GDP in Q1 (2014)

Link to BEA release: http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm

I haven't done this in a while, but given today's troubling release, I thought I'd re-start my quarterly analysis of the US GDP numbers.  The overall real GDP rate was an anemic 0.1% (annualized rate) in the 1st quarter.  Perhaps more important, though, is what made up that 0.1%.  GDP is basically composed of consumer spending + investment + government spending +/- net exports.  Net exports is exports - imports.  3% growth is a healthy and reasonable rate for the US.

The consumer spending part of GDP actually grew about 2% (all rates here are annualized rates) in Q1'14.  So, what happened?  Government was pretty flat, by percentage, but both exports and investment were down.

Exports being down a little is probably not cause for concern.  They have bounced up and down, and are heavily impacted by energy prices and currency exchange rates.  So, while exports being down certainly isn't good, I'm not sure it's representative of a long-term problematic trend.

Investment was a -1.01, and half of that was a change in inventories.  On the one hand, selling through inventory is good.  It means that in the future, we'll need to produce more, and that people were buying up more stuff than we had produced.  On the other hand, the general reduction in inventories AND in fixed investment could be taken as a sign that companies and individuals are not optimistic about their prospects in the future, and are neither investing nor building up inventories in anticipation.

Equally interesting is the breakdown of the +2.04% on the consumer spending side.  It was almost all services, where purchases of goods were basically flat.  The consumption of services is really not a bad thing at all, but one can't help but wish that more of that spending was on durable goods.  Durable goods are things that count toward GDP now, but continue to be useful for years in the future.  If people had all bought new washing machines last quarter, that would also mean that next quarter, most people would still have nearly new washing machines.  Services are less likely to represent any sort of 'investment' or any accumulation of wealth.  You can't borrow against the value of services you consumed last quarter, whereas if you bought a car, you now have an asset you can use.

On the whole, the GDP numbers are pretty sad.  Overall growth was flat, and what growth there was was in the more 'transitory' types of spending.  The things that are really good long-term signs, like more investment and more purchase of long-term goods, which are also the things that signal optimism, were somewhere between flat and down moderately.

The breakdown of contributions can be found here:

http://www.bea.gov/iTable/iTable.cfm?ReqID=9&step=1#reqid=9&step=3&isuri=1&903=2

Nature vs. Nurture

The question of “nature vs. nurture” has long fascinated me. Specifically, I have often tried to understand the extent to which nature was the ‘cause’ of the way a person is, and how much was left to nurture (or, more generally, the environment in which a person grows up and lives). It is only recently that I have adjusted my tentative answers to these questions quite a bit.

About 15 years ago I adopted the general tenet that "genetics provides a range and one's environment determines where one lands in the range,” which served me well. I never had any better way of describing the nature vs. nurture issue, nor did I think I needed one. Recently, though, stimulated by some stuff I learned in a lecture about neuroscience from a Cal professor named Hinshaw, I think I have come up with a new, and possibly more powerful, model for thinking about this issue.

Basically, I started with several revelations and new (new to me, not necessarily to science) pieces of info:

1) Imagine a peanut allergy that is completely determined by a single, simple gene. If you have the gene, you have the allergy. If you don't have the gene, you don't have the allergy. On the surface, the allergy seems to be 100% genetic in origin, and in some sense it is. But, in another sense, it's not. The reason I say that is that if you grow up in a world where there are no peanuts, you may think you have no peanut allergy, even if you have the gene. You'd never KNOW you had the allergy, and there wouldn't even be a test for it, because no one would know to look for it. So, in the case of someone with the allergy, it's "100% genetic" in origin (this is equivalent to saying that genes give you a 100% chance of having the allergy, with a range of +/- 0% determined by your environment). But, if you look only at outcomes, and you have a person who doesn't show the allergy, you could make a reasonable argument that in some sense, the outcome is 100% explained by environment, even though the allergy is also, in the previous sense, purely genetic in origin.

2) If you imagine a baby who is born with a healthy brain and body, but then locked in a box with feeding tubes and absolutely no sensory input, that baby's IQ after several years will probably be exceptionally low (perhaps below 35, where 100 is average). The "range" for this person, with a "normal" life, in terms of IQ, might have been 85-115, but the "range" considering these extreme conditions might be as wide as 15-100. There is nothing about this that makes the "range" invalid, but it appears to make it somewhat less useful, because it would seem there are multiple ranges, for normal vs. abnormal or rare scenarios. One might easily make a slight modification to the "range" model to try to account for this. We might call it the "additive" model. This additive model might be one where you get a "genetic IQ component" of [50 +/- 50] and an "environmental IQ component" of [50 +/- 50]. You could then add an "extreme cases" component that contributed [0 +/- 50]. In fact, scientists have sort of proposed this when they have broken down the "nurture" factors into "normal" and "abnormal" conditions. Still, though, this model seems unsatisfactory for explaining the sensory deprivation condition.

