As go borrowings, so go savings

Debts are bad and savings are good. Any homily on good moral values wouldn't have missed this out. Your parents and grandparents would have impressed this on you since your childhood days. But let's see what happens if everybody saves and none borrows. In modern times, this probably doesn't matter because you can always save. Whether others borrow is none of your business and you probably couldn't care less.

In fact you should. A hypothetical situation would shed some light. Imagine a situation on an isolated island with only two inhabitants, A and B. Each has some cash, say, $10 each. Although they are preoccupied with finding food to survive, let's also assume that both wish to settle their mutual transactions in economic terms. Suppose A is more productive in finding food for his own needs and then some, leaving B free to tinker with his contraption. A can sell the excess to B. In next to no time B will exhaust his cash reserve.

If B wants to continue consuming he has to issue IOUs to A. If not, the economic exchange breaks down. A can no longer save and B consume. To A, the $20 cash and the IOUs are his savings whereas to B the IOU s are debts. So the IOUs are actually money that supplements the $20 hard cash. In fact in the real world, there are more IOUs than physical cash. If B keeps on issuing IOUs with hardly any hope of ever redeeming them, A will realise one day that B's IOUs are as good as his worthless promise. The IOUs will lose their value overnight. It's the collapse of the IOUs or credit that is the cause of economic depression.

However, if suddenly, B could garner more food with his contraption than A with his muscle power, B's IOUs would retain their value. The money now moves in reverse provided A stops going about his usual food gathering business, using that opportunity to do other things instead. A and B's mini economy starts humming again until A's credit is fully stretched. If both parties come to their senses, they should specialise, say with one growing cereals and the other catching fish. They would trade their surpluses in such a way that no one excessively owes the other. In the real world of technological progress, this is very unlikely because one party can always outmanoeuvre the other with the help of technology.

We can now surmise that what an economy needs to continue operating indefinitely are continuing economic growth and a change in the fortune of the players. This presupposes the arrival of a new technology that will step up economic growth and redistribute economic wealth but a deliberation on this topic deserves its own separate posting. Alternatively, when economic growth has run its course, the players could attain a stable relationship among themselves by producing just enough for their own needs, precluding the accumulation of disproportionate savings.

The other important lesson, which actually is the subject of this post, is that savings and borrowings are indeed a zero-sum game. To be able to save, someone else must borrow. The proof for this assertion is the following diagram of a nation's GDP, taken from The Levy Economics Institute of Bard College site. On the left side of the top equation is national output or rather spending, commonly referred to as GDP while national income or GNI represents the right side. Making up the difference between a country's spending and its income is either net exports (income more than spending) or net imports (the other way round).

Although the diagram appears self-explanatory, a little explanation would help. Net exports as you'll notice sits on the left side of the top equation. You may think that exports are income but that's incorrect. Exports are actually foreigners' spending on goods and services while the corresponding domestic equivalents are household (consumption and property investment), business (capital expenditure) and government spending. The income from that spending is on the right. If net imports were to appear, the item would be offset against the domestic spending on the left. Business operating expenditure doesn't appear as it has been accounted for in computing business gross profits.

After some shuffling, the equation finally boils down to that of the last line. In the above diagram, the aim is to highlight business profits; the term Gross Profits actually means profits before depreciation since depreciation is a non-cash item. A modified Powerpoint page version of the above image can be downloaded for you to tinker with; you can change the flag to that of your preferred country. This version which puts government deficits on the left draws attention to the fact that in the present deflationary conditions, government's deficits is key to increased household savings and business profits. For other scenarios, you can move the icons around but make sure when you move icons from right to left or vice versa, the mathematical signs (+/-) are reversed.

Right now, for most economies, the other contributors to savings are anaemic. Investments in the form of business capex are moribund because of excess capacity and falling prices. Investments in real property are reaching its end game that would inflict a catastrophic blow on those who haven't exited. Exports are out of the question when all countries are winding down their spending. That leaves only government spending but after years of mega deficits, the governments' backs are about to be broken.

The increase in government deficits started during Reagan's days, towards the end of his first term (see chart below, taken from Morgan Stanley website). Now you know why Reagan was so popular. Clinton and Bush, Jr. continued this reckless practice with the non-government players (banks, corporates and households) doing the politicians' bidding. However these non-government players have been stretched to the limits of their borrowing ability after more than 15 years of continual credit growth. The US government took back the lead role in 2009 but after three years of more than a trillion dollar annual deficits, its critics are getting restless and demanding that the deficits be curtailed.

