Wednesday, December 31, 2008

Governmental Fiat

As quoted in George Will's recent Washington Post piece:

"By acting without rhyme or reason, politicians have destroyed the rules of the game. There is no reason to invest, no reason to take risk, no reason to be prudent, no reason to look for buyers if your firm is failing. Everything is up in the air and as a result, the only prudent policy is to wait and see what the government will do next. The frenetic efforts of FDR had the same impact: Net investment was negative through much of the 1930s." - Russell Roberts of George Mason University
Those who have had the misfortune of listening to me lately will find striking similarities in what Russell perceived about the '30s and what I've been lamenting about our current predicament.

The US Dollar is fiat money ... backed not by gold, not by collateral, but by everyone's faith in the strength and continuity of the US Government. People expect the US to continue to achieve, deliver, and grow for the foreseeable future. Thus they are happy to hold Dollars. History has proven them right: the Dollar has survived world tumult and domestic shock, inflation and stagnation without ever having a crisis of confidence (=a severe drop in exchange rate).

Underpinning this faith is stability. People trust the dollar, and it's issuer the United States, because both have historically been stable and predictable. The opposite, however, would be equally true: erratic moves by the US would cause suspicion, fear, and trepidation in people. Enough of that tumult, and people would lose faith in the dollar and the US economy. They'd flock out of Dollar-denominated assets in favor of other currencies (predominantly the Euro and Pound, with the Chinese Yuan as an interesting wild card). The US Dollar's exchange rate would tank ... not slide, not drift, but crash. This is a turn of events we cannot allow to occur.

Whereas the Feds thought their bold moves would "jump start" the economy by fiat, their erratic decision-making over the past few months has had the opposite effect, suppressing any recovery precisely because the "boldness" has scared people. Ambiguity on the future of bankruptcy law and assistance is causing households, businesses, and banks to delay bankruptcy filings. Ambiguity on the financial bail-out is keeping would-be bank investors from taking advantage of these bargain-basement stock prices. Ambiguity about interest rates and inflation is making banks sit on their inflated reserves rather than lending. Sounds a lot like the 1930's, no?

Rationally, those people are largely sitting on the sidelines waiting for things to calm down before they'll be willing to re-engage in economic activity. That's the generous view.

The not-so-generous view is that people see a new level of precariousness in the US economy and a new level of unpredictability in the behavior of the US government. Rationally, they are revising their expectations about the US economy to be a little less rosy and are beginning to act based on that new view. In this case, the horse is already out of the barn and it will be far more difficult to re-interest these people in engaging in economic activity ... at least here in the US.

History repeats. Again. Don't act so surprised.

Yin/Yang Graphic credit:
Coffee Talk Cartoon Credit:
Precarious Cartoon credit: Wide Dynamic Range

Friday, December 26, 2008

What Will Tomorrow Bring: Chinese Reverse Migration

As I blogged a while back, China's key success factor, as well as competitive advantage is it's access to a nearly-unlimited pool of unskilled, impoverished labor.

When the US needs more cheap labor, we turn a blind eye at the southern border for a while. When China needs the same, they simply open the tap slightly by granting a few thousand (or million) migration permits allowing poor western farmers to migrate to the cities in search of menial jobs, at which they're assured to make triple what they could in their home village. You see, in China, you must have a permit to live in the affluent cities of the coast.

As we've seen time and again in history, and as Marx and Engels were kind enough to highlight, growing income disparity pisses off the less fortunate. As such, there has long been fear (as Deng was acutely aware) that coastal modernization, liberalization, and the consequent wealth creation might ignite a repeat of the People's Revolution. Hence the restrictions on the mobility of the peasant class. Conventional wisdom holds that the only way to avoid revolution is with political reform and liberalization. However, the Chinese commies have so far avoided making any painful (for them) changes. Instead, whether intentional or by necessity, the government has allowed a continual trickle of peasants to flow east to partake, thus releasing just enough steam to keep unrest down to a manageable magnitude.

For those migrant workers lucky enough to be allowed into "the city," the transition must arouse a mix of ambition, hope, confusion, and humiliation. Up to that point, they have led traditional agrarian lives just as their ancestors had for hundreds of years. Then suddenly they find themselves witnessing first-hand the "foreign" trappings of wealth being played out on Chinese territory ... and by (Fendi-clad) Chinese. This is a lifestyle they never aspired to ... until they arrived in the city. But once they're exposed to it, this lifestyle must become a thing to covet, or at least worthy of animosity. Unlike America, however, the Chinese government makes it clear that migrant workers should not hold such aspirations. Their proletarian lot is fixed. They are to work. The caste system is alive and well in towns like Shanghai and Beijing.

