In Jack London’s short story, To Build a Fire, an Alaska prospector breaks through the ice of a frozen creek in the middle of winter, then finds he has only a few dry matches left to start a fire. The suspense builds as each match flickers out before a fire can catch. His fingers begin to freeze. Desperate, he tries to kill his dog so he can warm his hands by plunging them into the animal’s steaming guts. But it’s too late: his hands are frozen. He can’t even handle his knife. Finally, as hypothermia overcomes him, he sits down in the snow to die.
Fed Chairman Alan Greenspan’s situation isn’t quite as dire as London’s prospector. But with its latest rate cut on Wednesday, the Fed is almost down to its last match – at least as far as conventional monetary policy is concerned. Like the prospector, the chairman may soon have to consider the unconventional.
Don’t be surprised if someday soon you see Greenspan down at the D.C. dog pound, picking out a stray.
At 1%, the key Federal Funds rate isn’t just at its lowest point in 45 years – it’s also approaching the non-negotiable limit of how low the Fed can take it. Much lower, and money market funds, where most people keep their spare cash these days, won’t be able to cover their expenses – resulting in negative money fund yields. At that point, savers literally would be better off sticking their cash under their mattress.
Since money funds now constitutes a parallel, lightly regulated banking system – one that contains over $2 trillion in assets – encouraging depositors . . . cough . . . shareholders to pull their money out en masse probably isn’t the kind of behavior Chairman Greenspan wants to encourage right now. And if rates go lower still, the Fed will start mucking up the repo (short for repurchase agreement) market, where large financial institutions and corporations like to stash their spare cash.
What kind of effect could that have on the financial system? Well, imagine draining all the oil from your crankcase, and then trying to drive across town – doing 80 mph on the freeway. Now imagine what that would do to your engine.
So the Fed has maybe one more match left in the box – and it’s an itty bitty little paper match, the kind with the heads that are just as likely to break off as ignite.
Bull Run
Does this matter? Some people apparently think not. The stock market has rallied quite heroically these past few months, on the assumption the second half will finally bring the long-awaited “robust” recovery in economic growth and earnings – the same robust recovery that was predicted for the first half of this year, the second half of last year, the first half of last year . . . well, you get the idea.
The bulls have also taken comfort from the most recent monthly inflation numbers, which still have plus signs in front of them – meaning the economy hasn’t tilted into a full-fledged deflationary spiral. Besides, the housing market remains reasonably strong; consumers are consuming, the weaker dollar should give a nice pop to exports. All the elements of the “robust” recovery would seem to be in place.
Except the recovery. And there’s the rub.
In the Fed’s doctrine, inflation is a function of employment, which in turn is a function of economic growth – or rather, of the gap between actual and “potential” growth. When the economy is growing more slowly than it possibly could – given the underlying trends in population and productivity – the unemployment rate will rise. Inflation, on the other hand, will fall.
Or the reverse: If the economy is temporarily growing faster than its long-run potential, unemployment will decline and inflation will rise.
In theory, at least, this creates a direct, inverse relationship between the unemployment rate and the inflation rate. This is sometimes known as the Phillips Curve, after the British economist who, following in the footsteps of John Maynard Keynes, first came up with the idea.
Got My Mojo Workin'
In a more optimistic age, policymakers were encouraged to believe the Phillips Curve allowed them to mix and match. If keeping unemployment at rock bottom was what they desired (and what politician doesn’t?) they could use their monetary and fiscal mojo to juice up economic growth – if they were willing to accept the higher inflation that went with it.
For decades, elected politicians around the world tended to make just that choice. However, by the late 1960s it was becoming obvious the curve had broken down. The world was getting more inflation, but also more unemployment. And by the mid-70’s, it was getting lots more inflation and lots more unemployment:
Everybody had their own explanation for this puzzle. The monetarists, led by Milton Friedman, blamed excessive money growth – too many dollars chasing too few goods. This meant larger and larger doses of monetary stimulus were needed to produce the same downward effect on the unemployment rate. Since policymakers weren’t willing to tolerate German-style hyperinflation (although Carter’s first Fed Chairman, Bill Miller, sometimes seemed to toy with the idea) higher unemployment was the inevitable result.
The supply siders generally bought the monetarist argument, in part because it jibed with their big fetish at the time, which was putting the dollar back on the gold standard. But they added their own ideas about the corrosive effects of high marginal tax rates and regulation on output, which left even fewer goods for the too-many dollars to chase.
