state of the economy

(Warning: reading this column make make you so bored you end up in a worse condition than I am.)

In retrospect, I really regret ever saying I would do this post, as I haven't really been paying attention to the economy too much. Also, I realized it was a lot more work than I wanted to put in. I have watched a lot of political news, but it's all about the election. Listening to most of candidates speak actually hurts your economic knowledge, so I hope I don't say too much that doesn't make sense. I will tell you now, that raising the minimum wage to $11.15, as Edwards wanted, does not make sense (more later), and injecting $1 billion into the housing market, as Hillary wanted, does not make sense. I am not really sure where these people get their numbers. Do they just randomly think they make sense, or do they have economists who crunched the numbers and found they were the best? My guess is the former.

My other reason for not wanting to do a state of the economy blog is that surprisingly, I know very little about Macroeconomics--the area that deals with things like recessions. There are no Macroeconomist researcher on staff at U of A, and the one "Macro" class we do take is literally just a theory course on Dynamic Programming. The most helpful textbook was an operations research textbook, followed by Stokey, Lucas, Prescott. Basically, I know the math behind Macro, but nothing about Macro. This probably means nothing to most people, I just wanted to say I know very little about Macro. In fact, if you read the Economist weekly, you know more than I do.

So, all analysis here will really come from an introductory Econ class.

First, I need to talk about the dollar, because I am so annoyed by this McDonald's commercial. In case you haven't seen it, a group of nincompoops is sitting around talking about how the dollar is tanking. Then, a smug worker comes in saying he got a double cheeseburger for a dollar, and then all the nincompoops start talking about how strong the dollar is. The commercial makes me so upset, because these workers are confusing inflation with the strength of the dollar. Let's get one thing strait: changes in the price of domestic goods represents inflation. You paying more for a pair of Levi's, movie ticket, and other goods is inflation. If prices go down, that is deflation. Most likely, neither is correlated with the strength of the dollar.

The strength of the dollar represents how costly it is to buy a particular foreign currency. The dollar only rises and falls with respect to a particular other currency. For instance, it could rise against the pound but fall against the Euro. It so happens, that the dollar has continuously fallen against all: pound, Euro, Yen, Loonie, and other major currencies.

What does this mean? It means if you want to buy a European good or a European stock, it is going to now cost you more, because you have to trade in more dollars to get the same amount of Euros.

If you read a Newsweek article on the subject a year or two ago, you would think the falling dollar was a sign of the apocolypse, but what are the real consequences? They are both good and bad, but a weak dollar is not the end of the world. For instance, it is well known that the United States has a very bad trade imbalance. Since the 70's we have imported more than we have exported and keep doing so in larger proportions. A weaker dollar will help alleviate this problem, since it means that foreign goods are now more expensive. Also, for foreigners, our goods are relatively cheaper. So, foreigners will buy more of our goods and we will buy less of their goods; thus, reducing the trade imbalance.

The downside to a weak dollar is that if a foreigner wants to invest in U.S. stocks or bonds (and they do heavily) it is now more expensive for them to do do. Say someone in Japan wants to buy a 5 year Treasury note. Well, now they have to trade in more Yen than they used to in order to buy the note. So, we would expect a lowering of foreign investment into the United States.

Is this a problem? Yes. Investment is perhaps the biggest catalyst of growth. Firms (businesses) obviously need capital in order to finance new projects or to expand their businesses. We want firms to expand, because that means more jobs. It also means more innovation. We want there to be sufficient capital to help start new businesses and to help businesses develop new ideas. It may be cheesy, but it is true that this entrepreneurial spirit is what makes the U.S. so great, and it will be necessary to sustain our greatness in the future.

Aside: this is why the "big three" auto manufacturers make me so mad. They fail innovate and just stick with the same mold year in and year out. It makes me so mad, that I have had to start rooting against them. I don't understand how you could compete so poorly with foreign auto manufacturers. I do blame part of it on the unions, although they shouldn't bear the brunt of the blame. I can't find the numbers, but I once heard that union costs add somewhere between $500 to $1,000 to the price of every domestic car. The real reason for the "big three's" failure is an inability to innovate. They failed to forsee the compact car revolution and they failed to forsee the hybrid revolution. Ford does have a legitimate hybrid in the Escape but had to license the technology from Toyota after they violated Toyota's patent right. GM has as abundant amount of commericals lauding their hybrids but nothing to really compete with the Prius or Civic. Also, they have tended to focus on alternative fuels rather than electic cells like Toyota and Honda. If you look, the Malibu hybrid gets a whopping 32 mpg on the highway! Wow!

