Monopoly: The Metaphor

Are you looking for a metaphor of the modern American economy? You might wish to glance in the direction of Monopoly.

No, I’m not referring to any of the real-world industries that are dominated by monopolistic organizations, although numerous examples abound of sectors in which one or two mammoth companies have bought out most of their competitors. I’m referring to Monopoly, Hasbro’s board game.

Last month, based on the results of an online social media competition, Hasbro retired the game’s Thimble, Work Boot, and Wheelbarrow tokens. The firm then announced the addition of Dinosaur, Rubber Duck, and Penguin tokens.

So why is this a metaphor for our contemporary economy? When the three retired tokens were first introduced decades ago, they illustrated common tools of manufacturing activities in America’s then-dominant industrial sector. Indeed, the icons represented the capabilities of the United States to generate its own wealth, a theme that reflected the goal of the Monopoly game.

But now these tokens have been replaced by an extinct beast, a toy creature, and an animal that is imported into American zoos from foreign lands. In other words, the original “plain but meaningful” icons of productivity have been replaced by a new set of “cute but irrelevant” icons of mass entertainment.

If Hasbro had wished to modernize its assortment of tokens, it might have chosen to adopt representations of mobile communication devices, surgical lasers, and sleek aircraft. But instead, it opted for a motley menagerie.

It’s an apt metaphor for the contemporary economy of the United States, isn’t it? Unfortunately, the American business tools of thimbles, work boots, and wheelbarrows are now as obsolete as the Monopoly tokens that recently portrayed them.

The Great Potash Cartels!

Financial market watchdogs have long complained about the manipulation of various economic markets. Just within the past month, for instance, news about the manipulation of commodity metal values, energy prices, and interest rates have rocked the investment industry.

But are you ready for the possibility of manipulation in the potash market? Potash?

Potash is a natural resource that is mined and utilized to manufacture potassium, a compound that possesses a myriad of industrial and consumer uses. Salt, for instance, is produced from potassium chloride, and commercial fertilizer is produced from many varieties of potassium.

In other words, the food supply that humans, animals, and plants ingest is dependent on the continued existence of a stable and affordable global market of potash. Thus, by dominating the potash industry, organizations could gain control over food itself.

Until last week, the global potash market has been dominated by a pair of business cartels. One has been a venture between the Russian firm Uralkali and the Belorussian firm Belaruskali; the other, called Canpotex, has been a three way venture of the Canadian firms Potash Corporation, Mosaic, and Agrium.

But last week, Uralkali shook the industry by withdrawing from its cartel. And the global mining firm BHP Billiton is now considering a $14 billion Canadian resource opportunity that would bring a major new competitor to the potash market.

So what evidence exists of potential potash price manipulation? During the past six years, market prices have fluctuated from the low $300s per ton to the high $800s per ton. These fluctuations have been massive and abrupt in scope and direction, with no readily apparent explanation to account for them.

So, for now, the potash market remains under the control of a few giant firms. Nevertheless, the recent withdrawal of Uralkali and the potential entry of BHP may indeed portend a more competitive future.

Global Banking: Limit The Liabilities!

Some ideas that revolutionize society are proposed by our greatest leaders. Jean Monnet, for instance, was already an accomplished global banker and politician when he first described the “Common Market” that would evolve into the European Union. And Steve Jobs of Apple had already transformed the music and mobile technology industries when he introduced the iPad.

Other revolutionary ideas arise from the fringes of our society. Mohandas Gandhi, for instance, was an unknown South African barrister when he began to develop the techniques of nonviolent resistance. And John McConnell was working in a plastics factory when he first conceived of Earth Day as a global celebration of the environment.

Sometimes, though, new ideas are generated from the fringes of leadership, i.e. from individuals who work directly for our leading institutions but who are not widely known outside of the corridors of power. Last week, Daniel Tarullo emerged as one such figure.