What those critics fail to realise is that government deficits can never be tamed. Only the relative quantum, in this case reckoned against the GDP (see chart above) can be reduced. However, the absolute amount always increase year after year except when the households or corporates go on a borrowing binge, even then for short periods. For a big country like the US, the government can only go into surplus if the corporates and households are willing to endure increased borrowings. Only small countries can climb out of government deficits through exports.

If the relative government deficits could be trimmed in the 1970s and early 1980s, can we repeat the same feat now? Unlikely because the two critical factors necessary for the reduction are missing. First is economic growth or GDP. Since its highs in the 1960s, decadal economic growth has been decreasing. More crucial is the high inflation experienced during those years. Yes, inflation benefits debtors at the expense of creditors. It doesn't reduce the actual debt amount but relative to the general price level, that is in real terms, your debt gets reduced. However inflation is not likely to make a comeback anytime soon because capacity now outpaces consumption. The policymakers' fixation with snuffing inflation is akin to generals fighting the last war.

Anyway, the US credit expansion actually benefits the world. The chart (from The Economist) on the left shows that US current account deficits began to swell in the 1980s under Reagan's watch, turning the US from a creditor to a debtor nation. Soon after, President Bush, the first, suppressed the government deficits at a time when the Savings and Loan crisis led to a drop in the total credit. Not surprisingly, he didn't get a second term. But his successors continued Reagan's practice. As a result US current account deficits movement is a mirror image of its total credit growth.

But that's not the end of the story. US current account deficits have led to a steep expansion in the global forex

reserves (see left chart, also from The Economist). At present, the US dollars represent about 60 percent of the global forex reserves, down from 70 percent in the early 2000s. But more significant, without that 60 percent, the balance 40 percent wouldn't have existed simply because the other major economies, the EU, Japan and China, are current account surplus or creditor countries. The fact that their currencies are available as reserves is due to their ability to hold on to the dollars in exchange for giving up their currencies.

As the US could no longer expand its credit, the currency leg of the 4C will soon begin its winding down. Prices across the board will start descending. You'll soon watch dumbfounded policymakers arguing over what tools to use to fight deflation just as it appears inflation was the scourge. They haven't learned the most important lesson: when faced with an insurmountable obstacle, like the tsunami, you don't fight, you adapt. They should encourage the cancellation of unpayable debts. Everybody has to take a cut so that life can start anew. Sadly, greed precludes this course of action. If financial savings can't be extinguished, borrowings can't be cancelled. The end result is a breakdown in social cohesiveness that will harshly hit both borrowers and savers.

Reality in 4C

Why have economists been mostly wrong not only in prognosticating future economic outlook but also in rationalising past events? The root cause is the university and college economics curriculum. All over the world we are churning out armies of economists who've been wrongly taught and who in turn are preaching deviant thoughts. To stop accepting their economic nostrums, we must have ready a credible alternative.

To be sure, not all economists are clueless. Some really understood the workings of the economy; among them John Maynard Keynes, Hyman Minsky, Wynne Godley and Charles Kindleberger. Sadly they are all deceased. Outside the mainstream, the Austrian school of economists provides a good alternative viewpoint but in this case restrict yourself to just their view of the business cycle. Nikolai Kondratieff, a Russian economist executed by Stalin in 1938, was another proponent of the business cycle but he did not come out with a persuasive explanation to support his theory. Had he lived longer, he might have come out with one. As a result many successive 'experts' have come out with their own ideas which have no strong theoretical basis either.

What should we resort to? Nikolai Kondratieff's long waves are actually a good starting point. What we need is a sound underpinning in the form of a framework. It can only come after an exhaustive study of ancient as well as the modern post-Industrial Revolution societies. Only if the framework can successfully explain the rise and fall of all these societies, can we accept it as a valid theoretical basis.

No, this framework is not going to contain any mathematical symbol nor algebraic equation. Economics is about people, not numbers which should be restricted to the physical sciences and mathematics. With people, emotion generally trumps reason. The melancholic state of economics nowadays is a result of the field being taken over by the quants who have so much blind faith in mathematics. In finance and banking, they have wreaked havoc. Unknown to many, they also are doing much more serious damage to economics but till today such harm has yet to be exposed. The father of this movement is Paul Samuelson who happened to be the author of the widely used college economics text. Not surprisingly, Ben Bernanke was a student of Samuelson. So now you know why the Federal Reserve still can't get a handle on the US economy.