At least the work was always there ... and at least these people could count on sending money home to make their families wealthy by local standards ... to be enjoyed when (if) they ever reunite. At the same time, they've been keenly aware that this right could be revoked by government fiat. Between them, these two forces have maintained a strong incentive for migrant workers NOT to rock the boat.

Oddly, the world financial downturn may grant them their wish. As China's growth rate has slowed, it's demand for incremental labor has evaporated. For the first time since Mao, unemployment is shockingly on the rise. Keep in mind that "official" numbers never count the western farmers, so the conclusion is that this unemployment spike is happening on the coast. That means workers who have migrated east in the last 10 years are, for the first time, not able to find work.

Some may choose to return home to their villages, as they always planned to do. However, others may have to go against their will. While it's denied by the government, unemployed migrant workers quite often have their permits cancelled by the government. This forces them to return home or go underground. It's a tidy way for the commies to keep unemployment just where they want it.

The government's tea-leaf-readers have suggested that they may not be able to count on a quiet reverse migration this time around. It is possible that critical mass of disgruntled migrant workers may choose to stand up for themselves. This plays into the prevailing theory that an increase in Chinese unemployment might unleash a wave of pent-up social unrest. As we remember from 1989, China doesn't like unrest.

And that's why they've taken the unprecedented and fascinating Keynesian steps to stimulate the economy such as subsidizing private enterprises to take on (or at least keep) workers they don't need. These are the same enterprises the government only grudgingly allowed to emerge ten years ago. Quite an interesting turn of events!

Train Station photo credit: AP via AFP/Getty

Wednesday, December 24, 2008

Grumpy Old Men Quotes 2

I was at the Dairy Queen yesterday and the guy got my order right, handed me spoons and napkins without being asked, and even figured out the right change. Cool! I thought to myself. That's MY kind of recession.

Tuesday, December 16, 2008

Blog Shout Out: Separation of Owners and Executives

Phil Goldstein guest-blogged on The Icahn Report recently advocating more inclusivity in proxy vote ballots. While I agree with him, I'm not sure I see it as the end-all be-all that he does. That's not why I'm giving him a shout out. It's his priceless intro. He had me at "nutshell" but went on to offer some awesome and appropos quotes:

What is fundamentally wrong with corporate governance in America? In a nutshell, it is difficult for stockholders to hold management accountable for its misdeeds.

This is not a new insight. In 1776, Adam Smith wrote in The Wealth of Nations: "The directors of such companies, being the managers rather of other people’s money than of their own, will not watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own. Negligence and profusion therefore must always prevail in such a company."

Let's fast forward to 1934. Here is what Congressman Lea of California said in the Congressional record of May 1, 1934: "In the main, the men controlling these great corporations are not large owners of the stocks of the corporations they control. Too often they have yielded to the temptation to control these great business institutions to their own interests, and with a zeal out of proportion to the loyalty they have shown their stockholders. Thus in recent years we have seen the directors of corporations, without the knowledge of their shareholders, voting themselves vast bonuses out of all proportion to what legitimate management would justify. We have had revelations of salaries paid to directors and officers of great corporations which showed shameful mismanagement; which showed that the men in charge of some of these corporations were more concerned in managing its affairs for their own benefit than for the benefit of the stockholders."

It is now 2008 and it is fair to say that the lot of shareholders has hardly improved, considering the trillions of dollars in lost shareholder value over the last year, along with the egregious bonuses and salaries paid for this dismal performance.

Yes, yes, yes. Intermediation between owners and managers clearly creates perverse incentive structures and thus, as you may have noticed, opens up a gaping chasm of opportunity for disaster.

Once again it's back to basics: incentives must be aligned. Any crack of variance between the interests of management and that of the owners will be found and exploited if not monitored like a hawk. My prior post on the ills of modern boards of directors tried to highlight this. I was so bold as to suggest a few incentive-alignment mechanisms for directors.

At root, corporations are organizational structures to facilitate the most effective decision making across a bazillion tiny capital allocation choices. Layers of management are supposed to enhance that "effective" part by setting strategy, establishing standards, reviewing decisions, training staff, monitoring success metrics, and so on.

For the most part, corps do the above successfully. The trick lies in how you define "effective."

For long-term shareholders, effective probably means profit-maximizing whilst risk-minimizing in order to maximize the company's valuation (NPV of future cash flows). For day traders, it probably means share price volatility, for a shareholder-CEO, it might mean meeting revenue or share price targets on certain dates in order to release his performance bonus ... You can already see that even a perfect board would have to arbitrate among conflicting goals of various owners.

