Receeding Capitalism

The series of unfortunate events in banking, spreading to manufacturing, to job losses had to reach governments too. Governments, like the brave kings of yore have ridden in to the rescue. They have bought up banks, guaranteed deposits, secured pensions. Do not worry, your money is safe with us. (To discuss whether these governments are safe would border on political, which I declare out of the scope of this space).

For years it is these very governments that have prided themselves on being the vanguard of capitalism. Through the IMF they have declared large public sectors evil. They have made privatisation a condition of more funding in many emerging markets. Conditions there were similar – high debt, high public sector deficit, high trade gaps and high levels of unemployment.  Then, these conditions were chronic, and the solution was to shrink the size of the government. Now, it is ironic, that the same issues result in expanding the government. Did I hear that right?

 

So what happens to capitalism in this brave new world? Does it get redefined? Are free markets an unsustainable myth? Is equilibrium a mirage? Will there always be power and politics that controls the balance between safe and sorry, between creative and chaos, indeed between rich and poor?

 

They declared the death of communism a few decades ago and now capitalism is on the wane, for it has proved once again to be a false god. Will we forgive this once again and go back to being ruled by fear and greed, or shall we choose new gods to rule over us.

Or maybe, is it just possible that we emerge into this world, where there is funding for every good idea, rewards for every honest saver and investor and security for every home while keeping freedom for every individual? If this sounds like a fairy tale, maybe it is, for it does not mention the dark underbelly of risk – where things go wrong.

I wonder, and this is just a thought, that if we did not deal with chunks of money, and dealt only with slivers, would things be different? We aggregated money traditionally only because of intermediaries who knew how to deal with them. Truly, in this day of web 2.0 (and growing), do we need these intermediaries at all? We need information, analysis, processes and transactions. But do we need these to be consolidated in financial intermediaries? Or can we throw this yoke off now?

To inflate or to deflate…

Damned if you do and damned if you don’t, spend money that is.

I bet there are many heads of government sitting across their finance advisors these days asking this question, “So, are you asking me to cut spending or increase it?” And I can bet that they do not get a clear answer. I bet that their answer goes something like this, “well, if you…then…,  and if you….”

Its like this: if the governments spend money on great public works or whatever, they will be doing some good. They will be providing employment, they will be putting money in the economy, they will be supporting businesses (both by buying goods and services for these great works and the salaries of their new staff who can now buy their goodies), and they will be earning taxes. The wheel goes round and round.

Sounds good, why don’t they do it? What’s the problem then? Here is the biggie: where does the money come from? Most governments too have debts (budget deficits), they do not have the money to spend. Can they not borrow? Of course they can, but where are the big banks that used to lend them money – oh yes, I remember – being rescued by the governments!

There is no money. Its not as if the government can just print more money!?…???..Can they? Yes they can. But should they do that knowing that if you have too much money chasing the same production/goods, then the prices will surely rise. That is inflationary. Which of course will take us right back to the begining of the problem.

Okay, so we do not like the spend money (inflationary) idea. How about what the other guys are saying – cut costs. All of us know we are in this mess only because we spent too much when we did not have the money. Fine, sorry. Lets change that now and cut spending.

Wish we could do that – but now that is even more dangerous. With all the job losses, there just isn’t enough money to keep the wheels turning. If the government cuts their own spending, and encourages others to do the same, there will be even more businesses in trouble and more job losses.  Recession.

How about a bit of this and a bit of that?  Do a bit of the support prices thing, and a bit of the cost cutting thing. Spend a bit, give businesses a boost, then when that is done, then work on the inflation. Can that be done? I think, that is what will have to be done eventually. But how it will be done is a very tough question.

Too much of or too many swings in the markets will only confuse everybody. The press will support the hue and cry, the stock markets will be confused and will tumble again, the consumers will start hoarding and businesses will not know whether they are coming or going.

This is a very tricky situation. I would feel sorry for the people in charge of governments if I was not so angry with them. They are responsible for a car with punctured wheels – if they inflate too much, the tyres could explode; if they allow too much deflation, then we wobble and cannot move on. Unforunately, they do not have a good reat time gauge to measure our sustainable well being, so they really cannot know whether their actions are doing some good or harm. But they have to try.

Take it to a garage, you say? Where are the experts? Don’t they have the answers. In theory they do. Among the many answers, there is one called reflation, and they can talk for hours about it and its nuances. It is a very useful framework, and the real test of it is now – when you have to actually do it. Its easy to say it, far tougher to show and do.

This is a game of skill, finesse and timing.  And our livelihoods are at stake.

 

 

(c) meetasengupta

Trendz

Ever noticed how tough economic times make us behave in certain patterns that do not seem logical at first sight?

Yup, hemlines ride up and all the way down, indicating boom and bust cycles, as was noticed in the 1920s and then the 1960s.  Some even believe that fashions can be used as a predictor of economic cycles, though I am not sure I agree with the logic in the linked article. They say that people feel more insecure in tough times and tend to dress more demurely. Less flashy = less cash, kind of logic.  While I understand the thinking behind covering up and feeling safe inside a cocoon of clothing as a response to insecure economic times, I do not see how it represents less cash flashed. I have seen some really expensive long dresses, and some really expensive short ones. I do not see the point here.

