Category Archives: Economics

Gold will not necessarily go up during deflation

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Many financial commentators, including the usually on-the-spot Mish Shedlock, have been saying for quite some time that gold will go up in a deflationary environment. Their argument is that gold is money and money does well in deflation. I would be willing to wager that Mish has more understanding of economics while half asleep than I will ever hope to have, and so I assume he’s just being simplistic and inprecise with his words. However, people then repeat it often enough, and it takes on a life of its own. There are many people explicitly claiming that the price of gold should rise during both deflation and inflation. Empirical evidence to the contrary gets brushed aside by either (a) claims that the gold paper market (COMEX) is being manipulated or (b) we’re in a temporary period of gold falling due to hedge fund deleveraging.

However, straightforward logic will tell you that gold should not neccesarily go up in price during deflation. Yes, it’s money, but so are dollars! And since gold is always priced in units of somebody’s money, why should it always go up? Sure, it will increase in value, relative to other assets, during deflation, but without other factors to consider there is no reason to expect it will increase in price. After all, the Yen is money, so shouldn’t it go up during deflation? Obviously, every currency cannot go up relative to every other currency, and so, too, the price of gold will not automatically go up during deflation.

So the real question is this: is gold an attractive currency relative to the dollar? I’d argue it depends on the stuation. If you expect the deflation to be caused by lower demand for goods despite an increase in the money supply, you might consider gold a more stable value. But there are inherent disadvantages to gold, such that all things being equal, cash wins: You can’t pay debts with gold, and none of your future expenses are priced in units of ounces of the stuff. There’s no way to make gold disappear, but in our fractional reserve system, fiat currency can vanish during a period of debt destruction. If I were confident of such a monetary deflation persisting I’d personally want to keep my wealth in the ever scarcer fiat currency, not a form of money that’s dug out of the ground and hoarded by metric tons in central bank vaults around the world.

I certainly agree that it’s possible for gold to go up during deflation, and that if ever there were a situation where it should, it’s perhaps now. All I’m saying is that the idea that gold will always go up during deflation is as nonsensical and meaningless as saying the Euro will always go up during deflation. It depends on the situation. I think the best argument for holding gold during a period of deflation is simply the expectation that the government will soon do everything in its considerable power to reinflate the currency.

(Disclaimer: Lest anyone think I’m the typical antigold zealot sniping at the bugs, I’m actually long a significant portion of my meager grad student portfolio in GG and DGP.)

The bailout, part II

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Did I say bailout? I meant rescue. Here is an excerpt from one of the smartest financial writers I know of, Mish Shedlock:

To stimulate lending, the bailout plan will attempt to recapitalize banks. The method of recapitalization is best described as robbing Taxpayer Pete to pay Wall Street Paul. In essence, money is taken from the poor (via taxes, printing, and weakening of the dollar) and given to the wealthy so the wealthy supposedly will have enough money to lend back (at interest) to those who have just been robbed.

All this talk about Strategy, Implementation, Recruitment, Procurement, operations, compliance, and other details masks the essence of the plan. And even though “A program as large and complex as this would normally take months — or even years — to establish”, the Secretary for Financial Stability is going to ramrod something through as quickly as possible.

Unfortunately, no matter what seat of the pants strategies they come up with, I can guarantee in advance that the unforeseen consequences of whatever decisions they make, simply will not be any good. Besides, it is axiomatic that plans to rob Peter to pay Paul, can never really work in the first place, regardless of how much time is spent crafting them.

This is not to say that it won’t work overall, as this plan at least finally addresses the fact that what banks need is capital, not access to credit. In fact, this is the first article of Mish’ that wasn’t outright beligerent in calling Paulson and the Fed complete fools, so I guess that is as close to an endorsement as you’ll get. But it’s just sad that the masters of the universe screw up royally, and poor people will disproportionately pay the price. It’s also sad that this further concentrates Chinese power over the American economy as they will be undoubtedly financing a lot of this.

