Issue # 77  April 13, 2003
NOTICE:  All contents © 2003 by George A. Ure, MBA except other authors as noted.  This document is intended for the sole use of subscribers and may not be transmitted, reproduced, or in other way used without the written prior express consent of the author.  This publication is by subscription:  $50/year for web browser accessed delivery to a password protected site or $150/year delivered by personalized email in HTML..  Please pass along a copy to your friends and suggest that they subscribe.  To subscribe, send a check to: Guru Press, 1355 West Palmetto Road, #281, Boca Raton, FL  33486-3383.  You may also subscribe using PayPal.  Your username and password are both your email address, in all lower case to access the protected web site, so don't forget to include it!   Address comments and correspondence to: george@ure.net.    Read the disclaimer: http://www.urbansurvival.com/disclaim.htm This report is based on sources believed reliable and makes no specific investment advice.  Before you invest in anything, seek professional advice and remember, you can only spend it once, unless you are a member of the Fed, in which case you can spend it as fast as you can print  it.

The Curious World of Cadence:

Saturation Economics

Last week, we explored  why the economy was experiencing both layoffs and price appreciation at the retail level simultaneously.  To review, the concept is that once a market is saturation, demand may begin to fall, yet businesses wishing to "hold prices high" may fail to recognize that the critical point of highest yield has passed, and as a result, prices are held high while demand falls.

This week, we're going to take that line of inquiry a bit further and see what it really means and if there are some planning touchstones we can deduce that might be useful in our everyday economic lives.

Let's begin with government policy.

We all know that the Federal Reserve has been busily trying to do everything it can in its monetary powers to keep prices from falling because that would only contribute to the worldwide deflation that has been evolving like a creeping crud since the competitive currency devaluations swept through Asia in 1997 and more evidently since the peak of the tech bubble in March of 2000, as reflected most particularly in the drop of the NASDAQ. 

While it's tempting to ascribe the presently evolving Second Depression as a function of contemporary markets, I think Sornette's work definitely shows that the root causes of depressions are not the singular "peak" events (like the collapse of the Internet stocks) but rather are a result of systemically defined bounds.  In other words, once normal market oscillations around perfect pricing within a closed system (and the global economy is after all, a closed system) begin to touch almost invisible bounds, then curious small oscillations begin that eventually synchronize to become the killer oscillations that bring down whole economies.

Think of it as an army marching in cadence over a bridge.  If one person walks, all if fine.  If two or three people march, the bridge hangs together.  But should a few hundred soldiers march across a bridge, and they don't break cadence, the resonance of the simultaneous foot stompings of a close order march result in a huge magnification of stress, which can bring down a bridge.  Well, the same principle applies in economics.  Cadence.

Now sit back and think about the global economies which have, in the last dozen years or so, begun to synchronize in a 3.5 year cycle.  Not only did the think tank send me a nice summary of the Japanese work on how this newly identified 3.5 year "global cycle" is beginning to slosh around in the economy, but in addition, they had a great summary of the latest warnings from Dr. T.  As a longtime reader, you'll remember her as the head of the Russian Dhuma's economic office, not unlike our US GAO, and that when Dr. Tayana Koryagina speaks, we should all hear what she has to say:

Dr. T's latest is circulating and she is saying that US will enter
hyperinflation before the end of summer to the tune of over 42%
annualized. And at that rate, her guess is that it will only take the
FED about 2 months to have to go to over 80% annually just to
combat the next leg of global deflation.

Her article in Russian poses an interesting question....

Is it hyper inflation if deflation eats the increases in one or more
spots and does not allow the increase in money supply to make it
into general circulation? In other words if a negative real interest
rate would cause a hyper-dysfunctional economy such as currently
exists in the globe to 'eat' the increase in money supply in specific
fast-flow areas such as bonds..

As we know, the real crash in the previous depression occurred in
the bond markets after the equities went down on the second leg.
And that the bond market implosion was what really crashed the
cash flow through rates and really marketed the depression..

So if Dr T's  postulate is correct, a single asset class like bonds or
real estate (she says this one can't be it as it is already crashing
globally, and once a class crashes, it cannot be re-inflated) would
have hyper inflation while the rest of the classes of assets are
relatively normal until the crash of the hyper-asset, then the whole
flucker melts down in a day.

She is specifically predicting, now matter which way the hyper
inflation plays out, a systemic lock up by end of year with most
likely period for the 'binding' to occur in fall. For a variety of
reasons.....fall is the time.

However, she notes that trading this summer will be unlike any
other summer in history. And if she is correct, one of the keys
should be the commentary which will start to develop about how
unusually active the summer trading is this year.....

The other shoe?

How does hyper inflation work if houses are dropping in prices?

So now we've set the stage: Saturation of demand, the emerging global cadence, and what I think is best described as Sectorial Inflation.  Let's go surfing for useful concepts and see what might fit into a recognizable whole.  We'll spend no more than a half hour per search and see if we turn up anything useful.  Ready?  Set?  Here goes...

