Archives for May 2012

Are Bubbles A Product of Economic Cycles?

All economic cycles, particularly the long-term — say more than 5 years — have a great propensity to generate bubbles in one or several kinds of assets, depending on the variety of circumstances. However, price bubbles will never be very uniform or predictable, either in scope or duration. The biggest misunderstanding about price bubbles is precisely the reason for their existence. The reason is embarrassingly simple: human imperfection. There are three elements involved:

  • Human society has made substantial progress throughout the centuries.
  • Economics and financial knowledge are in essence also advanced.
  • Excesses are still well beyond the human capacity to overcome.

The not inconsiderable mechanisms, checks, and balances that have been developed through the ages to prevent drastic imbalances are easily overwhelmed by numerous factors:

  • The genuine human desire to progress, to always go further. Mankind has never adequately practiced the concept of limits. We tend to go overboard quite easily. This phenomena is particularly acute where credit-line management is concerned.
  • The greed that inevitably grows as a boom progresses — or fear, in the opposite extreme.
  • The lack of effective checks and balances to fight the many conflicts of interest, inevitable in any human process.

For instance, let’s expand on the last point. During the 2008-2009 sub-prime crisis, this kind of multiple conflicts had many actors: builders, sellers, middlemen, buyers,  government, and rating agencies, to name a few. They all contributed, though at different levels, to creation and nurturing of the humongous credit bubble that created so much chaos and ruin when it burst.

Of course, the three previous factors are not mutually exclusive; they usually interact and reinforce each other, magnifying the situation. While no substantial progress is made in these three areas, it is virtually impossible to expect that bubbles will not happen again. At best, the expectation would be to create less inflated bubbles, if possible is to achieve a better understanding of economic cycles and to make substantial progress in risk-management. For that purpose: the following assumptions are important:

  • At the very minimum, to avoid serious damage when the inevitable breakdown occurs.
  • In a much better scenario, to benefit from the bubble’s creation and its rupture as much as possible. However, this requires great skill in handling the tools for this purpose. The complexity of this approach begins by defining and selecting which tools to use and weighing the options, as well as the corresponding hierarchy when the frequency mixed signals appear. Both efforts, although many more in the second case, require commitment, research, and experience of two basic types:
    1. technical competence, and
    2. emotional management.


Joseph Schumpeter and Creative Destruction

positive effects of globalization

The original concept of creative destruction was introduced by the German economist and sociologist Werner Sombart (1863–1941) and developed and popularized by the brilliant Austrian-American economist Joseph Schumpeter (1883–1950) in his book Capitalism, Socialism and Democracy (1942).

From Schumpeter’s perspective, the process of creative destruction refers to disruptive new business platforms, methods, processes, products, and services. Once significant inefficiencies and gaps in the status quo have been identified in any economy, the new developments replace the old, obsolete schemes. The new platforms come to life, invigorating and re-energizing society. Fortunately, much more is created than destroyed, that is, there is a substantial net gain involved; otherwise, the creative destruction process would not constitute a self-sustaining mechanism. In short, despite the unquestionable negative side-effects, on the average, by and large, the net effect is positive globalization.

Sadly, there rarely are any halfway measures for these cases; the usual situation is total substitution which, understandably, creates a painful disruptive impact for employees, suppliers, and investors of the industry or sector under transformation. There are countless examples of this phenomenon. Let’s mention three:

  • The substitution of vacuum tubes for transistors.
  • The introduction of automatic telephone switchboards to replace manual plug-in systems.
  • A relatively recent example of creative destruction has to do with newspapers and print media in general.

Let’s draw out the most recent example of creative destruction. For a few years already, there has been a systematic, and at times quite dramatic, decline in printed materials, more so in developed countries. The whole world is pointing in that direction, as the Internet provides free information and eases the process of electronically subscribing to newspapers and other media services. Subscription rates for electronic devices is substantially cheaper, not to mention immediately delivered, than printed; readers have, therefore, increasingly leaned towards the e-devices, using their tablets, mobile phones, or computers, rather than physically turning the pages of a printed newspaper or magazine. In addition, free newspapers have entered the market – yet another example of how technology is changing habits for the better. Of course, that cannibalization of print media in favor of e-reading has its limits. Print media is not going to vanish; however, the new equilibrium in print media is going to be found substantially below to what it was before.