Aside2: It does not make sense to try to develop hydrogen or ethanol fuel compatible engines in the U.S. as GM is doing. First, how do we get hyrogen? In the U.S. we get it buy buring coal. So, calling hydrogen, "a green alternative" doesn't make sense. The U.S. currently gets about 50% of all its energy from coal, which is an issue I may discuss later, but coal is the worst option for producing energy, and I can't see why we'd want to use more of it. Second, ethanol can be used in fuel and is made from crops like sugar and corn. The problem is (1) why do we keep looking to natural resources as an answer when there is currently technology that allows propulsion to occur based on an automobiles' own energy. I.e. Toyota and Honda have developed a way to power a car using no outside fuel inputs. Shouldn't we be following this route rather than just looking for other inputs? (2) A surge in using agricultural commodities drastically affects agricultural markets. It doesn't take an Econ PhD to tell you what will happen to the price of corn when demand for it shoots through the roof-- it is going to raise high. In turn then, some people will turn to substitutes like wheat instead, and that increase in demand is going to raise the price of wheat. So, what you are doing is raising the prices of agricultural goods, and ultimately food prices in the U.S. Plus, the U.S. already consumes an unbelievable amount of corn. If you look at what you eat, you will be very surprised to see that you probably can't go a day without consuming corn. Anyone who simply drinks a soda will do so.

Sorry for the asides, but my point with the dollar is that it is not as bad as it is made out to be. If you are staying in the U.S. and not traveling abroad, it really shouldn't affect you too much. Also, as long as U.S. firms remain dominant, people will keep investing here.

So, Steve, what about this recession! First, contrary to what you might think, the economy is still in an expansionary phase, and we're not in a recession. Yes, many signs point to an upcoming recession. The Dow, Nasdaq, and S&P 500 all had down weeks; jobless numbers are up; and consumer confidence is down. These are all three indicators that an upcoming recession is LIKELY but does not mean that we will have own. I do lean towards there being a recession simply because of all the talk of a recession. The politicians and media have been working overtime to scare consumers, and just creating the expectation of a recession can cause a recession. Consumers will cutback on spending out of fear for their jobs or financial security and cause a recession. I didn't read a recent Newsweek, but again, the cover was a nightmarish prophecy of a doomed economy. I am not sure why Newsweek is so pessimistic, but they are not helping matters by scaring people. (If you did read this issue and I am wrong about scaring people, please let me know.)

In order to have a recession, we need two consecutive quarters of negative growth in real GDP (gross domestic product). In other words, we need to produce less as a country for two consecutive quarters. My guess is that if there is a recession, it will be relatively short and mild, much like the previous recession. That's one reason I can't understand this rush to create a stimulus package. The other reason is that stimulus packages rarely work. I am not a believer that President Bush's tax cuts got us out of the previous recession. I think we were on our way out anyway. I also think that by the time you get your $200 dollar check, the economy will probably be fine. Aside from the fact that stimulus packages like these are usually so poorly timed, there is no economic evidence that these types of stimulus packages do anything to help the economy. They only thing they do is help politicians. Stimulus packages are politically popular, because politicians need to be able to say, "look what I'm doing to help you." And most Americans buy into it. Unfortunately a lot of times no action is better than action, but politicians are too afraid to say this. John McCain was the only politician I saw who said he didn't know if he would do anything about the housing "crisis." Thank you John.

Let's talk for a minute about this "crisis." First, everyone saw it coming, but no one did anything. The Economist magazine had been predicting a collapse in the U.S. housing market at least two years before it actually happened and did so regularly. Did this cause financial institutions to change their lending practices, or homeowners to change their borrowing habits? No. So it is hard for me to feel too sorry for companies like Countrywide. To me, they were greedy in their practices of giving out loans, and should not be surprised that a large number of people had to default. If you are giving out no-doc loans you shouldn't be surprised when people can't pay. On the campaign trail Hillary Clinton has been talking about the family that took out a second mortgage to finance a college eduction for their kid and then had to default on their home. Well, Hillary, I don't think this is the average reason Americans were taking out second mortgages. Most saw that interest rates were low (temporarily) and decided to refinance to milk as much cash as they could out of their house. Most probably bought a new car, television, etc. Then, when interest rates went up, they were unable to pay because they signed some sort of variable interest mortgage. While, I feel for a lot of these people, I don't think a bail out of the mortgage industry is a good idea. In economics there is a term called moral hazard. It simply means that people act differently when they don't bear the consequences of their actions. I.e. people drive more recklessly when they have car insurance. Or here, financial institutions behave more poorly (take on too much risk) when they know the government is going to bail them out. If financial institutions know they are going to be bailed out by the government, then they are going to be too greedy in their actions. So, the government needs to set a precedent now, that they don't bail out companies that behaved poorly. Thank you to John McCain for being the only one to agree.

Back to the recession. The housing market will correct itself in time, and its impact on the economy will become minimal.

