NEW YORK—Investors staged a global flight from risk Thursday that sent U.S. stocks plummeting and 10-year Treasury yields to 1940s levels, after a gloomy outlook by the Federal Reserve renewed fears of a global economic slowdown.

Investors staged a global flight from risk Thursday that sent stocks plummeting and 10-year Treasury yields to 1940s levels renewed fears of a global economic slowdown. Paul Vigna, Dave Callaway and Bob O’Brien discuss on The News Hub.

The Dow Jones Industrial Average closed down 391.01 points, or 3.5%, to 10733.83, as investors barreled out of stocks and into “safe” assets like the U.S. dollar, which surged. The blue-chip measure fell more than 500 points in afternoon action, averting its lowest close in a year with a late-session lift. The action built on the stock market’s Wednesday selloff, when the Fed acknowledged “significant” downside risks to the economy and noted “strains” in global financial markets, a reference to debt-strapped Europe.

A weak reading on manufacturing in China contributed to the slowdown fears. Adding to the grim mood was a lack of appreciable progress in containing Europe’s debt crisis, which has weighed on markets for months.

The Standard Poor’s 500-stock index shed 37.20 points, or 3.2%, to 1129.56, after touching its lowest intraday level since early August. The technology-oriented Nasdaq Composite slumped 82.52 points, or 3.2%, to 2455.67.

Markets Drop Around the World

Among NYSE-listed issues, decliners outnumbered gainers by just over 7 to 1, while the Nasdaq losers outpaced rising issues by about 6 to 1.

All blue-chip stocks finished in the red, as did all SP 500 sectors. Materials and energy stocks were hit hardest, falling as investors acted on their economic slowdown worries and in reaction to the fast rise of the U.S. dollar.

“They’re selling literally everything,” said Alan Valdes, director of floor trading at DME Securities at the New York Stock Exchange. “It’s the realization that things aren’t getting better that has traders concerned. They’re selling gold, they’re selling copper, they’re selling everything.”

European stocks closed sharply lower. The Stoxx Europe 600 shed 4.6% to hit the lowest level in more than two years in intraday trading. Asian bourses also dropped sharply, with China’s Shanghai Composite losing 2.8% on news that manufacturing activity in China contracted in September. Hong Kong’s Hang Seng index slid 4.9%.

“A lot of people who had very significant investment positions based on a scenario of dollar weakness changed those position pretty violently,” said Douglas Cliggott, chief U.S. equity strategist at Credit Suisse. “I think the bottom line of the Fed’s decision was, ‘No, we’re not going to be growing our balance sheet for the foreseeable future.’ It leaves the U.S. as the odd man out in this effort to, in effect, grow central bank balance sheets and weaken currencies.”

The first improvement in U.S. jobless claims data in three weeks did little to change the negative tone of trading. New claims for unemployment benefits last week dropped by 9,000 to a seasonally adjusted 423,000, according to the Labor Department. The level remains too high to suggest much improvement in the stubbornly weak U.S. jobs market. In addition, the previous week’s figure was revised to reflect more jobless claims.

Investors also shrugged off other modestly positive economic data Thursday morning. The Conference Board’s index of leading economic indicators increased for the fourth consecutive month in August and government data showed that U.S. home prices increased in July for the fourth straight month.

In the backdrop was a flareup in U.S. debt worries, the result of the surprise failure of a bill to fund the U.S. government through mid-November. Conservative Republicans and most Democrats teamed up for the largest defeat inflicted on the Republican House majority this year. The episode was a reminder of market gyrations this summer, when Washington was caught in an impasse of raising the limit on federal borrowing.

In corporate news, shares of Goodrich gained 10% after the aircraft-components maker agreed to be acquired by blue-chip conglomerate United Technologies for $16.4 billion in cash. United Technologies fell 8.8%.

FedEx slipped 8.2% after the package-delivery service reported fiscal first-quarter results that were higher than expected, but said it slightly reduced its earnings outlook as it looked to adjust its cost structure to match lower demand.

Red Hat gained 3%. The software company reported better-than-expected fiscal second-quarter results.

CarMax lost 11%. The used-car dealership chain’s results missed estimates for the first time in about two and a half years amid a decline in customer traffic and same-store sales, which it attributed to the recent economic slowdown and weakness in consumer confidence.

—Jonathan Cheng, Christian Berthelsen, Min Zeng, Javier David, Mark Stein, Matthew Day, Katy Burne, Andrew J. Johnson and Leslie Josephs contributed to this article.

Write to Brendan Conway at brendan.conway@dowjones.com

Article source: Wall Street Journal

 

Recent disappointing economic growth figures have brought a halt to what some had perceived as a budding economic recovery.  The narrative had been that a rapid expansion of government spending in 2009 had “stimulate” the economy into recovery.  Not surprisingly, the same people who supported government stimulus before are now clamoring for even more spending.  However, the burgeoning national debt, and lack of significant improvement in employment and economic growth has caused some to call the effectiveness of government stimulus into question.

According to the economic philosophy of John Maynard Keynes, economic recessions represent a failure of private markets to spend sufficiently for the economy to produce full employment.  In this view of the world, the “slack” spending should be picked up with government stimulus.  Thus, the view was born that the antidote to economic woes is to increase government spending.  The theory is that the increased government spending will flow through to both individuals and businesses who will spend it in turn, with the end result expected to be an increase in total spending that stimulates the economy out of recession, and into recovery.

