Friday, January 13, 2012

Aggregate Demand

Even among Conservative Economists, the solution for job creation is to increase Aggregate Demand including government spending.  This blog is the only one that offers an alternative to the conclusions of Supply and Demand Theory.  In N Theory it is not Aggregate Demand, but Wealth that increases the willingness of the consumers to spend.  Even in Supply and Demand Theory it is the spending of money that increases Aggregate Demand (the total demand for goods and services over a specific time period).  For instance, it is the amount spent in a year on goods and services.  We can all agree with that definition, but it gets complicated when we compare this amount to Aggregate Supply (the volume of goods and services produced within the economy at a given overall price level) and then make predictions about the quantity sold (the main criteria for the number of jobs in the economy.  In other words, the price of goods sold equals the cost of goods produced including a profit. 

Now all the terms are in money.  We are talking apples to apples.  Therefore, the number of jobs in an economy is related to the amount spent on goods and services.  N Theory does not argue Supply and Demand Theory is wrong in this commonsense explanation, but disagrees about the role of government plays to increase spending (Aggregate Demand).  Supply and Demand Theory states if government increases spending (Aggregate Demand),  Aggregate Supply will increase as well.  This equation did not work during the Great Depression and did not work after the Great Recession.  Government spent lots of money, but the number of jobs created was minuscule.  N Theory explains that it is not the amount spent by government that matters, but the wealth and security of consumers (Buyers) that creates jobs.

In conclusion, it is not government spending that stimulates an economy, but a sense by consumers and manufactures that sustained spending will increase.  Consumers need confidence to take money out of savings or borrow to make a purchase.  They get this confidence when they feel their wealth is stable or increasing.  This  additional spending is stimulative since it expands the Money Supply by an amount equivalent to the profitability created.  Likewise, Manufacturers need confidence of increased consumer spending so they will take risk to expand their business and hire new employees.  Government spending actually discourages consumers and manufactures since government spending implies a problem in the economy and likely increased taxation.  It also implies a consumer or manufacturer's wealth is unlikely to increase and might actually decrease.  Government can spend us into a recession, but never out of one.

Tuesday, January 10, 2012


 In the midst of the 2012 Republican Presidential Primary Governor Romney has been declared the “most electable” candidate.  Why is that?  One reason may be that he possesses “gravitas” and the other candidates do not.  Gravitas is not charisma.  Charisma is a sort of attractiveness derived from our animal nature.  It is a magnetism derived from our heavily dominated sexual being.  It is the quality Hollywood looks for in a leading man and People magazine seeks for their cover.  Gravitas on the other hand is a quality we look for in our leaders rather than someone we look at and drool over.  Gravitas is a seriousness and intellectual focus that we seek in someone who will help us to understand or solve an issue.  Charisma is a quality of someone we want to be around, but it is not a quality that we expect to help us do anything.  Charisma is about making us feel warm and fuzzy inside.  Gravitas is the quality of confidence.  People with gravitas exuded intellectual superiority.  People with charisma exuded physical superiority. 

In a society that needs to overcome economic difficulties would be wise to select a leader with gravitas rather than charisma.   Many economic theorists possess gravitas.  Keynes certainly had gravitas.  Alan Greenspan had gravitas.  It is difficult to determine if historical figures had gravitas.  Without video tape it is difficult to speculate, but it seems so.  The importance of gravitas cannot be overlooked by a society seeking solutions to their problems.  The most brilliant of observations and the best advice might be overlooked when delivered by a messenger without gravitas.  

Therefore, Wall Street and Pennsylvania Avenue are not wrong to seek people to lead their corporations and country that possess appealing qualities.   But careful selection of traits is as important as choosing the potential candidates.  Often qualities like physical attractiveness are given as much weight as gravitas by the selectors.  This is a backwards approach.  The proper approach is to evaluate the position and determine what qualities the position requires rather than comparing the candidates side by side before meeting basic standards.  Comparing the candidates without providing a filter of personal qualities required for the job ends up skewing the criteria for selection.   For instance when the candidates are compared a quality like sense of humor or compassion might propel one candidate to the top of the pack even though those qualities are not significant requirements of the job.  Job skills need to be weighted and evaluated for each candidate before they are placed side by side for comparison.

If you are an American and will be voting to select the next United States President, first evaluate what five hurdle qualities a Presidential candidate should possess.  While you are mulling that over here are my minimum requirements:

·         Experience raising a child

·         Graduate school experience (could be as a perceptive janitor)

·         Three years of experience in a minimum wage job

·         Ten years of Private Sector experience

·         Gravitas

With that type of experience a candidate would have knowledge of all the most significant activities of human life: child rearing; higher education; the bottom of the economic ladder; understanding of the operation of the economy; and the ability to convey ideas.  Note, I do not think any experience in political life is necessary.  What is your list?

