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« Sensible: Tom Cruise is allowed to film in Germany | Main | When Venezuelans shout ‘Freedom,’ does the Chavez mob take names? »

June 29, 2007

Comments

JR88


Frank, you conclusion is wrong. GDP is just a measure of economic activity and it doesn’t take into account currency differences. Purchasing Power Parity, or PPP, does factor in currency differences. Furthermore, the economic activity doesn’t take into account the amount of debts US borrowed to maintain that level of consumption. Perhaps you are unaware, but US currently have almost $9 trillion in debts, and estimated $45-70 trillion in unfunded liabilities. The UN feels our debts are unsustainable. We pay more in interest to service our massive debts, than we do to fund our educational system.

When you account for currency differences, China is already 75% of US PPP. China also has a much healthier balance sheet, since it is not burdened by massive debts and unfunded liabilities. It has almost 1.2 trillion in reserves, and about 50% of GDP in savings. Therefore, it’s pretty clear it has a stronger balance sheet than US.

When you look at the growth rates, with US at an anemic rate of less than 1% this quarter, and China humming along at 10%+, it’s easy to figure out that China will surpass US by PPP in the near future.

Economic activity as reflected in GDP, is not the same as economic strength. With US spending borrowed monies, increasing the debts by almost $3 trillion dollars during Bush’s term, that doesn’t strengthen the US economy, but weakens it. We are now more dependent on foreign financing. Look at the net sellers of US Treasuries, including our allies UK and Japan, who are quietly selling.

Frank, you are misinformed about our economy, drawing your conclusion only by GDP. Rather than just look at GDP, look at PPP for currency adjustment, and analyze the health of an economy by looking at its balance sheet and income statement.

jj mollo

I think it's a little silly to characterize the PRC as having a "healthy" economy. Finally, finally, it has placed itself on a growth path, and of course, of course, it is growing very fast. Look where it started. It had only one thing going for it, and that was good central control with a freshly capitalistic concept.

Now, however, it is suffering all the curses of growth. It is a chaotic, cruel, corrupt, polluting, robber baron driven, exemplar of warlord capitalism. No country has ever grown at this rate. It is making foolish decisions and exposing itself for an eventual crash of horrific proportions. That being said, the pains of growth are better than the pains of stagnation and starvation. But really ...

For example, one thing the PRC is doing wrong is subsidizing gasoline for consumers, even while gas prices rise, thereby encouraging a automobile-dependent culture in an environment that cries out for investments in infrastructure, public transportation. What do they think is going to happen when every citizen has a car? Haven't they ever seen Los Angeles? Do they really want to follow that model? They are building coal-burning plants in the numbers by the week! When China already reeks with pollution. Don't they know how big they are? China is not one of the countries that will benefit from global warming.

An unfortunate highlight of their business culture is unchecked parasitical tendencies. Knockoffs. Piracy. Dishonest and even dangerous business dealings. At some point they are going to reach a critical mass where the PRC logo will go radioactive. I think it's close. The US has started to react to some outrageous PRC excesses and the PRC is reacting as if there were no problem beyond US greed. Tit-for-tat, they say.

What good is this US currency they are holding? They can't afford to use it. If they do, the dollar will plummet and they'll be left holding the bag.

The problems of growth are desirable problems I suppose, but there is more reason to worry about China than the US.

Frank Warner

JRBB, I'm totally with you in demanding that we look at the economy in many ways. As you point out, the United States has an enormous debt burden.

I often remind readers that our debt is out of control, our entitlements entirely unfunded. You might have noticed even in this post, I've pointed to our manufacturing decline and our failure to expand domestic energy supplies.

As far as China goes, my point has always been that China would overwhelm the world peacefully with its arts and sciences if it simply would free itself, not only economically, but politically. We'll see what happens there.

JR88

Frank:

It’s great that you see the US debt burden, and the major problems with our unfunded liabilities. Just for some perspective. Our estimated unfunded liabilities are greater than our estimated net worth. A smart accountant may retort and say, “Yes, but those liabilities are not all due in one year”. That’s true! But what it means is a large portion of Americans will be in trouble if they are counting on our entitlement programs for their retirement and health care. Do you know the number one reason for bankruptcy in America is health care cost?

Some people will draw wrong conclusions simply because they are only looking at GDP, and mistakenly think things are fine. I look at a lot of facts and data, some from our US Treasury, OMB, GAO, Reserve forex holdings, GDP, PPP, Macro and Micro Economic policies, Federal Reserve fiscal and monetary policies, our National balance sheet and income statement, Central Bankers around the world and their rebalancing activities, net sellers and buyers of US Treasuries, Foreign financing of US debts, etc. to come to an honest and objective analysis of the US economy.

China is not the problem. They are actually helping us finance our massive debts. Without their financing, interest rates would be even higher. Congress is looking for someone to blame, and China makes an easy scapegoat. But if we look at the facts and data objectively and honestly, it comes down to this:

1) The consumer sector of our economy over consumes, to the point it borrows money to consume. We have almost $8 trillion dollars in mortgage debts, and credit card debts aren’t much better.

