Reservations for ... 8 billion??

Quite recently, in various versions of these endeavors, there was an essay dealing with the Old Gold vs. New Gold situation. Not for the first time.

The hidden truth: the country with the reserve currency of the global economy will always, in fact must, run trade deficits. Think about the situation from the point of view of other economies. They have to get reserve currency in order to acquire goods and services.

Imagine my surprise, and wistfulness at not having gotten paid, to see today's NYT piece on just that subject. And about the same conclusion. Well, sort of.

Bernstein paraphrases a Treasury economist (Kenneth Austin) who has published an essay in The Journal of Post Keynesian Economics, here (it's not open, alas). The notion of post Keynes usually means full bore Randian, but not in this case:

Post-Keynesian economists are united in maintaining that Keynes's theory is seriously misrepresented by the two other principal Keynesian schools: neo-Keynesian economics which was orthodox in the 1950s and 60s -- and by New Keynesian economics, which together with various strands of neoclassical economics has been dominant in mainstream macroeconomics since the 1980s.

In any case, neither Bernstein nor Austin (filtered by Bernstein) defend the notion of the reserve country having to be a net debtor, only that the level of its currency circulating can, more or less, be under its control. As events stand now, they both argue the USofA is at the world's economies' mercy.

The Unfortunate Alternative is hard specie, and one need only read up world, and USofA, economic history from the 19th century through the Great Depression to see how foolish that is. If you think the world is not level now, you ain't seen nuthin yet.

The Poor Will Always Be Us

The environs of Washington, DC are widely excoriated by The Right as being the bastion of Liberal Evil. Not least, the disparity of median income there being higher than most, if not all depending on the year measured, of the rest of the country. Having lived there for the better part of a decade, I can say with certainty that income level was and is driven by the private sector consultants and such, not the bureaucrats who have difficulty keeping up. Bureaucrats aren't living in the big houses in McLean. The academic scene is largely liberal, with the notable exception of George Mason University, in Virginia. That state is really two, with Northern Virginia (actually spelled as such) turning a once deep red state a pleasing shade of lavender. It ain't blue yet, however.

GMU provides the NYT with one of its token right wingnuts, in the person of Tyler Cowen, who regularly displays a breathtaking degree of cognitive dissonance. That the Times would continue to print his stuff is puzzling. I can only guess that the Editors are allowing the loonies to shoot themselves in the foot on full view. I mention this mostly because his essay today exceeds his usual level of incompetence and villainy.

Let's wield the sharp cutlery, shall we?

For all the talk of the Great Depression, we might look at a different exemplar for modern times, 18th- and 19th-century economic history India. That country's economic retrogression during that era may help us understand the quandary that some parts of the world face today.

The overarching theme of the piece is that 18th and 19th century India is prescriptive for today's US and Western economies generally. Baloney. The 18th and 19th century global economy was dominated by mercantilism, with India and the New World colonies being principle examples of those on the losing end of the bargain. This period was marked, more than any other way, by the discovery and pillaging of natural resources in this New World, mostly by European overseers. The second most important point was the development of science and engineering from primitive to near completion (save for Einstein and Bohr and the final entries in the periodic table). Most of the widgets that you use and prize today were invented by The Great Depression, they're just smaller and faster now. In other words: the scope of new knowledge and new resources from 1800 to 1900 overwhelms what can be expected from 2000 forward. The simple fact is, we know just about all there is to know about the physical world and where the useful parts reside. And there is no New World to pillage. (For those talking about mining other planets and such: not with chemical rockets, boyo.) And we're nearing, if not met, the carrying capacity of these, now firmly limited, resources. Wealthy Chinese are scuttling away from their air and water as fast as possible. The notion that there's some magical, as yet undiscovered, venue of employment to support a vast new middle class is a pipe dream (and that phrase refers to the Chinese opium pipe, just so you know). The journey goes from farm to factory to cubicle. Full stop. We've found the whole pie, now we need to carve it up in such a way that civilization survives.

