Fighting excessive deflation is in some ways more difficult than fighting hyperinflation.
During inflationary times, there is basically no limit to how much central banks can raise interest rates.
But in the battle against deflation, once interest rates have been reduced to zero, there is little that central banks can do to stimulate further growth.
The two things that can be done once interest rates reach zero are:
Central banks use quantitative easing to create money
Faced with the economic meltdown following the 2008 crash, some central banks opted to stimulate their moribund economies via quantitative easing.
Quantitative easing uses the unlimited purchasing power of central banks to buy large quantities of bonds in the open market to pump cash into the economy.
Central banks use quantitative easing to create money where previously none existed.
How is this done?
A central bank "creates" money every time it dips into its "vaults" - essentially a black hole of unlimited financial resources - to buy existing bond from banks or other investors.
These purchases, often referred to as open market operations, inject new money into the economy.
The bank, instead of holding bonds, is now holding the "cash" it got from the central bank.
This money can now be made available for loans to consumers and individuals, thereby stimulating economic growth.
Populist leaders
Solving the economic crises was presented as the reason for expanding government power and limiting citizens' rights.
Marginalised workers usually don't want to hear arcane economic arguments when confronting low wages, unemployment and job insecurity.
Countries are increasingly being governed by radical popular politicians keen to exploit the average voter's fear and insecurities.
Economic and social turmoil have led voters to allow the democratic process to be severely eroded.
In many countries, the media has become a tool of the ruling party or leader, leaving virtually no possibility of disseminating opposing viewpoints or critical arguments domestically.
Once populists have gained power, a typical tactic is to attack the press or the justice system as being part of the problem, not the solution.
Autocratic leaders
In extreme cases, the populists become true autocrats by stifling any form of opposition, pointing out that they, and only they, are able to solve the economic problems in a way that will benefit the average worker.
Autocratic leaders often enrich themselves and their families at the expense of the voters or workers they are ostensibly there to protect.
The dirty little secret of autocratic leaders is that many are more interested in protecting their own interests, such as protecting selected political supporters or an inner circle of oligarchic businesspeople, so they play to the fears of average citizens, manipulating them into voting against the economic interests of the country as a whole.
The EU withdrawal process facing the United Kingdom.
Options
1. No deal.
2. Preferential access to the EU markets
"No deal"
This most extreme option required the United Kingdom to revert tot he status of a normal third-party EU trading partner, where trade is organized according to a set of basic guidelines set out by the WTO.
This radical option did not include any preferential access to the EU whatsoever - meaning that all EU borders, including the one dividing the Republic of Ireland with the UK's Northern Ireland, would have to be respected as if the UK were a foreign nation, with onerous restrictions on the movement of goods and people.
Preferential access
To have preferential access to the EU markets, three variations were considered:
Brexit referendum of 2016 in UK: To stay or to leave the European Union?
Arguments for leaving the EU
United Kingdom had been paying to the EU billions of euros in extra funds - to support everything from agricultural subsidies to infrastructure construction in the poorer countries. This money would return to make Britain a better place.
Arguments for staying in EU
The loss of access to preferential trade with the rest of Europe would, in fact, decrease economic growth and reduce the amount of money available to pay for health care and everything else.
Around the world, electorates were shaken by everything from increased immigration to interference from supranational institutions.. This has led to countries calling for limits on trade, immigration and almost everything else that seems foreign. The problem is that in the twenty-first century economy - which is based largely on cooperation and free exchange of goods, services and ideas - going it alone almost always has negative economic consequences.
Post-Brexit Britain
One of the immediate effects of the referendum vote was a sharp decline in the value of the British pound.
All other things being equal, trade halves as distance doubles
European Union was Britain's major trade partner, accounting for more than 40% of all British exports.
The entire EU trading area Britain was being asked to leave, in fact, encompassed more than 30 countries, including the non-EU members, Iceland, Norway and Switzerland.
One of the axioms of trading with other countries is that, all other things being equal, trade halves as distance doubles.
The head of the Bank of England saw the Brexit vote as an example of "deglobalization, not globalization" and predicted higher prices for consumers and the necessity of higher interest rates to keep inflation under control.
In 2018, the American government began unilaterally imposing tariffs on many foreign imports.
This tactic was seen as a direct affront to the agreement that all trade disputes be settled around a table at the WTO.
The U.S. claimed it was only protecting national security, a claim that was hard to take seriously since the "threat" was coming from longtime allies, such as Canada and the U.K.
The European Union and Canada immediately responded with calls to limit U.S. imports.