2) Our government sector continues to deficit spend, which adds more debts to our already existing massive debts.

3) We live in a gratification now society, where the typical American forgot how to save. We uses to be a saver nation, and now we are the largest debtor nation in the world, by a very large margin.

4) Some economist estimate that Iraq will cost us another $2 trillion dollars before it is done


The problem is very clear, but the solution is difficult. Our consumer and government sector consumes too much, even to the point of consuming with ever increasing borrowed monies. Both sectors need to consume within its means. Our Congress can do more for America by passing a Balance Budget Amendment, stopping deficit spending. Congress can also pass legislation to provide more tax incentives to encourage more people to save, and tax penalties to discourage over consumption. For example, passing a large gas tax will stop some people from wasting gas. We have artificially low gas prices compared to Europe. Congress should use its powers to change behavior, not pander for votes.

JR88

jj mello:

This is only my second time on this website, so I have not read your posting history to know if economics, finance, and accounting is your forte, or not. But based on your last response, you are only giving me your opinion, without any supporting facts or data. I don’t make specious opinions, because I feel it is a waste of time. I actually look at facts and data from many different angles to form my opinions. I also support my opinions with facts and data. I hope you invest the time to do likewise, so you can honestly and objectively see the problems and identify possible real world solutions to these problems.

China is not the problem. We (Americans) are the problem. See my post to Frank above. The sooner we take ownership of these problems, instead of looking for a scapegoat, or looking for other countries to fix our problems, the better off we will be. China didn’t make Americans over consume. China didn’t make our government deficit spend. We did that all by ourselves.

China has pollution problems, so encouraging more Chinese to drive cars will increase pollution problems, not to mention the cost of gas and other natural resources. But since we are the biggest consumers of natural resources (we are 5% of the world’s population, but we use about 25% of the gas and natural resources in the world), we have zero credibility to tell other countries to conserve. We need to lead by example if we want the rest of the world to listen, since no country is interested in following a hypocrite.

As far as China’s forex holding reserves, you are just uninformed. Even if China were to stop buying, their existing holdings are already costing us a lot. Since demand for dollar denominated assets are going down, we need China’s financing even more.

Here are some facts for you:

1) The rest of the world will not finance US indefinitely. During the period of March 2006 – March 2007, if not for China, Brazil, et al, US would have a net negative (meaning more Treasuries sold, than purchased). The countries that have excess savings, and can keep buying US Treasuries, are running out. Even US allies like the UK and Japan, are quietly selling. If China weren’t still buying, US would be in far deeper trouble.

2) As oil countries like Russia, Iran, and Venezuela increase oil transactions in euros, rubles, etc., demand for US dollars will sink further as others will not need as much petrodollars.

3) During Putin's address to the International Economic Forum, he talked about making Russia an alternative financial center with the ruble as a world reserve currency for other Central Banks. If this happens, that will further reduce demand for US dollars, so attracting financing will become even harder.

4) Putin also proposed creating several more world reserve currencies. Perhaps he is thinking of the ruble, or the RMB, or the eventual AU currency? If this happens, Russia may decide to sell more of its oil and gas, using alternative currencies besides dollars, further reducing demand for dollars.

5) Putin proposed creating a “basket of currencies” to trade goods and resources and create greater parity between countries. This is morally fair since the owner of assets and or resources should sell in whatever currency his wants. He can even decide not to sell resources and withhold it as strategic reserves.

6) In the last several months, Norway, Iran, Syria, UAE, Kuwait, and Venezuela announced they are cutting back on their USD reserves, converting to euro or a “basket of currencies”. As the dollar weakens, there is realistic concern about it as a “world reserve currency”. If Central Bankers go to the euro, ruble, or perhaps a future AU currency, then who will buy dollars and lend to US?

7) Putin is working on a gas cartel, to include Russia, Qatar, Iran and Algeria. This group control 40% of the world’s natural gas (these NG transactions will not be in dollars).

8) Brazil, Russia, India, and China are the four fastest growing economies in the world. One can make a good case that the Ruble and the RMB should be world reserve currencies in the future. An AU currency may eventually replace the RMB, which would not shock me, since the ASEAN platform already exist as a prelude to an AU.

9) If the ASEAN platform becomes an AU, then it is reasonable to expect an AU currency. Given the gravity of all the potential members of AU, it’s also reasonable to expect transactions will be done using the Asian currency, within the member countries, and perhaps even beyond it as a world reserve currency.

If you understand these realities, then you understand we need China’s financing. Our Congress is pandering for votes, instead of honestly and objectively passing legislation to help change consumption patterns, and reverse this growing problem. We can only control what we do, not what we want others to do. If our solution is dependent on changing other countries, we are in for a rude awakening.

Frank Warner

I'd like to see a value-added tax on imports and exports, to help fund our unfunded liabilities.

