What Santa brought the Mad Max kids

Ho Ho Ho MERRY CHRISTMAS!

So what does Santa bring the kids of a guy who cares only about maximizing benefits and minimizing costs? No, not a lump of coal (although the kids aren't so sure). Here it is and it is excellent.  In fact, my personal finance students will be reading it next semester. In this tiny paperback, Jesse Mecham does an outstanding job of presenting the case for a budget – no matter how little or how much you have. And his personal story will ring familiar for many who take the time (very little time, actually) to read this little gem.  

http://www.amazon.com/You-Need-Budget-Jesse-Mecham/dp/146353437X/ref=sr_1_2?ie=UTF8&qid=1387663291&sr=8-2&keywords=ynab 

If you like your job, you can keep your job. Period! 

Okay, maybe that was a cheap shot at a president who is an easy target these days. He didn’t quite say that everybody could keep their jobs if the minimum wage was increased, but he was in error when he stated that there is no strong evidence that minimum wages cause unemployment among unskilled workers.  

The controversy over adverse effects of minimum wages center on two things:  1) Where the minimum wage is relative to the market clearing wage, and 2) Whether we are talking short-term or long-term effects.  

I always enjoyed asking my students why McDonalds would recruit new employees at $7.00 per hour when the minimum wage was only $5.15. This would usually stop them in their tracks. Was McDonalds just being nice? Well, there may be a lot of nice people at McDonalds but they weren’t paying 36% more than the legal minimum to be altruistic. McDonalds was paying more because they have to compete for workers with Wendy’s, Burger King, Pizza Hut, and a zillion other establishments and the competition had bid up the market wage well past the $5.15 minimum.   

So, if burger flippers (as a former burger flipper, I use this term with great affection) were already making more than the minimum, why bother raising it if you are only going to increase it to what burger flippers are making (or will soon be making) anyway? This is where economics gives way to politics. Raising the minimum wage in this instance was merely a symbolic gesture from politicians wanting to take credit for increasing wages with no (or little) downside risk. Again, if all you are doing is raising the minimum wage to the market wage, what’s the point? If they had any guts -- and if politicians really believed that simply raising the minimum wage would help unskilled workers increase their standards of living – wouldn’t they raise it to $20 or $100? I suspect that even the most economically illiterate politician knows that a minimum wage that much higher than the market clearing level is going to cause problems. 

In Europe, politicians have not been so timid, however. But if you learn anything in economics it is that because we live in a world of scarce resources, there are always tradeoffs and opportunity costs. The tradeoff here is higher unemployment, and in places like France, Spain, and Belgium, unemployment is typically much higher than it is in the U.S. and high minimum wages are cited as a contributing factor. 

As for long-term versus short-term effects, the market for unskilled labor tends to be relatively supply and demand inelastic in the short-term. This means that if even if the minimum wage is placed above the market rate, there won’t be much of an impact on employment. However, over time, elasticity increases as employers figure ways to respond to the higher labor costs which causes the quantity of labor demanded to decrease. Also, over time, some who were otherwise engaged at the lower wages (students, homemakers) will alter their schedules and enter the job market at the higher wages. This will increase the quantity of labor supplied.  

Lower quantity demanded + higher quantity supplied = greater unemployment.  

Bottom line, we would expect studies where minimum wage increases remained at or below equilibrium, or only measure short-term effects, to conclude that minimum wage has no significant impact on employment. Similarly, we would expect studies where minimum wage is increased above the equilibrium and cover longer periods to conclude that there are adverse effects. Of course, a good politician will only recognize the studies that support his or her ideology, hence President Obama’s statement that there is no evidence that the minimum wage causes unemployment (See  MIT Press https://mitpress.mit.edu/books/minimum-wages and NBER http://www.nber.org/papers/w18681.pdf  for evidence to the contrary) 

So would the proposed $10.10 minimum diminish employment opportunities for unskilled workers? Maybe not in the short-term but if it proves to be substantially higher than equilibrium (and it appears to me that this is the case), we can expect problems down the road.    

If it were as simple as passing a law, how about raising the minimum wage to $1,000 per hour and we will all be driving Rolls Royces and living in beach front mansions J 

For more about the minimum wage see: http://www.thebigquestions.com/2013/02/18/thoughts-on-the-minimum-wage/

For current minimum wage demographics, see the video below: 

 

 

Government and Efficiency

The old joke goes something like this:

What are the three most outrageous statements?

1) The check is in the mail,
2) I’ll respect you in the morning,
3) I’m from the government. I’m here to help. 

