Tag Archives: labor

The Independent Globalist: an instruction manual

I drink your milkshake

You drank my milkshake!

Independent globalists optimize after-tax returns, labor, and supply chains into the tax and regulatory regimes that are most favorable.

It’s an optimization exercise and a chess game.  This seems to be the dominant strategy:

1) After-Tax Returns

The equation: taxes + regulation.   Taxes are simple; they reduce your profits by their rate.  Regulation is more complicated because it costs money to comply, but there are also opportunity costs from business activities that are no longer available.

The game: reduce and eliminate taxes and regulation.  Express the stresses of international competition to pressure national politics using one issue at a time in the countries where you do business.

2) Labor

The equation: salary + benefits, including long term commitments.  Retirement, health care, and other benefits have costs, but also may reduce employee turnover.

The game: reduce and eliminate costs within each role.  Divide operational units and move them to locations with optimal rules and costs.  Use the placement of these units to pressure politics to reduce labor’s collective bargaining rights.

3) Supply Chains

The equation: price.  Commodities and other non-labor costs are priced on global markets, and are mostly fungible.

The game: reduce and eliminate regulations that internalize costs of production for your suppliers.

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The Credit Crunch and the Market

[Download the complete article in PDF format, with charts and better formatting]

The past month has been a roller-coaster in the financial markets.

At the first hints of falling prices in the mortgage backed securities markets, Bear Sterns announced the bankruptcy of two large hedge funds, and 90% losses in a third fund which had $850 million invested in highly rated mortgage-backed securities. In the following weeks, other major funds also announced losses. Goldman Sachs’ Global Alpha hedge fund fell 27% this year through Aug. 13, prompting clients to ask for $1.6 billion in redemptions, investors told Bloomberg. DE Shaw, a pioneer of quantitative investing based on complex mathematical and computer techniques, has been hit hard in August. DE Shaw’s Valence fund is down more than 20% through August 24th, according to a fund of hedge fund manager.

These high-profile losses are prompting redemptions, and as cash flows out of hedge funds, managers must sell. Around the world, leveraged funds anticipate redemptions and are deleveraging (selling).

“When you can’t sell what you want, you sell what you can.”

Because the markets for mortgage-backed securities dried up so completely and so quickly, managers began selling positions that remained liquid and well-priced. In a sense, they had to sell good investments because they couldn’t sell the bad ones. What started as a series of collapsing mortgage strategies has spread into just about every other market that hedge funds touch. Prices fell in investments ranging from emerging market bonds to the price of hogs. In all, more than $1 trillion in value has been lost in US stock markets, alone. Many foreign markets and alternative asset classes suffered worse declines.

The trigger event is a credit tightening: mortgage issuers extended too much credit, were too loose with their lending standards, and may not have adequately communicated their loan terms. In response, lending standards have been increased and credit is tighter. US consumers might slow their spending, which might trigger a broader slowdown in the US economy, which might have implications for global growth. Uncertainty and fear prevail.

We view this fear as primarily psychological, wildly overestimated, and only loosely related to market fundamentals (See Figure 1). But that may not matter.

Contagion

The pricing of risk is driven by psychology. Investors require compensation for the possibility of loss and also for the inconvenience of uncertainty. So rising risk can cause capital to become scarce, lending rates to go up, and spending to slow. In this sense, the psychology can impact the fundamentals in what is sometimes called a “contagion”.

The “Greenspan put” was like a safety net, providing the comfort that credit would be made available on those occasions when it was needed. Bernanke has reiterated this strategy, but it remains to be seen if he has the same appreciation for what Keynes called the “animal spirits” of the market. Contagion is a real phenomenon, generally starting with a crisis in one market or a large fund, then spreading to other asset classes as volatility rises and investors require higher premiums for risky investments.

In our view, the excessive lending in the mortgage industry could trigger a contagion in a variety of ways, such as:

  • Rising rates and tightening lending standards leads to a contraction in home prices, reducing consumer spending and slowing economic growth.
  • A new awareness for the risk of debt investments causes borrowing costs for corporations and governments to rise, reducing investment and slowing economic growth.

