A Forecast, written on 9/30/05

Last night, I heard a journalist for the NY Times, who is a reporter in Baghdad, talk with Terry Gross (on NPR) and he basically confirmed what we Middle East Studies experts were thinking in 2003, which is that this insurgency is creeping toward civil war; Sunnis are entering Shiite neighborhoods and assassinating the few Sunni's who live there and Sunnis are entering Shiite neighborhoods and killing the few Sunni's, who live there. In fact there is a new industry that has emerged in which the assassins are paying "allahs" to guide them to the house of the victims. So, what we have going on now is ethnic cleansing and it is only serving to fuel the fire of the insurgency, which will soon become a civil war.

Like the Balkans, the involved ethnicities won't know that they are in a civil war until things reach a critical mass by which time it will be too late to stop it; the hornets nest will have already been struck. Once full blown civil war emerges, we predict that this will spillover into a regional war. This would be interesting and test Turkey's alliance to the US and Israel, let alone their newfound commitment to human rights as part of their bid to enter the EU. Turkey's truce with the Kurds in Southeastern Anatolia, which borders Iraq, is over and has been for some time. The Kurds in Iraq and Iran will ally with the Kurds in Turkey and Iran to fight the Turkish government. Turkey will deploy more troops into Northern Iraq and possibly Iran to deal with them. The Kurds are already aligned with the Shiites, who will have the support of Iran. Turkey and Israel already engage in military cooperation and no one knows whether it is a strategic cooperation agreement. If it is, then an attack on one is an attack on the other and the other must come to the attacked party's assistance.

The US would align with Israel and oppose Iran. Turkey is predominantly Sun'ni, the Sun'nis of Iraq are would align with them against the Kurds. So, you have Turkey and the Sunnis of Iraq against Iran; the Kurds, the Shiites, the US and Israel against Iran. If Turkey starts fighting the Kurds in Iraq, the US might have a difficult decision to make and it might test the strength of NATO, which could be torn apart at the seems since two critical members (Turkey is the second most powerful (militarily) player in NATO) might wind up fighting each other. The US/Israel will bomb Iran's nuclear facility, OPEC will use its "oil weapon" against the West, which will starve the west of Oil and since we would be engaged in a full-scale regional war, we would then tap into the strategic petroleum reserve for military purposes. This regional conflice could then escalate to a global war, if China allies with Iran for access to its energy resources. N. Korea will bandwagon with China and Iran. India would ally with the US, Turkey, and Israel's trilateral alliance, out of fear of China.

In any case, all the players in this puzzle lose. I really do think that this might have been engineered by the evangelical idiot we have in office as he thinks it will bring about Armageddon in which he would not die but be lifted into the heavens with all of his other faithful brethren, while the others are left to deal with the aftermath. Meanwhile, back in reality, we have a delusional leader who actually believes this fantasy and has begun the process of moving a delicate and strategically important region toward more instability. This, to me, seems ironic, given that one of our stated goals was to bring more stability to the region through bringing democracy to the region. I am of the belief that you can't impose democracy on a culture, but rather you can introduce it to them and let them evolve toward it on their own. This is a communautarian belief and the administration seems to be taking a cosmopolitan approach by arguing that all humans deserve to have democracy, imposed or not.

At any rate, all the experts know that it takes 15 years to quell an insurgency. We either knew that the ethnic tensions were so strong that this would happen and deliberately orchestrated things this way, or we were ignorant of their culture and went in with our imperialist arrogance in which case we deserve the comeuppance that we are being served.

I will step down from my soap box, now.

Free Trade and the Food vs. Fuel debate

The fundamentals of the global oil market don’t look very sweet for customers. We are in short supply, due to political events and refinery capacity, let alone upward pressure on demand, as we enter the summer season. Needless to state, we are vulnerable to the factors that impact the oil market.

One way that energy-independent Brazil has decided to deal with this threat is by switching to alternative fuels. They already use sugarcane-ethanol and it was recently reported that they may soon add coffee beans to their fuel mix. This is an interesting development. I would be interested to know what the yield is (in terms of ethanol) from coffee beans and how Brazil is positioned in the world coffee market.

