The Second Reformation – Part II

In part I we beat up on banks because they failed the very people who put their trust in them. As it turns out, there is another industry able to do even greater harm than the banks; and it is equally difficult to understand why. I am speaking of course about the health care industry, both health providers and health insurance companies.

The Health of a Society

The health care system in the United State is a competitive one, made up mostly of for profit health care providers and insurance companies. On the surface competition may sound like a good thing. Competition means that doctors should compete for patients by providing the best care at the lowest market price. However, this is far from what happens in the American system. A number of factors over the decades have led to a system out of control and headed for a cliff just as the financial markets have been for decades. Only when the medical establishment crashes, the result could be much direr; our very lives could be stake.

A full examination of the health care industry would take several thick books, so a summary will have to suffice here. Throughout the 1900’s and the first decade of the new millennium the health industry has meandered down a winding path in ill-conceived attempts to improve itself. There was a time in our history when health care was non-profit and non-corporate, and cost so little that except in the worst cases, the need for insurance was negligible.

When you become ill, you go see a doctor. Almost all Doctors now are forced to work for a large health care corporation. As we have seen earlier in the financial industry, corporations care only about making their stockholders happy with increased profit. This fact sets the stage for our first conflict of interest, but it gets worse, much worse.

Most medical care is now provided through insurance. Insurance companies are also for profit corporations.  An insurance company maximizes its profit by paying out less in health care costs than they collect in premiums. On the surface, it would seem logical that insurance companies would force the health provider establishment to keep costs down. However, the reality of the dynamic that arises from the interaction between these two related industries has taken some weird twists that have crippled the system.

The merging of health providers into large corporations has turned medical care into a commodity. There are plenty of sick people to go around, such that doctors rarely have to ‘build’ a medical practice any more. They go to work for a corporation with patients already lined up at the door. In the 60’s, 70’s and 80’s health care costs rose as new technologies made ever more elaborate, and expensive, options available. Hospital corporations figured they could make more of money by performing elaborate and expensive tests. No one complained if excessive tests and procedures were done as long as in the end, the patient survived and insurance paid the bill. Insurance companies were determined to put a halt to this abuse. In another move that on the surface made sense at the time, insurance companies started limiting how much they would pay for a specific ailment, not the treatment. A form of payment known as Capitation. Therefore, a diagnosis would yield a fixed payment to the health provider, regardless of a cost of actual treatment. Some insurance companies are no health providers also as they have merged, and they actually pay the doctor per patient like a salary, then deduct from that the cost of whatever treatment the doctor recommends. This of course puts the doctor in an untenable position.

This move by the health insurance companies had two major effects. The actual cost of treatment was now detached from the cost of providing health care and more easily hidden. There was a drive by corporate health providers to maximize profits by getting as many patients through the door as possible, diagnose early to get the fee they want, then rush the patient out the door with a minimum of actual expense. The fee for diagnoses would have to be averaged over many patients with different levels of care. Doctors who tried to work outside this system, stay independent and charge just for actual services rendered might only receive a partial payment from the insurance company. The result being, that even though they have insurance, the patient had to pick up the difference. Doctors simply could not compete with the corporate machine, and any doctors that were holding out on ethical grounds were forced to join the corporate medical system. The entire medical system is full of quick fixes that had unintended consequences because it is designed from the bottom up not to provide medical care in the best interest of a patient, it is designed to run like any other corporation and make a profit for their shareholders.

When there is a flaw in the design…redesign

When there is a fundamental flaw in the design of something, the last thing you want to do is create a short-term work around to mask the flaw. Eventually a case will appear when the work around fails and the original flaw is able to exacerbate that failure and make things even worse. If you design an aircraft that is too heavy to get off the ground, the best fix is not to simply get bigger engines. The best fix is usually to go back to the drawing board and design a lighter aircraft. You cannot fix a bad design with more bad design.

Our banking and health systems are poorly designed and rapidly failing because of the same fundamental flaw. They both are designed to serve their shareholders instead of the public good. The continued bad practices in the financial markets were not sustainable and eventually resulted in a sort of population crash of the system. That fundamental flaw still exists and so the next failure may be more devastating.

The same is true in health care. They are on an unsustainable trajectory of higher cost and poorer care. You would think with health care tripling in cost compared national GDP that we would have the best system money can buy. The reality however, that we spend three times as much money and we actually have the worst health care quality among the industrial nations.

Additionally, the growth of health care cost is not sustainable. Eventually the system will suffer a form of population crash like the one we saw in the financial sector. All it takes is some event like a mass illness; Avian flu perhaps could push the system to the breaking point where in all comes tumbling down. In addition, this time it might be accompanied with a real population crash.

Good Old Engineering

In part I of this series we looked at how one aspect of the system, banking, is broken. In this second part of the series we examined another industry; healthcare. One can point out a number of areas where banking and healthcare have failed the system, but if all you do is look at the direct cause of the failure, you never really understand how to prevent it from happening again. You end up applying Band-Aid’s to a chronic problem at best, or you get unintended consequences that are worse than the original problem.

Looking only at the points of failure is like examining a crashed jetliner, discovering the failure was a crack in the frame somewhere and then saying simply a crack caused it to crash, so we will give everyone a parachute. If you do not look at what led to a crack appearing in the first place, you never revise the design, and perform the engineering required to prevent the crack from appearing again.

