Mystery of the Mysterious Inflation and Organic and Inorganic growth

         Economic growth can take place in two ways and these are the organic route while the other is the inorganic route within an economic system. Both organic and inorganic route of an economy are never substitutes of each other nor are they independent of each other. The division is important primarily in the way the money is utilized in investments. It is the standard practice of most economies to make fiscal policy changes by the government and monetary policies of the Central Bank to spurt growth in an economy. However, it also seen that in most cases the reliance is heavily on the inorganic growth strategy than the direct organic route. Although the inorganic route over a period of time contributes to the organic growth of the economic system, it is by itself not sufficient enough especially when the economic growth of a country is slowing down or is in the grip of a recession. Here, there is need to channel funding of large mega structures that lead to growth, employment and value addition to the overall GDP.

        How does inorganic growth take place? Inorganic growth within the system takes place if there is greater liquidity within the system and these pave way for more investments in sectors which are already competitive or are in the verge of being competitive. The monetary interventions of the Central Bank would inevitably lead to more money inside the system with the idea that most parts of the money that the commercial banks have could be given as loan for purchase of consumer goods, investments in the innovative sectors and smaller and larger infrastructure projects. These are good if the overall economy is robust and there is still scope for newer investments to move forward each with their respective growth strategies and for existing organizations to expand their operations. However, more monetary easing when there is a downturn would lead to inflation as there is not many viable investment options in an economy experiencing a down slide.

        Does this mean that monetary easing is wrong? The idea behind any monetary easing is based upon the fact that some investors would surely bring about some kind of innovation that are way ahead of prevalent applications and can bring in greater transformation in the life of its citizens. These investments undoubtedly add to the GDP numbers yet during downturns there are only few investments of such nature and these too look risky. Yet providing liquidity inside the system assumes importance that some of the investments would catapult the growth of the economy unlike anything seen before. True, there have been instances in several countries where such sudden spurt in the economy had taken place due to one or other form of ground breaking inventions. Yet waiting for something like this to happen simply by providing liquidity into the system is not sufficient as the government initiative must be there to kick start such a growth by investing in large mega infrastructural projects, engineering projects, space projects, high levels of innovation in health, sanitation by forming consortium of investors including the government as an investor or monitoring authority. This is of foremost importance as most nations are aiming at near money instruments hoping that it would do the job of indirectly or directly stimulating an investment drive and save a debt ridden nation from an economical debacle. True, this would happen if some part of the money does stimulate an investment bringing about a path breaking technology or say bring about something like a unique substitute for oil or a range of technology that can further revolutionize the investment climate. However, this is still a matter of speculation until one such innovative investment do the job. Otherwise, the rest of the money is invested over and over again along the line of existing products with some changes mainly that of consumer goods, some services and other peripherals and with a stagnant population this becomes even more difficult to sustain.  Ultimately, there is rampant competition and not many people get employed. This is the prime reason why in spite of monetary policy easing and economy remaining liquid there is still unemployment and underemployment.

Mysterious Inflation

        Above all excess liquidity in the system is a sure sign of inflation and may even lead to hyperinflation. But does that mean that investments would lead to inflation. Here lies the mystery of inflation. It is seen that conditions brought about by excess liquidation and no gainful employment and this added with social pressures like subsidies and welfare are a bane although from the social angle these are also unavoidable as in India which has a lot of poverty and excess labor employed in land. Does this mean that there ought to be continuous subsidy or welfare to the people? The answer is that there should be no permanent subsidy or doles from the exchequer other than periodic intervention of such methods as population do shift from the stages of unemployment to employment, migration of labor from the villages to urban areas and sudden demand of labor due to spurt in economic activities at a particular region. Therefore, looking into the genuineness of the situation should such a method be followed which may be group specific or family specific or place specific.