For managers, it means getting a good perfomance review and keeping their boss happy so they get a nice promo or bonus. For a middle-aged staffer, it might be stability and healthcare. A Gen-Y up-n-comer's interest might be in flexibility, excitement, and recognition.

Each of this plethora of interests creates an incentive mechanism which guides the person's every action. There are a lot of smarties lately making a sport of disparaging the idea that humans make rational decisions. While I recognize we're not robots and thus mess up, I think that the vast majority of apparently "strange" or "bad" decisions would appear sensical if you could fully map the "context."

I use "context" as a shorthand term for the three factors I feel are at the heart of decision-making:

  • the complete incentive mechanism environment faced by the maker
  • all the information available at the point of the decision
  • and the (current) "horsepower" of the maker's brain process this information. Some humans are better than others at processing information and making decisions, but there are biological limits. Then environmental factors determine whether or not one's brain is working at full capacity like a well oiled machine.

And that's why I don't believe the board (or it's members) are always the cause and solution to every business problem. You can clean up a totally absentee board and improve the company's governance, but they're just a small group of humans. Not even Rain Man could process enough info to make enough decisions per hour to singlehandedly run GE, GM, or Microsoft.

For better and for worse, a board is just a bottleneck of power within an organization. Convenient in some cases, but inhibitory and ineffective if you try to cram too much through it. The daily scandals we see are the direct consequence of an absenteeism which arises less from lazy boards than from the skewed incentive structure under which each employee (especially management) operates.

So while I very much enjoy an agree with most of the gems that appear on Icahn's blog, I would argue that they need to spend a little less time inventing ways to gerrymander and a little more time getting the "context" right. This might require:

  • Mapping, measuring, assessing, and alining the incentive mechanisms. Here's a hint for all those newly out-of-work brains in finance and consulting: invent a demonstrably effective framework for rooting out perverse incentives and you'll have companies lining up at your doorstep like Macy's on the 26th of December.
  • Ensuring board members have enough information. Accurate information. This implys the need for a staff, as well as inciteful 3rd party analytics (are you listening entrepreneurs?)
  • Maximizing each member's computing capacity (for example, by limiting other demands on their attention as I suggested in my earlier blog), and then being realistic about how much you can expect the board to effectively handle. In a sense, this is just another incentive mechanism to be aligned. They're often incentivized to get through their agenda in set number of minutes, and will compromise on the other incentives to achieve that. Bad bad bad. Add board members, add time, and/or delegate power.

Just a start. Now You.

Saturday, December 13, 2008

What's REALLY in the National Interest?

Sad that Congress or the President would have to:

  1. School the car makers on PR. The private plane thing was pure melodrama ... but how'd they not see that coming? For chrissake, how much have these guys spent on advertisers, marketers, spinsters?
  2. Dictate glaringly obvious management strategies such as Bob Corker's 3-part plan: negotiating with debt holders; forcing management to innovate or get out of the way; and negotiating wages down to the market price.

I loved this ad-spoof that Autoblog put up recently. Blaming shitty cars is funny, but it's not really the issue. Kias aren't exactly Mercedeses, but they sell just fine ... AND at a profit. Were the car co's not so terribly hamstrung by a hundred years of collective bargaining and tacit-to-explicit government support on many levels, they hopefully would have been intelligent and ballsy enough to make the necessary business decisions (product innovation being but one) long ago. As it is, Washington has to spoon-feed them the most basic business life-support in the form of cash and directives.

Romney, well placed at the nexus of Michigan and (failing) business, is clearly wrangling for Car Czar. I'm OK with that as long as he calls a spade a spade and changes his name to Wesley Mouch. I'll give ya a car czar: it's called the bankruptcy court. Out with the old detritus and in with the new.

I guess I should be a little gentler on governmental ineffectiveness. It's not ALWAYS bad. At least their ineptitude at getting things done has (so far) forestalled the ridiculous waste of my future tax dollars.

The argument that "all the other countries are doing it, so we should" is so juvenile to refute, I can only take a fatherly tone in response: "If everyone else jumped into the Grand Canyon, would you?" Actually, the correct (and my favorite) response is this: "Great! Buy more foreign cars then!" If Japan, China, or Germany is willing to government-subsidize those companies, this is the same as a government rebate to US buyers of their cars ... provided by other countries, and thus free to the US. It is a straight transfer of wealth from German or Japanese taxpayers to US consumers. In these economic times, what could be better??

