A Rising Tide

I’ve been receiving emails with copies of opinion pieces that were forwarded to me by people who think I should get an insight into the viewpoint of those who are strongly opposed to any government intervention that they fear will become the foundations of what would be the end of Capitalism.

While I respect the concerns expressed, I’m equally cautious about the depth of the negative sentiments expressed based on what they project or perceive to be the ultimate goal of the current administration.

From a personal standpoint, I would hope that the government intervention that we’ve been witnessing of late is more akin to and can be likened to the air-bag in an automobile - it doesn't prevent an accident from happening and it shouldn't deploy until one happens. Like the air-bag, the government actions should help to cushion us from the full impact of the economic downturn. Similarly, just as it isn't advisable to drive around with a fully inflated air-bag, the interventions should not become permanent crutches that we become reliant on. Safe, defensive driving is always the better way to go.

Some notes of frustrations expressed in the emails were more pointed and pushed for the elimination of taxes (and thereby the government’s ability to spend or to intervene) and the adoption in its place a “user pays” system where the real tax payers are not forced to subsidize the cost of services rendered to those who don’t pay taxes. They argue that (i) American workers and industries are not competitive on an international level because of unnecessary regulations and taxes, and (ii) one half of the American population do not pay any taxes and they are the ones that take advantage of the services paid for or subsidized by the government through taxes imposed on the other half of the American population.

There is certainly merit to their claim that some of the recent government interventions have unfairly given the failing institutions a competitive advantage at the expense of others – why should any of the tax dollars paid by the innocent be used to save those who had lived vicariously and spent lavishly? In a free-market economy and in a true capitalistic environment, those institutions should be left to fail so that the laws of nature can prevail and others can come in and take their place.

Unfortunately, we have corporations and industries that have been allowed to grow so big that their executives can command remuneration levels that are sky-high while their failure have created a crater so big that it may cause other parts of the economy to implode. We also have been equally guilty of allowing unions to become so massive and powerful that the profits and resources that should have been reinvested into Research and Development to make better products to make our industries competitive have been diverted to fund benefits schemes that are way out of step with what the competition is paying.

If we truly believe that small businesses drive a major part of the US economy, we have to ensure that the laws favor them over the big corporations – or, at the very least, they are not at a disadvantage.

If we truly believe that executive compensation should be in line with the profits they are able to add to the bottom line each year, we have to ensure that a full assessment of the risks they have taken on are accounted for (and is transparent so that all investors are cognizant of their magnitude) and that the compensation is in tandem with obligations that stretches out for years beyond that in which the profits are reported.

If we truly believe that workers’ rights are trampled upon (with no unions to protect workers), we should enact laws that make them easily identifiable and punishable and leave the negotiation of wages and benefits to the dictate of the free market. If industry or a business underpays and is not competitive with other industries, it will so find itself with few qualified employees. What are elected government officials for if they surrender their duty and responsibility towards their constituents?

Government policy and intervention is a fact of our daily lives and are not all bad.

Monetary and interest rate policies affect businesses and individuals at every level but not everyone benefits at the same time. Businesses sure aren't complaining about the near zero interest rates of late but retirees depending on their savings for income are sure hurting.

The rich, in general, do not send their kids to public schools but millions of American families benefit from them. If only those who use public schools have to pay for those services, there would be a lot fewer Americans who can afford an education and that would be detrimental to the competitiveness of American employees and corporations.

Not everyone can afford the quality of healthcare that the insured, working population have access to thanks to the private medical insurance plans paid for (in full or in part) by their employers but it should not mean that the poor and those who are struggling and are uninsured should be denied even the very basic level of care. A healthy population can only be a good thing for the American economy. Anyone who says that the poor and uninsured can get medical attention by going to the Emergency Rooms at hospitals is in denial and ignoring the harsh realities of what that means. One can only wish on them the same ‘bad luck’ as they wish on the less fortunate.

A population that is continually progressing up the economic ladder can only be good for American industries and businesses. America needs a healthy, educated and progressively affluent consumer base. That’s what the economic growth in the last decades were based on.

These are exceptional times and we need exceptional solutions. We need to learn from history and not behave like Marie Antoinette who reputedly said “Let them eat cake” when told that the common, starving people on the streets of France had no bread to eat. Her head ended up on the floor of a guillotine.

These are times when the hard hit need the help of the more fortunate ones even more intensely. We can’t let the water drain from the lake and not be parched ourselves. After all, a rising tide lifts all boats.

Getting Back On Track

The U.S. economy is in the doldrums and, although the pace of job-loss appears to be slowing, the number of Americans claiming unemployment benefits is still at record levels – 6.35 million as of April 25. Further job losses can be expected in the months ahead as consolidations and reorganizations continue. Examples include:

- GM and Chrysler’s plant and dealerships closings. Suppliers to the auto companies that will be impacted will also shed jobs as a result.