         If one does study inflation of a particular region then one would notice that the inflation on consumable items or those like absolute necessities are higher when the region is experiencing lesser growth and more people are unemployed yet they are all under welfare system or getting subsidies as per a permanent welfare or subsidy act or unemployment benefits. Let’s call this situation X. However, if these people who are generally unemployed or underemployed in that region were to be weaned out of the welfare or subsidy system they would undoubtedly face the perils of poverty and hence wouldn’t be able to spend more and thus bring down inflation. Let’s call this situation Y. Thus, in the first situation X the people generally drove to subsidies and doles as it were available to one and all and therefore only remained complacent to their own status even while they do get employment or are underemployed or remain periodically employed while still pocketing the welfare fund. Add to this the excess cash in their hands they would surely spent it more on consumable items increasing the prices of the consumer goods even more. In sharp contrast is the case when the government or a large investment group through a large project employs the people of the region and also forces them to work by removing the welfare fund and subsidies then the rate of increase in inflation would be slightly higher over the rate when the situation is in Y yet much lower than when the situation is in X. This can be called the Z situation. It would seem surprising that in the situation Z most people are gainfully employed and yet they tend to spend lesser on consumer items, but take on more responsibility by saving for the future or keeping money as reserves or invest in long term instruments and assets. The idea of compulsive shopping slowly decreases which they would have otherwise resorted to in situation X mainly to ward off boredom and engaging in profligate behavior. Therefore, in situation Z inflation increases proportionate to the wage increase in the existing labor force and the immigrant labor force while in situation X, the people by their nature would remain in spending spree with a permanent welfare or subsidized system in place. The above situation stands good even after taking into factor like the irrational consumer behavior especially among certain individuals. However, it is assumed that there will not be commodities imported at lower than market price from other places into the particular region and that the meaning of consumable durables would be different from region to region and country to country. The main idea is to understand the inflationary aspect on the economic system of a particular region.

      There is quite a similarity with people who go for holidaying or vacationing. People who are otherwise quite prudent in their routine life or mostly tend to be so in their regular life, spent more than they can really afford upon the urge and the psychological feelings that they are on a holiday. Many travelers or vacationers even take loans for the mind boggling spending spree without any iota of responsibility as if there would never be another day tomorrow. This psychology here is that the more relaxed you are without much purpose you spend liberally to spend your time on deliberate spending whether to meet your immediate wants or not.

      Thus, where the economy is experiencing organic growth there is lesser tendency for inflation to shoot up dramatically in proportion to than when the economy is growing inorganically. Hence, the idea is to give stress on organic growth and that inorganic growth is a contributory part of the overall organic growth. This also means that monetary policy matters provide the liquidity to the system only when necessary and that larger responsibility is on the government’s fiscal policy where debt burden or deficit is channeled primarily in funding larger product or ground breaking research projects both for driving growth and creating mass employment. A part of this debt can be used for periodic interventions in welfare funding, providing subsidies and the like but no more. At rough estimate the monetary interventions shouldn’t be more than thirty to thirty five percent of the overall GDP as above this means hyperinflation which can derail the process of growth. If however, it is found that there is low inflation pattern in an economy in spite of high liquidity then there will be mass unemployment and no growth in the economy. This is mainly due to the fact that the people have less confidence in the economy of a country and their future and would reconcile to psychological state of ‘unsure inactivity’ in living their lives and spending patterns.

Reviving Confidence in the Economy

       There must be greater confidence in any economy where there is not much room for domestic consumption and investment opportunity. As a social science there must be relative stability in the minds of the people to take further risks. This can only be ensured if there is some positive news coming in and not just loud noise of a great future. It is psychological state that human either goes on thinking a lot of positive sides or go on thinking along the lines of negative paths. This is where the governments should place their priorities. It isn’t sufficient for the governments to publicize about such and such future event, but take concrete steps in fulfilling of some large projects which would spiral growth in all sectors whether related or unrelated. In modern economies with information boom a slight success in one sector can bring about noticeable positive changes in other sector as the confidence aspect of human being which is a potent force to kick start a stagnant economy is a contributory factor in development. Yet in economies which are really in an economic trough this would need a few more steps from the government by pitching forth into a few mega projects with the help of consortium of investors. This has already been stated in my article ‘Economic System and Future of Societies’.

         One of the most interesting factors in modern information driven economy is that if the necessary proactive steps like some new innovative investments or tax rebates or specialized application is undertaken in all specified core sectors of the economy then the economy gathers strength by the very nature of instilling confidence among the investors and general populace. This can be done by the government or the regulators or a group of entrepreneurs. Yet the whole action can boomerang in the reverse direction if only loud proclamations are made and no concrete steps are taken. This is the boon as well as the tragedy of the information driven economic world.

Investment in Emerging Economies

In order to boost the economy of the world on the whole it is inevitable to invest in emerging economies as these are best way to give a good fillip to the international trade as there can be no immediate solution to the problem and chaos that already exists. International trade with emerging economies as well as underdeveloped countries gives an extension to the existing market and can be a boon to both investors from developed nations as well as those in these countries. However, there is a problem here in international trade and this is the problem of trade surplus and the single currency based trade or to be more precise the dollar based trade. It is quite interesting to note that as on today there hasn’t been a clear cut answer to this problem which has seen a lot of chaos that exists in today’s world.