The inefficiency and waste of government has been talked about and joked about for ages but exactly what do we mean when we talk about government inefficiency? There is no better example than the Obama administration’s attempt to develop a health insurance website. The cost: $400,000,000. Yes, that’s 400 million dollars for a website that barely functions and has serious security problems. Why so much? Because the government is not subject to competition. It does not have to worry about going out of business if they produce an inferior product. And since they do not have to deal with competitive pressures, governments tend to be lax about productivity and cost controls.  

On the other hand, here is a private health insurance website that works just fine:  

www.ehealthinsurance.com  

Speaking of ehealthinsurance, they are cited in the following Wall Street Journal article that explains why insurance policies sold by the Affordable Care Act’s exchanges are more expensive and offer fewer choices:     

http://online.wsj.com/news/articles/SB10001424052702303460004579192081764514664#printMode

MM

Addendum: Bloomberg Government now estimates the cost of the ACA to be $1,000,000,000 (that's one BILLION dollars!!!)

The True Impact of the Affordable Care Act

The sticker shock of the Affordable Care Act is shaking the nation (along with the revelation that President Obama deceived the American people to get it passed -- and him reelected) but the biggest cost of the ACA is actually decades away. In the short-term, little change will be noticed. It is over the long-haul that we will see the true impact -- and it will be huge. Economist Brian Wesbury explains below: 

The economics of insurance and why the new health care law will break the bank

The economic function of insurance is to transfer risk that we cannot afford to retain. It is a very simple concept. Young parents, for example, may be totally confident that “as long as I am around” their kids will have all the opportunities life has to offer. The whole thing falls apart, however, if a parent dies before an estate can be built. To avoid such a devastating outcome, prudence dictates that this risk be transferred to a life insurance company. With life insurance, an estate would be provided in the event of a parent’s premature death. When the kids grow up and an estate is built, life insurance is typically no longer needed.

Again, there is nothing complicated about insurance. Since the concept of transferring the risk of a catastrophic event is so intuitive, it is puzzling how the purpose of insurance has become so misunderstood by so many. The insurance industry can take much of the credit for this confusion. They have done a masterful job of convincing us that we should transfer virtually all of life’s risks to them. The most outrageous example is their marketing of life insurance on kids. First, let me state that if I lost any of my kids, I doubt I would ever fully recover. My life would be dimmed forever -- but I would never have life insurance on them!

Why? Because kids are not financial assets. Quite to the contrary, my kids are three of the biggest cash suckeruppers this world ever saw. I would be much better off financially if I didn’t have them. Why would anyone insure a liability? Clearly, the premiums would be better used if they were invested in a fund on which the family could draw to pay final expenses (if that were to ever be necessary). If the balance of the fund turned out to be inadequate, the remainder could be borrowed and the money saved (and this sounds so cold) from not having the kid around anymore would quickly pay off any loans that may be needed. Flying in the face of sound economic reasoning, insurance companies have still managed to convince many parents that having life insurance on their kids is not only necessary, but a measure of their love for them.

We have also lost sight of the purpose and function of health insurance -- and in a big way. The economics is no different from other types of insurance. Yet, much like life insurance for kids, things have gone haywire.

There are many events that are fairly predictable and can easily be budgeted for. With great certainty we can assume that we will, on occasion, have to see a doctor for head colds, sore throat, minor injuries, etc. We may from time to time need to buy some medicine to speed our cure and make ourselves more comfortable. But, does the risk that we may catch cold really need to be transferred to an insurance company? Insurance companies are highly skilled at estimating probability and risk and they will not sell policies that cover these events unless the premiums are high enough to provide them a profit. Comprehensive policies cover these high frequency/low severity losses, and as a result, premiums must be higher to cover the additional administrative expenses. Insurance companies love to sell policies that cover such predictable events and agents are paid higher commissions for selling them.

However, it is more cost effective for the insured to retain the risk for these high frequency/low severity losses through the use of higher deductibles. This way, the cost of covering the administrative expenses can be reduced since the insurance is now focused on low frequency/high severity losses which also require less frequent administrative red tape. However, insurance companies (and now politicians) have been masters at convincing us that these high frequency/low severity situations are too risky for us to bear. Thus we see comprehensive policies sold where high deductible policies would be more efficient. (I do wonder when we will see haircut insurance. Wouldn’t it be nice to just give the beautician our insurance card whenever we get a trim? How about rain insurance? If we find ourselves stranded away from our car without an umbrella, all we would have to do is call a hotline and an umbrella would be delivered to us. We could forever eliminate the risk of getting wet!)

