Sunday, October 12, 2008

Economy part 1 -- the real root of our problems, and nobody's talking about it

As promised, here's part one of a three-part series on the economy. Tonight I write about what I believe is one of the key underlying contributors to the economic troubles we're experiencing today -- low productivity growth, a weaker dollar, high gas prices, failing banks and mortgage companies, national debt, etc...

Debby was correct with one of her comments on a previous post, saying that the root of economic crisis is often greed and entitlement. While that may be true, I'm not even remotely hopeful in ever changing that part of the human condition. What I'd rather do is channel that reality of greed into a more constructive, contributing workforce. First, though, a small aside to set the stage:

Aside #1 -- The Shell Game

Have you ever seen a guy doing the shell game on a sidwalk somewhere, maybe in New York City or Las Vegas. They're shuffling three shells around on a table or boxtop, and underneath one of the shells is a little rubber ball? They move slowly for a while, letting you feel confident you can follow the ball, but once money is being bet they always, always win. They do this one of two ways:

1) They move so fast during a game when an actual bet is placed, you have to make a pure guess about which shell the ball is under. So you only have a 33% chance of guessing the correct shell.
2) Well, you would have a 33% chance... if the ball was actually under any of the shells. Most gamemasters do a lightning-fast trick at the beginning of the game and hide the ball in the hand or up their sleeve, so the ball isn't actually in play at all. They'll sneak the ball back under a different shell (one you didn't pick) at the end of the game for the "reveal".

Here's a video to show you -- and this completes the aside:

Back to the topic at hand.

The foundational strength of an economy is in its ability to make consistent gains in productivity. That's it. To keep making more products, more services, more new jobs, and to do it faster and cheaper than the previous year. This is how the standard of living goes up.

Yes, these gains can be compromised and sometimes even erased by other factors (tax policies, government spending), but you have to at least start with solid gains in productivity. No policy in the world can help an economy that isn't using innovation and hard work to grow.

McCain and Obama have repeatedly stated that the US has many of the best and brightest people on the planet. As a US citizen I'm very biased but generally I agree. We've got tons of sharp people in America today.

But what types of jobs are our best and brightest choosing today? Do they become doctors and lawyers, extending our lives and defending our rights? Yes, some do. Do the most innovative and brilliant go into management and build businesses that create new jobs? Yes, some do, thankfully. These are all things that contribute strongly to growth in productivity.

But for a couple of decades we've been sending more and more of our brightest into financial jobs -- namely investment banking and brokerage. In other words, instead of building new things, extending life or creating jobs, our best and brightest are merely trading stocks of other companies that do that stuff.

Aside #2 -- My own experience

I got my MBA about 10 years ago, and it was a very intense program with lots of super-brilliant people. I was the youngest student so I was never going to be the superstar of the class -- my career experience was too lacking (read: non-existent).

But many other students had solid business experience even before the MBA. And by the time we approached graduation, they were both highly-trained and highly-experienced. They were the superstars. And what jobs did they pick? All four of the top students went to Enron, because at the time they were offering the most money. The students became energy traders, essentially "moving" kilowatts around the country to take advantage of price differentials. It was a shell game. They weren't actually creating anything of value -- it was a mirage covered by lots of fast motion and activity, but in the end only the gamemasters (Enron executives) were the winners. The students' talents were being wasted. Everyone else in the economy lost out while the best and brightest chased the money.

Aside over.

Am I saying that investment bankers and brokers are only playing shell games and don't provide any value to the economy? No, of course not. In my opinion, they provide a few very important services:

1) General financial advice and education to us non-expert people
2) Corporate research that gives us more transparency into which companies are solid and which are not, and as a result, which stocks might be good buys
3) Market trading programs and systems that help more investments happen faster, cheaper and more accurately

Note that one thing I didn't put in the list is how these guys create managed mutual funds for us to buy. It's a controversial topic, to be sure, but an analysis of history hasn't been kind to mutual fund performance. In general they don't do well compared to index funds which merely follow the market as a whole. Yet the management of mutual funds is where the industry makes its huge, huge money. Even though the vast majority of fund managers don't even beat the market. That part is a shell game, becuase the fund manager is guaranteed to win with big salaries and sometimes big bonuses, even if their own fund loses money. And if their fund actually makes money? Then the bonuses enter into "ridiculous" territory.

Investment bankers and brokers do deliver a service, in the three items I just listed above. But are the benefits of that list big enough and important enough to take up the efforts of our country's best and brightest? Who will design the next breakthroughs in consumer technology? Who will help find smart, profitable and sustainable uses of alternative energy? Who will get involved in public service and help this government solve the complicated mess of healthcare and social security?

There are so many big, pressing, tough issues facing us over the next decade. Just like every decade. And we need our best and brightest working on those problems, not on how to leverage a hedge fund.

I'll close with a final aside, then I'm done for today.

Aside #3 -- Does following the money really work?

More of my experience from the MBA program. I didn't go to Harvard but we used many of their case studies in our curriculum. One of their most fascinating stories was about themselves.

You see, for over 35 years Harvard has been polling its alumni on what their dreams are for their career. They've also been polling to see how many people actually followed their dreams after getting their MBA, and how many graduates just took big money and "settled" for a safe, secure job.