In 1750, India accounted for one-quarter of the world's manufacturing output, but by 1900 that was down to 2 percent.
...
India just didn't do enough to move toward production on a larger scale or with better machines.

Well, let's consider this period. Slave based production of cotton and textiles by the US South dominated the period. Why ship cotton half way around the world, when your slaves can grow it here? Of course, not. Virginia (tobacco) and the Carolinas (rice and cotton) are much closer to London than anywhere in India, after all. At the time of the American Revolution, slavery production was the major source of hard currency, not manufacturing. India didn't stand a chance. Moreover, industrializing agriculture yields more poor people when there aren't alternatives. Take the modern example: robotics replacing hands in the manufacture of autos. You know the rest. The notion that India somehow missed its opportunity to be Europe's supplier of industrial output in 1850, or thereabouts, if only India had spent more on machines is asinine. The reason that Apple, and the rest, can exploit China is the 747 freighter. That aircraft didn't exist in 1850. Nor did the container ship.

Here's where the cognitive dissonance really kicks in:

International trade grew rapidly after World War II, but at least in the early postwar years most of that trade was among countries with roughly comparable technologies and real wages. And that trade spurred growth rather than damaging laggard economies.

In the last 20 years, the economic surge of Asia, especially China, has brought a large trade readjustment to the world, one with few parallels with the possible exception of the rise of the Western economies several centuries ago.

The post WWII economic surge was built on the afterglow of socialism, but not by that name, of course. The war effort was a case of "all for one, and one for all". The notion of shared responsibility, rather than Randian greed (she didn't start in earnest until the 1950s), was the order of the day. Corporations paid real taxes, unions bargained widely, and Bretton Woods made the US buck supreme. Cowen, either because he's too stupid or vile, elides the simple fact: American corporations now exploit totalitarian labor for the benefit of the few. It was brought to you by Richard Nixon in 1972.

But this is all good for China, right?

China's per capita income, less than $300 in 1984, is now in the range of $10,000.

Well, Cowen, being an econ professor, knows that even in the best of economies mean/average/per capita income overstates reality. I can't find a median income measure for China, but that's not too surprising:

Results of a wide-ranging survey of Chinese family wealth and living habits released this week by Peking University show a wide gap in income between the nation's top earners and those at the bottom, and a vast difference between earners in top-tier coastal cities and those in interior provinces.
...
In March 2012, Bo Xilai, a top party official who was trying to create a populist image for himself and was later purged, said at a news conference that the Gini coefficient had reached an alarming 0.46. His willingness to announce the number came as a surprise to many observers.

(The US gini, 2011, was .477. That's worse than China, just to be clear how the number works.)

China's .1% are doing just fine, thanks. The rest, not so much.

Average annual income for a family in 2012 was 13,000 renminbi, or about $2,100.

I wonder, how did per capita income quintuple in a year? It didn't of course. Cowen just made it up. Or the ghost of Ayn whispered it in his ear while he nodded off during a lecture at AEI.

Back to Cowen:

French citizens expect a great deal from their government, and strikes are a common response to reduced wages or benefits.
...
Chinese export growth and wage competition may have been a kind of final straw that made old ways unsustainable.

So, it would appear, Cowen's remedy is for Western labor to accept Eastern poverty as the new normal? How, exactly, is that progress or a solution?

Reading history, and data, makes the story quite clear. Economies which (ahem!) enforce equity, such as the Scandinavians, thrive overall, while those which embrace Rand fall into revolt. Cowen bemoans the prospect of stagnant/falling median income in the USofA, but at no point offers a remedy other than benign acceptance; it's God's will. He has to know that while median income has gotten poorer, the 1% have gotten richer. And he has to know that these effects derive in concert, not by coincidence. And he has to know that slack demand is the result. And that slack demand leads to lowering median income. Rinse. Repeat.

When the dominance of a service economy was being first recognized, in the 1970s, the notion was that such a move was at least as beneficial, overall, as the migration from farm to factory pre-WWII. Instead of factory workers, we'd all be office think workers, earning much more than our beaten down factory fathers. Hasn't worked out that way. We, still, mostly buy real widgets. You can't eat software.