The background of Brazil’s sugarcane-ethanol fuel economy is interesting. Due to the subsidies to the US producers and European producers, as well as tariff duties levied by both political entities on Brazilian Sugarcane, Brazil has found that they can't compete with Sugarcane producers from those zones; though they are the most efficient at producing Sugarcane ($.04 per cane vs. $0.25 in the EU and the US). So, they have become the world leader in terms of using ethanol to power their vehicles. The last statistic I read was that 85% of their vehicles are powered off of the sugarcane-ethanol. This is one way that they have been able to leverage their strategic resources to become energy independent.

One of the reasons that we have such a problem in the US, with gasoline, is that we don't have enough refinery capacity; a new refinery has not been built in around 30 years, mainly due to capital and regulatory constraints. We are talking about using corn to develop ethanol, but sugarcane yields 8 times as much ethanol than corn. So, one can surmise that our ethanol won't be as cheap as Brazil's. However, it could be a step in the right direction, as we would conceivably be able to reduce our Ag Subsidies to corn; thus making us more competitive in at least one area of Ag. In addition, we would take a step toward energy independence.

Then we run into other gray areas. A supplier would have to make the decision of whether to supply the food market, or the energy market, and given the thirst for fuel, I could see there being a shortage of corn being supplied in grocery stores; thus driving the price up. This is known as the food vs. fuel debate.

So, the next time you hear a politician talking about free trade, keep this in mind. They are only interested in “free trade” that benefits their constituents and “free trade” isn’t always free.

An Ethical Dilemma

Suppose that you are a Pharmaceutical Exec and you are in charge of some medicine that could serve to alleviate suffering in millions of people in Africa, but there were huge R&D costs to get the medicine to market. Your company naturally has the patent for the new "art". Another company comes along and rips your product off and starts selling it in Africa at a deep discount to your price. You naturally have a high price to be compensate for the huge cost of drug commercialization.

You have little recourse, internationally, as there is not one world governing body that governs international patent law. You can take sue them over the issue, or you can allow them to do this and sacrifice millions of dollars that people would normally pay to gain access to the drug. Now, you, as a manager, are an agent of the shareholders and are obligated to act in their best interests, but you have other stakeholders such as your employees, customers, your community, etc. So, do you take action against this other company, knowing that if the legal gavel falls in favor of your side, assuming that the rule of law is institutionalized in the country (this institution is weak in many poor countries), people will die as their will be a certain segment of the population who will not be able to afford, or have access to the drug that would save their lives? That is, do you put your shareholders interests ahead of the thousands of people who will die as a result of your decision?

This is just to demonstrate that ethical decisions are not so black and white. Without the human dimension, the decision would be clear: if the cost to pursue effective recourse against them is less than the monetary value at stake, then do it. Else, do not. However, this decision impacts human lives.

There is the do nothing approach, which does nothing to serve the interests of the shareholders, but allows access to the drug to people who would otherwise be priced out of the market. Another option would be to pursue the drug company with a vengeance and not discount your product to allow for more access. An option that I prefer would be to take legal action, if it makes financial sense, and offer the drug at a discounted rate to the people in that market, which would serve the interests of the community in which we operate (Africa) and the shareholders.

These ethical decisions are not so black and white. There are many options and the key is to balance the interests of the stakeholders in such a way so as to maximize the good.

Do the Gains from Trade Offset the Losses?

I recently watched a film entitled, "Is Wal Mart good for America". As I watched this film, a comment made by a CATO institute economist resonated with me. He asserted that the gains from trade offset the losses. I couldn't help but think that this was a rather simplistic viewpoint. The types of jobs created by outsourcing would determine whether or not his claim was actually true.

I understand the CATO institute is a libertarian think-tank and any economist employed by CATO would be of the free market ideology. I also understand the theory that the excess consumer surplus in the pockets of Wal-Mart shoppers is either spent in other areas of the economy, or saved.

In the case of Wal-Mart, whether the consumers spend, or save, the consumer surplus would depend on the shoppers respective “Marginal Propensity to Consume” and “Marginal Propensity to Save”, which are figures that are driven by their incomes. That is, given the income level of WM’s shoppers, do they tend to save, when they save a buck, or do they tend to save it? If they spend it, then where do they spend it (i.e. which segment of the economy)? The multiplier effect varies throughout the economy depending on the type of expenditure.

