Creative Destruction: Newspaper Industry Headed For The Dinosaur Age?

When one or several companies of an industry are in the red financially, the losses may be attributed to the developments within the companies themselves.

However, when losses are evident on an industry scale, then the core dynamics of the industry may be in question.

This predicament currently applies to America's newspaper industry, whose survival seems threatened by the growing use of the internet for acquiring news.

Yet developments in the US could be an ominous sign for the world.

According to the Economist, ``MORE bad news for America's newspaper industry. In the six months to the end of September, daily circulation fell by 10.1% to 30.4m compared with the same period in 2008. All of the top 20 papers have seen their circulation plunge, with the exception of the Wall Street Journal. The Journal now has the biggest circulation in the country, surpassing USA Today, which suffered an enormous 17.5% drop in readership over the same period. Paying readers are now turning to the internet to get the news free." (bold highlights mine)

First, in terms of internet penetration level rates, North America appears to be the leader.

The chart above is from internetworldstats.com. In other words, perhaps the best measure for the evolving shift in the way news is being acquired would be from the world's most connected.

Next, the trend towards the internet as a source for information appears to be validated by survey.


The chart above courtesy of Pew Research.

According to a Pew report issued last December, ``Currently, 40% say they get most of their news about national and international issues from the internet, up from just 24% in September 2007. For the first time in a Pew survey, more people say they rely mostly on the internet for news than cite newspapers (35%). Television continues to be cited most frequently as a main source for national and international news, at 70%." (emphasis added)

So empirical evidence connects the cost- financial losses and the flagging usage trend of the of the news industry- to the beneficiary- the burgeoning use of the internet as a source of news.

Why this appears to be so?

Mr. Scott Bradner of Network world gives a clue, ``The three most important observations to me are that power is shifting from institutions (like newspapers) to individual journalists; that people increasingly want news "on demand" rather than scheduled, like the evening news; and that there has been a raise in importance of "minute-by-minute judgment in political journalism." These trends greatly benefit the Internet and Internet-based journalists. The latter two trends also benefit the full-time cable news channels, but only when the cable is available. And, in the office, cable is not generally available." (bold emphasis mine)

In other words, the conspicuous shift marks of a market based redistribution of power and wealth to the industry that satisfies the consumer most.

Bottom line: This seems to be a manifestation of Joseph Schumpeter's "process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one" or in short, the process known as "creative destruction" at work. This phenomenon largely emanates from the competitive nature brought about by capitalism.

Iceland's Devaluation Toll: McDonald's

Recently we dealt with The Evils Of Devaluation. And Iceland should be a good example.

Last year's meltdown heavily devastated Iceland, an erstwhile prosperous nation but whose banking system recklessly engaged in intensive leveraged based speculation [see last year's post Iceland, the Next Zimbabwe? A “Riches To Rags” Tale? ]

The consequent losses in the banking system prompted Iceland's government to intervene and provide support even when there had not been enough resources to do so. This eventually took toll on its currency, the Krona.

The Krona has devalued or collapsed from 60 to around 140 (chart courtesy of ino.com).

This fueled domestic inflation even amidst a spike in unemployment.

chart courtesy of tradingeconomics.com

Nevertheless Iceland's crisis has prompted one of the world's most prolific fast food chain, McDonald's (NYSE: MCD), to withdraw.

This from Financial Times

``Iceland edged further towards the margins of the global economy on Monday when McDonald's announced the closure of its three restaurants in the crisis-hit country and said that it had no plans to return.

``The move will see Iceland, one of the world's wealthiest nations per capita until the collapse of its banking sector last year, join Albania, Armenia and Bosnia and Herzegovina in a small band of European countries without a McDonald's.

``The loss of the Golden Arches highlights the extent of Iceland's economic demise since the pre-crisis boom years when its "Viking Raider" entrepreneurs turned Reykjavik into an international finance centre and launched a buying spree of high-profile European assets."

The reason...

``McDonald's blamed the closures on the "very challenging economic climate" and the "unique operational complexity" of doing business in an island nation of just 300,000 people on the edge of the Arctic Circle.

``Most ingredients used by McDonald's in Iceland are imported from Germany - leading to a doubling in costs as the krona has collapsed while the euro has strengthened.

``Magnus Ogmundsson, managing director of Lyst, the McDonald's franchise holder in Iceland, said that price rises of at least 20 per cent were needed to produce an acceptable profit. That would have pushed the price of a Big Mac burger well above the $5.75 it costs to buy one in Switzerland, home to the world's most expensive McDonald's, according to the Big Mac index."

Of course somebody's else problem could serve as another person's solution:

It could be argued that this should be healthy as there would be less junk foods.

Or that Iceland will have to rely more on their own.

Again the FT, ``Mr Ogmundsson admitted that some customers were alarmed by the symbolism of such a recognisable brand abandoning Iceland but others have reacted positively. "People are pleased that we will be sourcing more goods locally," he says.

Overall, Icelanders would have lesser choice and diminished privileges from today's modern society. In short, Iceland's living standard has retrogressed.