One of the cracks that appeared in the banking system was the fact that banks and investment firms were now in bed together and colluded to create ultra-risky investments while hiding the true risk of the underlying mortgages inside. A huge crack in the health system comes from the fact that two sectors, providers and insurers, compete increase their own profits and against each other with patients stuck in the middle taking most of the fire.

Regulation by the government can place a Band-Aid over the crack, but the underlying cause of the crack is still there. More regulation will likely just result in more unintended consequences, more inefficiency, and higher cost.

What this means is, that while one crack is patched others may start to appear. What is needed to fix this problem is not a patch over the crack, but a change in the design.

The Profit Motive

Why would the banks do what they did that led to the crisis in housing? Why would hospitals, staffed with caring and empathic doctors and nurses, work a system that is so ineffectual and unfair? Why would health insurance companies not just permit but also actually create so much pain and suffering in the world?

The answer is simple. They are corporations, and as such, they have shareholders who have invested in them. The humanity and compassion that is felt by the individual is nonexistent in corporations. Shareholders invest for one reason, to make money. The more money you make, the more investors will push your stock price up, and everyone gets rich. Banks, as the holders and creators of money, have a fiduciary responsibility to the people and society, to cause no harm. Health providers have a moral duty and take an oath to do no harm. However, they answer to their shareholders who demand more and more profit that has the potential to cause a great deal of harm. There is a conflict of interest between doing no harm to the people who put their trust in these institutions, and the investors whose demand for more profit drives all decisions. We live in a world where our financial health and physical health are in the hands of a board of directors who we will never meet, and who will never know the names of their victims.


In summary, we have seen how a basic flaw in the design of our banking and health industry leads to conflicts of interest with the good of society. We have discussed and probably witnessed firsthand the pain and suffering these kinds of conflicts of interest cause. However, no examination of bad design can be complete without offering some suggestions for design changes. That will be the topic of part III in this series.


The Second Reformation – Part I



Which form is the best economic system: Capitalism or Socialism




















2011 Predictions for the Comming Decade

In 2000 I was telling everyone that would listen, that global oil production would not be able to keep up with demand within the next 15 years. Does anyone doubt this now?

In 2005 I was telling anyone who would listen that within 5 to 10 years cars will be driving themselves like an airplane does on auto pilot. Most manufactures either have driver assist or partial auto pilot coming out by next year. Fully autonomous cars are only a few years away now. (update GM says they will provide sophisticated driver assist mostly for collision avoidance by 2015 and fully autonomous cars by 2020.)

So, what’s my latest prediction for the next decade?

Manufacturing will undergo a transformation so radical that the industrial revolution will be trivial when held up for comparison. Actually a number of new technologies stand at the cusp to revolutionize everything from the ground up.

1. New materials are coming out of Nanotechnology; glass that is stronger than steel, batteries that hold 10 times the charge and can be recharged in seconds, and a DVD disk that can hold 600 hours of video. New delivery for cancer drugs are being developed that will allow them to be carried by robots that are smaller than a blood cell, and can deliver their drug at a specific target site, killing only the tumor. Look for all of these to either be on the market or in trials within 3 to 5 years.

2. Computers will continue to double in power for the foreseable future every 12 to 18 months. A super computer will excede the processing power of the human brain before 2020. The software to create human level intellegence will take another 10 years.

There are two specific areas that will benefit from all other advances to revolutionize manufacturing, reshaping our world in ways we can’t even imagine; robotics and 3-D printing. We have had both technologies for some time now, however both seeing rapid advances due to other technologies that are enabling them.

3. Within 10 years most homes will start installing 3-D printers (a replicator not unlike those we saw on TV shows like Star Trek). Like the Microwave oven, it will be expensive and bulky at first, but eventually no household will be able to imagine life without one. Imagine the ability to manufacture 90% of anything you could ever want in your kitchen or garage. A new pare of shoes, a sweater, works of art, spare parts to fix your vacuum cleaner, or heck a whole new vacuum cleaner. Need a special tool to replace a roofing tile, print one, and then print the roofing tile. There are even plans to build a printer large enough to manufacture whole houses on-site. NASA is very interested in the house printer for off world home construction, and a general 3-D printer to make spare parts in space.

Even printing food is on the table:

4. The field of robotics is currently constrained mostly to special industrial situations like the automotive industry. Until now they were not well suited to work in close proximity with humans because they lacked the required attributes to operate safely around people. A new generation of robots is beginning to show up. Soon, robots will have skin that responds to touch, and have soft bodies so that they can avoid hurting people. Robot vision and artificial intelligence will be able to operate in our disorganized and cluttered world. They will communicate verbally as well as any natural person. Within 10 years robots will be commonplace in such environments as hospitals and nursing homes, helping with patient care. They will also start showing up to replace administrative and secretarial functions; though these latter units may not look like a traditional robot because they may simply exist in a person’s desktop computer. They may in fact show up in your home as a very fancy, and smart answering machine; one that not only answers the phone and interacts like a real person, but also wakes you up in the morning, reminds you of your doctors appointment and not only balance your checkbook but act as a finicial advisor and travel agent. Soon thereafter, as the price point comes down another order of magnitude, robots will start to replace domestic labor and become common household appliances, running around doing the laundry at 3 am when electricity is cheaper, and trimming the bushes in the yard. And yes, even putting the cat out at night.