The framework which is meant to undo this damage has been tested against the economic waxing and waning of the societies of Ancient Greece, Ancient Rome, Charlemagne's pre-medieval Europe, the Dutch Republic, the British Empire and the US Republic. In addition the framework must also be able to prognosticate the future economic outlook. The framework, consisting of four components - Capacity, Communication, Consumption and Currency - abbreviated as the 4C, is depicted below. In reality, the structure is a dense network with many-to-many relationship instead of the circular one-to-one relationship. However, understanding comes through simplification as long as the simplification doesn't change the substance of the subject matter.

Don't be deceived by the simplicity of the 4C. Remember Albert Einstein's dictum: "Everything should be made as simple as possible, but no simpler." In the 4C's simplicity lies a powerful tool enabling us to understand the past and foresee the future.

Let's walk through the framework. We know that an economy revolves around the exchange of goods or services. This implies that you must first produce goods or services surplus to your own needs. A self-subsistence existence on the other hand has no need for any economic exchange or trade. Capacity to produce surplus is thus the precondition for trade. But having capacity is useless unless the surplus production can be transported to those who want to consume it. Hence the communication and consumption legs. Finally a common measure, i.e., currency is needed to enable the exchange. Barter doesn't cut it because a plethora of prices will emerge to overwhelm the exchange. For example, under a barter system, 10 items will result in 45 prices, that is (10 x 9)/2, the formula being n(n-1)/2, whereas a common currency produces only 10 prices.

Currency doesn't have to be physical. In fact, most of our economic transactions are conducted using credit, the virtual currency that forms more than 90 percent of our money. Those who disparage fiat paper currency should have redirected their denunciation towards credit instead. Ancient and traditional societies with surplus economic goods also resorted to credit simply because there was not enough physical money, be they shells, beads or precious metals, to meet the needs of trade. And the main reason for the collapse of the discredited gold standard was its failure to meet the shortage of money.

In our modern day, the capacity and communication legs of the framework are primarily powered by technological advances. Hence to really understand them you need to have a full grasp of the history of technology. Historically, capacity has come in the form of cheaper and more plentiful energy and materials. Those are two out of the three hallmarks of the Industrial Revolution, the other being the setting of the work pace by machines.

Communication which can be either physical or virtual is the leg that drives stock market booms. The consumption leg on the other hand is tied up with demographic growth. Consequently a history of demography is a must. As population growth used to be highly dependent on food, a history of food is also in order. However in modern times, food and population no longer move in sync as fertility rates rapidly decline in the developed world though in the poor developing nations, high fertility rates and declining food production are storing up future troubles.

Only the currency aspect is within the purview of economists. Guess what do you need to know to master this? A history of economics for sure. Not the theoretical stuff peddled in universities. In effect, economists know only probably 20 percent of the knowledge needed to explain monumental shifts in economic conditions. No wonder their predictions go haywire and their rationalisations of the past fail scrutiny.

In the 4C framework, the circle or cell can represent an individual, a corporation or a state. A cell must be a producer (capacity) as well as a consumer (consumption). The purpose of an economy is to keep the network moving so that everybody produces and consumes; if he stops producing, he also cannot consume. If this happens to be a business enterprise, it can be made bankrupt. But you can't do that to humans or nations. That explains why good CEOs make poor politicians.

To support the flow of goods and services, the communication lines must keep the flow moving and there must be enough currency to lubricate the economic exchanges. Like a production planner on the factory floor, the aim is to balance the load along the network. There's no point in making some cells highly efficient in producing goods that the idled others cannot consume. The resources should have been diverted to the slow producing cells so that they can start producing and thus accumulate the wherewithal to pay for their consumption.

Among the four components of the framework, only the currency leg can be manipulated by policymakers. During the first half of any Kondratieff Wave, they would hike the interest rate in order to reduce credit growth. Because the interest rate is the price of money, the higher it is, the less money is borrowed. Through this means, they control consumption so as to be in line with capacity which is still trying to meet demand. A runaway inflation would be subdued in this manner.