Taxing the poor to bail out Wall Street

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It has been assumed that the cost of the putative bailout will be born by taxpayers. However, since that the Fed and Treasury will pay for it with debt and by printing money, the people who will pay for it are anyone who holds dollars. Given that the final cost could end up in the trillions, the result will be quite a bit of that hidden tax called “inflation,” as all the debt and new money dilutes the currency. Inflating the currency is actually a very regressive tax, however. Poor people generally have to live month-to-month, and thus aren’t able to save and invest money, holding most of their wealth in cash. They also don’t have access to as high yielding investments as the rich. Most importantly, they occupy jobs which are usually the last to see inflationary wage increases filter down to them (which is as it “should be” or otherwise inflation wouldn’t work so effectively as a hidden tax).

So, this bailout of Wall Street is going to be disproportionately paid for by the working poor. Good job congress.

Gatorade: a prime example of cynical marketing

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It should be obvious, but sometimes it bears reminding that people in corporate marketing often don’t operate with a tremendous amount of integrity. For lack of anything better to write, I thought I’d pass along a banal but telling observation I recently made about, of all things, Gatorade.

Gatorade was created by legitimate sports scientists, and while its formula is simple–sucrose, dextrose, salt and potassium–it really does have actual benefit. The sucrose and dextrose are sugars with relatively low glycemic indexes, and the salt and potassium provide electrolytes. All things that are rather important to the functioning of your muscles, and thus it reasons to replace them. Professional sports teams provide Gatorade partly because I’m sure they get money for it, but also because it has been shown to be truly effective.

Not surprisingly, the company has always marketed the product to consumers, who recken if pro sports teams provide it to their players, it must be worth buying. However, at some point, they changed the formula sold to consumers in order to save money. If you look at a current bottle of good old lemon-lime Gatorade, you’ll see that it doesn’t contain salt (though there is potassium) and the sucrose and dextrose have been replaced by the cheaper (thanks to our moronic farm subsidies) but far less healthy high fructose corn syrup. (America truly runs on high fructose corn syrup.) Corn syrup is a great way to get a sugar crash, the last thing an athlete wants to consume. I guess they figured the salt didn’t help the taste and was kind of pointless in the sham they now pawn off on consumers.

What makes this truly cynical marketing is not that the company makes two products of vastly different quality, but that they call them the same thing. Imagine if Honda made a special version of their cars with better safety to give to celebrities, trying to make it look like famous people drove Civics.

How much does Gatorade save? Whatever it is, I’m certain truly informed consumers would rather pay the extra few cents to get the healthier old formula. And does any of this really even help them in the long run? Some short sighted middle manager probably ordered the switch to give the company a one quarter boost in growth. I suspect this kind of business “improvement” is behind a lot of American corporate growth, and eventually it is self-defeating. In the long run you don’t grow an economy by shrinking quality. And you don’t maintain customers by fooling them: eventually some insufferable pedant is going to blog about it, no matter how mundane it is.

Saudi Oil and the US dollar

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Last week the dollar began to recover in value as the Bush administration finally started making serious noise about a strong dollar policy. Now, right on the heels of that display, the Saudis finally agree to up production.

Both events were a bit long in coming, at least relative to the reasons stated by each party. The Bush administration claimed it was (finally) worried that imports would become too expensive if the dollar were allowed to continue its slide. They didn’t seem concerned the past several years as the dollar slowly dropped a third in value. After all, it was their policies that caused it. Similarly, the Saudis have been fighting production increases all the way as oil has quadrupled in value. But now $140 is the magic number where they start to care?

It leads one to think maybe the two capitulations are connected. After all, high oil prices hurt America. A devalued dollar hurts the Saudis, as oil is priced in dollars. Priced in Euros, for example, the Saudis aren’t raking it in as much as it would seem. Given how much they trade with Europe, the dollar’s fall has offset a lot of the increase in the price of oil, especially given that they probably have a lot of production costs that are priced in other currencies, squeezing them from both directions. So, we prop up the dollar to help them, they increase production to help us. Given the connection between the Bushes and the Saudis, maybe the two governments finally addressing these longstanding problems at the same time is not a coincidence. Nor, perhaps, is it a coincidence that this coincidence happens during a presidential campaign.

Spend your stimulus money wisely!

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Alligator skin boots for her: $600,
Playstation 3 with Call of Duty 4 for him: $550,
Having your unborn grandchildren foot the bill: Priceless.

