“To discover truth is the task of all Sciences; it falls to logic to discern the laws of truth. I assign to logic the task of discovering the laws of truth, not of assertion or thought."
Gottlob Frege "The Thought : A Logical Inquiry" in Mind Vol. 65.
Reason is the human tool for survival and Logic is the study of principles of correct reasoning. The brain is wired to find patterns in disconnected pieces information but doing so without valid methods leads to results that may lead to false conclusions. Logic does not assert thought; it states the principles of a valid thought process.
Prominent psychologists (Kolberg among them) have suggested that only ten percent of the population ever reason at the highest or adult level. Valid reasoning is a learned process and we can improve reasoning abilities by studying the principles of correct reasoning.
There are many voices competing for credibility in our belief system. These voices include the media, the clergy, the government and even our own desires to simply believe what we feel like believing. We are free to evade the effort of thinking-to reject reason-but we are not free to escape the penalty of rejecting reason.
Logic is not a trick of language used to outsmart an opponent during an argument. It is not a detatched mathematical code incompatible with human emotions. It is also not something that could be set aside with a whim with no negative repercussions. In short logic is neither false nor useless. The purpose of logic is to learn the valid principles of reasoning. The purpose of learning the valid principles of reasoning is to arrive at the truth.
Sunday, January 27, 2008
Thursday, January 24, 2008
Economy - US vs China -The end game
With all the discussion on slowing economy and worries about burgeoning trade deficit, unsustainability of the US debt, a middle class that is getting squeezed, Jobs moving to China and a looming recession, I figured I should put my two cents in quickly lest Lou Dobbs drives Americans to spending their rebate checks on Zoloft or Prozac.
That China lends money to US to buy its goods and US gets more and more into debt is old news. There is a common misconception that some how China will emerge a winner in this pyramid scheme. In this blog post I attempt to simplify the nitty gritty of the flaws of artificially induced export led growth model and speculate where this pyramid is likely to end. More importantly chinese consumer behavioral factors that need to be addressed are discussed.
Hoarding of foreign paper currencies and bonds (money loaned) can be considered wealth only if it "can be" and will be cashed for consumption at some point in time.
A key measure to the wealth of a Nation is its domestic consumption and the degree of its indebtedness ( or lack of). Exports (which form a component of production) are primarily a means of earning foreign exchange to buy raw materials, goods and services that are in short supply or not available locally. It is also a means where private enterprise earns capital to invest in foreign countries. Prudent exports add to GDP, create jobs and kickstart domestic cosumption in developing countries . However, domestic consumption and production of goods and services for domestic consumption is the real indicator of a nations wealth and the path to sustainable economic growth. Reasonable savings that can be “cashed in” is good for a rainy day and a small deficit at times of capital investment is acceptable.
The behavioral model underlying this is export led development model is interesting. Economies of most countries are driven by domestic consumption except those which have predominantly Chinese population. Culturally the Chinese love saving and dislike spending (behavioral economics?). After double digit GDP growth and double digit annual salary increases the Chinese domestic consumption has been decreasing over the years and accounts only for 36-38% of their GDP. Consumer spending in China has fallen from 47% of GDP in the early 1990s to only 36% in 2006. Compare this to India's growth where domestic consumption accounts for 68% of GDP. The household consumption ratio to GDP is 68 per cent in India compared to 38 per cent in China. Even after adjusting healthcare, housing and education costs in comparable economies Chinas domestic consumption trailed far behind. Explanations such as lack of social security, healthcare coverage fail are a poor explanation for this. Comparable economies like India, Brazil, Russia are driven by domestic consumption growth.
Dr Mahathir Mohamed, Malaysia's ex-prime minister simplified this in a Chinese - Malay business meeting . Malaysia's population split is about 60% Malay, 30% Chinese and 10% Indian. The Chinese control most businesses in Malaysia. To justify Malaysia’s policy of favoring Malays in government jobs (affirmative action) ex prime minister of Malaysia Dr Mahathir Mohammed provided an argument on spending power and more money circulating in the market.