And then there's the argument that it's government-provided health care abroad that cripples the US manufacturers. If only GM didn't have to provide insurance, they'd be fine ... right? Guys, don't say that one too loudly or you might scare off Mercedes, Honda, Toyota, and the other foreign companies who manufacture here in the US ... and actually make money at it!

Or how about the "strategic industry" argument, that says domestic heavy industry is in the national interest, for example in case of war. By this argument, our national interest is already a complete basket case. We are not a country which can throw up mile-high steel walls and continue our way of life in a vacuum:

  • Our economy relies on foreign buyers of our goods and services. Suddenly absent these, we'd certainly undergo some length of depression.
  • Our economy relies on imported labor to support our domestic production of goods, services, and intellectual capital. Without dishwashers, strawberry pickers, IT consultants, physicians, and physics PhDs (just to name a few), our domestic economy would falter on multiple levels. Cost of production would shoot up, prices would skyrocket (or red ink would flow), lines would grow long, quality of service would suffer, as would our ability to innovate.
  • Our economy relies on a vast array of imports. We could not support our current demand for anything from TVs to computers to sushi to gym shoes solely based on domestic supply. Let's be clear: I'm not saying we COULDN'T produce those things. We haven't forgotten how. We just couldn't make/cultivate enough of them cheap enough to keep prices at a manageable level.
  • Even our national security, and that of our citizens abroad, cannot be 100% guaranteed by our many current forces of persuasion. We rely on neighbors, friends, allies, and enemies alike for some explicitly or tacitly agreed level of security assistance. Calling all the troops back home to stand shoulder-to-shoulder on the border simply wouldn't guarantee safety, as we've seen many different ways in the past few decades.
  • Even in case of war, should we decide GM, Ford, and Chrysler need to stop making SUVs and switch to tanks, it could not be done immediately. There would be a massive retooling and engineering period before this could be executed, just as there would be if we had to ramp up production from a much leaner auto-industry.

Bottom line, the George Washington-style bunker mentality didn't even work in HIS time, much less now. Obama is wrong on many things, but here he's right. Our national interest, our future prosperity and security can ONLY be furthered with deep, ubiquitous engagement with our fellow Earthlings. If you need any further evidence why, Tom Friedman's mantra "hot, flat, and crowded" pretty much sums it up.

Thursday, December 11, 2008

Blog Shout Out: Bailing out the Piano Industry

I couldn't have said it better myself, so I won't. One of my favorite bloggers, Jeffery Tucker over at the Mises Institute places our current, and beloved, federal decision-making in all it's ridiculous splendor in his recent post "The End of the US Piano Industry" I highly recommend reading it.

He even goes out on a limb enough to suggest that we must comply with ... ugh, don't say it ... [cringe, eek] ... reality.

Economics demands forward motion, a conforming to the facts on the ground and a relentless and realistic assessment of the relationship between cost and price, supply and demand. We must learn to love these forces in society because they are the only things that keep rationality alive in the way we use resources. Without them, there would be nothing but waste and chaos, and eventual starvation and death. We simply cannot live outside economic reality.
Here here, Jeff. Well done.

Mark Perry quoted the article on his (also awesome) blog. One recent comment starts "You gotta love the Austrians [Nik: the economists, not the citizens]. They make complex things look very simple..." Sadly the commenter then runs right off the rails, saying "They do this by avoiding the truly complex questions." he then goes on to rant about issues which, to be generous, I'll call tangentially related. So to Machiavelli1999 I say this: "Sometimes simple really is enough. Dumbass."

Monday, December 08, 2008

Containers and Car Lots

When people used to ask me about the state of the US economy, especially vis-a-vis other countries, I'd take them out to Port Newark, NJ. It's not hard to size up the situation there: Huge stacks of empty shipping containers meant that the dollar was strong and the US economy was perking right along. Empty lots meant that the economy and/or the dollar was weak and there wasnt much economic activity.

Well, here's rule three: if those lots are, instead, crammed with thousands of unwanted cars, we've got oversupply. The economy is tanking so fast they can't turn the boats around in time. Prices will have to fall (deflation anyone?), losses will have to be absorbed, inventories will have to settle down to normal levels. This all will take time.
And "time" is really what this whole panicked crisis mania is all about. Things will return to normal sooner or later. If we collectively thought it would take a week, nobody would be panicking. I can wait a week to buy a new car. But to wait a year or more would be painful, indeed.

So there's the bottom line: economic pain will be defined in terms of time. Patience, as always, will be a virtue.