EVEN THE DISMAL TALK IS GOOD NEWS

Successful investors learn to go in the opposite direction indicated by the talk of the pundits. The best prices are always found just when people think the worst of times are on the way. The negative talk actually serves a real economic purpose. The ugliest of times are caused by high inflation rates and one of the cures to high inflation is dismal talk.

The inflation formula is as follows:

Inflation = the rate of money growth (%M) + the change in the velocity of money (%V) - the rate of product output growth (%Y).

The above formula is nothing more than the concept that inflation is always a monetary problem, that of too much money chasing too few goods.

For several years, leading up to last August, the growth in the money base was held down by central bankers. Month after month, the economies of the world continued to expand rapidly because the velocity of money soared. People and businesses around the world were borrowing and spending. Hot money flowed quickly from bank to customer, from customer to bank and back to another customer. All the while, inflation was kept very low because the tail end of the above formula was growing even more rapidly than the front end. The output of goods soared. The sum of money growth and velocity was high because the velocity was high but the output of goods offset the change in velocity. Indeed, the price of manufactured goods fell.

Over the past several months, the situation has taken a dramatic turn. The FOMC has pushed up the growth rate of money in order to offset the dramatic slow down of velocity. The rate of growth of production also slowed. It is a normal sequence at mid cycle turns for inflation to pop up a little as the slow down in production coincides with the sharp increase in money growth. It is normal for pundits to talk about stagflation at turns as it is common for real growth to show considerable weakness partly because real growth is reduced by the inflation rate. (the formula is V*M = P*Q which is also = real GDP * the GDP deflator).

Part of the reason the chair of the central banks have to talk so dismally and show so much concern is because they feel the need to talk the inflation rate down. In other words, they can reduce inflation by convincing the markets to slow down the velocity of money. Once inflation is brought under control, the sentiment will change quickly. Talking down inflation allows interest rates to be cut to the point that the future economy is dramatically stimulated. That is where we sit today. The time required for interest rate cuts to kick in has already occurred. In the short run, asset buyers have waited for the bottom in rates. The "big" purchase for the average person is a home. The cost of buying a home drops hard as the interest rates fall. If one can wait a few months to lock in a 30 year loan, one can save a bundle over the life of the loan. Multiply the savings many times for a power company, an oil company or any other company that needs to finance a new project. Time appears to have already run out on those who hoped to buy at the exact bottom. Long term mortgage rates are already lifting up a little.

The market is betting that the FOMC will have to cut interest rates at least one more time. However, there are signs in the international market that cuts already made are causing growth in economic activity. Eastern Europe for example appears to have already come in for a "soft landing". Growth in a number of Eastern European countries has fallen from double digits to single digits, inflation picked up for a while but now growth is re-accelerating and inflation is moderating. Growth in Western Europe has slowed but these economies are not weak. Indeed, the average unemployment rate in Europe is at 7.2% which is the lowest rate in decades. All the while, China's citizens have headed to the malls! The Chinese are quickly learning that it makes sense to spend some of their new wealth. In a number of markets, Hong Kong being a good example, home prices have started climbing again. The first cut in US rates was about 6 months ago. The bigger cuts came only a month ago but rate cuts are cumulative. As production picks up again, inflation will fall, per the formula, which means the real GDP will be higher than expected. This also means that corporate profits will be higher than expected.

REMEMBER, THE BEST STOCK MARKET BUYS ARE MADE WHEN MOST PEOPLE BELIEVE THE WHEELS ARE FALLING OFF THE WAGON. Today, 81% of democrats believe George Bush has done a poor job as president and 78% of republicans believe the democratic congressional leaders have done a poor job. When you get extreme ratings such as these, you can bet on a turn coming soon!

A NEW WORD, DECLINISM, WAS COINED IN 1988

Allen Dowd has written a number of articles about the belief Americans have that the country is falling apart. The US is seen by many as being a nation in decline. The new word, "declinism", was coined in 1988 as a result of the belief that Japan was supplanting the USA as the economic power house. Dowd says that each decade we have something else to worry about. The cold war occupied the nation for years while it was assumed that the Soviet Union was about to become the worlds new military super power. Others figured it was Germany not Japan that was going to become the economic power house. At other times it was believed that America had lost its standing in the world because our imperialistic policies failed in Vietnam. In more recent times, we have suffered a loss of support in the world because we took over Iraq "to get its oil" while failing to look after the victims of Katrina. The story goes that it is America's fault that the terrorist are blowing up innocents.

Gerald Baker rebuts with the fact that even after the expansion of the EU to include eastern bloc states, the growth of the US will make the US share of GDP twice the size of the EU by the year 2021. He notes that we have spend 100's of billions of dollars helping out the victims of Katrina, more than what has ever been done by any other nation to help those who were hit by any other natural disaster.