It would be interesting to know a.) Whether these shoppers tend to spend more, or save more, of the consumer surplus yielded by shopping at Wal Mart, and b.) The types of expenditures this consumer surplus is yielding, if they do tend to consume more. This analysis could be very telling about whether the gains from trade do, in fact, offset the losses from trade.

Naturally, the market segment that WM targets are value shoppers and they will tend to stretch a dollar as far as it will go. So, I suspect that they would tend to spend their excess consumer surplus on low-wage sectors of the economy. It is well known that low wage workers spend a great deal of their consumption on goods in industries that also pay low wages.

On the other hand, if this market segment tends to save the alleged consumer surplus, then this would mean that more capital would be available for industrial expansion. One would think that because there is more capital available, if WM shoppers do indeed save the consumer surplus, business would invest in capital equipment, which would create jobs. However, there is another dimension at play here.

Just because the banks have more capital to lend doesn't mean that they will necessarily loan more money out. We saw this happen in the Great Depression. The capital that is available is a function of FED policy regarding the money supply. If the unemployment that is created by the outsourcing does not put the US economy over the Natural Rate of Unemployment, then the FED might not be very inclined to take any action. However, if it did edge us over the Natural Rate, then they could use the tools of the trade (i.e. open market operations, jawboning, reserve requirement, and the discount rate) to expand the money supply; thus making more capital expenditures more attractive to private industry, who would then presumably hire workers.

I suspect that with our knowledge economy a lot of the workers were laid off will lack sufficient training to be productive in this new economy. This structural adjustment is a problem, as on the fiscal side, we would need to allocate funding to retrain these workers in "new economy" skills. However, the current administration's policy has been to siphon funding from social programs to fund foreign policy initiatives and to stimulate investment a la "Trickle Down Economics".

While it is true that higher income Americans have a higher “Marginal Propensity to Save”, than the rest of us peasants, we can treat debt as dis-savings and since Americans, are in debt at all levels, this strategy didn't work. A good deal of the realized tax savings went to pay down individual debt; the majority of it was not invested.
An exogenous factor that may affect the banks’ willingness to loan out money for people to invest is inflation. If inflation is high, they will likely pull back on the money supply lever, by raising interest rates. So, now you have less funding available for industrial expansion, less money available from the gov’t (as they have re-directed funding to foreign policy initiatives), more people are out of work, and to make matters worse: the greenback doesn’t go as far as it did before.

The types of jobs that the untrained victims of globalization are likely to get are low skilled and in the service sector such as those in Wal-Mart, which doesn't pay very well and provide benefit programs that are out of reach of many of its employees. So, we are moving toward a two speed labor force.

In Robert Reich's "The Work of Nations", he argues that the structural transformations from national economies to those that are global in scope are rewarding skilled labor while relegating low skilled service workers to lower standards of living. So, it is no longer useful to think about competitiveness on a national scale; we need to take it to the individual level and make sure that we invest heavily in the education of our citizens so that we can compete in the new globalized market. One way to do this, in the short term, is to divert funds from the gains from trade, if they do in fact exist, to structural adjustment programs that retrain people to become more productive..

An Assessment of the International Political Economic Landscape

Asian banks generally tend to hold large amounts of Dollars. The US greenback is the international reserve currency, though the Euro is rapidly serving as its understudy. However, Asian banks hold greenbacks in extraordinary proportions. This is mainly because Asian firms, who export to the US tend to have large stacks of cash that they need to put somewhere. Last week, I started to think that Japan can use its dollar surplus to manipulate financial markets in their favor. In retaliation, though, the US could always to erect a bunch of anti-Japanese protectionist trade barriers to combat this move.

China is becoming the other nipple from which Japan nourishes itself, but the problem is that China exports to the US. So, it is an intermediary between the US and Japan. It has been estimated that China only adds 10% percent value to a product and it is all labor. It is the world's factory, but it also provides a means by which Japan can convert its dollar surplus into currencies that provide more options.