However, there are a few key points that Keynesian theory fails to fully address, which cause problems when the extended impacts of government stimulus projects play out.  Primary among these is the fact that spending isn’t free.  In addition to this, is the principals that spending is different from productivity, employment is the means instead of the end, and that debt must be repaid.  The combined impact of these factors bring the fallacy of government stimulus into full view.

Spending Isn’t Free

The single fundamental premise of Keynesian stimulus is that government (deficit) spending stimulates economic activity.  However, what these tidy and neat models ignore is where the money they are spending will come from.  Put another way, the government cannot “create” anything.  It can only extract resources from one area and then spend them in another.

For many functions such as ensuring national security and enforcing laws, this resource extraction is absolutely necessary.  However, as the level of government spending increases, it requires that more and more capital be extracted from the private sector.  This capital can be extracted directly through taxes, indirectly through borrowing, or stealthily through inflation.  (Since the government has the ability to print money, it can finance its operations by simply de-valuing all of the currency already in circulation)

Thus, the only way that government spending can represent a net value gain is if the projects being pursued by the government are more valuable than the ones that would have been done in the private sector if that capital had not been extracted.  When we are talking about things like protecting the nation against foreign invaders or guaranteeing contract law for the purpose of smooth business transactions, this value chain is quite clear.  When tax credits are awarded to politically favored companies for politically favored projects, or people are subsidized to engage in activities that result in no net economic productivity, it quickly becomes apparent that the government is taking capital from a more productive purpose and moving it toward a less productive one.  It should not be particularly surprising that this process generates the prolific waste that many perceive as synonymous with government operations.

Spending is Different from Productivity

Another key pillar in the temple of Keynesian stimulus is the notion of spending being paramount.  The theory states that when people spend more, it will create more economic activity and more employment.  The problem with this view is that it takes the notion of production and output for granted.  More specifically, if many people are engaged in “make work” jobs that do not produce anything of significant market value, then their spending will simply result in more competition for the products and services that people actually do value.

The fundamental question in regards to economic activity is whether it is increasing the products and services that people value.  When activity is directed by market forces, it naturally gravitates toward value-positive activities since products or services that people do not value are not purchased and the firms producing them go out of business.  However, when there is no market mechanism present … as is the case with most government initiatives, then it means that the planners must ‘guess’ about what is most valuable.  To wit, these decisions are made based on political instead of rational motivations, and the net result is lots of spending, and very little net value.

When spending increases, but the total amount of products and services stays the same, the result is inflation.  It’s not hard to see how this comes about, since more spending will create more competition for the things that people actually value.  As more resources are dedicated to low-value spending, it will simultaneously result in less production of those valuable things and more competition for those things of value.

Employment is the Means, Not the End

Many times, the stated goal of government stimulus is to grow employment.  Because of this, many of the projects underwritten become “make work” jobs where there is no compelling desire by the market to pay for a project because of its superior value.  Instead, projects are driven based on what a political official thinks should be done.  Furthermore, focus on employment frequently involves working in a highly inefficient manner.

In market-based competitive situations, there is a strong incentive to utilize technology to decrease the amount of people that are necessary to perform a particular job.  Politicians see this as greedy businessmen placing profits ahead of people, but the public at large sees it as progress, when prices drop and quality increases.  The thing that most people miss is how labor markets are dynamic, and the constant advance of technology creates a constant churn of new employment opportunity.

Thus, the path to prosperity is not by employing s many people as possible.  Instead, it comes from optimizing people’s productivity.  Employment is an ingredient of production, but is not the goal in and of itself.  Failure to recognize this fundamental truth is the golden road to eternal waste.

Debt Must be Repaid

Keynesian economic models are built around the notion of deficit spending during recessionary times that is repaid when the economy expands.  Unfortunately, the “real” trend is that increases in government spending raise the baseline for future government spending.  This is how the massive government “stimulus” from 2009 created a permanent budget deficit in excess of $1 Trillion dollars per year.  Up until this point, the worst yearly budget deficit was in the neighborhood of $500 billion.  However, the baseline has now expanded to double that level of deficit for each and every year.  The “stimulus” has created a permanent structural budget deficit that the current leadership has absolutely no desire to address in any meaningful manner.

The unfortunate impact of these continual deficits is a burgeoning national debt.  And true to form, this debt must be repaid.  As the size of the debt grows beyond the ability of government to reasonably collect taxes to pay, it will become necessary to devalue the currency through inflation in order for the government to meet its financial commitments.  Thus, the fallacy of “stimulus” becomes painfully clear.  The so-called stimulus from government spending simply extracts productive resources, deploys them in a less productive manner, and then pushes the cost of that spending onto future generations.

In the end, economic growth is and always will be driven by fundamentals.  Those fundamentals are principally about figuring out how to create more with the same amount of resources.  All attempts to circumvent this simple economic law will only result in distorted economic incentives, and a destructive level of governement debt.