3) Many studies are done on twins to try to determine the nature vs. nurture influence. Identical twins obviously have the same DNA, but may have very different "environments" in which they live their lives. One classic study looks at the variation in height between twins and non-twins, as well as between twins raised in the "same" environment vs. twins in "different" environments. It tries to apportion the observed variation to either genes or environment. Such studies usually show something like, "90% of height variation is explained by genetics and 10% by environment." On the surface, this seems completely intuitive and reasonable. Further, you might take the extreme example of someone who had their legs amputated as a child. This "environmental" factor may cause an extreme outlier, similar to the example from #2, but other than that, the "range" model seems to be very consistent with the findings of the actual studies on twins. This is where I had a sort of epiphany.

I assert that what most people *think* the twin results show is actually only 1 of 2 possible interpretations of studies of this type. First, let me tell you what I *thought* it must mean which is what I think most people assume it means. They assume that the twin studies on height mean that, "height is 90% determined by genetics and 10% determined by environment." Indeed, the study could be showing that. It could also, however, be showing something very different. It could be showing that our environments are 9 times as homogeneous as our genes. I'll explain what I mean by this through an example. Imagine that we could, with a magic wand, make every baby born tomorrow have exactly the same DNA. If we could do this, and then we measured the heights of the same babies 30 years later, 100% of variation in height would now be attributable to environment, not to genetics. Of course, the range (or, more precisely, the standard deviation) of this variance might be much smaller. In fact, comparing the standard deviation of the variance between babies born on a day with "the same genes," to the general population might yield some sort of actual, meaningful quantitative measure. This is exactly how the twin studies are supposed to work. Twins are this "comparison group." The problem with these studies is "what does 100% environmental" mean? What if we could, tomorrow, make all babies born somehow magically grow up in "the exact same environment." First, this is difficult to even conceptualize. They can't be "the same" because they can't all live in the same bedroom in the same house, even if we could clone their parents and make exact copies of the weather patterns and whatnot. Another way of saying the same thing is:

If, today, genes account for 90% of variation in height, and then next year we do a magic experiment where we make the environments "less similar" for children growing up, we might suddenly find that now genes only account for 80% of variation in height.

In fact, studies confirm this hypothesis as well. If you break down the twin studies of height, in particular, they appear to show approximately a 95% genetic component for height amongst the higher socioeconomic classes, and only about an 88% genetic component for those in the lower classes. This might be precisely because the environments for the higher socioeconomic classes are more homogeneous (more similar food, medical care, or activities).

So, saying that 90% of variation is due to nature could ALSO be interpreted as "the environment is far less homogeneous than our genes." The studies that are done aren't wrong - they do precisely what they purport to do; they attribute variation to its sources. What I thought that meant, but what it does not necessarily mean, is that "90% of height is caused by one’s genes."

This brings me to the formulation of a new mental model for this topic. I think that if you imagine a coloring book, like children draw in, with black outlines on a paper but color to be added by the artist, this is perhaps a good metaphor for the nature vs. nurture question. If the lines on the paper are heavy, thick, black, and close together (perhaps even forming a solid block of black ink), there may be no way to use a crayon to ever create a pink flower on that part of the paper. The best you may be able to do is a dark-brown flower in a black box. On the other hand, if you imagine smearing heavy paint over the whole page, you might be able to nearly completely obscure thin outlines beneath and change the paper to anything except a pure white color.

The metaphorical extension of this coloring book model is then to talk about the differences between people in terms of "Do they have the same picture, with slight differences in the lines?" "Do they have different pictures outlined but colored similarly?" "Do they have some condition so extreme (red paint splashed across the page) that you can't even make out the underlying outlines (mental illness, severe trauma, etc...)?"

This model is sort of like the "range" model in the general sense that, under normal circumstances, the broad strokes of the final picture are determined by the outlines, with the details added by the color. These details, while small in some ways, can radically change the net "impact" of the picture, and they can be harmonious or discordant. I think, though, that this model/metaphor may be more useful for explaining extreme or "edge" cases and outliers. My next step would be to try to create a mathematical equivalent to this model. I don't pretend that I can quantify the actual impact of nature vs. nurture (the quantification of which may not even be a sensible concept), but I do hope that I can show the relationships between factors.

In the height example, if we imagine an overly simple world where height is ONLY determined by genes and nutrition, I could imagine a 2nd (or higher)-order polynomial that would account for the extreme range of possibilities (3 ft - 10 ft), but would also, under normal circumstances, allow the "magnitude" or "contribution" of the genetic variable to dominate (say, in a ratio of 9:1) the nutrition variable. This would require that the two variables interacted either by multiplication or by raising one to the power of the other. This would distinguish this model from the "additive" model, which I think is basically the same as the range model, which would allow the terms to interact with each other only by addition and subtraction. The difference is between a model that might be "x- squared plus 1/2 y-squared" and a model that might be more like "2 times x + 1/2 x times y." Another way to think of this mathematical difference is to imagine what happens when one factor is set to 0. In the additive model, this can't completely overwhelm the other factor. In this multiplicative model, it can. I'm not sure which one is more "right" and rightness might only be defined by which is more useful in practice, but I propose this new model as a useful one, especially for trying to unify the 'range' of possibilities in 'normal' people with the prevalence of extreme factors, mental illness, and the like.

