We live in a world dominated by slogans. As a young boy, my first encounter with slogans came in the form of what are more aptly called proverbs, which I committed to memory and catalogued in my mind.
One of the first I heard from my mother was “haste makes waste.” Then came “many hands make light work,” along with its corollary, “the more, the merrier.” And who can forget, “you’re never too old to learn,” or “don’t judge a book by its cover”?
As I grew older, some new ones came along which seemed at odds with the catalogue I had created. “He who hesitates is lost.” But what about “haste makes waste”? “Too many cooks spoil the broth.” How does this jive with “the more the merrier”? “You can’t teach an old dog new tricks.” I thought “you’re never too old to learn.” “Look your best to feel your best.” But “don’t judge a book by its cover”?
After a while I realized that wisdom is to be found somewhere within the boundaries and not at the boundaries of the extreme. Moderation is a virtue. Balance is best. Perhaps this dialogue is epitomized in the French noun “savoir faire,” the ability to speak and act appropriately in each situation.
Nowhere is savoir faire more needed than in the area of economics. The appropriate course of action at one point might be non-apropos at another. A fantastic policy for one industry may be fatal for another.
Last week we finished on the note that generally, economists favor free trade among nations. Although opening one’s borders to free trade may cause some industries to shrink and some workers to be displaced, the benefit to all consumers is greater than the loss to a few workers.
But, as always, limits exist. Balance is needed. For example, if the U.S. were to hold a referendum asking voters to pay a 50-percent tax on televisions so as to bring back to the nation an electronics manufacturing capability, I doubt that such would pass. In contrast, if we could buy all of our wheat, at a large discount, from Russia, and save billions by outsourcing our U.S. Air Force fighter jets to China, I doubt that we would feel comfortable with such.
National defense and national security trump the cost benefits to consumers within the context of international trade. (And no, my use of the word “trump” is not a subliminal political message of any sort.)
Another area where unfettered international markets break down relates to capital flows. It has been the sorry experience of many nations that uncontrolled international capital flows can be and frequently are most destabilizing.
For those unfamiliar with the concept, international capital flows are movements of investment funds from one country to another. Developing nations are often short of investment capital and pursue policies to attract direct foreign investment.
Symbiotically, developed nations often have too much savings, an oversupply of investment capital, which is in search of good returns on investment. This sounds like a match made in econoheaven. But, like all things, it must be balanced. The herd character of capital must be tempered.
Economists have developed models which describe herd behavior. A classic example illustrates the point.
Image a shopping mall with three new restaurants. You and your husband walk past the first and see no one. You walk past the second and see no one. You come to the third and see a well-dressed couple inside. You naturally judge a book by its cover, assume the couple know something about the cafe, and go in.
Along comes another couple who go through the same exercise, but this time they see two couples in the third cafe, the one you saw and you. Now six are seated. Soon the restaurant is filled.
Then something happens. A man mistakes some fennel for a fly in his soup and loudly complains. Everyone overhears and heads for the door. Two people die in the stampede. The cafe closes, leaving the other two restaurants alive and well.
As an aside, the mall could only support two restaurants. But the two left open are the best and the worst of the three.
Now what has this to do with capital flows? Capital has a way of moving according to this pattern. One investment bank, for whatever reason, decides to fund a factory in Jakarta. Another investment bank notices this and decides it must be a good idea to be there. After all, he who hesitates is lost. They make a loan for another project.
Before long, the hedge-fund community has locked onto this bonanza. Good minds think alike. But fools seldom differ. And a fool and his money are soon parted.
Of course, these firms lend dollars, which are exchanged by the borrowing entity into Indonesian rupiahs. All of this buying keeps the rupiah strong and rising. Other speculators jump into the rising market.
A currency bubble develops. Then comes the crash: a couple of savvy investors begin to sell their rupiahs. This causes an avalanche of selling. Yes, too many cooks spoiled the broth. The steady flow of capital into Jakarta turns to swift mass exodus.
With the rupiah now significantly lower, the Indonesian corporations which borrowed dollars now owe more than they borrowed when measured in the local currency. Bankruptcy is the only option. This, in turn, leaves workers without pay, without a job.
Is this real or is this just a story? Look back to 1998 and see what happened in that very region of the world. Destabilizing capital flows created quite a slump.
More recently, consider our own housing debacle. Much of the investment community had to get in on the great deal of lending to subprime borrowers. Even the banks of Iceland couldn’t pass this up. The more the merrier. Nothing ventured, nothing gained. And then the flow stopped. Uh-oh. Better safe than sorry.
Even more recently than that, note the same phenomenon in Spain, which employed hot money from German banks. The sudden stop in capital flows brought Spain’s building industry to a standstill. Once again, too many cooks spoiled the broth. A generation of young Spaniards have now come out of college to find no jobs and few prospects. Family formation has been stunted.
In each of these cases, capital controls could have mitigated the mess brought on by the bursting bubbles. Balance is best.
What’s the moral of the story? Beware of Greeks bearing gifts. But don’t look a gift horse in the mouth.
(Marcus Hutchins is a former economist, treasury bond arbitrage trader, and hedge fund manager. He retired to Southport in 1997, where he resides with his wife, Andrea, and youngest daughter, Abbey. He welcomes feedback at email@example.com.)