More On Normalization

It seems as though we get interesting and unusual news about the world economy each and every day. What is going on here?

One theory that is worth watching is that we are undergoing a worldwide normalization of price, cost, and value. Historically, the value, price, and cost for the same or similar things has been completely different depending on where in the world you were. For example, a quadruple by-pass in Mumbai costs about $3000. The same procedure in New York City is more than $100,000. The two have identical mortality and success rates. Per capita income in India is a bit more than $5000, in the United States a bit more than $53,000. Are people in the United States more productive than in India? Yes, but not by a 10x factor. Even for the same jobs with similar results the labor cost in the United States is about 5x that of India.

The idea behind this normalization theory is that  a re-balancing is occuring. If this is true, it will be very deflationary for the United States. If wages ‘normalize’ to be in line with what most of the world experiences, then we can expect wages in the United States to drop dramatically. This is not necessarily horrible if prices of goods and services drop proportionally, except for two major traps: debt and government regulation.

The  debt trap is due to repayment challenges. If a borrower’s income drops, it becomes more difficult to repay the debt. For example, if wages were to drop from $45,000 a year to $30,000 a year, then the house the borrower paid $150,000 to purchase recently may then be worth only $100,000 based on the prevailing local wage. If the mortgage is $125,000 the borrower is now underwater.

The government regulation trap is created by government action intended to keep prices artificially high sometimes coupled with keeping the wages that go into building these products artificially high. For example, the automobile industry is highly regulated. Those regulations effectively place a floor on car prices. You can buy a new car in India for $2,000 but the least expensive new car in the United States is around $15,000. By placing an artificial floor on automobile prices in the United States via regulation, the government is able to support wages set by collective bargaining. The catch — if this normalization is true — is that fewer and fewer people will be able to afford one of those new cars, leading to fewer sales and less employment for those highly-paid workers. The situation quickly spirals out of control if those regulations remain in place.

An additional part of this theory is that the actions by the government and Federal Reserve to maintain the distorted markets are necessary to fight off this normalization. How long can the United States, Europe, Japan, and related economies continue to fight this off? It’s an open question, but if this normalization is occurring, then we can expect expect them to eventually lose the battle.

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