Marc Faber: Dollar Will Eventually Go to Value of Zero

Here is Dr. Marc Faber's interview at the Bloomberg...



Some quotes:

"Best is to have foreign currencies and commodities but also equities that protect you to some extent as they adjust upwards as the currency goes down."

"The fiscal position of the US is a complete disaster. Eventually in ten years time, in my opinion, about 50% of tax revenues will be used to just cover the interest payments on the government debt and that is unsustainable. Then you really are forced to print money"

"Stocks don`t have a big downside risk because of the Bernanke put. As soon as the S&P drops towards 900 or 800 Bernanke will print money again, he is a money printer, he is nothing else. But he does that well - he prints well; you have to give him a medal for that..."

Basically Dr. Marc Faber's perspectives epitomizes much of what the Austrian School of Economics have been saying.

Drug Decriminalization: Regulation Versus Prohibition

Here is an interesting article on drug decriminalization from Peter Moskos at the Washington Post.

Some notes:

1. Regulation versus Prohibition

``The Dutch classify marijuana as a "soft drug," which means that, like alcohol and tobacco, it is best regulated through controlled distribution. "Hard drugs," such as cocaine and heroin, remain illegal. But personal drug use is more a health matter than an arrestable offense.

``Even the Amsterdam police want to keep the coffee shops open. "Why push drug use underground?" asked Christian Koers, the police chief responsible for Amesterdam's red-light district. "Then you cannot control it, and it becomes more popular and more dangerous. "

``This idea -- that drugs are both enjoyable and dangerous and thus better regulated than prohibited by government and sold by criminals -- seems common-sense enough, even in America. Until now, the main opposition to a state's right to legalize marijuana has been the federal government. But last week, in a major policy shift, the U.S. Justice Department instructed federal prosecutors not to focus on "individuals whose actions are in clear and unambiguous compliance with existing state laws providing for the medical use of marijuana."

2. Illegal Dealing Spawns Violence

``There is little violence surrounding the private drug trade between friends, coworkers and family members. The real drug problem, along with addictive heroin and crystal meth, is illegal public dealing. In public drug markets, signs of violence are everywhere: Intimidating groups of youths stand on corners under graffiti memorializing slain friends; addicts roam the streets and squat in vacant buildings; "decent" people stay inside when gunshots ring out in the night."

3. Addressing Crime Is Distinct From Controlling Vice

``In another neighborhood in Amsterdam, a man caught breaking into cars was released pending trial. The arresting officer returned to him, along with his shoelaces and personal property, his heroin and drug tools. I was amazed. The officer admitted he wasn't supposed to do that; heroin is illegal. But the officer had thought it through: "As soon as he runs out of his heroin, he'll break into another car to get money for his next hit."

``For the addict, the problem was drugs. But for the police officer, the problem was crime. It made no sense, the officer told me, to take the drugs and hasten the addict's next crime. The addict was not a criminal when he had drugs (beyond possessing them); he was a criminal when he didn't have drugs.

``I asked the officer if giving drugs to addicts sends the wrong message. He said his message was simple: "Stop breaking into cars!" With a subtle smirk in my direction, he added, "It is very strange that a country as violent as America is so obsessed with jailing drug addicts." Indeed, Dutch policymakers plan, regulate, fix and pragmatically debate harms and benefits. Police in the Netherlands are not involved in a drug war; they're too busy doing real police work."

4. Decriminalization Doesn't Promote Usage, Regulation Reduces Chaos

``The results are telling. In America, 37 percent of adults have tried marijuana; in the Netherlands the figure is 17 percent. Heroin usage rates are three times higher in the United States than in the Netherlands. Crystal meth, so destructive here, is almost nonexistent there. By any standard -- drug usage rates, addiction, homicides, incarceration and dollars spent -- America has lost the war on drugs.

``And just as escalating the drug war over the past three decades hasn't caused a decrease in supply and demand, there's no good reason to believe that regulating drugs instead of outlawing them would cause an increase. If it did, why are drug usage rates in the Netherlands lower? People start and stop taking drugs for many different reasons, but the law seems to be pretty low on the list. Ask yourself: Would you shoot up tomorrow if heroin were legal"

``Nobody wants a drug free-for-all; but in fact, that's what we already have in many communities. What we need is regulation. Distribution without regulation equals criminals and chaos -- what police see every day on some of our streets. People will buy drugs because they want to get high, and the question is only how and where they will buy them.

5. Learning From History

``History provides some lessons. The 21st Amendment ending Prohibition did not force anybody to drink or any city to license saloons. In 1933, after the failure to ban alcohol, the feds simply got out of the game. Today, they should do the same -- and last week the Justice Department took a very small step in the right direction."

Read the entire article here

Hat tip Mark Perry

Unintended Consequences From Europe's Agricultural Subsidy

This is another example of the unintended effects from market distorting regulations.

From the New York Times

(all bold highlights mine)

``Call it the mystery of the European sugar triangle.