DECLINISM IS NOT NEW

In 1843 Thomas Carlyle, a Scottish Essayist used the term "dismal science" to describe the science of economics. Carlyle was brought up by strict Calvinist parents who expected him to become a preacher, before he lost his religion. His view of the world became pretty dismal when he saw the problems inherent in the laissez-fair form of capitalism that sprung up during the industrial revolution of the times. As we now know, when technology cuts the cost of manufacturing, jobs are initially lost. Carlyle was just 16 years old at the start of the Luddite movement. Ned Ludd was a man of action. If textile factories were going to be closed down as a result of water wheel powered looms, Ned said tear down the water wheels. It does seem natural to think that if water wheels reduce textile workers jobs that water wheels are a bad thing just as bad as a NAFTA trade agreement. The Luddite Movement was so strong that it took the British Army to stop it. Fifteen years after the start of the Luddite movement, the Reverend Thomas Malthus wrote the first of his 6 editions on "The Principle of Population". If you want to talk about "dismal science", read Malthus. He believed that the people of the earth are doomed to cycles of prosperity and famine. He believed that the population would always ultimately out grow the agricultural production necessary to feed the people. He saw no way out of starvation for millions of people. Malthus could not even imagine a rice plant producing 30 times as much rice as the plants of his day.

The story of "gloom and doom" goes on and on. The time of 1884 to 1914 is called the age of modernism. During this time, the concern was to try to figure out what was holding progress back. The German philosopher Nietzsche saw tragedy as an affirmation of life. War War I seemed to confirm that tragedy of one form or another would always come to end all eras of prosperity.

Yesterday, Mark Perry posted a link to an old Forbes article by Virginia Postrel. The article is titled, "The American Standard of Whining". She notes that the greatest proponent of free markets, Adam Smith, who wrote "The Wealth of Nations" in 1776 understood the need for news reporters to focus on "declinism". He wrote, "a continue series of prosperity would not give us near so much pleasure as an epic poem or a tragedy which make but one continued series of unhappy events." In other words, it seems to be human nature to want to hear and to repeat the "horror" story.

Today, we have people on both sides of the isle feeding off the public's voracious appetite for bad news. Pat Buchanan is one on the right who has made a few bucks by writing about how the US is becoming second rate. Hillary and Obama seem to be in a contest to tell how America has fallen in the eyes of the world. All three of these folk seem ready to end the prosperity brought about by free trade. One of the silliest things you will ever hear is the idea that the Chinese are unfairly manipulating their currency to take advantage of America. What these people apparently believe is that we are being duped because China is selling us stuff at too low of a price. Pat does not need to worry so about the power of the Chinese. No matter how economically strong they become, it will still make economic sense for them and for us to trade with them. Both countries will continue to benefit as long as we are willing to trade.

Allen Dowd does a good job of turning the thoughts of these folk upside down. He points out that from the foreigners point of view, "globalization is another word for Americanization". Here we are upset that English is only learned gradually by immigrants to the states when it has become the universal language of the world. We are upset about building factories in India when these factories actually represent the fact that the US dominates world commerce. A few examples mentioned by Dowd include the domination of the personal computer market by Dell and HP, the fact that 330 million PC's run MSFT operating systems and that Apple iTunes has displaced the Sony music download system in Japan! He goes on to mention Google's dominance in search and the 30,000 McDonald's restaurants outside the USA. Seventy percent of Coke is sold outside the US and Starbucks has stores in 39 countries. I considered posting a list of all the different international store brands owned by Wal-Mart but decided not to fill another page of text to make the point. Suffice it to say that there are 2,700 Wal-Mart Stores outside the USA and there are less than 30 countries that have a GDP larger than Wal-Mart sales. Obama likes to attack Wal-Mart but an objective study of the facts would probably show that Wal-Mart has brought more wealth to more people than any other organization in history.

NO ARMIES IN UTOPIA

George Washington initially believed that the USA did not need to maintain a standing army. Unfortunately the laws of nature require all species to be ready to defend themselves. The history of our country has been one of a "Stop and Go" military. We quickly forget the lessons of the past and are quick to lower our guard. The cost in treasure and lives has been enormous. We can only wonder how many lives were lost by the communication sent to Hitler from Franklin Roosevelt in 1938 that said, "the USA has no political involvements in Europe"? Britain and France have received the most criticism for trying to appease Hitler but the US was guilty as well. We let down our guard, informed Hitler that we would not stand up to his annexation of Austria and our actions ultimately cost millions of lives.

Less than 10 years ago, the US was enjoying a "peace dividend". We enjoyed a strong economy while not bothering to confront Islamic Extremist. The good news is that only a few hundred thousand lives have been lost in this war. The toll would have been much higher had the US not taken the preemptive steps necessary to confront the "bad guys".

American is blessed in so many ways. Our blessings include millions of well meaning educated people. Michelle Obama graduated from Princeton in 1987. Last week, she made a speech in which she said that "For the first time in my life, I am really proud of my country." WOW!

America is the land of the most charitable people in the world. We voluntarily give more to others per capita than any others. In addition to this individual giving, we have repeatedly donated the blood of our finest on behalf of the oppressed. The charitable giving is a measure of private donations but as a nation we spend billions of additional funds in service to our fellow world citizens. We catch a lot of grief and we certainly could do more but we need not beat ourselves up for not being perfect (even though we miss perfection by more than a few country miles). I am a proud American!