For those who are highly risk averse or have trouble managing their finances, perhaps big expensive coverage is a good idea. For those of us who are already expending a great deal of resources in health maintenance, the last thing we want to do is to pay to transfer risks that we have already worked hard to minimize. There are many, like myself and my family, who take health seriously enough to do everything possible to take care of themselves through proper eating, exercise, and by avoiding harmful substances like alcohol, tobacco, and illicit drugs. These prevention measures, however, are not without cost. Health club fees, food supplements, fitness equipment and maintenance (bicycles, running shoes, etc.) really add up. Good physical fitness is a major investment in time and money. With a comprehensive policy, we are effectively paying twice: once to transfer the full risk to the insurance company, and then again to minimize that very same risk we just paid to transfer.

It is therefore unfortunate that under the Affordable Care Act (aka Obama Care) many high deductible policies will not be allowed. Yes, our politicians in their infinite wisdom are ignoring economic reality and forcing us to purchase more insurance than we need. This is like a hungry man being forced to buy a whole herd of cattle just to get a Big Mac. He really needs the food but having to buy the whole Ponderosa is a serious financial burden. Of course, big, expensive comprehensive policies should be available for those who want them but they should not be the law of the land. Yes, everybody needs health insurance. The risk of catastrophic illness or injury is too great to self-insure. On the other hand, the risk of getting a head cold and needing some antibiotics is quite manageable and does not need to be transferred to an insurance company.

So why does the Affordable Care Act (aka Obama Care) require more insurance than is needed? Because this is more about redistributing income than it is about health care.

The ACA is built around the hope that by forcing the young and healthy to buy insurance, those funds can be used to pay for the health care of the sick and elderly and those with pre-existing conditions. The trick is to get the young to buy in. Unfortunately, because they will be forced to purchase more than they need, many will find it too expensive (except for those who are well connected politically, of course.  Young White House staffers, for example, have been exempted because it has been determined that it will cost too much).

Financial Analyst Dan Caplinger explains further in the video below: 

If twenty and thirty somethings opt out, where will the money come from to support the system? More taxes and more debt with the resulting drag on economic growth and standard of living. This is when the Affordable Care Act becomes even more unaffordable. (For more about the ACA's not-so-pretty fiscal picture, see: realclearmarketsobamacarefinancialunraveling)

With the new system breaking the bank and so many remaining uninsured, we will begin hearing arguments for a Canadian style single payer system – with all its accompanying shortages and backlogs. (This would have to be disconcerting for Canadians who have always had the U.S. as an outlet when wait-times have become too long. For example, Cleveland is now Canada's unofficial hip replacement center and the government of British Columbia had to contract with Seattle hospitals when the back log became too great. Where would Canadians go if the U.S. implemented the same system?)    

Canada's Frazier Institute tracks wait-times for health care. See: 

http://www.fraserinstitute.org/research-news/news/display.aspx?id=16488

More about the ACA in future posts.  

MM

How selling my truck made the world a better place

I sold my truck yesterday. My beloved Ford F-150, the top selling vehicle for as long as I can remember. But all good things come to an end (the up side is that all bad things also come to an end) and it was time to allocate those resources elsewhere. 

What is amazing is how merely making a simple trade improved the lives of the two people involved. As we completed the transaction at a local bank (where the buyer purchased a Cashier’s Check and I signed over the title) we were all smiles. Why? I was selling the truck for more than my reservation price, thus I was enjoying some newly created Producer Surplus and (at least judging by the smiles) my buyer was getting the truck he wanted for less than his reservation price and he was enjoying his newly created Consumer Surplus.

Our trade did not increase the number of trucks in the world. But by reallocating existing resources in a more efficient way, Economic Surplus was created and two lives improved. 

Trade truly does make the world a better place.  

MM

Bad News: Unemployment Keeps Falling  

Yes, you read that right, but how can falling unemployment be bad? It all depends on WHY it is falling. When the unemployment rate fell from 9.4% to 9.0% in January 2011 it looked like we were finally headed in the right direction. But a closer look at the numbers revealed that this decrease was primarily due to workers dropping out of the labor force. When the unemployment rate falls at the same time the labor force participation rate falls and few jobs are created, we have a problem.   

Here is why: Let's say that there are 100 people in the labor force and 5 of these people are unemployed. This means that the unemployment rate is 5/100 = 5%. Now, let's say that Bob (one of the five unemployed) gets tired of looking for a job. After months of no success he gives up. Since Bob is no longer looking for work, he is no longer part of the labor force and therefore no longer included in the unemployment statistics. What happens to the unemployment rate now that Bob has stopped looking? IT FALLS! Now, the labor force has only 99 participants and 4 of them are unemployed. The unemployment rate is now 4/99 = 4.04%. Thanks to Bob getting discouraged, the unemployment rate falls from 5% to 4.04%. Let's party!  

