Island economics – Is the United States in trouble?

The US dollar fell last month and probably has further to drop. The US is facing massive stagflation pressures as it deals with rising prices, but no economic growth. This happened before in the 1970s.

Here are 3 primary catalysts explaining why it’s happening again today.

  1. The US government butchered the pandemic response compared to other parts of the world like Taiwan or Singapore. Global investors see this as a weakness in governance, and a potential risk.
  2. Slow jobs growth. Last week economists were expecting 1 million new jobs created. They got 266,000. When a country’s work force becomes less productive the value of their currency will inevitably fall.
  3. The US is printing way too much money. This leads to debasement of the currency, and rising prices.

 

What’s dragging down the United State’s productivity? 

Economist Peter Schiff has a great analogy. I’ll add my own twist but here’s the basic story.

Imagine you’re stranded on an island with a few friends. You all agree to split up the work and specialize in gathering different resources. And it’s your job to gather coconuts.

At the end of each day, you can all trade with each other. Most of your friends operate a surplus – saving food for future consumption.

 

When consumption > production

One day you’ve run out of coconuts to trade. So you offer your friends IOUs instead. These are used to redeem real coconuts once you’ve gathered more. 🙂

This works for awhile. You create more and more IOUs out of thin air. The island is your oyster. But you can’t live beyond your means forever. There are consequences to owing people money (or coconuts in this case.) Sooner or later the chickens come home to roost.

Eventually your friends begin to doubt your ability to gather and pay back all the coconuts you owe them. They can no longer keep palm and carry on. They start to complain and lose faith in you and your IOUs.

value is derived from scarcity such as labour or productivity - island economics

You have to back up your paper promises with actual work and productivity. Otherwise your IOUs become less valuable and people will not want to accept them anymore.

 

Parallels to the US economy

The US has been consuming more from other countries than selling back to them. The government is also spending beyond its means. These deficits are funded by debt.

Every time there’s an economic crisis, government assistance programs grow. In the 1960s only 5% of personal incomes came from the government. Today, government transfers make up 25% of people’s personal incomes.

The increasing reliance on government support is disturbing, especially since the government doesn’t even have this money to give out in the first place, lol. The current $2 trillion stimulus package is funded 100% by government bonds (debt).

In my latest finance video I explain the island story more clearly, and also suggest investing globally in emerging markets. I recommend the Vanguard FTSE Emerging Market ETF (VWO in the US) or (VEE.TO in Canada). You can click here to watch the video on YouTube, or see below.

Economic growth comes from production, not consumption. If you don’t produce your wealth won’t grow, and if you combine this with money printing you get stagflation.

Just like in the island allegory, running a US budget deficit feels good in the moment. But there are negative long term consequences to spending beyond one’s means and not being productive. The US lost manufacturing and professional/business jobs last month. Not a great sign.

Nobody ever went broke from diversification so if you have nearly all your stocks in North America, it may be prudent to consider investing in some up and coming economies. 🙂

 

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Random Useless Fact:

Viscachas are rodents that constantly look tired.

viscacha look tired all the time.

 

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Ramone
Ramone
05/10/2021 8:58 pm

“…if you have nearly all your stocks in North America, it may be prudent to consider investing in some up and coming economies”

I’ve always thought this to be true, though I find it tough to research alternative stock exchanges as most of the companies listed I haven’t heard of and much of the content is in foreign language… Any suggestions? 😀
PS. Shout out to foreign ETF’s listed on the TSX, those are handy!

Ramone
Ramone
05/10/2021 9:44 pm

You’re a rockstar! I’ll look into it!

GYM
05/15/2021 9:52 pm

Ahh, I have VEE, wanted more EM even though there is a bit of EM in VXC.

Loved your post and the graphics, you are very talented with your drawings, even the stick men look cool.

US money printers go brrr brrr