Senate Banking Committee unveiled a long awaited proposal to reform America's financial system. The many elements include some moves back to Glass-Steagall, the repeal of which has been viewed as responsible for the financial system meltdown.

A more critical proposal involves the creation of a Financial Stability Oversight Council whose job is to flag large firms for special oversight by the Federal Reserve, which is likely to result in 'too big to fail' moral hazard. Large firms will also be required to pay disproportionately into the resolution account for rescuing failing firms, which may lead to the break up of full service financial firms (Citicorp, JP Morgan,...) into smaller, specialized businesses.

It it difficult to dispute the necessity for financial system reform. However, the imposition of yet more government onto an already complex system will only create opportunities for more obsfucation and gaming. The path to reform should result in simplification and transparency (not comlexity) to create information symmetry so that consumers and investors can make informed choices. Transparency will discipline errant banks by revealing their bad decisions early on.

While the spirit of Mr. Dodd's reforms is right, the methods he proposes fertilizes the seedbed for the next meltdown.

Moral Courage: The Lesson from Lehman

2010-03-13T14:15:00.001-05:00

In a 2000 page report, court appointed examiner, Anton R. Valukas, said that Lehman Brothers used a tactic for collateralizing short term financing to temporarily move assets off its books to reduce quarter-end debt levels while calling the transactions sales instead of loans.

Such shenanigans were not suppose to happen again after Enron, with strengthened whistle blower laws and Sarbanes-Oxley. It did, and with time, we will probably discover more such wrong doing among Wall Street firms involved in the meltdown. All this illustrates the simple point that no law and no amount of enforcement can replace leaders and employees with the moral courage to admit mistakes.

As an aside, it was fortunate the Treasury did not bail out Lehman. A bailout would have made the American taxpayer the ultimate patsy in a con game. Another reason not to do bailouts - period.

The Greek Solution

2010-03-04T10:30:00.003-05:00

Greece sold 5 billion euros of 10-year bonds today. This is a far cry from the 48 billion euros they need but its a very good development because it now introduces a form of marketplace discipline so the Greeks can no longer borrow and spend with impunity. It also sends a positive signal that will reassure the market for sovereign debt in Europe and make future bond sales more likely. The sale, apparently, was precipitated by the Germans signalling they are backing out of a bailout. They finally get it. Moral hazard is baked into bailouts. If only the U.S. government understands this.

Derivative Financial Instruments

2010-02-28T17:42:00.000-05:00

The Office of the Comptroller of the Currency reports that U.S. financial institutions held $13 trillion in credit derivatives in Q3 of 2009. Derivative instruments such as credit default swaps (tradable insurance policies against borrower default on commercial and real estate debt) have been blamed for the widespread failure of banks and the speed at which such failures rippled across the world.

Congress and even some economists have called for a halt to the use of such instruments. Such a solution would limit market liquidity without lowering structural risks. Instead, it would introduce operational risks to commercial enterprises that do not have the capacity or capability to self-insure.

Derivatives are perfectly fine devices for managing risks when the contracts are backed by the appropriate reserves. Counterparties simply need to demonstrate their capacity to meet the obligations of their contracts in the event of reversal.

The real problem is an interventionist government that has repudiated free market principles. Based on the paradigm that some banks are simply 'too big to fail', TARP sent the message that the U.S. government, through its taxpayers, was willing to be the lender of last resort. Risk disappeared from the system. 'Too big to fail' is a belief based on another (self-serving) belief that government must fix everything. It is not a statement about how free markets actually work. In free markets, nothing is too small to succeed nor too big to fail.

Germany and the U.S.

2010-02-27T12:07:00.002-05:00

This NYTimes article discusses how Germany's family-owned exporters are the economic shock absorbers against the worldwide recession. Although the article is focused on the impact of the trade imbalanced on the rest of Europe, the comparison to the U.S. and China is false.

Germany's trade surplus is not due to an artificially low currency (China) nor is it due to begger-thy-neighbor subsidies and tariffs (U.S.) Germany enjoys a trade surplus because its customers are willing to pay a premium for quality goods and services and German households are the largest savers in Europe.

The Administration should take note. Economic recovery does not come from sleight-of-hand tax and spend. Neither from force feeding money into an economy laden by historic levels of household debt. Economic recovery comes from innovative companies unfettered to invest and households spending less than they earn.

The Problem with Greece

2010-02-16T15:58:00.000-05:00

Actually, the problem is not with Greece. One cannot fault a government for pandering to its voters by public spending, particularly if someone else is paying the bill. The problem is the willingness of the Germans and French to finance Greece's profligacy; driven by their belief in the necessity of economic union. Economic systems do not exist independent of the political, historical and cultural institutions in which they are embedded. The diversity of institutions among member states in the EU imply fundamental differences (and incoherence) in economic systems. Greece is possible because of the EU. The problem is the EU.

The New Manufacturing

2010-01-27T12:22:00.002-05:00

In this intriguing article of the new manufacturing sector from Wired magazine, the writer reports on the technological ecology giving rise to microfactories that power crowd sourced design/build products. Policymakers should take note. Rescuing GM and GE is so 90s. Sustainable economic vitality depends on the free expression of a society's entreprenuerial tendencies. Unlease creativity, reward risk taking, get unions and politicians off the entreprenuer's back.

"The Quants"

2010-01-25T10:40:00.002-05:00

This precise of The Quants by Scott Patterson describes the role of financial econometrics and its practitioners in the near-collapse of the global financial system. It is a distressingly repetitive story. The 1997 Asian Financial Crisis can be traced to the activities of such funds as LTCM (Long Term Capital Management) that used similar techniques.

The problem is not the use of math to trade financial instruments, although one could question whether a prudent person should invest in securities for which there was little understanding.

The real problem is the lack of transparency and the lack of appreciation by bank CEOs for the risks. As long as traders made money, CEOs cared less what they did or how they did it. Apparently, there was such a thing as a free lunch.