In summary the outsourcing of manufacturing jobs overseas will be a short lived phenomenon. Manufacturing will become localized to where it is consumed. Robots will fill most other needs for manufacturing where items are either too large or too complex to be made with a 3-D printer/replicator. Demand for raw materials and delivery of raw materials to the site of manufacture will be in high demand, but there again, that industry easily lends itself to automation with the robots coming on line in the next decade. We will once again have to transform our economy to adapt to the new normal.

People need not fear the robot revolution in the next twenty years. After that, if were dumb enough to design them without safe guards then perhaps we need to loose.

If I were King – Part One: A social Experiment

What would you do if suddenly you were made king of the world? What would you do if given the chance to remake civilization however you desired? What kind of civilization would you create? Would you attempt to create a utopia of eternal bliss or perhaps a dictatorship where everyone served your needs? It is an interesting question with no simple answers.

This question is somewhat more than academic however, because someone in the near future may actually be presented with this very challenge. The world we all know and love is precariously near to the brink of a major meltdown. Many have believed it was coming for years, some think it may already be here, yet others would not believe it, even if the fires were licking at their soft parts.

We are not talking about alien invasion, Armageddon, or the rapture, and hopefully not nuclear war. No, the end of life as we know it will likely be much more subtle than that…at first. And, we are not talking about the end of all life, just our current society. We cannot say where it will start, nor can we say for sure what will start it, we cannot even say that it will occur with certainty. It could be financial, environmental, social, political or all of the above. All we can say is that the factors that could lead to such an event are getting stronger. The uprisings in the Middle East may just be the proverbial canary in the mine.

This article is not an attempt to scare, or predict however. Most people would agree that there are things in this world that they would like to change; an end to war, hunger, sickness, to have prosperity and equal opportunity for all, etc. Anything that could bring about change on that scale would require tearing down 90% of the world’s institutions and power structure, and rebuilding them from scratch. Therefore, let us assume for the sake of discussion that something happens that gives us the chance to rebuild, a clean slate from which we could create a new fabric of society. What would you do with that opportunity? What kind of fabric would you weave?

The problems

Even though technology has shrunk the world in the past few decades, it is still a very large and complex place. We have on this small globe a vast variety of cultures and belief systems, forms of government, types of economy, and rules of law. Because the world has shrunk so much with improved forms of communication and transportation, these differences are colliding with each other and creating difficulties everywhere.

To this day, we have nations that believe the only way to resolve conflict is by dropping bombs on each other. We have leaders who believe the only way to gain economically is at someone else’s expense. We have multinational mega corporations that go to any means necessary to use, abuse and repress people for the sake of almighty profits. We have religious leaders who use their religion to repress and control their people. We have whole populations of people who are taught from birth to hate anyone else who does not share the same beliefs or skin tone as them. There are so many, many more that we could easily fill several large books just listing them all.

Rather than dwell on what sort of a mega disaster of biblical proportions could shake things up enough to enable reforms that could remedy the kinds of problems mentioned above, we will take this imaginary opportunity to perform a thought experiment.  let us hope that we do not have to find out the hard way how this all turns out.

A Solution for a New World

To be successful and equitable for every person on Earth, and to prevent the types of abuse that invariably occurs when individual nations are enabled with absolute autonomy, the governing body must be inclusive of every person on Earth. That is the only way to guarantee equitable treatment of all peoples. A common foundation of beliefs, such as a constitution, must be enacted to grant every person equal rights under the law. Individual nations should be able to maintain some autonomy to set local laws in accordance with local tradition and customs, but should be guided by a central core of rights, and global laws that supersede any national desire. This should be in the form of a global constitution. Since this lays a foundation for all that follows, we will begin our conversation with what ought to be included in such a constitution.

A majority of people in the world today would agree, that trying to engineer a society from scratch is not an easy endeavor, and has a potential to take on characteristics that the designer could never have imagined. Carl Marx in his later years, upon seeing improvements to Capitalism, and how his idealist Communist utopia was corrupted in Russia, claimed he was no longer a Marxist. Therefore, any suggestions for an alternative to what we have now must, above all else, not lock in the population to an irreversible path; a path that they may live to regret. The only form of governance we have discovered to date that comes close to that ideal is a Democracy. In a democracy, the people are in ultimate control, not a central authority. Only a democracy can see its own flaws and make corrections. Nevertheless, democracy can come in many flavors, and some work better than others do. We will look at the major forms of democracy, settling eventually on the one best suited for the task of governing a new world.

Today, we have a global economy based mostly on the Capitalist model. Many countries have experimented with alternatives such as a centrally controlled communist economy and with every flavor in between Communism and Capitalism. Capitalism has been proven repeatedly to be the most robust and successful model for the modern world, especially when coupled with Democracy. Fascism has long been favored by corporations, and actually has its origins in the United States, not Italy as many believe. It has been shown to be very efficient in terms of pure production; however, it is quite deficient when merged with a free Democracy. Therefore, we will explore various theories of how to structure and govern Capitalism, settling eventually on one that seems the best alternative.