Failure of the Doha Round of free-trade talks
The Doha Round of free-trade talks languished during the first years of the twenty-first century.
This was primarily because of the reluctance of rich countries to lower barriers to trade on agricultural goods, bowing to their farmers' insistence on having protected markets.
These policies, however, ended up destroying the possibility for farmers from poor countries to increase agricultural exports and earn the income they needed to survive.
Another cause for the failure of the Doha Round was the growing reluctance of developing-world countries to open their markets to manufactured goods in order to protect inefficient local industries.
Bilateral Free-Trade Agreements (FTAs)
In the end, most countries decided to start small, by signing bilateral free-trade agreements (FTAs), which are easier to negotiate and easier to sell to isolationist electorates because
World Trade Organization (WTO)
Once FTAs are in place, some sort of mechanism is needed to ensure that countries respect the promises they have made.
Commissions were set up to monitor bilateral trade.
A worldwide trade watchdog, the World Trade Organization (WTO) resolves disputes in an organized forum based in Geneva, Switzerland.
The role of WTO is actually quite limited.
The three forms of trade barriers
There are 3 forms of barriers to trade:
Tariffs are a form of tax. Taxes of any form end up being paid for by the end consumer.
By imposing a quota, a country simply limits the quantity of foreign products that can be imported.
Both quotas and tariffs raise the price of foreign-made goods.
Governments can also use taxpayers' money to provide a subsidy to local producers, making the price of local goods artificially lower than the price of equivalent imported goods.
Why does a country impose trade barriers unilaterally?
Most trade barriers are imposed unilaterally by one country acting on its own to limit imports from abroad.
These barriers are usually designed to "temporarily" protect local producers from foreign competition, and in theory allow them to improve their productivity.
The problem is that local producers, once given the comfort of a protected market, rarely make the sacrifices necessary to improve their products or lower their prices.
Competing in the International Markets
Historically, developing countries have been some of the strongest proponents of reducing trade barriers, primarily because their only hope for sustainable growth is to have access to international markets.
Those that have insisted on putting up trade barriers, such as Brazil and India, usually remain in a low-productivity trap that ensures their goods are not competitive on the international markets, and they consistently run up large trade deficits.
Countries with low trade barriers, such as Switzerland and Singapore, not only consistently run trade surpluses - even with strong local currencies - they also provide their citizens with the benefit of free access to low-cost products from around the globe.
Multiparty trade system
In any multi-party trade system, there will always be imbalances, deficits or surpluses in the monetary value of goods and services traded.
These imports, if not made up for in an equal number of exports, are "paid for" by sending something else abroad - usually paper assets, such as stocks and bonds.
The purchase of U.S. dollar securities is the way most countries have compensated for the imbalances in trade with the United States.
In the interconnected global economy, what gets spent never stays in one place. What India earns from its many call centers can be spent on South Korean televisions, and what South Korea earns from its exports can be spent on Brazilian chickens or American tractors. In the end, it all adds up.
Deciding to start a trade war because you run a deficit against any one country is like saying you want to punish the country that sells you what you really want.
Trade deficits and Trade surpluses
The economic terms used by most politicians when beating the drums for trade wars are trade deficits and trade surpluses, which focus mainly on the trade in physical goods.
But many countries are making more and more money exporting services like
Trade Balance: Current account is balanced by the country's capital account
The obsession with trade deficits is misplaced because the deficit and surplus in goods and services is offset by monetary transfers.
Most economists, therefore, look at the total trade in goods and services, referred to as the current account, which also includes such financial transfers as money sent home by citizens working abroad and interest paid on foreign debt.
This current account is balanced by the country's capital account, which adds up all investments - mainly international purchases and sales of financial assets.
These two measures, when added together, always add up to zero. One balances out the other. Which is why the total measure of trade is referred to as the trade balance.
The benefits of free trade outweigh the disadvantages
Politicians who speak of "winning" and "losing" in trade don't understand that all trade in goods and services is balanced by monetary transfers moving in the opposite direction.
Essentially, all the global trade in goods and services and flows of money between countries add up to zero, but trade is not a zero-sum game, where one country's loss is necessarily another country's gain.
The benefits of free trade outweigh the disadvantages
All-out Trade War
An all-out trade war usually ends up hurting almost everyone in a given economy, even those segments the politicians say they are trying to help.
1. 2018 U.S. instigated trade war
Farmers and workers in the American Midwest were shocked to see that China and other countries retaliated to the opening salvos of the 2018 U.S instigated trade war by massively increasing tariffs of their own on American wheat, soybeans, and a variety of other goods produced in the Midwest, including Harley-Davidson motorcycles.