Search: Google >>> Terms:  +saturation +economics

Result 1:

"According to John Maynard Keynes, there is no limit to the scope of deficit financing on the part of the Government of a country as long as the standard of living of the people in the economy kept on rising and the country achieved full employment. He did not envisage that goods and services produced by a country having a higher standard of labor rates would not sell due to a competition from other countries having lower wage rates. A saturation of demand is bound to set in several sectors of a developed economy at some stage requiring a curtailment of production despite achieving higher labor productivity.  Deficit financing on the part of the Government after the saturation of the demand has taken place would induce greater foreign trade losses bringing about a leakage in the domestic money supply to be made good by matching foreign investments causing a drop in the turnover ratio of money in circulation even though production and sales may appear to be rising due to a faster depreciation in the exchange rate of the currency."

Keynes was way off in his estimate because he failed to anticipate that at some juncture, the world runs out of ways to "raise the standard of living".  At some point, when everyone has 2-3 cars per person, God knows how many television sets, what the "improvement in standard of living?"  Still, the site goes on to make the sage recommendation to countries:

"All countries can thus be urged to resort to deficit financing liberally to achieve the saturation point of their demand potential by raising the target of the growth of their money supply. Incurring further deficit financing by the Government after the saturation point has arrived, should cause foreign trade losses requiring the excess savings in the economy over and above the saturation point to move to the BOP account of another country. "

You do remember that BOP is Balance of Payments, right?

Result 3:

"Radio: In 1925, less than 25% of all households owned radios; by 1930 penetration reached 46%. By 1940, penetration reached 82%, and radio reached saturation by 1950 (see Tagland, p3). Television: In 1950, less than 10% of households owned a television. By 1965, less than 10% of homes were without a television (see Tagland, p3). Telephone: Between 1878 and 1958, telephone penetration went from zero to 75% with dips along the way during the depression. Penetration did not flatten until 1970 at 93%, where it has remained since (see Tagland, p4). McCluhan's vision is a good one, but it certainly isn't based on past performance; according to Tagland "...information services (like the telephone and now the Internet) require the household to make monthly payments. It took 60 years to reach saturation for electric service, 100 years for telephone service, and it has been 55 years and counting for cable TV service to reach saturation"

We might want to bookmark those figures about radio, because as the Joseph Paul Water's book (delaing with technological advances ands its relationship with the Great Depression) that 50% market saturation point for radio at the depths of the Depression is interesting.

You might recall here that Radio was a novelty - and families would actually gather around the radio in the earliest days of the technology, not unlike what happens today.  However, after the middle of the Depression, the system or radio became ubiquitous - radio was everywhere including in cars.  And that's something we're seeing in the evolution of the Internet.  It was a really cool appliance, there was a hell of a boom when the Internet ramped up, and it coincided with a major market top followed by a crash.  It had taken radio about 30 years to reach the 50% mark, but in the case of the Internet, it took less than 10-years.  Like radio, the Internet is becoming ubiquitous, and it will sink, just as radio did, from a "gee whiz" to a background "thing" we all just take for granted.

Result 6:

"New housing appliance saturation

Depending on the type of appliance, there will be different types of saturation equations and there will be different main drivers for the sales and increase of the appliance.

Large, major appliances like refrigerators, freezers, stoves, washing machines, dryers, and central air conditioning and heating systems will be driven by housing and will have household saturations. Personal appliances and devices like music equipment, personal computers, and to a lesser extent TV's, fans, and portable heaters will be driven more by the number of people or occupied rooms in a population. And the personal appliances will tend to move with the occupants.

In general we will assume that given a constant size and quality of a major appliance, that its saturation in new housing (of relatively constant characteristics) depends on three main economic parameters: Price, Operating Cost, and Household Income. We will also assume that the relationship between new housing saturations and these three parameters depends on five empirical parameters as follows:

Sat_NewHousing(P,OC,I) = Sat_{NewHousingMax}/(1+e^{(A+(B+C/I)*(P+PWF*OC))})

where Sat_NewHousing(P,OC,I) is the saturation, P  is the price, OC  is the operating cost and I, is the household income. Sat_{NewHousingMax} is the maximum practical saturation of the appliance in the new housing stock while A, B, and , C  are parameters that are calibrated with historical data when possible. The parameter B is the dominant parameter when household income in not much of a factor and purchase decisions are made compared to other consumer goods, while C is the dominant parameter when household income is a primary constraint on appliance purchases. PWF is a present worth factor that describes consumer trade-offs between operating cost and purchase price. The present worth factor can vary between 0 and about 5 depending on if consumers are very concerned about operating costs or completely unconcerned about operating costs. "

This is a wonderful model because it gives us a starting point with the formulas to work out global saturation of product given income states in the individual countries involved.  While it's more work that I care to take on right now, it's very clear from even a quick review that the same kinds of limits that apply to appliance pricing could be applied to whole nations and their GDP's. Maybe if we get enough rainy days with nothing to do we could project demand past saturation using the MUC (debt induced limits on demand) as a start, but realizing that besides the apparent cost of money there are other drivers such as the practical limits to consumption, as we can only drive one SUV at a time.

