Friday, November 30, 2012

The farcical cliff

Ben Bernanke seems to have a way with coining terms that can leave everybody in utter confusion. First, it's quantitative easing and now it's fiscal cliff. As the fiscal cliff looms ahead, we are being led to believe that failure to overcome the cliff will land us in recession. The cliffhanger is the showdown between the Democrats and Republicans. Both have different views on how the fiscal cliff should be handled. To reduce the deficits, the Republicans want to cut entitlement spending while the Democrats want to increase taxes. However these are all distractions serving to demonstrate that the politicians' primary job is to spin no-brainer issues into newsworthy material.

It's easy to figure out the Western thought process because it tends to be binary: either black or white, always insisting upon a solution and with little tolerance for grey areas. Since both parties are adamant that they're on the right track, both will not budge from their entrenched positions, more so when one side is still smarting from the recent election defeat.

Even without this fiscal cliff, Obama's ability to throw money at the economic problems will be severely crimped given that his administration's $1 trillion odd deficits in each of the last 4 years have not yielded any long-lasting recovery. That isn't surprising considering that we're in the second half of the Fourth Kondratieff Wave.

If you are presented with this situation, how should you approach it? To tackle this seemingly tough problem, you need a pattern as a guide. For this there is no better pattern than the Monopoly board game. The other thing that we need to know is where we are in the Kondratieff Wave cycle. There are 2 actually, the uptrend first half and the downtrend second half. With just these, you can foretell, like no economist can, how events will unfold.

The first half of the wave is when you start playing the Monopoly game. This is the most exciting part because everybody is eager to grab properties. So when the banker pours money into the game, it will keep circulating in the game as assets are being purchased and sold. But when you reach the second half, the excitement starts dwindling down. There are no more properties up for grabs. If you're losing, you'd rather be in jail since every move you make costs money. Any money poured by the banker will end up with the sole winner.

What has this got to do with our present predicament? Almost everything, in fact. All the current economic difficulties can be easily explained by the Monopoly game. So any deficit spending now will ultimately end up with the few winners. As the government will eventually be weakened by continual deficits, it must start getting the money from the winners, the rich, that is, to fund its spending. But the rich with their footloose wealth can run rings around the taxman. Ask Mitt Romney how. One is to park their financial wealth in offshore tax havens with ultra low tax rates. The other is to recast their incomes as capital gains which also attract a much lower tax rate. As long as capital controls are absent and tax law is riddled with loopholes, the ability of political leaders to control the national economy and by extension the national politics is tenuous.

What about the Republicans' proposal to cut entitlement spending while maintaining the current tax rates? Without increased spending, the economy will quickly go into a tailspin. The Republicans' contention is that the lower tax rates will encourage the rich to invest and create jobs. That's a load of bull. Again we seek the help of our Monopoly pattern. When the game has settled down to a predictable pattern, the winner will just collect rentals. He has no need to build new hotels. After all, with the present investment, he's already winning. The proof is in the statistics. Another of the various income imbalance charts that I've been plugging just to highlight the real cause of the depression is shown above (this one from The Financial Times).

If the government doesn't wrest the wealth from the rich, there's no new spending to perk up the economy. The rich fail to grasp that whatever spending the government makes, be it on entitlement, military or whatever, will ultimately end up in their bank accounts. So it is in their interest to pay more tax. They can play the Monopoly game much longer, and keep winning while at it.

Both groups of politicians can't comprehend this simple concept. As a result, they both agree that the deficits have to be reduced. For comparison, the 2012 US Federal deficit was estimated at US$1,089 billion. The fiscal cliff, if not addressed, will reduce the deficits by US$535 billion. The fiscal cliff is not the issue. The real issue is the amount of the deficits. The amount that they can agree will be substantially less than US$1 trillion. So fiscal cliff or not, it's highly conceivable that the US economy will slump in 2013.

Recriminations between the two parties will intensify with the worsening state of the economy, causing them to dig their heels deeper. One will insist that entitlement spending discourages people from working while the other will claim that reduced taxes do not trickle to the economy at large. This is an exercise in futility as the solution is not to be found in the Fourth Kondratieff Wave. Future economic growth has been forecast to be anaemic, meaning that the economy cannot outgrow the debt. To artificially boost growth, the economy really needs bigger spending but there's no longer any economic sector that can bear ever increasing spending. All have been squeezed dry, that is, except the rich.

As an aside, I can't help taking a dig at the housing bulls, especially The Financial Times which came up with the following headline in its 28 November 2012 issue: "US growth hopes lifted by housing data", just after the Case-Shiller index for September 2012 had been published. Now I've updated it in my own chart above. As you can see, the pattern of housing price increase still remains. But the increase was very marginal in September 2012 and if you project it to the next month, prices will start dropping. If an eminent financial newspaper can betray its economic ignorance with such a premature headline, what can you expect of economic pundits and talking heads who are much less endowed in their cognitive faculties?

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