We can't all be London Whales, crashing our small corner of the economy. And if we were, the whole economy crashes. Wait, didn't we do that?

So, you can be poor because totalitarian regimes elsewhere keep wages at bare subsistence and your job goes there or... you can be poor here as corporations implement wage arbitrage down to bare subsistence with the outsourcing as threat. Of course, in due course, there'll be no one in the USofA, or anywhere else, who can buy the all the widgets being made. What a country!! The United States of Mississippi. But, of course, you can't sell much in Mississippi; they're all really, really poor.

The fundamental problem is that wage or tax or foo arbitrage by corporations ultimately fails for structural reasons. As your Good Mother told you, "what would the world be like, if everybody behaved like you?" The second and third worlds, largely autocratic governments, provide cheap hands in order to earn hard currency (which they, mostly, keep for themselves, of course). Today, that's the US buck. The same thing goes on here, the red states ban unions and drive down wages, so corporations move to such states. The problem, of course, is that both kinds of arbitrage depend, absolutely, on a high wage population (those God hating blue staters, of course) to suck up output. What happens when there's no longer a pool of high wage earners to export to? The issue grows more dire as automation becomes both more widespread and expensive. You do remember the story about ditching 300mm wafer production for 450mm?? Hasn't happened. Likely, never will; insufficient demand for so many more chips to pay for the machinery. In due course, and since the world is non-linear (according to Dr. McElhone), demand utterly collapses when least expected.

Between Roxbury, CT and a Hard Place

Ah, to be a Googler (or spend enough time there to know about all of its nooks and crannies): Google Correlate powers a lengthy (the summer long?) analysis by David Leonhardt, et al of searches by the rich and the poor. Rich and poor, in this instance, being a bespoke index.

The main takeaway?

BARRY WAS RIGHT

And it's not surprising then they get bitter, they cling to guns or religion or antipathy to people who aren't like them or anti-immigrant sentiment or anti-trade sentiment as a way to explain their frustrations.

The Rednecks love them Guns and God.

Of course, the comments on the article just reinforce that; rather than being the "Land of the free and home of the brave", the USofA is really the "Land (rural) of the stupid and home (urban) of the smart". Doesn't go down all that well with the Tea Baggers (props to Maher, of course). But they're just puppets of Koch, in any case.

Peter, Peter Pumpkin Eater

I've never been a fan of the Austrian schools, just because they're by, for, and of the .1%. There's not much good for an entire economy in that. In looking for data to confirm, or refute, the notion that the Captains of Industry are just playing financial engineering games with all that moolah, I ran across this piece by Peter Schiff. He's a right wingnut, by a wide margin. You can look him up on the Wiki, if you're interested. What caught my eye was this:

In 2009, Gross Private Investment collapsed to almost 12% of GDP, which was the lowest level in the post WW2 period and compares with a median level of 19% in the three decades prior to the Great Recession. Since 2009, Gross Investment has rebounded and is now 16% of GDP. Many growth bulls expect this level to rise over the next few years, noting that the average age of U.S. capital stock (i.e. plant/equipment) is at record highs and needs to be upgraded. Recently, this view has gained traction with improvements in forward-looking surveys, like the Purchasing Managers Index (PMI). In the near-term, we do expect a modest bounce in capital investment to make up from weather related disruptions earlier in the year, but we are more skeptical about a multi-year boom.

First, we believe much of the recovery in private Investment was supported by bonus deprecation tax benefits (initiated during the recession) that enticed many corporations to accelerate investments in 2010-13. These incentives ended on Dec 31, 2013, so businesses have less reason for new investment. For companies to increase investment without government support, sales levels need to increase, which will remain difficult as household balance sheets and incomes remain under pressure. As a note, the current level of private investment (16% of GDP) is below median levels during the thirty years prior to the Great Recession (19% GDP), but it is consistent with the thirty year period following WW2 (17% GDP).