- Production capacity cuts at Boeing, one of the last bastions of the American manufacturing industry, as both U.S. and foreign airlines opt to push back the delivery dates of aircrafts on order.

- Continuing declines in employment rolls in banking as the recent voluntary and forced acquisitions move forward and duplicate positions are eliminated.

Many analysts expect the jobless rate will hit 10 percent by the end of this year.

Despite all these troubling signs, the U.S. dollar has stayed strong, regardless of how many interest rate cuts we’ve witnessed and how big the deficit has grown and how much more money the U.S. Treasury has printed. As a matter of fact, the U.S. dollar grew stronger as the global economic environment became more unpredictable. Why? Simple – it is the world’s reserve currency.

Unfortunately the status of being the reserve currency works against America’s interest in such difficult times. The artificially strong dollar continues to make it cheaper to import goods from foreign countries than to manufacture locally. While it may be true that American businesses’ productivity is higher, cheaper labor and lax controls (on things such as environmental impact) in developing countries make it hard for American manufacturers to compete on a cost basis. Fiber optics, high speed networks, and expanded bandwidth that enabled and accelerated the migration of technology and back-office jobs to lower costs countries will remain in place and keep those jobs out of the U.S.

To get back on the track of economic growth, we need to see a gradual but significant decline in the value of the U.S. dollar. Here are some reasons why:

- A weaker dollar will make imports and foreign labor more expensive, reversing the trend of both manufacturing and service job migration to off-shore locations.

- Conversely, a cheaper dollar would also make American made products more competitive in the world market.

- Foreign businesses (especially those in the EU) would want to invest in the U.S. to take advantage of a highly trained and productive work force.

- Subsidies to the agricultural sector would no longer be required as U.S. agricultural products are more competitively priced on the world market.

- Tourism would boom as visitors from other countries find U.S. destinations more affordable.

The counter argument is that America has become so dependent on imports that the higher prices on imported products will result in inflation and will ultimately hurt consumers. That may be true in the short term and for certain products – in the longer term, the U.S. can be largely self sufficient in many areas. Inflation is less of a threat until the unemployment numbers have declined significantly and liquidity has returned to normal. Beyond that, the Fed has plenty of room to aggressively raise interest rates to prevent run-away inflation.

Sure, we won’t be buying as many imported toys and gadgets but that’s not a bad thing. We’ve become overly reliant on toys (children and adults alike) to make us happy. The growing rate of obesity is not just from junk food and over-eating – it is also from a lack of exercise and time away from toys that do not help us burn up all those extra calories.

The best part of a cheaper currency is that businesses will not have to cut wages or staffing to be cost competitive. Consequently, the bleeding of jobs to offshore locations will stop. As American products, priced in U.S. dollars, become more attractive in the world markets, manufacturing and other jobs in the U.S. will grow again.

Crude oil and gasoline prices will likely go up as oil producing nations demand more dollars for each barrel of oil they pump out of the ground. However, the higher prices will have a positive long term impact as it will provide us with a greater impetus to move forward with the drilling for new oil-fields in addition to using alternative fuel and energy sources that are cleaner, greener and more sustainable.

Strange as it may sound, we may not have to take more specific action to bring the value of the U.S. dollar down. The yield on U.S. dollar Treasuries is practically down to zero and the massive amounts of money that the U.S. government has injected into the economy to help soften the impact of the downturn and to stimulate growth and job creation will, in the long run, deflate the value of the U.S. dollar. Diabolical…!

What we need to see happen is a resurgence in the markets’ confidence that the economy has bottomed out and a recovery is likely, albeit somewhat in the distance. Hopefully, the trend of the Dow in the past two months is a sign that the present administration has done the right things to calm a nervous market and to rebuild a confidence that had been badly shaken by the sub-prime mortgage meltdown and by Madoff’s multi billion dollar Ponzi scheme.

SIDEBAR

If you’ve been watching both the DOW and the currency markets, you’ll have seen the dollar’s strength moving in the opposite direction – each time the U.S. stock market is doing well, the U.S. dollar is weaker. Just as investors flock to the U.S. dollar in their “flight to safety” during uncertain times, they become less risk adverse in a more upbeat market and invest in currencies with the expectation of a higher rate of return.

Illustration 1 below shows that between September and December 2008, the drop in the Dow was closely mirrored by the drop in the exchange rate of the Australian Dollar (meaning that the U.S. Dollar got stronger). As the Dow began its recent climb starting in March, so has the value of the Australian dollar.

Illustration 2 below show the same movements in the Dow versus the Euro. The trends mirror each other but the relationship is not as tight as in Illustration 1 above as the Euro is less of a “speculative” currency.