Unfortunately, discouraged workers have been a major reason why unemployment has been falling the last couple of years (retiring baby boomers and students staying in school to avoid the soft labor market have also contributed). A lot of "Bob's" stopped looking for work which has created the illusion that things are getting better. Back in March, for example, 496,000 people stopped looking for work which brought the labor force participation rate to its lowest level since 1979. This caused the unemployment rate to fall from 7.7 to 7.6%. However, if labor force participation had remained constant, unemployment would have increased to 7.9% instead. And now we have the August report showing what appears to be the good news of unemployment falling to 7.3%. Unfortunately, this is because labor force participation has now fallen to its lowest level since 1978 (35 years!)  

Add back all those who have dropped out of the workforce since 2008 and unemployment would stand at over 11%. (If you are a Barack Obama fan, thank a discouraged worker. It is highly doubtful he could have been reelected with an unemployment rate that high).  

We need 100,000 to 125,000 new jobs created each month to stay even with population growth and about 300,000 per month to bring about any meaningful improvement. So far this year, monthly job creation has averaged only 180,000.

For unemployment rates, see:

http://data.bls.gov/PDQ/servlet/SurveyOutputServlet?series_id=LNS14000000

For labor force participation rates, see:

http://data.bls.gov/timeseries/LNS11300000/

For monthly job creation, see

http://data.bls.gov/timeseries/CES0000000001?output_view=net_1mth

Also see July 10th: Why is the Economy Stuck in Second Gear?

MM

 

Lucky for Venezuela 

The central challenge of socialism is keeping the production of goods and services from shrinking to dangerously low levels (See May 7th, A Parable of Equality and Efficiency). With the incentive to be productive and innovative weakened, putting enough food on the table can be a difficult problem.  

So, when president Hugo Chavez nationalized Venezuela's farming industry in 2008 and put price controls on crops, an easily predictable result was that farm output would fall. AND DID IT EVER! However, Venezuelan’s have not gone hungry. As reported in the Wall Street Journal article below, the food shortages Chavez created have been a boon to U.S. farmers who have stepped in to fill the gap. The collapse in Venezuelan farm production (and a lot of other production as well) has resulted in an increase in U.S. exports to Venezuela. Fortunately for Venezuela, there were greedy capitalists nearby who were willing to trade.

http://online.wsj.com/news/articles/SB10001424127887323681904578640291651501034

MM

August 18, 2013

U.S. Rice Farmers Cash In On Venezuelan Socialism

U.S. Exporters Benefit as Production Falls in Latin American Country

        By SARA SCHAEFER MUÑOZ

U.S. rice farmers are making large profits from exports to Venezuela, thanks to the impact of the late President Hugo Chavez's socialist policies. WSJ's Sara Schaefer Munoz reports.

STUTTGART, Ark.—Steve Orlicek, a rice farmer here, is living the American dream. He owns a thriving business; he vacations in the Bahamas.

His good fortune springs from many roots, including an unlikely one: He is a prime beneficiary of the socialist economic policies of Hugo Chávez, Venezuela's late president and critic of what he called U.S. "imperialism."

It is a paradoxical legacy of Mr. Chávez's self-styled socialist revolution that his policies became a moneymaker for the capitalist systems he deplored. During his 14 years in power, he nationalized large farms, redistributed land and controlled food prices as part of a strategy to help the poor.

But these policies turned Venezuela from a net exporter to a net importer of rice—from farmers like Mr. Orlicek. "The rice industry has been very good to us," Mr. Orlicek said, sitting in his newly renovated home, appointed with a baby grand piano played by his wife, Phyllis.

It isn't just rice. Production of steel, sugar and many other goods has fallen in Venezuela, leading to occasional shortages. Until recently, Venezuela was largely self-sufficient in beef and coffee. Now it imports both.

In this year's first half, the U.S. exported $94 million of rice to Venezuela, a 62% jump from a year-earlier, making Venezuela the U.S.'s fourth-largest rice market, according to the Department of Agriculture.

Overall, Venezuelan imports have quadrupled since Mr. Chávez took office, to $59.3 billion in 2012 from about $14.5 billion in 2000, according to Venezuela government figures and economists at Barclays PLC. Exports to Venezuela from the U.S. hit $12 billion in 2011, up 16% from the previous year, the latest U.S. government figures show.

Among the winners are the American aluminum company Alcoa Inc. Anglo-Swiss mining company Glencore Xstrata PLC and Brazilian firms like builder Odebrecht SA. In May, Venezuelan authorities announced they would import 50 million rolls of toilet paper. One supplier: Kimberly-Clark of the U.S.

"Chávez said, 'We are against capitalists and we are against big oligarchs,' " said Moisés Naím of Washington's Carnegie Endowment for International Peace. "But he left the country more beholden to foreigners and foreign companies than ever before."

