Archives For Economics

NOTE: Though I am referencing an article on a conservative website, this is NOT a political post. It’s an ECONOMICS post.

I read this article this morning. In case you’re not familiar, Dan Price, CEO of Gravity Payments announced recently that he was going to set his company’s minimum wage at $70,000 per year. A noble goal, according to some. The media went nuts. Everyone was singing this guy’s praises.

Well, it turns out it wasn’t such a great idea.

Actions meet (unintended) consequences:

What few outsiders realized, however, was how much turmoil all the hoopla was causing at the company itself. To begin with, Gravity was simply unprepared for the onslaught of emails, Facebook posts and phone calls. The attention was thrilling, but it was also exhausting and distracting. And with so many eyes focused on the firm, some hoping to witness failure, the pressure has been intense.

More troubling, a few customers, dismayed by what they viewed as a political statement, withdrew their business. Others, anticipating a fee increase — despite repeated assurances to the contrary — also left. While dozens of new clients, inspired by Mr. Price’s announcement, were signing up, those accounts will not start paying off for at least another year. To handle the flood, he has already had to hire a dozen additional employees — now at a significantly higher cost — and is struggling to figure out whether more are needed without knowing for certain how long the bonanza will last.

Two of Mr. Price’s most valued employees quit, spurred in part by their view that it was unfair to double the pay of some new hires while the longest-serving staff members got small or no raises. Some friends and associates in Seattle’s close-knit entrepreneurial network were also piqued that Mr. Price’s action made them look stingy in front of their own employees.

Then potentially the worst blow of all: Less than two weeks after the announcement, Mr. Price’s older brother and Gravity co-founder, Lucas Price, citing longstanding differences, filed a lawsuit that potentially threatened the company’s very existence. With legal bills quickly mounting and most of his own paycheck and last year’s $2.2 million in profits plowed into the salary increases, Dan Price said, “We don’t have a margin of error to pay those legal fees.”

The author of the article sums it up nicely:

It didn’t work for two reasons. First, a business can’t survive when employees can’t generate enough value to give you a big enough return on what you pay them. And if they can’t do that because you paid them too much, that’s not on them. It’s on you. Second, people don’t appreciate what they haven’t really earned. You think they’re going to be grateful and loyal to you because you were so good to them. It doesn’t work that way.

I just read a very interesting and insightful interview with Nouriel Roubini ($), Economist and Professor at New York University, in this week’s Barron’s. Here’s a few excerpts for you:

Barron’s: Which banks, specifically, will fail?

Roubini: I don’t want to name names, but many, given the housing bust, will become insolvent.

Figures! They never give the really important details.

Talking about prevention of this crisis…

Barron’s: What should Bernanke have done a year ago, or even prior to that?

Roubini: The damage was done earlier, beginning when the Greenspan Fed lowered interest rates in 2001 after the bust of the technology bubble, and kept them too low for too long. They kept cutting the federal funds rate all the way to 1% through 2004, and then raised it gradually instead of quickly. This fed the credit and housing bubble.

Also, the Fed and other regulators took a reckless approach to regulating the financial sector. It was the laissez-faire approach of the Bush administration, and (tantamount to) self-regulation, which really means no regulation and a lack of market discipline. The banks’ and brokers’ risk-management models didn’t make sense because no one listens to the risk managers in good times. As Chuck Prince (the deposed CEO of Citigroup) said, ‘when the music plays you have to dance.’

“…no one listens to the risk managers in good times.” So true! Just like no one listened to the bears during the internet bubble.

Talking about what regulators are doing now…

Barron’s: Now the regulators are attempting to make up for lost time. What do you think of their efforts?

Roubini: The paradox is they’re going to the opposite pole. They are overregulating, bailing out troubled participants and intervening in every market. The Securities and Exchange Commission has accused others of trying to manipulate stocks, but the government itself is now the manipulator. The regulators should investigate themselves for bailing out Fannie Mae (FNM) and Freddie Mac (FRE), the creditors of Bear Stearns and the financial system with new lending facilities. They have swapped U.S. Treasury bonds for toxic securities. It is privatizing the gains and profits, and socializing the losses, as usual. This is socialism for Wall Street and the rich.

EXACTLY! I see the same thing with executive pay!

Barron’s: So the government should have let Bear Stearns fail, not to mention Fannie and Freddie?