The Federal Reserve

Professor Tarullo was a professor of law at Georgetown University in Washington, DC. Three years ago, he became a member of the Board of Governors of the Federal Reserve System, America’s national bank.

Ben Bernanke, of course, is the Chairman of the Federal Reserve System; he serves as the public face and chief spokesman for the organization. Yet when the Fed determines critical policy issues, each Board member casts a single vote for decision making purposes; thus, Bernanke’s opinion carries the same weight as any other Governor’s.

That’s why the opinions and proposals of the individual Governors attract the attention of the global financial system. And last week, in Philadelphia, Tarullo proposed an innovative approach to limiting the size of the global banking giants. Instead of direct constraints, he suggested, why not try an indirect approach?

A Biological Analogy

Since the global economy crashed a few years ago, many financial leaders have proposed conventional approaches to limit the risks that “too big to fail” banks impose on the financial system. Former Citigroup CEO Sandy Weill, for instance, recently suggested that the banks should be split into independent entities. And former Federal Reserve Chairman Paul Volcker first proposed what is now known as the Volcker Rule, a regulation that prohibits banks from entering certain lines of business.

Governor Tarullo also believes in limiting the size of the global banks. But instead of following conventional strategies of dismemberment or prohibition, he proposes a novel approach. If we can limit the sources of wealth that the banking giants rely on to generate growth, he reasons, we can indirectly prevent that very growth. In fact, we may even be able to compel the banks to “downsize” their existing organizations.

For a biological analogy, consider the options that are available to an obese individual who seeks to lose weight. He can opt to undergo liposuction. Less dramatically, he can try to avoid certain restaurants. But why, instead, should he not simply adopt a low calorie diet?

Non Deposit Liabilities

Similarly, Tarullo proposes to limit the non deposit liabilities of global banks. Such liabilities, he believes, provide the proverbial calories that banks ingest in order to grow their asset bases.

The classic accounting model defines the net worth of any organization as the difference between its asset values and its liability values. When a bank borrows $1.00 and invests it in an asset that grows in value to $1.20, it can repay the $1.00 liability with $1.00 in assets and thus expand its asset base by a marginal $0.20. Thus, if a regulator restricts the bank’s ability to borrow the initial $1.00, its asset base is precluded from expanding by $0.20.

Interestingly, Governor Tarullo only proposes limitations on non deposit liabilities, and not on all bank liabilities. Why? Because, he reasons, banks that accept cash deposits for services like savings and checking accounts are engaging in low risk activities. Such deposit liabilities represent “healthy” sources of wealth for the banks, and thus Tarullo proposes no limitations on them.

Would It Work?

Regrettably, simple limitations on non deposit liabilities may not succeed at fully eliminating such sources of wealth that banks now utilize to fuel growth. That’s because the banks have grown adept at utilizing “off balance sheet” liabilities, i.e. liabilities that never appear on their own books and records, and that are thus not subject to accounting limitations.

Nevertheless, regulators have grown more adept at requiring banks to disclose the impact of their off balance sheet obligations to the general public. In essence, they are endeavoring to bring off balance sheet liabilities back onto the balance sheet, thereby enhancing the potential effectiveness of proposals like Governor Tarullo’s.

Regardless of the fate of this particular proposal, we can certainly applaud the emergence of creative suggestions from the fringes of our governmental institutions. Such “outside the box” ideas provide evidence that our leaders are seeking to identify flexible solutions to our most pressing economic and social problems.

Currency Conflict: Switzerland Declares War!

The Swiss at war? When was the last time that happened?

It’s been a long, long time — 1803, to be precise — since the Alpine nation engaged in an all-out, unlimited conflict. That was when Napoleon Bonaparte, soon-to-be Emperor of France, agreed to end his military occupation of Switzerland and respect Swiss autonomy so that he could focus his attacks on Austria and Russia.

During the early to mid 1800s, the Swiss did engage in a number of internal civil wars, until the cantons united under their first federal constitution in 1848. There were no Swiss declarations of war of any kind since that time; the nation even managed to remain completely neutral throughout the two world wars of the twentieth century.