This strategy only works, if others want to acquire dollars. The outlook for scenario is gloomy, as basically everyone has dollar surpluses. However, the greenback has stability and a relatively high interest rate working in its favor. Japan would need to create a trade deficit with the US, buying stuff from the US with dollars while maintaining trade surpluses elsewhere, but frankly we manufacture junk. So, I can’t blame them for not doing this. Why would China want to put itself into Japan’s position, you ask? Japan is a mature economy and they used an export-based model to grow during the post-WW2 era.

The small Tigers of Asia (i.e. Korea, Thailand, Singapore, and Taiwan) are modeling their economic strategies after the Japanese export-driven model. That is the reason why they have been so successful. In the short term, this works. Over the longer term, however, there will be an adjustment that takes place as the economy matures, as Japan has demonstrated with its decade-long slump that began in the 90s.

The problem arises, when the economy matures. So, China has time to let Economists figure their way out of this conundrum. I guess you could worry about the next punk-tiger on the block undercutting you, but I don’t think that any of these "Tigers" can undercut China’s currency hug. The "sleeping dragon" pegs its currency against the dollar so that the currency is undervalued and no other country can compete against their weak currency. They have the scalability to be able to do that.

China doesn’t really want to import the dollar problem. It is quite content to let Japan finance Chinese-American trade. The bulk of the goods that we get from Asia come from China. Therefore, they have all of these dollars that they don't know what to do with, except buy useless crap from us. Ah, but dollars are useful for buying oil. The currency of the international oil market is the mighty greenback. Both the Chinese and Japanese dragons have parched throats and are thirsty for the “black gold.”

Hence, the invasion and subsequent occupation of Iraq; to ensure that only dollars - and not Euros - are good for buying oil. For, if the component of demand for the dollar related to oil were to dry up, the value of the dollar would fall; thus driving up the price of exports, which is a key component of inflation. I have seen this movie before. What we are facing folks is stagflation.

A solution to the “Asiatic Dollar Surplus problem” would be to up oil consumption by Asian countries. Now, if Brazil had significant oil reserves, then Japan could cut us out of the loop, because the two nations have very close trade relations. The oil players in Latin America are Venezuela and Mexico. I don’t think that the US would mind transferring the dollar problem to Mexico and Venezuela. Then it would have an excuse to turn the FTAA into a dollar-currency zone.

The bottom line in all of this is that while the US is the number one net importer of stuff (we even have a mart where we buy stuff that we don't need), it is also the number one exporter of the greenback, which was by design per the Bretton Woods system. This is good for the American consumer, because he/she doesn't have to give up any of their output, yet they get to import portions of output from the rest of the world.

To the victor belongs the spoils, so the saying goes. Be careful Bush, this is a recipe for a downward spiral into a huge amount of debt. Ah, but when you devalue your currency you still get to keep the stuff and you get to wreak havoc on foreign banks, to boot. Fantastic you say? Well, this is bad news domestically, because as a result of this devaluation, the oil that we import just went up, as well. Oil is a major input to just about anything. Not just gas, but also plastic, rubber, etc. Look out for inflation in the near term. The assets you should hold in this environment include tangible assets such as real estate, and collectibles (i.e. gold). They tend to appreciate in an inflationary environment, while the NYSE will be headed downward.

The Austrian economist Joseph Schumpeter used the term "creative destruction" to describe the effect of innovation on the quality of life. A technology comes along through innovation and destroys the predecessor, subsequently improving the quality of life for everyone. We were all better off when the automobile replaced the horse and buggy, right? I would borrow the "creative destruction" term to characterize how the US perpetuates its imperial hegemony and keeps everyone else doing what they are told. The US creates the money and destroys in the process. Somehow, I don't think that this perversion is what Schumpeter had in mind.

Things look pretty for the time being, until the mess in the Middle East boils over and we have a regional war on our hands. I guess life in the oval office is too boring for old ‘W’. He had to go on a fool’s errand and smack a bee’s nest in the Middle East so as to cause the rapture that will serve as the comeuppance of his Zionist Fantasies. The Christian-right calls it the "second coming" and they are excited about it. Heck, they even have ‘W’ there to orchestrate it. You can't help God out enough. He needs all of it that he can get.