"The Chinese are stingy, said Dr Mahathir. They make money and keep it. They want to accumulate their wealth to become richer. The Malays, however, like to spend money. The more money they have, the more they spend. Even if they did not have money they would still spend. They would borrow to spend. Rich Chinese would not spend that much money in Chinese shops, argued Dr Mahathir. Rich Malays would. And, the more the Malays spend, the richer the Chinese would get. Therefore, said Dr Mahathir, it is to the interest of the Chinese they help the Malays become rich, because the money would all go back to the Chinese anyway and their businesses would flourish due to Malay spending."
I would not use a demeaning racial stereotype like "stingy" as Dr Mahathir did but I do think there is merit in China's national paper pointing out that the Chinese cultural propensity for saving (rather extraordinary saving) is bad for its national economy . Chinas annual planning commission report is trying to find a way to boost domestic consumption. This is turning out to be a difficult task (unlike a policy change) as it involves bringing about behavioral/cultural change in the population.From China's National Paper "Traditionally, Chinese people are fond of saving money, though the Chinese government now wants to encourage them to spend. By the end of November, private savings in Chinese banks totaled 17.033 trillion yuan, 371.6 billion yuan more than the end of 2006, even as many people withdrew their savings to play stocks. "And here is a link to the article on Chinas consumption http://english.peopledaily.com.cn/90001/90776/90884/6332607.html
Let us look at the fundamentals of this currency devalued export led model and the flaws in it. I tried to over simplify the model but covered the essentials. The 9 points listed below explain the economic model and list out why it is self destructive. Structural models and flaws can be changed easily by policy changes but behavioral models are an entirely different issue.
1. Let us say Country X (China) fixes the value of its currency to dollar at 100 to 1. Now Country X (China) could sell much to the USA, and the US very little to them. Now let us say country X also accepts payment in US dollars and the US pays them in paper dollars. What would the Country X's government or exporters do with the dollars? They cannot eat them, wear them, or live in them. If they were willing simply to hold them, then the printing industry-printing the dollar bills- would be a magnificent export industry. The printing industries output would enable United States to have the great things in life provided nearly free by Country X (China).
2. To hold the exchange rate at an artificial low Country X's (China) central bank buys up dollars and in exchange issues Chinese currency to local market. This causes monetary to supply to expand rapidly in Country X and as a result a high inflation. China's inflation is 6.5% and food prices have been up. The prices soared so much that when French retail giant Carrefour announced a discount on cooking oil in its China outlet three people died in a stampede. Of course, the Chinese penchant for saving might have played a role in the stampede.
3. Country X's (China) path to wealth and economic growth is based on the policy of exporting goods at a cheap price. To further this it adopts several policies. It directs its state owned banks to lend domestic savings interest free to state owned industries which manufacture goods cheaply using cheap labor ( and much of Chinas industry has substantial state ownership). To get cheap capital the Chinese Government caps the interest paid by banks on deposits. To get cheap labor the government bans trade unions and workers organizing themselves to groups. Chinas manufacturing adopts inexpensive manufacturing processes that pollute environment and utilizes government subsidized fuel. The state owned industry in china never has to pay back the government (and does not pay back) interest accrued on the capital. This results in direct loss of revenue in the form of return on investment for the government –i.e. loss of money that can be invested for public goods such as providing healthcare or education to its domestic population. Add to it the cost of health problems resulting from pollution and the cost of cleaning up the pollution and environmental damage at a later date (all this not factored in cost of product). A lot goes behind the cheap goods supplied to the world! It is no wonder that countries with lower per capita and labor costs cannot compete with china in this race to the bottom.
4. Country X (China) has extremely low domestic consumption - Its people have a culture of hoarding (or extraordinary saving) and dislike spending (as evidenced by their domestic consumption, refer to link from china daily at the bottom of the page). This makes country X very dependent on exports for its jobs and GDP. Country X needs to sell to country Y (USA) to keep its people employed and sell its goods. To continue selling to country Y (USA) Country X (China) needs to undervalue its currency and pay its people low wages. Further country X lends the paper back to Country Y (US) to boost country Y'S Consumption and thereby increase its exports.