These were all valid points – leaving aside the supply side gold fetish. But the critics didn’t really demolish the Phillips Curve, they’d just pointed out something that should have been obvious from the start: the relationship between unemployment and inflation is unstable. Depending on the economic circumstances, a little inflation may buy you lots of jobs, some jobs, or only a few jobs. Jacking up the unemployment rate may put barely a dent in the inflation dragon -- or it may cut the heart out of it.
But, as with Bill and Hillary, just because a relationship is unstable, even bizarre, that doesn’t mean the relationship doesn’t exist. In the case of the Phillips Curve, it has to exist. Otherwise, there’s no way to explain how monetary policy actually works. You need a transmission belt that converts changes in the supply of money or credit into changes in output and/or prices. And the Phillips Curve is the only explanation that makes any sense – easy money pumps up the demand for labor, which raises wages, which pushes prices higher. Tighter money does the opposite.
The Fed certainly understand this – in fact its entire economic forecasting model is built around it. But uttering the phrase “Phillips Curve” to a supply sider (and all good Republicans are supply siders these days) is asking for trouble. The Phillips Curve is Keynesian. Keynesians are Democrats. Doubleplus ungood. Thought crime, even. Room 101 for you.
NAIRU Jacket
So the Fed has learned to pretend. Instead of talking about the Phillips Curve, it talks about the things like the NAIRU – the Non-Accelerating Inflation Rate of Unemployment. Think of the NAIRU as the Phillips Curve in drag. It’s defined as the unemployment rate that will keep the inflation rate stable. If the Consumer Price Index is rising at a 3% annual rate, for example, it will continue to rise at a 3% annual rate – no faster, no slower.
The problem (and the reason why the Fed is so nervous right now) is that as long as the unemployment rate remains above the NAIRU, the inflation rate will fall – and keep on falling. Soon 3% CPI growth will become 2%, then 1%, then 0, then negative 1%, negative 2%, etc.
In other words, the economy will eventually tip over into deflation, which will only get worse as long as unemployment remains above the NAIRU. But, given the well-known effects of deflation on profits and spending, the unemployment rate is likely to rise in a deflationary environment, causing prices to fall faster, causing the unemployment rate to rise even more.
That’s the point where the economy really could start to resemble Jack London’s hypothermic prospector, sitting down in the snow to die.
But, as noted above, the Phillips Curve is unstable, which means the NAIRU is unstable, too. This means Greenspan really doesn’t have any way of knowing when he (and we) are in the red zone.
Trouble in Mind
He does, however, have plenty of reasons to be worried:
- Productivity – the measure of output per hour of work – appears to be rising briskly, despite the economy’s sluggish growth. Employers keep finding new ways to trim their labor costs, allowing them to either fire workers or avoid hiring new ones. This is putting upward pressure on the unemployment rate.
- The economy grew at about a 1.5% rate in the first half. That’s probably less than half what it could grow, given population and productivity trends. In the Fed’s model, as long as actual growth remains below potential, the unemployment rate will tend to rise, and inflation will tend to decelerate.
- Monetary growth is slowing. The relationship between the so-called monetary aggregates (M1, M2, etc.) and the economy is very fuzzy – and getting more so as the financial system evolves. Apparently, even Milton Friedman has given up on them. Still, the slowdown in the growth of most of the aggregates (M1 is the exception) has to worry Greenspan. It suggests the Fed is, as the saying goes, “pushing on a string.”
To be sure, the monetary aggregates have given false signals before – most recently in the mid-1990s, when a sharp contraction in most of the Ms was followed by an acceleration in economic growth. So it can be useful to look more directly at the Fed’s own policy actions to see whether they are ahead -- or behind – the economic curve.
The chart below shows the change in the monetary base – the narrowest money measure and the one controlled most directly by the Fed – minus the rate of inflation. In essence, when the base is growing faster than inflation (north of zero on the chart) the Fed is being accommodative. When the base is growing more slowly than inflation (south of zero) the Fed is stepping on the brakes.
The periods marked by the red bars on the chart are recessions. Typically, the Fed tightens monetary policy to squelch an inflationary surge, steps on the brake too hard or for too long, and tips the economy over into a recession.