Roubini: If you let Bear Stearns fail you can have a run on the entire banking system. But there are ways to manage Bear or Fannie and Freddie in a fairer way. If public money is to be put at stake, first all the shareholders of these companies have to be wiped out. Management has to be wiped out, and the creditors of Bear should have taken a hit. Why did the Fed buy $29 billion of the most toxic securities, and essentially bail out JPMorgan Chase (JPM), which bought Bear Stearns?

I like this guy.

The rest of the interview is just as interesting as the points I highlighted. I’m going to see if I can get Barron’s to make it publicly available.

Take a look at the chart of the five-year history of the U.S. Dollar’s relationship with the Euro:

Back in August 2003, one U.S. Dollar purchased .9184 Euros. As of last Thursday, one U.S. Dollar only purchased .637 Euros, a decline of 30.64%! To put it in perspective, imagine you are going to take a trip to Europe. You reserved a hotel that is €200 per night or $313 per night (€200 ÷ .634 = $313). Leaving out inflation, that same hotel room would have only cost you $217 per night back in August 2003. That’s quite a difference. This is why other countries are griping about the falling dollar: it makes their goods and services more expensive compared to the U.S. Dollar.

Of course there’s another side to this: goods and services purchased in the U.S. with Euros are now cheaper. Using the example from the previous paragraph, a hotel that is $200 per night will cost a European tourist €127 per night. That same hotel would have cost them nearly €184 per night back in 2003 (again, ignoring inflation), or 44% more.

The dollar’s fall also makes imported goods and services more expensive here in the U.S., which means U.S.-produced goods and services are now more affordable when compared to imports and it also makes our goods and services cheaper overseas. This is good for us but bad for other countries.

There are negative aspects to the dollar’s fall. The biggest in my opinion, is with the price of oil. According to OPEC’s President, Chakib Khelil, each 1% drop in the value of the dollar against the Euro, means a $4 increase in the price of a barrel of oil. (I’m not sure how he came up with those numbers.) The dollar is down about 7% against the Euro so far this year. Based on that, about $28 of oil’s $50 price rise can be attributed to the falling dollar.

These trade-offs (and lots of others) are what make the study of economics so interesting.

I’m not saying the dollar’s fall is a good thing, but it does have some benefits.

I read a very interesting opinion piece in the Wall Street Journal titled, We Can Lower Oil Prices Now. The author of the editorial is Martin Feldstein, who was chairman of the Council of Economic Advisers under President Reagan and is a professor at Harvard and a member of The Wall Street Journal’s board of contributors. What he says makes a lot of sense. Especially this (I hate to cut and paste so much of the article but I need it all to illustrate his point):

Unlike perishable agricultural products, oil can be stored in the ground. So when will an owner of oil reduce production or increase inventories instead of selling his oil and converting the proceeds into investible cash? A simplified answer is that he will keep the oil in the ground if its price is expected to rise faster than the interest rate that could be earned on the money obtained from selling the oil. The actual price of oil may rise faster or slower than is expected, but the decision to sell (or hold) the oil depends on the expected price rise.

There are of course considerations of risk, and of the impact of price changes on long-term consumer behavior, that complicate the oil owner’s decision – and therefore the behavior of prices. The Organization of Petroleum Exporting Countries (the OPEC cartel), with its strong pricing power, still plays a role. But the fundamental insight is that owners of oil will adjust their production and inventories until the price of oil is expected to rise at the rate of interest, appropriately adjusted for risk. If the price of oil is expected to rise faster, they’ll keep the oil in the ground. In contrast, if the price of oil is not expected to rise as fast as the rate of interest, the owners will extract more and invest the proceeds.

The relationship between future and current oil prices implies that an expected change in the future price of oil will have an immediate impact on the current price of oil.

Thus, when oil producers concluded that the demand for oil in China and some other countries will grow more rapidly in future years than they had previously expected, they inferred that the future price of oil would be higher than they had previously believed. They responded by reducing supply and raising the spot price enough to bring the expected price rise back to its initial rate.

Hence, with no change in the current demand for oil, the expectation of a greater future demand and a higher future price caused the current price to rise. Similarly, credible reports about the future decline of oil production in Russia and in Mexico implied a higher future global price of oil – and that also required an increase in the current oil price to maintain the initial expected rate of increase in the price of oil.

That would explain why OPEC isn’t falling all over themselves to produce more oil. Why would they want to do anything that would lower the price? I do think it’s almost criminal for OPEC’s president to come out and make predictions on the price of oil. What does he think is going to happen when oil is trading at $140 and he says it’s going to $170? Surely he knows he has the ability to drive prices!

Anyhow, read the entire editorial. He makes a lot of sense.