5. With the mounting US debt and trade deficit Country X's government grew fearful about its paper wealth and wished to convert it to a more tangible saving. As a safety valve it hoped it could use its holdings to buy up some key assets in Country Y. However, Country Y (USA) restricted Country X's government owned funds from buying assets in country Y. For those who are not in on international financials let me introduce a term here called the sovereign wealth funds. Sovereign wealth funds are export surpluses/savings of foreign governments. China's sovereign wealth funds (Chinese government's US dollar hoard) was recently barred from investing in some key US assets.
6. Country X (China) is now stuck with its wealth which is primarily paper money and bonds
7. If Country X (China) wants to spend its wealth it has to sell its paper bonds or paper currency. The moment it puts up a significant portion of these bonds or currencies for sale the currency value of country Y (US) nose dives and subsequently Country X (China) looses all its wealth and savings accumulated by years of cheap labor, environmental pollution and hard work.
8. Alternatively Country X needs to buy goods and services from Country Y. Since Country X (China) devalued its currency it doesnt make much sense for it to buy those goods and services. If it does revalue its currency and buys goods and services from country Y (USA) it stands to transfers back the wealth to country Y.
9.Now the mutually assured destruction scenario: Country X ( China) decides to get rid of all its hoarded paper wealth and stop supplying credit and goods to country Y ( USA). Result: country Y's currency crashes. Since Country Y ( USA) has the technology and infrastructure to produce goods It moves back manufacturing to its country creating domestic Jobs and growth (It will be difficult to finds another fool who accepts to take country Y's paper and T-bills and give it a favorable currency arbitrage). This ofcourse involves a painful transition for country Y. Oil exporting countries would de-peg their currency with the dollar and trade in alternative currency. With the de valued dollar the price of fuel would skyrocket (for country Y ( US). The resulting turmoil might suppress demand and might drive down prices-depending of course of how close we are to peak oil. Moreover, Country Y(US) looses it privileged reserve currency position. It now needs to earn foreign exchange to buy goods and services from other countries and that includes oil.
The politicians in Washington may be thrown out of office and the streets of Beijing will be filled with unemployment and Chaos.Since politicos never want to be out of office we can expect the US to keep pumping T bills, fiat money and the Chinese to keep expanding their monetary supply. The end result- a period of runaway inflation, price controls, a big recession and coming to senses!
For those interested in finding out how the exchange rate of a foreign currency is determined to figure out the real worth of US dollar here is the split. If not skip points A-D
A)An increase in the demand of that country's goods abroad (Since US runs a trade deficit this doesnt appear to drive the value of US currency)
B)An increase in the demand for domestic investment by foreigners . A proper interpretation of the data reveals that the source of capital inflows in US is primarily foreign governments, not foreign private investors. Martin Feldstein says, "If the foreign government decides to buy fewer dollar bonds, the US current account deficit could not continue to be financed at current exchange rates and interest rates." He believes a 30% decline in the dollar is necessary to get the current account down from 6% of GDP to a more sustainable level of 3% and that much larger changes are possible. Finally, he says the only thing holding up the dollar currently is the belief that interest differentials that make U.S. financial investment attractive will persist.)
C)The belief that the value of the currency will rise in the future (Against currencies that artificially held low.. Not likely)
D)A central bank wanting to increase its holdings of that currency ( This is the primary factor which is driving the US dollar valuation-Countries such as China, Taiwan, Singapore hoarding up on US dollar to prop up its valuation and depress the value of their own currency)
Economy? Seems to work for now! Chinese government appears content with its paper dollars. ..and Americans are happy giving them more paper dollars for their inexpensive goods& services. Americans are also enjoying the privileges of Chinas oil subsidy, interest free capital investment, subsidy on environmental pollution clean up etc. And where would I keep my money..hmm Canadian dollars, Swiss franks and a few Indian Rupees!