At least, that’s the way it usually works. But look at the trend since the “end” of the last recession, which I’ve placed at the beginning of 2002 (The recession actually hasn’t officially been declared over yet.) You can see that since then, money growth has been drifting down, relative to inflation – despite the Fed’s pump priming.
True, the spread is still positive, but it’s definitely heading the wrong way. And that’s not what you want to see if you’re a central banker with – at most – one more rate cut left in the drawer.
However, we’ve already established that the money aggregates can give false signals. Given the drastic changes in the financial system, broader credit measures might give us a more accurate picture. Unfortunately for the Fed, that picture isn’t very nice, either.
These are the Fed’s own numbers for year-over-year growth in non-financial debt (the flip side of credit). When the economy is expanding, and the Fed is feeding that growth, you would expect debt growth to be sharply positive. When the Fed is tightening – as in the mid-‘70s or the late-‘80s – you’d expect credit growth to fall. (And in the late 1980s it fell a lot, almost taking the U.S. banking system down with it.)
Despite the Fed’s pump-priming efforts, debt growth has been decelerating since the Nasdaq bubble burst in early 2000. The growth of business debt – a good proxy for fixed investment – has slowed even more dramatically. Recently there have been some signs of a weak rebound. But once again: if you’re Alan Greenspan and you’re down to your last rate cut, you really would like to see something more robust.
Will he? Will we? Perhaps. The early 1990s also was a period of persistently sluggish growth – in credit, employment and GDP. But the Fed’s rate cuts finally took hold. Conditions gradually improved, business investment recovered, credit growth resumed. The boat righted itself.
The same thing could happen now – particularly since (unlike 1991-92) the banking system isn’t on the edge of collapse. On the other hand, the global economic environment is much weaker than it was in the early ‘90s, and there’s much more excess productive capacity here at home.
Pension Pains
There isn’t a whole lot the Fed can do to fix those structural problems. But it can make them worse.
For example, one of the problems with using rock-bottom interest rates to treat an asset bubble hangover is the perverse effect it has on future liabilities. Using the standard discounting model, companies have to mark up the costs of their pension obligations as bond yields fall. The collapse of the stock market bubble has already deflated the asset side of the equation. The result is a huge, and growing, overhang of unfunded pension liabilities – a hidden debt which could exceed $1 trillion.
To fund those liabilities, corporations either have to borrow (as GM recently did) mark down their net worth, take a hit to earnings – or some combination of the three. Ultimately, the effect is the same: lower profits. This negates some of the economic kick to investment that otherwise would come from lower interest rates, which tend to reduce corporate debt service costs.
U.S. corporations (not to mention the stock market) can hardly afford that kind of bad news. The corporate sector is already teetering on the edge of a profits crisis, as the next chart shows:
In part, the problem is secular: profit margins have been declining for almost three generations now. Much of the hoopla surrounding the “New Economy” of the 1990s grew from the perception that this downward trend had finally been broken. But that mirage has long since vanished. And even the normal cyclical recovery in profits that followed the “end” of the 2000-01 recession has been relatively weak, historically.
Weak profits despite strong productivity growth suggests the deflationary squeeze on corporate pricing power is really beginning to bite. But without a decent profits recovery, business have little incentive to invest. Without investment, growth will remain low; unemployment high – increasing the deflationary squeeze on prices.
The Fed has yet another problem -- one that seems trully perverse, given its fear of looming deflation. In an effort to see its reduction in short-term rates matched by declines in long-term bond yields, it has deliberately encouraged speculators to go wild: borrowing money at the short end in order to buy bonds at the long end. But this "carry trade" is inherently risky -- even a small wrong move on either end of the bet can result in huge losses.
Now that the Fed is nearing the end of its rope, the speculators are becoming more nervous about the one tied around their necks. They were extremely disappointed by the Fed's modest rate cut (a quarter of a percentage point, instead of the half point they had wanted.) So they sold bonds, resulting in a nasty spike in yields. This suggests there is a limit on the Fed's ability to "twist" long-term yields down -- and that limit may have been reached.
What can the Fed do if its last match fails to light the fire of a “normal” economic recovery? That’s a subject for another post. But if I were Greenspan, I’d try to get a hold of that dog. Because the Chairman’s hands are starting to look awfully cold.