THE NEW PARADIGM

One of the TED lecture series notes that man has survived through cooperation. Surely we are competitive beings but the examples of man helping others is blossoming in ways that were unimaginable just a few years ago. People have spent millions of hours completing Wiki encyclopedias and millions of other hours sharing knowledge in other ways and without compensation. The speed of life has increased dramatically because we have found new ways to build trust in one another. EBAY's rating system is an example of how two total strangers can agree to a long distance transaction with confidence of being treated fairly.

Along the way, a backlash has developed. The NAFTA law signed by Bill Clinton contributed to a great surge of wealth in the USA and the much of the rest of the world. It is not unexpected for such a successful law to receive backlash. The Luddites of Britain were rebelling against machinery that was ushering a new age of prosperity but the dramatic increase in efficiency put some people out of work temporarily. It was the French who took off their wooden shoes, Sabots, and threw them in the gears of machinery in their attempts to destroy the industrial revolution. The French did not give up easily, they broke the Sabots that held railroad tracks in place during the strike of 1910 and only last year were the French laws changed to permit workers to be fired. It took unemployment rates of 22% to make workers willing to accept rational economic policies. The rapid pace of technology has caused the rapid destruction of jobs in America. The prosperity created by the new technology is allowing millions of people to find better jobs.

Twenty or so years ago, uneducated Americans were quick to condemn the hiring of Chinese at $2 per day to make Nike tennis shoes. The unintended consequence of the protest was to punish the Chinese workers by sending them back to their old jobs. The old jobs paid 75 cents per day. Today, $1 per day workers are finding $3 per day jobs and living far better than their parents lived.

One of the things that Americans need to understand is that we reduce the probability of war by trading with others. Milton Friedman was one of the greatest economist of all time. In 1962 in "Capitalism and Freedom", he wrote that political freedom follows economic freedom. One does not need to be a brilliant economist to understand that a hungry man is more likely to be aggressive toward his neighbors. Milton was famous for a lot of ideas. For example, he was the one who declared that there is no such thing as a free lunch. It has only been in recent years that this concept has been more fully understood. Today, millions and millions of micro loans are outstanding. The poorest of people are borrowing small sums of money to get an economic start. Because the people are required to pay the money back, the money is lent to those who have an idea about how to invest a small loan to get a return. A common example is a loan to buy a bicycle that might be used to haul products to a village market.

PAY IT FORWARD OR PAY IT BACK

The concept of paying forward has been around for a long time. Sociologist have found what they call general reciprocity in all sorts of religions and cultures. The concept was practiced among family members in ancient days, when grandpa helped his son, he expected nothing in return except similar treatment for his grandson. Among the Amish, the concept is routinely practiced when it is time to "raise a barn".

Today, many people are "barn raisers". People cooperate to build everything from community green ways to computer networks. It does not matter if one promises to pay it forward or to pay it back, the deed is not a free lunch. Still it certainly is nice that people today feel that they can afford to do a deed without the hope of getting back direct compensation.

DISMAL TALK BUT EVIDENCE OF GOOD WORKS

Yes there is still a lot of dismal talk all around but there is a lot of good stuff happening. One of the good things that is happening is that people all around the world are discovering that it is not a good thing to confiscate the property from the wealthy. Back in 1999, Russia had a 44% marginal income tax rate and the government took in about 100 million dollars per year. By 2001, the tax rates were collapsed into a flat 13% rate. Government tax revenues by 2005 reached 700 billion dollars; seven times the tax revenues were collected by charging one third of the tax rate! Who cares? The people of Russia care because the economic revival has been a blessing to the entire population. The people are living much better.

HOPE AND DISMAL TALK

Obama talks about hope and in the same breath talks about taxing more. Since the 1950's and 60's when Milton Friedman wrote about limited government being best, we have seen example after example where private systems serve the public best. It often takes years for free enterprise to remake the poor systems that develop as a result of government control. For example, the government monopoly granted to the telephone system of 1984 restricted the development of communications networks. Today we individually enjoy abundant streams of communication at a fraction of the old costs. We would not have the internet today if AT&T still had a monopoly. In like manner, it took 30 years for railroads to totally shake loose of the restrictions built up over years of excessive government control. Railroads are enjoying a building boom and the public has enjoyed lower cost over the past 30 years and they will enjoy lower costs over the next 30 years as a result of free markets. During a time of higher energy costs, it is easy to lose sight of the fact that railroad deregulation has helped to dramatically lower the real cost of electricity. Airlines are finally ready to spread their wings. FedEx and UPS has given us untold collective benefits.

The talk of change and hope implies forward movement but in this case it represents a reactionary movement. Many Americans dream about the "good old days" without remembering how tough those days were. Back in 1776, Adam Smith understood that people felt the need to tell about the wonderful days of old. Today, the average American believes that pollution has gotten to be a real problem. They simply cannot imagine walking down a street littered with horse manure while fighting off flies caring every thing from dung to typhoid fever. Did you ever notice the absence of horse manure in cowboy movies? Technology is taking us forward. Let's not fight it but use it. By using the new tools that have been provided, we can move toward Utopia. We will never get there but let's have fun on the journey! Even the dismal talk is good news because the market is ripe for rising up out of this swamp of despair!