What is the role of animal spirits in the political sphere in producing economic crises?

“Conventional economic theories exclude the changing thought patterns and modes of doing business that bring on a crisis. They even exclude the loss of trust and confidence. They exclude the sense of fairness that inhibits the wage and price flexibility that could possibly stabilize an economy. They exclude the role of corruption and the sale of bad products in booms, and the role of their revelation when the bubbles burst. They also exclude the role of stories that interpret the economy. All of these exclusions from conventional explanations of how the economy behaves were responsible for the suspension of disbelief that led up to the current crisis” (George Akerlof and Robert Shiller, “Animal Spirits”, 2009, p 167).

I don’t have many problems with the argument of Akerlof and Shiller (A & S) that animal spirits play an important role in economic crises. I think they attempt to carry their argument too far; it seems to me that the economic system tends to be self-equilibrating despite notions of fairness and money illusion. But I accept that when there is high leverage in the system (i.e. high levels of debt relative to equity) it is a lot more vulnerable to economic crises than when there is low leverage. I also accept that changes in confidence help explain why leverage fluctuates. Stories that interpret the economy seem to have a big role in determining confidence. A few years ago it was common to hear the story that the risks involved in lending on housing were minimal – even “as safe as houses”. Now the story we hear is that investment in government-backed securities offers “a safe harbour”.

The main problem I have with this book is its failure to recognize that animal spirits also play a role in politics. In fact, as Arnold Kling and Clive Crook have pointed out, A & S fail to mention public choice theory. Instead, their model of government is what Kling describes as the “shockingly naive metaphor of a parent”. In their preface, A & S write:

“The proper role of the government, like the proper role of the advice-book parent, is to…give full rein to the creativity of capitalism. But it should also countervail the excesses that occur because of our animal spirits.”

Crook writes: “This is an unappealing analogy. I would sooner take up arms against a government that saw me as a child than vote for it.”

It seems to me that the most important animal spirit that Akerlof and Shiller fail to mention is the anti-market bias, stemming from an excessive desire for security and stability, which comes to the surface whenever a financial crisis threatens to occur. Rather than allowing the normal process of liquidation to occur when large financial institutions fail, the animal spirits that rule the political domain say that everything must be done to “keep the first domino from falling” (as A & S advocate on page 85).

When viewed in isolation, the bail-out of each institution seems like cheap insurance to government policy advisors. The problem is that a series of bail-outs tends to generate excessive confidence in central banks and governments. If you are lending money to a company that you expect to be backed by government, then you are not going to be too worried if the salary packages of the executives of that company give them incentives to take excessive risks. Creditors might not be surprised if the company gets into financial difficulty, but they will be shocked if it isn’t rescued by government.

From the A & S perspective the current crisis occurred not because parents encouraged the kids to act unwisely by incurring gambling debts , but because the parents decided to let one of their wayward children file for bankruptcy. That unsettled the creditors, so the parents lost their nerve and decided to pay all the kids’ debts. At this stage the lesson that the parents seem to have learned from this is that the kids need more parental supervision to make sure that their animal spirits don’t ever get out of control again. How will the kids respond? Will they leave home to get away from this parental supervision? Or will their animal spirits lead them to pretend to be good for a while in order to re-establish cosy relationships with their parents?

Digital Companies In A Physical World

Technology keeps thrusting forward at an ever increasing rate as the Information Age transforms the world at a rapid pace.  Business is happening at the speed of thought as companies are beginning to morph into digital entities in a physical world.  Fortunes have already been made in supply chain management and product distribution as evidenced with Toyota and WalMart.  With top lines under constant pressure as the credit contraction grinds on increased efficiency is being eked out of every possible source.

Man’s financial progress is a function of effort times tools.  Business has, is and will be the primary tool to generate wealth.  The ‘job’, a relic of the Industrial Age, is rapidly being replaced with outsourced freelancers.  Millions of Americans have lost their jobs in recent months.

This vast pool of usually skilled workers are now navigating a brave new world.  While hundreds apply for a single job; an exponentially expanding web invites the adventurous and rewards the productive.  Never in the history of the world has there been such powerful Internet marketing tools available to the lone entrepreneur to leverage their productivity.