Until last week, that is, when the Swiss National Bank publicly declared an “unlimited war” on the rest of Europe. And oddly enough, the first European nation compelled to respond was Norway.

Defend The Currency!

What would drive the Swiss to such a declaration? It is the continuing collapse of the value of the euro against the Swiss franc that led the Bank last week to assert that “the current massive overvaluation of the Swiss franc poses an acute threat to the Swiss economy (which it) will no longer tolerate.” The Bank then drew a line in the sand at an exchange rate of 1.20 francs to the euro, and swore to “enforce this minimum rate with the utmost determination (by buying) foreign currency in unlimited quantities …”

Unlimited buying of currency? That means war! Especially in a nation known for its global banking industry.

The underlying source of all this brouhaha is the European Union’s banking crisis, which threatens to topple the EU’s economy if the fiscal collapse of its weakest members (the proverbial PIGS, i.e. Portugal, Italy, Greece, and Spain) leads to the bankruptcies of the EU’s largest banks. Many believe that the collapse of “too big to fail” EU banks like BNP Paribas, Credit Agricole, and Societe Generale will drop the EU (and perhaps the United States and Japan as well) into a dreaded double dip recession.

This concern has compelled currency speculators to pull their capital out of EU and American asset markets — including the currency markets — and to buy up the assets of fiscally conservative markets. Switzerland, being the quintessential example of a conservative fiscal market, has thus witnessed a massive increase in demand for its currency, which in turn has driven up its value around the world.

Pros and Cons

There are, of course, some very real benefits to maintaining a strengthening currency. Swiss citizens who travel abroad, or who buy goods that are manufactured in other nations, can effectively purchase more for their money. And Swiss manufacturers that outsource functions to firms in other countries, or that purchase supplies and components from suppliers in those countries, can spend fewer Swiss francs when converting its funds to other currencies.

On the other hand, Swiss exporters inevitably find that they must greatly increase their sales prices when selling to foreign customers in their home currencies. In other words, when Nestle sells chocolate in Paris, and when Rolex sells wrist watches on the French Riviera, they must increase their euro prices significantly in order to receive the same amount of Swiss francs when they convert their sales revenue from euros into francs. That gives competitive firms like Godiva and Cartier a huge advantage because, when they sell to EU customers, they simply collect sales revenue in their own home currencies and need not worry about conversion losses at all.

Some nations do not rely heavily on export industries, and thus are not terribly inconvenienced by soaring currency values. But Switzerland, as a relatively small nation with many prestigious, luxury product exporters, finds itself disproportionately affected by such conditions.

Norway Responds … and Japan Does Too!

Ironically, the first nation that appeared to be affected by the Swiss declaration of war on the euro was not an EU nation. It was Norway, another small, independent, and fiscally conservative European nation outside of the EU, that became the center of attention when currency traders began searching for alternatives to the Swiss franc.

Unlike the Swiss National Bank, though, the Norwegians declared that they had no desire whatsoever to intervene in the currency markets in support of their home currency, the krone. And Japan — another export oriented nation with a soaring currency — did likewise, asserting that it “should not compete with other countries to weaken its currency.”

As long as other nations back away from the fray, Switzerland’s war is not likely to grow into a worldwide currency conflict. In the high stakes battle for global economic supremacy, though, hedge funds and other speculators will likely continue to find profitable transaction opportunities in the volatile currency trading markets for quite some time to come.

Commodities Crash: A Market Economist’s Nightmare

Do you remember the first great internet investment bubble of the late 1990s?

Hundreds of millions of dollars were invested in astonishingly flimsy firms like Pets.com and drkoop.com. The NASDAQ market, host to many of the Initial Public Offerings (IPOs) that attracted funds to these companies, witnessed its composite index quintuple in value in just six brief years between 1995 (when it surpassed 1,000 for the first time) and 2001. But then, like all bubbles, the index valuation crashed, collapsing back to a value slightly above 1,100 by late 2002.

