Reasons Unbeknownst

I have some assumptions about economics, finance, and trends but I don’t spend much time looking at how things would have to change to accommodate my weird predictions. So that’s what I’m writing about tonight… Tonight I make omelets.

My condensed take on the economic camps’ assumptions about our predicament: The Austrians assume job growth resulting from lower taxes will organically release us from the Great Recession. The Keynesian camp assumes deficit spending will save us. I think both are wrong in this case. The housing boom masked the fact that the middle class is shrinking due to automation and global wage arbitrage. Neither of which show any signs of abating.

Both camps assume that for 300 years the middle class will remain stable. They do that because their models (mainly Keynesian) get too complex unless you assume all things are equal. So the complexity of their models preclude the notion that demographics and common sense can come into play. This is probably why they missed the housing bubble. My take assumes accelerating societal change.

The Austrian school isn’t so burdened by math (they did see the housing bubble coming) but its practitioners are burdened by political assumptions about fairness and justice (Bastiat and Rand). The social consequences of a shrinking middle class aren’t a concern for most Libertarians. But in the long run you start to have serious problem with a society with no middle class (so I’ve heard).

In short, they Keynsians think they can avoid the inevitable and the Austrians just don’t give a damn. So nobody is writing much about the problem.

In the back of my head I’ve remained optimistic that the brains in Washington can transition society to a future where there is no middle class because of rampant productivity growth which will (not ironically) make increased wealth redistribution palatable. This rising productivity simultaneously solves the deficit problem. Then I read this unfortunate bit of research today from Julius Wilson via The Atlantic:

“A neighborhood in which people are poor but employed is different from a neighborhood in which many people are poor and jobless. Many of today’s problems in the inner-city ghetto neighborhoods—crime, family dissolution, welfare, low levels of social organization, and so on—are fundamentally a consequence of the disappearance of work. “

So there are two problems for the future. The first is dealing with the potentially outdated financial framework that assumes a healthy, stable middle class (think 30 year mortgages). And the second is the psychological ramifications of joblessness even with bountiful welfare benefits.

So politicians are going to have to look at how to make wealth redistribution work given the understanding that you can’t just throw money at the jobless and expect them to avoid dysfunction.

Woohoo! I’m writing again. It feels good. (and cooking, mostly high end omelets). My thoughts from the last week:

“In this case it’s the application of reason to the study of the financial
behavior of irrational, social, creatures (humans). AKA economics. ”

“20 years ago we could blame the lack of information for our inability to fix the world’s problems. Now we’re the bottleneck.”

On CA:
“Our taxes are high but they’re not nearly high enough to pay for all of the earth fixing programs we like to “fund”.

“California is basically a giant version of an idealistic student at Berkeley with a Visa who has never taken a class on personal finance.”

“Don’t forget California. The Republicans are supposed to come in and cut taxes and spending but they find it’s a lot easier to just cut taxes.”

On wholistic medicine:
“It’s called the placebo effect and it does work but, like Peter Pan, only if you believe.”

On Keynesian misconceptions and fiscal shenanigans:
“Krugman (liberal) thinks Obama isn’t doing enough to stimulate the economy. Their prevailing wisdom is that you do need to worry about deficits but not until we’re through this recession. Otherwise we could get caught in a deflationary spiral (see Great Depression).
A deflationary spiral would collapse tax receipts and would grow the deficit. This is why unfunded spending and low GDP both have a negative impact on the dollar.”

“Giving away mortgages on crack houses only makes them crack homes.”

On the moon:
“Some of us Luddites think we should pay down the deficit before space travel becomes a priority.”

“Baby boomers already saw a guy on the moon. At this point in their lives they’re going to vote for more drug benefits. The baby boomers get what they want.”

On Socialism:
“Socialism is basically the Apple model. Things cost more but you get a strong leader (Jobs) and nationalistic pride (the Apple brand/ lifestyle), and you don’t have to worry about evil monopolies because you assume the government monopoly is benevolent.

Some of us prefer an open model with fierce competition. Brands aren’t as important because if companies are dropping prices fast and innovating faster, nobody will remain king of the hill. This is Capitalism but it requires regulation.

Bill Gates was completely wrong when he likened Open Source to Communism. Socialism consists of government run monopolies. Bill Gates as a politician in other words.

Socialism is basically the admission that the lobbyists have won, no regulation will pass, and it’s time to pray for competent bureaucrats. We Americans have trouble admitting that, probably given our history of occasionally tarring and feathering corrupt politicians.

Though I think we should take from the rich and give to the poor (within reason, wealth divides are growing) it doesn’t mean the government has to expand out from the department of motor vehicles and start running our supermarkets. If you don’t see the problems inherent in letting the government run businesses then you’ll probably like Socialism.”

On law:
“If regulation is just legislation and you assume laws are enforced then leadership should only consist of representatives. A Representative Democracy is arguably the antithesis of strong leadership.”

On Toyota:
“I think you should engineer safe gas pedals rather than change the behavior of the throttle system.”

“Toyotal Recall” My highest ranked comment this week but it looks like some headline writers at Fox news thought it up a few days before me.

