Mosquito Curtains Blog

Dear Mr. Buffett,

            I am an ordinary guy who pays attention and would like to share a few policy ideas with you to hopefully receive your feedback.  I read some of your writings and like that you take a helicopter view of issues and are able to simplify complex issues using easy to understand analogies.  My favorite was Squanderville vs. Thriftville.  Unfortunately, no one listens to ordinary guys like me, which is why I am reaching out to you.

            We seriously need a game plan to reintroduce fiscal prudence if and when we return to prosperity.  The answer is to give the Fed/Treasury more variable knobs they can turn to steer economic behavior.

Our policy making system has what child psychologists term “Low EQ” (Emotional Quotient).  Essentially, low EQ is a lack of temporal maturity where near term gratification trumps long term rational decisions that are in the best interest of our country.  Our policy makers are so encumbered by electability that they only seem to act under crisis management.  It isn’t that any one politician is guilty or even that they are collectively guilty.  The system of politics itself is an entity with a personality and behavioral characteristics.  It is the system that has a low EQ and a faulty assessment of risk with the misconceptions of mean reversion during bad times and extrapolated prosperity during good times.  Our current risk psyche in a crisis is, “Just get me back to a good place and I am smart enough to immunize myself from future catastrophe.”

I am most concerned with the sequential propping up of our economy.  Bush Sr’s recession was saved by the dot com bubble and dubious accounting, which was saved by the real estate boom and cash out refinancing that poured gasoline on consumption, which is now being saved by economic stimulus.  While we have advanced in many ways, our way out of our crisis has been quick fix solutions that lack real legs.  When times are good, policy makers are reluctant to back fill the holes they’ve dug for themselves and don’t want to make difficult decisions.  After all, when times are good, why mess with things?  If you are a politician, you take credit for the good times, but you certainly don’t use good times as an opportunity to pay down debt, unless you want to help out your opponent. This mentality creates a serious ratchet effect where we take 1 step forward and 3 steps back.

Group dynamics is where our problems gestate.  Individuals and business create both positive and negative economic externalities from their activities.  Mr. Squander’s activity impacts the general economic health and should pay for the risk he has saddled onto Mr. Thrift.  The key to a solution is to identify and measure the impact of these externalities and either reward or require compensation for the effect of externalities.  In addition, to the extent possible, depoliticize economic policy by moving the decisions elsewhere.

The Treasury and the Federal Reserve Bank have very limited power to make adjustments in our economy.  What if they had more tools at their disposal to make variable adjustments to the economy?  What if in a limited way the Fed and Treasury could turn certain knobs to alter savings, consumer spending, capital requirements, or even taxation?  The obvious issue is usurping the Constitutional authority of Congress.  However, I think that if a new system is far more rational, it can be sold. (Delusion is a prerequisite for us entrepreneurs.)

Let’s examine one variable for simplicity.  Let’s say that there was a national sales tax that the Fed could alter within a strict range of 0 to 2%.  Use of proceeds could be general debt reduction (not to be measured in Congressional budgeting).  When the economy heats up the Fed could bump sales tax to cool things down while paying off the credit card in times of prosperity.  But before we choke on the Constitutional issues, let’s take a peek at other merits.

When the Fed has tools other than monetary policy to slow the economy it can perhaps pinpoint the issue with greater effectiveness.  When a consumer is contemplating a major purchase, price hits him right between the eyes.  Interest rates are only a roundabout means for getting him to slow down.  Most probably don’t even give the interest rate a second thought so long as they can afford the payments with little forethought to the possibility that their economic circumstance could change.  Taking a little steam out of an overheated economy might help us to avoid asset bubbles while paying down debt during good times. 

By having tools other than interest rates, I suspect that the volatility of interest rates might diminish.  Think of what that might mean for the option component of mortgage spreads and the ability of corporations to plan in a more stable rate environment.  Wall Street and hedge funds might not be too happy since volatility is a source of trading profits, but that might actually be a populist selling point of such a program. 

By using sales tax to slow the economy, the government doesn’t need to raise interest rates that also increase the cost of servicing the national debt. It might actually relieve politicians of the burden voters put upon them to create short term prosperity at any cost.  Individually, I think politicians are more fiscally responsible than they vote.  I actually think I have some interesting selling points that might appeal to both parties.

There are a number of knobs I would love to see placed at the Fed / Treasury’s disposal. 

• National Sales Tax (0-X%)
• Credit card surcharge on increased balances (0-X%)
• Cash out refinance surcharge (0-X%)
• Variable capital requirements for financial institutions based on risk.
• Tax credits you have offered to solve foreign trading imbalances

I’m certain there may be other more effective knobs that the Fed / Treasury may be able to twist and turn to improve the EQ of our American economy.  I offer only a conceptual approach to the problem.  We don’t live in a static economy and should never rely on static policy or sequentially static policy particularly when electability is a motivator.  Instead, we should give independent authority to tweak variables, within a range, to correct the externalities of bad behavior and at the same time reduce our national debt.  I would be terribly grateful for your thoughts.