So, how useful is this model? Personally, I would say it's moderately more useful than the "range" model. I'll give an example where it seems no more useful and one where it seems more useful:

No More Useful: Taking something more complex, like cancer for example, rather than say, "I'm genetically 2x as likely to get cancer as another person but then I influence that by living a healthy lifestyle," we might instead say something like "I have the risk factors and precursors for several types of cancer, but my lifestyle choices far outweigh those factors" or "Despite living a healthy life, I haven't been able to control the several genetic cancer risk factors I inherited." Of course, these are very subjective statements, and it would be useful to try to quantify, at least roughly, how much impact lifestyle has compared to genetics. Perhaps such a set of equations could be derived. This would require the same kinds of twin studies done now, but it would also require some sort of quantifiable measurement of "environmental homogeneity." Further, it would require comparing these things over time (since we don't know what to use as a baseline for "sameness" of environment). Such studies would be both longitudinal and latitudinal. In education and medical research, for example, they have been extremely hard to do. In this case, the two models seem to describe the situation equally well.

More Useful: Taking sexual orientation, I think the coloring book model may be more useful than the range model. I have found little use in trying to ascertain an underlying "range" of homo-vs-heterosexuality for an individual and then adding in a set of influences that occur after birth (both internal thoughts and external influences). I think the reason for this difficulty is because it tries to place homo- and heterosexuality as opposite poles on one axis (I think this has been a common attempt since Kinsey made it in "Sexual Behavior in the Human Male" around 1950. This may be the problem. A homosexual and a heterosexual may be very "similar" in some dimensions, either genetically, environmentally, or both, and very different in other dimensions. Thus, the "range" model seems unable to capture the complexity (specifically, the number of 'dimensions') whereas the coloring book model is inherently two-dimensional, better capturing this multi-dimensional possibility (although the dimensionality of the determinants of sexuality may be large).

I believe that a multiplicative model (or similar), which assumes that every factor may be both minor or conclusive, and allows for complex interactions between factors is a better mental construct for addressing such issues as “What makes a person homosexual, nature or nurture?” or “Why did one child turn out ‘smarter’ than another?”

Taxes and the cost of living

My friend David said, "This has bothered me for a while. Why don't taxes take cost of living into account? I am bothered that someone making the same I do that's living in the middle of nowhere pays the same as I do."

Months ago, I promised to respond. This is my response.

First I will examine the assumption David makes that taxes don’t take cost of living into account.

There are many kinds of taxes. Income taxes and sales taxes are the ones with which we’re most familiar, and I assume David’s comment was primarily about income taxes. But, do income taxes take cost of living into account? I think that there are two different kinds of arguments that they do:

1) Argument from progressive nature of tax code - Basically, the tax code allows for different sized deductions that do factor in cost-of-living. For example, mortgage interest income is deductible from taxes. Mortgage interest income is higher where housing prices are higher, and housing prices are a major contributor to overall cost of living. So, if you make $100,000, would owe $35,000 in taxes, but save $5,000 due to your mortgage, and then move to a more expensive place and start saving $10,000 due to a larger mortgage interest, then, in a sense, the net taxes you pay are 'including' the cost of living (at least the cost of housing). It's important that this deduction comes off the "top" of your income, because that means that the more you earn (until you are sufficiently far into the highest tax bracket), the more these deductions are "worth" to you.

Sales taxes are less progressive. The rate is the same for everyone. Still, though. where the cost of living is higher, the sales taxes are ALSO a larger amount in terms of absolute dollars. One way in which there is some progressivity is that the major purchase category for which sales tax is not charged (basic food items) constitutes a larger portion of the spending for lower-income individuals. Nonetheless, sales taxes generally exemplify David's statement. If you move somewhere more expensive, you pay more in sales taxes, even though it also costs you more to live in that place.

2) Argument from cost-of-living determining salary. Returning to income taxes for a moment, it is important to consider that income taxes are based on your salary. If it costs 10% more to live in a place, but you also get paid 10% more, in some sense the taxes should not "need" to factor in cost-of-living. To really do this calculation correctly, and be precise, you'd have to look at net taxes (because there are different rates and different deductions, depending on income), but in theory, this would work, and no further adjustments would be needed once you adjusted the salary to compensate for cost-of-living.

What this really means, as far as answering David's point is: "That person living in the middle of nowhere *doesn't* make the same amount as you." Let's say you earn $60,000 per year in San Francisco. That guy out there in Des Moines who earns $60,000 per year is probably one level higher than you in the corporate hierarchy. He's probably saying, "I can't believe this guy who's one level lower than I am makes the same amount I do!" If he said this, though, he'd be wrong, because his standard of living, at the same salary, actually is higher.