Billmon,
I forgot to say that I thought your essay was very well written. Using London's story as a lead is brilliant. The image of Greenspan selecting a dog at the pound is tight. He might even bump into Frist fondling a few kittens.
Look at that post-1941 slump in profits.
Where did those '40s profit margins come from?
Socialism.
Yeah, you heard me. The New Deal was socialism, and the GOP has been trying to get rid of those good times ever since.
Bastards.
New Deal, socialism? feh. I'm with Norman Thomas. when asked by a reporter whether Roosevelt hadn't carried out socialism, Thomas answered, "Yes -- on a stretcher."
Billmon, nice overview, in general.
I disagree with your implicit deflation warning, though. the US has a lot of problems, but it's not Japan 1989 here. if all the same things were happening and the dollar were *up* 20% against the rest of the world over the last 18 months, instead of down, you might have a leg to stand on. as it is, there's a whole lot of very real money exiting dollar-denominated assets that say deflation is not coming.
I am intrigued at your mention-in-passing of tying the dollar to the gold standard. Is there any indication that the supply-siders want to re-attach the dollar to gold? What kind of havoc would that wreak?
sgc
Ever thought of writing economics so lay people could understand?
You should. Seriously
Norman Thomas was bemoaning the fact that FDR stole the thunder from the SP. The core achievments of the New Deal--recognition of labor's right to collective bargaining, social security programs, and government regulation of production and consumption were ideas that came out of the socialist movement. But it was more a Eugene Deb's sort of socialism than a Lenin's sort.
The 1940's spike came from our financing and supplying Allied forces in World War II. Harry Truman first got noticed nationally as being the Senator who investigated price gouging of the government. This is not a slam on socialism by any means. I'm just saying that those profit margins came at a very unique time.
The problem is not with the interest rates, but the loss of purchasing power by your average American IMO.
Greenspan's move don't really help Joe Sixpack one bit. He's been doing for almost 2 years with no effect. Greenie only helps the elite period.
This loss of buying power is a result of several factors:
1) Exporting our jobs overseas. This has been killing the middle-class.
2) Companies still downsizing.
3) The .dot com implosion. This gutted the hi-tech field which also butchered 401K accounts in the process.
4) Massive credit card debt still carried by most people. Which BTW helped fuel our consumer economy.
5) No saftey net for the long term unemployed.
6) The so-called service economy only produced low-income jobs. Not the high paying jobs needed to sustain communities.
For starters we need to fine companies exporting jobs out of country to save a buck and impose import fees on American companies that have the bulk of their goods made in foreign countries. Also impose a penalty tax for all American corporations with offshore hq's in the Bahamas. In addition penalize the hell out companies like Intel and others who use H1-B visa to bring in high-tech sweatshop labor. Throwing some CEO's and WS investment analysts in Rikers Island ought to bring American business men around. Plus bring back the high income tax brackets we had in the1950's. This will bring in revenue.
Lastly take re-examine our model of the economy which seems to be based on a unsustainable growth assumptions, very much like a tumor.
Have this tax money go to the people impacted by these corps.
Is there any indication that the supply-siders want to re-attach the dollar to gold? What kind of havoc would that wreak? ---sgc
This would lead to monumental crises because of the relative non-flexibility of a gold-denominated money supply.
BTW, good work, billmon. What would you propose as a solution, though?
To me, it seems obvious. The attempts to influence the economy through indirect incentives have not worked. I think we got lucky during the nineties due to the introduction of new technologies. I saw some figures some time ago that the growth in the economy we saw was almost entirely due to the tech sectors. It seems we have two options: invest heavily in new technologies (non-polluting energy, anyone?) or prime the pump through massive public works projects. If we can funnel the money where it can be spent, we will have averted the ominous confluence of negative economic circumstances that is afflicting the economy.
The tariffs generally don't work. Imposing such measures leads to tariff battles which we will lose because of our high-priced labor force. Maybe we should consider energy self-sufficiency. That could provide a competitive advantage that less advanced nations could have difficulty matching.
I disagree with your implicit deflation warning, though. the US has a lot of problems, but it's not Japan 1989 here.
You have a point -- countries with huge current account deficits and weak currencies usually have to worry about inflation, not deflation. But the global economic situation is extremely deflationary, which is why everybody is trying to keep the U.S. consumption and credit bubble from deflating. A collapse/abrupt decline in the dollar could have deflationary, as well as inflationary consequences, if it causes a flight of foreign capital -- a milder version of the Argentina scenario.
