Risks Of Blind Extrapolation Ii

The 2003-05 'recovery' of the US economy is clearly attributable to excessive consumption paid for by deficit spending. This spending was encouraged by low taxes and low interest rates, the latter financed in turn by foreign investment in US government bonds.2 That investment has been explicitly intended to keep US interest rates low and the US dollar overvalued in comparison with the Chinese and other Asian currencies. An overvalued US dollar is very good for Asian exporters and US consumers, especially of oil, but very bad for US workers and manufacturers. The US consumption boom is being financed by a large fraction - as much as three-quarters - of the net savings of the entire world. This obviously cannot continue for long. How it will end nobody can say with certainty, but clues are beginning to emerge.

The extraordinarily low interest rates of 2003-04, together with unwise deregulation of the banking sector, led to the proliferation of 'sub-prime' mortgages, with adjustable rates that come into effect after the first two or three years. This 'teaser' induced many under-qualified people to buy homes they cannot really afford, while simultaneously creating a housing boom and rising real-estate prices. Meanwhile many of the risky mortgages have been packaged into mortgage-backed securities and sold to investors around the world. The rather sudden discovery that these securities are nowhere near as safe as they were advertised to be, has already caused the virtual collapse of one savings bank in the UK. As of this writing (October 2007), other financial ripples are feared. And the US housing market, booming until spring 2007, has also suffered a dramatic setback.

Apart from immediate problems, there are a number of other drivers of past growth that are now showing signs of exhaustion. These include: (1) the benefits of free trade (globalization), (2) monetization of domestic and agricultural labor, (3) job specialization (division of labor), (4) borrowing from past accumulation of capital to consume in the present, (5) borrowing from the future to increase consumption in the present, (6) increasing technological efficiency of converting resource inputs to useful work and power and (7) borrowing - in the sense of using without payment - from the waste assimilation capacity of nature.

The efficiency benefits of free trade today are considerably exaggerated by many mainstream economists who like the theory of international division of labor and ignore the reality. The major benefits are enjoyed by dominant producers who can exploit the fact that larger markets permit greater economies of scale and experience, thus cutting costs and prices (in a competitive market). But opening product markets to cheap imports also weakens smaller local producers and domestic trade unions, in both the US and developing countries. The net result is to intensify competition, driving weaker firms out of business and enabling surviving producers to keep wages low and to export jobs to low wage countries. Globalization is certainly one of the factors driving the increasing gap between income levels enjoyed by the top executives and the ordinary workers. It is not surprising that big businessmen favor free trade. But it is very questionable whether the lower consumer prices offered by Wal-Mart and other large-scale importers ultimately justify the adverse consequences to most wage earners and smaller companies, especially in the long run.

GDP growth during the past two centuries has been partly due to the monetization of (formerly) un-monetized domestic labor (by women) and subsistence farm labor. This process of monetization is now largely complete in the industrial world, though barely beginning in many third world countries. Specialization of labor was very important at the beginning of the industrial revolution, as pointed out by Adam Smith. It probably peaked a century ago during the heyday of Taylorism. Today, workers are actually less specialized than in the past, as specialized skills are increasingly embodied in machines and human workers are increasingly valued for their flexibility and ability to respond to change. Future GDP growth in the US cannot be driven by further monetization or specialization of labor.

In principle, wage earners are able to do one of two things with their income: spend or save. As mentioned earlier, simple economic models tend to attribute growth to saving and investment, even though higher savings must necessarily cut spending. 'Optimal' growth, in the Ramsey tradition, is determined by the tradeoff between spending in the present and spending in the future, which boils down to 'time preference' (Ramsey 1928). In reality, there is a third option that allows spending in the present: namely, to borrow. In principle, people borrow to purchase cars or houses, and the loan is secured by the object of the loan. When people take second mortgages, they are borrowing from their own accumulated assets. But unsecured credit card loans and sub-prime mortgages are a different matter. In principle, unsecured credit enables people to exist with negative assets. This problem is just now becoming acute.