Friday, January 6, 2012

Need for New Economic Theory

I just came across a paper published in April 2010 that shares a number of the same assumptions underlying N Theory.  It is the work of three economists: Orio Giarini working in Switzerland; Garry Jacobs an American working in India; and Ivo Slaus working in Slovenia.  Their paper is titled: "Introductory paper for a programme on The Wealth of Nations Revisited."

Like N Theory they begin by recognizing that our economic system is a social system created by humans and therefore, can be modified by humankind.  Similarly, they point out the world has changed in the past couple of hundred years and yet out current economic theory is "constructed on a foundation laid more than 200 years ago."  The authors of the paper point out that "today the world suffers from excess production capacity backed by insufficient purchasing power."  N Theory starts from this same point showing an insufficient supply of money in the hands of people.  A supply inadequate to support the productive capacity available to fulfill all wants and needs.  N Theory states this is the problem with conventional economic theory.  It does not achieve the purpose of economics: wealth creation adequate to provide for basic necessities.  As Giarini, Jacobs and Slaus note "classical and neo-classical economic theory incorrectly focus on the central importance of supply and demand, rather than on the central importance of human welfare."  In the Rule of Money a couple of chapters are dedicated to showing the inadequacy of supply and demand theory.

N theory makes wealth creation central to the goal of a new economic system since implementation of effective change will require financial resources.  In N Theory the Wealth Rule: The purpose of a monetary system is to create wealth, plays a dominant role in deciding among what sector of the economy should be in charge.  The three authors of the paper cited above agree with this approach when they state; "The goal of economic systems is the generation of wealth to promote human welfare." 

Agreement among economists about the idea of wealth creation alone would provide a benchmark for evaluating economic policy.  Much of economic policy activity surrounds fixing holes in the dyke rather than understanding the goal is to keep seawater out of the wetlands.  If the repair is inadequate and results in the collapse of the dyke then a new system needs to be constructed.  We can do that since as the paper points out, "As distinct from physical systems, social systems are man-made and purposeful.  They are capable of conscious adaption and evolution."

N Theory is a new purposeful system that intends to create more worldwide wealth and distribute in a fair and equitable way.  Along the way this process will eliminate the special privileges that the influential and powerful possess.  N Theory is just the first step, but it is a map that can point the way.

It is encouraging to see prominent economists from Europe are along on this journey.

Upside Down Asset Pyramid

The Icelandic Banking Crisis is a good lesson for every financial manager to remember.  In a country of 300,000 people the banks grew assets from $1 billion in 2000 to $140 billion in 2006.  Little of this money came from depositors.  Most of the funds came from the issuance of bank bonds.  All of which needed to be paid back with interest.  It was attractive to bond investors to make these purchases since the market prospects for the banks looked so positive.  The bonds looked extremely secure since the bonds paid a 3% interest in Yen or Euros, and money could be lent at 15% in Icelandic Kroner (the prevailing interest rate for Icelandic loans).

Unfortunately, the interest spread is only stable if the currency values do not change relative to each other.  When the inevitable currency collapse occurred the loans in Kroner were returning less than the interest due.  Unfortunately, without a central bank Iceland had no way to protect their currency. Since the bank depositors were making deposits in Kroner and the bank needed to pay back their loans in Yen and Euros the situation only got worse and worse.

Although the poor financial decision making of the Icelandic banks caused the crisis, their decisions like the investments in RMBS during the housing boom of the early 21st century were not egregious or fraudulent.  The time for throwing stones should come to an end and be replaced with a thoughtful strategy to avoid the problems reoccurring.  The easy, but incorrect solution is to throw the bums out.  The problem with that approach is there are always going to be bums.  It is human nature.  What we need is a system that prevents the bums from getting into positions of authority.   That is probably impossible also.  Our next best alternative is a system that prevents the bums from taking advantage of the system.

I suggest we return to the original solution that led to the creation of central banks, spreading the risk.  The original purpose of central banks was not to control the Money Supply or set interest rates or the most ridiculous of all, increase employment, it was to spread the risk of a bank run across the entire banking industry. 

What we are discovering with the European Debt Crisis is even a continent is not larger enough to absorb the losses of a financial mistake of a single country.  Therefore, why not expand the community of banks to include the entire world.  The banking industry could achieve this without government assistance.  It would simplify regulation and with a large Private Sector insurance agency providing the backstop for the banks it would remove government from a business they do not understand and they could focus their resources or building missiles and outfitting Presidential jets.