Beating and doping a dying donkey.

Albert Einstein conspicuously suggested, that the main difference between genius and stupidity was …, that the former had its limits. Stupidity is on the rise in a planet where groupthink is the norm. Furthermore, experience teaches us that groupthink begets stupidity, or, to say the least, they are undoubtedly highly correlated.

I keep on saying that there has to be a limit to everything. Put stupidity on the list of things that need an urgent regulatory limit. It is more urgent than limiting the expansion of too-big-to-fail’s. Hi Janet: happy to see how I take your point of view on the advantages of regulation vs monetary policy?

Confusing a donkey for a Ferrari shows stupidity at its top. As you try to increase the donkeys performance, you end up with no Ferrari … and a dead donkey as well. Add the unpleasant reality that you are not going to be happy during the years spent whipping the donkey, while trying to achieve a cruising 55 mph speed. Perpetual frustration is not what Buddists would recommend in order to achieve your personal nirvana.

I am 57 years old and absolutely nothing in my body works like I am still 21. I try to use wisdom to make up for other lost abilities, but, no matter how hard I try, it never seems to add enough to balance it all out.  At least wisdom helps me peacefully assume that I will never go past the 100 meter mark below 11 secs again. Or any other physical feat. That doesn’t mean we can’t be happy. In fact, as I grow in wisdom and lose on everything else, I live and increasingly happier and enjoyable life. I just have to realize I am not a yuppie (my generation’s desideratum) but an intellectually active loving grandfather, and a passable skipper.

The world’s economy has been steadily degrading from Ferrari, to donkey. We can only change that to an extent, and not before some hard work, plenty of time, and intelligent decisions to accompany the two previous requirements. Working out ten hours a day will not help me get my athletic high marks back again. Most likely, I will just generate some additional unwanted health problems. Equilibrium is always more important than growth, speed or achievement. It is always the journey that counts, not the destination (yes, in economics as well).

Keynesian cocktails, and euthanizing the saver and or the rentier (as John Maynard fervently wished) only jeopardize the donkey’s health, and certainly do not contribute to increasing his performance to something remotely similar to a Ferrari. Painting the donkey in red is as far as I would go, and only if I was pressed to do so. Flogging, or doping the donkey, makes no sense at all.

donkey-pulled-cart-gazaMoreover, now that the economy has morphed into a donkey, we have been loading the donkey like a drunken 19th century farmer as well. We load the donkey with debt and entitlements, steal a substantial portion of his food (with corruption of all kinds) and expect it to race faster still?

Come on Mr. Groupthink (wherever you are). Donkeys are not all that bad. You have to see the positive side of things. All assets come with a liability, and all balance sheet reductions also reduce the liability side. Maybe a donkey is not fast, or elegant, but it helps preserve the planet, fertilizes our land, and gives us more time to think and interact while travelling. In any case, a donkey is what we’ve got right now. And it works with a carrot and a stick. If you steal the carrot, overload the donkey, and use the stick intensively, you will end up carrying the entitlement and debt load on your own.

We are seven trillion souls alive right now, over time we will (in all likelihood) not be able to hold on to more than one house and car per family. The price of buying them will probably not be the main constraint. Maintenance and real estate taxes will make it unaffordable. But we will live longer than our grandparents, will also be able to work less, and we will remain fully active until well into our eighties or nineties (unless we are particularly unlucky). We are not getting such a bad deal after all.

So why not get rid of the whip, relax and enjoy the countryside and the trip, and begin to think of ways to engineer an improvement of the abilities of our donkey. Not feeding it ever higher doses of Keynesian drugs, but improving our genetic engineering capabilites. Think “Dolly” (yes, I am aware she is not a donkey).

This time around I will not engage in some additional sarcastic Keynesian thrashing. Ben and Paul deserve every bit of it, but it is a waste of time and energy. In fact the Keynesian mule (doctrine) is already dead, you can smell the corpse already. And we all know it’s hopeless to beat a dead horse.

The world’s economic infrastructure works on inputs in order to generate an output that has to be sold. Provided all output is sold, supply -in the Keynesian reviled long run-, always generates its own demand (Say). In fact prosperity is mainly about generating as much net output as possible, and simultaneously ensuring that it is sold. Unsold or unwanted output is a drag on the system that has to be constantly purged. Massive bail-outs are counterproductive because they fail to revamp the supply side. As a clear example of what I say, we have an obese financial sector in the US (and almost everywhere), and instead of allowing the GFC to streamline it, we have reinforced its weight as a percentage of GDP. As Paul Volcker constantly suggests, half of it is redundant.

financial-services april15

Generating output is not that difficult, as long as there is not excessive overcapacity installed. It requires a decent combination of technology, capital, and human resources to originate positive added value. If you can access the adequate resources at a market price, and the business model is more or less right, you are likely to get going. And yes, I know all sectors show overcapacity today. The fact being it should not be there, if we had allowed the Wicksellian interest rate to reign (vs the central bank directory imposed rates), and we had made a habit of a permanent healthy creative destruction of inefficient supply. Combing excess capacity in construction of finance, just to name two sectors, is going to take a long time. Particularly with an unhappy army of unemployed tensely watching.

