Economics 101 for the rest of us

Warren Buffet and Carl Icahn are famous investors but fewer people may know Ray Dalio.  Mr. Dalio founded an investment firm 40 years ago called Bridgewater Associates.  With $160 billion under management, Bridgewater runs one of the largest hedge funds in the world.

Bridgewater founder Ray Dalio, Bridgewater website

I recently discovered (among 3 million other people) a thirty minute YouTube video that Mr. Dalio produced to explain fundamentals of what he calls the economic machine. 

This video, which he narrates has been translated into several languages and viewed over 3,200,000 times.  The content begins slowly with basic concepts but progresses to explain the primary levers that policy-makers use to manage and stimulate the economy.  You can find it here.  

There are numerous lessons cleverly and clearly explained here.  Example: I hadn't appreciated why economists seem obsessed with Wage Growth until I watched this simple animated video.  The importance of wage growth has less to do with the oft-used and politically-charged phrase, "income inequality" and more to do with our collective ability to consume and deflate credit bubbles.

Also explained, is the concept of Credit, which Mr. Dalio asserts, "...is the most important part of the economy and probably the least understood". Other explanatory notes...

• "A beautiful deleveraging" of our massive debt and deficits is the catalyst for a soft landing we all pray for in order to avert "social disorder" and societal collapse.  
• Spending cuts are generally what people think of when they hear about "austerity" measures exercised by government, individuals and businesses to lower spending on goods and services.  
• Wealth redistribution occurs primarily through higher taxation on upper income Americans.  
• Money-printing refers to Federal Reserve purchases of government bonds and other financial assets ($2T since the Great Recession alone).

So what's the correct mix and emphasis of lever-pulling required for a soft landing?  Perhaps Mr. Dalio will address that question -- and what exactly is meant by a soft landing -- on this same platform at http://www.economicprinciples.org.

Holiday gifts for the American consumer

Have you read about the recent boost in U.S. consumer spending?  Of course you have and you know it is attributed -- at least in part -- to a steep drop in energy prices, particularly a drop in gasoline prices.   

Office.com clip art

This development is described by some in the financial press as a tax cut because the benefit accrues to the consumer in much the same way a tax cut does.  That is, by paying less at the pump, we automatically keep more of what we earn.  I wonder how Keynesians who routinely advocate for enormous government spending to stimulate demand are reacting.  Putting money directly in the hands of taxpayers can also spur consumption.  

When compromise and experts are dangerous

With a title like, "Are Economists Really That Smart" I had to read Bill Flax's piece in this month's issue of Forbes magazine, especially after digesting his first sentence, "Remember when Joe Biden admonished us to keep spending or else we'd go bankrupt?"  Mr. Biden's statement reminded me of something Nancy Pelosi uttered before enactment of the unpopular Obamacare legislation affecting 1/6th of our national economy.  Of course, Joe Biden and Nancy Pelosi are not trained economists, nor am I, but these people are running the country.  This clip is only two seconds...

My timing to read the aforementioned Forbes piece was good since I'd just finished fighting my way through Nassim Taleb's best selling book, The Black Swan.  (I say "fighting" because several technical aspects are beyond me).

In their own ways, Messrs. Flax and Taleb fillet and roast the cadre of economists, public policy-makers and financial journalists who worship at the Keynesian alter.  Living within one's means and free market principles are concepts ignored, even ridiculed, by economic intelligentsia as they advocate for trillions in "stimulus".  

Their voices clamor for more government spending.  The reason QE2 failed, according to these experts, is that the sum wasn't large enough and all the fresh liquidity wasn't given enough time to work.  On the other hand, economists like Nassim Taleb see the economic calamities we now face through a different lens.  But back to the Forbes, piece.  

Mr. Flax says of economics and its modern day application to fiscal policy, 

"The principal failing of macroeconomics is the intrusion it invites and the certainty it instills in politicians...no planner, no matter how wise, could possibly appreciate all the subjective nuances lurking behind these numbers.  Such schemes are doomed to folly."

There also exists today, a notion that Pols sparring over fiscal policy must "compromise" as if the key to solving our economic morass falls in the middle of some ideological bell curve. 

Icon by Creatype at freepik

Compromise might produce added legislation, but it won't cure a deficit spending addiction.  Consider Nassim Taleb's eighth principle for a Black-Swan-Robust Society,

"Do not give an addict drugs if he has withdrawal pains.  Using leverage to cure the problems of too much leverage is not homeopathy, it's denial.  We need rehab."

1900 advertisement treatment for morphine addiction - Wikipedia

The same metaphor I used in January of 2009 (and used elsewhere by others) of a drug addict who needs to take the pain, was also used by Dr. Taleb.  

The point is one cannot compromise with a drug addict, they only come back for more, which is why we must lower federal spending.  Tax increases and money printing are analogous to a government's morphine fix -- it feels good for a while, but it only makes the problem worse before the inexorable crash.  We must go cold turkey and take the pain incrementally.  