Two years ago, this VAT was supposed to be the funding source for Bush's plan to save Social Security, but the Democrats in Congress refused to even debate the idea.

Considering how much more this country imports than exports (and considering how the Social Security fund soon will have no loot-able income), a value-added tax on imports and exports would benefit the United States in many ways.

jj mollo

JR88,

I admit I am uninformed. I am uninformed on just about every topic. But I think a lot and I believe that ideas can be evaluated reliably by people who don't know a lot if they stick to certain principles of analysis. One of these principles is that I respect other people's opinions but I don't respect their claims to authority per se. I also respect my own opinion enough to defend it vigorously against anyone. If you convince me of something, my opinion will change (perhaps a little more slowly than it should.)

It so happens that I agree with the bulk of your comments in the your most recent comment, the one that was directed at me. I believe that the US is doing a lot of things wrong, that our people are self-indulgent and that our government is always reluctant to give us the bad news and tell us to straighten up. I think our deficits in foreign exchange and our budget deficits are very dangerous, but I'm also aware that there are arguments among economists on exactly how bad these things are. The economy remains strong as near as I can tell. The trade deficit with China is largely driven by the fact that Chinese products are incredibly cheap and by the fact that China has been holding the exchange rate fixed. They are choosing to over-invest in US currency for reasons of their own. I believe they are trying to subsidize employement by keeping exports strong. Is this silly of them? I believe we are simply buying all this stuff because its a good deal for us. Does it not make sense to borrow when a fire sale is going on? Yes we need to do something, but what is it? It's hard to trust the wisdom of our leaders, but the Market itself will do a lot to make up for our stupidity, assuming that you and I are right on that we're being stupid.

As to your first post, I thought you were speaking as a defender of China rather than as a US citizen. My response was that comparing the positions of China and the US, I'd rather be in the position that the US is in. Do you disagree with that?

I strongly share your worries about Putin, but is it realistic to think that the ruble can be used as a "world reserve currency"? We need to take steps, dramatic steps, to curb our appetite for foreign fossil fuels. That is the secret for dealing with most of the threatening aspects of foreign market manipulation. Putin's monopoly powers would evaporate if we were to keep the prices soft.

Another question. Why is it such a great benefit to be the "world reserve currency"? You seem to imply that the transition to another currency would naturally coincide with some sort of catastrophic collapse of the dollar and the world currency trading system in general.

JR88

Frank:

VAT on imports and exports will not really help us as much, for 3 reasons.

1) VAT will hurt US MNCs like Wal-Mart, Target, etc., since they import a lot of products to sell to US consumers. Perhaps you are fine with punishing these US MNCs, which is a separate issue. But using a VAT to help our unfunded liabilities is a drop in the proverbial bucket, since we are talking about estimated unfunded liabilities of up to $70 trillion dollars.

2) Net Exports is really just a very small percentage of total GDP. Here is the traditional GDP formula. (Percentage of each component vary from year to year, but these are the approximate %)

C + I + G +NX = GDP

C: Consumption spending (about 65% of total GDP), consumers buying things like cars, furniture, and appliances, food, clothing, rent paid on apartments (or estimated values for owner occupied housing), airplane tickets, legal and medical advice or treatment, electricity and other utilities, etc.

I: Investment spending (about 18% of total GDP) varies significantly from year to year. Investment includes the building of factories, the production of new machines, and the manufacturing of computers for business use, building new homes or apartments, inventory changes consist of changes in the level of stocks of goods necessary for production and finished goods ready to be sold, etc.

G: Government spending (about 21% of total GDP) consists of federal, state, and local government spending on goods and services such as research, roads, defense, schools, and police and fire departments. This spending does not include transfer payments such as Social Security, unemployment compensation, and welfare payments, which do not represent production of goods and services, etc.

NX: Net Exports (about –4% of total GDP) are equal to exports minus imports. (This number is negative because imports are greater than exports)


When you look at the components of GDP, it’s obvious Investments are too low, and consumer and government spending is too high. I feel it is more effective to focus on 85% of the problem (C and G), rather than just –4 of the problem.

3) Even if we had trade parity today with China, where Net Exports go from –4 to 0, it still will not fix the root problem of how we got to massive debts and unfunded liabilities. C and G got us here. Fix 85% of the problem, and you will be much more effective in reversing our increasing problem.

JR88

jj mello:

I don’t need to assert authority to buttress my opinions. I’m comfortable using facts and data to support my opinions, and welcome anyone to fact check me. If someone can make a cogent argument and support their opinions with facts and data, I can also change my mind too! Specious opinions with no supporting facts or data, is a waste of time.

You assert the economy remains strong. My question is, “Based on what?”