However, any reform proposed by the Administration should not try to curb the use of such tools - it is pointless. Reform must be aimed at improving governance by increasing transparency and holding accountable the CEOs and Boards of Directors of banks for basic risk management practices.

Perhaps criminalizing the lack of accountability would be a good way to start.

The Way Out

2010-01-24T19:06:00.002-05:00

In this article, Tom Friedman from the NY Times urges President Obama to begin a national movement to encourage entrepreneurship among the young. He is right.

The way to sustainable economic recovery is not more government made-up jobs by transfering money from private to public hands. It is by destroying the psychological and economic barriers to risk taking, saving, and innovation.

By firing up the imaginations of our young people in the sciences, engineering, and business, we build the means for a new era of sustainable job creation. Countries around the world are racing to create their own entreprenuerial economies. We have the advantage of an immigrant heritage with the attendant 'can do', risk taking attitude.

President Obama's legacy to the generation that put him in office should be to lift the curse of big government so they can lead us out of this economic mess.

The US Economy in Europe

2010-01-16T17:55:00.003-05:00

Writing from Berlin, Germany, it's painful to see the impact of the remarkably weak US dollar (.62 Euro at the bank). Evidence of the resulting precipitous drop in exports (Germany is the largest exporter relative to GDP) is every where. The Sony Center, packed on Saturday nites, is a ghost town. Restaurants at their traditional peak times, Saturday dinner, are empty. Train stations, notably the pan-European Hauptbahnhof, are bereft of travellers. Perhaps its the weather, but I don't think so.

The multi-trillion dollar expansion of the U.S. government is creating a debt burden lasting generations. This short sighted attempt to alleviate the pain from unintelligent commercial and individual decisions has not gone unnoticed. The world used to happily finance the U.S. consumer because he kept the factories running and there was confidence in the U.S. government's fiduciary sensibility. No more.

Transnational corporations can hedge by keeping their books in Euros, Pounds or (eventually) Yuan. Not so the the U.S. citizen. A weak dollar does not help the U.S. citizen trying to claw his way out of a debt mountain or keep living standards in a regime of relative wage declines.

Lessons from AOL-Time Warner

2010-01-11T12:02:00.003-05:00

In this New York Times retrospective on one of the largest mergers in U.S. industrial history, AOL and Time Warner, the writer interviews key players who reflect on what went wrong. Regardless of the specific causes (culture clash, wrong business model, implementation mis-steps) the story holds a critical lesson for management.

The more complex a system, the more likely it will break. Whether in healthcare, national security, financial institutions or energy security, the Federal government's attempts to build massively complex systems needs to be re-thought. Build simple and flexible systems that push decisions down to the level to where they are first felt. Such systems can break without catastrophe and are easy to fix.

Economic recovery requires risk seeking capital to reflow. The uncertainty surrounding the government's various massively complex interventions, coupled by the likelihood and costs of failure, will keep risk money on the sidelines.

Post-Recession Jobs

2010-01-05T15:52:00.001-05:00

In this segment on WYPR, I discuss the outlook for various types of jobs in the post-recession. There are two ways to think about this issue. We know that jobs derive from the structure of the productive capacity in an economy. Therefore, 'What jobs are going to be in demand?' is a function of forecasted sectoral growth. For example, if by 2020 30% of U.S. GDP will be driven by demand for services and products in the healthcare and lifesciences sectors, job growth can be anticipated in those industries. Statistics from the Federal and the State of Maryland governments seem to suggest this.

Another way to think about this question is at the individual level, 'What jobs can I prepare for in the post-recession?' This is more difficult since it asks about the flexibility, training, education, experience, and tolerance for ambiguity of the individual. The general rule is that one should get as the maximum amount of training and education to remain flexible. As it was impossible to predict the Internet revolution or the Green (as in agriculture) revolution, it is difficult to predict the next 'big thing'. Some jobs probably haven't been invented.

We know this. We cannot assume job security from our employers. The only security is that which we create by focusing on the value add we bring to an employment situation. As workers, we are no longer selling time and effort (labor); we are selling productivity.

Unhappy New Year

2009-12-31T16:52:00.000-05:00

The economic meltdown continues into the new year. TARP extended to the Fall, Fannie Mae and Freddie Mac get blank checks to cash, $800 billion for stimulus part 2, multi-trillion dollar healthcare package rushed through Congress. There is no end in sight. That 'loud sucking sound from Washington' (Ross Perot), has turned into a roar.

At some point, domestic capital accumulation will collapse as corporations accelerate outsourcing, and individuals move their money abroad for better investment opportunities. The added pressure on government entitlement programs will lead to even higher taxes. We are not far from 1970s Britian where the top tax rate exceeded 90%.

What is more frightening about this recession is that we are simultaneously fighting a long war against terrorism, with its implied direct and indirect economic costs, as this article from the New York Times points out.

The way out is to provide incentives for investment in innovation, education, and productive assets. Unfortunately, in 2010 it appears the political tides will make this unplatable.

Government Controlled Healthcare

2009-12-24T15:42:00.003-05:00

It is true that a country of such wealth should not have citizens choosing between food and medicine. This is a travesty.

However, it is also true that the government bureacracy in charge of everything from the Arts to Medicare has not shown itself competent. Does anyone seriously believe that turning over a third of the economy, on a matter of life and death, to the same government is the right thing to do?

Even if, for the sake of argument, that we accept the market has failed in healthcare, the course of action is to fix the market - improve information flows so consumer decisions are efficient - not throw it out entirely.

We know this. That the tax burden from the healthcare reform bill will slow perhaps even stall economic recovery by reducing private investments in capital formation.

Copenhagen Compromise

2009-12-18T20:43:00.004-05:00

The Copenhagen Climate Conference inevitably concluded without meaningful decision. It's not such a bad thing since the entire premise of the conference was flawed. The $100 billion (if it materialized) is simply more aid to poor countries, dressed up in green. Most donor countries are likely to shift earmarks for aid to green projects, further distorting consumption and production decisions in those countries that can least afford the subversion of the market mechanisms needed for their economic wellbeing.