Supporters of Mr. Chávez say his fiery populism empowered the poor and fought hunger and poverty by providing subsidized food, housing and medical clinics. Yet job prospects and wages have fallen. A recent World Bank report says that 30% of people who were originally considered "not poor" in Venezuela fell into poverty between 1992 and 2006. In most other Latin American countries, the middle class grew in that time.

Venezuela's import reliance will be a major headache for President Nicolás Maduro, Mr. Chávez's successor. His government's wallet is stretched. Venezuela's budget deficit reached 12% of GDP last year, according to analysts, higher than the troubled Euro-zone economies like Greece or Spain. Its annual inflation rate rose to 42.6% in July.

Mr. Maduro, like Mr. Chávez, blames food shortages on hoarding by private companies waging "economic war" against his government, a charge that the few remaining private firms have denied.

Despite Mr. Maduro's stance, however, he has moved to make more dollars available to importers—which could help farmers obtain supplies abroad. In May, in a hugely symbolic move, he reached out to the head of Venezuela's largest private food company to collaborate on food issues.

Oil, the only strong export that Venezuela enjoys, accounts for about half the government's income. If oil falls to $90 a barrel for a year, from the current $105, the government would have to slash imports, said David Rees, an emerging-markets specialist with Capital Economics in London. "That would have terrible repercussions in terms of everything, especially food," he said.

Venezuelan officials defend the country's record. A Ministry of Agriculture official directed questions to a recorded interview with Henry Silva, president of a state-owned food company. Mr. Silva said Mr. Chávez's polices "made available means of production to the people that function to nourish and meet the needs of our population."

Alongside agriculture, Venezuela's industrial output has faltered since 2006, when Venezuela said it would pursue an "endogenous," or self-sufficient, development model that shuns profit-making and focuses instead on cooperatives. The government took control of wide swaths of major industries including steel and cement.

"We've lost our national sovereignty in steel, aluminum and bauxite. It's an embarrassment," said Damian Prat, author of a book about Venezuelan industry. Production of bauxite, a key ingredient in making aluminum, fell 70% between 2007 and 2012, he estimates.

That loss has been others' gain. Exports from neighboring Brazil have soared to $5.1 billion dollars in 2012, compared with $800 million 10 years ago, according to Brazil's Foreign Trade Association. "Right now we have very little competition" from within Venezuela, said Jose Augusto de Castro, the association's president.

Among the biggest beneficiaries of Mr. Chávez's policies have been Mr. Orlicek and other U.S. farmers. Mr. Orlicek, who grew up farming, considered becoming a lawyer but decided he would rather be outdoors. So he went to work on the farm that had belonged to his wife's parents.

Thanks to strong exports and rising prices, Mr. Orlicek runs his farm with the latest technology. His state-of-the-art tractors, which cost around $230,000 apiece, carry $15,000 GPS systems that can drive the tractors themselves.

A few years ago, as export profits rose, he took the expensive step of starting to level his 800 acres of rice fields using laser technology. Doing so costs him $400 per acre, but it ensures level irrigation—saving water and increasing yields by around 20%.

"I really want to take care of this land so future generations can raise rice on it," Mr. Orlicek said recently, driving among vivid green rice fields. He hopes his daughter will someday come back and farm.

Mr. Orlicek acknowledges that he has benefited from Venezuela's socialist policies. But he empathizes with the country's farmers.

Mr. Chávez "really gutted" Venezuelan agriculture, he said. "I'd like to see it turn around, and I am sure the farmers there would, too."

One is rice farmer Eloy Alvarez. Born in Spain, Mr. Alvarez came to Venezuela in the 1940s and saw the promise in Venezuela's hot and wet central plains, land that lends itself to rice growing. He bought some land for a song, and he and his wife spent 60 years farming it

They eventually acquired 500 acres and raised two daughters and sent them to private school. In the early 2000s, the farm was producing its maximum of seven metric tons of rice a year.

But in recent years, Mr. Alvarez's fortunes changed. The government set prices for rice and other products. With prices fixed but inflation rising, it became harder to afford equipment. He stopped buying new tractors and instead tried to fix his old ones. Import controls, however, made even parts hard to come by.

The 2010 nationalization of Venezuela's main farm-supply company compounded the problems. Farmers say it is now often late in delivering basics, like fertilizer. That same year, weeds choked Mr. Alvarez's rice crop—the result, he says, of herbicide delays. He now produces about 30% less than in the past.

Recently on Mr. Alvarez's farm, a decades-old Ford tractor stood rusting in a shed. On a flat expanse of field, under a flock of circling white birds, another timeworn machine moved slowly, struggling to reap a rice field overrun with weeds.