To sum up : The risks of an export led growth model based on depressed/devalued currency include:
1. Puts developing countries in a cheap labor competition
2. Puts workers in developed countries out of job and puts developing countries workers in conflict with workers in developed countries.
3. Weak currency causes inflation.
4. Deprives domestic market of the better quality stuff - Certain goods are limited such as best quality fruit or seafood. Currency devaluation makes traders export out all the best stuff
5. Vulnerable to slow down in export markets.
6. Reduces innovation ability: blocks development of domestic consumption themes suitable for domestic market. By domestic consumption theme I mean creating goods suitable for local market weather, culture, environment, food habits etc. For example a halter top , snow cleaner or American football is not a domestic consumption theme for the Saudis .
That China lends money to US to buy its goods and US gets more and more into debt is old news. There is a common misconception that some how China will emerge a winner in this pyramid scheme. In this blog post I attempt to simplify the nitty gritty of the flaws of artificially induced export led growth model and speculate where this pyramid is likely to end. More importantly chinese consumer behavioral factors that need to be addressed are discussed.
Hoarding of foreign paper currencies and bonds (money loaned) can be considered wealth only if it "can be" and will be cashed for consumption at some point in time.
A key measure to the wealth of a Nation is its domestic consumption and the degree of its indebtedness ( or lack of). Exports (which form a component of production) are primarily a means of earning foreign exchange to buy raw materials, goods and services that are in short supply or not available locally. It is also a means where private enterprise earns capital to invest in foreign countries. Prudent exports add to GDP, create jobs and kickstart domestic cosumption in developing countries . However, domestic consumption and production of goods and services for domestic consumption is the real indicator of a nations wealth and the path to sustainable economic growth. Reasonable savings that can be “cashed in” is good for a rainy day and a small deficit at times of capital investment is acceptable.
The behavioral model underlying this is export led development model is interesting. Economies of most countries are driven by domestic consumption except those which have predominantly Chinese population. Culturally the Chinese love saving and dislike spending (behavioral economics?). After double digit GDP growth and double digit annual salary increases the Chinese domestic consumption has been decreasing over the years and accounts only for 36-38% of their GDP. Consumer spending in China has fallen from 47% of GDP in the early 1990s to only 36% in 2006. Compare this to India's growth where domestic consumption accounts for 68% of GDP. The household consumption ratio to GDP is 68 per cent in India compared to 38 per cent in China. Even after adjusting healthcare, housing and education costs in comparable economies Chinas domestic consumption trailed far behind. Explanations such as lack of social security, healthcare coverage fail are a poor explanation for this. Comparable economies like India, Brazil, Russia are driven by domestic consumption growth.
Dr Mahathir Mohamed, Malaysia's ex-prime minister simplified this in a Chinese - Malay business meeting . Malaysia's population split is about 60% Malay, 30% Chinese and 10% Indian. The Chinese control most businesses in Malaysia. To justify Malaysia’s policy of favoring Malays in government jobs (affirmative action) ex prime minister of Malaysia Dr Mahathir Mohammed provided an argument on spending power and more money circulating in the market.
"The Chinese are stingy, said Dr Mahathir. They make money and keep it. They want to accumulate their wealth to become richer. The Malays, however, like to spend money. The more money they have, the more they spend. Even if they did not have money they would still spend. They would borrow to spend. Rich Chinese would not spend that much money in Chinese shops, argued Dr Mahathir. Rich Malays would. And, the more the Malays spend, the richer the Chinese would get. Therefore, said Dr Mahathir, it is to the interest of the Chinese they help the Malays become rich, because the money would all go back to the Chinese anyway and their businesses would flourish due to Malay spending."
