Browsing the archives for the Economic Activity tag.

Virtual Fixed Assets

Economic Reality, Virtual Reality
According to the US Bureau of Economic Activity, the real US economy (i.e. non-public sector) spends just over $1 Trillion / year on non-structural fixed assets.
This number excludes the cost of buildings, warehouses and factories but includes all household, farm, business, and non-profit organization spending on fixed assets.  A precise definition is found here.
Roughly half of that amount ($537 Billion in 2011) is on information processing equipment and slightly over half of that amount ($279 B) is software.
Spending on transportation equipment (trucks, cars, ships) was $232 B and industrial equipment (engines, lathes, robots, …) $178 B. Furniture and other types of equipment (e.g. agricultural, mining, oil rigs, …) was $194 B.
Within the $537 B on information processing equipment, is spending on computers ($79 B ) and network equipment ($77 B).  The 3rd largest sub-category after software is medical equipment at $72 B.
So the largest single spending area for fixed assets is for software which is a virtual asset! Henry Ford must be spinning in his grave!
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Demystifying The Price of Gold

Economic Reality, Financial Crisis

Putting long-term savings into GICs is turning out to be riskier than investing in hard asset such as precious metals, land, or other commodities such as oil, copper, etc.

The World Gold Council just published a historical view of central bank “balance sheets” since the 2007 crisis: (click on the chart if you need to make it larger)

A central bank’s “balance sheet’ is a relative measure of money supply.  Although there are more exact measures of money supply, when you see a central bank’s “balance sheet” tripling in the case of the USA, or quadrupling in the case of the UK, it really doesn’t matter which one you use and this one is good enough to understand the price of gold.

The buying power of money over time reflects the forces of supply & demand in an economy.  Basically you have money supply on the one side and economic demand for money on the other (i.e. the size of the economy).  If these are not in balance, then inflation or deflation will occur.

  • Suppose a country has $1 T dollars and an economy measured using a hard asset (like gold) worth $1 T dollars.
  • If the economy grows, as it has since 2007, by roughly 2% compounded per year, it will have grown 10.4% after 5 years – i.e. to $1.1 Trillion.
  • If money supply had stayed constant, each 2007 dollar would be able to buy 10% more in 2012 than it did in 2007 since there is more economic value for the same amount of dollars.
  • But if the money supply tripled over the same time period, as it did in the USA, there would be $3 T dollars to balance that $1.1T in economic activity.
  • So each 2012 dollar is actually worth 1/3 x 1.1 = $0.37 compared to its buying power in 2007.

Can that be true?

  • Consider that the price of gold on Jan 2, 2007 was $639.75 in USD.
  • On Oct 18, 2012 it is $1752 in USD.
  • Deflating back to 2007 dollars, we get $1752 x 0.37 = $642.33!
  • Not quite spot on since we used an average of 2% for economic growth over 5 years instead of individual values.  But you can plainly see what has happened.

By inflating the money supply beyond the natural growth in the economy, the buying power of our long-term savings has dropped by 60%.  The reason why we haven’t seen prices radically increase depends on the type of good:

  • Any commodity which is consumed by economic activity (oil, copper, iron, etc.) will have its price primarily determined by the forces of supply and demand for that commodity (to establish a value) and secondarily by the buying power of money (to establish a price for that value).
  • As an example, we’ve seen a significant increase in the cost of oil & gas but this increase is also affected by global consumption of the fixed supply of oil.  Recently global consumption has been dampened by the global recession being experienced everywhere except Asia, causing a drag on what would otherwise be a soaring price.
  • A manufactured good contains both commodity and labour as inputs.  While the input commodity prices in a manufactured product like a refrigerator or car has increased, the labour cost has decreased since most manufacturing has moved to low cost labour centres such as China, Thailand, and Vietnam.
  • Cheap labour has acted as a brake on inflation in developed economies – effectively exporting the inflation problem to Asian economies.  As an example, the official inflation rate in China has been 2 – 4x the North American rate since 2007 and the actual rate is widely believed to be higher than the official numbers.
  • A precious metal such as gold, or a non-consumable good such as land, will act as a perfect reflector for the buying power of money.  For example, although the value of land in the USA was artificially depressed by the explosion of the housing market bubble in 2007, the price of housing in economies unaffected by that crash, such as Canada, has soared.
  • Much of this increase is not due to another bubble forming, but due to the decline in the buying power of the dollar.  In other words, the house is still worth what it was in 2007, it just takes more 2012 dollars to buy it since a 2012 dollar buys less than a 2007 dollar.

So if you think that the banking crisis is over in Europe and that the USA can afford its ridiculous debt levels without either raising taxes or cutting military spending, then go ahead and invest your hard-earned savings in GICs.

Or you can invest some of your savings in gold as a safe hedge against further erosion of your buying power in future.

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A Better Type of Financial Intervention?

Financial Crisis

At the request of European Union finance ministers meeting in Nice (Sept. 12-13), the European Investment Bank will modernise and increase significantly its volume of lending to small and medium-sized enterprises in 2008 and 2009 to help mitigate the effects of the current credit crisis.

Ministers agreed the Bank should target loans to SMEs totalling 15 billion euro over the two year period as part of a global envelope of 30 billion euro. This level of lending would represent an increase of around 50 percent compared with 2007, when the Bank lent 5.2 billion euro to SMEs via its network of partner banks from the private sector.

In addition, the EIB announced to ministers its intention to give a new 1 billion euro mandate to its European Investment Fund subsidiary to provide mezzanine finance to SMEs.

The increase in lending will accompany sweeping reforms to the EIB’s SME loan product that should make loans both simpler and more attractive for companies and the EIB’s partner banks.”

Instead of propping up and rewarding reckless banking with bail out packages, it is far better to secure the underlying foundation for the economy. 80% of economic activity in both NA and Europe depends on the health of Small and Midsized Enterprises (SMEs) who are currently finding it difficult to access cash for normal operations.

SMEs routinely need to finance receivables, lease equipment, finance inventory, and make leashold improvements in their physical infrastructure. Most banks are currently jacking up interest rates and lowering credit ratings as they attempt to squeeze SMEs for the cash that the banks need to make up for their mistakes.

Failing to help SMEs will result in massive closures, job loss, and an economic meltdown that will make the Great Depression look like an economic plateau. Already 20% of US car dealers are on the brink of bankruptcy because they cannot finance their inventory.

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