The RMB is relatively cheap. China does buy US Treasuries and other dollar denominated assets. It is also maintaining its currency within a narrow trade band relative to the dollar. Their currency policies support exports. We can only control what we do, not what we want others to do. If our solution is dependent on changing other countries, we are in for a rude awakening. China didn’t force us to over consume. China didn’t make our government deficit spend. We did that, and it is time we take ownership of this problem. Furthermore, even if we had trade parity today, it still would not correct the massive debt and unfunded liabilities. Review the GDP components above and I think you will agree Net Exports is the wrong area to focus on since it is such a small percentage of GDP. Common sense tells me we should focus on 85% of the problem, instead of -4 of the problem.

The Ruble is not a strong currency. But if Putin requires that Russian oil and gas must be purchased in Rubles, then the Ruble will gain international legitimacy as a world currency since others who want Russian oil or gas, will need Rubles to buy, creating steady demand for Rubles. If the Ruble becomes a widely used Petro-currency, then Central Bankers will need to include Rubles as part of their currency reserves, which can make it a de facto world reserve currency. If the Ruble becomes the currency to buy Russian oil and gas, given the insatiable demand for oil and gas, then Putin will successfully legitimize the Ruble for Central Bankers around the world to include as part of their reserve portfolio.

Gold was once backing the US dollar. In the 70’s, Nixon took us off the Gold Standard, and made the dollar backed only by the full faith and credit of the USA. He did this partly so US could print fiat dollars to pay the deficit, debts, etc. He knew he needed to support the dollar to maintain demand as a world reserve currency that other Central Bankers would want and need. He did so by convincing the Saudis, the Middle Eastern countries to make oil transactions in dollars. For several decades, US and UK maintaining the two largest oil bourse to conduct world oil transactions. They required oil transactions be done in dollars, to maintain demand of dollars so US can print fiat dollars to pay bills. In the real world, the euro came alone. I also gave you a list of other reasons why demand for dollars is going down steadily. When there is reducing demand for dollars, increasing money supply by printing more dollars, is downright bad since history tells us that will result in hyperinflation.

But since our politicians are so afraid of not getting re-elected, they rather adopt policies that result in inflation, than to tell the people to stop over consuming, save more money, and we need to increase your taxes to pay the bills. Inflation is really just an indirect tax. I remember my father raised a large family on one income, as my mother didn’t need to work. Today, that is more the exception, than the rule as inflation has made almost everything more costly, compared to the past.

Therefore, it’s understandable that US wants to maintain the dollar demanded by Central Bankers around the world, as a reserve currency, so it can keep financing our consumption. But the rest of the world also wants demand for their currency for similar reasons. Central Bankers around the world make decisions regarding their reserve portfolio based on what is appropriate for their country and their needs. If more and more countries convert to euro, or ruble, or a basket of other currencies, that means less demand for dollars, which ultimately means less available financing, which ultimately means US will need to pay its own bills. That why the intense focus on what currencies will countries us to conduct oil and gas transactions. I think it is morally right for the owner of assets and resources to decide what currency to use, for transactions.

Frank Warner

If the VAT would be a drop in the bucket, then it's a start. It wouldn't "punish" Wal-Mart. It would require that Wal-Mart and American consumers pay their way in a nation that has too many unfunded obligations. The price difference hardly would be noticed, particularly if China keeps manipulating its exchange rate.

You can target consumer spending and reasonably restrict consumer credit, and that's fine. But one part of the economy always affects all other parts of the economy. I could argue that restricting consumer spending is another way to "punish" Wal-Mart, but I won't.

And cutting government spending? Fine again. At least freeze it. But that's more easily said than done. Social Security is about to run out of its cash stream and baby boomers are starting to retire. Medicare is near bankruptcy and people still get sick. And we do have a few undropped shoes out there (Iran and China, for examples) that might give us some new economic shocks in the next decade.

We know the bills are on the way. Let's get some money in the bank.

JR88

The VAT idea on imports and exports is a drop in the bucket. Some economists feel there can be unintended consequences not only for a VAT, but also for tariffs in general. With dollar demands going down steadily, and assuming we will continue deficit spending, we do need foreign financing. Here is the irony! Congress is asking for a tariff, and want China to revalue the RMB up, because they feel that will help US exports. China can revalue the RMB by slowing new purchases of dollar assets, reducing forex reserves, but that will result in higher interest rates in US, because we still need the foreign financing. Our housing sector has increasing foreclosures partly because of interest rate increases.

Let’s assume for the sake of discussion that we did the VAT, and we have trade parity now (I’m not saying this assumption is correct since I do feel there are unintended consequences that will render a VAT ineffective in getting the desired results), it still doesn’t solve 85% of the problem, with over-consumption by the consumer sector, and deficit spending by our government sector.

I don’t mine punishing US MNCs, especially exploitive ones like Wal-Mart, but that is another issue. To me, the realistic solution starts with things within our control.