The U.S. has refused to directly help China and other emerging countries remediate carbon emissions. This is hypocritical since a majority of the factory production in apparel, consumer electronics, industrial machinery, and furniture consumed in the U.S. comes from China. The anthropogenic carbon cycle needs to be analyzed across the entire value chain, from pre-production to post-consumption. In this light, the U.S. consumer’s carbon footprint is not only global, it is vast.

If we were really serious about carbon emissions reduction, we would gladly pay China and transfer the technology needed to lower OUR carbon footprint. If there is no political will to impose a carbon tax at home to pay China, we can at least not stand in the way of the necessary export carbon tariffs they would need to invest in clean production technology, non-carbon based energy research, and training. Failing all this, we should probably seek economic integration with China. Economic integration would make transparent the true cost of consumption.

Of course all this will greatly raise prices at home, lower consumption, reduce production in China, and slow global economic growth. We will have to live in smaller houses, buy one less pair of shoes, acquire less furniture, drive smaller cars, and get by with lower paying jobs.

All this, of course, will not happen. Not in America. Thank goodness. Instead, we have cap and trade to make us feel better.

Department of Energy as Venture Capitalist

2009-12-14T18:31:00.001-05:00

This WSj article, reports on a $13 billion gusher from the Department of Energy to fund 'Cleantech' start ups. Unfortunately, what appears to be happening is the emergence of an industry designed to maximize the acquisition of government handouts. Whenever massive amounts of money are poured into a economy, distortions in incentives and risk preceptions will occur. One does not have to look further than the corn-based ethanol fiasco of 2008. Why is private venture capital funding for Cleantech only 1/5 of the DOE's? Could it be that the market knows something the government does not?

Cap and Trade Redux

2009-12-10T19:53:00.001-05:00

Much has been made of cap and trade in the Copenhagen Climate Summit. As I explain in this radio segment on WYPR, cap and trade is not only inefficient, it is fundamentally dishonest. All production results in consumption. The problem with taxing production is that it hides the cost of the consumption decision, so there is no incentive to mitigate our consumption.

While the 'trade' creates the illusion of a market mechanism for the right to pollute, the 'cap' is politically determined or at least heavily influenced in negotiation by powerful stakeholders. There is no well founded reason, for example, why the EU target of a 20% reduction by 2020 is any better or worse than the revised target of 30% reduction by 2020. Therefore, the 'trade' is merely an arbitrage opportunity. It does not actually allocate resources, based on consumer choice, in the same way that a real market would.

Cap and trade is simply a politically expedient way to avoid the tough question, which is this, 'How much economic growth and jobs are we willing to give up to slow carbon emissions growth?' It is true that CO2 emissions as a ratio of GDP has steadily fallen in the last 25 years. This is largely due to the increase in technological intensity and shift from manufacturing to services. However, 85% of energy sources in the U.S. is carbon based and given that energy is the basic input to productive and consumption activities, any scheduled reduction in carbon based energy use implies reductions in consumption, which means reductions in production and hence economic growth, and jobs. There's simply no such thing as a free lunch, no matter what the politicians try to tell us.

No one disputes the importance of the environment. In fact, any system that directly reveals the environmental costs of our individual choices (like a carbon tax) is at least more honest, and certain more efficient than the political laden cap and trade. We should find ways to limit our environmental footprint. We can't do this well until we have an honest discussion of the tradeoffs.

Extension of TARP

2009-12-09T12:49:00.002-05:00

The Treasury's decision to extend TARP to October 2010 could be seen as a signal of the ongoing weakness in our banking system or the self-perpectuation instinct built into every government program. Given the record profit on Wall Street, and the continue process of bank closings, without apparent ill effects on the economy, my guess is the latter explanation holds. Look next for attempts to make TARP a statutory appendage of Treasury.

Telling is the statement from Geithner that even though $700B is authorized, only $550B might be spent. Why keep a $150B rainy day fund? This is the type of excuse corporations give to shareholders for keeping large sums of cash. According to free cash flow theory (c.f. Professor Mike Jensen at the Harvard Business School) managers now have free rein to spend money without oversight.

Treasury should go to Congress each time it wants more money. The extension of TARP and the built-in rainy day fund is a way around Congressional oversight. Treasury should return this money to the rightful owners - you and I, the taxpayer.

Dangerous CO2

2009-12-06T00:32:00.000-05:00

According to this WSJ report, the EPA is getting ready to declare CO2 a danger to the public. Should we now exhale less? Seriously, if we had doubts that the EPA is a political organization under the cover of 'science', we need no longer wonder. Declaring CO2 as verboten opens the floodgates to legislation on carbon limits with serious economic consequences. It would stand to reason that before we legislate, we should know whose interests are served, who decides the limits, how the limits are decided, and who pays. During a lingering economic crisis, such issues should take on an added weight in the public discourse.

Resignation of GM CEO

2009-12-02T13:51:00.000-05:00

The latest casualty in the continuing saga of General Motor's attempts to find its way in this recession plagued automotive industry is CEO, Fritz Henderson. By all accounts, he did the right things to restructure GM, change its culture, and improve product performance in the marketplace. But apparently this was not enough or fast enough for the board, which now represents the government as a major stockholder. The firing illustrates the difficulty of the task, particularly in a tightening consumer market. There is simply no room to manuever. The bottom line: it may have been more efficient, and humane to let GM die.

GM's talented autoworkers and executives could have been deployed by the more effective foreign automakers domiciled in the U.S. Unleashed from the constraints of foreign content laws, pressures of competing with a subsidized giant, recalcitrant unions, and byzantine distribution systems, these producers could have ushered in the renaissance of the U.S. automotive industry. The American people's love affair with the car will see to that. Unfortunately, what we have is a car wreck in slow motion, financed by the government through we, the taxpayer.

