An economy can be compared to a dam built on river. Productive effort of the people in that economy is the water that flows into the dam, in the form of wealth. It can be stored and diverted, for productive purposes like infrastructure development and advancement of technology, just as water in a dam can be used for irrigation and power generation. But wherever there is a flow, there is silt that gets carried along and deposited.
In case of a river it is in the form of tiny fragments of rocks ranging from pebbles to fine sand. The rate or deposition of silt is directly proportional to the rate of flow. Just as dams need de-silting on a regular basis to keep them operational, economies also need to be de-silted to stay operational.
The bottom gates in a dam are opened to flush out the silt accumulated in the reservoir of a dam to increase the water holding capacity of the dam. This needs to done on a regular basis as too much silt poses a structural risk to the dam. In other words too much of heavy silt behind the dam can and will break it over time.
In case of an economy the non-performing institutions, represent the silt. They sink to the bottom and gradually choke the economy by reducing its capacity. This silt builds up over time and eventually leads to the failure of the economy, as its capacity to hold real wealth generated by productive effort diminishes.
Dredging is an operation designed to clear up navigation channels in rivers and not for de-silting dams. Similarly, using superficial austerity measures to de silt an economy is like using a spoon to dig a 6 feet deep ditch in the ground. Letting any institution in the economy that is not financially prudent, fail and wind up is akin to flushing a dam by opening the gates at its bottom.
Pumping up desalinated sea water to irrigate the fields to compensate for the loss of water holding capacity of a dam, instead of flushing out the silt deposited in the dam is a highly energy inefficient act. Only a government can justify such an action on the basis of generation of employment at the expense of someone’s/taxpayer’s money. Other similar insane actions of a government include, asking central bank in an economy to print money out of thin air. Currency devaluation and heist on a national scale is carried out to keep the economy going. It is not generation of wealth, but destruction of productive effort of the people in the economy.
Silting in a dam can be reduced by afforestation in the catchment area of the river. In case of an economy it can be achieved with the use of gold standard for money and with prudent lending standards. There is nothing that is too big to fail in an economy. Every empire in human history including the largest of them, the British Empire did wind up. A government that support failing ‘too big to fail’ institutions, eventually gets flushed out.
Almost every government in the world is reluctant to do some economy flushing. Iceland is an exception in recent times. Most economies are very reluctantly resorting to dredging. Tax increases and budget cuts in the range of 1-5% are comparable to using a dredger to desilt a dam. Flushing out the silt can be achieved only when taxpayer money is not used to support non-profitable institutions, irrespective of their size.
Default of a different kind is happening as you read this article. Governments around the world are draining out the productive effort of hardworking prudent people. Every time a central bank in any part of the world prints money out of thin air, everyone using that currency is being subjected to larceny. This is akin to opening the floodgates, at the top of a silted dam to drain out water that cannot be stored.
There is a very interesting zero sum game happening in the global economy right now. Prudent depositors in many European countries are moving their deposits from account denominated in Euros to those denominated in US dollars with a hope of preserving their capital in the event of a ‘catastrophic’ default in the Euro-zone leading to a collapse of the Euro.
The US FED (federal reserve bank) is sending dollars to Europe to buy out bonds of the weaker economies to bail them out, Italy being the most recent beneficiary. The borrowing cost for Italy (interest rate paid to get some debt) fell by about 50% in just about one month. Italian economy did not improve so dramatically in the span of a month, but yet the cost of borrowing has decreased by half, thanks to the benevolence of Uncle SAM (US Government and FED). US taxpayers might never be able to figure out why Uncle Sam is often benevolent to outsiders while behaving like Shakespeare’s Shylock (the wicked moneylender from the ‘The Merchant of Venice’) towards them.
In the Indian economy, subsidies represent the silt choking the dam. If captains of industry and foreign investors can demand tax holidays and land for free and many other sops to create jobs then why not reimburse political parties that create part time employment for millions and full time employment for hundreds of thousands of unskilled labor in India. From food to fuel, subsidies should be seen as a return on investment for a political party that manages to win in the world’s largest democracy. Blessed are those, who feel or believe that subsidies are for the betterment of the hungry millions, for they shall inherit utopia.
Reforms such as FDI (foreign direct investment) in retail are vehemently opposed, as they would disrupt the present system of cash and balances (instead of checks and balances) that nourishes the political machinery at the grass roots. Big branded retail shops would make a significant dent in the profits of the established retailers, the main source of funding for the lowly political worker. Taxes paid by major retailers end up in the pockets of political bosses in the ruling party and seldom trickle down to the party worker at the street level.
The present single window system is much easier to comprehend for a small entrepreneur willing to start/operate an enterprise. S/he just is required pay a negotiable and easily decipherable tax/contribution to the local politician, instead of a plethora of taxes with weird names like MAT,GST, VAT, Octroi (not octopus), electricity bill, Commercial tax… and the list goes on and may be never ends.
Privatization in telecom sector is portrayed as a shining example of reforms. However there is a dark side of it that often goes un(der) reported. All those public sector employees, associated in one way or another with telecommunications in the country, prior to the privatization suffered a great loss. Many of them lost their jobs and almost all of them lost a great cash cow called ‘telephone bribe’.
Until the dawn of this millennium telephones were pricier than humans. The bribe needed to get a certificate for everything inclusive of birth and death of a person was much less as compared to that needed to get or get rid of a telephone connection and everything in between. Some economists portray FDI in retail as the panacea for everything that leads to high food inflation in India. One can recollect about a similar pitch for FDI in power sector about 20 years ago and the saga of the now (in)famous Enron-Dabhol power project. Two decades and four 5 year plans later, India is still a power deficit country with rampant power blackouts. Is it due to the silt called government intervention choking up the economy dam? The voter of India has to make the final call.
Foreign investors feel so and they are voting with their money, the effects of it can be seen in the form of a devaluing rupee. In a world full of silted dams, gold is like the monsoon. It fails occasionally, but has been decently consistent throughout recorded human history. Gold did appreciate by about 30% in the previous year and by a similar margin in the years prior to it. Increasing geo-political turmoil in 2012 could mean more volatility in the equity and commodity markets and more demand for gold. 2012 would be a year of great opportunities and profits for the vigilant and prudent investor.
Dinakarananda wishes all of you a very happy, healthy, successful, peaceful and prosperous new year.