Market Reflections

Thoughts, ideas and musings on current state and evolution of financial markets

Global Imbalances. The Real Problem

Global imbalances are generally referred to as countries with chronic large current account deficits (US, GB for decades) versus other countries with chronic and large current account surplus (China, Japan).

Current account balance is calculated as difference between the inflow and outflow of money from a country. Some argue that these imbalances are the real reason for current financial crisis and it will not resolve until these imbalances are resolved. Others argue that the current calculation method misses substantial components of money flow (e.g. investment return rates). If the missed components would be counted in then the imbalances would not exist.
Our failed lawyers (aka senators, congressmen and the president) fault China for manipulating its currency and causing them trouble in deficit spending.

Why “failed lawyers”? Vast majority of our politicians have a law degree. Most of them have never had a successful law business even though it does not take an MBA to run one and income from any remotely successful law business beats a senator’s salary hands down (that is if the senator is not corrupt, of course). Large numbers of these lawyers have become “career politicians” – they have no clue about real world outside of what they hear from lobbyists. Only business they know is how to get re-elected. They are failed as lawyers … or failed in any other productive profession for that matter.

There is some truth in all of these opinions, but this is only part of the truth, only scratching the surface.

Looking into the underlying reasons for account deficits makes yours truly to believe that so called global imbalances (whichever way calculated) are only the symptom, not the cause. The global economic imbalances do exist and they are the cause of current and ongoing economic trouble in the world. They must and will be eliminated over time. Current account imbalances are mere reflection of the beginning of a long and painful adjustment process in the world economy. This process will take much longer time than any of the world politicians want to believe. Traditional weapons of politicians: taxing more, regulating more, nationalizing and subsidizing failed industries and printing more money are the real reason for the imbalances. More of the same will essentially only increase them. Whichever country does it more will lose at the end of this process.

Why do we actually have the problem?
No matter how dumb a politician or a “leader” he/she is very unlikely to attempt to kill someone who produces stuff he/she lives on or produces. Peace is the reason for the world moving to global economy and the reason a country can no longer flourish in isolation. Today’s military arsenals are loaded with weaponry that can kill everyone and everything on this planet many times over. In that environment there is no alternative to peace on Earth. The only ongoing war, the Islamic extremists against the world, is because the Islamists are not engaged in the global economy. They produce only illegal drugs and they cannot legally trade this product. The process of moving to the global economy prevents World War III. It also brings out the fundamental imbalances in the business conditions of different countries. Intertwined with cultural and social aspects of each nation, they will take time to work out in process of integration.

The Terms
Before being able to analyze the problem we’d need to agree on some basic terms. In any economic system capitalism, socialism, communism or half this and half the other the basic building block is a business. The fundamental objective of a business (independent of economic system) is to produce a product or provide a service for its customers as efficiently as possible. The efficiency is measured simply by the difference between the cost of production and the value to the customer (sales revenue). The cost includes all costs of operating the business not only the direct production cost of the product or service. The difference is the profit to the owners (in form of shareholders or any other). In principle, no business can exist without customers and owners, but it can exist without employees. Employees can be eliminated simply by full automation of the production process – if such makes economic sense. Please note that the option of total elimination of employees from a business was not even dreamed of at the time the foundation of modern socialism/communism was laid. Its founders’ Engels, Marx and Lenin did not have foresight to see this possible.
I am pretty sure that everyone can agree to the basic terms without much thinking. Including the folks who adamantly oppose NAFTA, CAFTA and any other trade agreements ever made. While they realize that directly or indirectly (via their pension funds, for example) they are the owners of a business demanding maximum profits, they may also be the customers of the very same business shopping for the best price. The fact that they might also be the employees at the same time may cloud the judgment for a moment, but being an owner or a customer is certainly more important. It is also critical to realize that while the owner/employee/customer roles may converge in one person. This is an exception rather than norm.

The Problem in Terms
To fulfill its purpose in the society a business must find the least cost way to produce and best way to service the customer. To produce at least cost a business needs a beneficial and stable legal, tax, environmental and labor conditions. To service its customer best the business needs to understand its needs – be close to the customer. In global economic environment these components of any business process do not have to be implemented in the same country. In other words a product can be produced in one country with beneficial environment for production, but sold in others where there is market for it. That by itself opens the door for the global imbalances which if not resolved, will continue to undermine the same concept of global economy we cannot abandon either.

For the imbalances to disappear the business conditions in different countries will eventually have to even out. More specifically, hourly earnings of employees (including the cost of benefits), taxation, environmental restrictions, legal restrictions, etc must even out. In broader brush, the living standards in developed countries and emerging countries must balance out. This can be achieved in two fundamentally different economic systems the human society knows: capitalism or socialism.

The inherent vice of capitalism is the unequal sharing of the blessings. The inherent blessing of socialism is the equal sharing of misery. Winston Churchill

If the answer is socialism then the standard of living in the United States and Europe would have to reduce to the level of China, Brazil, India, Russia, … If the answer is capitalism then the living standard in emerging world must catch up with that of the United States and Europe. We will probably end up somewhere in between the capitalism and socialism. In any case we all have to make adjustments and many of these will be painful. Suffice to bring up the hailed achievement of Democrats – the minimum hourly pay – is out of the window as long as Chinese, Indians and … are not getting equal!

What’s next
In following posts in this category we’ll look into details of each of the imbalances. Discuss what must be done to make the adjustment least painful and fastest for all parties involved. Suggest what the politicians must do instead of what they are doing to serve their customers (the voters) the best. Discuss the best ways for the people to adjust to the new economic environment and look into consequences of not doing it. Bring up the social and cultural obstacles of achieving the balance in business conditions.
Next post coming up soon, stay tuned.

About The Author

Raymond has been active on financial markets since 1989 mostly trading commodity and currency futures and options. Trading systems and strategies, statistical and empirical modeling of markets have been his focus almost two decades now. Few projects are listed on his website. Raymond believes that every person could and should take responsibility and protect his/her finances. At least to be able to identify scams and fraud before giving life savings to a crook. It is not enough to rely on government because way too often officials (elected or other) are part of the scam themselves. Whether their reasons are campaign contributions, cushy job or lack of knowledge to understand the consequences of their actions none will help the victim. Recent succession of governments each trying to bankrupt the country faster than the previous it may very well happen that the world largest Ponzi schemes Social Security and Medicare will go down with the country. Without prudent financial decisions now one may sorely miss every penny of his/her savings lost to scam artists and “professionals”. To help out Raymond is sharing with users his analysis and views on variety of economic, financial market and trading issues.


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