1. Consumer sector cut consumption, increase savings (that will reduce trade deficit)

2. Government start spending within its revenue means (Balance Budget Amendment)

3. Reform our Health Care System (HMOs, Medical Insurance Industry, Big Pharmaceuticals, etc. is killing US competitiveness) I read somewhere that GM cannot compete with the Japanese because health care cost for its employees is greater than the cost of pension contributions. I cannot verify if that statement is true or not, but if true, that is a good sign the system is broken.

4. Stop unnecessary wars like Iraq, which some economists think will cost us another $2 trillion dollars

5. Develop an actionable plan to reduce our debts, so we are not so dependent on foreign financing

6. Develop an actionable plan to reduce our reliance on foreign oil

Focus on ideas that we can do for ourselves, within our control, as a realistic start to reversing USA’s increasing economic problems.

jj mollo

On the strength of the US economy:

I don't know if history counts for anything, but our real GDP has been growing for a long time. According to the PPP tables in Wikipedia we are substantially behind only Luxembourg and a handful of islands. Does that indicate we have a strong economy? I seem to remember that the Dow was breaking records recently.

Here's what the US Treasury Department has to say about the current status of the economy:
Job Growth: 157,000 new jobs were created in May and 2 million new jobs have been created over the past 12 months. The United States has added 8 million jobs since August 2003 – more new jobs than all the other major industrialized countries combined. Our economy has seen job gains for 45 straight months. Employment has increased in 47 states and the District of Columbia within the past year. (Last updated: June 19, 2007)

Low Unemployment: The unemployment rate of 4.5 percent is close to the lowest reading in six years. Unemployment rates have decreased or held steady in 32 states and the District of Columbia over the past year. (Last updated: June 19, 2007)

Here's one of Bush's advisors, Alan Hubbard on the state of the economy.

Here's the Washington Post:
The U.S. economy turned in a surprisingly strong performance last year, new data show, growing 3.4 percent despite higher interest rates, high oil prices and the sharpest housing downturn in 15 years.

The report from the Commerce Department, showing that economic growth picked up in 2006 from the 3.2 percent growth of 2005, dispelled any lingering doubts about the momentum of the economy going into this year. Many economists predict growth will slow this year, but gone are the recession worries of last summer.

"Nothing, other than an external shock, will derail the economy this year," said Eugenio J. Alem?n, senior economist at Wells Fargo. "The economy's in good shape."

Here's Carl Steidtmannat Deloitte Touche:
While the housing industry certainly faces a difficult year, much of the rest of the economy is doing quite well. The services sector remains extremely strong. Financial services, health care and professional and business services are all experiencing strong growth. Non-residential construction is also doing well as road building in the public sector and new office and lodging construction in the private sector are taking up some of the slack from a declining housing market.

Here's Ben Bernanke:
... As expected, we have also seen a gradual ebbing of core inflation, although its level remains somewhat elevated. Despite recent increases in the prices of crude oil and gasoline, energy prices overall are below last year’s peak; the rate of increase in shelter costs seems likely to slow, although the timing remains uncertain; and long-run inflation expectations, as derived from both surveys and market-based measures of inflation compensation, have remained contained. However, although core inflation seems likely to moderate gradually over time, the risks to this forecast remain to the upside. In particular, the continuing high rate of resource utilization suggests that the level of final demand may still be high relative to the underlying productive capacity of the economy.

OK, maybe we're skating on thin ice. There are several long-term problems for the US: 1) increasing inequality in wealth, 2) extreme dependency on certain commodities effectively monopolized by small groups of countries, 3) fiscal intemperence, 4) possible changing climate impacts on productivity.

Basically, I stand by my statement that the economy is strong. There's no need to be apocalyptic just yet.

jj mollo

On Balance of Payments problem:

JR88, you and I and Warren Buffet agree that the trade imbalance is a serious problem that needs to be attacked on many fronts. But I do think you can't just roll over the opposing viewpoint. Milton Friedman, himself, felt that it was no big deal.

Here's a quote from Wikipedia:

... The United States has been carrying a negative current account balance for many years, and this debt has been primarily financed by issuing securities. This interpretation of the data, however, is disputed by Milton Friedman (Balance of Trade) claiming that cheaper, riskier, foreign capital is exchanged for "riskless", expensive, US capital and that the difference is made up with extra goods and services. Nevertheless, Friedman's interpretation is incomplete with respect to countries that interfere with the market prices of their currencies through the changes in their reserves. ...

and another:

...Milton Friedman, the Nobel Prize-winning economist and father of Monetarism, argued that many of the fears of trade deficits are unfair criticisms in an attempt to push macroeconomic policies favorable to exporting[4] industries. He stated that these deficits are not harmful to the country as the currency always comes back to the country of origin in some form or another (country A sells to country B, country B sells to country C who buys from country A, but the trade deficit only includes A and B). In fact, in his view, the "worst case scenario" of the currency never returning to the country of origin was actually the best possible outcome: the country actually purchased its goods by exchanging them for pieces of cheaply-made paper. As Friedman put it, this would be the same result as if the exporting country burned the dollars it earned, never returning it to market circulation. ...