#2 brings up a tricky point in this whole topic - there are three independent levels of taxation: federal, state, and local. This makes it hard to figure out exactly what 'fair' means. Some taxes differ from place to place. Others (like most federal) don't. This does make it confusing because the 'local' part of a sales tax might be different in different locales, but the 'state' part might be the same. In fact, the 'wealthier' counties/cities, with higher costs of living, probably also tend to have the higher taxes. This, like all progressive taxation, is 'fair' in one sense and 'unfair' in another.

Taxes can be based on property, sales, use, business profits, value addition, income, or other factors. In each case, there will tend to be an extent to which these taxes automatically adjust for cost-of-living differences and an extent to which they don't. Sales taxes, for example, do a mediocre job of aligning with cost-of-living differences. Imagine two people, earning the same income, and buying the exact same stuff, in two different places. The stuff simply costs more in one place than another. The person in the more expensive place will pay more in taxes than the person in the less expensive place. Property taxes are similarly mediocre. Property taxes punish people where values of assets are going up and reward those where values of assets are going down. Income taxes and corporate profit taxes (which are similar in their function and structure), probably do a little better job of adjusting for cost-of-living differences, but are still imperfect.

One more complication is to look at the usage of services. A big city might use more or less services, per capita, than a small town. The cost of providing a sewer, for example, is lower in a big city than in a rural area per capita ceteris paribus. Therefore, the taxes paid for such a thing should be lower. In reality, though, because the land used to build a sewer system is so much more expensive in the city than the country, taxes end up being higher in the city despite the fact that the cost of living (to which the cost of land is a contributor) is already higher.

Finally, there is another point I should make. For the most part, I think incomes adjust for costs of living, and so income taxes don't need to. But there are places/instances where taxes and costs-of-living are out of whack. We still have to ask ourselves, though, if we should do anything about it. Let's say that in some sense, David's situation is 'unfair' and he pays a 10% penalty for living in a certain place. We could change this, by lowering the taxes in that area to compensate, but that would just make the problem worse (even more people would flock to this magical place, driving costs up further). So, instead, we must trust the market to solve these problems. What David should do is demand more income from his employer to cover the taxes. If they refuse, he should move. Eventually, this will force companies to locate where the cost of living is lower.

Pelosi

Nancy Pelosi is the epitome of what's wrong with politics. She's a pure partisan who cares only about "winning" and doesn't care about actual policy-making goals. She understands little about economics, international relations, history, sociology, or government.

This article is just the most recent example of her continual partisanship. If she was a real partisan because she had some ulterior motive, which was ideological, I might be able to forgive her. But she doesn't have such a goal. She isn't even an ideologue. She doesn't believe in ANYTHING. She just thinks her job is to get elected as many times as possible and get as many other people on her "team" elected as possible. THAT IS NOT THE GOAL.

This article basically says that her new goal is to keep the president from compromising with the Republicans. With the Republicans in control of the House, how is anything going to get done without a compromise? Oh, wait, Pelosi doesn't care about getting things done - she only cares about winning. The Obama White House didn't exactly take the most conciliatory approach or bipartisan stances, yet Pelosi believes they did too much compromising.

Tax legislation, for example, must originate in the House. So, how are we going either make any deal about the tax cuts without a compromise between the House and the President?

Pelosi is worthless and should retire from politics before she destroys the Democratic party, which is clearly floundering under her "leadership."

What's Going on in Korea?

What is going on with the two Koreas?

Events leading up to today

There are many events that go on, including abductions of S. Koreans and others, as well as frequent near-skirmishes between the militaries of North and South Korea. Here are a few selected, and hopefully relevant, issues that have come up recently:

Since the 90s, at least, N. Korea has been working on a variety of nuclear weapons programs. All attempts by the US and others to stifle (or even identify) all such programs seem to have failed.

From about 1998-2008, S. Korea pursued what is called the “Sunshine Policy.” This was a policy of accommodation and rapprochement with N. Korea. It seemed, at times, to be succeeding, when economic or social ties between the two countries improved.

Before, during, and after the Iraq War, the US reduced the number of troops in S. Korea by about half. Removing troops from the border area is often considered an aggressive move, because the troops are within range of N. Korean artillery. It was generally believed that if the US were to seriously attack N. Korea, the first thing it would do is remove troops from that area before commencing massive bombing of the North. The Iraq War provided a good excuse to remove troops because they were needed in the Middle East.

North Korea appears to have tested a crude nuclear device in 2006. It is unclear to what extent they had integrated such capability with a delivery mechanism (such as a missile).

In 2009, N. Korea again tested a nuclear device underground, as well as several missiles. It is still unclear to what extent they have been able to weaponize a nuclear device.

In March, a S. Korean warship was sunk by an explosion, killing 46. Several reports later concluded that the explosion was caused by a N. Korean torpedo.

In late September, Kim Jong Un, son of Kim Jong Il, was designated as the next leader of the country. Some felt there was internal dissent or tension at this time, possibly between factions within the military.

Last week, N. Korea revealed a previously undisclosed uranium-enriching operation. The equipment was modern and recently constructed.