 

Recent news has been dominated by the debate surrounding raising the US debt limit.  The US Treasury has stated that August 2nd is the date after which the US government would not be able to meet all of its planned spending, due to a shortage of funds.  This situation is the dreaded “default” that many have referred to in the repeated interviews and press conferences that have been conducted on this topic.

The part that most in political office fail to disclose is that the interest on government debt makes up a very small portion of government spending, and would presumably be given first priority if immediate spending cuts were required.  Evidence of this can be found in the fact that financial markets have not been plunged into the free fall that would be expected in advance of a real default.  A contributory factor to this could be the fact that President Obama has privately assured banks that payments on government bonds will not be disrupted, even if the debt limit is not raised by the August 2nd Treasury dept. deadline.

Thus, since a “default” on government bonds is clearly off the table (even for the people who talk the most noise about default), it raises the natural question of what will happen if the debt limit is not raised?  The simple answer is that the US government will be forced into immediately running a balanced budget.  In the current political and economic climate, immediately reducing government spending to the tune 0f one to one and a half trillion dollars per year will be certain to make many people very unhappy.  The current situation has been brought about by an explosion in the government budget deficit that began in 2009 and has continued through 2010, and into 2011.

A simple look at government receipts and expenditures published by the Bureau of Economic Analysis tells the story quite succinctly.  In 2006, total government tax receipts from all sources amounted to approximately $4 Trillion dollars, while total government spending amounted to approximately $4.15 Trillion dollars.  The resulting budget deficit was a relatively small $152 billion dollars.  However, in 2010 total tax receipts from all sources are still approximately $4 Trillion dollars, but total government spending has grown to approximately $5.3 Trillion dollars.  In-between 2006 and 2010 was the expansion and collapse of the real estate bubble, the financial crisis of 2008, and the subsequent economic recession.  The recession spurred a massive binge of government spending that failed to discernibly improve either economic growth or employment, since the rates of recovery for both are far slower than in previous recessions & recoveries.

This gets us to the debt limit political debate.  During 2008, the Democrat party was swept to power by a wave of voter discontentment over the weakening economy.  By 2010, that discontentment had turned around and swept the Republican party to power in Congress, based on promises to limit government spending and bring the nations finances back into balance.  In the current fiscal and economic situation, three things are highly apparent.

1. The Democrat party favors continuing high levels of government spending, which favors their constituents.
2. The Republican party favors lowers taxes and constraining spending, which favors their constituents.
3. If the current trajectory of spending is not changed, it will precipitate an economic collapse when either taxes become so high that it crushes the economy or interest rates climb so high from spiraling debt that it crushes the economy.

Thus, the current gridlock of Republicans and Democrats over the debt limit can be easily understood by viewing it as a high-stakes negotiation between two parties with opposite interests.  There have been many proposals floated over the past few weeks, but the general direction of proposals from Democrats have been heavy on tax increases and very vague on spending cuts, frequently resorting to budget gimmicks or counting spending reductions that will happen anyway as cuts.  Conversely, Republicans have been pushing back against the notion of raising taxes on the basis of an argument that it is more important to cut spending first since it is not possible to raise enough taxes to close the current budget gap without crippling the economy.

In order for the United States to move toward long-term solvency, it is most certainly true that large amounts of spending will need to be cut in one manner or another.  It is also true that the tax code will most likely need to be revised so that many of the distortions from credits and deductions are removed to re-align economic incentives with long-term growth.  However, the structure and timing of these inevitable changes seem to be the critical point of the arguments.

Democrats have stalwartly resisted any substantial change to government spending, even though most know full well that the current spending trajectory is flatly unsustainable.  Republicans have pushed back against the notion of raising taxes in accordance with the views of their political supporters, even though many are quite aware that some change in the tax code is all but inevitable.

In the end, it is likely that some form of deal will be struck in the near future.  It may or may not be by the August 2nd “deadline” set by the Treasury, but there will be no disruption to the financial markets regardless of whether the “deadline” is met due to the priority that is placed on paying government debt obligations before any other spending.  In the end, this whole issue comes back to the fundamental situation that precipitated this debate and will fuel future debates.  This issue is the trajectory of government spending.  Until something is done to address this fundamental problem, it is most likely that we will see many more of these debates emerge over the coming years.

 

Jean-Baptiste Say

One of the ideas that have been advanced repeatedly during the recent economic crisis, recession, and prolonged stagnated recovery is the notion of “stimulus” as a way to revive the economy.  This strategy is based on Keynesian economic theory, and is predicated on the notion that when an economy drops into recession, the fundamental problem is a shortage of people consuming.  The solution offered by Keynesian economist is intervention by government entities through monetary expansion, and spending to fill the perceived gap in spending.  The fundamental underpinning of Keynesian theory is the notion that consumption creates production.

A alternative view to the Keynesian theory is the one advanced by Jean-Babtiste Say, contributing to the larger Classical economic theory.  A principal idea advanced by Say was known as Say’s Law or the idea that “Products are purchased with Products.”  This theory underscores the fact that wealth is defined by what is produced, and shuffling products from one person to another in an accelerated manner does not increase the total amount of wealth.  According to Say’s law, a general economic recession is not the result of insufficient consumption, but incorrect production … namely that production has been over-pursued in some areas (such as home building) and under-pursued in others.

