Economic Evolution

The Daily Reckoning PRESENTS: What’s going to happen when those friendly foreign investors open their eyes to the state of the U.S. economy – and start dumping the dollar with abandon? Justice Litle believes that as the dollar continues its slump, people will increasingly turn to our favorite yellow metal…

ECONOMIC EVOLUTION

In discussing gold’s return as money in the 21st century, two vital threads holding this talk together are the concepts of evolution and natural selection. Not evolution in its controversial form – we will not be discussing biological origins, the hand of God or the stirring of the primordial soup. Rather, we are talking about evolution in its noncontroversial form, the process of change and growth that we see evidence of every day.

The American Heritage Dictionary defines “evolution” like this: “A gradual process in which something changes into a different and usually more complex or better form.”

For better or worse, that characterizes what is happening to our global economy, our global financial system and markets in general. New technology, new innovations, new connections and new participants mean things are always changing. Sometimes for the better, and sometimes for the worse.

It is easy to forget that our entire financial system as it exists today is really nothing more than a series of experiments from which current rules, regulations and standards have evolved over time. Fiat currencies are still a relatively new thing, introduced by Nixon’s slamming shut of the gold window in 1971. Even the Federal Reserve is a relatively recent addition as far as the history of money is concerned. While the first central bank goes all the way back to the Swedish Riksbank in the 17th century, it was less than 100 years ago that the concept of an active Federal Reserve first applied to an industrial economy. The Fed has been making mistakes and conducting policy by trial and error for as long as it has existed. We only think it is an ancient body of wise men who can do no wrong because that is precisely the image of stability and certainty they wish to project.

The process of natural selection is the one by which well-adapted animals survive and poorly adapted ones do not. In a herd of gazelles, the slowest gazelles will tend to be caught more often by the cheetahs and lions that stalk them, while the faster and more nimble gazelles will tend to survive and procreate.

This process of natural selection applies to ideas as well as animals. In the world of entrepreneurs and venture capital, good ideas spread and thrive while bad ideas die a quick death. This is not always the case, of course. Sometimes deserving ideas do not come to fruition due to poor execution or bad luck, and sometimes bad ideas get far more funding and attention than they deserve. But on the whole, the rule of natural selection is self-evident.

“Creative Destruction,” a term first coined by economist Joseph Schumpeter in 1942, is a colorful term describing evolution and natural selection at work in the economic world. It is the process by which better ideas and better processes replace what came before. Over time, Creative Destruction makes life better on average, because everything is constantly being improved upon.

But funnily enough, Creative Destruction points out the value of the old as well as the new. If an idea or a way of doing things has an extremely long lifespan and nothing has come up to replace it, then it is probably a quite good idea. The good stuff sticks around. Consider the fork, an invention most of you will shortly be using to eat your lunch. The reason that the fork hasn’t changed much in the past thousand years is because the original design was so darned useful.

In the decades and years to come we will realize a few things. First, we will recognize that fiat currency, which Nixon introduced to us, was a truly bad idea – Creative Destruction led down a blind alley. Second, we will realize that the gold standard, which has withstood the test of time, was a pretty darn GOOD idea that deserves to be reintroduced – and WILL be reintroduced, albeit gradually and in stages. We will come to realize that not only fiat currencies, but also the concept of a world reserve currency, will turn out to be a 20th-century fad that did not last, a byproduct of the Industrial Revolution that will pass into history as the information age comes into its own.

Those who view gold as a “barbarous relic” tend to see it as antiquated and obsolete. They believe that our mastery of modern technology, our ability to manipulate bits and bytes, has made gold irrelevant. They will come to realize – after much pain and anguish – that we still need gold, because we still need something to put our trust in. And they will come to realize that rather than competing with modern technology, the return of gold as a new monetary standard will actually be tied to technology. The proliferation of “digital currency” in the 21st century will enhance gold’s standing as the ultimate form of money, not hold it back. The more abstract our transactions get, the more we rely on electrons, the more we will want something solid at the end of the chain to bring about peace of mind.