``It began when Belgian customs officials examined shipping records for dozens of giant tanker trucks that outlined an odd, triangular journey across Europe. The trucks, each carrying 22 tons of liquid sugar, swung through eight nations and covered a driving distance of roughly 2,500 miles from a Belgian sugar refinery to Croatia and back — instead of taking the most direct, 900-mile route.

``Along the way the trucks made a brief stop in Kaliningrad, a grim and bustling Russian border checkpoint on the Baltic Sea.

``Suddenly the sugar triangle made sense to them. Because Russia, and not Croatia, was listed as the intended destination, the shipments qualified for valuable special payments known as export rebates from the European Union’s farm subsidy program.

``Some 200 shipments roared along this route over a three-year-period, investigators say, earning 3 million euros in refunds (about $4.5 million) for the Belgian sugar maker Beneo-Orafti. In the spring, dozens of Belgian and European investigators raided the company’s offices, freezing half of its refunds and initiating an investigation that could cost the company the remaining 1.5 million euros, and possibly more. In the sprawling European subsidy program — which lavishes more than 50 billion euros ($75 billion at current exchange rates) a year in agricultural aid — no commodity is more susceptible to fraud, chicanery and rule-bending, experts say, than simple household sugar."

Regulatory arbitrage according to wikipedia.org is "where a regulated institution takes advantage of the difference between its real (or economic) risk and the regulatory position".

Simply put, where some people try to profit from regulatory loopholes. The New York Times call this "cookie jar waiting to be pilfered"

Additional notes from the article:

-impact of price control via subsidies...

``Critics have long said that Europe’s subsidy system distorts the market, skewing competition and driving up prices. That is especially true for sugar, which in Europe has traded at roughly double the world market rate for almost two decades. European sugar prices are the highest per capita of any region in the world and about 20 percent higher than in the United States.

-failed goals

``But investigators say that fraud and rule-bending also contribute significantly to higher costs, because of the millions lost in uncollected revenue and in the payment of undeserved subsidies."

-spawns illegal activities...

``In addition, there are continuing investigations in Germany, Hungary and Belgium into cartel activity aimed at fixing prices and dividing up customers and territory."

``Perhaps the most common scheme used to game the system is to mix in cheap cane sugar from abroad with European beet sugar, which lowers production costs and increases volume. Companies doing this often falsely declare the country of origin for the sugar, which is illegal.

-producers confused with the bureaucratic maze...

``Sugar companies claim their activities are misinterpreted because they are governed by a byzantine European Union system that invites confusion. “It’s very complicated” and difficult for anyone to understand, said Dominik Risser, a spokesman for the Südzucker Group, a German company that is the industry giant in Europe and owns 40 factories in 10 nations, including those of Beneo-Orafti.

-producers or traders devise schemes to evade or circumvent regulations and taxes

``The mixing schemes extend into exotic hybrids — sugar mixed with dashes of tea and cocoa. By doing this, exporters can declare their products processed foods, and thus pay lower customs fees or avoid them altogether."

All these translates to a failure of policy or regulations.

Let me add that such distortive regulations will further put a strain on the global food supply chain as monetary stimulus from global central banks gains more traction, heightening the risks of a food crisis.

It's time to abolish such subsidies.

Graphic: World's Resources By Country

Mint.com provides a pleasant graphic on the distribution of the world's resources per country

Debating Climate Change Over Bed Time Stories

Here is the Thesis (Government advert implying deaths of family pets received many complaints from viewers-Protector1973)


Here is the Anti-Thesis (revised version Maggie's Farm)



Hat Tip: Russ Roberts Cafe Hayek

Niall Ferguson: Excessive Debt Predictor Of US Decline, China's Transitioning Role As A Rival

This interesting interview with Professor Niall Ferguson by Yahoo Tech Ticker

From Yahoo

``The U.S. is an empire in decline, according to Niall Ferguson, Harvard professor and author of The Ascent of Money.

"People have predicted the end of America in the past and been wrong," Ferguson concedes. "But let's face it: If you're trying to borrow $9 trillion to save your financial system...and already half your public debt held by foreigners, it's not really the conduct of rising empires, is it?"

Given its massive deficits and overseas military adventures, America today is similar to the Spanish Empire in the 17th century and Britain's in the 20th, he says. "Excessive debt is usually a predictor of subsequent trouble."

Putting a finer point on it, Ferguson says America today is comparable to Britain circa 1900: a dominant empire underestimating the rise of a new power. In Britain's case back then it was Germany; in America's case today, it's China.

"When China's economy is equal in size to that of the U.S., which could come as early as 2027...it means China becomes not only a major economic competitor - it's that already, it then becomes a diplomatic competitor and a military competitor," the history professor declares.

The most obvious sign of this is China's major naval construction program, featuring next generation submarines and up to three aircraft carriers, Ferguson says. "There's no other way of interpreting this than as a challenge to the hegemony of the U.S. in the Asia-Pacific region."

As to analysts like Stratfor's George Friedman, who downplay China's naval ambitions, Ferguson notes British experts - including Winston Churchill - were similarly complacent about Germany at the dawn of the 20th century.