In fact, creative destruction is society’s primary growth pattern. Fortunately it tends to be much more creative than destructive. Undoubtedly, one of the most typical mechanisms of positive globalization.

Unfortunately though, the destruction is inevitable. Operations that become obsolete sooner or later are affected by a wave of renewal, and eventually disappear from the market or will be minimized. Mahatma Gandhi’s dictum “Do or die” illustrates the phenomenon quite well.

Free-market mechanisms have proven to be the best instruments to add value to society despite the often rude lessons they inflict, such as the never-ending creative destruction processes inherent to them.

Globalization Wins Five Stars in ForeWord Clarion Review

Reviews are important for authors, because it shows other’s approve of their work, and offers readers insight into the work that is objective. Today my book earned a five out of five star rating and was reviewed by ForeWord Clarion Reviews,  a print magazine and online review service for readers, booksellers, book buyers, publishing insiders, universities and librarians. Read the review here.

ForeWord Clarion Review reaches 20,000 print subscribers and about 150,000 people visit the review service’s website every month.

Among the comments of the reviewer, Barry Silverstein wrote, “The second section of Globalization, titled ‘Around the World in Ten Chapters,’ should prove to be exceptionally useful to any corporate manager who needs insight into the economic viability of virtually every region of the world.”

“The breadth and depth of Globalization suggests this book could be the single reference required for the reader who needs to know more about any aspect of the global economy.”

My intention for writing this book is to show people how current globalization movement can effect them, but more important to help them find answers to engage the globalization movement. So the comment from Silverstein is approps.

John Maynard Keynes, Milton Friedman, and the Robinson Crusoe Economy

Many writings have led most people to believe that, in essence, Milton Friedman (1912–2006) ideologically antagonized with John Maynard Keynes (1883–1946). This simplistic –and inaccurate– perception would lead us to believe that to solve most economic challenges, Keynes would recommend changes in government expenditures, while Friedman would go with monetary way –modifying the money supply, and interest rates levels– both of them almost exclusively recommending the mentioned changes, in the corresponding direction, up or down. While it is true that those two outstanding economist of the 20th century were mostly known for their research and findings in the mentioned areas, the scope of their vision was well beyond their major area of expertise. Both were very bright economists and, as such, very well versed on the complexities of any economic system. In the final analysis, Keynes’s and Friedman’s way of focusing the economy are actually two different –and indispensable– sides of the same pyramid, and so, are not necessarily antagonistic by definition. Furthermore, in most cases, they complement each other. To avoid sterile debates and confusions, a return to basics is an extremely useful thought pattern for all science and humanities disciplines; economics is no exception.

Simplicity is not incompatible with depth and truth. It is rather unnecessarily complex approaches, that can easily throw us into confusion and error. Unnecessary complexity is often quite harmful; its added value is very questionable. Since many centuries ago, remarkable and famous thinkers have unequivocally leaned on the direction of simplicity. The lofty Leonardo Da Vinci would say, “Simplicity is the ultimate sophistication.” And the great Albert Einstein commented, “Everything should be as simple as possible but no simpler.”

Comparing and analyzing any confusing situation with the basic premises often leads us to the right track, clarifying the picture –going back to basics.

The monetary system, unquestionably represents a useful and pragmatic sophistication of thought evolution and social practice. However, analyzing the pre-monetary economy, that is, the barter system, is a very useful exercise because it helps tremendously to clear up doubts and confusion. This type of economy is referred to as the Robinson Crusoe economy: the most basic kind, in its simplest form.

Let us visualize this character’s environment, once his idyllic island was inhabited and several hundred families ended up living there in peaceful, harmonious coexistence. It was a primitive subsistence, yet an organized society and economy. In essence, everything worked similarly to today’s economy regarding the items they produced and the activities they developed. Of course, this kind of economy produced and developed only very basic items and activities: drinking water, food, clothing, housing, harvesting and herb storage, and very elementary  entertainment (such as swimming, running, and having lots of time to enjoy nature). Of utmost importance, they already had specialized labor.