Conversely, during the second half, they would reduce the price of money so as to stimulate demand for money. It works, but in the form of a borrowing and spending binge on real estate, and only for a very short duration. To understand why, you must drag in the capacity and the consumption legs. During this stage, the capacity has become lopsided with a few extremely efficient producers cornering the market. As a result the consumption also fails since many cells have been knocked out of the economic game because of their inefficient productive capacity. If this were a factory, you'd see harried economists confusedly scurrying around trying to fix a production flow that heaped superfluous parts at the wrong work cells while starving others of needed parts. So even at zero price or interest, there are no takers for the money. Nobody can borrow if they have no income to repay the loan. Borrowings plummet and money supply drops. Deflation ensues morphing eventually into a depression. A new beginning takes place only when a new 4C replaces the outmoded 4C.

The real life stories are more interesting and will be posted over time. In fact, with this framework as a guide, history will appear to you as a jigsaw puzzle capable of being solved. You'll spot gaps in the narratives of even noted historians. History will no longer be the boring stuff but a fascinating subject offering many lessons and patterns for the future. But one thing is certain, once you've viewed reality in 4C, you'll never want to go back to 3D.

Absolutely zero comparative advantage

Free trade has its economic underpinning in the law of comparative advantage, first formulated by the English economist David Ricardo (1772-1823). Legions of economists have accepted this law unquestioningly, ignoring the context in which it was first written. Going back in time, the law of comparative advantage made its first appearance in 1817 in David Ricardo's book, On the Principles of Political Economy and Taxation. More important, it was written during the dawn of the Industrial Revolution which can be roughly dated to have begun in 1780.

It was in the 1780s decade that the fossil fuel mechanical engine began to mechanise industrial production with the improvement by James Watt from the to-and-fro movement of his steam engine into a rotary motion in 1781. Of course, credit for the engine lies with Thomas Newcomen who invented the unidirectional steam engine in 1712 and James Watt who added a condenser and turned the movement into a back and forth motion in 1774. But both these machines found their uses in the mines only. With the improved engines, Richard Arkwright began using them in his factories in 1783.

Of the three hallmarks of the Industrial Revolution, one of them was the dictating of the work pace by machines instead of humans. And the factory was the right setting for it. In the underground mine, the steam engines only pumped the water out, not set the rhythm of miners' work. Admittedly, in the factory, Richard Arkwright's water-powered spinning mill preceded the steam engines in 1771 but the water-powered machines were limited to areas with flowing streams. Also their operating months in winter were constrained by the frozen streams. Edmund Cartwright's invention broke the geographical and seasonal constraints, leaving production running uninterruptedly. As long as the factories were not far off from rivers, canals could always be built to move coal.

As a result of these innovations, the Industrial Revolution radically shifted the paradigm. Before, mankind always had to contend with inadequate production of agriculture and manufactured goods. After the Industrial Revolution, the periods of inadequate supply have alternated with periods of excess supply, each period succeeding the other in a predictable pattern.

The timing when one or the other prevails is important because it determines whether the economic condition is inflationary or deflationary. How can we know which one is dominant? Simple. Using 1780 as the starting point, you add 60 for every Kondratieff Wave. So you have 1840, 1900 and 1960 as the start points of the Second, Third and Fourth Waves. The Fifth and final wave will begin in 2020. For each wave, the first half or 30 years is the inflationary period and the subsequent 30 years is the deflationary period. The pattern is generally regular despite our perception that the rate of innovation has hastened in the last few decades. In fact, it's getting harder because as the start base becomes bigger, the leap needed to achieve the same level of incremental progress as before gets more difficult. If you begin with 10, a 10 percent increment needs only 1 but if you start with 100 you'll need 10.

Now if we view the situation that David Ricardo was in, the conditions then were at the beginning of a deflationary cycle. However, he would have grappled with the idea long before it was put on paper. Most likely, he would have known only life in an inflationary environment. Thus what Ricardo wrote was not wrong but it was right in the conditions that he was in. What the economists after him have failed to do is to reexamine the context. Had they done so, they would have restricted the applicability of the law of comparative advantage only to the first half of each Kondratieff Wave.

Let's analyse what the law is really about. Below is a hypothetical example of two countries, the USA and Australia, that produce two items, bolts and nuts. It just so happens that the US and the Aussie dollars are on a par with each other. So that makes it easier to focus on the workings of the law of comparative advantage itself. Later we'll see the impact of tweaking the exchange rate in order to spirit wealth away from one's trading partners.