"I'm not predicting World War III but we have to recognize...China is becoming more assertive, a rival not a partner," he says, adding that China's navy doesn't have to be as large as America's to pose a problem. "They don't have to have an equally large navy, just big enough to pose a strategic threat [and] cause trouble" for the U.S. Navy."

Additional noteworthy quotes:

“Excessive debt is usually a predictor of subsequent trouble”

“The more debt you have the more interest payments you have to make especially if interest rates move up”

On military: “They [China-mine] don’t have to catch up… they just have to have a big enough…to pose a strategic threat… can you handle two major challenges [debt and geopolitics-mine] simultaneously?”

My notes and comments:

-Interest payment burdens alone can translate to a self fulfilling prophecy for the US empire's decline

-Professor Ferguson comments that as China’s economy grows to reach parity with US, the character of relationship will transition from today's partnership to one of rivalry, i.e. from economic, to diplomatic, to military and to the naval sphere.

-The Soviet Union never rose to the occasion to challenge the US in terms of matching economic growth and military power.

-China's military doesn't have to reach the scalability of the US, it only needs to reach a critical mass to pose a serious threat.

-Besides, the US will be challenged by fighting its inner demons aside from coping with evolving realities of geopolitics.

The Evils Of Devaluation

``The much talked about advantages which devaluation secures in foreign trade and tourism, are entirely due to the fact that the adjustment of domestic prices and wage rates to the state of affairs created by devaluation requires some time. As long as this adjustment process is not yet completed, exporting is encouraged and importing is discouraged. However, this merely means that in this interval the citizens of the devaluating country are getting less for what they are selling abroad and paying more for what they are buying abroad; concomitantly they must restrict their consumption. This effect may appear as a boon in the opinion of those for whom the balance of trade is the yardstick of a nation's welfare.”-Ludwig von Mises, The Objectives of Currency Devaluation, Human Action, Chapter 31

Policies can be said to be socially beneficial if gains exceed the costs.

By such measure we can say that devaluation, as seen by some as a necessary evil, is nothing but an illusion.

How? Because devaluation:

1. Undermines the role of the US dollar as international currency reserve.

The role of the US dollar as the world’s currency reserve is to provide the medium of exchange function not only for national use but for the global economy. This means that the main channel of providing liquidity for international exchange is to have strong (overvalued) currency that imports more than it exports. By expanding current account deficits, the US finances global transactions mostly invoiced in US dollars.

However once the US dollar reaches a point where deficits would be vented on the currency, the role of the US dollar as the sole international currency reserve may be in danger.

The global central bank holdings of US dollar have reportedly been down to about 62% from over 70% during the past years. Moreover, as discussed in What Global Financial Markets Seem To Be Telling Us, the clamor to replace the US dollar standard has been getting strident.

Last week, a Latin American trade bloc of 9 members, the Bolivarian Alternative for the Americas (ALBA) declared that it would cease using the US dollar for regional commerce next year (Chosun English).

All these means that if the US continues to devalue its dollar, to point of losing its privileges from international seignorage [net revenue derived from issuing currency], or its international currency reserve status, this would translate to diminished access to global finance to fund domestic (trade or fiscal) deficits, reduced access to more goods and services worldwide, and a diluted leverage on the geopolitical sphere.

In short, the cost of devaluation greatly overwhelms the alleged benefits.

2. Overestimates the role of international trade as the share of the US economy.

One of the mainstream reductio ad absurdum is to overemphasize or, on the other hand understate, the role of global trade in the US economy, depending on the bias of the commentator.

For instance, some deflation proponents use 13% of import share to the US economy as rationale to downplay the transmission mechanism of global inflation to the US economy.

Using the data from wikipedia.com, we note that exports account for only 9% ($1.283 2008) of the US economy ($14.441 trillion 2008) while imports account for 15% ($2.115 trillion). The point is international trade accounts only one fourth of the US economy.

Yet common sense tells us that policies that allegedly promote 9% (exports) of the US economy at the expense of 91%, which is deemed by some as being net beneficial to the economy, is deceiving oneself or is consumed by political or economic ideological blindness, or is totally ignorant of the tradeoffs of the cost and benefits from said policies or is extending the intoxicating influence of political propaganda.

3. Creates Systemic Inflation Which Overwhelms Advantages From Currency Depreciation

When governments decide to devalue, it embarks on credit expansion or conduct fiscal spending or other monetary tools or a combination of these policies, in support of special interest groups, as in the case of the US, the banking system (for media, the exporters) for a specific goal (debt repudiation or promotion of exports/tourism).

This in essence would lead to a redirection of investments or a diversion of real resources from other activities.

If the currency depreciates as a result of the government actions but the impact of which does not reflect on domestic prices, then the interest groups supported by such policies or those that engage in foreign currency exchange or trade will likely incur large profits.

However, once prices adjust to manifest the impact of the currency depreciation on imports and to producer and consumer goods, then the short term advantage erodes.