At the time of the crash, many American investors swore that they would never again be beguiled by future bubble markets, promising to restrict their funding decisions to more stable industry sectors. And yet, just a few years later, rock-bottom mortgage interest rates created a mammoth real estate bubble, supported by the irrational proposition that home investment valuations in the United States could never decline in absolute terms. Nevertheless, when that bubble burst in late 2008, it nearly brought the entire global economy down with it.

Have global investors learned their lessons about avoiding manic bubbles? Apparently not! In fact, yet another investment sector appeared to gyrate towards a crash last week, one so universally significant that it is giving market economists nightmares.

Silver and Gold and Oil, Oh My!

The sound of the largest crash last week came from the silver market. The value of silver, having soared by 57% during the first four months of 2011, suddenly reversed direction and fell more than 25% during the first five trading days of May.

And yet gold, too, went into a tailspin. After having jumped from $1,000 to $1,541 between September 2009 and April 2011, it suddenly slumped by close to 5% during the most recent four trading days. And oil, having soared from $33 per barrel in January 2009 to levels beyond $100 per barrel in February 2011, fell by almost 15% last week.

Pundits blamed these sudden lurches in commodity values on investment speculators who buy and sell vast quantities of these materials on the global markets. Unfortunately, though, firms that use these commodities for industrial and consumer applications must purchase them on the same global markets. Inevitably, when prices fluctuate so dramatically, corporate planning activities for the future — as well as their operations activities in the present — become unmanageable.

Ripple Effects

Gold, for instance, is more than just a glittering metal that is shaped into rings and necklaces. It is also an excellent conductor of electricity, and is therefore employed as an industrial component in many types of electronics equipment. Manufacturers of computers and cell phones thus feel their profits pinched whenever speculators drive up the cost of the precious commodity.

Silver, as well, is a strong conductor of electricity and heat, and is able to withstand extreme variations in temperature. Manufacturers of conventional batteries and solar energy panels rely heavily on it, and likewise see their profits vanish whenever the cost of silver increases. And in the nascent alternative energy industry, where losses are common even under the best of conditions, such cost bubbles can drive development projects (and entire firms) into bankruptcy.

Sharp increases in the cost of crude oil can, likewise, ripple through the entire global economy. Airlines simply retreat from markets that become impossible to serve profitably, cutting off tourist areas and business markets from their constituents. And, on a personal level, economically strapped families in cold weather states like Massachusetts and Michigan are forced to wonder how they’ll find the funds to heat their homes through frigid northern winters.

The Cost of Uncertainty

As market economists know, the true costs of such massive fluctuations in commodity values extend far beyond the expenditures that are required to procure the materials themselves. Indeed, the greatest costs of all may emanate from the uncertainty that is generated by such fluctuations, an effect that paralyzes commercial activity and drives up the cost of capital.

When the Chief Financial Officers of alternative energy firms witness the cost of traditional crude oil more than triple within two years, and then drop by almost 15% in a single week, they cannot help but wonder whether that cost might continue plummeting in the near future. If such declines actually continue, the cost of oil-based energy would likely fall so low as to make the cost of alternative energy unattractive by comparison.

Furthermore, banks and investors would perceive such alternative producers in a far more risky light, and would raise their interest and dividend demands accordingly. In other words, the cost of obtaining investment capital at alternative energy firms would soar at the very moment that their competitors’ operating costs would fall.

The result would be paralysis in the alternative energy sector, thereby locking our economy into the perpetual boom-and-bust price cycles of the traditional commodities sector. Can we afford to continue living with such outcomes? Perhaps not, because without stability in the price levels of commodities and other raw materials, no business can feel comfortable investing in growth plans for the future.

From Stocks to Spoons: The Perils of Globalization

Can America’s Windy City rescue its Big Apple from the perils of globalization?