In general, winter is a hard time in N. Korea. The economy there struggles to produce enough food, energy, or medical care to take care of its people. Frequently, especially in the winter, the North is dependent on food, heating oil, and medicine aid from the US, Japan, Europe, China, and S. Korea. In recent years, deals for such aid were often struck at the “Six Party Negotiations” between China, the US, Russia, N. Korea, S. Korea, and Japan.

No serious reaction from S. Korea or the US over the torpedo attack or the uranium enrichment has been made public (and probably, nothing had yet really occurred). The Six Party Talks are not currently underway and the US has made cessation of nuclear activities a precursor to resuming them. N. Korea has requested direct, bi-lateral negotiations with the US, which the US has refused.

Here is a more thorough timeline: http://www.nytimes.com/info/north-korea/news/.

Today’s events

The events that unfolded today actually started a couple of days ago. South Korea regularly does large-scale military exercises near North Korean waters. Some territorial waters are disputed. S. Korea generally has the better, if not airtight, claims to these waters in the eyes of the international community. Although invited to participate, the US was not involved in the recent exercises. The North asked South Korea not to use live ammunition in the exercises, but the South did, anyway. The South was generally firing away from N. Korea (from north to south). A few days ago, N. Korea seems to have requested that the exercises not occur (or perhaps again that they not use live ammunition). The South seems to have ignored this request. In fact, the South continued the exercise and fired some shots into a region of ocean to which N. Korea disputes S. Korea’s claim. There were no N. Korean targets there, just disputed water.

Today, N. Korean artillery began shelling an island near N. Korean waters. The island has both civilian and military structures and people on it. Two S. Korean marines were killed and some civilians and soldiers were injured. South Korea returned artillery fire and launched aircraft which apparently struck targets in N. Korea. Information about the extent of the damage or casualties in N. Korea doesn’t seem to be available. After an hour or two, both sides stopped firing and S. Korea began evacuating people and putting out fires on the island. Their military remains at the highest alert.

Why did they do it?

The first interesting question is what motivated this attack, which was a clear escalation. Complaining about somebody else doing live-fire exercises and shooting at civilians’ houses are obviously very different “levels.” It is almost impossible to understand the motivations of the N. Korean regime, which don’t always seem consistent, let alone understandable, predictable, or rational. I believe there are several possibilities for explaining N. Korea’s blatant escalation today:

1) The North believed a return to the Six Party Talks was imminent, perhaps over the uranium revelation, and is trying to gain some kind of advantage in the negotiation. If you create a problem, you can offer “stopping the problem” as a concession in negotiations. I don’t know that this strategy would work, but the North seems to have used it before.

2) They are trying to force a return to the Six Party Talks before the cold of winter deepens, perhaps because they believed that the West was going to “let them starve” this winter. Perhaps, behind the scenes, the US was already threatening N. Korea with something and this is their way of “changing the equation.”

3) The new leader is being given some sort of opportunity to ingratiate himself with the military or prove himself to the military.

4) Because of the weak response or lack of response to the torpedo incident and the uranium facility revelation, perhaps the North is overconfident. Perhaps they believe the US and S. Korea don’t have the will to respond and the N. Koreans are simply pushing the envelope.

5) There is internal division in the North, and an aggressive or militant faction is testing its ability to act independently from the leadership.

6) There is a lack of command and control in the North, and soldiers accidentally escalated a situation without the permission of the leadership.

What must S. Korea and the US consider in response?

It is very difficult for the US or S. Korea to respond. There are several considerations:

1) The US cannot allow provocations like this to go unanswered, because it seriously undermines alliance with S. Korea and Japan and casts doubt upon America’s ability to defend its allies. It risks emboldening China to use (or continue to use) N. Korea as a proxy bully to influence S. Korea and Japan while diffusing blame away from itself.

2) Any military response risks further escalation. Tens of millions of S. Koreans are within range of N. Korean weapons on the border. N. Korea has a huge, standing army.

3) China has not been willing to enforce any serious sanctions on N. Korea.

4) Everyone seems worried about internal stability in N. Korea, and whether there is some sort of struggle going on there, as well as what would happen were the leadership to fail or be removed.

5) N. Korea may have a nuclear device that can be “fired” or “launched.” No one is quite sure. It is unclear whether the US knows where such devices are and could pre-emptively destroy them. Given that we can’t find the enrichment facilities, it seems unlikely we could pre-empt such a launch. Such a device could probably only reach S. Korea, but possibly Japan.

Andy’s recommendation:

There must be a serious response and it must take China into account. We must break the pattern of letting N. Korea provoke the world, then negotiating, then giving away carrots in negotiations. That pattern encourages continued aggression. We must also somehow punish N. Korea without escalating the military situation if possible, and without causing an all-out war.

In many ways, the ideal response would be a total blockade of the North. This would again re-balance the negotiating positions. In eventual negotiations, the US would then be offering simply to stop blockading the North, rather than offering it incentives to stop attack S. Korea. However, the North has previously claimed they would consider this an act of war (they have to say that, for obvious reasons), and China has never honored such a blockade. China is the biggest trading partner for the North. Even if such a blockade were to succeed, millions of N. Koreans could die from cold and starvation.