According to Dr. Frank Shostak, ``the so-called improved competitiveness on account of currency depreciation means that the citizens of a country are now getting less real imports for a given amount of real exports. In short, while the country is getting rich in terms of foreign currency, it is getting poor in terms of real wealth, i.e., in terms of the goods and services required for maintaining peoples' life and well-beings. As time goes by however, the effects of loose monetary policy filters through a broad spectrum of prices of goods and services and ultimately undermine exporters profits. In short, a rise in prices puts to an end the illusory attempt to create economic prosperity out of thin air.” (bold emphasis added)

In short, the beneficial impact of devaluation to certain groups will likely be short term and will eventually be offset by inflation.

4. Neglects The Role of Division Of Labor In Terms Of Imports and Exports

Adding to the fallaciously oversimplistic methodology by which mainstream seem to look at the world as operating from a homogeneous form of capital, whose product is produced by a single type of labor and sold as one dimensional product to an indiscriminate market affected by the same degree of price sensitivity, they also seem to think that exports have little correlation to imports, whereby final product sold abroad are all locally designed or processed- raw material sourcing, assembly, manufacturing, packaging, testing and etc...

The mainstream forgets about re-exports or imports of semi assembled products, parts or components that make up another product to be re-exported.

Applied to Asia, global parts and component trades have increasingly made up manufacturing output (see figure 3)

Figure 3: ADB: Emerging Asian Regionalism

To quote the ADB, ``In Integrating Asia, the share of parts and components trade (PCT) in manufacturing trade shot up from 24.3% in 1996 to 29.4% in 2006. That is a remarkable rise, not least since worldwide its share has scarcely increased, edging up from 19.6% to 20.2% over the same period.

``As a share of GDP, PCT is among the highest in the world in the ASEAN (especially in Malaysia, the Philippines, Singapore, and Thailand) and in Taipei,China, perhaps because the relatively small size of their economies makes specializing in small niches of comparative advantage particularly important. Broadly speaking, the success of these economies is based on policies that welcome foreign companies, encourage technological upgrading, and build strong connections with world markets, as well as on their proximity to Asian neighbors following similar strategies. PCT is particularly significant among ASEAN countries: it rose from an average of 35% of manufacturing trade in 1996 to 43% in 2006. The PCT share in the PRC nearly doubled over the same period, from 12.5% to 24.0%, while in India it remained at around 10.0%.” (bold emphasis mine)

In short, in a world where the integration of the global economy has been deepening to reflect on the specialization or division of labor, imports has significantly contributed to manufactured products which are eventually re-exported. Such trade specialization constitutes as the lengthening of the economic structure.

Figure 4: ADB: How A Typical Hard Drive Is Produced

As an example, the ADB shows how Asia’s parts and component trade (PCT) for a hard disk drive, assembled in Thailand, is networked within Asia and partly outside the region. And that’s merely for a hard disk, which also is only a component for a computer set.

So currency prices haven’t been the only factor that shapes production, but importantly trade openness, comparative advantages, division of labor and variability of markets as the ADB points out.

Here, globalization reveals that the division of labor and comparative advantage has been more than just “ideal” or “theoretical”. Instead, these economic forces depict of its pervasiveness in the global economic capital construct. They have even proven to be a more potent force than simply acquiring market share via currency price adjustments.

Talk about a genuine multiplier effect from free trade!

5. Overlooks On The Role of Societal Transition

One of the reasons why many support the government’s devaluation policies has been underpinned by concerns that US manufacturing output as a share of GDP has been declining.

The misimpression is that jobs have been exported out to third world countries.

Again, mainstream myopia which only looks at the surface sees jobs as one dimensional in nature. Their highly mechanistic viewpoint can’t seem to distinguish between low-scale low-value highly-commoditized jobs vis-à-vis high value specialized jobs or can’t seem to comprehend or digest the role of comparative advantage and specialization or division of labor in a world which practices globalization or freer trade.

The US supposedly is the premiere representative of the world’s democratic capitalism which implies that she has once been the world’s freest economy. Yet it is when an economy is economically free or open to trade that the advantages of comparative advantage and specialization can be seen and felt most.

For instance: in the 2008 capital goods accounted for the top US exports, according to US Department of Commerce, International Trade Administration, ``Capital goods represent the largest goods export category (end-use) for the U.S. with $469.5 billion worth of exports in 2008. The U.S. trade surplus in capital goods rose $12.8 billion to reach $15.7 billion in 2008, up from a surplus of $2.9 billion in 2007.”

On the other hand, top imports for 2008 crude oil, passenger cars, medicinal preparation, automotive accessories, other household goods, computer accessories, petroleum products, cotton apparel, telecom and video equipments (world’s richest countries). This means that aside from final consumption goods, the US imports parts and components for assembly or re-exports as well as raw materials.

The other way to look at this is that the US sells goods or services which reflect on its advance “technology age” state (capital goods) while buying input goods for reprocessing or commoditized goods for the end user.

Simply said, if the world has evolved from the agricultural era (agricultural economy) to the industrial era (manufacturing economy), then we are presently in a transition towards the information age or the post industrial society as identified by Alvin Toffler in his Third Wave Theory.

This means that the lengthening or expanding phase of an economy’s capital structure in an information age extrapolates to a bigger share of contribution from information and technology based goods and services relative to the overall economy.