Warren Buffet has a very interesting idea for controlling the problem:

... Buffett proposes a remedy so simple it's odd that, given his profile, it's received so little attention. Under his system, you couldn't import into America without holding permits to do so. And the only way to get a million dollars worth of import permits would be to achieve exports of a million dollars from America — or buy the permits from someone who had. ...

jj mollo

On Balance of Payments problem:

JR88, you and I and Warren Buffet agree that the trade imbalance is a serious problem that needs to be attacked on many fronts. But I do think you can't just roll over the opposing viewpoint. Milton Friedman, himself, felt that it was no big deal.

Here's a quote from Wikipedia:

... The United States has been carrying a negative current account balance for many years, and this debt has been primarily financed by issuing securities. This interpretation of the data, however, is disputed by Milton Friedman (Balance of Trade) claiming that cheaper, riskier, foreign capital is exchanged for "riskless", expensive, US capital and that the difference is made up with extra goods and services. Nevertheless, Friedman's interpretation is incomplete with respect to countries that interfere with the market prices of their currencies through the changes in their reserves. ...

and another:

...Milton Friedman, the Nobel Prize-winning economist and father of Monetarism, argued that many of the fears of trade deficits are unfair criticisms in an attempt to push macroeconomic policies favorable to exporting[4] industries. He stated that these deficits are not harmful to the country as the currency always comes back to the country of origin in some form or another (country A sells to country B, country B sells to country C who buys from country A, but the trade deficit only includes A and B). In fact, in his view, the "worst case scenario" of the currency never returning to the country of origin was actually the best possible outcome: the country actually purchased its goods by exchanging them for pieces of cheaply-made paper. As Friedman put it, this would be the same result as if the exporting country burned the dollars it earned, never returning it to market circulation. ...

Warren Buffet has a very interesting idea for controlling the problem:

... Buffett proposes a remedy so simple it's odd that, given his profile, it's received so little attention. Under his system, you couldn't import into America without holding permits to do so. And the only way to get a million dollars worth of import permits would be to achieve exports of a million dollars from America — or buy the permits from someone who had. ...

jj mollo

Permit me to interpolate my opinions here:

1. Consumer sector cut consumption, increase savings (that will reduce trade deficit)

I agree with this, but to be fair I think we seriously underestimate the amount of savings in the US. Most of the people I know are investing a fair amount in 401K pension funds and a lot of people invest in real estate and improvements to their properties. This amount is ignored in the analyses I’ve read and I’m not sure that it should be.

2. Government start spending within its revenue means (Balance Budget Amendment)
I agree strongly with the first part but not the second. I think that the govt needs to be able, for fiscal management of the economy, to overspend in times of crisis and recession. I just think we need more self-discipline so that the average over time comes to zero.

3. Reform our Health Care System (HMOs, Medical Insurance Industry, Big Pharmaceuticals, etc. is killing US competitiveness) I read somewhere that GM cannot compete with the Japanese because health care cost for its employees is greater than the cost of pension contributions. I cannot verify if that statement is true or not, but if true, that is a good sign the system is broken.
Agree. The fact that other countries subsidize medical care is indirectly subsidizing their businesses, making our businesses relatively less competitive. The single-payer system is the way to go. Not to mention the fact that the current system is really unfair and inefficient.

4. Stop unnecessary wars like Iraq, which some economists think will cost us another $2 trillion dollars
I disagree strongly on this one. How do we know Iraq is unnecessary? And how can we evaluate an investment without knowing the cost of its alternative? There are reasons why people argue over this subject.

5. Develop an actionable plan to reduce our debts, so we are not so dependent on foreign financing
Agree. But once again, there is a body of economic thought that does not. Market forces have a way of balancing things out.

6. Develop an actionable plan to reduce our reliance on foreign oil

Yes, Yes and Yes! For many reasons. I’m in favor of a fossil fuel tax and a massive increase of nuclear power development. CAFE standards and conservation across the board are also necessary. I don’t think President Bush is against any of this in principle. Frank has blogged about the intertwined issues of Global Warming, and fossil fuel dependency on numerous occasions. Here’s a partial list.

http://frankwarner.typepad.com/free_frank_warner/2007/05/sen_bob_casey_w.html
http://frankwarner.typepad.com/free_frank_warner/2007/05/would_nasa_offi.html
http://frankwarner.typepad.com/free_frank_warner/2007/05/al_gores_soluti.html
http://frankwarner.typepad.com/free_frank_warner/2007/03/uh_oh_saudi_ara.html
http://frankwarner.typepad.com/free_frank_warner/2006/04/banana_approach.html
http://frankwarner.typepad.com/free_frank_warner/2006/04/greenpeace_cofo.html
http://frankwarner.typepad.com/free_frank_warner/2006/04/1975_when_the_c.html
http://frankwarner.typepad.com/free_frank_warner/2005/10/global_warming_.html
http://frankwarner.typepad.com/free_frank_warner/2005/06/president_bush_.html
http://frankwarner.typepad.com/free_frank_warner/2005/02/nuclear_power_v.html

JR88

jj mollo:

GDP/PPP is probably the two most often misused and misunderstood economic statistic. GDP and PPP is a measurement of economic activity, not a measurement of economic strength.