THE OLD ORDER

Creative destruction is taking place in almost every aspect of the the economy from the exciting realm of newspapers and journalism to the mundane of postal and package delivery.  The United States Postal Service enjoys a substantial monopoly imposed by Federal law.  Predictably this system has catered to special interests with their army of lobbyists.  That is the reason most receive tons of dirty and annoying advertising SPAM in the mailboxes that waste their time and like most governmental policies harm the environment.

Bloomberg reports that “The U.S. Postal Service said it will offer early retirement to about 150,000 workers … In the past year the service has taken ‘very aggressive cost-cutting actions,’ including a nationwide hiring freeze and halting construction of new postal facilities, according to the statement.  Potter [Postmaster General] asked Congress in January to let the Postal Service reduce its six-days-a-week delivery schedule by one day to save money.”

Why does postal mail, the vast majority of it SPAM, need to be physically delivered even once a week?  Why does an address in north Alaska cost the same to deliver to as one in Los Angeles?  Legislative interferences in the marketplace to prop up failing institutions lead to expensive moral hazard, inefficient systems, poor customer service and a lower quality of product.  Is the use of violence to perpetuate this failing system moral?

THE NEW ORDER

With the advent of the Internet the delivery of postal mail and packages can be accomplished with greater efficiency.  Through innovative Internet-powered CMRAs (Commercial Mail Receiving Agency), customers can view images of their envelopes in email or online and have their mail securely scanned into a PDF, recycled, shredded, or forwarded.  For the privacy minded, like victims of spousal abuse, etc. the ability to vanish using this type of ghost address is extremely valuable.

As the Center on Budget and Policy Priorities reports, “States are facing a great fiscal crisis.  At least 47 states faced or are facing shortfalls in their budgets for this and/or next year, and severe fiscal problems are highly likely to continue into the following year as well.  Combined budget gaps for the remainder of this fiscal year and state fiscal years 2010 and 2011 are estimated to total more than $350 billion.”

Many individuals have their own budget with policy priorities and given all the Tea Parties, I highly doubt it involves paying more taxes than legally required.  For example, customers can easily have the ability to receive packages in states like Oregon where there is no sales tax, forward the package using Fedex or the United Postal Service (UPS), and the savings would likely be greater than the cost of an entire year of the service.  This may slightly perturb some States, which are breaking into safety deposit boxes and auctioning the contents on Ebay, resulting in greater enforcement of sales and use tax laws but that will likely be very difficult.

Ebay and Amazon are simply digital flea markets and the digital nomad can finish all their work at a Fedex Office.  The Internet entrepreneur relies on package tracking to ensure their products and sold on the digital flea markets are delivered.  And so it happens that business goes offline to online and online to offline.

DIGITAL BEHEMOTHS

Most people think of Ebay, Amazon and Google as the digital behemoths.  But Fedex CEO Frederick Smith understood the future with his long-held mantra that “The information about a package is as important as the package itself.”  Fedex and UPS are as much information management companies as they are shipping companies.  They have large, deep and formidable moats that will prevent competitors from siphoning market share.

Their charts are likewise similar:

While Fedex has recently laid off 1,000 of its 223,400 employees both it and UPS, which is expanding door-to-door service in Mexico, will be around generating profits for a long time.  But the current administration is exacerbating the greater depression which will drag down their earnings.  So when will UPS and Fedex shares be a good value? Gold is the most reliable instrument for calculating value and is being re-enthroned as a currency in ordinary daily transactions.

gg = gold gram FEDEX UPS
Share Price $51 or 1.786gg $53.50 or 1.852gg
Market Capitalization $16B $53B
EPS $2.35 $2.94
Target Price 1.100gg 1.250gg

CONCLUSION

Creative destruction is taking place at a rapid pace during the Information Age.  Many Internet marketing tools are available for the entrepreneur.  Services like Earth Class Mail, which exist through voluntary relationships, will rise.  The old State sponsored monopolies enforced through violence will fall.  Fedex and UPS are digital behemoths which will play a critical role in the new online to offline and offline to online economy.

As the great credit contraction continues the top lines of firms will be under extreme pressure and will most likely affect Fedex and UPS while the FRN$ will continue its wild fluctuations in purchasing power.  Therefore, while Fedex and UPS are solid companies with a bright future they should get materially cheaper, at 1.1gg and 1.25gg per share respectively, before they become a good value.  They will most likely be back there again.

Disclosures:  Long physical gold and silver with no position in UPS, FDX, or the other firms mentioned.