In the above example, Australia's output for both items is higher than that of the US. For every bolt that the US produces, Australia can produce 1.16 bolts with the same input. For nuts, it's 1.20. As Australia has the edge in both items, it is said to have an absolute advantage. Assuming that each nut is priced at US$1 or A$1, the price of bolt in each country is different because of the different productivity level required to produce bolts relative to nuts. In reality, the relative prices are not determined solely by labour productivity. Land and capital have to be factored in and this complicates the matter. In our simplified example which calculates labour input only, the price of bolt in the US would be $1.05 while in Australia it's $1.09.

Assuming that each country produces both items, the total output for every two manhours of input is 205 bolts and 220 nuts, with one hour each spent on producing bolts and nuts, as shown in the top part of the table below.

Although Australia has an absolute advantage, its comparative advantage lies in producing nuts because it can produce 1.20 nuts for every nut that the US produces compared to 1.16 for bolts. Suppose it focuses on nuts while the US on bolts, the total output now is 190 bolts and 240 nuts. Using $1 as the price of bolts and $1.0909, as the price of nuts, the specialisation has increased the economic return by $3.64.

But Ricardo's law has its fundamental flaw exposed when the economic conditions change as a result of technological advances. One major change brought about by modern technology is the almost limitless production capacity. Assuming that the cost remains constant, Australia can now produce both products for both countries. The US workforce can remain idle, which is what it is doing right now as China takes over the manufacturing of most stuff.

In our hypothetical example, can the US turn the table on Australia even if its labour productivity lags that of Australia? It can by devaluing its currency. Suppose it depreciates its currency by 50 percent, its 200 nuts would cost the same as Australia's 120 nuts. As for bolts, it's 190 to 110. The Australian workers would now be out of work. The US workers would get less pay since the currency is now worth half but it's a hundred times better than having no pay. Australia can nullify the US action by carrying a similar competitive devaluation. In our current real life situation, the US cannot devalue because China will match any US devaluation with one of its own, thus keeping the exchange rate stable.

If this one-sided trade is allowed to persist, it's the surplus accumulating country that would suffer a blowback. In international trade, each country's trade account must balance out for the long-term benefit of all nations. Surely, trade in this manner is inefficient since the cheapest goods may not be available to all. But more important than economic efficiency is social stability. In ecology, predator and prey cannot outwit one another all the time. They must achieve a stable relationship with one another or else an ecological collapse, disastrous for both parties, will set in. The root cause for the Middle East upheaval is the region's inability to produce stuff; the seeming demand for freedom is a symptom, now confused by many for causation.

What sort of blowback would hit China? The same one that hit Japan in the early 1990s for which until now Japan has not been able to recover from. In fact Japan's financial wave tsunami is insidious but more devastating than its tidal wave tsunami. A trade surplus country would naturally experience a rising currency as it holds more of the trade deficit country's currency. In relative terms, China's supply of yuan will increase at a slower rate than that of the US dollars (USD) as the US has to issue more dollars to finance its trade deficits. Simple mathematics will tell you that the yuan value must rise. China, infatuated with increasing the foreign currency amount in its vault, would have none of that. To sterilise its increased value, it must create more yuan, not through big government deficits as carried out by Obama, but by large scale private lending.

Since China does not buy as much imported goods as its exports, that money is chanelled internally towards a real estate frenzy. Everybody in China thinks property prices can only go up, that is, until he meets an American homeowner. In fact China's yuan value should move lower relative to that of the USD since total credit supply in the US has been static over the last two years. The only thing keeping its value high is the influx of speculative inflows hoping to cash in on the supposed China growth story. Certainly, the stratospheric property prices are never supported by matching rental income. When the owner-speculators could no longer flip the properties to suckers, the prices will crash to the bottom pulling the banks down with them. Money supply will vanish as the bank loans get written off. By then the yuan value will rise because its supply relative to that of the USD will decrease. That's the reason why the Japanese yen is stubbornly high even though its economy is in the doldrums. Similarly China's absolute advantage will turn full circle.

In the short term, this exchange rate setting mechanism is distorted by the hot speculative money. Actually politicians must not allow liberal currency movement because it negates their control of the economy and by extension politics. This also extends to trade, especially in the second half of the Kondratieff Wave. Notice that Ricardo's treatise is titled Political Economy. In the 18th and 19th centuries, economics did not stand alone but was studied with politics because the scholars then understood that economics undergirded politics. You split the two at the expense of the nation's stability. Now economics is being used to rigorously test mundane matters, of no importance to a nation well-being. That's why you find economists accepting the law of comparative advantage as the irrefutable truth. And politicians, clueless as ever, cling on to this dangerous notion without a hint of the tragedy that this blind adherence will inflict on the nation.