On dog lovers eaten by their own dogs:
“You would expect man hungry dogs to eat a man so that’s not ironic but the fact that he is the supposed leader of their wolf-pack is.”

On Graphine based processors:
“I doubt that other than supercomputers the effort will be in reaching that level of performance. For most of us they’ll try to slow them down to only what is required for the application to reduce power consumption. Cell phones lasting a week on a charge would be nice.”

“Dixon Ticonderoga Number Two processors.” My second highest rated thought for the week according to Reddit.

” I think the concept of “good enough” may start to apply in the near future.
I would rather have a cell phone or PC that uses 5 watts than something that requires 150 but can render full length Pixar movies.
GPUs will probably jump on this for performance but it’s hard to argue many people are dissatisfied with current top of the line graphics.”

“Watch your cpu use, even during compiling, a lot of the bottleneck these days is IO. Most people are surprised what their CPU can do after installing a good SSD.”

Economics, and specifically the economy, will be the dominant issue in the ’08 race. I believe that because I’m aware of the toxic waste keeping the economy afloat that nobody seems to want to talk about. I’m a long term optimist due to the effect of accelerating change on productivity but here is my list of facts that bode ill for ’08.

• The housing correction is just getting started. Trillions of dollars of homeowner wealth will vanish.
• The economy is 70% consumer spending. Home ownership is 70%.
• Opacity of derivatives markets. Things are now so complicated that nobody really knows what sort of dysfunction lies beneath the surface.
• Consumer indebtedness. People have been spending more than they earn for quite a while. That is not sustainable.
• Monolines – Insurance companies that back bonds are starting to flail due to unprecedented foreclosures. If they go down ratings on munies fall and pension funds are forced to sell (bad for stocks)
• Credit bubble which we’ve been blowing for 20+ years is about to pop and if you believe Hayek/Mises things are about to get ugly. This explains the housing bubble and current credit squeeze.
• Government spending (state and local is 10% of the economy) is going to fall as tax revenues fall in a recession.
• Commercial real estate is starting to fall. This was a bright spot until recently.
• Even if the Fed can bail out financial markets it will do so using inflation (hence my preference for gold). Higher prices mean less discretionary spending which bodes ill for the economy.
• Recessions are a natural part of the business cycle and we’re way overdue
• Home equity lines of credit and loans are evaporating
• Credit card delinquencies are rising.
• I could go on but you get the picture

I’m going to predict an Obama victory for the sake of argument. Here is his problem: We’re probably going to be in an unusually nasty recession when he’s being inaugurated next year and presidential approval ratings are roughly equal to consumer sentiment. Of course the president doesn’t have much of an effect on business (credit?) cycles in a $14 Trillion economy but that is the way the cookie crumbles.

Obama is probably going to make the economy a huge part of his campaign as the economy slides which will give Americans hope that everything will be puppies and roses as soon as he takes the helm of this rusty ship. Assuming this isn’t a repeat of the ’70s (or, dare I say it, 30s) we should be well on the road to recovery which bodes well for a 2nd Obama term, all things equal.

Optimism:
I said that I’m an optimist due to the effect of accelerating change on productivity. Accelerating change is a branch of future studies that nobody is really looking at in terms of economics yet. Kurzweil has a good chapter on it but it deserves a entire book. My take is that accelerating change will start to seriously ramp up productivity. The problem is that we don’t have the ability to train workers fast enough to take advantage of what should be a wealth boom for more than just the privileged few. The growing wealth divide is currently blamed on tax cuts. That may be the case but I think it is also due to the accelerating economic changes we’re witnessing due to the internet and off shore outsourcing.

Gold:
Nearly every time we see a sell off in the markets (DOW is off 2% as I write this) Gold goes down with it. But gold seems to go down about half as much as equities, the assumption is that the smaller decline is due to the belief that the Fed is now cutting rates (using inflation) to prop up the stock market and maybe because it’s a destination in a flight to safety.

Asia Times has a good multi-part series on the inflation/deflation debate here. They’re in the hyperinflation camp. For the deflationary angle check out this post from Mish at Global Economic Analysis.

Image by Big-E-Mr-G.

Republicans:
Giuliani – This looks like a death sentence. Even Ron Paul beat him.
Huckabee – Massive support from evangelicals probably won’t work outside of Iowa. Skeletons congregating in his closet.
Romney – Considering the amount of money he spent he should have done much better. But his good hair could be the difference.
McCain – He’s going to have another meltdown, too unpredictable to make a good nominee.
Thompson – He could possibly win if his heart was in it. Feels like he’s doing this as a favor for a friend.
Paul – Beat Giuliani, 4% out of 3rd behind a weak 1 & 2. Could do better in New Hampshire, a libertarian friendly state.

Democrats:
Obama – Smart, personable, represents change. Would have good advisers. Untested.
Edwards – Anti-establishment populist, hair is a little too well groomed. Obama beats him unless he slips up.
Clinton – Change is the theme of ’08. Clinton represents anything but change. Smart but Obama tends to out debate her.

Prediction for New Hampshire:
Romney, Huckabee, McCain, Paul, Thompson
Obama, Edwards, Clinton

Photo by pete etchells on Flickr