Today I got the same letter from the IRS that some 120 million other Americans received, informing me that in the not-so-distant future my wife and I will be honored with a check for $1200 from the US treasury. Apparently we’re going to avoid the recession caused by us borrowing too much money by borrowing more money. Given that this is a done deal, there’s no point in opining on the criminal irresponsibility of our pandering politicians adding hundreds of billions of dollars to the national debt to buy us bread and circus in an impotent attempt to stave off the well-deserved economic hangover we all should have known was coming after decades of partying on credit. So I won’t mention that.

But given that we’re going to be getting this de facto tax break, I think we all should do our best to actually help the American economy with it. This is harder than it seems. You can’t just go out and buy an iPod. Sure, Apple will get some of the money, but all the components and the manufacturing are done overseas. I don’t think taking our tax money and using it to worsen the current account deficit is the idea here. What does America still make? Mostly lattes, lawyers, pills, software and movies. So, it’s not going to be easy to spend your money on the American economy. Thus, I’ve decided to provide a few ideas, some of them even feasible, for fun things to spend your money on that will maximize the impact on the American economy and won’t require you to sue anybody:

  • Pay off debt. It may not give an immediate jump to the GDP, but it has long term benefits that will accrue to it.
  • Patronize those locally owned restaurants you’ve been meaning to try. Tip heavily.
  • Go to the theater. Buy lots of candy and popcorn. (But stay away from the Nestle products.)
  • Rent a Harley and take a trip somewhere. No going into Canada!
  • Take flying lessons. You won’t be able to get your license with $1200, but you’ll have a lot of fun and will probably get to the point of soloing. No going into Canada!
  • Get 20 friends together at work and buy a car to raffle off. I suggest the new Charger, but just make sure it’s American.
  • Finally buy legal copies of all that software you’ve been pirating. Yes, I know about that copy of Photoshop!
  • By some really good California wine. I recommend Coturri.
  • Purchase a custom made bag by Timbuk2, built by hand in San Francisco.
  • Take a class or two at the local community college.
  • Get a weekly massage and get a happy ending for the American economy.

More as I think of stuff. Suggestions always welcome.

Smoking and mirrors

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The AP is reporting on a study showing that preventative medicine for obesity and smoking actually results in higher healthcare costs. For example, smoking will increase your life expectancy by about 8%, but will increase your healthcare costs by 25%. This is the result of the disproportionate amount of money spent to keep people alive at the end of their lives. Studies have shown that one third of the lifetime cost of healthcare is incurred over the age of 85 (for those living that long). From the report:

Cancer incidence, except for lung cancer, was the same in all three groups. Obese people had the most diabetes, and healthy people had the most strokes. Ultimately, the thin and healthy group cost the most, about $417,000, from age 20 on.

The cost of care for obese people was $371,000, and for smokers, about $326,000.

The results counter the common perception that preventing obesity will save health systems worldwide millions of dollars.

“This throws a bucket of cold water onto the idea that obesity is going to cost trillions of dollars,” said Patrick Basham, a professor of health politics at Johns Hopkins University who was unconnected to the study. He said that government projections about obesity costs are frequently based on guesswork, political agendas, and changing science.

What’s especially interesting and relevent about this is that both Obama and Clinton insist that much of the tremendous cost of their healthcare proposals will be paid for by better preventative healthcare, especially for obesity. It’s pretty much a given that whatever they claim the cost will be, you can pretty much double that. Anyone who doesn’t believe me can look at Massachusetts’ universal coverage initiative (or anything else the government does, for that matter). But with this new study, maybe even that is an underestimate.

Instead of trying to placate us by “lowering” health care costs by simply shifting them onto our tax costs (plus overhead) it would be nice if one candidate would come out for actually lowering the cost of healthcare in a meaningful way. Tort reform and more intelligent allocation of research funding would do a lot. There’s also the radical notion that maybe we could make some sacrifices and just say ‘no’ to some of the incredibly expensive yet only marginally more effective medical technology that we’re always paying for. A good example is 3D ultrasound. Do we really need to pay billions of dollars as a nation just to make really creepy renderings of babies? Especially when its those babies who are going to inherit the debt—and precedent—for the frivolity.

It seem to me the main problem being addressed by these proposals is that there are a lot of people who can’t afford healthcare. Why not just buy them healthcare as part of our existing welfare infrastructure? Why the need for yet another beaurocracy? We should agree to more government only with reluctance, not relish.