Sunday, March 29, 2009

Kohelet 3:19

For there is a happening for the children of men, and there is a happening for the beasts-and they have one happening-like the death of this one is the death of that one, and all have one spirit, and the superiority of man over beast is nought, for all is vanity.

American's Comprehension Problem

I have to link to this post by Matt Yglesias: anyone who thinks that the US should be getting involved in conflicts around the world should read this.

"in a straightforward contest of power between the United States and Pakistan, we can of course win. But in a scenario where we are trying to manipulate the situation in Pakistan in such-and-such a way and Pakistani actors are trying to manipulate the situation for their own ends, the odds of us actually outwitting the Pakistanis are terrible. They’re in a much better position to manipulate us than we are them."

Friday, March 27, 2009

What if Everything Goes to Shit

This post is pure speculation, it is not a prediction of what I think will happen, but is my attempt to think through a worst case scenario.

If all of the attempts to revive the economy fail and we continue sinking into a deeper depression for the foreseeable future at some point politics will trump economics as the primary concern. The US is blessed with an extremely resilient political system; through civil wars, depressions, world wars and countless other trials our system has continued uninterrupted without so much as a delayed election. Most countries aren't so fortunate. A prolonged depression would have profound geopolitical consequences.

Let's start with Europe: I doubt the Euro would survive a depression. The worse the economy becomes the greater the pressure to devalue the currency will be in hard hit countries such as Spain. Populist pressure will force governments in countries such as Spain, Portugal, Greece, Italy and Ireland to drop the Euro. As the Euro zone retracts, Euro nationalism will emerge as an important force. Pressure to punish the defecting nations will create strong tensions between the remaining Euro countries and the rest of Europe.

In Eastern Europe, the door to further Integration will slam shut. Many countries will look to strengthen ties with Russia as further integration with a crumbling EU will seem less probable and less appealing. Old communist parties will emerge from the dustbin of history on a wave of populist support. In the Balkans tensions between Serbs, Croats and Albanians will return with a vengeance. Without the prospect of EU membership as an inducement to sound moderate policies, extreme nationalists will gain power.

In India, a severe downturn will destroy the moderate Congress led government of Monmohan Singh. My prediction is that the Hindu Nationalist BJP and the Communist party, the second and third largest parties in parliament, will join forces to promote an extremist agenda. Ethnic violence will escalate and tensions with Pakistan will emerge into a full scale war. Millions of members of the emerging middle class will find themselves thrust back into poverty.

The Middle East will get Ugly.

In Latin America, I predict a sharp Backlash against the moderate pro-growth goverments in Brazil, Colombia and Mexico. More countries will align themselves with Hugo Chavez in a defiantly anti-american and anti-capitalist pose. Mexico may feel the worst of it. The government is barely hanging on against the drug cartels today. In a severe depression, it is not hard to imagine the government outright failing.

So how will it all end? Much like the last depression, geopolitics will force the remaining democratic governments to enact the necessary fiscal stimulus. In other words war. If the various drug cartels succeed in toppling the Mexican Government we would be forced to act. America cannot tolerate an anarchistic failed state directly to our South. A full scale land invasion of Mexico combined with increased military spending around the world may be enough to reignite aggregate demand.

If the economy continues to contract at its stunning pace, one way or another fiscal stimulus will have to pull us out. Will it be in the form of productive investment in infrastructure health and education, or will it be in the form of devastating wars in Mexico, the Balkans, the Middle East and South Asia.

Reintroducing the Enron Rule

I am bringing back an old thought that first occurred to me in 2001 after the collapse of Enron. Businesses exist to create real value for real people. Any business should be able to explain how the are adding value and for whom. Ideally, this should be a simple process; a sentence or at most a paragraph. If a company can't explain this that should raise a red flag.

Of course, some companies provide genuinely obscure products or services. These companies profits should reflect the esoteric nature of their business. The largest most successful businesses from McDonalds to Microsoft should be those companies that are serving vast swathes of the population. If a business claims that its operations are so complex that mere mortals couldn't possibly comprehend them, that should raise about 10 million red flags.

Monday, March 16, 2009

Why are T-Bills so popular

One of the puzzling aspects of the current economy is the soaring demand for US treasury bonds. On the face of it, T-Bills seem like a pretty terrible investment. The yields are low and given the massive government and current account deficits being run by the United States, it is highly likely that the dollar will lose value relative to other currencies.

But these loans aren't investments, they are insurance. With the global economy in free fall nobody knows how bad things could get. There is a non-zero probability that we could be witnessing a true economic collapse. The sort of era defining event that will signal the end of the 500 year march of human progress and plunge us into a new dark ages. How will we know when it's time to bust out the old amour suit. A good guess will be when treasuries fail. In other words if the US government defaults, we are all fucked. The only assets that will be worth anything will be shotguns and canned beans.

Lets say things don't get that bad, there is still a long way to fall. If the economy continues contracting at its current rate, by the end of 2010 things will be as bad as the 1930's. An economic collapse of that magnitude will have profound political consequences. Which brings us back to the original topic of the post.