The Constitution

A constitution provides the guiding principles we would like to our society to embrace. It sets the foundation for any laws that govern the land; for all laws must adhere to the constitution. Language is very important, because differences in interpretation of language is the stuff that wealthy attorneys are made of. Therefore, the constitution should be simple in both language and meaning, yet broad in scope to be inclusive off all peoples on this planet.

The Constitution of the Free Peoples of Earth:

  1. A person shall be defined as any entity that is a discrete unit, with the capacity to reason and think about its own existence and have the capacity to choose of its own free will.
  2. No person shall be denied of free will unless their action denies the rights of another person.
  3. All persons shall receive equal treatment under the law.
  4. Government shall exist for the common good of all persons. Government shall not endorse or exist for the exclusive benefit of any entity, person, or group.
  5. Only persons may have a say in how they are governed.

That is it. It is simple, permits people to retain the most important parts of their culture, yet lays out some very basic ground rules that everyone must follow.

The first provision may seem the strangest, but it is important to declare ‘what’ a person is under the law. With science on the verge of creating artificial intelligences equal to or greater than that of the human mind, it is going to be a contested subject very soon. In addition, some people are trying to give true personhood with all of the attendant rights to a group of unthinking cells living within a women’s body. Yet another group would grant full personhood to a business entity, which cannot exist except as an artificial contrivance. A corporation cannot think and ponder its existence or act of its own accord. It can only act at the behest of other persons; therefore, it should not receive the rights of a living person.

The second provision is the most profound. I means basically that no person may be denied from doing what they want to do, so long as what they do does not infringe on some else’s rights. It is saying that in order for there to be a crime, there must be a victim. People cannot commit a crime against themselves, or in the absence of another person who is being denied their free will.

Suppose for example, you want to hurt yourself by taking drugs, knock yourself out, just do not do it in a way that puts others in danger. Besides, the taxing of illicit drugs will pay for centers that treat drug abuse, and probably a whole host of other social programs. Once legalized and in the open where it can be seen, monitored, and treated as a social problem not a crime, its abuse will likely be no worse than alcohol or tobacco. In addition, a huge underground industry will be eliminated, and converted into a regulated and taxed enterprise and we will save billions on the cost prisons.

The third provision is perhaps the most important and will be the most difficult for some cultures to accept. Equal treatment under the law means just that; all people will be equal, and must be treated equally, regardless of sex, race, religion, or any factor that does not relate directly to their ability to perform the thing they wish to do. This does not mean they will be of equal means, or ability. But they should all have equal access to resources and an equal opportunity to grow and succeed.

The fourth provision states that government must always act for the common good of all people. Government will be prohibited from promoting, or favoring a person or group of persons (such as a religion or ethnic group).

The fifth provision turns the fourth provision around, and states that only persons may have a say in the operation of their government. Non-persons are prohibited from having any influence on government. So sorry to all those Politian’s who are on the payroll of some corporation. You will have to find new sources of revenue. This will be very critical in a global arena. The potential for corporations to become so large that they can control or unduly influince government to their favor is a very real threat and undermines government real goal, to serve the people.

This concludes part one. Part two will begin by discussing the forms of Democracy, and which form might fit best into this new world.

Economics: The most important things in life are the least understood – Part Two

Are recessions a necessary part of a Capitalist economy?

What really happened in 2007? Why do we get hit every few years with these recessions?

A recession is defined as “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real gross domestic product (GDP), real income, employment, industrial production, and wholesale-retail sales.” There is no definitive definition for the term Depression, though it generally involves either a decline in GDP of more than 10% or a recession lasting for two years or more.

To put things in perspective the Great Depression of 1929 saw a GDP decline of 26.7% and lasted 4 years and 7 months. The Great Recession of 2007 saw a GDP decline of 4.1% and lasted 1 year 6 month. However, it is the worst downturn in the economy since the Great Depression. The only time GDP dropped more in the last 75 years was at the end of World War II when government spending for the war effort ended.

The recession of 2007 was and still is terrible by many people’s standards, but things have been a lot worse in the past. Just, not in the recent past. So, are things in this country getting worse, or is this just part of the normal economic cycle; like the weather?

Some questions that you may be pondering these days are:

What caused this recession?

What is wrong with our economy that we keep having these problems; is this normal?

Will it happen again?

Isn’t there something we can do to prevent recessions from happening?

Some of the most heated debates around the country these days are centered on answering the questions above. If you ask 10 professional economists, you will likely get 10 different answers. Therefore, what is a reasonable person to do, and how can we ever hope to make an intelligent decision about which approach to back when it comes time to cast our vote?

To begin with, stop listening to people trying to tell you what to do. Get, as many of the facts as you can and decide for yourself what you feel the best approach would be.

What caused this recession?

Everywhere you look, someone is pointing the finger at someone else. It seems we have become a nation of finger pointers. It’s relatively easy to look at a sick patient and determine what is hurting at the moment. With a little effort, you can even determine what immediate thing may have caused that pain. It is considerably harder though to go back farther and look at the habits, daily activities, and long-term environment that may have been a factor in causing the current condition.