The 2 indicators to watch out for

Do you feel overwhelmed by the flood of economic metrics? Probably not since most laymen have come to shrug off the meaningless numbers. The numbers only matter to policymakers who only look out for positive news. Any negative news are dismissed as noises.

Indicators or metrics are important but most are red herring. If you pick up the wrong ones, you'll be misled all the way like most political leaders and economic policymakers. Business leaders or managers also rely a lot on them and most got flummoxed by their underlings who manipulate the numbers, euphemistically termed Key Performance Indicators (KPIs) in the corporate world.

Even profits could be massaged by bean counters who exploit their knowledge of accounting standards to bypass expenses out of the income statement straight to the balance sheet but always channel income through the income statement. Aside from accountants, you should also always be on guard when dealing with lawyers. Both relish wallowing in grey areas, one with numbers, the other with words. God help you should you happen to have dealings with an accountant-cum-lawyer.

So what choice do we have? The most important rule is to know what patterns need to be monitored. This depends on the situation in hand. For example, the current economic situation we are in is deflationary. So the most important thing to monitor is the total credit which actually determines the money supply. Another critical metric is property prices since in deflationary conditions, the endgame is always in real property. If the total credit and property prices are increasing, well and good. You can still dabble in stocks and commodities as they still have legs. Once the credit and property indicators start moving into negative territory, you'd better switch to US treasury bonds. Your goal is to preserve wealth, not to earn income. Actually from the vantage point of macroeconomics, that's a bad advice. Wealth should be destroyed so that we are motivated to create more wealth. But from the perspective of the individual layman, that's the advised approach.

So where to get the two indicators? The first can be extracted from the total credit report issued by the US Federal Reserve on a quarterly basis. The report is published with a two-month lag. For example, the measure for the last quarter of 2010 was issued on the 10th of March 2011. But the numbers are real numbers, not the estimates or surveys used in compiling the GDP or unemployment statistics. That's why the report always comes out late. Ben Bernanke would probably be the first person to peruse this report the moment it comes off the press.

Of the slew of files on the Fed's Statistical Release page, choose the 'Debt growth, borrowing and outstanding table'. The most important part of this document is on page 9, as reproduced below.

The aim here is to find out the extent of the annual change in credit computed on a quarterly basis. Extract the numbers from just three columns: the Total for Domestic nonfinancial sectors, the Domestic financial sectors and Foreign. Add the three and divide by the comparative figure for the same quarter last year. For example, the numbers for Q4 2010 (in US$ billions) are 36295.5, 14236.3 and 2104.4 which add up to 52636.2. The last number is the total credit in the US, i.e., $52.6 trillion. The equivalent total for Q4 2009 is 52260.9. Divide the 2010 number by that of 2009, you'll get a credit increase of only 0.7 percent in the last quarter of 2010. If you do the same for the preceding three quarters, you'll end up with marginally negative figures for all three.

The reason for this ambivalent state is obvious if you look at the Federal government column. It shows that since the last quarter of 2008, that is under President Bush's watch, the US federal government has been pumping more than a trillion dollars every single year, not to keep the economy growing but to prevent it from collapsing. Now as we enter 2011, this life support is being threatened by the debt limit and budget battle between the Democrats and the Republicans. Both parties do not understand that there is no solution; what has been carried out is only a countermeasure. The economy will collapse. Period. We can keep the economy on life support but the prolongation will make the eventual collapse worse. And if we take out the life support now as implored by the Tea Partiers, not only the US but the whole world will cave in.

The deficit or surplus debate is the mother of all Catch-22s, to paraphrase Saddam Hussein's famous remark. Rather than arguing who's right, it would have been better if the debate is framed between biting the bullet now and deferring it to the future but at a heavier price. Of course Obama wants to defer it to 2013 after he's secured his second term and the Republicans want it now so that they will see the last of Obama come 2012. Nobody cares about the jobless millions.

The other indicator is the housing price index. You can use the Case-Shiller 20-city or 10-city composite indices which are 3-month moving averages of housing prices. Like the Fed's total credit report, the published date is two months after, on the last Tuesday of every month. Select the seasonally adjusted Home Price Index Levels. Download it in Excel format so that you can easily carry out the needed computation.