In a climate of extreme uncertainty, the long history of stability is a unique asset of the American economy. The Euro is the most obvious rival currency to the dollar, but with less than a decade of experience the Euro has never survived a severe crises. If this recession hits the depths of the 1930,s politicians in hard hit countries like Spain and Ireland will be under intense pressure to break free of the Euro. During the great depression, countries that abandoned the gold standard benefited immensely from their devalued currencies.

Developing, countries don't offer better security prospects. It is hard to think of a developing country whose economic and political stability wouldn't be threatened by a severe depression. The communist party is the third largest party in India's parliament and the nationalist BJP is the second largest. It is easy to imagine a severe downturn tipping the balance of power towards these parties at the expense of international investors.

Latin America has a long history of socialist governments taking power and appropriating private property. It is not hard to imagine these elements gaining strength in countries such as Brazil, Mexico and Argentina. Africa and the Middle East are considered risky places to invest for too many reasons to list here. It is uncertain if the Chinese government can maintain stability through a severe downturn.

That leaves the US and the other wealthy English speaking countries as the most likely economies to survive a severe downturn. The catastrophe in Iceland demonstrates the danger of lending too much to a small economy. Given the quantity of money looking for a harbor it is possible to imagine international capital overwhelming a country such as Canada or Australia. Simply put it is possible to imagine the US economy surviving a complete meltdown in Canada, but there is no way Canada survives a collapse in America.

So what does this all mean for the future. As long as complete systemic collapse remains a real possibility, investors will be rushing to loan money to the US government. But as investors gain confidence that recovery is in sight demand for American debt will dry up. One sign that a recovery is on the horizon will be a decline in the dollar relative to other currencies. As the economy rises from the grave the dollar will steadily weaken.

This should be encouraged. One of the driving forces behind global instability has been the huge amounts of foreign capital entering the US economy and the countervailing large trade deficit that Americans have run. If we emerge from this crises with a more balanced global economy that would be a good thing.

Sunday, March 15, 2009

The Michigan Exodus

I grew up in Michigan, and like thousands of other young people from Michigan I now live in Chicago. Everywhere you go in this city you meet Michigan refugees, people who have realized that their future is not in Michigan. I look forward to the formation of an ethnic enclave, like Chinatown, complete with a Coney Island, Big Boys and Vernors available in every restaurant.

For at least half a decade, Michigan has had the worst economy of any state, so its not surprising that thousands of people are choosing to settle elsewhere. I know from my own experience that the bulk of my friends from high school now live elsewhere. However, we'll probably have to wait until the next census results come out to know the full extent of the damage. It's a given that Michigan will lose at least one seat in the house, but could the state be poised to lose two or even three representatives. I wouldn't be surprised.

Obviously, the decline of the US auto industry was going to hit Michigan hard, but the failed urban policies that Detroit embraced in the 60s are as much responsible for the predicament Michigan currently faces. No city embraced the pernicious movement towards suburbanization as wholeheartedly as Detroit. The Detroit Metro is one of the most segregated in America. The city of Detroit is nearly 90% black, while nearly all white people live in more affluent suburbs. The tension between black city and white suburbs has led to a complete failure of regional planning. The state of public transportation in the metro area is pitiful for a region of nearly 5 million people.

Richard Florida's excellent piece in the Atlantic demonstrates the importance of vibrant urban areas to promoting innovation and economic growth. Unfortunately, Detroit offers little to the creative class. No educated young person would choose to settle in Detroit when midwestern cities like Chicago, Milwaukee and Minneapolis have so much more to offer. Let alone the opportunities available in coastal cities like New York, DC or Seattle.

Anyways, these are my thoughts on the sad state of Michigan. I would love to hear from other ex Michiganders.

Thursday, March 12, 2009

My take on banking regulation

I wrote these articles last fall, there not particularly original, but they sum up what I think is the basic problem with the financial sector.

Whats wrong with finance

How to fix it

The crack of dawn

Obviously, the economy sucks, but I get the feeling that we are seeing the very early signs that things are getting better. After three months of nothing, but awful news there appears to be several reports showing some good news. While the economy is still contracting, perhaps we are no longer in free fall.

Tuesday, March 10, 2009

Are you sure?

The following question was asked in a Newsweek poll
How much longer do you think the current economic recession is likely to last? Would you say?

12 Less than 12 months
54 One to two years
23 Three to five years, OR
8 More than five years?
3 (DO NOT READ) Don’t know

It always surprises me how few people are willing to admit that they don't know the answer to a question.

Is America's power shrinking? Who Cares?

Robert Kaplan's article in the Atlantic concludes with this dire warning;

"Defense policy will be increasingly geared toward protecting the homeland, even as globalization makes for a smaller, more intricately connected world. America, in the final analysis, will be better protected, even as its global reach wanes."

I am supposed to worry because... Maybe, I'm just a left wing nut case, but isn't the protecting the homeland the primary reason that most Americans are willing to spend hundreds of billions of dollars on the military. I didn't realize the goal of US defense policy was to ensure that American diplomats get to sit at the cool table at international summits.

I have yet to hear a compelling argument why I should care about America's global dominance. Even if China were to develop a military that could threaten ours, would it really be so bad. I don't think anyone in either country is eager to start a war. Same with India, the EU or any other country that could theoretically challenge America's military. (Not that anyone is even close to challenging us in this area.)