The reason so few people can agree who to point the finger at, is because it is the confluence of a number of things that went wrong to create the perfect storm. Really, it was several perfect storms that all came together to create a mega storm.

The immediate cause of the 2007 Recession was a failure in the mortgage-backed securities market. When investors suddenly became aware of the high level of foreclosures being experienced in these investments, they panicked, and could not sell them fast enough. Suddenly no one wanted to buy them, and everyone wanted to sell.  This creates a situation where you have a run on a security. The price drops through the floor.

So, why was this so devastating? We have had real estate bubbles before and it never created this kind of damage. The short answer; deregulation in the banking and financial services industry. Banks that used to be prohibited from investing their own assets in the market were now in with both feet. In addition, the creation of extremely complex investments were permitted that concealed the real risk of the investment to those would be investors. It is as if Wall Street was in the car sales business, slapping on a fresh coat of paint to cover up an old wreck, and sold it as a brand new vehicle. Many of the banks that failed were simply the victims of an unscrupulous Wall Street used car salesman. However, it is important to note that they never would have been put in that position if not for banking deregulation that let them do it.

Ok, we know why now, but why did all those mortgages start failing in the first place? If you applied for a mortgage 30 years ago like I did, you probably recall going through an agonizing process trying to qualify for the home of your dreams. Banks and mortgage companies had no problem drawing a solid line in the sand about how much house you could afford. They took great care to sell only mortgages where they felt relatively assured of getting their money back. That is because they were embarking on a long journey with the mortgagee of twenty or thirty years. They had a stake in selling only solid mortgages. In addition, they were constrained by law to require certain things of a person requesting a new mortgage. Plus, the average American was not living beyond their means, and able to save some of their surplus income.

Enter the new age of easy credit. Did anyone notice the explosion of credit cards on the market? Something happened in the last 30 years that has fundamentally altered the typical Americans financial habits. Where it used to be a sign of good credit worthiness to carry a credit card, suddenly everyone had one, then two, then four, five or more. People started living month-to-month paying for daily expenses with their credit cards. Some people even had to resort to taking out new cards to make payments to their old cards. People who did not have the financial maturity to handle credit suddenly started going off the deep end getting into debt.

During the eighties, while people were becoming consumer debtors, lending institutions starting figuring out they could make a lot of money in low quality loans called sub-prime, by charging higher interest rates and exorbitant fees. This of course led to the savings and loan crisis in the late eighties. However, did we learn anything from that? no! The political thinking at that time was that trying to regulate an industry created inefficiencies, so the solution of course is more deregulation. This practice was continued throughout the nineties as we saw the fall of one law after another designed to prevent the type of disaster we went through in 1929. Everyone thought we had evolved past the point of needing such antiquated regulations, that they are just stifling innovation and hurting profits.

Sub-Prime mortgages started becoming a larger and larger part of every mortgage portfolio, including Fannie Mae and Freddie Mac. Conventional wisdom had supply side economics winning the day. The solution to every economic problem was to control the money supply by easing credit. The thinking goes that by making it easier to borrow, money flowing into the system would create a prosperous economy. What they did not foresee was human nature. The sub-prime market was hugely profitable. They were now easily packaged into investments and sold off the highest bidder. There was no longer a long term relationship with your bank. Mortgages were a fire and forget industry. With the easing of credit to businesses, the number of companies chasing after the get rich quick sub-prime mortgage sales plan skyrocketed. Even the U.S. Postal service was granted a reprieve from going broke because of the large volume of junk mail being sent out soliciting mortgages. I personally remember getting four or five mailers soliciting mortgages every single day. Some companies even resorted to bait and switch tactics where they would lure someone in with a ridiculously attractive add, then switch them into something considerable uglier and more profitable.

Ok, so now, we know that deregulation of the banking and investment industry coupled with a policy of making credit easy to obtain created a situation where people could exorcise their natural inclination to make a quick buck. Why did anyone think those were good ideas, and where did such notions come from? In addition, more importantly, have we learned from our mistakes; deciding to do things differently?

As to where those notions come from, they are based on an idea of economic theory that began with a fella named Adam Smith who published ‘The Wealth of Nations’ back in 1776. This was to be the beginning of the Capitalist era. Smiths theory of Capitalism is known as the Classical model. For the first 140 years or so, there were no regulations controlling capitalism, and we had a very small government. The early years were experimental while we played with the notion of who should print and control currency. They were understandably rocky years, with the economy growing and contracting in fits. However, even after resolving the currency issues, the economy was still like a roller coaster ride. Quick spurts of growth were followed by sharp downturns and rough years. In fact the bad years were almost as numerous as the good years. See the chart below.

Many economists struggled with the problem of Recessionary cycles; what caused them? Hundreds of theories were put forth. One theory that would become known as the Neo-Classical model claimed that the cycles were just a normal part of the business cycle. This theory held that capitalist markets are the most efficient when they are unhindered. That any attempt to intervene in a natural cycle just exacerbates and prolongs the problem. This theory also believed that the downturns were usually a problem that interfered with supply. It was determined that demand for goods was irrelevant to the discussion, that all problems could be rectified by insuring industry was not impeded from creating a supply of goods. It was reasoned that if all variables involved in manufacture, including labor were kept flexible, then things would just naturally find equilibrium and become stable.