As much as the share of output in agriculture shrank relative to the overall economy during the industrial era, today’s modern economy should see a smaller or declining contribution from the vestiges of the agricultural and the industrial output relative to economy.

Figure 5: Carpe Diem: Manufacturing Output and Productivity at Record Highs

Nevertheless, contrary to mainstream’s fanatical obduracy, US manufacturing in terms of productivity is at a record high (left window).

Moreover, while manufacturing jobs have been on a decline to reflect on productivity gains (right window), it is only during the last year’s recession where a drop of manufacturing output from record highs occurred. Still yet, all these, signify the advancement and not retrenchment of US manufacturing at the present state.

As University of Michigan’s Professor Mark Perry recently observed, ``More and more manufacturing output with fewer and fewer workers should be considered a positive trend for the U.S. economy, not a negative development. We should think of it the same way as the trend in farming over the last 150 years - we're much better off as a country, with a much higher standard of living, with 3% of Americans working on farms compared to 150 years ago when about 65% of Americans toiled on farms. If we can continue to produce more manufacturing output with fewer workers, we'll be better off as a country, not worse off.” (bold highlights mine)

So anyone who expects a return of the conditions of the industrial manufacturing age in today’s post industrial society simply suggest of the curtailment of progress or a throwback in time similar to Argentina in the 1930s or is against human progress.

And to adopt a protectionist economy combined with massive devaluation, which likewise signifies fear of competition, is a sure route towards decadence.

6. Promotes Capital Flight

Mainstream outlook seem to discern people as irresponsive to the incentives provided for by the governing circumstances. They haughtily presume of better intelligence than most of the society. While they could be somewhat correct, in terms of information (and not knowledge), we know that macro thinking is a poor substitute to the knowledge of F.A. Hayek’s “man-on-spot”.

This implies that when major policies which tend to have a momentous impact on society are undertaken, people consequently will respond in accordance to how such policies are transmitted into their respective fields or industries. In other words, in the marketplace a micro outlook is fundamentally superior than a presumptive model based macro analysis.

And devaluation policies would likely have an unintended effect: capital flight!

While there will be some sectors or interest groups that would benefit from a reconfiguration of investment flows, the alternative bet would be for capital to flow out of the country which have been engaged in policy devaluation and flow into assets of foreign currencies which have not or to real assets.

Economist David Malpass, a columnist at Forbes magazine, recently wrote an incisive article articulating how capital flight will subdue any tinge of benefits from devaluation.

Mr. Malpass wrote, ``Some weak-dollar advocates believe that American workers will eventually get cheap enough in foreign-currency terms to win manufacturing jobs back. In practice, however, capital outflows overwhelm the trade flows, causing more job losses than cheap real wages create. This was the lesson of the British malaise, the Carter malaise, the Mexican malaise of the 1990s, Yeltsin's Russian malaise through 1999 and the rest. No countries have devalued their way into prosperity, while many—Hong Kong, China, Australia today—have used stable money to invite capital and jobs. The more the dollar devalued against the yen in the 1970s and '80s, the more Japan gained share in valued-added manufacturing, using the capital from weak-currency countries to increase productivity. China is doing the same now. It watches in chagrin as the U.S. pleads with it to strengthen the yuan, adding productivity fast with the dollars rushing its way in search of currency stability” (bold emphasis mine)

Figure 6: Casey Research: Drumbeats For The US Dollar

Systemic inflation aggravated by capital flight is likely to overwhelm any purported gains from devaluation.

Currently, foreign flows into the US by both private and official sectors appear to be in a swan dive as the interest to own US securities have evaporated (see figure 6).

If capital flight from US residents and foreigners snowball into a tsunami, then the risks of exchange controls could be in the horizon.

This would be different from the recent capital controls imposed by Brazil, which uncannily slapped a 2% tax on foreign capital flows into fixed income and the stock market (Bloomberg). Such unorthodox move was meant to stem the tide of capital inflows where the Brazilian government deems the recent surge of the real and its stock market as indications of a seminal bubble.

Conventionally, capital controls are instituted to curb capital from stampeding out of a national economy or from the region.

Applied to the Asian financial crisis of 1997 which had been largely blamed by the domestic officialdom on speculative hedge funds, Joe Studwell in Asian Godfathers, Money and Power in Hong Kong and Southeast Asia argue that local tycoons were more culpable, ``An enquiry after the crisis found little evidence that hedge funds and other leverage investors played a significant role. There was widespread in the region of massive capital flight orchestrated by local tycoons; but Singaporean and Hong Kong banking secrecy is such that this is impossible to quantify.”

Exchange controls only serve to appropriate the properties of its constituents and of foreigners. By adopting a close door policy in finance and trade, the impact would be to dramatically increase the risk profile of a country. This should translate to a reduction of wealth via a markdown on assets as investors will pay less to own income flows or property or demand higher premium than where there is full convertibility of the currency.

The bottom line is present policies aimed at attenuating the US dollar risks not only capital flight from foreigners but also from local residents.