Therefore, I believe the US should pursue a multi-pronged strategy:

1) The US should declare a partial blockade of N. Korea and should move an aircraft carrier East of of Japan. It should pledge to board and search all ships entering N. Korea under the non-proliferation initiative framework to check all cargo for contraband. It should reserve the right to refuse passage to any or all ships into N. Korean waters as well as to seize any cargo meant for N. Korea. It should not necessarily enforce this blockade, but should set up the infrastructure to do so. All aid shipments should be suspended.

2) The US should signal consideration of committing an additional $1 trillion to missile defense programs over the next 20 years. It should signal that these missile defense systems would be designed to protect Taiwan, Japan, and S. Korea, and that such systems would be designed to “destroy all missiles launched from the region, including all nuclear missiles.” It should indicate that such programs could still be cancelled.

3) The US should immediately propose to sell the Aegis weapon system to the navies of S. Korea, Japan, and Taiwan to “promote regional safety and stability.”

4) The US should immediately request that India be added to the UN Security Council.

5) The US should also immediately pledge $10M (a token amount) to promoting “democracy and freedom of information in Asia.”

6) S. Korea should immediately pledge “support to Google, Microsoft, Yahoo!, and other American, Japanese, and S. Korean internet companies” to provide a haven for search engines, internet media, etc. in S. Korea from which to “serve Asian users.”

7) S. Korea, Japan, and the US should immediately announce new rules requiring any acquisition of any American, Japanese, or S. Korean company by any Chinese entity must be reviewed by the respective governments.

8) The US should tell China that it must publicly denounce the N. Korean attacks and announce public support for the Six Party Talks to resume.

9) The US should propose a resumption of the Six Party Talks.

10) The US should explain to China that many of these provisions can be reversed, and should agree in private with China on whether to back a coup d’etat by the military in N. Korea, should one occur.

11) The US should announce that if a “peaceful actor” were to change the regime in N. Korea, the US would recognize that entity as a new government and would lift the restrictions on N. Korea.

12) The US should move a token number of troops (perhaps 500) away from the Korean border. It should claim that they are being “redeployed” for “security reasons.” It should announce that it is contemplating further “redeployments.”

13) The US should immediately order Patriot-missile-type systems as well as other defensive weapons moved to S. Korea “sometime during 2011.”

14) The US should propose replacing SEATO with a new organization, complete with a true mutual defense pact, to include the US, UK, Japan, S. Korea, Taiwan, Australia, and India. It should propose placing its remaining troops in Japan and S. Korea under the command of this body, which would operate much the way NATO does. It should gain commitments totaling 40K troops and many naval assets from the other countries. It should set a timetable for building up such an organization’s capabilities by 2015. The US should further propose that a broader organization, to include Pakistan and other SEATO members, but without the mutual defense pact, also be created.

In all cases, these are measures which could be negotiated away but which would, if not negotiated away, actually be pursued. I believe these measures (or measures like these) strike the right balance between punishment and escalation, while pressuring China, but don’t give enough provocation to the North for it to escalate the military attacks.

GDP in Q3 (2011)

The Tutorial

Below is an analysis of the US GDP numbers for Q3 as well as a tutorial on reading these charts.

The chart I like the best is the one that shows contributions to percent change in real GDP. First of all, it's inflation-adjusted. That takes care of one variable. Second, it's broken down into the units and terms we're used to. We normally think of GDP in terms of the annualized % growth rate. Saying the GDP grew 1.7% in Q2 means that the rate the economy was growing during Q2 would result in the economy being 1.7% larger after one year. It's kind of like talking about credit card interest rates or loans in terms of "APR." It's a standardized measure we're accustomed to interpreting.

The US GDP grew at a rate of 2% in Q3'11. This isn't 2% before inflation, it's 2% after inflation. If inflation was 3% (annualized rate), it means that the absolute GDP growth rate would have been 5%. Remember, too, that the GDP didn't grow 2% in Q3. It grew at an annualized rate of 2%. If that growth was spread out evenly over the year, that would mean that it grew about 0.5% during Q3.

GDP is calculated as the value of all goods and services produced in three sectors (consumers, business investment, and government) +/- net foreign trade. The reason why you have to add or subtract foreign trade is that otherwise, if we produced more, but sold more overseas, it would look like our economy hadn't grown, even though it had. Similarly, if we bought more outside the US, it would look like we had produced things which we didn't (someone else produced them and we bought them). Remember, GDP is a measure of production; even if parts of it are calculated my measuring consumption. It's not a measure of the amoung of wealth saved up in bank accounts or a measure of consumption. It's also only sort of a measure of how much we've really invested. The GDP is broken down into durable and non-durable components, but these breakdowns don't tell the whole story. We could build 100,000,000 tractors and the GDP would seem really good for one quarter, but the long-term quality of this investment strategy is questionable at best. The way this chart works, if you add up the contribution from consumption in Q3 (1.79), the contribution from investment (1.54), and then the contribution from government (0.68), then add a negative (2.01) (for foreign trade), you get the overall annualized rate of 2.0%.