Selling what you produce (be it a product or a service) is the difficult part. Henry Ford hit a home run when he began to make cars to serve people’s needs, and not the other way around. In order to get the product or service sold, you have to generate enough interest on the demand side. And additionally the demand side has to be able to pay for it. Your pricing has to consider the buying power of your target client. Business should be conducted with an embedded “build to order” mentality. Where is the need, how do you define it precisely, and how you configure your output to satisfy it, at a price that is payable by your prospective customer, and generates value for you. That’s a truism, both from a macro and a micro perspective.

It’s that simple, really. In a healthy system, some enterprises have to go bust when they do not get their business model right, in order to adapt global output to the requirements of the demand side (capex and consumption demand). A wise old axiom. Joseph Schumpeter discovered creative destruction a long time ago. Keynesian groupthink has forgotten that we need it on a daily basis. The supply side has to be in constant evolution to adapt to the new needs and buying power of the demand side. Doing that daily, will ensure we keep a Say based stable equilibrium in the real economy (the financial economy is a different story as Mr. Minsky proved not that long ago). Schumpeter would have been bewildered for months if had seen the GFC bailouts.

Fiscal or monetary shots are shortcuts to be used sparsely if at all. They can provide a quick fix for aggregate demand, but they are more addictive than heroin. Even prescribers end up with some characteristic hallucination symptoms. Intellectually sound people like Larry Summers are even advocating economic ¡free lunches! (not to mention brainless politicians in “Podemos”  or “Syriza”, that also think money printing or fiscal profligacy are the route to prosperity). Maybe they should read Milton Friedman: “there’s no such thing as a free lunch”. Economics 101.

The perfect economic Ferrari specs are:

  • An institutional infrastructure that favors the combination of inputs, channeled through efficient economic units, in a way that generates as much added value as possible.  And it does so simultaneously minimizing both environmental and social costs, and notably, the institutional infrastructure’s own costs.
  • An economic infrastructure such as motorways, rail links, energy grid, commercial ports etc.
  • High quality and/or cheap and abundant inputs. Labor, land, capital, and energy and technology as newcomers not accounted for by the neoclassics.
  • An intelligent flexible macro-management (market prices as opposed to politburos o CB’s directories) that ensures the right mix of goods and services generating the minimum mismatches between what the demand side requests and what the supply side can offer.
  • An adequate funding of the potential demand side so that they can buy the goods and services for consumption or capex without incurring in debt.

Needless to say, it will become pretty obvious, as I write, that our beautiful Ferrari has morphed into a dying donkey.

1.- Institutional infrastructure.- We need  a concept that has been developed by various economists, and is difficult to quantify and specify with any precision. Michael Pettis describes it as “social capital”:

The fundamental difference between rich countries and poor countries … is not the amount of capital stock per worker but rather the institutional framework that gives workers and businesses the ability to absorb additional capital productively…
The right institutions matter tremendously, but because there is no easy way to quantify what the “right” institutions are, we tend to ignore their importance in favor of more easily measurable factors, such as broad measures of capital stock. I would argue, however, that economies are much better at absorbing and exploiting capital if they operate under an institutional framework that

  •  creates incentives and rewards for managerial or technological innovation (which probably must include clear and enforceable legal and property rights),
  • encourages the creation of new businesses and penalizes less efficient businesses, perhaps at least in part by institutionalizing methods by which capital can quickly be transferred from less efficient to more efficient businesses, and
  • maximizes participation in economic activity by the whole population while minimizing distortions in that participation…

…Social capital is the set of institutions – including the legal framework, the financial system, the nature of corporate governance, political practices and traditions, educational and health levels, the structure of taxes, etc. – that determine the way individuals are given incentives to create value with the tools and infrastructure that they have.

The developed world is in dire need of an overhaul of its social capital infrastructure. In a way, we will not grow ourselves out of debt, for the very same reason we were unable to develop latin-american economies using the traditional IMF recipes: lack of adequate institutional capital. Ours (the OECD’s) is far better, but it has become overweight and obsolete. In Spain this is a top priority, of which nobody seems to be aware.

If we want whatever new money or credit exists (we need equilibrium and “uncommon sense” in the money supply side) to be routed to capex, we need to open up new sectors, and change the weighting of the old ones. It is unfortunately, a prerequisite to fix the social capital issue seriously. Donkeys do not morph into Ferraris if this issue is not taken care of. Of course the establishment does not see this as their own interest. Do we need a war or a revolution? I hope not, but chances of getting it done peacefully are slim.