Furthermore, attempting to “solve” problems by printing more money does absolutely nothing to increase or change the total amount of production or the total amount of wealth.  When more money chases the same amount of products and services, the result is high prices or inflation.  Recent increases in food and energy costs, in the wake of massive monetary expansion by the US Federal Reserve have caused many to re-visit Classical and Austrian economic theory.

The importance of Say’s law is frequently difficult for people to directly see, since most employees don’t work for products … they work for money.  Thus, people equate the money that they earn with wealth.  However, it is nothing of the sort … money is simply paper.  Wealth is what you can buy with the money.  Since most people work in the preparation, sale, or delivery of some product or service, it is ultimately true that the products and services we buy are purchased with the products and services we create.  Money is simply the medium through which this transaction takes place.

Another important aspect of Say’s law is the notion that products and services are not homogeneous.  What this means is that producing more of something people aren’t willing to pay for is not the path to wealth.  This situation is actually the cause of market sector crashes when excess production cannot be sold profitably.  Furthermore, if government bailouts are created to “save” the companies that gambled incorrectly, it results in a perpetuation of low-value production that impedes economic growth.

In a dynamic, market economy, downturns in a sector such as home building will result in price declines that eventually attract investment capital without the necessity of government incentives.  The people who built speculative houses in the expectation of big profits would go bankrupt.  The assets of those companies would be sold off at a discount.  The companies that acted prudently would be able to purchase those assets very inexpensively and launch new growth initiatives.  The problem confronted with bailouts is that they reward irresponsible behavior while punishing those who are responsible by denying them investment opportunities that would emerge if prices adjusted to their true value.

This is where the fundamental flaw of Keynesian theory comes to bear.  In the view of Kenesians, supply and demand are aggregated.  This view combines the production, consumption, and unemployment from healthy sectors with unhealthy ones.  Whenever a large correction occurs, this leads to the conclusion that the whole economy is unhealthy.  However, that is not necessarily true … even in the worst of recessions, there are frequently sectors of the economy that are perfectly healthy.  Attempting to address a so-called aggregate problem with aggregate solutions results in subsidies for foolish investments and penalties for responsible investors.

Furthermore, stimulus programs are necessarily administered by government agencies and financial institutions that extract a significant amount of overhead from the total amount that is spent.  This is where the problem of intermediaries emerges.  In a market system, intermediaries only exist in situations where they add value to the system … otherwise the buyers and sellers would ‘cut out the middleman’ to get greater volumes and lower prices.  However, in the world of legislative fiat, middlemen stand between the money and the products, taking a percentage of the transaction and doing absolutely nothing to enhance or optimize the quantity or quality of total output.

This ultimately devolves into what many have called “Crony Capitalism” where large corporations dominate the marketplace, not because of any particular skill in creating or selling products and services, but because their connections to lawmakers allow for advantages that other firms do not enjoy.  The financial institutions and automotive companies that avoided bankruptcy and maintained all of their leadership / business practices serve as primary examples of this principal.  If AIG had been allowed to go bankrupt, its assets would have been sold off at a discount and a new competitor would have emerged to fill the vacancy created by AIG’s departure.  This company would have every incentive to hire the AIG employees who were responsible, and would have no incentive to hire the people who cause the company to collapse.

In the end, products and services are truly paid for with other products and services.  Attempting to circumvent this simple economic reality has resulted in tremendous mis-allocations of capital, and enriched politically connected organizations, while preventing real economic growth from emerging.  Unfortunately, we do not have the capacity to stop this trend as individuals.  However, we do have the ability to adjust our own decisions so that the impact of these trends on our lives is minimized.

The most important thing that any person can do is to work and live in the “real” economy that produces real products and services for real people that they purchase by producing real products and services for other real people.  The runway for extracting resources through smoke-and-mirrors financial manipulation is drawing short.  The time is quickly approaching when governments can no longer afford to rely on smoke-and-mirrors to disguise fiscal problems and unfunded promises that cannot be kept.  When this reality finally emerges, it be very painful for many people who have become dependent on the fictional reality.  Make sure that your well being is built on a solid foundation.

 

Economic lunacy abounds, and often the most learned, including Nobel Laureates, are its primary victims. The most recent example of economic lunacy is found in a Huffington Post article titled “The Silver Lining of Japan’s Quake” written by Nathan Gardels, editor of New Perspectives Quarterly, who has also written articles for The Wall Street Journal, Los Angeles Times, New York Times and Washington Post.

Mr. Gardels says, “No one — least of all someone like myself who has experienced the existential terror of California’s regular tremors and knows the big one is coming here next — would minimize the grief, suffering and disruption caused by Japan’s massive earthquake and tsunami. But if one can look past the devastation, there is a silver lining. The need to rebuild a large swath of Japan will create huge opportunities for domestic economic growth, particularly in energy-efficient technologies, while also stimulating global demand and hastening the integration of East Asia. … By taking Japan’s mature economy down a notch, Mother Nature has accomplished what fiscal policy and the central bank could not.”

Gardels is not alone in seeing silver linings in disasters. Harvard University’s Professor Larry Summers, former Obama economic adviser and Treasury secretary, said the disaster “may lead to some temporary increments, ironically, to GDP as a process of rebuilding takes place. In the wake of the earlier Kobe earthquake, Japan actually gained some economic strength.”