Last week, just as the New York Stock Exchange (NYSE) appeared to accept a merger deal with the Deutsche Borse Group of Frankfurt, Germany – one that would provide the German stock exchange with 60% majority control over both organizations – rumors swirled through Wall Street that an American white knight might ride to the rescue.

It was Chicago’s CME Group, the world leader in derivatives trading, that was reportedly considering an offer of its own. And the report appeared to be credible; after all, the CME has been operating in New York City since paying $8.3 billion to acquire the New York Mercantile Exchange in 2008. That acquisition occurred barely a year after the CME itself was formed by a merger of the Chicago Mercantile Exchange and the Chicago Board of Trade.

Interestingly, although some Washington politicians voiced concerns about the stock trading sector being controlled by foreign organizations, no such outcries were heard about last year’s fall of a different American industry. But what other industry suffered the same fate as the one that the NYSE is facing today?

Goodbye, American Flatware

It is the venerable flatware industry, manufacturers of spoons, forks, knives, and other types of cutlery. Paul Revere, the great colonial patriot whose famed midnight ride in 1775 sparked the American Revolution, designed and manufactured silver flatware. And in the late 1800s, Walter Scott Lenox founded his namesake china and flatware company in Trenton, New Jersey, a firm that has manufactured White House tableware for Presidents Wilson, Truman, Reagan, Clinton, and Bush.

Although one of the companies founded by Paul Revere is still manufacturing products in the United States, his flatware business only exists today as an Oneida Ltd. brand name. Oneida itself represents a quirky American success story, founded in 1848 by a religious Utopian society in upstate New York. Oneida Ltd. emerged from the society in the late 1880s as a tableware manufacturer; it still markets tableware products throughout the United States today.

However, nobody — not Revere, Lenox, or Oneida — manufactures any flatware in America any longer. In 2005, Oneida spun off an historic factory, located in the Silver City of Sherrill, New York, which represented the last remaining flatware production facility in the United States. Last week, while the New York Times ran major high profile stories about the NYSE transaction, it quietly published a little noticed story about the factory’s closure in the face of relentless Chinese competition.

Farewell, Buttonwood Tree

It’s difficult to attribute the Sherrill closure, and indeed the entire decline of America’s flatware industry, to anything other than a loss of a domestic business to foreign rivals. A Deutsche Bourse takeover of the NYSE, though, represents a more complex tale.

That’s because the NYSE itself has not been solely based in the United States for several years; it boldly purchased a group of European trading exchanges in 2006 for $10 billion, and has been operating throughout Western Europe since that time. In other words, although the NYSE was primarily an American institution from the time of its founding under a buttonwood tree in 1792 through the first half decade of the 21st century, it has expanded aggressively into global markets since then. Ironically, it may now be falling prey to those very markets.

It is, of course, quite possible that the CME may break up the Deutsche Bourse’s takeover bid and preserve American control over the Wall Street icon. Nevertheless, the very forces of globalization that have destroyed America’s flatware industry will undoubtedly continue to pummel its financial services organizations as well.

The Chinese Century?

Many prognosticators believe that the current century will prove to be the Chinese Century, following the dominance of the United States in the 1900s and of Great Britain in the 1800s. Given that China surpassed Japan at the end of last year to become the world’s second largest economy, it would certainly seem reasonable to predict that the mighty Asian colossus may soon overtake the United States.

Nevertheless, with the diverse BRIC nations of Brazil, India, and Russia nipping at China’s heels, and with the emergence of sustained economic growth in Africa, there is no guarantee that the spoils of this century will tilt in any specific nation’s direction. It is even possible that, after the demographic bulge of the twentieth century’s baby boom generations passes away in nations like Italy and Japan, younger and more entrepreneurial generations may emerge and reinvigorate their national economies.

Thus, if we are to bid farewell to any historical certainty, it may be to the assumption that our world will always revolve in a tidy manner around a unipolar or bipolar set of dominant economies. Instead, the same centrifugal forces that have dispersed entire American industries around the globe may well do the same for the economic fortunes of other powerful nations.