Let me give you a simple example to illustrate the point.

Person A

Income: 50,000
Living Expenses: 40,000

Balance Sheet: 0 Net worth

Person B

Income: 50,000
Living Expenses: 40,000

Balance Sheet: 0 Net worth


Both have the same exact income, living expenses, and have a 0 net worth, to simplify this illustration. (In the real world, there are other variables like taxes, inflation, cost of living adjustment,etc. (which favor the saver and investor)

Person A: Will spend all his $50,000 income, and will borrow Person B’s $10,000 surplus every year for the next ten years to spend and consume.

Person B: Will only spend $40,000 and save the $10,000 every year to loan to Person A.

Fast forward to year 10:

Person A:

Income: 50,000
Living Expenses 40,000
Interest Payable on Debts

Balance Sheet: Liability of $100,000 ($10,000 x 10 years)


Person B:

Income: 50,000
Living Expenses 40,000
Interest Earned on Debts


Balance Sheet: Assets of $100,000 ($10,000 x 10 years)

Summary: Person A had a $60,000 GDP and Person B had a $40,000 GDP for each of those 10 years. But after 10 years of over consumption by Person A, he has a weaker balance sheet and income statement than Person B. During those ten years, Person A, consumed more stuff, more economic active, but it didn’t translate to strong economy, because Person B not only has greater net income, but stronger balance sheet. Person A has a negative net worth of $100,000. Person B has a positive net worth of $100,000. I know this is a very simplified example, but it does illustrate the difference between Person A, a chronic over consumers burdened with high debts, versus Person B, a chronic saver and investor, benefiting from interest income and assets. Therefore, it is a mistake to use GDP/PPP as a representation of economic strength.

If you have purchased a home or business before, you will know a lender will ask for the financial statement – namely balance sheet and income statement. The income statement will show your ability to repay the loan. The balance sheet will show how secure is the loan. That’s real world, as GDP/PPP is neither income nor assets. That’s why no one can go to the store to buy something with GDP/PPP.

(Continue next time)

George

Person B's positive net worth consists of a $100,000 IOU. As JJ pointed out, if the dollar were to plummet, that IOU isn't worth so much.

Economic activity is what creates jobs. When a rich man simply keeps his money under the mattress, it doesn't do anybody any good. If he spends money, it gives others work to do and, in turn, gives them money to again spend, in turn, creating work for others. It has a snowball effect on creating jobs.

jj mollo

I would agree with George. It all depends on what person A spent his money on. If A were spending the money on infrastructure, durable goods, education, health improvements, investiments that promise future rewards, then it may well be worth it.

I don't think we spend our money wisely enough, but I don't think we are completely profligate either. My big issue is that we don't see where our money goes and what other people do with it. The oil money we spend is being used against us, not to buy our products and services. The drug money likewise. Those are are biggest foreign expenditure mistakes.

If, on the other hand, I buy a 3 dollar hammer from the PRC, a good hammer worth $20 from Western sources, then it's a good investment to borrow the 3 dollars, even if it costs me a little interest.

There is a Keynesian argument for flexibility. I don't think Nixon was wrong in releasing our currency either. Markets can be trusted. But you do have to be smart about it and you need to exercise a little self-discipline, and to that extent I agree with you. I'm still interested in what you think about Buffett's idea.

Preevyet

4. Stop unnecessary wars like Iraq, which some economists think will cost us another $2 trillion dollars.

Would you say the WWII was unecessary? Korean War? VietNam? Gulf War I? How can you say any war is unecessary? Unfortunately, war is a necessary evil, and by definition is a continuation of political means. It's all political, and stopping a ruthless dictator and restoring democracy should not have a price tag on it. You can't just look at what something costs in a war, or you'll lose the point. And don't say Iraq is pointless, because you obviously have never been there. I loaded $250,000 missiles during Gulf War I, and we fired of over 400 of them. Not to mention the cost of fuel, and labor to load them, fly the jets, etc., was it worth it? Well, Kuwait is a "free" country and not a province of Iraq, so yes it was.

JR88

George:

I think you undermine your argument. If the dollar is plummeting, that is even a stronger reason I rather be Person B. I understand inflation and devaluing the dollar will ultimately reduce the interest earnings on that investment, but at least Person B has investment income to earn. Person A has no investment income.

Person B has $100,000 in Assets generating interest income, and increasing net income.

Person A has $100,000 in Debts, costing interesting expense, and decreasing net income.

That is a difference of $200,000 swing in net worth.

In bad economic times, I rather face it with savings, than with debts.