Happy Thanksgiving ... Shopping

2009-11-26T11:24:00.011-05:00

This New York Times article reports new tactics retailers are using to get shoppers into their stores beyond Black Friday. Retailers have always known that short, steep discounts cannot create sustainable sales cycles. Hence, WalMart's 'Everyday Low Prices', Southwest Airline's consistent policy of low prices, and (now defunct) Saturn's no haggling prices. However, few retailers can sustain such strategies unless they had cost structures that allowed selective responses to rivals without subverting their business models.

The alternative to everyday low prices are price wars, which often result in spiraling declines in pricing power. Good for consumers, bad for everything else. Congress's attempt to impose Cap and Trade, together with the various state-level initiatives to limit carbon emissions will pressure manufacturers that cannot pass on the inevitable cost increases to consumers. Consumers who are now conditioned to a world of paying low prices all the time.

Companies that want to stay in business will have to find ways to be more efficient; for example, by replacing human with technological capital, outsourcing services to lower cost regions, and restructuring their business models to deliver more with less. Net result? Lower levels of employment, lower consumption, lower global economic growth, at least for now.

Don't get me wrong. Limiting pollution is a good thing. However, exogenously imposing limits on choice does not lead to economically sustainable growth. The solution to pollution must be endogenous to the production-consumption dynamic. This requires consumers to think differently about the way they buy, producers to rethink their product design and business goals, and legislators to move away from abstract notions of 'good' to understanding the impact of their laws on human communities. There are early indications that consumers and producers are responding, not to legislation, but enlightened self-interest. There is no indication that legislators are similarly driven. This is because if legislators were honest with themselves, they would arrive at the obvious conclusion that legislating choice is almost never a good idea. What then would they ever do with all that time on their hands?

The Continuing Economic Malaise

2009-11-18T20:31:00.004-05:00

As we go into the peak shopping season of the year, economic indicators on production, producer prices, and so on suggest continue uncertainty. Consumer goods manufacturers generally build inventory in anticipation of the season. This is not happening. In fact, the numbers indicate continued economic malaise. In this one hour segment on the local NPR station, WYPR, I discuss the implications of producer indicators, housing sales, and employment growth in Maryland.

We have been in a fifteen year transition in which the sources of value creation are shifting to services, healthcare, biosciences, and information technology. The shape of the economy to come is unclear. However, there are some things we can do to firewall ourselves against the inevitable fallouts from this transition. Get (re)educated and (re)trained. Lower expectations for job security. Increase expectations for job mobility. Take greater personal responsibility for career managment. The prize in this race will not necessarily go to the most hardworking but the most adaptive.

Not so merry Christmas

2009-11-16T18:21:00.003-05:00

This Wall Street Journal article points to another way Congress is trying to raise taxes to pay for the impending healthcare bill. With the same creativity and energy our government has used to rewrite social welfare in this country, they have found other ways to soak the middle class. It's the classic salami strategy of slicing the problem so thin no one can mount a concerted defense. After all, how can anyone object to a 1% increase in Medicare tax for the 'rich'?

President Obama wasn't kidding when he said he's going to spread the wealth around. The only problem is that these death-by-a-thousand-cuts fiscal tactics will shrink the amount of wealth to spread around. Capital flight, lower private investment, and slower economic growth will see to that.

Warren Buffet Bets on America - Really?

2009-11-03T08:35:00.005-05:00

The recent news of Bershire Hathaway's $26 billion purchase of the remaining equity of Burlington Northern it does not own has been touted as Mr. Buffett's bet on America. Hardly. The purchase, while large in dollar terms is not terribly risky, given the company's knowledge of the railroad as part-owner and the strategic value of the asset as the most economical form of mass transport for commodities and high weight/value industrial goods. Commercial rail has always had a healthy prognosis (this cannot be said for passenger rail) in this country. As the cost of energy increases and the White House's greening push intensifies, the value of rail can only increase. The valuable right-of-way enjoyed by railroads in urban and suburban precincts is itself an inimitable and rare asset that confers a monopolistic advantage with stable rent streams. The challenge for Berkshire is to reinvest the cashflows to improve the infrastructure and technologies that make the business valuable. This is necessary to increase the capacity to meet rising demand. But it will be difficult, given the current economic recession and the implied cost of capital represented by the premium in the takeover price.

$60 Billion Medicare/Medicaid Fraud

2009-10-25T20:57:00.007-04:00

In this latest installment of CBS's news magazine, 60 Minutes, light is cast on the biggest government run healthcare insurance program in the world, Medicare and Medicaid.

The reporter interviews a fraudster who, at one point in the story, laughs at the idea that the government can actually do anything about the problem of outright fraud (billing for services not rendered), let alone deal with the problem of overcharging.

The Obama Administration, has increased funding for policing Medicare/Medicaid fraud to the tune of $200 million. So, in this crazy world of public health care insurance, one has to spend money in order to 'save' money.

The annual cost of Medicare and Medicaid fraud is already greater than the illicit drug problem. The temptation of a $2 trillion program is too much for even the most casual of petty crooks. What would an additional $1 trillion in the shape of the health care 'reform' do for the industry of health care fraud? Politicians would be wise to keep this in mind when voting for the public insurance option.

Government Ownership and CEO Compensation

2009-10-23T10:38:00.003-04:00

Given the government's ownership of TARP financed companies, the imposed CEO compensation caps are not surprising. In the past, shareholders of publicly listed companies have tried to do the same using shareholder resolutions and proxy fights. Those attempts have never succeeded. As I explain in my book, such direct control of governance decisions by shareholders can be dangerous. Shareholders do not always share interests with each other. For starters, it's not difficult to imagine what government controlled banks and auto companies could morph into by simply looking at Amtrak, the Post Office, the power utilities,... What would that do for the minority investors in such companies?

Another Mindless Assault on Business

2009-10-19T15:31:00.008-04:00

In this interesting tidbit in the WSJ, the 5th Circuit accorded plaintiffs in New Orleans standing in their suit against energy companies for causing global warming and thus contributing to the damage caused by Hurricane Katrina.