It’s not just disasters in Japan. After Florida’s devastating 2004 hurricane, newspapers carried headlines such as “Storms create lucrative times.” and “Economic growth from hurricanes could outweigh costs.” Economist Steve Cochrane added, “It’s a perverse thing … there’s real pain, but from an economic point of view, it is a plus.”

Why might Japan’s and Florida’s devastation be seen as “pluses”? French economist Frederic Bastiat (1801-1850) explained it in his pamphlet “What is Seen and What is Not Seen,” saying, “There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen.”

Bastiat elaborated further in his “Broken Window Fallacy” parable where a vandal smashes a shopkeeper’s window.

A crowd forms, sympathizing with the shopkeeper. Soon, someone in the crowd suggests that instead of a tragedy, there might be a silver lining. Instead of the boy being a vandal, he was a public benefactor, creating economic benefits for everyone in town. Fixing the broken window creates employment for the glazier, who will then buy bread and benefit the baker, who will then buy shoes and benefit the cobbler and so forth.

Bastiat says that’s what’s seen. What is not seen is what the shopkeeper would have done with the money had his window not been smashed. He might have purchased a suit from the tailor. Therefore, an act that created a job for the glazier destroyed a job for the tailor. On top of that, had the property destruction not occurred, the shopkeeper would have had a suit and a window. Now he has just a window and as a result, he is poorer.

After the 2001 terrorist attack, economist and Nobel Laureate Paul Krugman wrote in his New York Times column “After the Horror,” “Ghastly as it may seem to say this, the terror attack — like the original day of infamy, which brought an end to the Great Depression — could do some economic good.” He explained that rebuilding the destruction would stimulate the economy through business investment and job creation.

Do a simple smell test on these examples of economic lunacy. Would the Japanese economy face even greater opportunities for economic growth had the earthquake and tsunami also struck Tokyo, Hiroshima, Yokohama and other major cities? Would the 9-11 terrorists have done us an even bigger economic favor had they destroyed buildings in other cities? The belief that society benefits from destruction is lunacy.

Walter E. Williams is a professor of economics at George Mason University. To find out more about Walter E. Williams and read features by other Creators Syndicate writers and cartoonists, visit the Creators Syndicate Web page at www.creators.com.

COPYRIGHT 2011 CREATORS.COM

Article source: Creators.com

 

Recent news that the rising cost of food and energy has brought the topic of inflation back into the forefront of public awareness.  Specifically, food prices jumped 3.9% in February, which was the highest since November of 1974.  In addition to this, housing starts are at the lowest level since April of 2009, and are the second lowest in the last 50 years.

All of this adds up to some very interesting economic dynamics.  The “core” component consumer price index has food and energy removed, meaning that government statistics are currently showing very low rates of inflation.  However, these reports are coming in the midst of rapid price increases for many items that are considered ‘necessities’ of living a normal life.

In the economic environment that is emerging, we are seeing two simultaneous opposite movements in prices.  One set of movements is coming in commodity products such as food and energy that are purchased with cash, and the other movements are coming in the realm of technology, luxury goods, and assets that are purchased with credit.  Put another way, the price of things that people “need” are going up, while the price of things people “want” are coming down.

Things We Need Getting More Expensive

The important thing to understand about price movements for things like food and energy is that they are commodity products people purchase with cash, and that are bought on a very frequent basis.  This means that when new money is created by the Federal Reserve, its impacts are felt first and most intensely by the items that are traded frequently and bought with cash.  This is the reason why inflation hits food and energy first and hardest.  As the government continues to use monetary expansion as a way of financing its operations, it will continue to place upward pressures on necessities such as food, energy, and other consumable commodities.

Things We Want Getting Less Expensive

In contrast to food and energy, we have technology products, luxury goods, and credit-based assets.  Technology products are driven by Moore’s Law, which describes how the transistor density of integrated circuits doubles every 18 months.  By extension, this means that the cost of compute power drops in half every 18 months.  This has enabled fantastic advances in technology at continually declining prices.  However, in a recent media event by the Federal Reserve, it was pointed out that the iPad 2 is twice as powerful as the original iPad, but at the same price.  In response to this, one of the people in attendance stated:  “I can’t eat an iPad”.

In addition to technology, we have luxury goods and credit-based assets.  The reason why these two items are becoming less expensive are very similar.  In the case of luxury goods, there has been a dramatic decrease in the number of highly affluent people.  This has resulted in an imbalance of luxury goods available relative to the number of people who are willing to pay for them, which is placing downward pressure on price.  In the case of credit-based assets such as houses, the stringent tightening of lending standards by government lending agencies has constrained the availability of credit.  This constrained ability of credit means that many potential buyers have dropped out of the marketplace, and prices have adjusted downward.  This trend has been accelerated by a proliferation of foreclosures that are suppressing prices even further, and triggering more defaults.

What Can I Do?