On the other hand, if foreign investors and central banks continue to prop up the dollar, then the deflationary pressures from the rest of the world will continue to be transmitted to the United States, and the output gap will continue to put downward pressure on the inflation rate. That's the scenario Greenspan seems to be most worried about.
I am intrigued at your mention-in-passing of tying the dollar to the gold standard. Is there any indication that the supply-siders want to re-attach the dollar to gold? What kind of havoc would that wreak?
Jeez, I can remember listening to Jack Kemp deliver a 20-minute rant about the gold standard -- I mean steam was practically coming out of his ears. This was a big deal fopr the supply siders back in the '70s, when inflation was bad and the price of gold was soaring. One of their two magic bullets -- the other, of course, being lower marginal tax rates.
Just about every legitimate economist under the sun has pointed out to them that you can't have a fixed exchange rate and run humongous budget deficits and current account deficits -- not for long anyway.
But, as with every other point of common sense, the supply siders are oblivious to reason.
This would lead to monumental crises because of the relative non-flexibility of a gold-denominated money supply.
What he said.
What would you propose as a solution, though?
I don't know of any solution that doesn't involve a lot of pain. Ideally, the U.S. would switch from domestic-led to export-led growth, while the rest of the world (particularly the lesser developed countries) did the opposite. Then the U.S. would be contributing resources to global economic development, instead of sucking them inward. But the Asians don't want to stop being export Tigers, and we don't really want to stop borrowing and spending. So here we are.
I've thought about great big WPA-style high-tech projects -- like providing high-speed Internet access to everybody, etc. But I'm dubious of both their feasibility and their usefulness.
But I'm dismayed by the paradox of huge domestic (and global) economic needs combined with massive amounts of unused productive capacity.
Regarding the public works projects suggestion, isn't that what Japan has been doing for ten years with very little impact?
And as far as high-tech broadband, isn't one of the reasons telecom is in the tank is that there's way more cable than needed (except for the "last mile")?
All I know is in Japan, you can buy a 300 Mb/s fiber-to-home connection for the same $50 a month you can spend in the US for a 1.5 Mb/s or less connection, but that's a topic for another thread.
What I want to know is how come labor always has to take it in the shorts when it comes to pain of structural adjustments? Why don't we punish capital for once instead? Something's fishy when we give and give in the way of unemployment, lost pensions, degraded health care, increased productivity, and lower wages only to be told the solution will have to be "painful" - maybe it's time for those enjoying the comfort of wealth to feel some insecurity for a change.
Josh -
You are right on point about Japan provided ultra-broadband services. I was frankly shocked by it and the low downtime.
About your other point, whenever you start mentioning "making the wealthy feel some insecurity", the economic conservatives start screaming "that's wealth redistribution" and you know what gets said next:
"I earned these millions; you can't force me to do anything."
"Maybe those folks need to work harder!"
"The middle class isn't taxed like we are."
"Hey, there's a free market out there... USE IT!"
Etc... Etc... Etc...
I've always thought that a little socialism is what will help fix our economy since it is so ME-driven.
What I want to know is how come labor always has to take it in the shorts when it comes to pain of structural adjustments?
Labor always takes it in the shorts, because labor has, since 1968, fallen repeatedly for Republican lies due to fear of change. Orange County, California, was the main bastion of Richard Nixon's Silent Majority. Until the last few years, about the time of the fall of Robert Dornan, Orange County was as reactionary as you can get, and the majority of these reactionaries were unionized aerospace workers. They were being paid some of the highest wages in the nation and were afraid of losing them. Because of this fear, and an inflated nationalistic patriotism, they were putty in the hands of the corporate CEOs who massaged them gently into supporting anti-labor politics. They were far too short-sighted to see that they were working against themselves. They paid the price heavily in the '80s when Reagan began moving their $20/hr jobs to $8/hr states.
Why don't we punish capital for once instead?