These risks can be self-reinforcing, and could change the fundamental characteristics of the economy. These are the type of events that could change our investment strategies if they appear to develop out of control.

So far, these contagions have not caused a significant slowdown in economic activity. Volatility triggered by major hedge fund failures is different; it generally causes sharp declines in recently popular asset classes followed by recovery. These declines can proceed in unexpected ways, and can continue for some time because each price shock runs the risk of triggering another failure. It is surprising how many hedge funds use leverage sufficient to make them incompatible with price shocks. As months pass, however, these shocks can be a blessing because they offer rare value opportunities.

We should all hope that a full-fledged contagion does not develop, and be thankful that the world’s central banks are standing guard.

The Federal Reserve

It is important for the government to intervene if a contagion might damage the economy in fundamental ways, but also important for the government to avoid interfering otherwise. The Federal Reserve and foreign central banks play an important role in managing the stability of economic growth by changing the availability of capital at money-center banks, but interventions can also cause distortions in currency exchange rates, changes in the money supply affect inflation expectations, and reliance upon government intervention can lead investors take excessive risks.

On the 17th, the Federal Reserve followed several foreign central banks (European Central Bank, Australia, Japan, and others) by pumping capital into their nations’ banking systems in response to the recent volatility. This intervention increases the monetary supply, but the psychology of selling is still driving down many market prices as global investors reduce their exposure to risk and shift their portfolios to hold more cash and US Treasury Bonds.

Credit tightening is a reasonable response to excessive lending, but the signal from global central banks is that they are ready to smooth the volatility, even if it means increasing the money supply. This indicates that they may intend to inflate their way out of potential economic pain. As a result, we are less concerned about a recession, but our long-term expectations for inflation have risen. This combination makes stocks and real assets more attractive because they are better hedges against inflation, and reduces the value of fixed income instruments (such as US Treasury Bonds). Meanwhile, the global investor crowd has been doing the opposite. If higher inflation will be the ultimate outcome of this recent roller coaster, then the massive global shift toward cash and fixed income may ultimately be reversed.

Impose Tariff Triggers to Raise Global Labor Standards

Problem: The US has lost some of its competitive advantage with companies in other countries. A major part of this problem is the differences in economic policy and labor standards that prevail in various countries.

Solution: Set specific global Tariff Triggers. For example: 5% on countries that peg their currency, 10% on countries that allow child labor, 10% on countries that outlaw organized labor, etc. These numbers are just examples. The triggers should be set to offset some of the unfair competitive disadvantage.

Benefits: US workers will be competing more fairly with international competitors.

Some foreign countries will improve their labor standards in order to avoid tariffs on their exports. In those cases, US workers will benefit because the foreign competition will have have to operate under similar rules as US companies.

Some foreign countries will not change their labor standards or economic policies, so they will trigger the tariff. This will also protect US workers from those unfair practices (to some degree) because import tariffs drive up the prices of those specific competing imports.

View and comment at SinceSlicedBread

Reduce Homelessness

Problem: Homelessness exists. Untrained workers might be worth too little to hire, and they cannot receive training. This is how the cycle of joblessness starts.

Solution: Break the cycle by allowing workers to take jobs even when they pay less than minimum wage; and give them a tax break until they gain financial momentum. Specifically: eliminate the minimum wage and increase the standard tax deduction to $25k.

Implications: A huge new number of low-paying jobs would open up, offering an opportunity for training and experience to young or untrained workers. And everyone earning $25k/year or less would have no tax bill at the end of the year. The large number of new workers and jobs would rapidly grow the economy. This might not completely eliminate homelessness, but it would help a great deal. Far more jobs would be created than would be filled, so those earning the minimum wage now should expect that the job market would become more attractive, and offer better income to those with some experience or training.

View and comment at SinceSlicedBread.

Inflation: Labor, Commodities and Energy

There has been a lot of talk about the impact of rising energy prices on corporate profit margins. This is over-rated.

