$600 Bln? Lookout, the Fedcoats are coming...

Fed announces another $600 Bln of "Quantitative Easing" (read money printing to buy Government debt). This is to join the other 5.5 trillion dollars of debt that is already owned by the FED. This dwarfs the puny approximate $1 trillion each we owe China and Japan.

So is this good or bad?

This new $0.6 Trillion, is swapped for government debt on the open market and is the mechanism used to bring the interest rate down. The fresh cash injected will get loaned out again and again multiplying the amount of loans. This will introduce many trillions of new money into the economy through bank loans. Theoretically, new bank loans don't disturb the balance if the loans create assets of equal value to the loan (e.g. build a factory) but too many of new loans go to speculation where no new value is created, only inflation.

Lets see where the next speculation bubble is going to be. My bet is on gold.

Prosperity Index

No two people will truly agree on what "Prosperity" is but these guys took a crack at it.
Found it interesting that countries with a socialist bent top the "prosperity-index" for 2010. Of course the index itself is highly subjective but food for thought.

One has to ignore Norway due to its highly subsidized economy (from oil) but the others stand on their own merits.

Here is the list:

The Top 10:

1. Norway

2. Denmark

3. Finland

4. Austrailia

5. New Zealand

6. Sweden

7. Canada

8. Switzerland

9. Netherlands

10. United States

From here:

http://www.cnn.com/2010/LIVING/10/26/prosperity.index/

Cutting up the American Pie.

Since the 70s the size of the American Economy (real income) has essentially doubled. How did this larger pie get divided up?

None of this growth went to the bottom quintile. Two thirds of it went to the richest 20%.

There is a lot of outrage over this and its in many articles.

So here is a dumb question. Since the rich have all the investment dollars and investors want p

ositive real returns, isn't this situation inevitable?

Maybe if I spell it out a bit clearer.

If the pie (U.S. production) is growing at 3% a year and investors in U.S. based investments are seeing their share of the pie grow by, say, 6%, then their gain is someone else's loss. The investors are getting richer at the expense of the wage earners. Only if the investments grow at the rate of economic growth can the situation reach equilibrium. If the investors in the U

.S. are making higher real returns than economic growth, those investors are structurally taking pie away from non-investors. So here is proposition number one:

In the U.S., the capital owners, by design, get a steadily increasing percentage of the pie than wage earners if they get above economy returns. This gets a bit murkier when you consider that U.S. investment will often have some overseas component but in some ways this can apply to many countries.

I've put some numbers together from census.gov to highlight the trend which has been in place since the 60s. The surprise for me was that even a big chunk the middle classes, often the knowledge workers , were losing share to the rich. I would love to do some research into the 50s and early 60s when the trend was the opposite to try to find out exactly what was going on.

One may argue that the rich's capital is necessary to make the pie bigger in the first place, a debate for another time, but it seems its built into the system that the rich's slice of the pie will, by design, grow faster than everyone else's.

Where do the poor people come from....?

If you want to understand the poor, study the rich. They create the poor, or at the very least, decide how many of them they will tolerate.

In most advanced countries the average worker pays an average of about 35% tax. A big chunk of this tax goes to the "poor" of society in the form of public education, healthcare and some form of social security. These Governments, for all their inefficiency, seem to have gotten a lot of it right. The majority of these countries have abolished life threatening poverty, starvation and widespread disease. A miracle which would have been inconceivable a few hundred years ago in any of these countries. Unsurprisingly, rich people believe they are taxed too high and poorer people believe that they are ripped off by the rich. Rich and poor alike believe they could all be better off if the government wasn't so wasteful.

The U.S. is a strange animal in this regard. It has low voter turnout, especially in mid-term elections. The rich and middle classes vote, the poor don't. This is the opposite of a country like India. As a result the rich are more represented in the U.S. Government and the poor wonder why the policies go against them. This is one reason why the voters in the U.S. are going to punish the Obama administration in the upcoming mid-terms for spending a lot of their money on healthcare for the poor, something taken for granted in most other countries.