The right-wing Israelis think that part of Syria would make a great Palestinian homeland. Heck, it might make a good Lebanese homeland as well. The Lebanese and Jews still do business deals, but just offshore (Cyprus), though. I find that interesting. They may be screaming bloody hell to each other while in their own region, but whence they are off shore, they have no problem doing business with each other. Further evidence that dollars drive will.

A Lesson in Finance

Since I live in the US and I presume most of my readership is in the US, I will confine this essay to the US equity markets, but the concepts can be applied globally. The US Stock Market has historically returned about 11-12%. Investing about $30K today will yield $3MM in 40 years, but this ignores inflation, which has averaged 3% historically. Inflation erodes the purchasing power of the $3 MM. So, when analyzing investment returns, we control for this up front so that everyone is talking about the same thing: the real value of the investment. If we subtract the 3% from the historic returns of the stock market and we get a ballpark estimate of the real annual return of somewhere between 8 and 9%. Given the inflation devil, we can count on the market to return 8% real, over the long term.

The "Time Value of Money" concept means that a dollar today is worth more than it is tomorrow. So, let's analyze a $30,000 investment in the stock market over 40 years at 8%. If we invest $30,000, today, and sit on it for 40 years with an 8% real rate of return, compounded annually, we will have $651, 735.64, assuming no taxes and no transaction costs. Another way of saying it is that in 40 years, $651,735 will be equivalent to $30,000, today, given these parameters. Or, the $3MM at 12% in 40 years will have the purchasing power of $651,735 in today's dollars.

Now let's look at what we would need to do to have $3,000,000 in the future. In order for us to have $3 million, in an 8% interest rate environment, we would need to invest $138,092.80, today, assuming that you meet the market in your return over the course of the investment. The 8% is the mean and there are deviations around that mean. The standard deviation, in finance, is how we measure risk. That is to say, you won't earn 8% every year; there will be deviations around this long term average return. However, for those who invest for the long-haul, they will find that more often than not they will hit their annual 8% real return target in a diversified portfolio.

There are two kinds of risk about which we must worry, when investing: systematic and unsystematic. Systematic risk refers to the risk associated with the market; it is the risk that you face due to changes in the overall market. We cannot control this piece. Then there is the unsystematic risk component, which is something that we can control.

The best way to eliminate unsystematic risk and ensure that you meet the market is to invest in an Index Fund, which is a fund that includes all of the market. There is no unsystematic risk and one does not face the huge transaction costs that one would face were they to buy one of each stock in the market. If you want to match the market, then invest in an index fund.

On the other hand, if you think that you can beat the market by engineering a sophisticated portfolio, then you would decrease the systematic piece of your risk and increase the unsystematic piece. This would increase your risk, but you would also have a potential to beat the market and the risk can be managed through diversification. For unsystematic risk, the way we deal with it is to diversify across different sectors of the market, such as energy/utilities, airlines, telecommunications, etc.

This strategy is a hedge such that if one sector falls vis-a-vis the market, another will rise to a certain degree with respect to the market and depending on their relative risk levels and the weights in your portfolio, the movements will offset each other.
Depending on your risk appetite, we could also include some T-Bills to help you manage your portfolio risks, given a certain appetite for risk. We use T-Bills, or what we call "riskless securities", because they are backed by the US Government, which has never missed an interest payment since it has been in business. I could start talking about Betas - a measure of a stock's relative risk vis-a-vis the market, but it would only complicate this analysis and it might confuse you.

In terms of any portfolio, the key is diversification to minimize risk and maximize exposure to the market such that you optimize your portfolio, given your risk appetite. The best strategy to construct a portfolio that meets or beats the market (75% of the Mutual Funds out there don't do beat this benchmark), while minimizing the portfolio's exposure to risk. A good strategy for a young person would be to buy an Index Fund in a Roth IRA (i.e. with after tax $$), which meets the market return, but also bears the market risks. To further minimize an investor's risk, one would divert some of their nest egg away from the Index Fund and into bonds and some international holdings.

As we near retirement, we will want to gear down the aggressive capital appreciation strategy of our youth and allocate this capital into more conservative investments such as bonds. As a matter of fact, young people should have bonds in their portfolios, anyway. This serves as an effective means to insulate our portfolios against market variations, or systematic risk. Young people should probably allocate 10-20% of their nest egg toward bonds and another 10% to international holdings. If I were constructing a portfolio, I would probably have 10% in a Bond Fund, 10% in an International Fund, and 80% in an Index fund.