This theory states that in a down turn, the market can be restored by easing credit and lowering taxes so the companies are better equipped to create a supply of goods. The extra production would create jobs and lead to consumers able to buy the extra goods produced. Thus growth could be sustained.

An alternative to the Neo-Classical theory was put forth by John Maynard Keynes in 1936. He postulated that the cycles are actually caused by an interruption in demand. He stated that demand creates a need for supply, not the other way around. That for any number of reasons, potential buyers elect to withhold their dollars from purchasing; creating an initial panic or run on a market. Then, a contraction in manufacturing prolongs the downturn by paying fewer wages, which are needed to restore the market.

This theory states that in a down turn, the government should intervene with spending; creating the jobs that would be lost from industries contracting in order to bolster a demand for goods. This alone would not prevent recessions, but it would help them recover much quicker. Regulations on industry would help prevent the natural volatility in markets to bubble, and then burst. Controlling labor cost by holding wages steady during a downturn actually lent stability to the market preventing a self-feeding cycle downward with declining consumption. Therefore, unions were seen as a stabilizing factor in the economy.

If we are to evaluate the merits of each of the two theories above we need to look at how they actually behaved in practice. The Classical theory was king from 1776 until the late 1930. The Neo-Classical theory contains only minor revisions of detail about controlling money supply and came back into favor in 1980 and has ruled economic theory until the Recession of 2007. The Keynesian theory was in favor from 1936 until 1980.

The average period for a recession to run its course before and including the Great Depression in 1929 was 23 months. The average time between events was 4.1 years. So, you can see almost as much time was spent in a down turn as in a growing economy.

After Keynesian theory became popular until 1980, we have not had a depression. The average recession lasted only 11 months, with 10.1 years between events.

Since Neo-Classical theory was brought back, the average recession lasted 11.2 months with the last one lasting 16 months. The average time between recessions has dropped back down to 6 years.

As we now see, the practice of easing credit and deregulating of industry that began in the eighties and continued for 25 years led directly to the recession of 2007. Those policies had their birth at the inception of the Capitalist enlightenment in 1776. Once some inherent flaws were identified, remedies were enacted in the 1930’s that actually worked pretty well. Big business however hated anything that might constrain their ability to make a profit and fought tooth and nail until they finally got what they wanted in 1980 by bringing back the Classical model.

So, there you have the analysis. The key facts laid bare for your consumption. Only you can decide what to do now.

Economics: The most important things in life are the least understood – Part One

Why are the most important things in life often the least understood? Economics, our economy, decides how the fabric of our society functions in terms of the things we use and do every day. It is huge, it is important, and its true function is very poorly understood by all but a few of the brightest minds in our country.

How can the average person ever hope to make intelligent decisions about something so important, and trust they are doing the right thing, when they barely understand even the basic concepts? The answer is they cannot. What usually happens is that they defer the decision to someone else that they trust, because they share some other unrelated interest. It may be a politician, a radio talk show host, or their next-door neighbor. The mistake is that the person they are listening to probably knows little more than they do.

I struggled with this problem for many years. I am not a professional Economist; I am actually a software developer. I decided however to stop letting other people decide how to think for me. This meant I needed to do a lot of research into an area where even the experts disagree. It was necessary to read all sides of the argument, and then decide for myself what the best course should be to take. Few of you have the time or inclination to spend thousands of your precious hours reading mostly boring books on the history of political economics, or current economic theory. Therefore, I will attempt in this blog to share with you some of what I have learned through my own research in the hope that I educate you enough to start thinking for yourself, and try not indoctrinating you to my own philosophy.

We first have to create a model to describe Economics in easily understood terms, then we need to explore what the right thing to do might be for each of us, and then finally we will discuss what each of us can do as individuals to alter something as large and complex as an Economy?

Throughout my 35-year career, I have designed software for a number of large companies as well as governments at every level from local to federal. In designing software I always strive to model complex systems in simple terms in order to understand the higher order processes that drive the organization. That same approach can be applied to economics to explain the very complex interactions in a model simple enough for the average person to grasp.

What is Economics

Economics is the study of how our economy functions. It looks at how all goods, services and money flows throughout society to create this extremely complex fabric of transactions. It defines what kind of society we live in, and is the single most important factor in establishing your quality of life. The study of Political Economics looks at the role government has in shaping economic policy.

The Transaction

To begin our discussion, we first have to understand what an economy is at the lowest, most basic level. Once we understand this, we can build up to ideas that are more abstract.

At the core of an economy is the transaction. Everything that happens in our economy when something of value is transferred from one entity to another is through a transaction. Every transaction, no matter how simple, has two components; the part given and the part received. If you are an employee, you give labor and receive a wage as money and benefits. If you are at the grocery store, you give money and receive groceries in return.

Capital is the term we give to the things transferred; capital is value, thus, we have a capitalist economic system. The diagram above illustrates a transaction between a business and a person. They are each represented by what I will describe in more detail in the next section as a tank of water. The amount of water in each tank represents the total capital, net worth of that entity. In a transaction, each entity gives something of value and receives something of value. If over time an entity receives more value than they give, they will see their tank fill up; their net worth will increase. Each tank then contains everything of value that an entity owns; cash, real estate, other assets, plus money due as receivables, minus money due as debt. The worksheet used to calculate the total is called the Balance Sheet, but that is starting to get into an area known as accounting, so we will stop here. Every entity can calculate their net worth with a Balance Sheet, people, businesses, even non-profit organizations.