"You can't get the herbicide," said Alexi Chambuco, 63 years old, one of Mr. Alvarez's farmhands, wiping his face with a handkerchief. "And now it's difficult to harvest."

Mr. Alvarez's wife died in May, and he carries a creased picture in his pocket, taken during their earlier years on the farm. Yet despite the hassles, many farmers like him don't quit farming. If they do, their idle land is at risk of being seized by the state.

"We have to pull out of this," Mr. Alvarez said of Venezuela's farming decline. "But there's been a lot of damage done."

So who’s reading this thing anyway?

I’ve been a blogger for a little over four months now. As stated in my first post, this was just a way to try to sneak some financial literacy into my kids -- but if anybody happened to stumble in, they were certainly welcome.

Well, amazingly a whole lot more bodies have stumbled in than I ever thought possible. I have no idea how so many readers found their way here. While I am not quite ready to quit my day job, I am very honored to count folks from the following countries among my readers: 

 

United States

Russia

Germany

South Korea

Brazil

Netherlands

Ukraine

Finland

France

New Zealand

Turkey

China

Italy

Malaysia

United Kingdom

Philippines

 

Welcome aboard everyone! It is a pleasure and an honor.  

MM

 

 

Why Trade?

Why do I buy my bread from Wegmans instead of making it myself? Why do I drive a Mercury Sable instead of building my own car? Why did I buy a house that somebody else built instead of building it myself? The answers are actually pretty straight forward. I buy bread from Wegmans because I value the bread more than I value the dollar I use to pay for the bread (or more precisely, I value the bread more than I value the next best alternative I could have purchased with that same dollar). This is because Wegmans has a lower OPPORTUNITY COST of producing bread than I do. The same is true of auto manufacturers and housing contractors. They all have lower opportunity costs than I do. This is why I trade with them rather than trying to produce these goods myself. The bottom line is that when somebody else has something we value more than we value our own stuff (and vice versa) trading makes us better off.

But what if my trading partner lives in Rochester? Will I still gain by trading? Of course! What if my trading partner lives in Pennsylvania? The gains from trade are still there. It doesn't matter where our trading partners live as long as we value what they have more than we value what we have. But, what if my trading partner lives in Quebec? Are there still gains to be made from trade? Again, the gains from trade are the same regardless of where your trading partner lives (though transportation costs may begin to eat into those gains). The economics of trade is the same for intercity trade, interstate trade, and international trade. However, the POLITICS changes when trade becomes international. We get very touchy about goods and jobs crossing international borders (and here in New York, we are a little touchy about state borders, as we watch more and more jobs move south because of our ultra-high taxes)

We are sometimes tempted to place barriers on trade by imposing tariffs and quotas – but we need to be careful. This only serves to reduce the gains from trade and can stifle economic growth. This is why economists are virtually unified in support of trade. Yes, we can make some short-term gains by restricting trade (mostly political, and this is why you often hear politicians railing against trade, especially in an election year) but at the expense of long-term economic benefits.

Economists really don’t debate the merits of trade (at least not with each other) any more than physicists debate gravity or mathematicians debate linear algebra. But observers from all over the political spectrum continue to object in the face of overwhelming evidence. The arguments that trade will destroy jobs, and lead to unemployment and falling incomes are fallacies that history and experience have refuted time and again. For example:

"With America’s high standard of living, we cannot successfully compete against foreign producers because of lower foreign wages and a lower cost of production."

That was Herbert Hoover in 1929! Also, does anybody remember Ross Perot’s giant sucking sound from the 1992 presidential campaign? As one economist stated:

"Free traders are trapped in a public policy version of the movie Ground Hog Day, forced to refute the same fallacious arguments over and over again, decade after decade."

Paul Krugman (Princeton University economist, New York Times columnist, and Nobel Prize winner) sums it up this way:

"The logic that says that tariffs and import quotas almost always reduce real income is deep and has survived a century and a half of often vitriolic criticism nearly intact. And experience teaches that governments that imagine or pretend that their interventionist strategies are a sophisticated improvement on free trade nearly always turn out, on closer examination, to be engaged in largely irrational policies – or worse, in policies that are rational only in the sense that benefit key interest groups at the expense of everyone else."

The bottom line is that unless you make your own clothes, bake your own bread, grow your own wheat, and build your own house, you have bought into the benefits of trade –and in a big way! Jeffrey Sachs (Director of Columbia University's Earth Institute and one of the world's foremost economists) points out in his book The End of Poverty:

“Embracing globalization is a key to ending world poverty”.

Evidence to support the benefits of trade are summarized and documented in the book, Free Trade under Fire by Douglas Irwin if you are interested in exploring this topic further.