The current economic environment is one of correction.  For many years, lending standards were too loose and people simply borrowed to spend and assumed that they could continue re-financing their home indefinitely to absorb this additional spending.  Borrowing to consume is an unsustainable economic trajectory, and always results in a period of adjustment.  In this case, the problem was allowed to grow very large, so the adjustment is proving to be very painful.  (There are many who believe that the current trend of government borrowing to finance entitlement spending will precipitate an even larger adjustment in the future)

While we are going through this period of correction, it is important to understand the fundamental economic drivers so that we can make more informed decisions.  When it comes to food and energy, little can be done to address the base cost inflation, but individuals can realize considerable savings by ‘cutting out the middleman’ and buying un-processed or lightly processed food.  The reduced processing means less cost (in addition to less convenience).  Many people can trim their food budget considerably by substituting meals at a restaurant for cooking at home.  In the short-term, there is also little that we can do to directly address the cost of energy.  As costs continue to escalate, it is likely that car-pooling will increase and people will choose to run their appliances less.  None of these actions can directly stop rising energy costs, but when combined they can help to avoid excessive budgetary strain from rapid price shocks.

In the midst of cost increases, there are also many cost decreases that people can take advantage of.  With technology products becoming perpetually less expensive, it has never been easier to create a web-based small business.  In addition to this, the price reductions in many real estate markets have resulted in superior investment opportunities.  It is important to understand that every period of adjustment or correction creates opportunities.  The people who capitalize on those opportunities are the ones who will emerge from our current economic slump with brighter prospects for their personal, professional, and economic lives.

 

Why is it that Egyptians do well in the U.S. but not Egypt? We could make that same observation and pose that same question about Nigerians, Cambodians, Jamaicans and others of the underdeveloped world who migrate to the U.S. Until recently, we could make the same observation about Indians in India, and the Chinese citizens of the People’s Republic of China, but not Chinese citizens of Hong Kong and Taiwan.

Let’s look at Egypt. According to various reports, about 40 percent of Egypt’s 80 million people live on or below the $2 per-day poverty line set by the World Bank. Unemployment is estimated to be twice the official rate pegged at 10 percent.

Much of Egypt’s economic problems are directly related to government interference and control that have resulted in weak institutions vital to prosperity. Hernando De Soto, president of Peru’s Institute for Liberty and Democracy (www.ild.org.pe), laid out much of Egypt’s problem in his Wall Street Journal article (Feb. 3, 2011), “Egypt’s Economic Apartheid.” More than 90 percent of Egyptians hold their property without legal title.

De Soto says, “Without clear legal title to their assets and real estate, in short, these entrepreneurs own what I have called ‘dead capital’ — property that cannot be leveraged as collateral for loans, to obtain investment capital, or as security for long-term contractual deals. And so the majority of these Egyptian enterprises remain small and relatively poor.”

Egypt’s legal private sector employs 6.8 million people and the public sector 5.9 million. More than 9 million people work in the extralegal sector, making Egypt’s underground economy the nation’s biggest employer.

Why are so many Egyptians in the underground economy? De Soto, who’s done extensive study of hampered entrepreneurship, gives a typical example: “To open a small bakery, our investigators found, would take more than 500 days. To get legal title to a vacant piece of land would take more than 10 years of dealing with red tape. To do business in Egypt, an aspiring poor entrepreneur would have to deal with 56 government agencies and repetitive government inspections.”

Poverty in Egypt, or anywhere else, is not very difficult to explain.

There are three basic causes: People are poor because they cannot produce anything highly valued by others. They can produce things highly valued by others but are hampered or prevented from doing so. Or, they volunteer to be poor.

Some people use the excuse of colonialism to explain Third World poverty, but that’s nonsense. Some the world’s richest countries are former colonies: United States, Canada, Australia, New Zealand and Hong Kong. Some of the world’s poorest countries were never colonies, at least for not long, such as Ethiopia, Liberia, Tibet and Nepal. Pointing to the U.S., some say that it’s bountiful natural resources that explain wealth. Again nonsense. The two natural resources richest continents, Africa and South America, are home to the world’s most miserably poor. Hong Kong, Great Britain and Japan, poor in natural resources, are among the world’s richest nations.

We do not fully know what makes some societies more affluent than others; however, we can make some guesses based on correlations. Rank countries according to their economic systems. Conceptually, we could arrange them from those more capitalistic (having a large market sector and private property rights) to the more socialistic (with extensive state intervention, planning and weak private property rights). Then consult Amnesty International’s ranking of countries according to human rights abuses going from those with the greatest human rights protections to those with the least. Then get World Bank income statistics and rank countries from highest to lowest per capita income.

Having compiled those three lists, one would observe a very strong, though imperfect correlation: Those countries with greater economic liberty and private property rights tend also to have stronger protections of human rights. And as an important side benefit of that greater economic liberty and human rights protections, their people are wealthier. We need to persuade our fellow man around the globe that liberty is a necessary ingredient for prosperity.

Walter E. Williams is a professor of economics at George Mason University. To find out more about Walter E. Williams and read features by other Creators Syndicate writers and cartoonists, visit the Creators Syndicate Web page at www.creators.com.

COPYRIGHT 2011 CREATORS.COM

Article source: Creators.com

 

There is a persistent trend among people in the news media and political establishment to misunderstand wages, labor, and productivity when it comes to employment, trade, and economic output.  Unfortunately, this misunderstanding has driven many decades of public policy that impedes economic development.