If you look at the indices, whether the 10-city or 20-city, the peak was reached back in April 2006. Your objective is to compute the extent of the drop since then. For the 20-city, the index as of April 2006 was 206.55 while the latest for April 2011 was 141.62. The percentage fall is thus (206.55-141.62)/206.55 x 100 = 31.4 percent. The New York Times published a nice graph of the index since 1890 (see below) in January 2010. The chart taken from Shiller's Irrational Exuberance book was updated to reflect the latest housing prices then.
Three important points can be gleaned from this chart. First, it's the plotted projection. It shows an eventual fall of 50 percent. That's not Great Recession, mind you, but the Grand Depression in the works. Second, look at the period of the Great Depression in the early 1930s. The fall in nominal prices from 1925 to 1933 was only 30 percent but because of deflation the fall in real prices, bottoming in 1932, was only 13 percent. It was relatively mild simply because the borrowings were mainly used for speculation in the stock market. But the impact hit the man in the street real hard. What more when the man in the street is now indebted for his unpayable mortgage debt. Last, the curve follows the classic S-curve pattern, except that the pullback is going to be so severe, presaging the very hard times to come.

Alternatively, for a more encompassing home price index covering the whole of the US that reports data for the month only, you can rely on the real estate website, Zillow.com. Like Case-Shiller, the Zillow.com index marks June 2006 as the zenith in the US home real estate prices with an average price of $241k. Up to March 2011, the price has continuously fallen a record 57 months. As of that month, the average price stood at $170k, a fall of a tad below 30 percent from its peak, not much different from that of Case-Shiller.

There you have it. Choose whatever index you want, they all tell the same picture, plain and clear. If you have investments in property and banks, it's time you bail out, that is, not the banks but you, your own self. Batten your hatch and brace yourself for the coming financial tsunami.

The island rule

Should a nation-state remain big or small? Should an organisation put growth as a strategy to outwit competition?

Like most things in nature, there is no definite answer. It all depends on a multitude of factors. Animals grow big if their food supply is plentiful. Certainly, there are natural limits to their growth. Too big and their movements become unwieldy: finding food gets more difficult and falling prey to predators becomes easier.

The link between animals and resource availability is evidently demonstrated by 'the island rule', a principle first articulated in 1964 by J. Bristol Foster. The island rule states that big mammals above the size of rabbits would scale down to dwarf equivalents of their mainland cousins while those smaller than rabbits would size up to no bigger than rabbits. This phenomenon has important implications to economics and politics, particularly globalisation and the coming break-up of nation-states. This natural rule for animals isolated on islands applies generally to non-carnivorous mammals because of their warm bloodedness and their low reliance on body size to procure food.

We need to appreciate the benefits and costs of having a warm blooded relative to a cold blooded one and why in the long run, the cold blooded stands a better chance of survival. Warm blooded animals can keep their body temperatures constant because their metabolic engines are always firing. This allows the mammals to maintain a sustained active lifestyle, moving around in search of food or running away from predators.

But warm bloodedness imposes a cost in terms of energy usage. A mammal's body thermal engine needs to continuously fire itself while cold blooded animals, such as reptiles can slow down and fire up as and when needed. Therefore for body size, a mammal must strike a balance between the need for finding food, evading predation and conserving energy. By and large, the environment in which it lives in dictates the appropriate size for its long term survival.

Mammals can grow to the largest being in the animal kingdom as exemplified by the blue whale. They can inhabit extreme regions from the hottest climate, found in deserts, to the coldest, i.e., Antartic and Artic. Only the Australian desert is off limits to mammals, mainly because the place is barren in its soil nutrients. Other deserts are quite forgiving as past geologic movements have brought nutrients to the surface. Reptiles on the other hand cannot survive the Antartic and Artic regions since ice crystals can be fatal to the reptilian cells but they can survive on the scarce nutrients of the Australian desert.

On the mainland, large non-carnivorous mammals that don't rely on speed or other non-body size related predator evading strategies, need to bulk up to deter predators. On the other hand, the small mammals take the opposite approach; they dwindle in size the better to hide in burrows away from predators. On an island, the rules differ because of the absence of major mammalian predators. Such predators cannot sustain themselves since, being at the pinnacle of the food chain, their population base on an island is too small to escape the genetic defects from inbreeding. As predators disappear, the big non-carnivorous mammals no longer need the protection afforded by their bulky size.