Second, companies have recently been more inclined to acquire rather than try to grow organically. In the first half of 2014, total U.S. M&A deals were over $750B, which was up 50% from the same period in 2013 and on pace to hit annual levels not seen since 2006-2007. Also, almost 95% of recent deals have been strategic (companies, not private equity, buying other companies) which compares with just 75% in 2006-07. If companies saw organic opportunities then this cash would be invested in new plant and equipment instead of paying premiums for existing firms. With easy access to relatively cheap capital, we expect the M&A spree to continue, noting that this will actually result in job losses (vs. capital spending that drives job gains).

Finally, companies that have not found attractive M&A opportunities have been using cash to raise dividends and buy back stock. In the first quarter of 2014, U.S. share buybacks and dividends hit a record level of $241 billion. Returning excess cash to shareholders is normal when growth prospects are dismal, but the recent trend has been exacerbated by activist investors that are pressuring companies to use leverage to return cash. As a result of this, combined with M&A activity discussed above, business (non-financial) leverage is at record levels. This bodes poorly for a surge in real investment.

Closely read, he makes the refuting argument to his basic thesis: the US consumes too much and invests too little. Even though he is credited with calling the The Great Recession, he, by all accounts, missed the motivation; even in the early 00s the Captains of Industry were running from physical investment to financial game playing. Cognitive dissonance rides again.

The hidden truth: the country with the reserve currency of the global economy will always, in fact must, run trade deficits. Think about the situation from the point of view of other economies. They have to get reserve currency in order to acquire goods and services. In order to do that, they have to sell lots o widgets to the reserve currency economy, which means that economy has to buy lots o widgets. As The Great Recession demonstrated, when the global economy gets wonky, even a weakened reserve currency is still the best bet. The alternative is to return to a specie regime, which, among other things, puts the global economy in the hands of the likes of South Africa. The global economy had the chance to switch to a commodity based currency, the petrodollar, in the aftermath of the 1973 OPEC embargo. That never happened for the good and simple reason that the First World economies recognized, even if their leaders would never be so honest as to say so, giving control to natural resource rich, but otherwise backward autocrats didn't serve them. Neither in the long run or short run.

You can't have organic growth when the 1% or .1% control most of the moolah. Especially in light of the fact that you can't eat software.

An Open Letter to Dr. Shiller [update]

In today's Times Business section, Robert Shiller gives his take on stocks, specifically the question: are they priced too high? He titles the piece (dead trees version), "The Mystery of Lofty Elevations". The web title is similar.

Note, of course the use of the word 'mystery'. Are stock prices really too high? As I've been arguing for some time, NO. Those with piles of moolah to 'invest' have traditionally been in bonds, clipping coupons each quarter. Living off the interest, in simple terms. As even Dr. Shiller has to know, short term interest rates (in particular, the Fed Funds rate) are not what determines long term (corporate) interest rates. The value of corporate bonds is determined by the return earnable from new plant and equipment in the hands of 'job creators'. To the extent that 'job creators' choose to not buy plant and equipment, at any rate of interest, then the long term return to moolah holders will go down.

There's also the matter of the supply of loanable funds, aka "The Giant Pool of Money". It's still around, and corporations continue to hold ever larger amounts of idle cash. They'd love, I'm sure, to be given 10% annually by Washington or Bejing, but that ain't gonna happen. Until such time as the 'job creators' decide that physical investment is more lucrative than fiduciary games, the supply of long term funds will outstrip the demand for such. It's that simple. So far, their notion of smart capital allocation is to stuff it into the mattress.

The Captains of Industry have simply run out of ideas. The digital economy is, on the whole, super-cheap to run. Even as we approach the next (and, perhaps, last) barrier to continuance of Moore's Law (for myself, it looks like physics has repealed the law), the cost per cycle continues to diminish. In any case, the web economy amounts to little more than giants and dwarves fighting over advert buyers and advert clickers. Arabs, and their blue eyed Texas brethren, learned the hard way that you can't eat oil. The web economy will eventually realize that advert peddling is just a lot of wheel spinning; much ado about little.