Breaking the numbers down in this way helps one understand the numbers enough to make use of them. Let's say you work at a company that paints office buildings. These paint jobs are durable goods and services. They are things which would contribute to the 1.54 contribution from investment. Here is a chart that shows the breakdown of the US GDP by sector. This shows NOT how much each sector contributed to the growth in the GDP, but simply how big each sector is. Notice how the investment component is fairly small. Business investment makes up only perhaps 10-15% of the total GDP. This means that the 1.54 contribution is REALLY LARGE. Over 3/4 of the total net growth in GDP was attributable to the private investment sector (which is nearly all business) despite the fact that that sector is only about 1/10 of the overall economy.

So, if you're an office painter, you might think, "Wow, great. That means that my industry is booming! I might have lots of new customers!" A deeper look, however, dashes these hopes. Let's look at the breakdown of the Gross Private Domestic Investment component. Of the 1.54, 1.44 is just a change in inventories. Our painter now seems less optimistic. Only 0.10 of that 1.54 is made up of investment in "Structures" which are the things he paints. The painter might take some solace in seeing that inventories are up, though, and think, "Maybe stores will be trying to get rid of inventory and now is a good time to stock up on paint!" And indeed, that might be a good idea. He would need to look at a more detailed breakdown to see how much he could learn about the inventories for paint in particular (because, again, it might be that while inventories are up in general, they aren't up among paint manufacturers or vendors).

Technical note: In general, if you want to see if a contribution from one area is large relative to another, you must "normalize" them by a) dividing the contribution from a sector by the total GDP growth, and then b) comparing this to the percentage of the total GDP which this sector comprises. Where (a) yields a larger number than (b), you've identified a sector where growth was relatively fast.

My Analysis

I apply the above process to the GDP across all the different components, and I look for things that stand out. Here is the summary of what I see in the Q3 2011 numbers:

Imports: The imports number in Q2 was a HUGE drag on the economy. In Q3 it's not dragging the overall number down as much, but it's still significant. We're importing a ton of goods, and a lot less services. This is pretty important, because it means that if you're an a service industry, the relevant parts of the GDP might be "growing" faster for you than in general.

Personal consumption: This is, by far, the largest sector of the economy, and it posted its best number (by % contribution) of the last 11 quarters.

Exports: Exports grew during Q3'11. This is not intuitive, because net foreign trade contributed negatively to the overall GDP growth. But, exports grew. Imports just grew more quickly. This is really important because if you're generally a company that, say, helps exporters, your likely pool of customers grew. Just because there are more importers doesn't mean there are less exporters.

Sellers of "goods": If you work for a company that sells TV's at Best Buy, these numbers are so-so. You don't really care too much about imports and exports, because it doesn't really matter to you where the stuff at Best Buy comes from, you just want to know if retail sales are generally "strong" or "weak." Personal consumption (much of which is sales at retail), here, is a fairly strong contributor. However, much of this positivity comes from services, not goods. Non-durable goods make up about 16% of the overall GDP, and account for about 10% of the growth in GDP.

Government: State and local governments make up about 59% of the whole government sector in the country. This number has actually fallen, as local governments have laid people off and the federal government has spent massive amounts of money to stimulate the economy and run huge, huge deficits. As recently as 2008, local and state government accounted for 63% of all government spending. Many years ago, as much as 70% of government was state and local. The shift from state and local spending to federal spending is good and bad. From the standpoint of suppliers to the government, it means fewer, large, centralized contracts. It may also mean more jobs in Washington and less jobs in Columbus, Lansing, and Albany. Generally, when the economy is growing and yet the government sector is shrinking, that is a really good sign for businesses and long-term prospects. It means that manufacturing and trade activity are flourishing.

Connection to jobs: Many, many things influence the growth of jobs in the country. The GDP doesn't tell the whole story when it comes to jobs. But, it does provide a starting point. If the GDP is growing, economic activity is growing. Usually, this leads to jobs being created (sometimes with a lag). However, the population of the country is also changing. People immigrate and emigrate, they age and die. New people are born. It is overly simplistic, but if the country's population is growing 2% per year and the real GDP is growing 2% per year, one might expect the unemployment rate to stay constant (because there are just as many new jobs being created as there are new job seekers). This type of analysis is very crude, but it is consistent with what we're seeing today. If we just looked at consumption, investment, and government, we would see a GDP growth rate of 4.01%. That's roughly equivalent to the rate that we're "consuming" things. However, half of that consumption "growth" is being supplied by foreign producers. Thus, not very many jobs in the US are being created. It's tempting to think we should, therefore, stop imports. This is wrong and usually doesn't work, but it seems intuitive. Remember, though, that stopping imports isn't what matters. Increasing exports creates jobs. Ceasing imports doesn't create jobs, it just makes things more expensive. We should try to grow exports, consumption, and investment. Those are all drivers of jobs. We should grow government where it's efficient, but the overall size of government is probably already big enough. Government is generally less efficient than private industry, and it certainly lags behind private industry in two important categories: 1) making smart investments, and 2) creating productivity-enhancing technology.