The Abstract Model

The next step involves taking a step back and creating what we call in software design an abstraction of the model. In doing this we group like things together, and look at the interactions between the groups. This creates a simpler model of the system that makes it possible for average folks like myself to wrap their minds around it.

In the previous section we illustrated a business and a person with a simple transaction. In this model, we are going to create an abstraction of the entire economy by creating four groups. We will create one group to represent all businesses. We will then create three more groups of people to represent the different economic classes; upper income, middle income and lower income. Why these three groups of people? Because we want to explore the interactions between them, and it is very important in clearing up some poorly understood concepts that people have about each group.

We will stick with the water tank analogy we use earlier to describe these four groups. What you need to understand is that now each group is represented by a single water tank, that holds all the capital, the net worth of all those who are in that group. In doing this we can now look at our economy in action with only a few moving parts instead of the billions of individual transactions that take place without this abstraction.

The business tank represents an aggregation of all the businesses in our Economy. You can think of water flowing into the tank as income the business group receives from the sale of goods and services, as well as interest and dividends from investments. The water flowing out of the tank represents all of the costs incurred in the production of the goods or services sold. If more water (Capital) flows into the tank than flows out, then the value of the business increases.

The other three tanks represent three economic tiers of the population; upper income, middle income and lower income. As with the business tank, the other three tanks represent aggregate groups of the population with incoming and outgoing flows of capital. Incoming flows represent income from wages, interest, and dividends. Outgoing flows occur every time an expense is incurred; goods or services purchased. Flows can take place directly between population groups. If more water flows into a tank than flows out, the water level in the tank goes up and net worth of the group is increased.

It is important to note that included in all four tanks are all of the capital, assets, property and possessions currently owned by that group. There is a constant flow of money, goods and services flowing from tank to tank. We want to keep our model simple at first so that we can understand the basics without being bogged down in detail. Therefore, we shall ignore for a moment the Federal Reserve’s ability to add water to the tanks by printing more money, and the effect of international markets.

We now have a closed system, where the amount of water (capital) in the system is constant.

If the system is in perfect balance the flows into and out of each tank would be equal over time, such that the relative wealth of each sector would stay fairly even. No one sector or group could grow without a corresponding loss elsewhere. This does not imply that the amount of water must be equal between all groups. This is often the first thing most people think of when discussing the redistribution of wealth in economics. That was the communist model, and no sane person would recommend that. Rather, balance means that the relative share of wealth remains about the same. It means simply that if the lower income group has 5% of the water supply today, they will still have 5% of the water supply tomorrow. So, that dollar in your pocket is not really yours, your name is not on it, you are just holding it for a while until you pass it to someone else to hold. It is just a token used to represent how much value (capital) you possess.

One problem we see happen in free market capitalism is that it is never in balance. In fact, there is a strong tendency for the flows to favor business and the upper income group. This is because they tend to have more control over how the flows are adjusted to be in their favor. No one is saying that is not fair, it is just a fact of life, like the fact that the sky is blue.

If left unchecked however, wealth will accumulate at the top of the economic food chain with a corresponding drop in the lower and middle-income tanks. I know what many of you are thinking right now, because I always hear the same argument presented. They are just being rewarded for their hard work and making a profit, that is how our system works. That is true, we do not want to stifle innovation and hard work, but this is not a monopoly game, where one person has all the cash at the end and wins the game. Therefore, our challenge when trying to make decisions about the economy is how we structure the flows of capital in our system such that we maintain an orderly and functioning society without stifling rewards for innovation and hard work. I hope that you will agree that we need a system where we all can enjoy the opportunities available in this great country, a system where ANYONE with initiative and hard work can get ahead and create a better future for their children.

In my next post, I will discuss how human nature is to blame for many of the economic ills we face, and how that impacts decisions we make about our economy.

History Repeats Itself – An Economic Roller Coaster

A debate is raging between Neo-Classical vs. Keynesian economic theory, about which model we should be following, and the pros and cons of each. We always talk about 1929 as when the Classical theory failed. However, one only needs to look to history to see the failure started allot earlier than that.

The idea of Capitalism was born in 1776 with the publishing of ‘The Wealth of Nations’ by Adam Smith. It took a few decades to alter the fabric of a young Economy around a new theory, but by 1800 the United States had a burgeoning Capitalist Economy. From the beginning, there seemed to be a slight problem with the system; it was very unstable. Every few years the economy would go through convulsions that the theory could not account for, and every few decades the convulsion was serious enough to be called a depression. They often used the term panic instead of recession back then, because that’s how most of the downturns began; in a state of panic. How many of these stories are being retold today.

The Panic of 1819 – Speculation in land created a run on real estate. This was followed by a contraction in the availability of credit. Unable to fuel the continued run on real estate with new debt, the bubble burst and the market crashed. Many banks were forced to close, and many fortunes were lost.

The Depression of 1832 – 800 banks close, and the entire banking system in the U.S. collapses. Unemployment in New York reaches 30%.