I looked over some stats. The most common stat used to measure income disparity is the Gini Co-efficient but I've picked another one here as I think its more intuitive. I've divided the Consumption of the richest 10% by the poorest 10%. The rankings based on this stat is almost identical to using the Gini stat. The raw data is here:

http://siteresources.worldbank.org/DATASTATISTICS/Resources/table2_7.pdf

But some interesting ratios I calculated:

In the U.S. the richest 10% consume 16 times the amount the poorest 10% consume

U.K. the number is 14

Germany 7 times

Finland 6 times.

The poorest African and South American Countries vary between 50 and 150.

The U.S. has more of the problems of poverty than, say, Germany. Higher crime rate, higher incarceration rate and more health problems and lower life expectancy for poor people. However, the U.S. has a higher entrepreneurial rate, higher average income and number of millionaires per capita. The argument is too much wealth redistribution (via taxes) curbs incentive and innovation for all and brings down everyone, even the poor.

However, when you compare the incomes of the bottom 10% in each country, the U.S. comes near the bottom. http://www.contorno.org.mx/pdfs_reporte/diciembre08/growing_unequal_ocde.pdf page 37.

One of the most disturbing statistics I've seen in recent years (from the Economist) is the levels of "escape". If you are born to parents in poverty, what is the likelihood that you will remain in poverty all your life. Using a somewhat inaccurate and blunt value of, say, the bottom 20% being "poor", the chances of getting out of the bottom quintile in the U.S. is about 1 in 7, whereas in Finland is about 1 in 2, and the U.K. is about 1 in 3. Essentially, if you are born poor in the U.S. you stay poor, and since the poor don't vote, it's likely to stay that way. Not the American Dream you expected.

The Damage of Ivy League Schools

The most disappointing thing in life may be its brute unfairness. The greatest decision you can make is to be born to the right family. Choose poorly, and there is little forgiveness. However, the education system may give you a second chance. Higher education is the level playing fiend and if you are talented enough you can get into a top ranked school where you can become a real leader. Except that this isn't true. Not only do Ivy League schools show the same bias as the rest of society, but they are major players in propagating that bias. I put forward the argument that America puts the irrational demand on its leaders that they must graduate from these Universities.

The last 4 presidents did their graduate degrees at either Yale or Harvard, out of a choice of hundreds of possible universities. Out of the 200 accredited law schools in the U.S. only 3 are represented in the supreme court (Harvard, Yale & Columbia). The top law firms in the U.S. hire from only a few establishments. Getting a top job in Industry and Government seems to require going to the right university. Harvard, Columbia and Stanford are the business schools most represented in the top spot of fortune 500 companies. The rule today is, if in doubt, hire the guy with the shiniest degree, usually from a business school or law school.

So maybe these are the smartest people in the U.S. Maybe these Universities got it right and deserve the role of king-makers in our government and industry. But the problem is that they get it wrong. This is evidenced by a few things:

(1) CEOs with ivy league degrees, on average, perform worse than the others, suggesting that there is a tendency to promote them past their competence (http://www.forbes.com/2002/04/25/0425ceoschools.html)

(2) When there are situations where the success is blind to the college degrees, it is shocking how little having an ivy league degree seems to matter (e.g. the fastest growing founder-run small companies have few ivy league people at the helm)

(3) If you are to believe that the top Universities pick only the best people, then you have to assume that the top people coincidentally are mainly from the richest 10% of the population, and until recent decades structurally excluded women and minorities.

Almost all the students accepted by these top Universities do reach a certain minimum standard based on grades and standardized tests. However, once this standard is met, the remaining criteria used to select the students is straight out of Jane Austins rulebook for selecting a husband. Your chances of getting into a top University for undergrad is theoretically about 1 in 10. If you are not a minority, athlete and didn't go to a top private school, or have a parent that went there, the chances are more like 1 in 30 and its getting harder.

I do have an ivy league degree myself (Columbia) and I think many of my peers would agree that it was astonishing the caliber those turned down compared to many who were let in.

If you are from the rich ruling classes and your parents went to an ivy league schools you are much more likely get in because:

(1) You have the money to go to the best private schools who will give you not just the best education with the best teachers but the best extracurricular activities and sports too. There are more "athletes" from rich elite prep school sports (like rowing and fencing) than from popular sports like basketball and football.