More importantly, the population in the US, Europe and Japan is aging. The ratio of workers to retirees is declining rapidly, even faster in Japan and Europe than the US (which has more young immigrants, mainly from Mexico). Result: fewer workers to support more non-workers in coming years. Early retirement, longer life and declining birth-rates have exacerbated this situation. An aging society, like an aging individual worker, depends increasingly on wealth accumulated from past investments by others to pay for current consumption. When a society, or an individual, is young - has few assets - it (or he/she) must save and invest out of current income in order to enjoy greater income in the future. For a society, long-term investments range from education and research to infrastructure to factories and enterprises.

An aging society, politically controlled by its older citizens, tends to introduce social welfare programs instead of investing. These amount to income redistribution from the young to the old. Taxpayers from the working age groups are asked to pay for social welfare services, health services and pensions for the elderly, from current income. Insofar as these transfer payments shift spendable income from the well-off to the less well-off, they tend to increase immediate demand for basic products and services. However, redistribution from the young for consumption by the old also cuts the pool of disposable income available for savings and investment, as the Ramsey model indicates. It is tantamount to living on capital.

Just as the monetization of (formerly) unpaid labor has contributed to past GDP growth, monetization of unearned future wages and profits

- via stock prices and bond issues or rising real estate values - enables individuals and firms to spend the money (in a rising market) before it has been earned. Business firms are able to monetize future earnings by issuing equity shares to the public. Stock market valuations often reflect 'technical' analysis, which amounts to bets on what other investors will buy or sell, rather than fundamentals. This phenomenon helps to explain what would otherwise be very difficult to understand, namely the fact, periodically emphasized by investment advisors, that stock market returns have far outpaced economic growth for many decades.

Another form of indirect monetization is the increase in value of real estate. As consumers' net worth, including borrowing capacity, has grown, demand for scarce goods, and especially urban land, has increased more or less in parallel. But rising demand leads to higher prices, which are reflected in increasing the equity - and net worth - of the existing landowners and home owners. This enables them to borrow and spend still more, for example by remortgaging existing properties or 'trading up' to more expensive ones.

The monetization of expected future earnings for individuals also occurs partly through the growth of unsecured personal credit (credit cards). Clearly the underlying assumption on the part of creditors and investors is that the loans, or investments, can and will be repaid from future income, without reducing future consumption. This can happen - it has happened in the past - thanks to the magical 'growth dividend'. But future economic growth is not guaranteed by any law of nature.

Unsecured consumer credit card debt in the US more than quadrupled from 1990 to 2005. In 1990 the average balance outstanding by 88 million card-owners was $2550. By the end of 2003, 144 million people had cards (up 75 percent) and the average balance was up to $7520 (Walker 2002). More disturbing, credit cards have become so easy to get that debt has increased most rapidly, by far, among the lowest income families. Consumer debt, mostly secured by durable goods (automobiles) or real estate, has also risen steadily during the past two decades. It was slightly over 65 percent of household income in 1983. In 2003, consumer debt reached 110 percent of household income. In all of these cases, the net effect is to allow firms and individuals to increase current consumption by borrowing (in effect) from the future.

Most politicians, and even most economists, seem unaware of the severity of the combined entitlement and consumer debt problems. But the 'solution' they all hope for is faster growth, fueled by lower taxes and increased borrowing. If economic growth does not accelerate to levels above the historical average - well above 4 percent per annum, year in and year out - these structural imbalances can only get worse.

Retirement Planning For The Golden Years

Retirement Planning For The Golden Years

If mutual funds seem boring to you, there are other higher risk investment opportunities in the form of stocks. I seriously recommend studying the market carefully and completely before making the leap into stock trading but this can be quite the short-term quick profit rush that you are looking for if you am willing to risk your retirement investment for the sake of increasing your net worth. If you do choose to invest in the stock market please take the time to learn the proper procedures, the risks, and the process before diving in. If you have a financial planner and you definitely should then he or she may prove to be an exceptional resource when it comes to the practice of 'playing' the stock market.

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