But, Steve, should the government do anything? The only thing I would do is TEMPORARILY alter unemployment benefits. You should see research/articles by Alan Krueger on the matter. In most times, I do not believe in high unemployment benefits. It has been well shown that high unemployment benefits lead to a much higher unemployment rate. This is why the unemployment rate in the U.S. is two times lower that most Western European countries. Western European countries have a very large unemployment web to fall into, and unemployment benefits last for a long time and benefits are very high. I don't think you have to be an economist to see why unemployment would be a lot higher. During times of downturn though, high benefits don't keep people from working as much, and as I said, they help ease consumer fears. Consumers won't spend much less, knowing that if they lose their job, they wond't lose their financial security. I emphasized temporary, because many social fixes start out as temporary but become permanent.

I think the government needs to be a little more worried about the long term health of the economy, and there are a few things that hinder it. The first, is the much talked about dependence on foreign energy. The solution has been to invest in things like ethanol, which I just don't get, and cannot understand why we aren't looking at other alternatives. One is wind. Wind power has steadily grown in the U.S. but setting up a "wind farm" is such a capital intensive operation that an insufficient number are set up. Also, there were originally problems with the blades cutting down flocks of birds, but the blades now turn slow enough that this isn't a problem. Another benefit of wind power is that once the "farm" is set up, there are really no additional costs. Wind power isn't popular though, because there is no one to lobby for it like there is for ethanol. President Bush is going to promote ethanol because that's where the money is.

Another option is nuclear energy. France actually gets something like 70% of its energy from nuclear sources. My main point though, is that there are other means than ethanol to look into.

The second hindrance for long term growth is the U.S.'s high corporate tax rate. The U.S. corporate income tax rate is 34%, and is the highest among OECD countries. As a reference, in Ireland the corporate income tax rate is 12.5% and since Ireland lowered their corporate income tax rate, they have seen an incredible surge in their economy. You may have heard the term "Celtic Tiger" to describe Ireland's economy. As American's it is natural to be concerned with the exodous of U.S. corporations to other countries, but we must ask ourselves why is this happening. Part of the answer is cheap labor abroad, but part of the answer is that the tax situation in other countries is much more friendly. Many Asian economies have areas that are no tax zones, so that a U.S. corporation could move there are pay no corporate income tax. It's then not hard to see why it is tempting for U.S. corporations to move off-shore.

Corporations have to compete, and the fact is that not all corporations are as successful as Microsoft. Many struggle to be viable, and those that are viable have to maintain healthy profits to satisfy shareholders. We can make it less attractive for marginal corporations to move off-shore if we lower the corporate income tax rate. It is not Microsoft that we are worried about moving its headquarters to Thailand. Companies like this can afford to pay the high rate. In fact, they probably prefer the high rate because it drives out marginal competitors. So, its not like you are really socking it to the Wall-Street fat cats by having a high corporate income tax. You are socking it to the marginal corporation operating in an ordinary American city.

Lastly, this is my problem with the minimum wage. You are not hurting Microsoft with a high minimum wage. But you are hurting your local coffee shop or sandwich shop. These businesses that are on the margin of surviving are the ones that are hurt and are the ones that will either have to lay people off or go out of business. If they can't lay off people, then they have to raise their prices, which is what happened to many shops in Tucson after the recent minimum wage increase. I think there is a common misperception that just because you have a business you must be doing well and can afford to have money taken away from you, but this is just not the case for the vast majority of businesses in the U.S. I recently talked with a local coffee shop owner who said her business was already struggling and with a new increase in the Arizona minimum wage was really worried about her shop. She did say she was for the increase, but that it did hurt her business. I only bring this up, because John Edwards wanted to raise the minimum wage even way higher to like $11.15. Well, this may make sense in Seattle, but what do you think this is going to do in West Virginia. I guarantee you it would hurt employment. And who do you think is going to have a hard time finding a job? Well-educated people? No, poor, uneducated people are hurt the most be the minimum wage, because their jobs are the first to go. Some people end up winners-those that can keep their jobs, but some end up losers because they can't get a job at that high of a wage rate.

If you made it this far congratulations. I hope I didn't bore you too much and feel free to criticize me all you want. Like I said, I am not an expert on the subject, but do have an opinion. I could very well be wrong on a number of things, but the alternative energy and corporate tax thing I am pretty passionate about.

Steve


Oh, and my last two points were going to be the educational system in the United States and the amount of visas given out to educated foreigners. I think its silly to restrict these visas, as we have. I think our primary and secondary educational systems are broken. But I am not one to believe in some national fix. I think it's each state's responsibility to invest heavily in education and to try to innovate. By not nationalizing education, hopefully we promote innovation, where different states try different things and we can learn from the successes and failures in order to grow.