Being big is actually more efficient: Kleiber's law, named after Max Kleiber, states that the metabolic rate for a mammal is proportional to the 3/4 power of its body mass. While an elephant shrew has to consume more than its body weight daily, an elephant needs only four percent of its weight. But the elephant has to consume so much herbage that individually it is very vulnerable to a reduction in its resource availability. The elephant shrew, on the other hand, may suffer a decline in population but at least there will be enough members of its species to carry the species through.

So how do mammalian species adapt to diminishing resource availability. Where predators are absent, they adapt by modifying their body sizes but this happens in small increments over many generations. Large mammals now have no use for their bulk regardless of how efficient it is in terms of energy burned per unit of weight. Their long-term survival as species is more secure with size reduction. A given level of resource can now support many more members, increasing the odds of survivability. And for small mammals, freed from having to hide from predators, they can now grow in order to achieve a lower burn rate of energy per unit of weight.

This pattern plays out in other fields as well. Computers used to come only in mainframe size. Although a mainframe needs special cooling, raised flooring and dedicated systems programmers, at least it is being efficiently used for the purpose it has been bought for. Now with computers being ubiquitous and extremely mobile (a cellphone is now effectively a computer), the energy consumption in the form of time wasted by their owners on fickle tasks is staggering. ADHD is no longer an inherited isolated disorder; it is an acquired widespread phenomenon. This bodes ill for pattern recognition because lack of attention and focus frustrate the discovery of patterns underlying trends in economics, politics and other major fields relevant to human endeavours.

Nation-states are similarly subject to this pattern. As more wealth is generated, nation-states grow in size. Those that don't share a common culture form union of states in order to benefit from increased economic and human exchange. Small nation-states are expensive to sustain because their per capita costs of maintaining the trappings of bureaucracy are high. Unless blessed by resources from nature, small nation-states, such as Singapore must embrace free trade, playing their role as traders smoothing trades between other nation-states.

Now as the world enters what appears to be a long economically lean period, nation-states must certainly adapt themselves if they need to still maintain a semblance of nation-states. Big countries, such as the US must be prepared to scale down its size the way the Soviet Union did on its dissolution in 1991. The break-up of USSR and its successor, Russia, is still unfinished business. Communism failed from the beginning because it discouraged production. The USSR could sustain for so long thanks to its natural resources, namely, oil. When oil prices collapsed in 1986, the writing of the fall of USSR was already on the wall. Its withdrawal from Afghanistan in 1989 wasn't due to losses to the mujahideen but to the clobbering from slumping oil prices.

We are witnessing some states in the US facing budgetary nightmare while some others enjoying surpluses. These forces are pulling the US apart. How the US pulls itself together as a cohesive nation is an interesting development to watch. But eventually, the US has to give in because sustaining itself in its current form is expensive and demands continual wealth creation.

In nature, the ecology is in balance if predator and prey can never outwit each other. When the USSR in its heyday, offered itself as a counterbalance to the US, the global conflict was about two economic systems. Conflict wasn't emotional and passionate. If it so happened that in one area, the US and some Islamists fought each other out, the US didn't have to suffer the opprobrium from the entire Islamic world since it might be helping another Islamists in another corner of the world in opposing the communist threat.

The critical danger now arises with the unipolar world. The stable counterbalancing act is gone. China would never replace the Soviet empire. Its only interest in faraway countries is the grabbing of as many natural resources it can get its hands on. It doesn't offer any political ideology. Anything goes as long at it makes money, for China, that is.

The successful non-state combatants have realised that the key to survival is to dwindle in size until their big adversaries disappear by which time they can bulk up but not to the size of current nation-states. They no longer need the bureaucratic expense of a nation-state. They are no more warm-blooded mammals but cold-blooded - both literally and figuratively - reptiles or insects.

Ants could never subdue elephants and neither could elephants wipe out ants. But when food resources diminish, elephants would be the first to perish unless they could size down in time. Ants would still survive albeit with a reduction in the number of colonies. The lesson to the big nation-states is to refrain from engaging the jihadists outside the homeland. They could never defeat one another. The fall of nation-states would only come about from shriveling economic growth. But not having a clue on how to ameliorate the currently worsening crisis, their leaders have turned their gaze instead towards political issues beyond their borders. They may or may not have the right solution but they certainly are stuck with the wrong problem.