Looking at the global economy over the past 30 years or so, we can definitely see evolution and natural selection at work. Through the process of no-holds-barred competition, some companies survive and thrive while others fall by the wayside. Markets have gotten more sophisticated and efficient. Business processes have improved dramatically. Production cycles have been cut in half, and then halved yet again. Innovations like just-in-time manufacturing have revolutionized entire industries. New industries have sprung up from nowhere overnight. Sleepy industries have been turned upside down or completely wiped out. Innovation, the lifeblood of economic growth, is really just Schumpeter’s Creative Destruction at work, which in turn is evolution and natural selection at work in the private sector.

One area has NOT evolved or improved significantly over the past few decades, however, and that is government. Some progress has been made here and there, some efficiency has been gained, but on average, the world’s big governments are just as huge and bloated and inefficient as ever. What gives? How can we see so much positive change and forward movement in the private world while the public world has progressed at a snail’s pace, if at all?

The answer I propose is that governments evolve differently than private businesses do. They are less likely to improve on the fly, for one very obvious reason: They don’t have to. In the business world, evolution and improvement is a result of competitive pressure. In the public sector, there IS no competitive pressure. Think of the post office before FedEx came in. Imagine what eating out would be like if McDonald’s was the only restaurant.

Because they are so much slower and bigger, 20th-century governments are less like nimble mammals and more like lumbering dinosaurs. Among dinosaurs, the king was arguably not Tyrannosaurus rex, but rather the Seismosaurus, a descendant of the Diplodocus. The Seismosaurus was reckoned to be the largest living creature of all time, bigger even than the blue whale. With a brain the size of a walnut, a stomach that couldn’t digest its own food without assistance and a close relative by the name of DiPLODocus, you can see why the Seismosaur is an appropriate metaphor for modern-day government.

At one time, the environment favored great lumbering beasts like the Seismosaur. But suddenly and shockingly, these monsters went extinct, leaving the world to the warm blooded. A similar extinction is set to occur soon, one in which today’s gargantuan governments will fall and leave the world to smaller, more nimble ones. The relative speed with which this transformation will occur brings about another evolutionary term: “punctuated equilibrium.”

In a nutshell, punctuated equilibrium is an evolutionary theory that suggests major change happens in large jumps, spaced between long periods of stability over time. For, say, 97% of the time, everything is quiet and stable, with little to no adjustment in the way things are done. But the other 3% of the time, things are hectic and violent enough to radically alter the physical and biological landscape.

Regardless of how well the theory of punctuated equilibrium fits the evolution of species, it comes in handy when summing up the history of governments. Behemoth governments are typically plodding, stable entities, their power and scope changing little, if at all, perhaps creeping upward in size over time – right up until the catastrophic event or storm of violent change that cuts them in half or destroys them entirely.

As we look around today, it is not a hard stretch to imagine the conditions necessary for a punctuated equilibrium-type event to unfold. Thanks to the introduction of 3 billion new capitalists and the looming scarcity of the world’s natural resources, Western world governments are experiencing change and upheaval like never before. Decades worth of evolution will be packed into a small space… and the result will not be pretty. In fact, for the world’s bloated Western governments, one of the most painful aspects of the coming punctuated equilibrium event will be bankruptcy.

Regards,

Justice Litle
for The Daily Reckoning
April 5, 2006

P.S. Gold has been on a tear lately, and a good year for gold means a good year for the “other” precious metal: silver. When gold jumps, silver almost always follows, because both respond to many of the same trends. There’s even what’s called the gold-silver ratio built into the price. If gold hits the levels I’m predicting…and silver just sticks to its average historical relationship with the gold price…we’re talking a gain of at least 644% – well over six times every dollar invested.

Editor’s Note: Justice Litle is an editor of Outstanding Investments, ranked number one by Hulbert’s Financial Digest for total return performance over the past five years. He has worked with soybean farmers, cattle ranchers, energy consultants, currency hedgers, scrap metal dealers and everything in between, including multiple hedge funds. Mr. Litle also acted as head trader for a private equity partnership, and made contributions to Trend Following: How Great Traders Make Millions in Up or Down Markets, a popular trading book by Mike Covel (FT/Prentice Hall).