Search: Google >>> Terms:  +sectorial +inflation

Result 8:

"The paper investigates whether it is the level of inflation, changes in the inflation rate or unanticipated inflation which influence the variability of sectoral output growth rate, using the U.S. monthly industrial data from 1957 to 1997. We experiment a range of specifications - our main finding is there is no systematic relationship between inflation and sectorial growth. The effective exchange rate and the real oil price do help to explain some of the dispersion in output growth rates."

If inflation doesn't drive sector growth, which we sort of suspected all along, the sectors are therefore open to the kind of model which we envision: One where saturation and growth really come into play.

Result 24

"The literature proposes five explanations for the phenomenon of rapidly rising service prices: 1) some believe that service inflation is a statistical artifact that stems from the inherent difficulties in measuring service output and hence price changes;¹ 2) continued economic prosperity has put additional upward pressure on demand for services thus pushing up their price;² 3) unbalanced sectorial growth as suggested originally by Baumol (1967), is according to some the principal cause for the divergent inflation rates between both sectors of the economy; 4) many services are categorized as untradable and thus much more isolated from foreign competition than tradables such is the case of many goods;³ and 5) the last thesis is a combination of 2) and 4), whereby increased competition from emerging economies will lower prices for manufactured goods in rich countries, raise the real money supply and in turn boost spending on other goods and services, raising their prices.^4"

Looks to us like Baumol is right, given that we have observed saturation is some markets, which is now becoming recognized, such as the recognition by automakers, as signaled in zero percent financing schemes, while housing prices in most areas have stopped increasing, and in some regions, like the Pacific Northwest and the South Bay of California, have actually retreated.

These initial researches can be used as building blocks as we look at the world as a vastly complex machine. Not to say that randomness isn't involved in the operation of international economics, because is certainly is to some extent, such as the impacts of weather.  But in the larger view, it's likely that we are either "plateauing" or declining on a global basis because of the issue of consumption.  To many people have reached a poit where they either can't buy the "next big thing", or there is "no big next thing" to buy.

When you see how the US got out of the first Depression, you can see how the building of the Federal Highway system was a critical element, as was the Rural Electrification Agency.  But in today's world, we lack the kind of large-scale consumption drivers that made recovery from the Depression (and World War II) possible.  The cost of building the information super highway was relatively small, as a proportion of resources.  And, while there was a lot of intellectual property involved, IP is easy to ignore. It's not like plant and equipment that sit out in the rain and deteriorate if not used. 

So today, we sit on the precipice of the Second Depression, seemingly ignorant of the need to built the next "big thing" and in its place, government is concocting wars (such as Iraq) which have morphed completely before the ignorant public's eyes.  The Theft of Iraq's oil fields, which began as a response to a huge "They have weapons of mass destruction!" campaign, and evolved into a "they're working with al Qaida!" campaign into a "We're really going to get Saddam" which ended with "Oh, this was really a war about liberating enslaved people" is the single most amazing PR stunt I have ever seen in my life.  Especially because the real agenda was getting the oil under control, something that was accomplished in about a week.

I think Hans Blix said it best in an interview this week: The US wanted the war, needed the war, and the inconvenient lack of WMD's wasn't going to stop us. 

Might they still be found?  Yes, it's possible.  So is a war against Syria and or Iran.  And yes, this will lead to more polarization between the Muslim and Western worldviews.  But that might not be such a bad thing from a purely economic perspective.

You see the world is past Iraq, and corporations are mired in crappy earnings, and people are not yet thinking clearly or for themselves about what it all boils down to.  Let me suggest that what we're seeing in governmental is a response to a problem them don't know how to solve: How do we bring a lot of people up to a higher standard of living without increasing population, and at the same time have sufficient growth to keep industry producing ever more to feed the real monster behind the curtain: the debt monster?

On to the Charts!

This week, I want to focus on a "bonus chart"  that I whipped up for you.  It's based on something I built a while back called the Global Aggregate Index.  What I did was equally weighted the market indices of the US, Canada, England, France, Germany, Hong Kong, Japan, and Korea and presented in just as we've used the Aggregate index approach to look at the direction of the US economy.

As this week's update shows, the US S&P has faired better than the rest of the world since it became clear that we would fight a war int he Middle East.

Where the jury is still out is on the question whether this latest increase, which reverses the trend of the past two years or so, is anything more than a statistical blip, due to people investing in the US because we're the world's reserve currency, or whether this is the genuine start of something great - namely a recovery.  I'm inclined to take it as a flight to safety (of American investments) because the earnings reports that are now flowing do not support the notion that "good times are around the corner".  Earnings are still nearly as high on a relative basis as they were at the peak.  What's kept them from reverting to historical norms has been a market that continues in our judgment to be overpriced.

"Write when you get rich...."

Don't forget to visit Elaine's new site: www.independencejournal.com

George Ure (click here to  email a note)