So I've been trying to come up with a theory to explain today's elevated stock prices -- and maybe convince myself that they could remain lofty for some time. One factor to consider is that bond prices are high, too.

It's as simple as I've said: bond prices are high (yields low) because the Captains of Industry aren't smart enough to figure out new ways to turn moolah into machines. Even with money available at historically low rates, and retained earnings at historical highs, the Captains just don't know what to do with it.

When there aren't enough good investing opportunities, people wishing to save more for the future may succeed only in bidding up existing assets even if they think they're overpriced. Call it the "life preserver on the Titanic" theory.

And, in other words, all those Koch Brothers types who bleat that Americans have to save and invest more ignore the plain fact that corporate America hasn't been able to allocate The Giant Pool of Money that's already sloshing around. Push more money into the Pool, and returns will fall still further. Econ 101.

We can expect yet more bleating from the .1% class that capital gains taxes are ruinous. Why? Since they can't get by on the low coupon returns, they must needs turn to stock price appreciation (as we've seen) and share selling for income. And, of course, since only Little People pay taxes, their incomes shouldn't be taxed. Just watch.

[update]
Seems some of the sell-side analysts (larger fish in the pundit pond than I, alas) take exception. This shouldn't be too surprising, since they make their obscene incomes flogging stocks. But they do have a salient point: they tout forward P/E, while Shiller's CAPE (where's Superman when you need him) is explicitly backward looking and for a long time at that. The notion that more data is better is generally a good thing, except when there's been an inflection in the data of your model, and worse if the inflection is in the recent past. The evidence is clear that the Captains of Industry are using fiduciary capital in more financial engineering exercises and less in buying plant and machines. No physical investment, no hard returns to capital, no interest earned, no demand for additional capital. The causation is that long term earnings determine short term rates. Central banks can hope to manipulate short term rates, and even set one or two, but they can't change the course of science and engineering (the real kind). Without tech progress, there's only foregone consumption to pay the vig. Looking at 21^st century economies through the lens of 19^th century experience (even to mid 20^th) is folly.

It isn't a fluke that The Giant Pool of Money (larger now than then) was dumped into non-productive real estate. The Captains of Industry had no use for it. They still don't.

A Visit in the Hadleyverse

Hadley Wickham is interviewed by Eduardo Arino de la Rubia in conjunction with the useR! meeting in Los Angeles. He warms the cockles of my heart starting at 15:50 of the interview, when they discuss the bipolar (my term, not theirs) nature of R. Yes, R is both an Excel on steroids (neither of them says Excel, but reading between the lines...) and a kinda, sorta language to write programs. Since most of us know Hadley via his packages (and he's using Rcpp more, lately), and this interview is about how he goes about making same, it's impossible to judge how he feels about R as a stat command language for stats, quants, data scientists, and the like. But it is clear that he gets the difference. It's also my inference that he envisions lots o London Whales making their mistakes in R rather than Excel. Whether that's a good thing is another matter. Sometimes brain surgery should only be done by trained neurosurgeons. If The Great Recession taught us nothing else, it's that quant is too often done cavalierly, by those with little to no understanding of what they're doing, yet with an outcomes' agenda. Bad dog.

Sovaldi Sings Iago

For those who aren't up on Shakespeare and Rossini, Iago is a bad guy. A really bad guy. Sovaldi, according to some (and a growing count, by most accounts), is the archetype of Big Pharma profiteering; taking money from the many to give to the few for little or no real value.

Sovaldi is Gilead's hep/C vaccine, more accurately anti-viral, which costs $1,000/pill or $84,000/treatment. It is claimed to offer higher cure rate, lower side effects, and shorter treatment period.