2. 1929 stock market crash massive trade barriers
The U.S. put up massive trade barriers after the stock market crash of 1929. It led to a serious decline in economic activity and the loss of millions of American jobs when the rest of the world responded in kind. The result was a worldwide depression.
The goal of free trade
The goal of free trade is ostensibly to provide a level playing field, permitting individuals and companies to have the opportunity to sell their goods and services in foreign lands.
In theory, when every country in the world is allowed to do what it does best, the world economy prospers, and almost everyone is better off.
In general, trade increase income and with access to imports, companies and consumers have more of a choice about what to do with their increased income.
But what happens when one country imports more than it exports, leading to job losses?
Is the answer simply to close off the country to trade?
1. Opium Wars
Trade wars in the past have sometime ended with actual military conflict.
The Opium Wars between the Qing dynasty and the British Empire in the mid-1800s. This ended up forcing the Chinese to remove virtually all its onerous import duties as well as to give up Hong Kong to British rule. By the time Hong Kong was returned to China in 1997, it was one of the most successful trading centers in the world.
2. Banana Wars
The occurred between United States and several European countries at the end of the twentieth century. These centered on removing European barriers to Latin American banana producers, which were mainly owned by U.S. companies.
3. Pasta Wars
In the mid-1980s, Reagan administration tried to open up markets for American lemons and walnuts in Europe by placing punitive tariffs on imports of European-made pasta.
Both the Banana and Pasta Wars disputes were resolved amicably with the warring parties gradually removing the disputed tariffs.
Economic Growth and Happy Electorate
Economic growth did not necessarily translate into a happy electorate.
GDP and GNP
GDP is the traditional measure of the total output of goods and services per year. Basically, GDP adds up the money we as consumers and companies and government entities spend over the course of the year.
GNP - gross national product - picks up where GDP leaves off and includes international expenditures in its summary of economic growth.
GNP>GDP or GDP>GNP
Sometimes GNP is bigger than GDP, and sometimes it is the other way around.
How do you compare GDP among countries with different currencies?
It is difficult, because the value of economic activity in each country is denominated in currencies that are constantly changing in value.
One method is simply take the value of each country's GDP at the end of the year and translate it into one common currency using official exchange rates.
Most economists and statisticians, try to adjust each country's GDP using a "real world" exchange rate.
PPP is a simple calculation.
One country's currency, such as the U.S. dollar, is chosen as the base currency.
The dollar value of a selected basket of goods and services is then compared to the value of the same items in another country using traditional exchange rates. In most cases, the two values won't be the same.
It is often difficult to come up with a perfectly reliable PPP. The choice of items to be included in the basket used to determine PPP has to be made carefully.
The Big Mac Index
The Economist magazine, somewhat jokingly, came up with a PPP using the costs of Big Macs around the world.
Since the Big Mac is identical in every country, and sold all over the world, the Big Mac Index has now become a reliable tool to see how prices vary around the world.
GDP per capita
It can also be useful to relate a country's total GDP to the number of inhabitants, giving us a more realistic view of how wealthy a country really is.
GDP per capita, is often used to compare economic power among countries.
By dividing each country's total economic output by the number of people living in the country, we get a more accurate idea of who is richer.
Impossible to capture the complete picture
No measure of economic growth and economic power, however, is able to capture the complete picture.
Quality of life
Quality of life, for example, isn't included in traditional measures of GDP.
The GNP does not allow for the health of our children, the quality of their education, or the joy of their play.
Neither GNP nor GDP gives us a truly complete picture of our economic health.
UNHDI measures of Economic well-being (most popular)
The most popular accepted measure of economic well-being is the United Nations Human Development Index (UNHDI), which rates countries according to their levels of health, education, and income.
The UNHDI measures such areas as
Gross National Happiness Index
Some countries, such as Bhutan, have tried to look less at tangible measures and more at happiness, instituting a Gross National Happiness measure in 1972.
Although happiness and well-being are notoriously difficult to measure, tracking opinion polls, search request data, and social media activity give us valuable information that can be used to determine which country can justifiably chant, "We're number one!"
Bretton Woods Conference (end of World War 2)
One of the major accomplishments of the Bretton Woods Conference was the plan to link virtually all the world's major currencies to the U.S. dollar in a sort of fixed-exchange system, with the dollar serving as an anchor to global economic activity
The value of the dollar, in turn, would be linked o a fixed amount of gold - one ounce for every thirty five dollars.