Kind regards,

Kurt Jordan

Ordinary guy

www.MosquitoCurtains.com

In Part 1, we mentioned that the wealthy class is also the investor class.  From a helicopter view, our latest financial crisis has already created a huge wealth redistribution.  Consider two classes of people. The first is the consumption class that predominantly saves nothing and consumes every dollar earned. The second is the investment class who earns more money than it consumes and therefor invests the surplus in stocks, bonds and other investments. 

Implicitly, the wealthy class pulled a reverse Carnegie.  It lent money to the consumtion class to buy homes, refinance mortgages to go on vacation and to buy consumables.  The motivation was that the investor class could make money and there is nothing wrong with that.  However, the wealthy class didn’t run a credit check and the loans were not repaid.  Who lost? 

Asset values plumetted from stocks, to home values, to all the excess stuff on Ebay for sale.  If you have nothing, you have nothing to lose.  If you are the investor class, you have everything to lose.  As an economy, we pulled a reverse Carnegie and there is no savings for a rainy day. The right hand gave it to the left hand and the left hand spent it.

The solution is to allow capitalism to ruthlessly punish the bad decisions so that those responsible are purged from the system.  The absolute worse thing to do is to try to solve the problem by throwing even more money at the problem through the endless consumption stimulus proposals.  America needs to increase its propensity to save so that we can reinvest in things that will last.  Instead, we tried to spend our way out on the perception of the good faith credit of the USA.  While it creates short term relief, it will cause long term pain in ways that will be very difficult to recover from. 

Economic power is every bit as important as military power and in most cases wields more influence.  China is on course to slowly buy up American assets and that fact matters when we sit down to discuss issues like Iran and North Korea. 

What is interesting about the current financial crisis is the paralysis that it has created and the terrible allocation of the nation’s resources.  I want to leave you with a bit of optimism.  The month before the crisis and the month following the crisis were not all that different.  We still have an educated work force and we still have all the stuff we’ve made or built.  The crisis was simply a wake up call to say, “You were spending your money unproductively!” Instead of mass producing new homes, you should have built something else.  The unproductive effort was a waste of time and resources that will set you back, but thank God we have that information.  Unfortunately, our road out of the mess is exactly the road that got us here, unless we make the tough decisions and re-establish a firm financial foundation. 

Politics measures horizons to the next election.  Polititians are motivated to get re-elected.  It’s the flawed decision structure we’ve made for ourselves.  It is up to responsible citizens to remotivate Washington to take a long term approach to this crisis.

Andrew Carnegie was considered a ruthless employer who squeezed as much production out of his workers for as little wages as absolutely possible. He used his power to immobilize workers and give them few options but to do his bidding.  Working for Carnegie was life in a sweat shop.  His view was that the workers would spend their money on consumables that would be gone by the end of the month. Instead, he would spend it for them.

 Carnegie never had the intention to consume all the wealth he had amassed (and I’m not sure any one man had the capacity to do so). His view was that he would use the money to create an endowment to invest in things that would last 1,000 years, primarily the arts. Hospitals and education. What is interesting is that he empirically saw that the public’s propensity to consume would never create lasting wealth. For the general public this was great in the long run, but must have really sucked if you were a Carnegie worker.  These Carnegie workers paid the price for the greater good of later generations though it was not their choice to do so.

 Economies need to be careful that the gap between the wealthy and poor classes does not get to be too wide since envy may cause a revolt.   Certain segments of the poorer class will invariable face certain circumstances where they earn below even sustenance living.  Whether it is mismanagement of resources, or circumstances like a blind brother who is unable to work, war or weather, the poorer class is vulnerable.  They still need to survive and they may very well take what they need to live regardless of how much script their market wage has earned them.

 Wealthy individuals who live in countries where there is a wide gap between the haves and have not’s, live behind tall walls with barbed wire and armed guards.  A smart wealthy class will create some measure of a safety net that ensures that everyone is taken care of at some basic level.  Smart economies create a balance that must be maintained for the benefit of everyone. 

 Pure unregulated capitalism and controlled socialism are two extreme ends of a spectrum of possibilities.  History has shown us that each extreme has certain benefits and flaws.  Unregulated capitalism, where individuals act independently according to their own personal interest will create a class system with an ever widening gap, but will allocate resources efficiently and invest in infrastructure that will tend to improve the standard of living for everyone.  The Industrial Revolution has shown that unregulated capitalism can be quite cruel to the working class.

 Pure socialism is more egalitarian, but is also, terribly inefficient with its allocation of resources.  Socialism will likely go down in history as a failed experiment.  The paradox of capitalism is that when individuals make independent decisions, it is better for the group as a whole though it is not very egalitarian.  Socialism has a similar paradox that a centrally planned economy is inferior for the group as a whole but seems to champion the individuals.  (The Communist made an attempt at socialism, but for the most part replaced the capitalist class with the elite and privileged Communist Party.)  Socialism just doesn’t seem to fit the nature of human beings to differentiate themselves in a world of Two-ness.  The contradiction simply could not endure and it is drifting into Darwinian extinction.  The question is, do we really have free market capitalism?