With the decline in the union political power since 1968, there has been no contervailing political force to oppose corporate power. As more and more union workers began voting against their own economic and political advantages, more and more the union power declined. The unions never effectively countered the charges that they were socialistic, even Communistic, at a time when, thanks to Vietnam, the flag was being waved so hard that it almost broke. Blind patriotism was utilized as a way to counter those traitorous anti-war protesters, and the unions were among the most vigorous flag wavers. Each time the unions were asked to support programs designed to improve the security of the nation (sound familiar?), the unions responded without noticing that these programs were going to affect their rights as well. Because of long-term union contracts, these effects couldn't be felt immediately, and the workers would be surprised when the effects were applied to them with the next contract. Eventually, unions had surrendered enough power that they could no longer counter the power of the employers, and the result since is that labor has always taken it in the shorts.
Something's fishy when we give and give in the way of unemployment, lost pensions, degraded health care, increased productivity, and lower wages only to be told the solution will have to be "painful" - maybe it's time for those enjoying the comfort of wealth to feel some insecurity for a change.
Be careful what you wish for, you just might get it.
This attitude has been the basis for every major European revolution in history. To quickly take this point to the most extreme, think France in 1789 and Russia in 1917. These were the "most successful" in terms of ousting the existing power stucture, but the entire society became so unstable that, after a few years, a strongman had emerged, rising to popular acclaim, to reestablish "law and order" - think here Napoleon and Stalin - and each time demanded more "sacrifice" from the population, which was designed to "enhance" the power of the state. To sum up, within one generation, each nation had ended up where it began, only with a newer and more efficient power structure.
In order not to destroy the fabric of the American society, any attempt to reverse the direction of the political trends, assuming no police state emerges to protect the advantages of the rich, is going to take at least as long as it took to get where we are. Too many workers still fall for the BS of the employers. Too many voters still support their oppressors without seeing that connection.
It may take something like the Great Depression (which was the last time America was in this condition) to awaken people - and we all have heard about how hard that was for most Americans.
Tangentially:
The high-speed internet issue is an isolated one, I think. It's the difference between a small country with a lot of people and a lot of money and a massive one. I live quite literally in the middle of nowhere, a place called Daesan in South Korea. I'm surrounded by rice paddies. Daesan doesn't have a movie theatre, a swimming pool, a supermarket, a pet shop, any american-style fast food restaurants, etc. Yet every single person living out here can get 100Mbps flat-rate internet access for W30000 per month - about US$25. Both the RoK and Japan have recently and aggressively replaced outdateed telecoms infrastructures with the up-to-date technology they supply to the rest of the world, but to do such a thing in a country the size of the USA, Canada, Australia would be much more of an undertaking.
The rest of these issues I won't comment on for lack of knowledge, but I read with interest and maybe one day I'll know almost enough to say a few words. I do, however, want to say that it's hard to put into words my gratitudde to Billmon for his ability to use literary analogy with such acuity and timeliness.
Cheers, or as we say here, Konbe!
L
The basic problem of the global economy is pretty baic: too many workers, not enough consumers.
Population 6 Billion, Workers 4 Billion +, Consumers 1 billion tops (~300 million in North America, ~350 million in Europe, ~100 million in Japan, ~250 million thru out the rest of the world)
In a free market and perfect competition, consumer prices eventually move towards equilibrium with wages. Cut wages 10%, and you'll see that prices must drop 10%, not immediately, but with time.
Linkmeister- since the conservatroids have no problem telling us that Bush's tax cuts have "kept things from being even worse" then I have no problem saying that the Japanese spending programs has "kept things from being even worse."
Louis Guerin: maybe I'm over romanticizing, but rice paddies and broadband and no strip malls, that sounds way cool.
As usual, a well thought and informative post, Billmon. The Nation just had a front page article about
this. Also see Robert Prechter's website, he has been warning about global deflation for many years. He is often right, but early in his predictions.
WARNING: STORY SPOILER FOLLOWS
Billmon, you missed the worst twist in the story. He actually does start a fire, and it looks like he's going to make it; but he has started it under a snow-covered tree, and the heat from the fire makes the accumulated snow slide off the branches right into the fire, extinguishing it utterly. That's when he knows he's going to die.
Ville,
That would be true if wages was the only input when calculating price. A 10% wage cut is more likely to result in a lower price cut. I'm no economist but I see a simple model showing this:
Your assumption: 10% wage cut. Eventually prices lower to match loss of income.
Let's breakdown a mythical retail item that everyone in our economy buys. Its inputs are 30% wages, 30% raw materials, 30% manufacturing costs and 10% profits.
A flat 10% cut in wages will result in 3% savings from wages. 1% savings from raw materials (cost of materials divided by wage component divided by wage cut), and 1% savings from manufacturing costs (same as raw materials).