There all kinds of different kinds of bonds that people can buy and interest rate games that speculators can play. I could go into these, but it would make this post very long. It is too long to get into in one post and there is a difference between investing and speculation. Speculation is like gambling; one should only engage in it, if they can afford to lose the cash.

The key is to invest for the long term and be diligent about investing on a consistent basis. Ultimately, your long term return depends on how much risk you assume; the market rewards those who assume risk in their portfolios. Your job is just to minimize your exposure to it. The theory teaches us that the more risk you are willing to take, the more reward you can expect. That is not to say that there won't be bumps along the way. It just means that over the longer term, when things average out, you will be compensated for the added risk you assumed, given that you took appropriate measures to manage the risk in your portfolio.

The Inmates are Running the Asylum...

Mankind's constant state of warfare, or constant posturing thereto has perplexed the finest minds to have ever graced this planet. Why do we, as the richest country in the world, continue to wage war. It would be one thing, if we were merely protecting ourselves, but we go out looking for wars.

One answer might be that we have created a cancer within our society called the Military-Industrial Complex, which demands to be fed. Soon we will be a new Prussia. We won't be a state with a military, but rather a military with a state. "Jawohl mein Fuehrer! Sieg Heil!"

In liberal democracies, the military is supposed to be subordinate to civilian-rule. That is, we are supposed to be a state with a military, not a military with a state. I fear that it is too late to change the tide. We needed to listen for when the military starts complaining of civilian leadership that has no military background running the military, and how bad that is for the military. It sounds a little like a birdie saying "Coup? Coup?"

Here is a rule of thumb: Never trust a military officer, when they say something that leads to the conclusion we need a new high-tech, obscenely expensive and very profitable weapons system. They are in bed with the corporate interests.

On Innovation

Innovation is stifled in two ways: poor communication culture and grade inflation. Economics is the study of incentives and both grade inflation and poor communication are products of perverse incentives. As we will see, in the course of this discussion, perverse incentives can take many forms and yield some interesting results.

Companies run more efficiently when executives cooperate with each other; instead of merely trying to protect their turf and keep from getting “beat up” in meetings. I am a consultant and at my last client, there was no incentive for one department to talk to the other, because they just wanted to protect their turf. In organizations that lack a free and open communication culture, where executives keep things secret at the top, innovation is stifled. People don't want to take risks as they are afraid of being punished or what I term "thrown under the bus." Thus, the whole enterprise suffers.

We can take the metaphor of a house in which the CEO is the patriarch and the departmental heads are the children. If a lamp is broken, people start protecting their terf, instead of together to figure out how to fix the problem (i.e. sharing info), the result is a modus operandi of constant crisis. Things are constantly operated in "crisis mode" and the goal of each chief is to put out fires so that their ass doesn't get burnt.

Naturally, in this reactive management style, there is no management of anything except crises. It is better for executives to manage things proactively, as things run more efficiently. The challenge that I see is how to convert an organization that is reacting to crises to one that proactively addresses issues in which cross-functional specialists collaborate on how to fix core business problems. This would have the result of increasing innovation, allowing people to take calculated risks, and more operational efficiency.

If the variable pay of executives were tied to how well they communicated with other departments (although evaluating this would be the challenge, given its subjective nature), then the incentive would exist for departments to collaborate and a firm could move from a reactive management style to one that is proactive. Communication is the key to planning. Companies are built off of information and when information stops flowing, progress is stifled. Companies don't plan correctly and this is why they hire consultants to come in and tell them they are stupid.

The command and control concept comes from how the military runs. Management Science wasn't even a discipline prior to WW-2, when the US military needed to optimize its logistics for the war. In general, fragmentation of your troops, units, and divisions is bad news. In military operations, one needs central planning of the war so as to maximize the efficiency by effective resource allocation across the battles.

