Piecing Together The Economic Puzzle

"It’s kind of muddled. Look, there’s a series of things that cause the—like, for example, benefits are calculated based upon the increase of wages, as opposed to the increase of prices. Some have suggested that we calculate—the benefits will rise based upon inflation, as opposed to wage increases. There is a reform that would help solve the red if that were put into effect. In other words, how fast benefits grow, how fast the promised benefits grow, if those—if that growth is affected, it will help on the red."— George Bush explaining his plan to save Social Security, Tampa, Fla., Feb. 4, 2005

I’m always in awe of smart people who can actually communicate a complex idea effectively because explaining something difficult in a difficult language is easy; explaining something difficult in an easy language is difficult. 

That’s why I encourage you to read John Maudlin’s Outside the Box letter this week.  He highlights an article from GaveKal about the relationship between the US and Chinese economy that is very incisive and clear.  GaveKal outlines the interrelationship between strong profit margins, income disparity, inflation, a confused Fed, and China’s export prices to come to the conclusion that Adam Smith’s "invisible hand" is making the world economies work as well as can be expected…

We will admit that we are in awe at how Adam Smith’s "invisible hand" works in strange and funny ways. If anyone had told us a decade ago that a "trade" would be put in place whereas China would say "give us all the jobs" and American companies would say "we’ll take all the profits" and that this trade would lead to greater wealth, and greater social harmony in both countries, we most likely would have been very skeptical. Of course, we would have been wrong, for we would have forgotten to put our faith in Adam Smith’s invisible hand which somehow has a way to make things work out in the end.

To conclude, we would like to leave the reader with the following points:

Inflation, at this stage, does not seem to us to be a viable threat. The current increase in prices we are witnessing reflects the past years’ easy monetary policies and increases in China’s export prices. These factors are now behind us. In front of us, we have the fact that China is once again exporting deflation (a fact which might help explain Japan’s weak equity market performance) and the tighter monetary policies of recent quarters.

In a tighter liquidity environment such as the one we are now facing, owning the guy that says "I’ll take all the profits" makes a lot more sense to us than owning the guy that says "I’ll take all the jobs".

While I believe inflation remains a bigger threat than GaveKal concludes, the article is well worth reading.  I wish I had the clarity of sight to write such a compelling piece on global economic relationships.