On balance, there are three fundamental mistakes that are driven by this misunderstanding.  The first is assuming that ability and productivity are the same.  The second is assuming that hourly wages and labor per unit of output are the same.  The third is assuming that economic output is driven by employment and not productivity.  Understanding these three distinctions will provide critical insights into both the national and international economy.  It will also provide the key to making ourselves more valuable to our customers and employers.

Mistake #1: Assuming that ability and productivity are the same

At first glance, these two words appear to be describing the same thing.  However, there is a very important difference in the extended meaning that each conveys.  Ability describes the skills that we bring to the table when undertaking a given occupation or profession.  It is the piece of achievement that is unique to ourselves.  On the other end of the continuum, we have productivity.  The relationship between these two concepts is that ability plays a part in productivity, but it is not the only factor.  Our total productivity is a combination of our ability, the environment or system that we operate in, and the resources at our disposal to generate output.  Thus, it is possible that two people of equal ability who live and work in different areas can have vastly different levels of productivity.

Mistake #2: Assuming that hourly wages and labor per unit of output are the same

A common misconception about ‘labor’ is that it is equal to the hourly compensation paid to workers.  While this is certainly one way to measure the cost of labor, it is much more relevant to measure the cost of labor per unit of output.  The difference between these two measurements is that one simply looks at what workers are being paid while the other takes into account what and how much is being produced.  Because of this, a worker who is paid a high hourly rate and produces a high level of output may generate a lower labor cost per unit than a much lower paid worker who is not as productive.  Thus, the competitive danger to business is not from “low wage labor”, but from “high productivity labor” . . . some high productivity labor may come from countries with relatively low wage rates and relatively high levels of productivity, but most of the time high productivity comes from working smarter with better ideas and a better business model.

Mistake #3: Assuming that economic output is driven by employment and not productivity

One of the statements that is most commonly heard in political circles is that “America is losing its manufacturing base”.  The truth of this statement depends on whether you are measuring employment or output.  It is most certainly true that manufacturing employment is declining over time, but it is also true that output is rising over time.  The reason for this is that manufacturing employers are far more productive (on average) than they were 10, 20, 30, 40, and 50 years ago.  This means that much more output can be produced  per person employed.  The public at large benefits from higher quality and lower prices than otherwise would have been possible, and the overall economy benefits from the opportunities that emerge from an economy that is on a consistent path of improving productivity.  The implicit cost of these gains in productivity is that they will systematically render some jobs and business sectors uncompetitive or unnecessary.

This concept is extremely important as it relates to public policy, since many subsidies, bailouts, and other forms of government intervention are specifically aimed at preserving employment in a particular economic sector.  However, the funds that are given to those companies must be extracted from somebody else who is being economically productive without any government assistance at all.  The net result of repeated interventions and subsidies is that the government extracts resources from economic activities and individuals who are the most productive and gives it to those who are the least productive.  The recipients of these resources are always happy to have assistance in staying competitive, but the economy at large is made steadily less productive with each transfer that is made.  It is certainly true that in the political realm, there is a consistent trade-off that exists between the policies that are the most growth optimal and those that are optimal for generating favor with constituents.

In the end, there is very little that we can do as individuals to change public policy.  However, there is quite a bit we can do to change the trajectory of our own personal, professional, and financial life.  One thing that we can do is focus on how we can be more productive for the benefit of our employer and customers.  Instead of demanding more compensation for our “qualifications” we should seek to optimize what we produce with our skills and abilities.  By shifting the focus away from what we “do” to earn a living and more toward what “value” we produce, it opens the door for a marvelous journey of personal, professional, and financial growth.

 

The recent financial turmoil in the global economy has caused many people to adopt a dour perspective on the state of financial responsibility in the nation, and across the world.  Much of this cynicism is certainly well deserved, as there were many governments enforcing irresponsible regulations, banks making irresponsible loans, and people taking on an irresponsible amount of debt.

However, it is important to avoid overlooking the fact that there are many people who have remained very fiscally responsible throughout all of this financial silliness that has erupted recently.  The dynamics of the current credit markets are such that risk tolerance has almost completely disappeared, creating a ‘flight to quality’ that has drastically increased the demand for guaranteed treasury notes.  This increase in demand has significantly reduced the interest rate for mortgages that are tied to these treasury notes . . . but only for the people that qualify for loans under the current (more stringent) standards.

Thus, in a strange turn of events there is a ‘responsibility dividend’ that is available to people who have managed their finances prudently.  Since the market appetite for risk has evaporated, there are tremendous opportunities available for low-risk borrowers to make intelligent investments.  This is because the financial crisis has pushed most of the high-risk investors out of the market since they can no longer get capital from lenders that are very timid about taking risk in the current economic environment.

The result of the current situation is that investors who have remained responsible over the past few years will have a brief window of opportunity to make lucrative investments with very minimal competition.  This will result in many fortunes being made over the coming years, just as new fortunes are always created from economic recovery.  Each of us must ask ourselves whether we will be one of the people who create a new fortune.