Unlike breast cancer or prostate cancer, hep/C, by and large, is a Bad Person's Disease; mostly IV drug users. A lifestyle choice. Mostly, not all. It happens that a large number of the infected are also incarcerated, which shouldn't be too surprising. Turns out prisons don't get mandated discounts. Remember those TV cop shows, where the perp turns out to be an ex-con who just can't seem to get it together on the outside, and heists a bodega in order to get back inside? Likely see more of that.

The drug's virtue, that it frequently cures a chronic and sometimes very costly disease, is not always relevant in the prison setting. Hepatitis C can take up to 30 years to turn from active infection to serious liver disease. Therefore, a costly investment in a cure for those prisoners close to their release date will offer no relief to a prison's long-term medical budget, even if it might improve the prisoner's lifetime health.

In other words, this is what happens when public health problems are shunted off to for-profit outfits. Gilead gets all the profit (they did drop more than $11 billion to buy the company which devised it, though). Taxpayers get all the costs. What would Adam Smith (the real one) say? I mean, where's the cost/benefit analysis of making life more comfortable for drug addicts? There are nearly as effective, far less costly, existing therapies. So, what is the marginal benefit? What is the marginal cost?

Here's another case where even the 1% will need Obamacare. If the insurance companies, and other right wing scolds ("$84,000 for drug addicts!!") get their way, then far fewer treatments will happen, and Gilead will, unless stopped by the Damn Gummint, raise the price further. By restricting the use of Sovaldi to those who get hep/C, but not through Bad Behavior, the unit price will have to go up in order to preserve Gilead's entitled profit. How much up? Well, according to this chart from CDC data between 5% and 15% of infections can be considered non-willful. Like that word? Very Biblical, that word. So, the innocents infected will have to pay (or some form of insurer) some multiple of $84,000 to keep Gilead in golden threads. Take away 90% of your customers, and, if you can get away with it, the remaining 10% get truly hosed.

Here's the kicker (which hasn't been stated, so far as I've seen): since 60% (more or less) of those infected are IV drug users, and Sovaldi isn't a vaccine which offers immunity to disease, but an anti-viral, we should expect that those 60% will rotate through with some frequency. Drug use: the gift that keeps on giving. Perhaps, at the end of treatment, patients get an 'S' tattoo, indicating that they've had their once-in-a-lifetime Sovaldi treatment. No second helpings.

This is the prototypical case where an army of forensic accountants could be unleashed to discover how much of Sovaldi's claimed development cost actually was spent on the ground, and how much went to SG&A. I'd love to see that number. Not going to happen.

Big Fish, Little Fish

The NYT DealB%k has an interesting piece from one of the regulars on the Big Fish eating the Little Fish in the cloistered world of the innterTubes. But Solomon leaves out the lede, as they say in the pubbiz: these Big Fish ain't really conglomerates.

The paradox is that conglomerates outside the tech sector are an endangered species. The 1960s was the age of the conglomerates. ITT, for example, made both weapons and movies, with the idea that smart managers could operate any business and different operations would diversify the business. But that strategy did not work out as planned. The problem was that managers needed to focus on their businesses. If investors wanted to diversify, they could do so by simply investing in the separate companies. And splitting off businesses would discipline managers not to waste extra cash.

What he misses, or simply doesn't want to say, is that Google, et al, of today aren't (structurally) anything like GTE, ITT or the rightfully infamous Gulf+Western of Charley Bluhdorn. Those were real conglomerates, with real divisions (ex-companies) in real, different, businesses. With the possible exception (too soon to tell) of Apple/Beats, the rest are all agglomerations of advert pushing platforms. Despite the appearance of differing users and "products" for those users, the real clients are the advert buyers. And they're (Google, et al) all attempting what the New York Yankees have done for generations: buy up any player who's any good to keep said player from ending up with another team. It takes very little to create an web-based advert platform; WhatsApp was, what, 6 guys? If you're Google, that makes your sphincter kinda tight. 93% of its revenue is from adverts, still (last 10-K). How much of its profit is assigned, I couldn't find, but I'll guess all of it. All of the side projects are just that: on the side.

In any case, these aren't conglomerates, just oligopolists aiming to be the monopolist.