I have a friend who is a bit of a doctrinaire Marxist. We argue, cheerfully, about whether the primary crisis in the world economy is one of resource depletion or of the inherent contradiction in capitalism. If I understand correctly, the latter refers to the necessity of simultaneously depressing wages while expanding markets, a problem epitomized by an apocryphal exchange involving Walter Reuther, UAW:
I went through this Ford engine plant about three years ago, when they first opened it. There are acres and acres of machines, and here and there you will find a worker standing at a master switchboard, just watching, green and yellow lights blinking off and on, which tell the worker what is happening in the machine. One of the management people, with a slightly gleeful tone in his voice said to me, “How are you going to collect union dues from all these machines?” And I replied, “You know, that is not what’s bothering me. I’m troubled by the problem of how to sell automobiles to these machines.
This disagreement abruptly resolved itself two weeks ago with an extraordinary blog piece by Gail “The Actuary” Tverberg entitled How Economic Growth Fails. The fact is, both resource extraction and market development suffer from diminishing returns at the margins, and this leads, inevitably, to macroeconomic trouble.
You Haul Sixteen Tons, What Do You Get?
Lets start with the resource extraction side of the equation. You have a mine with a good seam of coal. You send 200 miners down every day, and get back 3200 tons of coal. You sell the coal, skim off operating expenses and a nice profit, and pay your miners.
The seam runs out. You find a tapered seam connected to it, but now you send down 200 miners and only get 1500 tons of coal. You sell the coal… and you have to pay your miners less, because you can’t double the price and still sell any. Maybe you hire on another 200 miners, so that you can get 3000 tons per day, but now you really have to cut wages. The only thing that can save you is finding another seam of coal, large enough that each miner can pull up 16+ tons per day, before they all go back to school and start working as nurses aides.
This makes inherent sense to people if you tell the story, because the law of diminish returns in blue-collar extraction industries is so obvious. But now lets go white collar and talk about coca-cola. You have a sales force of a thousand, who go out through the world and find places that have water, electricity, and no coca-cola. Coke is good, right? So when the sales people arrive, contract a water purification company to buy syrup and sell cold coke, the company does a bang up business. Lets say each sales worker gets one new bottling plant open per year.
Eventually, though, those new markets are going to run out. You’ve run out of towns in Germany that just didn’t have ready coke. You’ve run out of urban centers in Pakistan. You’re down to waiting for small towns to get reliable utilities, or for protectionist countries to allow more US businesses. You still have your sales force of a thousand, but now it takes two years to open a bottling plant. Your marginal market expansion- the thing that the salespeople are supposed to do- is now half as productive. What do you do? Same as the mine owner- hire more people and pay them a lot less.
The problem is, these are coupled networks. When your sales force stops earning enormous paychecks, they stop buying enormous houses that require three air conditioners to keep cool. So they buy less electricity, which means lower demand for coal, which means more underemployed, underpaid coal miners sitting around drinking tap water instead of coke. This is the definition of a deflationary spiral: the problem is the customers are broke.
Does this have something to do with oil, or China?
Eh, so what, right? We’re headed for Weimar-esque hyperinflation? Look at Zimbabwe? Sorry but no. Hyperinflation happens when the government goes broke before people do, when there’s still production of basic commodities and services and people are able to find them, but can’t negotiate in the available currency. Most of the arguments I’ve seen for impending US hyperinflation are at their core moral arguments- it shouldn’t be possible to borrow your way through life, hence doom will fall on those who try, namely the Fed who we don’t like for other less printable reasons. Right? Buy goooooooooold….
Only moral arguments don’t mean much economically (if they did, we could start with climate change). The fall in the price of oil, rather precipitous given the modest growth in production, probably has to do with the same problem Guitar Center is facing in the link above. Globally, fewer people have the disposable income to put towards oil-intensive stuff, just like domestically stagnating real wages mean nobody has an extra thou for a high-end guitar.
My bet is that today’s (and last week’s) stock collapse reflects a problem of prediction. Up until China started going wonky, American and European businesses based their forecasts on the assumption that soon, they would be selling things like mid-grade circular saws, e-readers, tankless water heaters to “emerging” Chinese, Indian and Brazilian middle-class consumers. Now, with China sneezing mightily and Brazil catching pneumonia (China is Brazil’s primary export market), those forecasts have to be re-envisioned; consumer sales this decade may only reflect current middle-class consumers- the “coal seam” of emerging markets may be much smaller than originally surveyed.
Two obvious effects- the “miners” are going to be paid less, and capital dedicated to meeting last month’s plan for increased capacity is going to sit idle. The result is sort of like the housing crisis, only for everything. Housing prices and mortgage financing got cheaper, but everybody got smacked by the recession and still couldn’t afford to buy. If this turns into another mini-2007, we’ll see cheaper stuff, but you and I aren’t going to have any cash to buy it with.
Interestingly, this deflationary problem- nobody has wages, because nobody is buying, because nobody has wages- is exactly what Keynesian stimulus programs were invented to solve. Give people at the bottom a measured amount of cash for doing something semi-relevant (Keynes said burying empty bottles, Roosevelt said recording the memories of old people) and they’ll spend it buying stuff that they- and everybody else- really needs. The people they buy from will have the money to go back into business and buy from each other, and eventually “the economy” starts moving again. Of course, cynics will argue that it took WWII, which was “good for the economy” (can you imagine what would have happened to “the economy” if the US had lost? war is only “good” when you win), and less cynical people will point to the earned income tax credit (EITC) as a successful example of Keynesianism that everyone takes for granted. Whatever, I’m not really an economist.