We have a powerful incentive to trade. People tend to prefer more to less and trade helps make that happen. By specializing in what we do best and trading with others who are also specializing in what they do best, we raise our standard of living. Specialization and exchange actually allows us to consume beyond our production possibilities (Adam Smith, the father of modern economics, pointed this out way back in 1776 in his revolutionary book An Inquiry into the Nature and Causes of the Wealth of Nations)

The data are very clear on this: In wealthy nations, people are highly specialized with lots of interaction and trade. This results in greater productivity and a higher standard of living. In poor countries, people are much more independent. They make their own clothes and grow their own food and trade much less with each other. This results in lower productivity and a lower standard of living.

Please see the following Paul Solman video:  

Specialization

MM

The Old Rules Still Apply

After the mortgage meltdown and subsequent recession, it was sometimes claimed that the economics profession had been turned on its head and the textbooks would all have to be rewritten. EVERYTHING has changed! NOTHING IS THE SAME, they cried! Even the rules of investing were supposed to have changed. 

My goodness, such extremes merely from failing to predict the future. When did economics become fortune telling? I have been teaching and studying economics for over 30 years. Somehow I missed that memo. 

The fact is that the old rules still very much apply. We still live in a world of scarcity and thus face tradeoffs and opportunity costs, productivity and innovation still drive our standard of living, and buying, holding, diversifying, and rebalancing is still the most prudent way to invest. Despite all the hype and rhetoric, not all that much is different. 

In the videos linked below, Burton Malkiel, Princeton University economist and author of the investments classic A Random Walk Down Wall Street, explains why the “rules” are still the same. 

Burton Malkiel Explains Why The Old Rules Are Not Dead

Malkiel Questions and Answers 

MM

Why is it so difficult to beat the market?

 

Financial markets and agriculture are the two of the most cited examples of markets that approach what economists call Perfect Competition. The characteristics of a perfectly competitive market are: 

• A large number of buyers and sellers
• No buyer or seller has the power to impact the price
• The market dictates the price thus everybody is a price taker
• Output is homogeneous thus nobody can tell the difference between the output of one producer and another producer
• Information is symmetric thus both buyers and sellers have a complete knowledge of the information that is available. 

With agriculture these characteristics are fairly obvious. There are a very large number of farmers, Farmer Smith’s corn is pretty much identical to Farmer Jones’, and buyers and sellers of corn know all that is important to know about the market for corn. With financial markets we have these same characteristics – more or less. There are lots of buyers and sellers so everybody is a price taker (however, there are some exceptions because large institutional investors such as mutual funds and pension plans can impact the price), buyers and sellers have access to the same information about a particular stock (such as financial statements, macroeconomic data, and industry statistics), and the product investors are after (the return on investment) is pretty much homogeneous (a risk adjusted 10% return in stock X is the same as a risk adjusted 10% in stock Y).

 

A big hot-button issue in finance is whether or not it is possible to create a portfolio of stocks that returns more than the investor would have received had he simply purchased every stock in the market. By buying all of the stocks, there is no need to study financial statements, forecast cash flows, and analyze macroeconomic data. You just buy them. If you do spend hours doing all that analysis and you don’t do any better than the market averages, you pretty much wasted your time (unless analyzing stocks is something you do for fun) 

 

Typically, we use the Standard and Poors 500 index as a proxy for "all of the stocks”. So, if the S&P 500 returns 12% and your portfolio returned 14%, congratulations! You beat the market. Virtually all portfolio managers can beat the market now and then but almost nobody beats the market over the long haul. Why not?

 

Just as wheat farmers receive what the wheat market has to offer, on average, portfolio managers receive what the stock market has to offer. This is because over the long term, financial markets process information fairly accurately (in finance lingo, the market is efficient). So, even though the markets can have severe short-term fluctuations, ultimately stock prices will gravitate to their true intrinsic value which leaves little opportunity to find mispriced stocks to be exploited for economic gain (during these short-term fluctuations it is not uncommon to beat the market – but whether this is skill or luck is tough to determine)

 

Years ago, Wall Street Journal reporter John Dorfman started a weekly column in which he pitted portfolio managers against a portfolio chosen by throwing darts at the financial pages. Over the ensuing months, the pros were about even with the forces of chance -- with the darts holding a slight edge. Amazing! All that work and research and all you can get for it is a return that is no better than throwing darts!