Nevermind that anyone who chooses to live in a flood plain or worse, below sea level grade area, is asking for it (why don't they sue Mother Nature); such frivolity will lead to more lawsuits that only polyester-clad lawyers could love. It will most certainly not solve climate change, instigate thoughtful discourse and policymaking or even create smarter homeowners.

The Inconvenient Truth of CEO Pay

2009-10-09T20:16:00.008-04:00

In the following commentary, David Yermack makes a case against the regulation of CEO pay, arguing that the incidences of abuse are few, compared to the vast majority of properly functioning pay schemes.

Setting aside the argument that regulation is a blunt instrument that may lead to net losses in economic welfare, the research has clearly demonstrated a lack of a correlation between firm performance and CEO pay. Many cite this as the reason to regulate the latter.

It's not so simple.

What is 'excessive' CEO pay?

There has yet to be a compelling economic argument for why CEO pay is 'excessive'. Compensation is not a monolithic construct. Any compensation package includes pay for services, social capital (a CEO's reputation may add brand value to the firm), performance above expectation, and risk taking. Pay is wage, incentive and reward all mixed up. More critically, a CEO's performance is not the same thing as firm performance. While there may be some connection between pay and firm performance, it is normatively weak.

Is regulation the best approach?

No amount of regulation can anticipate the endogenous and exogenous contingencies and the interactions that drive firm performance. Hence, no regulation can contemplate the fine grained decisions involved in pay setting. There are best made close to the conditions on the ground, in the boardroom.

There is also an argument that replacing the informal institutions of shareholder activism and board decision making with the formal institution of regulation will further divorce directors from their sense of fiduciary. The net impact may be more abuse. It is not coincident that the increase in the complexity of the tax code is correlated with the increase in tax fraud.

The media loves to instigate popular sentiments against 'excessive' pay because they have economic incentives to do so. It is also understandable opportunistic politicians would jump on that bandwagon. As a thinking citizenry, we should know better. The genie of regulation, once out of the bottle, extracts a hefty price and cannot be tamed.

Better that we find ways to hold the directors accountable than for the government to set pay.

Healthcare and the Consumer

2009-10-01T14:46:00.004-04:00

Here is a sensible piece from the Wall Street Journal on what is missing in the healthcare debate and, by extension, virtually all discussions related to public programs, such as environment legislation and homeland security in Congress.

No one is talking about the prices that individuals are expected to pay for the government mandates passing off as healthcare reform. At the very end, you and I have to pay whether directly through high taxes or indirectly through higher prices for products and services made by companies forced to pay higher taxes.

The only sustainable system is one in which the cost of healthcare consumption is apparent to the individuals making the choices. The reason extant proposals are dishonest is they strenously try to hide the true cost to the individual with such schemes as public insurance, forced provision clauses, and price caps on insurances, procedures, and drugs. This 'something-for-nothing' mentality is to be expected from lawmakers and a President who have never had to make payroll or worry about where the next customer will come from. However, shame on us, the electorate, if we allow them to get away with it.

The Real Engine of Job Creation (not the White House)

2009-09-30T16:49:00.007-04:00

We know that virtually all of the new employment (and hence incremental consumption) in the U.S. economy comes from small companies. It stands to reason that anything inhibiting new ventures - credit, capital financing, rules and regulations, lack of skilled labor, labor immobility, taxes, technology, and access to markets - serve only to arrest job creation.

Here is an example of a company on the West Coast that is in the business of creating businesses.

I have yet to see the current administration capable of or willing to foster the emergence of such companies. All we hear is how small companies will be taxed to pay for the healthcare and unemployment benefits of workers displaced from large companies that have lost their competitiveness.

The current administration, it seems, is bent on pouring sand into the country's engine of employment.

Trial Lawyers and Healthcare

2009-09-29T17:12:00.006-04:00

This well written article in the Wall Street Journal cites the costs of not reforming medical malpractice. No one can honestly defend the system of tort that currently exists, in which about half of all awards go to the lawyers. Imagine if half the proceeds from the sale of your home is handed over to your real estate agent!

If the trial lawyers are truly honest in their desire to 'protect the weak', they should readily accept a schedule of fees for services rended - just like the hospitals and doctors have to accept Medicaid and Medicare's schedules.

Reform should disallow contingent payments and outlaw class actions (as in many countries). Each case should be tried on its merits, which will bring honesty back to the profession and eliminate the costly practice of defensive medicine. Unfortunately, the Democrats, in the driver's seat on healthcare reform, are in the pockets of the trial lawyers. Even one of their own - John Edwards - made his fortune 'chasing the ambulance'.

First class travel drops by 1/4

2009-09-22T20:31:00.005-04:00

The following article in the New York Times reports inceasing (precipitous) declines in first and business class travel on airlines around the world.

More than 80% of an aircraft's operating cost is fixed. The front of the plane contributes up to 40% of profitability, which makes this a very valuable asset. Hence, airlines will fight hard to resist the inevitable pricing pressures. How they do this, reducing capacity in the front, increasing amenities or offering an in-between product, is a matter of business strategy.

More critically, business class travel is a discretionary expense, so this lagging indicator of global corporate fortunes suggests that we are in for a deepening drawn-out recession.

Unions and the Future of America

2009-09-19T16:06:00.003-04:00

The AFL-CIO has annointed a new boss - Richard Trumka, who in his acceptance speech says he wants to change the face of the labor movement in America. But listen closely and one will hear the same tired formula. Card check, public health insurance, anti-management rhetoric... all ignore the fact that wrestling for a 'bigger slice' of a shrinking pie is what led unions to their current sorry state, representing only 12% of the workforce in America. Mr. Trumka is singing from the same songbook as his predecessors and fewer Americans, worried about their futures, are singing along. Politicians who cast their lot with him are, by definition, marginalized. If Mr. Trumka is truly interested in participating in America's new social compact he has to talk about value creation in a globalized economy. This means partnering, not fighting, with investors, management, and the community to improve human capital and strategic flexibility.