I would not use a demeaning racial stereotype like "stingy" as Dr Mahathir did but I do think there is merit in China's national paper pointing out that the Chinese cultural propensity for saving (rather extraordinary saving) is bad for its national economy . Chinas annual planning commission report is trying to find a way to boost domestic consumption. This is turning out to be a difficult task (unlike a policy change) as it involves bringing about behavioral/cultural change in the population.From China's National Paper "Traditionally, Chinese people are fond of saving money, though the Chinese government now wants to encourage them to spend. By the end of November, private savings in Chinese banks totaled 17.033 trillion yuan, 371.6 billion yuan more than the end of 2006, even as many people withdrew their savings to play stocks. "And here is a link to the article on Chinas consumption http://english.peopledaily.com.cn/90001/90776/90884/6332607.html
Let us look at the fundamentals of this currency devalued export led model and the flaws in it. I tried to over simplify the model but covered the essentials. The 9 points listed below explain the economic model and list out why it is self destructive. Structural models and flaws can be changed easily by policy changes but behavioral models are an entirely different issue.
1. Let us say Country X (China) fixes the value of its currency to dollar at 100 to 1. Now Country X (China) could sell much to the USA, and the US very little to them. Now let us say country X also accepts payment in US dollars and the US pays them in paper dollars. What would the Country X's government or exporters do with the dollars? They cannot eat them, wear them, or live in them. If they were willing simply to hold them, then the printing industry-printing the dollar bills- would be a magnificent export industry. The printing industries output would enable United States to have the great things in life provided nearly free by Country X (China).
2. To hold the exchange rate at an artificial low Country X's (China) central bank buys up dollars and in exchange issues Chinese currency to local market. This causes monetary to supply to expand rapidly in Country X and as a result a high inflation. China's inflation is 6.5% and food prices have been up. The prices soared so much that when French retail giant Carrefour announced a discount on cooking oil in its China outlet three people died in a stampede. Of course, the Chinese penchant for saving might have played a role in the stampede.
3. Country X's (China) path to wealth and economic growth is based on the policy of exporting goods at a cheap price. To further this it adopts several policies. It directs its state owned banks to lend domestic savings interest free to state owned industries which manufacture goods cheaply using cheap labor ( and much of Chinas industry has substantial state ownership). To get cheap capital the Chinese Government caps the interest paid by banks on deposits. To get cheap labor the government bans trade unions and workers organizing themselves to groups. Chinas manufacturing adopts inexpensive manufacturing processes that pollute environment and utilizes government subsidized fuel. The state owned industry in china never has to pay back the government (and does not pay back) interest accrued on the capital. This results in direct loss of revenue in the form of return on investment for the government –i.e. loss of money that can be invested for public goods such as providing healthcare or education to its domestic population. Add to it the cost of health problems resulting from pollution and the cost of cleaning up the pollution and environmental damage at a later date (all this not factored in cost of product). A lot goes behind the cheap goods supplied to the world! It is no wonder that countries with lower per capita and labor costs cannot compete with china in this race to the bottom.
4. Country X (China) has extremely low domestic consumption - Its people have a culture of hoarding (or extraordinary saving) and dislike spending (as evidenced by their domestic consumption, refer to link from china daily at the bottom of the page). This makes country X very dependent on exports for its jobs and GDP. Country X needs to sell to country Y (USA) to keep its people employed and sell its goods. To continue selling to country Y (USA) Country X (China) needs to undervalue its currency and pay its people low wages. Further country X lends the paper back to Country Y (US) to boost country Y'S Consumption and thereby increase its exports.
5. With the mounting US debt and trade deficit Country X's government grew fearful about its paper wealth and wished to convert it to a more tangible saving. As a safety valve it hoped it could use its holdings to buy up some key assets in Country Y. However, Country Y (USA) restricted Country X's government owned funds from buying assets in country Y. For those who are not in on international financials let me introduce a term here called the sovereign wealth funds. Sovereign wealth funds are export surpluses/savings of foreign governments. China's sovereign wealth funds (Chinese government's US dollar hoard) was recently barred from investing in some key US assets.