“They need to express themselves from time to time…”

Thus did the friendly lady at the Budget Rent-a-Car counter analyze the cause of yesterday’s strikes and demonstrations in France. Which is why your editor was at the counter in the first place: the strike had brought to a halt much of the country’s rail traffic; we were obliged to travel by automobile.

Our clerk’s casual explanation differed little from others we’ve heard: “It has been 40 years since the last major student uprising,” said a Parisian friend. “They don’t really have anything to demonstrate against, but that doesn’t stop them.”

In the opinion of their learned elders, the young people raising hell in France are selfish, shortsighted and dumb. “They have no ideals,” said the president of the Sorbonne, “they only have illusions.”

The biggest illusion they have is that they won’t have to compete with two billion Asians working at a tenth the price.

“The stupidity of youth…” begins a column in the Times of London. But the tadpoles really aren’t so stupid. What they want is no different from what most Americans want – protection from the real world. A little longer in the fish tank before they get thrown into the river to struggle upstream.

At issue in the French brouhaha is a minor piece of quack legislation – which would soften up some of the bad consequences of still other quack legislation. In France, employers are reluctant to employ. And little wonder. There’s no one worth employing. Take our mason…Monsieur Goupil. He is a gem of an artisan; a master worker whose plaster and tile work is flawless. Now in his 60s, he continued to tote heavy bags of plaster up three flights of stairs all by himself until he retired last year. Now in the small town in which he lives, there is no one to replace him. No one else knows anymore how to do that kind of work.

“Why don’t you get a young assistant?” we once asked him, “Someone to carry the heavy bags of plaster…and someone to whom you can teach your trade?”

The question seemed to us a logical one. France has a lot of young men with time hanging on their hands. “Immigrant groups” – code language for newcomers from Africa – have unemployment among their young people that runs as high as 40%.

“What! Are you kidding?” Monsieur Goupil guffawed. “Young people don’t want to do this kind of work. It’s too hard. And it takes too long to learn how to do it right. Besides, I wouldn’t want to hire anyone anyway. Too expensive…and too much trouble. You have to do all that paperwork. And then you can’t get rid of them if it doesn’t work out.”

What triggered the riots and demonstrations was a new law that would make it easier for Monsieur Goupil to hire someone. It would give him two years to train his apprentice without having him for life. During those two years the young employee could be fired without his boss having to justify himself in front of a labor tribunal or pay a heavy severance.

You’d think young people would be in favor of such a law; it would after all make it easier for them to find work. But that just shows how out-of-touch you are. Young people in France don’t want to find work…at least not the kind of work where there’s a risk they might fail. They want well-paid, fail-safe jobs – with the government, of course – with six weeks’ paid vacation…and lush benefits. And if they can’t get a job like that, then they don’t want any job at all. Just keep those unemployment checks coming!

How can anyone expect such things anymore in an economy that has become globalized…in a world where millions of Asians are ready, willing, and able to do the same work as Europeans and Americans for 10% of the pay – and none of the safety net?
In France, at least, it is only the young who cling desperately to such illusions. In America, on the other hand, practically everyone grabs for them. How else to explain the mounting talk of protecting U.S. industry from foreign competition…as if the United States could prosper by pretending the rest of the world did not exist. No people ever got richer by denying itself whatever others are willing to offer – whether cheaper labor rates or finer products. We might as well board up all our Italian restaurants, dump out our French wine, and send back the Mercedes. Let’s all just buy inferior products at higher prices. That’s sure to make everyone’s standard of living go up, right?

There is probably no need to explain why protectionism is imbecilic. Everyone already knows it is. If you could really get richer by refusing to trade with the rest of the world, North Korea would be the richest country on the planet. Instead, its people are starving.

But here at The Daily Reckoning, we don’t quarrel with the facts of life. We take the world, and its people, as they are. Things degrade and degenerate, no matter what we might think or what we might want. It is in the nature of them. A free, robust republic pokes its head up like a tender bamboo shoot and prospers at first. Then, if it is lucky, it begins to age, like an oak. And finally, not too much later, it becomes infested with worms, bugs, vermin and parasites, all of which have a keen interest in keeping it going as long as possible – in its senile, decaying form, of course.

And now, we turn to our currency counselor…