The Obama Plan

2009-09-09T22:50:00.012-04:00

The White House has finally laid down the specifics of its healthcare plan for the country.

It is very long on the benefits - complete coverage, protection of existing benefits, anti-discrimination,.... It is very short on how it will all be paid for - pay-as-you-go, vague references to cost savings, malpractice reform, downloading costs to 'large' employers (those with more than 50 workers). Its not a very reassuring plan. There are no specifics on what will be cut. Healthcare cost is a systemic problem and if tackled piecemeal will merely result in the shifting of costs to other players without representation in Congress (such as the doctors). Therefore, any cost saving initiatives will likely occur in the distant future, if at all.

Given that the benefits are immediate and must be paid for without increasing the deficit, the most likely scenario is an increase in taxes and a massive hit on small and medium sized enterprises, which the Small Business Administration defines as under 500 employees. No matter how you cut it, this is socialized medicine and the most sweeping 'spread the wealth' program ever to emerge from the White House since FDR.

No wonder the electorate is not convinced. An honest plan must include the following: caps on the punitive portion of malpractice awards to under $10,000; drug formularies that mandate the use of generics where they exist but will pay full price otherwise; mandated profit margins that cover the cost of capital for insurance companies (effectively turning them into public utilities); preventive healthcare requirements (and benefits) to qualify for coverage (smoking cessation, weight control).

Stimulatingly illogical

2009-09-05T11:22:00.006-04:00

The Administration promised a jobless rate of under 8% as a result of the stimulus package. So far, they have spent more than a half trillion dollars of our money. So far, jobs are still being lost faster than they are created. The iron law that a job can only exist when it produces something that someone wants to buy is known to every 8-year old operating a lemonade stand. The White House thinks it has found a way to defy this simple law - 'shovel ready' projects, cash for clunkers, mortgage bailouts, federal government expansions - so far, the law is intact.

The End of an Era

2009-08-27T21:40:00.002-04:00

Toyota annouced that it will close New United Motors Manufacturing (Nuumi), following the decision by GM not to continue in the joint venture. Nuumi is special because it was Toyota's beachhead in 1984 to learn how to make cars with unionized labor and sell them in the United States. GM joined the venture to learn how to make small engine cars. We know the rest of the story.

Toyota learned well, none of its other plants in the U.S. has ever been successfully organized. The lessons - treat your employees with respect, pay them a decent wage, produce a product no one can refuse and thus guarantee employment for more than two decades.

Typical of the UAW, they accuse Toyota of breaking a trust, ignoring the fact that GM's pullout precipitated Toyota's decision. However, despite the current downtown and inevitable plant closures, Toyota continues to be an employer of choice in the U.S. automotive industry, evidenced by the continued failure of the UAW to organize its workers.

As a side note, the Corolla, produced at NUUMI, is the most popular car in the Cash for Clunkers program. The Corolla is now likely to be produced in Kentucy; demonstrating that productive capacity will migrate to more efficient locales. A reason why market friendly states like Kentucky are prospering at the expense of labor friendly California.

Global Restrictions on Compensation?

2009-08-25T15:59:00.006-04:00

In this article, the New York Times reports on a recent agreement between French bankers and their government on restricting bonus payments.

Unfortunately, in the EU such 'agreements' can become precedent for a law if Brussels believes it good for politics. After all, what's the indignation of a few bankers compared to the ire of the unwashed masses?

The concern for us should be that such populist notions will spread across the Atlantic and hamper the ability of our financial institutions to hire the best talent, for which we have been in a global war for the last 25 years. There is already a movement in Congress to restrict executive compensation. What our leaders do not seem to realize is that brain drain is a real problem - ask the Canadians - and can degrade the long term capacity of a country to innovate and improve its standard of living.

Cash for Clunkers

2009-08-19T14:52:00.005-04:00

By all accounts, the Cash for Clunker's program, in which the U.S. government will pay up to $4,600 to scrap a car in favor of a new, more fuel efficient car, is working as it should. GM has recalled more than a thousand workers on furlough and is running extra shifts to ramp up production to meet demand. All well and good.

Less known is a report in the New York Times that more than 200 auto dealers in New York have pulled out of the program, citing delays in reimbursements. Other potential problems with the program? It shifts demand from later periods to the current period, distorting the business cycle for automakers attempting to forecast demand to manage production and inventory levels. So it is conceivable that the rehiring of furloughed workers will only end with layoffs when the current round of subsidies end and the economy does not fundamentally recover from its current downturn.

For those more protectionist in their predelictions, Cash for Clunkers shifts market share from domestic to foreign carmakers. According to the government's own data, of the top 5 cars bought in the program, only one, a Ford, is a domestic nameplate whereas of the top 5 trade-ins, all are domestic.

Bottom line: If this scheme, according Larry Kudlow, is the least objectionable in the suite of recovery programs offer by the government, then we are in for a drawn out recovery, lengthened by the heavy hand of the government's clumsy interventions.

Goldman Sachs' blowout quarter

2009-07-14T11:41:00.006-04:00

The continued robust turnaround of Goldman, reporting a blowout quarter after paying off the TARP money is a good argument for allowing the markets to work in concert with unfettered managerial discretion. Causality is always difficult to detect but the speed of Goldman's turnaround, before the government got involved, compared to the limping recovery of Citi and BoA, suggests that government's heavy hand restrains rather than enables.

Healthcare Reform

2009-07-11T16:06:00.005-04:00

It is now clear that this Democrat controlled Congress has no backbone to make tough tradeoffs and hard choices needed to solve the healthcare crisis. This would require tackling, among other things, tort reform and rationing. Instead, our leaders are cooking up schemes to soak the rich (aka individuals earning $280k and families earning $350k). They need to raise $1 trillion to fund healthcare entitlements and other vote-buying schemes to stay in power. Why am I not surprised? See this well written article in the New York Times.