The Depression of 1836 – With the demise of the Federal Banking system, state banks start printing their own currency and run amuck. Attempting to rein the banks in creates another real estate crash.

The Depression of 1837- 1843 – English banks lose confidence in the U.S. Economy and raise interest rates. The cotton market is decimated for six years.

The panic of 1857 – Improved communications with the telegraph ushered in a new breed of investor; the speculator. Speculation created a bubble in railroads and real estate. At the end of the Crimean war, agriculture exports were reduced drastically, which led to a rush to sell railroads and real estate to cover debts. The stock market crashed. Crowds of starving unemployed flooded the streets of New York, demanding food and work.

Depression of 1869-1871 – Black Friday refers to September 24th, 1869 (not 1929). Speculators pushed gold up to 162 1/2, along with railroad stock to new highs. Then, in just 15 minutes gold dropped to 133 wiping out many investors. Railroad stock values shrank, and soon all businesses were paralyzed.

The panic of 1873 – The economy has expanded rapidly for two years, especially the railroads, which were being financed in part by Jay Cooke and Company, a large bank. On September 18, 1873 Jay Cooke and Company filed notice of bankruptcy. A panic ensues causing a three-year depression and over 10,000 businesses shutter their doors.

The panic of 1893 – Again the railroads which have been on a long run begin to show signs of weakness. A massive sell off ensues causing many railroads to go out of business and many large financial trusts start to collapse. The run quickly spreads to other sectors eventually hitting the banks causing 500 banks to close. The depression for the first time goes global, destroying huge amounts of wealth in all sectors of the world economy.

The panic of 1901 – The stock market had become a place for speculators, and gamblers. Men who had not a dime amassed fortunes. Most had taken to borrowing money to gamble with on the stock market; called leverage. When the market started to drop, panic selling took place as people tried to cover their bets and pay their debts. Many were reduced to paupers.

The depression of 1929 – The gamblers and speculators have returned to the stock market and are riding a long wave of good fortune that seems will never end. But all good things it seems come to an end. When the market started dropping, gamblers who were heavily leveraged started panic selling. They quickly went bust, and the banks who had loaned them the money to gamble with suddenly had a bunch of worthless loans. The banks started showing signs of stress as more and more loans became worthless, and soon a lack of confidence in the banks led to a run to get cash out before they too failed. This of course precipitated their failure. What really set this crash apart, was the fact that the market had become so popular, that every person who could scrape up a dime was getting in to get rich quick. Jesse Livermore, who got out in time,  stated that when his house cleaner came to him asking for investment advice, he knew it was time to sell. The crash did not just wipe out a few get rich quick speculators, this time it hit businesses and people all across the country. Businesses closed and the national unemployment rate hit 25%.

Around this time, economists started trying to figure out what would cause such wild fluctuations in the economy. Why did the Great Depression happen? Will it happen again? The Economic models based on Classical theory state the market is self-correcting and should be stable. It was not just the U.S. either; every country that had adopted Adam Smith’s Capitalism went through the same turmoil of feast and famine cycles. In some countries, citizens became so disenchanted with the roller coaster cycles of capitalism, that they adopted radical alternatives such as communism and Fascism.

John Maynard Keynes was not a fan of socialism or its cousin Communism; however, he recognized that there were serious flaws in Classical Economics, which invariably led to wild cycles of boom and bust. These cycles were making it exceedingly hard to maintain a happy population. He formulated a new theory of economics designed to account for many factors that classical theory ignored, such as the importance of Demand, and the need for Government to create policies that would act like the governor on an economic engine to prevent the runaway effect of boom cycles that always end in a big bust. In this, it was postulated we could have relatively steady, albeit slightly slower growth without the wild swings.

Unfortunately, just a year after he published his seminal work, ‘The General Theory of Employment, Interest and Money’ in 1936, he suffered a heart attack. He survived, but being in ill health, he was not equipped to expand on and educate others about his theories. Many of his theories were poorly understood or misunderstood entirely. Therefore, what emerged as Keynesian Economics was actually a hybrid of Classical and Keynes theory. The parts of his theories that were implemented correctly, worked wonders with the economy. He stated for example, the role of government in a downturn was to stabilize employment through public works. The extra employment and income provided by the government would increase the demand for goods (something classical theory ignored completely), and with higher demand for their goods the producers could finally expand. A radical idea at the time, but it worked. He also stated that such big deficit spending should be reserved for times of extreme economic stress.

Over the years, his economic policies were weakened by classical ideals trying to creep back in. Lessons learned are quickly forgotten when short term profits are at stake. However, from 1936 through 1980 the U.S. suffered only minor recessions averaging 11 months down from 23 month prior to and including the Great Depression. The average time between events increased from every 4 years to 10 years.

The events in 74 when American oil production could no longer keep up with consumption,  were used by proponents of Classical Economics to call Keynesian economics a failure, permitting those wishing a return to the good old days to reinstate their beloved theory throughout the developed world. Since 1980, the average time between recessions has dropped back down to 6 years. The old trend of boom and bust cycles is in full bloom. This is now forcing many economists throughout the world to suspect that they threw the baby out with the bath water in 1980, and to start re-evaluating the Keynesian school of economics. I can only hope that sanity prevails.