What they've found is that long-term, over an entire career, the people who followed the money actually made less of it than their dream-following peers.

Lesson: Follow your dream. Use your talents. It will inherently tend to do the most good for the most people, lifting all of us up. That's how an economy, and a culture, grows. Oh, and by the way, you'll make more money too. So if you want to help people, follow your dream. And if you're just greedy and want to make money? Follow your dream.


Bob said...

Really interesting. Michael for Treasury Secretary.

"Follow your dream" is such good advice. My younger son wants to work for ESPN. What are the odds? But shouldn't I encourage him to dream?

McCain and Obama both missed so many opportunities in the debate. If someone had asked Bill Clinton how she could trust either of the candidates, he would have looked at her, bitten his bottom lip and convinced her how he felt her pain. She would have met him for a drink afterward if he had asked (and of course HE probably would have asked).

The point is, as you stated, they both blew it big time, which means McCain, who needed to land a knockout punch, LOST. Why not be honest and say of course it's going to get worse before it gets better but I'll be there working my ass off to see things DO get better?

t.k.foster said...

I agree with many points you made and some others as well. Here are some other issues:

1. We, the United States, have a horrible view of retirement. At what point should I stop contributing to society and only withdraw and is this ethical? To me, it is never ethical. But health insurance companies limit the age at which you can work.

2. Our entire system is based on profit and more of it. Maybe some things - like health - should not be profitable. Maybe other things should. But what happens when you add profit to everything is you'll end up with a disaster because greed often will prevent success so that it can make more.

3. Since other countries in Europe and Asia do offer things like universal health care and the United States doesn't, and my generation wants that, are we not surprised that many of our brightest are going overseas to others jobs? The United States is either going to have to step up and compete or fall behind and lose.

4. The United States does not have the most intelligent people - that is a myth told by politicians. When you see things like a 12 year old boy in Israel developing advanced solar cells or Stockholm re-designing the food pyramid to prevent diabetes and other problems, you realize that the United States is a country of greed, not people who do things to positively contribute to society. That is only done when money is involved - but there are more important things in life than money.

Yes, it's harsh, but the sad truth is that only Americans think their system is superior. Elsewhere and places I've been, people think Americans are far inferior. And I agree.

Redlefty said...

Thanks guys -- great comments.

Don said...

Mike- I have enjoyed your posts on the economy. Can't say I have understood everything, but enough to see you have a good grasp of the problem. Thanks for adding your commentary on the situation.

Bob said...

Michael, I don't even pretend to understand how our economy works, what caused this current mess or what we need to do to get out of it. It makes my head swim. I suspect that no one fully understands the actual mechanics of it, and if any one person does it's probably Bernanke or someone like him. One thing I do know is that it took years to get here; it'll likely take years to dig ourselves out of it.

Having said that, you're absolutely right: If you're not a "value producer" then you're just ripping off society by providing a "service" that may or may not be strictly necessary. Yet culturally, we seem to enjoy paying people inordinate sums of money for doing...well...nothing but moving money around. It is a shell game.

I guess I'm lucky. I did follow my dream and now am doing what I've wanted to do since I was a little kid. I don't make a whole hell of a lot of money (I'm no Trump), but I make "enough" and I have ZERO credit card debt. Hopefully, I'll be able to keep that up for a while.

Anonymous said...

RL - nice post. The rabid pursuit of monitarizing (sp) everything has been totally toxic to all concerned. Unfortunataly they made the bede and we all get to sleep in it. So the next question from this 'no economic training' person beyond what I read: To what degree is monitarizing necessary, and how do we control it. Greenspan and the current admin intentionally blocked all attempts at control. And if control of the money supply (Chicago School as I understand it) is important, how do we cope with innumerable ways of privately expanding the supply. As I understand it the government's printing press is no longer the largest source of new money. RobLL

Redlefty said...

Rob, the private monetization is absolutely essential to a solid economy. Simple example:

You have $100 in a savings account at your bank. But they don't actually have all $100 of your money in their vault -- they only keep $2 or $3 for cash needs. The rest they loan out, creating an income stream of interest.

And all the people who borrowed those dollars (your dollars) from the bank are using the money to buy goods, build businesses and create more value.

All from your initial $100. That part isn't a shell game -- it's based on real value and goes out to create even more.

The problem is when the very foundation of this beautiful chain isn't a savings account, but instead is a piece of paper with no real value. Then things get nasty and the whole chain can suffer.

And that's just the private side of monetization. When the Fed steps in and (VOILA!) creates hundreds of billions of dollars out of thin air to get credit moving, it's no good either. It's guaranteed inflation, because there are more dollars flowing, but no new value created.

It also hurts the value of the dollar vs. other currencies, which is a huge contributor to our current oil prices. If the dollar had kept up with the euro over the past five years, gas would be about $2 per gallon right now.

Sorry to everybody that I'm late with parts 2 and 3 of this blog series -- my whole family has had the stomach flu this week. Started with Jack on Monday, then me and Jamie, and now Samantha started today. Our house smells of Lysol and jello, which makes it hard to concentrate. :)