Exit of 10 Large Banks from TARP

2009-06-10T03:22:00.004-04:00

It it noteworthy that the decision by the government to allow 10 large bank holding companies including JPMorgan Chase, Goldman, and AMEX to repay more than $68billion in loans and exit TARP has been greeted with some diapproval among the more liberal policymakers and media pundits.

They claim that allowing the banks to extricate themselves from government interference will hamper efforts at forcing the restructuring of the banking sector to limit executive compensation, participation in non-bank financial products, forced lending to credit defaulters, and other social programs. Such claims give some credence to the charge that TARP is a backdoor to nationalization of banking, and with it a model for nationalizing such other sectors such automobile.

In fact, the escape from TARP should be seen as a triumph of market forces. TARP hampered the ability of the banks to hire the best talent, which are necessary for long term competitive advantage, reduced flexibility in jettisoning broken business models, and straight jacketed management from dealing creatively with borrowers, lenders, shareholders and other stakeholders in the community. The freedom from government intervention is the only way the, admittedly wrenching, market adjustments can be made quickly so the macroeconomy can stablize.

State Owned Enterprises - Redux

2009-05-27T10:36:00.005-04:00

The latest attempt to rescue too-big-to-fail companies now involves General Motors. When all is done, the government will own more than 80% of the company (about 10% will be own through the employee pension plan, part of which was hived off to the government two years ago). Together with AIG, these massive diversions of resources can only lead to more taxation and a longer economic recovery.

How can anyone imagine the U.S. will succeed with her State Owned Enterprises when the 50-year history of such ventures in China, Brazil, Britain, Italy, France, and Canada tells us different?

This infuriatingly common sensical article in the New York Times lays it out.

Continuing Saga of AIG

2009-05-23T13:23:00.003-04:00

Ed Liddy, just a 1/2 year into the job, is stepping down from AIG. Being told by Congressmen, who collectively never employed more than 100 people in their lives, that despite a $1 salary he was not doing a good enough job is apparently too much even for someone motivated by public service. This pathetic episode illustrates the dangers of government direct involvement in company management. If the Congress insists on taking ownership of companies on behalf of taxpayers, it should behave as a fiduciary. This means hiring and paying for the best managers for the taxpayers' companies. Of course this implies that Congress understands the meaning of fiduciary.

Stimulus and the small enterprise

2009-05-16T12:10:00.004-04:00

There are hundreds of thousands of small enterprises with less than 1,000 employees around the country being devasted by the current economic crisis. Many were healthy ongoing concerns. Many were probably already uncompetitive. Regardless, even the healthiest of these businesses are being threatened. Yet, we have heard precious little how credit availability will be enhanced, business and capital gains taxes will be eliminated, mandated healthcare and unemployment costs will be reduce for them. Instead, that loud sucking sound we are hearing in Washington (employment is projected to increase by 2.4% inside the Beltway) is drawn from the lifeblood of the small enterprise. Meanwile, millions of jobs created and sustained by these enterprises are at risk.

Blaming the Virtuous

2009-05-04T12:40:00.007-04:00

This article from the New York Times engages in a little hyperbole but the point is very well taken. We still don't get it. We must make difficult choices.

The thinking in the White House and Congress imply we will resume the high life if only we can get through this difficult period. This should never be the goal of economic recovery. We should not be cooking schemes for taxpayer financed consumer spending. It is not sustainable nor is it morally responsible. Instead, our leadership should have frank discussions about the total costs of consumption with the aim of lowering economic growth to sustainable levels (i.e., no more than population growth, which is net births + in-migration).

The rest of the world that depends on the American consumer will suffer but perhaps this will get emerging economy governments to rethink their development trajectories to include really important things, like justice and equality, so that the reasons for social instability and terror may be ameliorated.

A recession can be a useful thing if it brings reality back to disneyland.

Healthcare in the U.S.

2009-04-29T23:37:00.007-04:00

The White House and Congress have argued that the skyrocketing cost of healthcare will continue to hamper U.S. competitiveness and further constrain consumer choice. They are right. However, the solution they offer - single payer, and the reasons for it - greedy drug companies and pilfering insurance providers, are not only simple minded but also disingenuous.

The real cause of skyrocketing healthcare is not the cost of drugs, which, for most therapies, is a fraction of the total cost. The cause is skyrocketing health insurance, driven by a legal system that encourages doctors and hospitals to order unnecessary tests in order to defend against no-limit malpractice lawsuits, and a reimbursement system (Medicare and Medicaid) that incentivizes healthcare providers to maximize procedures.

If the politicians are honest, they should tell the people that a single payer system will require caps on malpractice awards. In Canada, with a single payer system, malpractice awards are capped. However, we do not need a single payer as a reason to cap or eliminate malpractice punitive awards. Such reforms can be justified by acknowledging the senselessness of pitting patients against doctors and hospitals, which is the state of our current legal system.

Congress and the White House should restructure the payment system at Medicare and Medicaid to incentivize wellness and disease prevention rather than just treatment.

These two measures will cause insurance rates to drop, doctors to go back to doctoring (rather than acting as quasi-lawyers), and drug companies to return to discovery instead of spending resources to justify their existence.

Finally, we should have an honest discussion with our politicians. As consumers, we in the U.S. are not only spoilt for choice but have very little stomach for tradeoffs. We want that 5000 sq ft house even though we really can't afford it. We want the biggest and baddest cars to drive to soccer practice but are unwilling to pay for gasoline. We want the best healthcare in the world at all costs (more than 80% of healthcare costs are expended in the last third of life) but someone else has to pay.

Reform cannot and will not happen until we live in the light and speak the truth to ourselves. This year, however, the White House is manuevering to make its healthcare plan filibuster proof and with the defection of Specter, woolly headed thinking now has the impetus to become policy.