So your doohickey has a natural savings of 5% not 10%. However, your consumers are all making 10% less so the cost of living has gone up. For your assumption to work the cost of living has to have gone up beyond the ability of the consumers to absorb (there can be no elastic demand).
For the system to stabilize at its previous level, profits might have to go down, but is a 10% cut in wages worth a 50% reduction in profits from the earlier stable scenario?
Or will the corporation accept lower sales? What effects will that have?
There is no one-to-one effect, the situation is not as simple as the naive free marketeers would believe.
There are no free markets with perfect competition. Those are helpful economic models that assist in understanding what the real economy does. It is no more helpful to think they are real than it is for a physicist to work from the assumption that atomic particles are actually real billiards balls.
Two points...
Billmon - if you ever need/want an agent to get your opinions into the newspapers, let me know. At the very least, you would be a bracing read for folks used to some pretty drab "investment advice".
Second - it's weird that we have such bifurcation between America's and the rest-of-the-world's economic status, but I dimly remember when stagflation hit the USA, and lots of smart people at the beginning said that what was happening - high inflation and high unemployment - was impossible back then. It just sounds like we have to start thinking more about "bizarre" economic scenarios, taking them to their logical conclusions, and figuring out how to counteract such possibilities.
I have to second that emotion on the broadband rice paddies. That sounds totally awesome.
and then, of course, the evil Billmo has to ruin our romantic rice paddy fantasy by reminding us that Mr. Guerin may be in the middle of the next war zone. good luck, sir.
I work as a searcher in a real estate title office. Trust me, this bubble ain't gonna burst for a while, at least in my neck of the woods (rural Florida). Ibuprofin in my friend.
in=is
in re the paradox of huge domestic (and global) economic needs combined with massive amounts of unused productive capacity, the answer would seem to be simple. one, take a page from the left: help the masses, not the wealthy. two, take a page from the GOP: let the individual spend his own money.
in other words, the answer to overcapacity is to let consumers spend more money, and capitalists invest less. the working poor don't overinvest in telecoms capacity, after all -- they spend their money on what they want and need.
as a politician, I'd start pushing for tax cuts for the poor and working class, plus a low, simple flat tax to make up the difference -- a flat *asset* tax. after all, everyone's assets are protected by an expensive legal, judicial, police and corrections system. they may as well pay for that service.
He actually does start a fire, and it looks like he's going to make it; but he has started it under a snow-covered tree, and the heat from the fire makes the accumulated snow slide off the branches right into the fire, extinguishing it utterly
So the Fed will succeed in igniting some economic growth, the massive deficit will cause an upward spike in interest rates, decimating the housing bubble and other sectors, extinguishing economic growth utterly?
Gotta keep the metaphor.
How about massive project on alternative energy technology instead of broad-band? It would certainly help in the whole world-peace/global warming side of things . . .
Down to the last match indeed. And what is all that howling I am hearing?
Billmon, you missed the worst twist in the story. He actually does start a fire, and it looks like he's going to make it; but he has started it under a snow-covered tree, and the heat from the fire makes the accumulated snow slide off the branches right into the fire, extinguishing it utterly. That's when he knows he's going to die.
Actually, that part happens first -- right after the prospector falls in the creek. I started to work it in, but I thought the lead was getting too long so I took it out. Maybe I shouldn't have: the analogy is still apt. The Fed did appear to be getting a nice fire going early last year, but then the Bush crew dumped a big fat load of war hysteria on top of it.
My favorite part of the story is that the dog knew where home was all along. He stayed with the prospector until he died and then trotted over the hill toward camp. I love that story.
It's too late, since the story's ending has been revealed, but here's an online copy.
Hey, I thought the same thing (ends with snow from tree) as moominpapa.
Seems more than coincidence, and since I'm hardly ever wrong about anything (/sarcasm) I thought about it a bit.
I read the story when I was really young, but later on I saw a short on probably PBS. Must have been PBS, it was before cable!! And, American that I am, the TV version is the one that stuck harder.
And I'm pretty sure the short ended with the snow falling off the tree and wiping out the final fire. That would be more dramatic in a visual medium than of the failure of the last tiny match.
If anybody cares.
Billmon, thank you for that explanation.