The Bretton Woods system allowed countries from Japan to Germany and from France to Brazil to grow and prosper. But when the U.S. began running huge deficits - printing enormous sums of money to pay for everything from Asian wars to Great Society antipoverty programs - the rest of the world began to lose confidence
Abandoning the Gold Standard
In late 1960s, France began losing confidence in the system and started asking for the actual gold that had been backing up the U.S. dollar, and other nations followed the example. Soon, more than half of the U.S. gold reserves had been transferred abroad.
The American government decided that the only solution was to abandon the gold standard. From 1971 onward, the U.S. dollar and virtually all currencies in the world became fiat currencies, backed by nothing than the faith of the people using them.
From that moment on the Bretton Woods system of fixed exchange rates was transformed into a system of freely floating currencies, with their values determined by the foreign exchange markets.
Interest rates and Money supply
Interest rates and money supply are the major tools the Fed and other central banks have traditionally used to control economic growth; the key is in how the tools are applied.
A country's economy is regulated by its money supply, which determines interest rates. And each country's money supply is controlled by its central bank. These quasi-public institutions are set up by governments but are then given the independence to keep an economy under control without undue interference from dabbling politicians.
How to measure and monitor growth and inflation in an economy?
Despite the tendency of the media to concentrate on the latest major economic statistic, such as GDP growth or unemployment, there is no one single indicator that tells us
In addition, there is no way to know how quickly an economy will respond to changes in monetary policy.
Central bankers, therefore, need to be prescient and extremely careful - keeping
In the twenty first century, with the amount of capital flowing around the world dwarfing many countries' money supplies, it is almost impossible to know with certainty what the effect of any one monetary decision will have on a local economy, let alone on the world.
Fiscal policy or Massive deficit spending
Given the extremely low inflation rates in the 2010s, some have called for alternative methods for controlling economic growth. Instead of using the central banks' authority to raise tor lower interest rates, referred to as "monetary policy," another solution would be to use "fiscal policy" to alter the money supply - essentially allowing governments to circumvent central banks by printing massive amounts of money to increase the money supply, for example.
The use of a government's ability to issue new currency to influence economic growth, commonly referred to as Modern Monetary Theory (MMT), is not unproblematic in that inflation can come roaring back at a moment's notice.
Many governments may misuse the power of MMT to pay for massive deficit spending in ways that lack the prudent guidance provided by the world's central banks.
Unforeseen and unpredictable events
Sometimes financial crises are caused by - and sometimes solved by forces - entirely unconnected to the original problem.
Most of the recent financial meltdowns,
were exacerbated by economic and sociopolitical forces well outside the control of any one country and greatly affected markets around the world.
U.S. dollar as the world's main reserve currency
Almost a third of foreign central banks hold the U.S. dollar as their main reserve currency.
These persistent trade deficits, led the U.S. president in 2018 to begin a series of trade wars, hoping to keep the benefits of holding the world's reserve currency while using the threat of global trade wars to eliminate the deficits, come what may..
An isolated event in one part of the world can have an immediate effect on markets worldwide.
Global investors who are losing money in one sector often tend to sell investments in another sector, or another part of the world, to cover their losses.
It works in the opposite way for countries that have currencies that are considered safe havens in time of economic turmoil.
Today's news is peppered with economic terms, but rarely is any attempt made to help us cut through the complex jargon we are being bombarded with.
Essentially, the world economy is no more complicated than the domestic economy that we navigate daily. Sound economic judgement is one of the most needed skills in the world today. We need to have the tools to be able to make sense of future economic events - good or bad.
Many of us are bewildered by a fast changing global economy that seems too big and too complicated for us to understand. So we let the politicians make our decisions for us. Unfortunately, the politicians are not always going to do what is best for us. They are going to do what is best for them and their re-election chances.
Politicians care about what voters think, especially voters in blocks, and not a shred about what economists think. Talking to politicians about economics is therefore a waste of time. The only way to make governments behave as if they were economically literate is to confront them with electorates that are.
Value investing rests on three key characteristics of financial markets:
1. The prices of financial securities are subject to significant and capricious movements.
2. Despite these gyrations in the market prices of financial assets, many of these assets do have underlying or fundamental economic values that are relatively stable and that can be measured with reasonable accuracy by a diligent and disciplined investor.
3. A strategy of buying securities only when their market prices are significantly below the calculated intrinsic value will produce superior returns in the long run.
Think of this formula as the master recipe of Graham and Dodd value investing:
These are not trivial decisions. To search for securities selling below their intrinsic value is one thing, to find them quite another.