(2) You have a plethora of family and friends that can help you with essays, resume padding and other soft portions of the application process. They can make sure you learn French in France at 12, volunteer for the right projects when you are 14. Trust me, if you are applying to these schools completely by yourself, the odds are so against you getting it right by accident.

(3) Through your connections, you are likely to have glowing references from very important people which many of these universities seem to openly want.

(4) Almost all the schools lower the requirements for children of alumni. They are quite open about it.

(5) Lets face it, if you last name is Rockefeller, Carnegie or Bush they might (and do) reduce the requirements, and not just a little.....

There is a wonderful investigation of this process in the book "The Price Of Admission" by Daniel Golden.

So four fifths of the students will come from the richest 10%. The remaining "poor" fifth of students have included people like Bill Clinton and Barak Obama. Bill Clinton had developed powerful political friends in spite of his poor background and Barak Obama had the additional advantage of his race. Even so, consider how small this group actually is compared to the 80% that includes George Bush, John Kerry and a disproportionate group of politicians sons and daughters. There are few second or third generation senators that did not go to Ivy League schools or have children that go there. Its called the greatest affirmative action program in history. When they open up more positions in Universities for athletes and minorities, they take those positions from the unconnected middle class people, not the connected rich people. This makes getting in through the front door even harder by merit alone, especially for those unfamiliar with the system.

But is this wrong? These are private institutions that should be free to allow in anyone they wish. There are many industries that cater only to the rich (the yachting industry comes to mind). This formula has worked for a long time and resulted in these Universities having massive endowments measuring in the tens of billions in certain cases. The children of the incumbent wealthy and powerful are likely to themselves be wealthy and powerful enhancing the status and wealth of the University when they graduate. Their policies are meant to look out for the University, not to be fair. Why would and should they change?

I believe the problem lies somewhere else. Why does the political machine only allow Harvard and Yale people apply for the position of president? If Barak Obama had graduated from the highly competitive U.C. Berkeley instead of Harvard Law could he still be President? By not considering the graduates of the other 197 law schools in America for the supreme court, surely America is losing some important and diverse viewpoints. Why is America shrinking its pool of candidates to apply for the most important jobs? This wasn't the case so much in the past. There is so much evidence that ivy league degrees (including the likes of Stanford which is technically not ivy league) add little to the raw abilities or values of individuals compared with those who went to lower ranked colleges with the same academic scores. So the blame is really with America itself for blindly valuing something for much more than what its worth. Other countries seem to be able to get by without being obsessed like this , why can't America?

I don't really know why America puts this bizarre requirement on it leaders. It allows for little forgiveness. Get into the right University as an 18 year old or you are out of the race for the rest of your life. Three law schools have become the sole candidate pool for the most important legal roles in America. Perhaps its because Hollywood is glamorizing these Universities. Perhaps the rich and powerful go there with reserved places so it automatically becomes the club meeting hall. Perhaps its just become an accepted tenet that people don't question anymore.

Whatever the reason, its hurting America. If the top spots in the country only go to people from a tiny set of universities which mainly representing the richest 10% of the population then the contribution of the other 90% will be diminished and everyone loses.

Is The National Debt a Dream...?

According to the national debt clock (http://www.brillig.com/debt_clock/) every baby, toddler, child, teenager and adult owes $44,000 each in future taxes (with interest) on behalf of the government just to repay stuff that has happened years ago.

The national debt could be eliminated if the Fed just printed a note just like the one to the left but changed "Zimbabwe" to "United States". In fact there would be quite a bit of change left over. I bought this on ebay a while back and as I understand it this particular note would have bought you a loaf of bread in Zimbabwe until they lopped 12 zeros off their currency.

The FED can issue money to buy any stuff Congress allows. If its hasn't enough money, Congress can allow it to issue more. If it wants to buy chickens instead of T-Bills, Congress can pass a bill to allow that too. The FED typically only buys Treasury Bills (short term and sometimes long term) in accordance to prearranged monetary policy, such as controlling inflation by manipulating interest rates but has let its goals get a bit more complex over the years.

All U.S. debt is in dollars. The Government can wave its magic wand, print off a couple of trillion and wipe it away.