 

It is important to state that this does not mean that financial analysts and portfolio managers are dumb. To the contrary, some of the brightest people around go into this field. It just means that the financial markets are extremely competitive. Much like athletics, you may have a super star dominate for a while but eventually the competition catches up and ends the hot streak. In the financial markets there are thousands of professional investors (and thousands more amateur investors) who have the same information, which means nobody has a clear advantage and it is unlikely that any one investor or portfolio manager will beat the others consistently over the long haul. The only information investors don’t have is news events and since the news is unpredictable, so are the markets. Although there are many in the investment field who insist that they can beat the market, the evidence is that they can’t, UNLESS… 

 

I can’t end this without telling you that there is a way to beat the market EVERY TIME! Unfortunately, if caught you go to jail. It is called insider trading. If you are in possession of information that you know to be non-public AND know that the information would have an impact on the stock price if it were public, you are in violation of the law if you trade on that information. In this case, information has become ASYMMETRIC, that is one party to the transaction knows more than the other. Asymmetric information changes everything and we are no longer operating within the realm of competition.

 

The reason insider trading is such a serious issue is that if it becomes generally believed that the only way to make money in stocks is to know somebody on the inside (company executives, investment bankers, etc) people will keep their money out to the markets and this will make capital investment more expensive as there will be less savings available for financing. The result would be slower economic growth and smaller gains in the standard of living. Unfortunately, it is difficult to prove what somebody knew and when they knew it. As a result, there are relatively few insider-trading cases prosecuted. 

 

In the following video, Princeton University economist Burton Malkiel (author of A Random Walk Down Wall Street) debates a reporter. Be sure to watch (nine minutes)  

 

Passive Versus Actively Managed Mutual Funds 

MM

 

 

Why is the Economy Stuck in Second Gear? 

Unemployment hit a high of 10% in October 2009 and came down to 9.5% in mid-2010. Since then it has fallen to 8.1% and then back up to 8.2%, down to 7.8% and back up to 7.9%. Months later it sits at 7.6% with job creation too mild to expect any meaningful improvement. With a natural unemployment rate (the rate at which we consider the economy to be fully employed) in the area of 5%, current unemployment is dramatically higher (52% higher) than we would like it to be -- and it is only as low as it is because so many people have dropped out of the labor force. If labor force participation had remained constant, current unemployment would be over 11%. 

 

The question often asked: We had enormous amounts of stimulus spending, why haven’t we seen more, well, stimulus? Here are the most likely reasons:    

·       Much of what has been spent was stimulus in name only. Former Chief of Staff Rahm Emanuel said it best: “Never waste a crisis.” In other words, hard times present an opportunity to achieve a political agenda that would not be possible otherwise. As a result, we have seen a lot of spending on earmarks and social programs and hasty projects like this one and this one. Calling this stimulus does not make it so. It is very difficult to spend wisely so quickly. It takes many months (years, actually) to plan and execute good projects (public or private). After much hype and celebration, even President Obama later had to concede that there is no such thing as a “shovel ready project”.   

 

·    New hiring tends to come later on in any expansion.  Businesses typically wait until they are confident that the expansion is well underway before hiring back workers. Labor is the most expensive input in any production process and businesses will get as much as they can out of their current employees before they are willing to incur the expense of expanding their workforce.   

 

·     Uncertainties about new taxes and mandates on business seem to be putting a drag on economic growth and employment. It is tough enough for businesses to add new employees in the early going of an expansion but in this expansion, businesses have more to worry about than usual. Because of the massive and unprecedented amounts of government spending, government has also been doing massive and unprecedented amounts of borrowing and the public debt has exploded. This is causing firms (and citizens in general) to worry about how high taxes will have to go to service all this new debt. Expectations of higher future taxes can curb hiring by businesses as well as spending by consumers. A recent survey by the U.S. Chamber of Commerce of small businesses (the primary engine of economic growth) confirms this. 78% of responders report that taxation, regulation and legislation from Washington make it harder for their business to hire more employees. 74% say the recent health care law makes it harder to hire more employees.    

 

The result is less hiring than we usually see coming out of a recession. 

 

While the “stimulus” has helped relieve some of the pain of the recession, it hasn’t done much for permanently improving the economy. This kind of spending during the Great Depression had the same results (though this last recession was light years from being as bad as the Great Depression) While there was modest improvement during the 1930s, it wasn't until World War II that the Depression came to an end. 

 

The bottom line is that despite mountains of rhetoric, ideology, and deficit spending, not all that much economic stimulus has actually taken place (which is why a THIRD stimulus package -- the jobs plan -- has been proposed). Meanwhile, the enormous debt that has been racked up will all have to be repaid – much of it by those who have not yet been born!  This is often referred to as The War on Kids, and indeed it is. How noble of us to live beyond our means and let our posterity pick up the tab. 

 

For unemployment rates, see:

http://data.bls.gov/PDQ/servlet/SurveyOutputServlet?series_id=LNS14000000

For labor force participation rates, see:

http://data.bls.gov/timeseries/LNS11300000/ 

For monthly job creation, see   

http://data.bls.gov/timeseries/CES0000000001?output_view=net_1mth

MM