I never say anything about just sitting on the money and keeping it under the mattress. I’m a real estate syndicator and investor. I understand and apply the concepts of money multiplier, leverage, ROI, etc. Person B is investing his surplus and earning a return. I only used a simple example, because the issue here is NOT how to leverage and get the highest ROI, IRR, etc. or to enhance return, as that is a different subject. This was a simple example to illustrate the difference between a chronic spender burdened with debts, versus a chronic saver and investor, benefiting from added passive income.

Spending does create jobs. But if you look at the GDP breakdown, too much of our spending is in the consumer consumption sector (65%), and not enough in the Investment sector (18%). We spend the vast majority of GDP buying depreciating consumables that don’t generate a return, and don’t spend enough buying appreciating Investments that do generate a return. We are only growing GDP by spending borrowed money, and getting deeper in debt. That’s why the balance sheet and income statement is getting weaker. GDP is just economy activity, not economic strength.

Regardless of the economic outlook, I would still rather face it with savings and assets, rather than increasing debts and unfunded liabilities. The argument of inflation and devalued dollars only make the choice easier, since those external factors affect both Person A and B.

jj mollo:

Let me think about Buffett’s idea some more, before I answer you. It’s an intriguing idea. Over the weekend, I will have more time to reply to your earlier posting. Can you expand on the Buffett idea some more?


Preevyet:

Yes, I can say Iraq (current war) was an unnecessary war. You may not agree with me and that is fine. You and I are entitled to our respective opinions. Just because you served in a war theatre, doesn’t make your opinion more valid than mine.

I feel Osama bin Laden should be our first priority because Al Qaeda did 9/11, not Saddam. We should prioritize our military to go after bin Laden first, because we have limited available military personnel. By using so much of the US military in Iraq, we weaken our ability to get bin Laden. This is about priority, so I disagree with Bush’s priority.

JR88

jj mollo:

I clicked on your Buffett link, and I don't see this article you are referring to. I like to know more details about the Buffett proposal, so I can comment on it.

jj mollo

JR88,

Which of our previous wars would you agree were necessary? What would be the maximum expenditures you would be willing to invest for each of them? Is this really just about money?

I don't know any more about Buffett's idea than is printed in The Age at the link shown above. I suspect he might have more detail on the Berkshire Hathaway site. I haven't looked in a couple years, but I'm sure he's got some essays that are well worth reading.

jj mollo

Yes. I had the same trouble. I'm not sure what it is, though it might be all the fruit salad on the end of the url. This is the same address, but it's a little fresher and trimmed. Try
squanderville.

jj mollo

I think George's IOU analogy is pretty good. In the real world, person A goes bankrupt. Person B settles for 25 cents on the dollar.

You really can't save money like that. You have to do something with the money and you have to decide among investments. The reason you give it to the US is that they are the country most likely to be good for it. But it's silly to give even the US that kind of money. If you need it in a hurry, it's going to shrink. Trying to maintain a fixed currency exchange will just make it that much worse. China should be using the money for quality public education and for keeping kids in school instead of sending them to work in brick factories. It should be using the money to protect peasant farms and to build mass transit and bullet trains like the ones in Japan. Surely they have a better use for it than we do.

JR88

jj mollo:

I read the Buffett article, and I see several problems. I will write about it during the weekend since my response will take more time to write.

As far as your assertion that in the real world, Person A goes bankrupt, and Person B settles for 25 cents on the dollar, that is not true. What do you do for a living, since that is not real world?

I have a lending division, so I’ve seen many 1003’s, 1040’s, 1099’s, and plenty of personal and coroporate balance sheet and income statements. In the real world, a lender like Person B would look at Person A’s financial statement, not get sidetracked by his GDP, and apply sound underwriting guidelines to determine ability and security. B can continue to lend to A if the ability and security as represented by A’s balance sheet and income statement is still financially sound. Otherwise, B can stop lending and move on to a stronger borrowed. Furthermore, since B has savings, he can chose to not lend at all, and find better investments that give him a better return. I simplified the example so as not to introduce too many extraneous variables that sidetrack from illustrating the core principle – how to strengthen one’s finances.

Strengthening the financial statements is simple to learn, but it requires some discipline and consistency to execute.

- Make Income or Revenues (if it is a business)
- Spend less than what you make, so you have some surplus every month
- Save that surplus, and invest it for higher return investments, to create more passive income
- Do this with discipline and consistency every month
- Your investments will make more and more passive income
- When this goes on long enough, the passive income is large enough to replace the work income

This is a VERY SIMPLIFIED example of how to strengthen the financial statement, since the person who is doing the steps above, will have more and more income, and greater and greater net worth. As an investor, I have done real estate deals with other investor’s money in syndication, where I didn’t even have to invest my own money. I didn’t want to complicate matters and introduce too many variables since it doesn’t change the core principle - make income, save some, invest it, grow it, and get stronger financially. Make income, spend all of it, borrow to spend more, don’t save, don’t invest wisely, and get weaker financially.

Living by this simple set of principles has served me well.

(Continue next time)

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