If we do a one time print off (more like press 1 and a few zeros into a computer) whats the worst that can happen.....?

(1) A massive inflow of dollars not backed by production or economic growth will result is a huge devaluation of the dollar and show up as a period of massive inflation.

(2) The banks will get mad - Suddenly their 30 year fixed mortgages will be for bargain basement interest rates which will be lower than inflation - That said, they will still be making profits, just in devalued dollars.

(3) Anybody owed money will get mad. All debts will become in devalued dollars making them easier to repay but the creditors will feel ripped off since they will be in essence getting less money back.

(4) Everybody will see the value of their savings drops, although real assets like houses should be okay since their prices will adjust to inflation

(5) People will not take the Dollar seriously as the international reserve currency. Even Americans may try to do transactions in other currencies if they believe the Government will print their way out of trouble.

But if debt mounts and we cannot pay whats the worst that can happen....?

(1) Everyone who owes money and will not be able to pay as there is not enough money to go around - Foreclosures and repossessions

(2) With massive debts mounting:

(a) Consumption will go way down

(b) Unemployment will soar

(c) Profits will disappear

(d) An inevitable recession and maybe depression

So its inflate or default.

This printing of money has been done many times before - (as evidenced by the Zimbabwe note above) and resulted in no one trusting the currency and ridiculous inflation. In fact the "quantitative easing" we are doing right now is essentially a "printoff" where the U.S. Treasury debt is being bought by the FED. One hand of the government is printing money to buy the debts of the other hand. One could be excused for wondering if one day the FED will do a massive debt forgiveness to the Treasury.

But the FED could print a lot more and forgive all debt in one swoop. Are we at this desperate crossroads yet? Depends on whom you ask . However, if they take the printing press out of the basement for a "one-time fix", will the politicians every put it back? Its just tooooo easy to keep going and never worry about balancing a budget again. The road to Zimbabwe is paved with good intentions.

The most dangerous man I ever met.

There was an old monk that came to visit us in catholic school once.

His order had taken a vow of poverty and discussed the freedom and benefits

that such a life offered him and tried to convince us to join him. He was the most dangerous man I ever met!

If everyone became content with the basics and took a vow of poverty, then we could get used to consuming a WHOLE LOT LESS. Unemployment would soar as there would be no one to buy the BMWs, tequila sunrises and Tivos. It would probably take about 10% of the population or less, to be employed to feed and clothe the other 90%, although what would the other 90% barter with? The only way to make it seem fair would be to not allow anyone use technology developed in the last 200 years and go back to a medieval style life. That way, we could all be kept busy as subsistence farmers.

The economy runs on the principle that, in order for there to be full employment, the average Joe must consume about as much as an average Joe can produce. When you add up the labor gone into your hairdryer, your facial, your bus ride, your japanese chia pet, they should all average out to the amount of stuff you have produced (approximated by your income). Even your savings, if re-invested or re-loaned out by the bank, will end up being spent on labor somewhere. It makes sense. You can only consume in a year what is produced in a year (ignoring a lot of unsustainable craziness going on with credit right now)

As Joe gets more productive, he must also get more consumptive, as otherwise unemployment goes up. As luck would have it, turns out that human nature has a tendency to consume as much as you can afford. So long as the seven deadly sins remain in vogue (particularly vanity, greed, sloth and gluttony) we are all safe. But if the population suddenly comes over all funny and only starts consuming what they need and not according to their ego, then the machine breaks, unemployment soars, and since the unemployed can't afford anything, production itself collapses until we all embrace the welfare state.

As all processes undergo immense automation its getting harder and harder to imagine full employment in the future. As less and less labor go into every device, our consumption of stuff has to grow by orders of magnitude. We have lasted to far since consumption has kept up with production and when people can't buy more of the stuff they need they will buy stuff that makes no sense (e.g. $2,000 sunglasses) in some primeval ritual to create levels inside the societal tribe.

So the race is on. Can consumption keep up with production? I hate to bring up the Luddite argument but it is true that some day in the future we will produce cars, burgers and foot massages with no people involved in the production. Heck, the technology is available today. So what then? And if productivity per person keeps growing rapidly, when does it stop?

Stay tuned over the next 100 years as we see economics reinvented.....