Recycling of Trade Surpluses of countries

      In order to understand trade surpluses and how to recycle them we must understand why there is an international trade in the first place. International trade between countries takes place because one country’s surplus is mitigated by the other country’s deficits in those products and services which one country has comparative advantage over the other and also due to political considerations, historical conditions, technological prowess, larger resource base and a growing population with large demand base and others. Thus, it is implicit in international trade that one country extends support or trades in goods and services due to the very reason that the other has something equal to give in return to cover its own deficit. In other words, international trade is a great equalizer and as such no one country is superior to the other over the exchange of products or services. Cocooned in itself and its territories no country  by itself, however superior it may be in technological or investing skills, can add value to its GDP without the base provided by the other country in the form of population, resource and territorial access. Hence, it is in reality a 50/50 participation no matter what except of course for the value of goods and services traded and the access to the territory and human populace base.

Trade through multiple currencies or one single world currency

       There are actually a few good options for international trade exists to promote multi-lateral trade ties between countries. The idea of one single country for easier and smoother transaction has been there in the minds of the economists for some time and for the moment there has been no proper substitute for any such reserve currency other than the US dollar. The idea is to have one single standard reserve currency which would lead to proper trade among countries without exchange rate fluctuations, same global interest rates, no transaction costs, smoothness of the medium and others. However, this is far cry from its actual implementation with nations being divided into different cultural entities, religion, language and their own respect to their own nation state and its local currency.

        The idea of a single currency has been there in the mind even when Keynes suggested ‘bancor’ as the international currency. Before, we accept this basic condition of a single currency we must once again think of economics as a social science and there no nation that are the same, but are divided even within their own neighboring geography. Again, the US currency which is actually an extension of what one may call it the imperial arm is not an international currency in the true sense of the term. It had a free run based on the strength of it being a petro-dollar and the transparency of the country’s financial sector. It was all right so long as US was calling the shots everywhere (from US stand point) but now there is going to be an irreversible swing in favor of other currencies and likely opposition from the Yuan.

        In real economics no currency can be called an international currency just because it is originating from a country with great economic and military prowess, but that the international currency must have the stamp of approval of the World Bank after getting the requisite majority vote in the UN. Suppose US dollar were to be certified as such then each note before circulation must be stamped by the World Bank. Then dollar becomes Dollar 1 for the purpose of world currency while the ones in circulation within the US would have to be Dollar 2 with a slight decrease in value than Dollar 1 initially. Then Dollar 1 is floated as world currency with full convertibility and then gradually the Dollar 2 should be faced out. The reason why dollar is not instantly made a global currency is that the rest of the world would have to meet with the debt obligations of the previous dollar without much reason as US has a piled up enough to make the whole world go under. There is talk within the US that with the size of debt it owes to China the latter might buy out half of US and more and then run the show on its own.

        But thankfully enough we are geographically, culturally, religiously and linguistically a divided wonderland. I say thankfully because there will be no one nation that would pull the shots in the future but a group of well defined geographically interlinked countries that would have their own sovereignty kept intact. Surely, with some of the inherent difficulties these groups of nations like the European Union would have their own currency limiting the number of currencies in circulation to half a dozen or a dozen. This is what the immediate future world would like and surely beneficial as some advantages of single currency would be there if not all its merits. Hence, for another 100 years this would be what we might see around the world with nations not able to see eye to eye in most of the points of a globalized world. As economics is a social science and not one brought about an independent ruling we have to subject ourselves to certain anomalies that comes with it. Further, due to the rapidly evolving e-banking system a lot of problems inherent in converting different currencies would go.

      Thus, in the foreseeable future we would as nations confront and go on confronting the balance of trade position.

How to adjust the Surpluses in International Trade

Given to reason that there will not be a single currency in the foreseeable future and that the world trade would go on among consortium of countries having a common currency and also some individual nations by the sheer size of their economic size, we can safely assume that the surpluses of nations would have to be adjusted. This is in fact a must as there are grave dangers associated with continued balance of trade positions and balance of payment positions between countries. There is convincing reason to believe that an overstretched surplus and deficit position can have severe economic, political and social repercussions as we see in today’s world. In fact, the most permanent thing in both economical and socio-political and socio- economical world is CHANGE. This means that what we project today may not hold well after a period of time until and unless there is time bound programs and treaties. Having said that there are still countries due to their colonial positions or strength of their superiority over others in trade and commerce and technology had a feeling that there isn’t any need for periodic interventions in international agreements and leveling or recycling of international trade surpluses and balancing the international trade deficits.

           The idea that the trade surpluses for some countries can continue for an indefinite period of time while some countries can have trade deficits as long as others have trade surpluses result from colonial or imperialistic perception that somehow or other there are a few countries which in the long run stand to gain. This would have been the case still had not the surpluses tilted favorably to some ideologically separate and almost close door countries. The case here is that of the US and China and there are reports in the media by different scholars as to whether this is a sound policy.