Goldman Sachs and TARP

2009-04-15T18:43:00.006-04:00

The blowout quarter reported by Goldman Sachs, its plans for a second tranche of IPO, and its intention to pay off the TARP bailout early (swapping out taxpayers, who had no choice in investing, with shareholders, who choose to invest) is the best evidence for the mishandling of the banking crisis by the Feds.

The economic models of investment banks and retail banks are very different. The former is inherently riskier because of the markets into which they sell their products and services. Yet, risk is not cause of the problem in this banking fiasco. Clearly, Goldman understood risk and managed it well; reaping the benefits. It's part of the 'white shoe elite'. The retail banks that suffered did so because of ambiguity, for which there is no managing. Ambiguity comes from the lack of managerial appreciation for the complexities and differences between the investment and retail banking business. Investing in mortgage insurance is very different from investing in credit default swaps (another type of insurance). Such ambiguity clouds the consequences of managerial decisions, resulting in 'me-too' strategies.

The TARP and other regulatory bodies want to treat all banks the same way by forcing them to take bailout money even when they did not need it. Those inclined to conspiracy theories say the tactic is a backdoor to control the largest banking institutions. Regardless, it's time the Goldmans of the financial world stop worrying about how they appear to the politicians and throw our money back at them. Investors and taxpayers - UNITE!

The New New Economy

2009-04-13T23:04:00.004-04:00

Actually, it's the old economy. In the old economy, when asset values inflate, the cost of money to acquire them goes up (unless the Fed artificially maintains low interest rates). In the old economy the rise in asset values would exclude buyers who cannot afford to pay (unless lenders give money away for free, courtesy of the Fed). In the old economy, when companies produce goods and services that nobody wants to buy, sometimes at any price, they go out of business (unless the government declares them too big to fail).

We know it's the old economy because despite the best efforts of woolly-headed community activists and the policymakers trying to please them, the market finally declares a holiday on the misallocation of productive resources and deflates to properly reflect the real value of our choices. The sad but entirely predictable result is the loss of jobs devoted to the making and selling things that nobody wants to buy.

In the old economy, this is called a recession. It's an opportunity for consumers to reprioritize wants, adjust expectations, and save for the future. It's an opportunity for businesses to reinvent themselves - jettison old ways, strengthen connections to stakeholders, and innovate new products and services.

In the New New Economy, such adjustments are seen as bad. Instead, in the New New Economy, politicians deny their own excesses, scapegoat the rich (who are the only group with enough risk taking capacity to restart the engine of wealth creation), and force feed more money into communities, companies and banks already suffering from an overdose of the cheap stuff.

Like mainlining alchohol to the drunk, politicians in the New New Economy cannot seem to arrest spiraling asset deflation and job losses but are intent on making sure we cannot feel the pain. In the New New Economy, it seems, the only destination is a White House-induced Depression.

Where are the watchdogs?

2009-04-04T21:55:00.001-04:00

It always amazes me that whenever responsibility for corporate failure is assigned, management is trotted up to the firing line. To be sure managerial decisions could have been more carefully considered, data could have been more thoroughly analyzed, and there could have been more humility in accepting responsibility. However, the reason that companies have boards of directors is precisely that management needs overseers to check their logic, test their assumptions, and verify their motives. I have yet to see directors take the 'perp walk' much less grilled by our brave politicians. We are looking in the wrong places to assign blame or fix the problem. One can understand management for acting in their self-interest but there is no excuse for directors, charged with the moral responsibility of protecting the corporation and its stakeholders, for sleeping at the switch.

U.S. Auto Industry

2009-04-01T17:31:00.000-04:00

By propping up the Big Three, the White House has disadvantaged the thousands of workers building cars that people actually want to buy in such cities like Lexington, KY, Spartanburg, SC, Greensburg, IN, and the dealers and suppliers to these companies across the country.

Yes, its the other U.S. automobile industry, building cars with nameplates called Toyota, BMW, Honda, and a host of others that are taking the world by storm, creating secure and well paying jobs for American families, and producing goods and services that markets actually want.

If we really want to have a worldclass automotive manufacturing industry, the White House should be investing our billions into those companies to strengthen their competitive abilities, skills sets, and market reach. Sensible people bet on winners. Our government, it appears, prefer betting on losers.

The Troubles in Detroit

2009-03-30T12:50:00.000-04:00

Now the White House is deciding who runs our companies. I suppose this is inevitable, given the penchant for this administration to tell everyone how to mind their business. Look for further intrusions into the free market. George Orwell was only a couple of decades off.

The problem with the government deciding who makes what cars, when and how, is that it gives the U.S. automakers the perfect excuse for poor performance. After all, if the White House's directive for certain strategies do not yield results, then the managers cannot be blamed. For example, why would anyone imagine that combining two failed companies(Fiat and Chrysler), both on life support from their governments, could produce a successful one?

Market competition and the consequences of failure no longer exist. Responsibility is a dirty word. Success is punished by subsidies to the losers. Everyone, it appears, is now a victim.

The AIG Mess

2009-03-29T20:33:00.000-04:00

The reason we have bankruptcy reorganization is to allow the orderly unwinding of inefficiently employed corporate assets while allowing the continuation of business.

The U.S. government made two massive errors that contributed to the current mess. By walking away from Lehman Bros without enabling the company room to reorganize, and by not using the reorganization laws to force AIG into bankruptcy reorganization, before pouring billions into the company, the U.S. government sent conflicting signals about its competence in dealing with the financial crisis.

The crisis of confidence resulting from the failure of Lehman Bros sent a contagion throughout the banking system, so that the subsequently continued bailout of AIG served to feed the fear. The treatment of AIG officials, notwithstanding the latter's lack of good taste, destroyed any remaining confidence in Congress; who rather than deal dispassionately with the problem, seemed more interested in grand gestures, to the point of passing unconstitutional legislation.

2009-03-28T14:54:00.000-04:00

I am a professor of management at the Johns Hopkins Carey Business School.

This blog represents my thoughts on the current economic meltdown, specific comments on news items, and ideas for how the effects of future meltdowns can be mitigated.