A Wharton economist called George Taylor even created a hemline index in the 1920s to correlate the Dow Jones Index with hemlines. I do not know whether he started off trying to demonstrate nonsense correlation. This is when stuff unrelated to each other shows high correlation levels, though completely meaningless. A good example of this would be the sun rising everyday and my doing my paperwork. The correlation would be a perfect negative, one always happens (thats the sun!) and the other never does. But the there is no relationship between these two. Anyway, Taylor discovered that the stock index was correlated to hemlines, and this has been proven time and again in the 20th century. I would be interested to hear of (serious) work done on establishing causality here. Does it only work one way? Can I and the sisterhood raise my hemline and ward off the bad times? Should kilts be the order of the day?

At the same time, using hemlines to predict economic cycles is a fascinating art. Unfortunately, while it tells us what is goong to happen, it does not tell us when it is going to happen. Not very useful for stock-picking then.

But there are things that we tend to consume more of in tough economic times. According to a New York Times article, we tend to prefer slow songs, laxatives and beans (any correlation between beans and laxatives?). Chocolates, dry goods, candy, beer and pasta sauce are supposed to be pretty recession proof. Stock pickers, anyone?

Hard economic times have been better for health in the Western economies. Apparently, Britain was at its healthiest after the war and rationing years. Butter, cheese and meat were rationed, people had to eat limited quantities of food. Everybody had to work harder, including physical work – involuntary physical exercise led to fitter bodies. This time round we do not have rationing, but higher food prices have led many of us to cut back on our consumption. This may be a good time to, like me, make some healthy economic decisions.

 

(c) meetasengupta

Of Rationality

Assumption number one of all socio economic sciences is rationality. All economic theories depend on this assumption, all models of financial behaviour are built to the expectation that the participants in the money game will behave rationally. If rational behaviour does not occur, the theories and models are rubbish – of less value and must be looked at again (rubbish).

So what is this rationality? It means that given a set of choices, people will always choose the option that gives them maximum value. So, if you have a choice between two banks to save your money in, one offering 3% and the other offering 4% returns, you will choose the one that gives you higher returns. Another example: if you have a sum of money to invest, you will invest it in a project that promises you the best returns (adjusted for risk).

Sometimes this does not work, of course. We are human beings and do not always operate in our best interests. (My coaching business is built on this assumption!) Going back to the example of the investor in a project: suppose he has two choices. One with a cousin whose family have been very kind to him and put him through school where the investment will yield 10% return. The other option is to invest in the bank at 10.5%. Both investments are for the same time period. The cousin’s business is of course more risky than the bank, but not really very much more. It is an established business and he just needs the money to refresh his machinery. The business has been giving higher profits than the 10% promised for this deal, so we are quite sure we will get the money back. What should our investor do?

Rationality demands that he maximises his returns and invest in the bank. But when unquantifiable emotions of loyalty, friendship or even fear come into the picture, economic decision making will not necessarily be rational. How will the computers and the financial models deal with this issue?

This is not the only time when rationality is abandoned. How many of us have said, “I must have a salad for lunch” and ended up eating something much more calorific? The rational decision making process was abandoned for something that gave a different kind of value. Or invested our purchasing dollars in the chocolate market when other markets made stronger calls on our wallet.

Why bother with rationality at all? Why does it matter? Because all of our markets are built and sustained on their ability to predict. The salad bar stocks as much salad as they predict rational customers will buy. If impulse takes over from rationality, then the shopkeeper must hold wasted stock, which, since it is perishable is a clear loss. 

Banks too have the same principle. They hold only as much loose cash as they predict will be required by their customers on a daily basis. The rest of the money that we put with them is invested in other people’s projects – locked away for a few years – you many say. If rationality gives way to fear, there will be a run on the bank. They will need to pay out more than they predicted, which of course isn’t there, at least for now.

What does that mean for us, the ordinary joe-on-the-street? Do we hold on to rationality just to keep their precious models and big banks going? Because, I’m going to do what’s right for me.

 

Yup, agreed.

And that’s the difference between micro and macro economics. Ditch the jargon, stay with the story. If I, blogjoe, feel insecure about my income and savings, I will start hoarding my money. Hell, I’ll even buy 50 cans of baked beans every few months and save them up. And so will a lot of people, because they are doing what’s right for them. If I could, I’d even stock up electricity payments and such like. And, I’m going to stop buying shoes, bags, chocolate, newspapers, cut back on cigarettes and alcohol.

What does that do to the economy if all of us do this? It kills the shoe industry, bag industry, chocolate industry etc. And they are employers too….but not for long. No income for them means no pay for their employees. Redundancies loom. Less money to spend means more companies in trouble, means more redundancies.

Does everybody suffer? And what does this have to do with rationality?

No, everybody does not suffer: The baked bean companies should do very well if all of us keep buying (till we get sick of them and the economy picks up!) Utilites are essentials, they should do well, as should discount retailers.  Our economic behaviour is perfectly rational, from our point of view. But my rationality is not our rationality. Once we understand that, we begin to understand why we are in a recession.

 

(c) meetasengupta