Corporate costs in America are much more heavily weighted toward labor. And it is labor cost inflation that hurts corporate profit margins most. Corporate costs are, on average, 70% labor, 5% commodities, and 3% energy. Energy and commodity prices could continue to rise – even double from here – without changing the cost structure of American businesses in a drastic way. The same dynamic is not true in many other countries, including emerging markets, where labor costs represent a smaller proportion of corporate costs. As energy and commodity prices rise, those companies may encounter much more pressure on their profit margins.

So what’s the bottom line? Energy and commodities can continue to rally without significantly damaging corporate profit margins. Furthermore, rising energy and commodity prices will give a relative advantage to the most efficient producers.

North Korea

The conflict with North Korea is based on deception and fear.

North Korean leadership has deceived their population into believing that America started the Korean War and killed hundreds of thousands of Koreans. Based on this belief, North Koreans fear that Americans will attack and kill them. Their nuclear agenda may have started as part of their conflict with South Korea, but it has evolved into a defense against a perceived American attack.

To avoid war and encourage positive change, the US and the rest of the world should make an effort to integrate North Korea into the economic landscape. Companies and governments should offer to pay North Korea for exports — clothes, pots and pans, and basic manufactured goods to start. If the North Koreans can develop a growing economy, then greater employment will bring better education and reform.

With basic commercial trade, power is shifted slightly toward the economy and away from the state.

Is Global Free Trade Always Good?

As long as trade is at will by both parties, it is good, right?

Not necessarily.

Innovation has led to great developments in goods and services, and led to amazing increases in productivity and capacity utilization. International trade is distributing value more efficiently than ever.

Peter Weiss raises an important counterpoint:

“[clip] The dislocation is often painful and some people cannot make the transition for any number of reasons – I don’t minimize or ignore their pain, or loss. As people living in a community, however we define it, we should consider how we respond to them [clip]”

Throughout history, the waves of displaced workers have ranged from negligible to crisis levels. Displaced workers are typically older workers who are highly skilled in a shrinking industry, or people of all ages who do not have economically rewarding skills. The first set of people is generally easier to define because they had and lost their jobs, while the second set may be far more difficult to quantify.

In the transition to the industrial age, displaced farmers, craftsmen, and tradespeople went through fairly desperate poverty, but there was a large industrial complex forming, ready to hire people with a wide range of skills. In the information age, and with a far larger and more anonymous society, we are dealing with new dynamics. Automation is increasingly replacing labor in production, putting a greater emphasis on capital. The economically rewarding skill set is becoming more cognitive, scalable, and competitive. The highly scaled production of the globally efficient producers displaces less efficient producers throughout the rest of the world.

Why would this be a problem? Clearly, we already acknowledge that some trade should be illegal: monopolistic mergers are restricted by the Federal Trade Commission. Even overly concentrated industries may have restrictions on further consolidation. With information services and assets, marginal costs fall to about zero, and this economy of scale is a strong force for monopolies within each product or service class. Innovation can be stifled if monopolists prevail. However, this dynamic cannot be controlled globally by the US Federal Trade Commission.

But it goes further than that: whenever productivity rises faster than production, fewer workers are required in aggregate. Production may still be growing, but the non-working population and increasing concentration of wealth means that the median utility may shrink. Recent drops in interest rates has promoted refinancing and debt, enabling continuation of consumer spending, but factoring out this externality implies a scary economic reality.

I’m afraid I can’t offer a comprehensive solution, but as policy makers (or simple commentators), the goal should be maximizing the growth rate of the median utility, right? The Fed and international trade policy are currently influenced by an optimization problem that maximizes total GDP growth. Changing the nature of the optimization has the potential to imply that free trade might not always be good. Similar to the measures put in place to avoid the downsides of monopolistic trade in the US, legal and financial policy reform may be due in the next decades to enforce rules as a Global Trade Commission, and also to target disadvantages from productivity growth overwhelming production growth.