The chirpy analysts that keep saying that economy is ready for a rebound drive me nuts sometimes. I know in the high tech industry, it looks like a long hard slog. No one knows when their company is going to get trapped by into having to do more layoffs since businesses are just waiting to see if there is a reason to invest. And with the state economies being crushed, the numbers of unemployed are certainly increasing (even if the numbers are stable - since those who are just graduating aren't finding jobs and others are failing off the umemployment list).
From my perspective, it looks like the only growth industry is with the war machine. But as Eisenhower said, that industry sucks the life out of the rest of the economy. I don't see any reason to be optimistic. (Besides which, our country will be bankrupt when the babyboomers start to retire, but perhaps the Bushies have a plan for that as well.)
Argggh. MarketPlace just had one of those chirpy stockbrokers talking about how everybody, oops, make that almost everybody was going to be so happy because that tax cut was going to show up on their next check. And it would make them so happy they would go out and buy stuff and the economy would come roaring back in the second half of 2003. Isn't that just peachy.
This thread reminds me of a book I read recently called "The Divine Right of Capital" by Marjorie Kelley. THere's a section in which she "unpacks biases in financial statements" that favor capital and screw employees. It will explain why labor gets shafted - and how to re-frame the balance sheet to favor labor and question the divine right of capital.
She draws a detailed analogy between the divine right of capital and the divine right of kings. We tend to believe in the divine right of capital without question, when it's just an agreement. we could overturn it the way we overturned the English monarchy.
THere are many great ideas in this book about how to redesign the corporate economic system using the fundamental ideals of this country. What I like is how she shows you that it could be done within our constitution - she's not advocating overthrowing the government, just the idea of corporate primacy.
I have nothing to do with the author - a friend of mine at her publishing house sent me the book and I found it fascinating.
She draws a detailed analogy between the divine right of capital and the divine right of kings.
FDR called it "economic royalism"
Yeah, rice paddies and broadband is plenty tranquil, but it's not all peaches and cream. We're 25km away from the nearest folks who speak enough English for a conversation. Still, it's about as far from the ratrace as I've ever been, which is brilliant. It's enabling both my wife and I to continue a bit of postgrad, and improved my photography no end.
A final remark on the war/economy thing:
"War is good for the economy like cannibalism is nutritious."
-George Bernard Shaw
L
and then, of course, the evil Billmo has to ruin our romantic rice paddy fantasy by reminding us that Mr. Guerin may be in the middle of the next war zone. good luck, sir.
I live about 7km from a massive petrochemical plant, oil refinery, water treatment and chemical processing complex. Absolutely gargantuan. Like a small city of pipes and tanks and towers.
I'm told by some of the boys who work there (unofficially, of course) that it's considered to be very high on the list of potential targets for a long-range North Korean missile strike, and that the impact estimate of a direct conventional bombardment is that everything for about 10km on the landward side would be rendered uninhabitable within a couple hours due to explosions, chemical fallout, toxic smoke, flying debris, etc, and the damage to the waterways and the West Sea (aka the Yellow Sea), including a nearby marine reserve, would take decades to clear.
But that's nothing compared to a bombardment of similar complexes around the country, including a smaller plant at Ichon, 30km southeast of Seoul, which would potentially contaminate much of Seoul and Incheon, Suwon and Kwangju, and is only another 30-50km from the USFK command centres at Osan and Pyongtaek. Not to mention an assault on Seoul itself.
It all goes to show how South Koreans really don't believe that the DPRK would strike first: partly, they have to believe that, otherwise they'd drive themselves insane with worry. And it also gives you an indication of the potential for massive anti-US backlash that a preemptive strike on the DPRK could unleash, particularly if it results in reprisal attacks on South Korea.
L
A couple of weeks ago The Economist had a special section on the dangers of the property bubble bursting in the U.S. and abroad. This is a fear that has been lurking at the margins among many of the SF Bay Area's recent home buyers. From time to time a story about the possiblity of a housing bust appears in a local newspaper. Certainly the rental market has taken a big hit--when I go for my a.m. run I see lot of for rent signs and I know more than one tenant who has gotten a break from their landlord or who has moved to take advantage of better offers. My landlord did not raise my rent this year. Sales volume at the high end has apprently dropped markedly and "deals" can be had. Prices at the low end (everything is relative) are still holding. But there is a sense that things are holding by a thin, thin rope.