We can see the results of misallocation of resources as far back as the Civil War. During the Civil War, the regiments of the South were fragmented. Soldiers thought of themselves first as Virginians and second as members of the Confederacy. There was very little central planning. However, this weakness in their operations was offset by the Southern man's “will to fight”; if you see your house burnt down by a Yankee, you don't care about anything except killing Yankees. In the North, the soldiers really didn't care about the war as much as the Southerner. To them, it was just a steady paycheck.

The Civil War wasn't about slavery. Only the elite, which constituted 15% of Southerners (i.e. the landed upper-class) could even afford to own slaves. Of the other 85% of Southerners, who couldn't even afford to own a slave, a good portion of them didn't agree with the practice.

The fact is that the war was about states’ rights. When you boil that down, you can see a clash of two economies: agriculture and industrial. Each had its own set of values and priorities, which determined their position on what was "morally right." After the Civil War, states lost their rights and we became more federal; power became concentrated in the Federal Government.

One could plausibly argue that slaves were healthier as slaves, than when they were free because the plantation owner had an incentive to keep them healthy. There the pesky economics goes again, rearing its ugly head. Sharecropping was just another iteration of slavery, but people had the illusion of freedom. Slavery was destined to die off, though; the rest of the world was already moving in that direction.

Ultimately, the Civil War settled a dispute over the Constitution. The South really lost the war in the definitive Battle of Gettysburg, when Lee told one of his top officers (i.e. Pickett) to take a hill on which the Union was positioned. It was a gross waste of resources, because "Pickett’s Charge" cost Lee 15,000 men over the course of two battles. If I could go back in time just once, I would go to Lee that day and whisper in his ear "never try to take a hill from a downward position; you are at a disadvantage."

Another stifling factor for innovation and a primary cause of the housing boom has been grade inflation. You may raise your eyebrows at this thought, but just hear me out. There is a correlation. I believe the housing boom has been fed by two factors: excess global liquidity and diminished confidence in capital markets.

We can expect interest rates across the board to increase over the near term to address the excess liquidity and equilibrate capital demand with supply. The reason that there is excess capital is because people are putting their eggs in tangible assets and staying away from equity investments. They were burned in the Internet bubble of the early 00's and so they are staying away from equity investments. This fear is feeding the current housing bubble. People are moving their nest egg into real estate, which has historically returned 5% per year, adjusted for inflation.

This is part of the problem in 3rd world countries, where people lack confidence in capital markets. So, they buy something tangible such as land. However, land alone is unproductive. So, you have capital being invested in land, but not being made available for the capital markets, because there is a problem of transparency.

This problem stifles innovation, because people with ideas need capital to invest in R & D, which then causes the overall quality of life for the market in question to improve. This is what we mean, when we talk of "dead capital" in the 3rd world. Capital assets should be generating income; they should be put to use bringing the ideas on which capitalism is based to life through investment in R & D.

We in the US have our own problems with capital markets. In the US, people have lost confidence in capital markets as a suitable place for their nest egg. We can thank the accounting scandals for this. Why did we have the accounting scandals? I posit that the CPA's don't know how to audit anymore. Thus, they weren’t smelling rats, when they should have. This goes to grade and test score inflation. People are passing the CPA exam, who should not be, because they lack the necessary auditing skills to hold companies accountable to their financial statements, which is the primary information that investors use to base their decisions.

Now why do we have grade and test score inflation, you scratch your noggin? I posit that the reason these menaces exist is two pronged: a shift in the approach to education and the nature of the education business. The philosophy of education has transformed from one where an average grade was a "C" to one where the grades are inflated. There have been more perfect scores on the SAT in recent years than at any other time in history. Now, either we can give props to Darwin insofar as we are witnessing natural selection at work and our gene pool is flushing out the idiots, while keeping the geniuses, or the test itself is getting easier. There has been a shift in the approach to education. The education system has been moving toward enhancing student self-esteem. However, I think there is a larger problem at play.

When companies hire newly minted graduates, they hire those with the most A's. Businesses view schools that produce many students with high grades as providing a quality product. So, they have an incentive to “shop” there for skilled labor. In this context, the school has an incentive to inflate grades so that its graduates get top jobs or go to top graduate schools, which it can subsequently advertise to prospective students as the return that they will earn for choosing their school. The machine feeds off of itself.