AEI scholars' research: taxes vs. spending cuts

OMB Chart

Excerpts published at Examiner.com

An editorial grabbed my attention recently.  Titled, "The Right Way to Balance the Budget" the piece was published on page A13 of the Wall Street Journal on December 29th. 

Three scholars from the American Enterprise Institute (AEI) collaborated on the aforementioned article.  They examined the likelihood of success coming from three choices we have to address our deficits and the national debt.

The choices of course are: tax increases, spending cuts, or a combination of both.

AEI website: Andrew Biggs

AEI website: Kevin Hassett

Two PhD economists, Andrew Biggs (London School of Economics) and Kevin Hassett (University of Pennsylvania) and economic research analyst Matt Jensen, argue their case by building on the prior work of two Harvard economists: Albert Alesina and Silvia Ardagna.

Messrs. Biggs, Hassett and Jensen conclude the primary way to fix our fiscal predicament is singular in nature -- cut government spending.  Period.  (Although they'd hasten to add that the type of spending cuts implemented does matter).  According to their thesis, the notion of raising taxes, or even using a combination of tax raises and spending cuts -- will not work. 

The case for cutting federal (and state) government spending has been simple -- increasing revenues for the government without statutory spending restraints, will only result in continued spending because historically, government reverts to its spendthrift ways when it is not legally shackled to do otherwise.

Remember, we had a balanced federal budget as recently as 1998 and ran surpluses for a few years but Congress and the Executive branch of government failed to continue a fiscally responsible path, so here we are in 2010 facing a 14 Trillion dollar monster.

No wonder many Americans believe that neither Congress, or any President can be trusted to remain fiscally responsible.  So, what about the experience of other industrialized, debt-laden countries?  Here's the verdict from the AEI authors who analyzed the history of debt consolidations attempted in 21 nations over the course of 37 years...

The authors assert, "...the typical unsuccessful consolidation relied on 53% tax increases and 47% spending cuts."  

Some observers predict that this is precisely the sort of compromise (i.e. arriving at a closely weighted mix of tax increases and spending cuts) which will be hatched by pols in Washington trying to tackle our own debt problem (or appear as though they are).

Biggs-Hassett-Jensen conclude that nations achieve fiscal balance only after applying austerity measures which include a minimum 85% reduction in spending cuts.  In other words, no more than 15% of the total solution, comes from tax increases.  They also hold that nations achieve these cuts primarily by responsible reduction of social transfer payments.

Surprised?  We have to significantly reduce spending now to avoid much more devastating pain later, because nations don't tax their way to solvency.

Midwestern watchdog reporting still works

Here are two current examples of how the Fourth Estate still serves the public interest.

1.  Locally, in my home town of Milwaukee, readers were shocked and angry to learn how their tax dollars are squandered (again) by a $350 million state child care program that is routinely plundered by a number of providers, including one -- who as a result of Journal Sentinel investigations -- turned herself in to state authorities.  Fine reporting indeed, by Ms. Raquel Rutledge and others at the Journal Sentinel. Read more about the scams they uncovered at www.jsonline.com/cashinginonkids

2.  Ninety miles south of me, another series by the Chicago Tribune exposes corrupt admission practices at the University of Illinois, as well as other cheats and cronyism throughout the Land of Lincoln. Here's the spot to read, "State of Corruption".

I'm not sure how we'd learn about these issues if old fashioned, gumshoe reporting didn't occur.

What sequence of events caused the mess?

Hedge fund executive Oscar Schafer in a Barron's interview (January 12, 2009, "Hang on Tight!") described our current economic condition thus: "The world is experiencing a giant margin call."

Yes, a giant margin call enabled by easy credit extended to millions of people who couldn't afford as much home as they purchased, or as much cashed out equity to finance a lifestyle they couldn't afford, before defaulting on their mortgages. 

These mortgages would be bundled into what equated to securitized time bombs gobbled up by over-leveraged financial institutions. 

How did it all happen?


Policy makers in Washington wanted to guarantee home ownership for anyone with a pulse. Then the Fed left open the spigot of cheap money by keeping rates too low for too long and America became intoxicated by illusory home price appreciation. Money center moguls and central bankers made enormous bets upon this whole sorry misuse of credit, until the system collapsed.  

Millions of people, who either ought to have remained renters until their income and assets could justify their mortgage, or who should have purchased more modest homes and received loans at fixed rates, were enabled by government-coddled institutions like Fannie and Freddie and populist legislation to "invest in our communities". 

The risks they took (policy makers, investment banks...and millions of  Americans), have poisoned the well that the rest of us must drink from -- perhaps for decades. Now we hear that the other shoe to drop will come from commercial credit busts, or the next highest risk level of mortgages above subprime.  

Grandma warned us when we were children.  If you can't afford it -- don't buy it. If you can't afford to lose it -- don't risk it. In short, live within your means.  Greed is the same thing that destroyed Rome. How will we get treatment and beat our addiction to debt before we all go down in flames?