Summary: In summary, the GDP growth numbers are mixed. The economy is growing, but it's not growing fast enough to create a lot of jobs. Some of that growth is government, which isn't as sustainable in the long run as other kinds of growth. No one sector, right now, is horribly under- or over-performing. An overall growth rate of about 3.5% is a much more healthy level. Hopefully we'll reach that kind of rate again in another quarter or two, but I'm not holding my breath. I think we may be in for several more quarters of lackluster 1.8-2.8% growth.

The Personal Savings Rate and Job Growth

Why are we in a jobless recovery? When will the jobs come back? It's going to take a long time, and the reason is because we're still paying for the job growth we had last decade. I'll explain what I mean.

First, let's examine when the recession actually occurred. One rule-of-thumb definition of recession is that in order to have a recession you must have 2 consecutive quarters of negative GDP growth. Basically, this means that the total value of all goods and services (+/- foreign trade) produced in a quarter went down. This is equivalent to "the economy getting smaller." The chart below shows that we were really in a recession from approximately January '08 to about June '09 (+/- a couple of months on each end). Right now, our economy is probably back to about the same size that it was before the recession (roughly). So, why don't we have all the jobs back?

Here's a chart of US GDP growth over the past few years (just look at the top line):

As long as the economy is getting bigger, there is a reasonably good chance that all that increased activity will turn into income for someone (through paychecks, government spending, stock dividends, etc...). When people spend that additional income, they are likely to cause businesses to add workers. Sometimes there is a lag, and it's not always that simple, but that's the basic idea. So, if the economy is growing at 3% per year, jobs are probably being added (I'm ignoring productivity growth for today). The population is also growing (due to immigration, mostly) and so there is more or less a match between the number of job seekers and jobs available (on an aggregate level). Back in 2005 and 2006, for example, companies were employing lots of people who were building many products and selling many services. In fact, because people were borrowing so much and saving so little, almost every single dollar that was earned was subsequently spent on something else, so it took a lot of "jobs" to produce all those products and services.

One complication is: what if people save the extra money instead of spending it? On the surface, this would seem to allow for "growth" without jobs. Is that exactly what's happening now, you might ask? In practice, though, money saved is invested. Either businesses borrow against these savings to expand or individual households save this money for later. Saving money for later obviously delays the spending of the same dollars on cars, iPods, and Starbucks, but businesses are smart enough to handle this case. It takes many years to develop some products or build new houses or stores, so if all that money were really being saved up to spend next year or even next decade, some economic activity would start today to plan for how all that future spending is going to happen. So, on the surface, the fact that our savings rate has gone up would seem to explain the shrink in GDP. But, if we imagine that businesses are smart enough to account for this, then it doesn't explain anything.

The problem we're having today is that our savings rate as a country was SO LOW (at times it was probably negative) during the last decade, that we took on lots and lots of debt. Although the personal savings rate (as opposed to the total savings rate, which includes businesses and the government) now is a much more respectable 5-7%, that savings rate is something of an illusion. People aren't really putting this money into a savings account; mostly, they're paying off old debts (including mortgages). Savings is really the difference between income and spending. It can be money that's put into a savings account or money that pays off a car loan. Both count as "savings."

Let's say that of every $5 "saved" by households in the US right now, $4 is going to pay down mortgages and other debts that originated some time between 2000 and 2009. The "job" that built the house or iPod purchased back then is finished; the work is already done. That means only $1 of that money is being "saved" for future consumption (like retirement savings, saving for a rainy day, saving to buy a new house, etc...).

Let's call the current personal savings rate 4% (the approximate average over the last several quarters). Next, let's pretend that the consumer sector of GDP (about 2/3 of US GDP is personal consumption) is exactly equivalent to the group that's doing the personal or household savings. So, that 4% savings rate could represent about 2.68% (0.04*0.67) of growth potential for the US economy as a whole. To simplify, we could think of that personal savings rate of 4% as representing enough dollars to cause a 2.68% increase in total GDP next year (or spread out over many future years). But, if 3/4 of that amount is really going to pay off last year's debts, then the amount that's really being "saved" to be invested or spent represents a potential contribution to GDP of only about 0.67% in the future.

So, is it a wonder that businesses aren't adding jobs? They're seeing that, right now, people are saving instead of spending. However, they're also seeing that what they're "saving" can't be spent in the future on new goods and services; it was already spent in the past. That money is just paying for all the stuff people have already bought. So, the same businesses aren't eager to add workers, because they don't see very great prospects for growth. Incidentally (and not surprisingly), some of the few areas that have done better during this recession are repair and service shops. This makes perfect sense; all the money people *are* spending is going back into old purchases. In the case of cars, at least this causes more mechanics to be employed. For many things, though, it has no positive impact on current or future employment.