7. Raises The Risks Of Global Currency War

The perils of using models for prediction would be the assumption that conditions of the past have similar dynamics today. For instance, when Fed Chair Ben Bernanke used the Great Depression as paradigm for measuring the success of devaluation, he probably assumes that the US dollar today can devalue against other currencies without much resistance or would be cordially tolerated by other central bankers.

This would be highly presumptuous.

During the Great Depression, the US managed to devalue because it operated under a gold standard. President Franklin D. Roosevelt’s EO 6102 basically confiscated gold from every Americans in 1933 from which gold’s role as the public’s medium of exchange had been indefinitely suspended.

Since President Richard Nixon closed the Bretton Woods standard in 1971, otherwise known as the Nixon shock, the US dollar has assumed the role of gold as transaction currency for international exchange and as anchor reserve currency for global central banks.

Compared to gold based notes whose rate of issuance would depend on the rate of output from extracting gold from the ground, which is vastly limited due to the high cost and the attendant risks from mining, should the US decide to massively devalue, it could easily facilitate these using the Federal Reserve’s printing press or the technology enhanced digital press. Yet this would impact fundamentally all currencies, given its role as the world’s foreign reserve currency.

To consider according to wikipedia.org, 14 countries are unofficial users of the US dollar or has a dollarized economy. In addition, 23 countries are pegged to the US dollar. If the US dollar continues with its descent in response to the prevailing policy actions, then basically all 37 countries will be importing inflation from the US. Yet, their economies haven’t been afflicted by the same debt woes.

This may lead to a supply shock, where massive waves of money will be chasing after scarce supply of real goods or property.

Moreover, one can’t discount that the other central bankers may not be as cordial or as permissive as Ben Bernanke expects them to be and might attempt to counteract the US devaluation policies by arbitrarily conducting their own currency weakening process.

At the end of the day, if more and more government hops into the devaluation bandwagon then we could countenance a global currency war. And a global currency war risks a horrendous hyperinflation on a worldwide scale.

Ludwig von Mises has admonished us on the possibility of such risks, ``If one looks at devaluation not with the eyes of an apologist of government and union policies, but with the eyes of an economist, one must first of all stress the point that all its alleged blessings are temporary only. Moreover, they depend on the condition that only one country devalues while the other countries abstain from devaluing their own currencies. If the other countries devalue in the same proportion, no changes in foreign trade appear. If they devalue to a greater extent, all these transitory blessings, whatever they may be, favor them exclusively. A general acceptance of the principles of the flexible standard must therefore result in a race between the nations to outbid one another. At the end of this competition is the complete destruction of all nations' monetary systems.” (bold emphasis mine)

Devaluation is a risk endeavor which US policymakers appear likely to undertake (or in my view “gamble on”) in order to neutralize the impact from an unmanageable debt burden plaguing its system.

And this has been cheered upon by their exponents. Yet given the above, it would seem that policymakers and their cheerleaders don’t truly have the necessary understanding or comprehension of the risks involved or has vastly underestimated them.

Devaluation isn’t a necessary evil. Devaluation can take the form of the inflation demon, from which having emerged from the inferno, may wreak more systemic havoc than expected. After all, in the context of history, devaluations have been the seeds to the extinction of currencies. This time may not be different.

Bernanke’s Devaluation Is About Debt Deflation, Tenuous Link Between Weak Currency And Strong Exports

A devaluation, however, is always couched in terms designed to make people believe that the government has performed some sort of fiscal miracle. What, in fact, it has done is announced that it is reneging on its debts.-Robert Ringer, The True Cause of Inflation...

Rising financial markets amidst a world where the US dollar flounders seem to have set loose growing cacophonous voices in support of such politically induced environment. The general theme is: A falling US dollar (via devaluation) translates to surging exports and bigger profits from multinationals, hence are seen as a good development for the markets and economy.

Essentially rationalizing devaluation as the best alternative path for economic recovery is clearly a manifestation of the reflexivity theory-a reinforcing feedback loop mechanism where people interpret prices as signifying real events, and where real events reinforce these price signals. The positive temporal effects from a weak dollar have been construed as blessings. Hence the appearance of asset price and economic recovery seem to have drawn in a growing number of weak dollar fans.

Yet oblivious of the present dynamics, the mainstream fails to take into the account that asset pricing today hardly reflects actual demand and supply balances but importantly signifies as the various degrees of government interventions in the marketplace aimed at “patching” the system.

In short, growing misinterpretations from rising asset prices by a system surviving on straps of band-aids leads to false confidence.

Inflation Is Not A One Size Fits All Formula

The mainstream seems baffled by the genuine reasons behind why US policy appears to be directed towards a lower US dollar. Programs such as the nationalization of the US mortgage market by the immensely expansionary roles of GSEs as Fannie Mae, Freddie Mac and FHA, an extended period of zero interest rate regime, equity stakes at key financial institutions, centralization of Fed powers, large fiscal deficits, a broad alphabet soup of makeshift programs aimed at providing marketmaker, lender, buyer or investor of last resort and importantly “money printing” Quantitative Easing programs, have all contributed to the falling US dollar or the “devaluation”.

