global economics 101

Ever wonder how it all works?

- the budget deficit, the value of the dollar, the plethora of "made in China" labels? Ever wonder where the economy is going? Is it all going to hell in a handbasket made in Malaysia?

I came across an insightful yet fairly accessable explanation of the current state of global economics. If like myself, you have been puzzling over "how does it all work?" (actually it's more like "how in the h*ll can all of this cr*p possibly fit together???") perhaps this will give you a starting point.

Most of these ideas come from John Mauldin (free registration required). NO, I'm not promoting the site. I just learned a lot there and like most bloggers... share. Be advised- Mauldin appears to be a Republican. Apply salt grains "liberally." Nonetheless his conclusions regarding budget deficits take red-ink Republicans to the woodshed. Personally I do not see Repubs as the enemy- simply the opposition. After reading this however, I DO see red-ink Repubs as an enemy. Their actions are threatening the well-being of our nation. You'll understand better if you read.

Remember the movie "A Beautiful Mind?"

Russell Crowe played John Nash, the brilliant mathmetician. The real John Nash, amongst many accomplishments, conceived mathematically that rivals could ..well, get along. It was a big mathematical breakthrough. "Nash Equilibriums" (natural equilibriums) can arise even amongst rivals if they are motivated to make certain choices (a lost political concept). Mauldin begins by referencing a set of Nash Equilibriums that currently exist amongst world economies. But there is trouble in global paradise. Over time, some things have gotten out of balance. Why? Because there are different economic models in different nations. Things slip through the cracks of world trade. Also some governments are on crack (deficit crack for instance).

"Disequilibrium"

Mauldin describes the resulting imbalances as disequilibrium -the fancy name is Mixed Model Microeconomic Disequilibrium:

Three inconsistent models are at work simultaneously ...the US adheres closely to a textbook model of microeconomics in which all three factor markets (capital, labor, and product) are deregulated and flexible. Europe possesses a different model that tolerates much more rigidity in product and labor markets than in the US. Finally, Japan and China possess a third model that deviates still further from textbook. It is characterized by extreme mercantilism, disregard for intellectual property rights, lack of transparency, repressed domestic consumption at the expense of investment, and currency market intervention (Japan) and pegging (China).

He explains the resulting imbalances:

US debt is financed by foreign bank ownership of US Treasuries. The US trade deficit could not exist without Asian willingness to buy our debt in a sort of (Asian corporation) financing scheme.

Huh? Why would they do that? They do it too keep their main market, the U.S.A. alive -and- the resulting business growth has kept large numbers of people employed, in particular amongst Chinese transitioning from poor agricultural backgrounds to more modern urban lives. There are a LOT of those Chinese in transition. So the average Chinese works cheap to get off the farm, while the average American consumes (buys) at a level that shocks the world thereby helping even more Chinese get off the farm. The Chinese government underwrites it because they see this as a way to evolve beyond being a nation of poor farmers.

What about the Europeans?

Whatever happened to the powerful growth that a European Union was supposed to bring? Germany and France are mired in slow or no growth economies, with massive 10% (or more) unemployment. As "Old Europe" has taxed (literally) its growth capacity, created a work environment that is non-competitive, and created a socialist state that is increasingly incapable of funding itself, it has choked off consumer spending and economic growth. Instead of being a growth engine that could, and should, drive the world, Europe is an ad hoc collection of nations mired in costly bureaucracies.

The average Europe is stagnated by more regulation than most Americans would believe. Ever checked out the price of gas in Europe? Some say they know what their choosing to do...others say they pay to high a price. This is a subject for some interesting elaboration, but I'll stay on course for now.

Conclusion:

In all quarters, there is a failure to understand what is killing the global system -the cumulative damage of over 20 years of mixed model disequilibrium. ..absent needed microeconomic changes, today's imbalances will worsen and the long run denouement will probably be a collapse of the dollar. This will of course precipitate a whole new set of problems. For the reasons we have identified, the world is in a mess and we are very concerned about the long-run outcome.

WARNING- This is NOT the place to stop reading! If you only read this far- you do yourself a disservice. There are pathways out of this mess. Greenspan identified some.

What can be done:

Remember, all players in this game can see the problems. And all players want to avoid as much pain as possible. This is not some game where China simply buys a great deal of our debt and then sells it, crashing our markets out of some supposed geo-political conspiracy theory.

For better or worse, they are married to our markets. They drink the water from our pond. It would not be in their interests to foul it. The challenge is to balance global trade without strangling the world economy.

Radical microeconomic policy reform is needed in which all players realign their models towards that of the textbook microeconomics. There is only one such textbook model taught around the world in economics courses from Berkeley to the Sorbonne. And the US model better approximates this than do its principal trading partners.

The US MUST begin to balance its federal budget. Fiscal discipline must be the order of the day. This will not be fun, but it will reduce the need for foreign financing and decrease the systemic risk of a dollar collapse.

Europe must free up its markets, encourage internal consumption, lower its structural costs and get a central bank that does not wear black leather and carry whips and chains. Sado-monetarism, indeed.

Each major group and nation is going to have to take a little pain willingly, or everyone takes a whole lot more pain collectively. Asia needs to start allowing the dollar to gently fall- "measured." That will not be fun, but it is a first step.

In a nutshell, Mauldin proposes that the world economies must move more toward the US model to "avoid as much pain as possible." Mauldin thinks that there is a 70% chance that the world will "muddle through" stepping back out in a decade or so into a more balanced and sustainable economic future. Glass is 70% full in a decade kind of guy. He thinks the world can handle a 30% decline in the value of the dollar..."we've done that before." The bottom line is that all of the major world economies must become free economies closer to the textbook model best exemplified by the US model at this time. But, and it's a big but, massive US federal deficits threaten the situation as much as any other factor.

I've a few thoughts of my own about that, but I'd rather hear what you think. With that I throw this diary into the feeding tank. Try not to go "Beautiful Mind" on me.