6. Country X (China) is now stuck with its wealth which is primarily paper money and bonds
7. If Country X (China) wants to spend its wealth it has to sell its paper bonds or paper currency. The moment it puts up a significant portion of these bonds or currencies for sale the currency value of country Y (US) nose dives and subsequently Country X (China) looses all its wealth and savings accumulated by years of cheap labor, environmental pollution and hard work.
8. Alternatively Country X needs to buy goods and services from Country Y. Since Country X (China) devalued its currency it doesnt make much sense for it to buy those goods and services. If it does revalue its currency and buys goods and services from country Y (USA) it stands to transfers back the wealth to country Y.
9.Now the mutually assured destruction scenario: Country X ( China) decides to get rid of all its hoarded paper wealth and stop supplying credit and goods to country Y ( USA). Result: country Y's currency crashes. Since Country Y ( USA) has the technology and infrastructure to produce goods It moves back manufacturing to its country creating domestic Jobs and growth (It will be difficult to finds another fool who accepts to take country Y's paper and T-bills and give it a favorable currency arbitrage). This ofcourse involves a painful transition for country Y. Oil exporting countries would de-peg their currency with the dollar and trade in alternative currency. With the de valued dollar the price of fuel would skyrocket (for country Y ( US). The resulting turmoil might suppress demand and might drive down prices-depending of course of how close we are to peak oil. Moreover, Country Y(US) looses it privileged reserve currency position. It now needs to earn foreign exchange to buy goods and services from other countries and that includes oil.
The politicians in Washington may be thrown out of office and the streets of Beijing will be filled with unemployment and Chaos.Since politicos never want to be out of office we can expect the US to keep pumping T bills, fiat money and the Chinese to keep expanding their monetary supply. The end result- a period of runaway inflation, price controls, a big recession and coming to senses!
For those interested in finding out how the exchange rate of a foreign currency is determined to figure out the real worth of US dollar here is the split. If not skip points A-D
A)An increase in the demand of that country's goods abroad (Since US runs a trade deficit this doesnt appear to drive the value of US currency)
B)An increase in the demand for domestic investment by foreigners . A proper interpretation of the data reveals that the source of capital inflows in US is primarily foreign governments, not foreign private investors. Martin Feldstein says, "If the foreign government decides to buy fewer dollar bonds, the US current account deficit could not continue to be financed at current exchange rates and interest rates." He believes a 30% decline in the dollar is necessary to get the current account down from 6% of GDP to a more sustainable level of 3% and that much larger changes are possible. Finally, he says the only thing holding up the dollar currently is the belief that interest differentials that make U.S. financial investment attractive will persist.)
C)The belief that the value of the currency will rise in the future (Against currencies that artificially held low.. Not likely)
D)A central bank wanting to increase its holdings of that currency ( This is the primary factor which is driving the US dollar valuation-Countries such as China, Taiwan, Singapore hoarding up on US dollar to prop up its valuation and depress the value of their own currency)
Economy? Seems to work for now! Chinese government appears content with its paper dollars. ..and Americans are happy giving them more paper dollars for their inexpensive goods& services. Americans are also enjoying the privileges of Chinas oil subsidy, interest free capital investment, subsidy on environmental pollution clean up etc. And where would I keep my money..hmm Canadian dollars, Swiss franks and a few Indian Rupees!
To sum up : The risks of an export led growth model based on depressed/devalued currency include:
1. Puts developing countries in a cheap labor competition
2. Puts workers in developed countries out of job and puts developing countries workers in conflict with workers in developed countries.
3. Weak currency causes inflation.
4. Deprives domestic market of the better quality stuff - Certain goods are limited such as best quality fruit or seafood. Currency devaluation makes traders export out all the best stuff
5. Vulnerable to slow down in export markets.
6. Reduces innovation ability: blocks development of domestic consumption themes suitable for domestic market. By domestic consumption theme I mean creating goods suitable for local market weather, culture, environment, food habits etc. For example a halter top , snow cleaner or American football is not a domestic consumption theme for the Saudis .
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