2.- Economic infrastructure. Everybody understands this, so I will not elaborate on this point. In the US it is a serious problem, whilst in Europe it does not list as a concern. Our European Ferrari morphed to donkey because of the degradation of the first requirement. Economic infrastructure is OK. The US is worse off in this area. That is why famous Larry Summers insists in deficit financing an infrastructure investment spree as a “free lunch”.

At the risk of being wrong, because I only visit the US every now and then, I still think the social infrastructure issue is a priority, even in the US. We must think that social infrastructure is a concept applicable as well to concepts such as a smaller footprint for the public sector, smaller welfare overhead, better resource use, environmental protection, etc. All these matters show a better starting point for the US, but still far from a decent solution that comes anywhere near the specifications for a Ferrari.

3.- High quality, and cheap -if available, inputs. We do not only need the social and economic infrastructure to cater for productive inputs, we need abundance of them as well. Let’s talk labor as an example. It’s no use to have a decent educational infrastructure if young generations leave the country in search of a job outside (the Spanish situation). It won’t help either if we have a perfect power grid but do not have the energy production level to utilize it to a high percentage of installed capacity.

So economies need labor, energy and capital on top of the social and economic infrastructure. An economic infrastructure, and a disastrous social infrastructure won’t do the job (Spain). And a social infrastructure needs an economic infrastructure to develop. Lastly, all of them make no sense if you don’t hire the people needed to produce, and commit to the CAPEX funding needed to get production running with the right productivity levels.

Resource limitations are to be considered when trying to estimate the donkey’s possibilities. Population growth and the decrease in effective hours worked per individual as well. Those are mostly “given factors”, and we have to deal with them as they come. We can improve other aspects, but resource limitations and the amount of hours increased provide some practical limits against which it is difficult to set up a successful fight.

4.- An efficient visible (preferably invisible) hand, setting relative prices, and ensuring efficient distribution of incomes and allocation of resources. I am not one of those twentieth century compulsive free marketers. Market prices are far from perfect, and I feel particularly distanced from the EMH theory, or any other that presumes rationality by market players. But if we try to regulate them, ensure that actors do not abuse them, facilitate unbiased understandable information to all, and try to avoid public sector induced market price distortions, they are the best asset allocation policy.

ZIRP, NIRP and POMO are acronyms that reflect the opposite policy. The central bank directory economy is a hopeless, futile experience, of economic dirigisme.

Our best option is to try to ensure that prices in all markets resemble or come close to the market price that would result in a theoretical EMH generated price environment. EMH pricing is indeed a target (thank you Eugene Fama). But it is not real by a long shot. Nevertheless a pricing system that can take us as close as possible to EMH determined prices, is a much better system than politburo or CB directory pricing.

5.- And the whole economic set up doesn’t work if there is no structural (Say based) demand for the economic goods produced by the system. On a global consolidated basis, the external factor (trade and capital flows) is neutral. The only way you can keep demand artificially elevated, as opposed to the natural levels implied by Says law, is expansionary fiscal and monetary policy. After more than two decades of monetary doping, CB directories are all junkies.

But, even if we do not stimulate de economy with some Keynesian multiplier, and we are talking about natural demand (generated by payments done by the supply side) we still have another precondition to fulfill. A fair distribution of income between the economic actors in the production process.

income-growth april15

Crushing inequality is not only a moral imperative. It is a serious economic requirement for the equilibrium of the system. And a must, if we want to preserve peace for long. Anyway, the donkey won’t morph back into a Ferrari until and unless we rebuild aggregate demand on solid pillars: Say’s law. The economic system has to ensure that agents have enough buying power without resorting to credit, money printing or fiscal profligacy -via deficit generating entitlements.

All in all, I think we cannot think of growing more than one to two percent real, in developed countries, and two to three percent in the emerging countries (on average) for the next five years if not for the next decade. That’s low but we should be able to handle it. Debt and entitlements will have to play the role of adjustable variables. Not pretty, I know.

The stark reality is that the number of hours worked, and expected productivity gains, even playing with optimistic assumptions, put a limit on the economy’s growth. Worse yet, if you want to look at disposable income side of the GDP equation, you have to additionally net out resource cost increases that sum up as gross output, but do not improve the well-being of the standard family (save for OPEC countries, Russia, and Texas). And regardless of pricing, the cost of oil will continue to mount.

Our donkey is over-doped and tired. If we want to grow above 3% again, we have to improve our donkey and, with the benefit of time, morph it back into a Ferrari again. Doping and whacking it further will only kill what’s left of it. While writing this, I am doing my part to try and improve the donkey. ¿Are you doing yours?

matrixSome Keynesian cannabis on weekends is Ok. But remember that doesn’t take us anywhere long term. We have to grow the supply side slowly, taking care of all the above mentioned variables, and improving them all, gradually and simultaneously. They need to improve all at a time, or the global improvement will not fly.

A tough job ahead. It is an impossible feat to try and change the economic landscape in less than ten years (in truth likely a lot more). I wish we were at it already. Anyway, better late than never. Janet: ¿are you listening?