          Hence, to bring about the much needed equilibrium in international trade, two mutually trading countries must have a time bound treaty during which period it must maintain equilibrium. Thus, taking into consideration the aspect of change in world environment, a maximum period of 5 years must be the limit within which two or more countries must maintain equilibrium status or status-quo.

         How is it possible for two or more countries to come to equilibrium so that a renewed treaty stretching for not more than five years can be continued from zero balance? This can be done as given below.

         It must be reiterated as written already above that two countries while trading are doing it on mutually agreed and mutually beneficial agreement and that there is no superiority of another country over the other as both stand to gain out of it. Let’s call this aspect ‘mutually agreed opening of trade’ (MAOT). Now in this example there are two countries A and B for easy understanding of things. It is seen that after a period of 5 years country A has a surplus of Rs100 while country B with its trade of 5 years with A has a deficit of Rs100. Now at the end of 5 years period officials of countries A and B meet together and close the treaty with a mutual program of action. This aspect can be called ‘mutually agreed closing of trade’ (MACT). After closing the trade a new one is opened so that they may take the advantage of each others comparative advantage of trade.

     Now what is to be done with country A’s surplus and country B’s deficit? Country A (surplus country) and Country B (deficit country) has three options as follows:

(1)    Country A can receive down payment in an internationally acceptable currency or currencies which is by rule an unacceptable practice as an international trade has been committed which is mutually beneficial to both parties right at the signing of the treaty. This can be resorted to if only there is permanent closing of trade for a foreseeable future period.

(2)    Country B can level of the balance tilted unfavorably towards it by selling off from its resources which may include natural resources, creating tourism centers, recreation centers or such like programs.

(3)    Country A (Surplus country) will invest in Country B (deficit country) fully its surplus with the latter or draw out a plan where B is also an equal stakeholder in the investment and must bear the risks of profits or losses which can be 50/50.

         The above salient points are the best available options of which the No.3 the last option has an agreement which is implied that both the countries must bear the burden or loss or profit  with the surplus as the very initial idea of entering into MOAT is due to the advantages each one has is some respects over the other. Mostly the last strategy will hold good as there might be social, economical and political implications in the above two options, that is, 1&2. There is another hitherto not much looked into advantage in the third option. By giving equal stakes in the investments both A and B can be speeding up and contributing to the overall growth of world trade and at the same time contributing to the organic growth of the global economic system. Again, both A & B are driven with zeal to capture and expand their economies by signing the treaty and as such a surplus need not be biased as there is an explicit understanding that deficit B has suffered the deficit purposely to give an added advantage to surplus A country. If a project is mutually agreed upon then both countries gain further and if the project cost is slightly higher than the balance of Rs.100 as in our example then the increased amount can be divided according to a mutually agreed ratio. Yet when Rs100 is invested by A the surplus country it is implied that the surplus is the cause of conceding B’s territorial resources and workforce and market base and hence any profit or loss is 50/50. This is the reason why international trade is mutually beneficial and is a great economic leveler. Similar would be the case if the surplus is invested by two countries in another country C with the hope of reaping rewards 50/50 out of the investment.  By coming and closing (MACT) the two countries can renew yet another treaty for a period of 5 years.

        In order to make matters clearer another example would be serve to remove whatever confusions that may arise.

        Suppose there are two island countries X & Y having good trade relations over the years. To make it even simpler they trade only in 2 items. X country sells apples to Y country over which it has a comparative advantage while Y country sells to X oranges over which it has a comparative advantage. Both the nations due to the quantity of produce and particular cost of producing each others produce have been maintaining equilibrium for several happy years. Now in course of time, X starts making large ships so as to increase the standard of living of the people of the nation by allocating better jobs. Y doesn’t do anything as it has sufficient yachts and boats. X in order to further increase the standard of the people of its natives goes out and out for dialogue and publicity with Y and an agreement is signed. Under the said agreement X country produces one extra large ship and sells it to Y country for its use. There is a trade surplus in favor of X although Y is a sure participant in the whole game.

        Here although X enjoyed a surplus it is not a profit over a trade for X country has already reaped the profit by producing the extra ship and after having sold it to X. Here, the surplus is merely a monetary surplus data kept in the form of exchange (Y’s currency) at X’s account. Similarly, the deficit of country Y is merely a monetary deficit data that is kept in the form of exchange (X’s currency as a liability) at Y’s account. In other words, both X & Y are liable to the surplus equally as well as to the deficit that arose in their bilateral trade.