 

The persistent economic recession that was triggered by the financial crisis of 2008 and has lingered through 2010 is showing every sign that it will drag into 2011.  This is not intended to be a foreboding of doom and gloom, but an honest assessment of the fundamental mis-alignment that the economy is still attempting to reconcile.  The reason for this slow, anemic recovery is a fundamental misunderstanding of the fundamentals that drive economic growth, bubbles, crashes and recovery.

The advent of business cycles is certainly not a new phenomenon.  Economic expansions and contractions have been commonplace throughout human history.  The thing that has made this economic downturn so painful is the fact that it followed successive decades of “fine tuning” the economy by government and quasi-government institutions that skewed incentives and systematically diverted economic resources away from their optimal use.  When this artificial stability (necessarily) collapsed, the result was a much more intense adjustment than most people had anticipated.

In order to understand this phenomenon more completely, we should begin by examining the six stages of boom, bust, and recovery.  These stages are built on top of a natural growth trajectory for free markets that systematically allocate resources to their optimal economic use.  The reason why booms and busts materialize in the first place is when public policy shifts the incentives for market players so that they reap greater rewards from pursuing actions that are not economically optimal.  (Even if they are politically favorable)  These six stages are the bubble (aka ‘boom’), the peak, the bust (frequently involving a ‘crisis’), the decline, the trough, and finally the recovery.  Each of these stages plays an important role and merits further examination.

The Bubble

Bubbles are a market phenomenon where the price of something (such as stocks or homes) rises much higher than is justified by its underlying fundamentals.  Stock Market bubbles are frequently driven by speculative buying of companies that have not yet produced a profit but are expected to grow rapidly in the near future.  Real Estate bubbles are typically driven by a change in financial policy that makes it easier for people to obtain financing, resulting in more buyers and higher prices.  In all cases, market bubbles rely on continued escalation in price for a particular type of labor or asset that eventually surpasses its fundamental value.

The Peak

When bubbles reach their zenith, they result in a market peak.  These peaks are impossible to predict in advance and only become apparent when viewed in hindsight.  The way that they typically emerge is when ‘casual’ investors hear about the spectacular profits being made by other people and finally decide to buy into the market.  Unfortunately, many of these casual investors buy-in just as the irrational value escalation reaches its apex.  All bubbles share a common characteristic in that the price increases will eventually reach a point where no new buyers can be found.  Thus, what the peak really represents is the stopping point where nobody else is willing to pay more than the last person did.

The Bust

When bubble markets eventually rise to a peak, there is typically some type of ‘trigger’ event that initiates a sell-off.  Sometimes it is a disappointing earnings report, sometimes it is news about political unrest that may disrupt food or energy prices, and sometimes it appears to be nothing at all.  However, in all bubbles, there eventually comes a time when new buyers willing to pay higher prices cannot be found and prices fall.  If a rapid succession of bad news accompanies this reduction in prices (as was the case in the fall of 2008) then the adjustment can turn into a crash.

The Decline

At this point in the market cycle, most of the players finally come to realize that the assets they were buying aren’t fundamentally worth the previous market prices.  When it becomes apparent that the hot new stock is not going to reach profitability as expected, or that the large speculative property will not have any buyers, it frequently results in a sell-off among investors who cannot afford to carry the asset indefinitely without selling.  During the bubble, there was a surplus of buyers relative to sellers and now there is a surplus of sellers relative to buyers.  The decline can be further intensified by the fact that many investors feel uncertain about buying-in since they do not yet know where values will eventually hit bottom.

The Trough

When values finally reach a low enough point that investors are willing to accept the risk of further losses in exchange for the opportunity to capture upside gains, a value bottom is frequent reached.  In some cases, the trough can last a very long time if investors are systemically unwilling to begin buying aggressively because of fears that future growth expectations will materialize.  Alternatively, if banks are holding a lot of foreclosed properties, they will naturally want to sell those properties as quickly as possible, provided that they do not drive down the market prices even further.  Ultimately, the length of the trough depends on how many mistaken investments need to be disposed of.  This process is extremely important, because it systematically shifts the ownership of capital toward people with the prudence to deploy it responsibly.

The Recovery

Once the over-priced capital has been sold at reduced prices and the new owners begin deploying that capital in a way that produces value, a recovery can ensue.  Fundamentally, economic growth emerges when the same amount of input can produce a greater output.  (This is also called productivity growth)  Put another way, the recovery unfolds when labor and capital eventually find their optimal use.  This is the only way that our economy will return to a path of real growth.

In the end, market cycles are critically important to long-term growth and prosperity.  They are a way of systematically steering resources to their optimal use.  This happens as the people who made foolish decisions go out of business and are replaced by people who purchase their assets at low prices and have a built-in incentive to operate more prudently. The important thing for each person to understand is that this process cannot be avoided.  Attempts to ‘fine tune’ a ‘soft landing’ for the economy will only drag out the inevitable adjustment.

Economic progress means that capital and labor must find its optimal use.  When the economy gets to a point where the present use of capital and labor is far away from it’s optimal use, that means a period of extreme adjustment is inevitable.  However, for the people who see this trend and capitalize on the opportunities inherent in times of change, there are historic opportunities for gain.  The only question remaining is whether you will take advantage of the opportunity or be thrown about by the change.  The forces are the same . . . the circumstances are the same . . . it is your decisions and actions that will make all the difference.