Many have erroneously moored their views on the alleged necessity to restore “imbalances” of the US economy (e.g. wage differentials, nominal GDP, unemployment) allegedly targeted to enhance competitiveness relative to the world via devaluation. However, such perspective camouflages on the authentic but implied reason: To forestall systemic deflation from unwieldy debt aggregated within the system.

We have repeatedly been saying that Federal Reserve Chairman Ben Bernanke has made this campaign against deflation as the foremost incentive for today’s policy action, as noted his famous November 2002 Helicopter Speech Deflation: Making Sure "It" Doesn't Happen Here.

Yet Mr. Bernanke’s sweeping examination of the Great Depression as model for today’s policy guidance, from which his panoply of antidotes has been devised from, emanates from mostly the monetarists’ dimension. However, this framework diminishes the weight of influence from wage and price controls instituted during the New Deal era.

The US recovered from the Great Depression not from inflationary policies, as Mr. Bernanke perceives, but from the massive attendant price and wage adjustments. Importantly ``a partial dismantling of the regulatory infrastructure that had grown up during the Depression and the war; in effect, it was a rediscovery of the market and a new birth of freedom for entrepreneurs and workers” notes Professor Art Carden, post World War II.

This means that throughout history, devaluation, as Henry Hazlitt rightly exposes, is the modern euphemism for debasement of the coinage. It always means repudiation. It means that the promise to pay a certain definite weight of gold has been broken, and that the devaluing government, for its bonds or currency notes, will pay a smaller weight of gold.”

In other words, policies dealing with tacit debt repudiation should be seen in a different light compared with that from the adjustments from economic imbalances.

Theoretically, in order to solve unemployment government can hire everyone (communist model). But this would be different from preventing systemic deflation from outsized debt by concentrating taxpayer resources on the banking system as seen today. Because the objectives and policy recourse actions are different, hence the repercussions from current policy actions will be different. So it would be a folly to lump debt repudiation and economic imbalances as a “one size fits all elixir”.

Presently, the global governments’ collective approach has been to substitute constricting private sector debt fueled consumption (from economies blighted by the recent bubble) with its own.

As Morgan Stanley’s Spyros Andreopoulos rightly observed, ``This time around, however, eroding the debt through faster growth may not be an option. Instead, growth in many developed countries is likely to slow significantly going forward as labour forces shrink due to the demographic transition. Worse, population ageing will impose added pressure on public expenditure through higher pensions and healthcare costs. If outgrowing the debt is unlikely, and if governments lack the resolve to cut spending and/or raise taxes sufficiently, the remaining options are default and inflation. No policymaker in the developed world - and, by now, few in the developing world - would want to countenance default as an option. This leaves inflation.” (bold emphasis mine)

So while mainstream engages in data mining of facts in order to fit in to their preferred bias/s with its accompanying outcome, the reality is that policy actions have been concentrated on managing the intractable debt burdens.

Dismissing The Benefits Of Devaluation From Empirical Evidence

Figure 1: New York Times: China Grabs Export Leadership

The post hoc fallacy assumption that a falling currency is a boon to international competitiveness, as represented by export growth, can easily be disputed from the reference point of today’s roster of biggest exporters.

Simplistically this suggests that top exporters have weak currencies.

Figure 2: Economagic: Currencies of Major Exporters

Seen from the perspective of the Euro (blue line-top window; currency of Germany, Netherlands, France, Italy and Belguim) and the British Pound (red line top window), aside from the Japanese Yen (blue line, lower window), except for the 2008 meltdown, these currencies have been on a long term appreciation, in spite of their roles as the world’s largest exporters.

The South Korean won (red line lower window) which devalued by half as a result of the Asian crisis in 1997, has seen a recovery of its currency yet its exports exploded over the same period. One should note that the Bank of Korea used the Asian crisis as an opportunity to liberalize its capital account in two phases to offset the impact of the crisis.

Alternatively, if the weak currencies equate to strong exports: Zimbabwe, the Philippines or the previous hyperinflations episodes of Argentina or Brazil should have made them export giants of today. None of this is true.

Incidentally, Argentina used to be one of the world’s most prosperous countries in the world during the first quarter of the 20^th century or the “golden age of growth” (Library of Parliament). Its political and economic regression had been largely due to the protectionist and isolationist policies (wikipedia.org) post 1930 or the Great Depression.

Hence given the Argentine experience, devaluation and closed door policies make a lethal combination to lower the standards of living of a society.

Today, Argentina is classified as an emerging market.

Although one may point to Argentina’s export recovery following the 1999-2002 crisis, which saw the Peso massively fall anew, the fact is that Argentina’s exports has mainly been in commodities, agricultural (54%) and energy (12.2%). In other words, Argentina’s export recovery can be construed from less of the international competitiveness from a weak currency, but mainly levered from global demand for commodities which appears to be in a supply ‘shock’ following years of underinvestment.

So based on empirical evidences as shown above, the notion that weak currency equals greater international competitiveness is utterly unfounded and represents sloppy and an oversimplistic thought process meant only to justify government interventions.