It was, however, an unpretentious, subsistence economy without money. In such society, the economic cycle was closely associated with three key variables:

  1. Demographic variables, the composition of the workforce in particular: the proportion of young people to seniors and children, as well as the proportion of men to women. In the end, too many children and elderly people relative to working adults would cause severe production and service disruptions, because of the imbalance between the work force and its dependents.
  2.  Health risks: for example, epidemics (in both humans and their animals) or pests in their crops.
  3. Natural disasters: hurricanes, floods, earthquakes, volcanic eruptions, droughts, fires, and so on.

The economic cycle would be virtually nonexistent while none of the above three sets of variables underwent substantial, unfavorable changes. This was a subsistence economy (essentially, an agricultural economy) to the extent that all people of working age (men and women) could work every day (probably including Saturdays and Sundays). Some would fish, hunt, or milk the cows and goats, while others (probably women) would collect or plant fruit and vegetables, make clothes, and so on. Unemployment and contraction of the economy would be unknown in such an economy, as long as none of the adverse factors contained in any of the three groups of variables materialized.

On the island, everyone would understand the need to individually fulfill specific functions, according to the community’s solidarity spirit, needs, and possibilities. It would be an economy that Karl Marx would envy, since everyone would have more or less the same, sharing the resources and products of their labor with the others. In summary, it would be a primitive life in itself but reasonably harmonious, with all the basic necessities covered.

This would be a very stable economy, with close to full, permanent employment. The only possibility of a contraction of economic activity would be due to an adverse development in any of the three previously mentioned groups of variables (or combination thereof).

It stands to reason that, if the contemporary monetary system were managed in a highly efficient and effective manner, in essence, there should not be any other valid reason for contractionary cycles (recessions and depressions), unless any of the 3 previously mentioned groups and variables  (or combination thereof) experienced a sizeable setback. The evidence, however, clearly points we still have a lot to learn before fiscal and monetary management of any economy gets near that the level and excellence required. That is, if and when both fiscal and monetary policies are managed with a high level of effectiveness (around 85 or 90% rate of success) the economic cycle will continue to behave as we have known it for the past centuries.

The Scottish Connection: Adam Smith, Charles Darwin and Andrew Carnegie

It might be pure coincidence, but the three notables mentioned defined and/or revolutionized very important areas of knowledge and human activity.

Adam Smith (1723-1790) the undisputed father of economics –to whom a previous post was dedicated– established the foundations of that area of knowledge with his seminal book, An Inquiry into the Nature and Causes of the Wealth of Nations (1776). He was born and lived most of his life in Edinburgh.

Charles Darwin (1809-1862) revolutionized biology with his momentous theory of the evolution of species. Like Smith, he was also born, and lived most of his life in Edinburgh.

Andrew Carnegie (1835-1919) –born in Scotland, in Dunfermline, northwest of Edinburgh– was probably the first philanthropist in the world to go loud, public and wholeheartedly into devoting his life in this direction, setting an utmost precedent for future generations.

The profound personal transformation that Andrew Carnegie experienced –being one of the wealthiest industrialists in the world and becoming an ardent practitioner and advocate of philanthropy– was unprecedented. In his early 30s, Carnegie began to manifest a marked spiritual search centered on helping others, on a mass scale, while simultaneously detaching himself from material wealth.  In those years, he drafted a memo to himself that read, among other concepts: “ …the man who dies thus rich dies disgraced.”

The philanthropic work of Carnegie is legendary. Faithful to his strong beliefs, it is estimated that by the time of his death he had given away as much as 98% of his personal wealth. He reputedly helped open over 2,800 libraries. Devoted to learning, in 1904 Carnegie founded the Carnegie Institute of Technology in Pittsburgh, now the Carnegie-Mellon University. One of Carnegie’s major philanthropic interests was world peace; towards that end, in 1910 he established the Carnegie Endowment for International Peace.

Most contemporary praiseworthy philanthropists can trace back their ideological roots to this great human being.

In summary, the Scottish lands were the birthplace of three outstanding characters:

  • The father of economics

  • The redefiner of biology

  • The pioneer in large-scale-high-visibility philanthropy

It is truly remarkable and unusual for a single region to have produced such outstanding set of minds, within a time window of a little over a century.

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