Nostradoofus

The Greek financial crisis is a mere deck chair on a political Titanic: European monetary union is inherently unstable without fiscal and central bank union. Fiscal/central bank union would require political union, a political impossibility. Thus, EMU cannot move past its current unstable state. Retreating to a mere trade union offers most of the benefits of EMU, at a fraction of the complexity and distortion.

Thus, almost inevitably, the euro area will shrink or break up, while the EU trade area will thrive.

Why is EMU inherently unstable? Because it is, by its nature, a transitional condition. Fiat currency, central bank and fiscal policy are logically a single module: a governing entity manages its fiat currency through fiscal and monetary policy to achieve domestic political goals (rational or irrational, short or long term oriented).

If a country tries to use someone else’s fiat currency without control of the monetary and fiscal policy of that currency (as occurs, for example, when Argentina dollarizes or when China pegs, or when Greece euro-izes), the result, every time, is systemic imbalance: inflation/deflation, current account deficit/surplus, etc. This happens because the solution to such imbalances is to revalue the currency — but they can’t, because it’s someone else’s currency.

To eliminate these distortions, the inevitable end is always either to unify more (merge politically) or less (stop using someone else’s currency).

Some EU framers understood this, and from the beginning intended EMU to be a transitional step toward political union. However, as it turned out, EMU was opposed by a popular majority in nearly every country where it was adopted. Going further — giving up the national budget to Brussels — is obviously impossible in the foreseeable future. So one has to ask if an inherently transitional state, with its inherent distortions, can persist indefinitely.

At this point, it makes sense to ask why Europe ever wanted this. The answer is rooted in World War II. When European politicians hatched these ideas in the early 1950s, militant nationalism was a vivid memory. The intended benefits of the EU were something like these:

1. Minimize cross-border transaction costs.
2. Present a united geopolitical force vs the USSR.
3. Prevent nationalist warfare among European states.

But in the 60 years it has taken to get this far, conditions have completely changed. There is little external military threat. Intra-European warfare sounds quaint. Europe’s trade union, coupled with modern IT/comms technology, has already greatly reduced cross-border transaction costs.

Under modern geopolitical conditions, a mere trade union may be Pareto-optimal: with a fraction of the complexity and distortion of a currency union, a trade union achieves most of the economic benefit, provides most of the necessary bargaining power vs Russia, yet avoids, for example, the inherent division between fiscal management styles of Mediterranean and non-Mediterranean countries.

A partial euro breakup may thus be inevitable, but, given the impossibility of political union, may also be for the best.  In essence, Europe is doing something today that makes no sense — just because it made sense 50 years ago.

—

A popular finance blogger asked me yesterday where Palm went wrong. Though I was a leading developer of Palm games and graphics software, I hadn’t considered this in a while. The specific question might be:

Why does the iPhone earn a third of all smartphone segment profits on just 8% share (by revenue), while Palm, despite an 11-year lead in mobile devices, is on life support, with negative lifetime profits, its shares down a split-adjusted 99.26% since the IPO?  What happened?

The answer is prosaic:  profit requires a sustainable competitive advantage.  Palm never found one.  Apple did.

One could kvetch all day (all week) about operational errors at Palm, but the central problem was strategic.  They never raised barriers to entry.  The carriers, retailers, distributors and PC vendors always held the power. Palm remained just a tool — though a very good one — for replicating other vendors’ PC data in the field.

Many bought the iPhone because they already own a pile of music purchased through iTunes — music that can only be played through an iPod.  You don’t want to carry a separate phone and iPod, so you pay a premium for an iPhone.  In short, the switching costs and network effects of iTunes are a big reason iPhone is so profitable.

Also when you buy an iPhone, likely as not you buy it directly from Apple.  There is no 3rd-party distributor or retailer to eat up margin.

Yes, iPhone is a great product, but that is not what sustains the margins.  The switching costs and distribution control sustain the margins.

Palm never grasped this. They still don’t.  They are narrowly focused on product. Their original design was fantastic, and opened a whole product category. The Pre is also great, by all indications. But good design is merely a necessary, not a sufficient, condition for consistent profitability.

Lacking any defenses, Palm still must fight every day for retail shelf space and wholesale pricing; Apple need not.  Palm cannot cross-sell from desktop computers; Apple can.  Palm controls no meaningful content format;  Apple does.  There is a long list like this, and it accounts for Palm’s travails as much as, or more than, any operational limitation.

For a time, perhaps 1996 to 2003, Palm had a big tactical advantage.  Their original design was so far out in front that competition was fragmented and poorly orchestrated.  That time could have been spent developing defenses.

For example, Palm could have used the PalmPilot sync software as a beachhead to wrest control of PC contact management software from ACT.  Palm could then have mainted those contacts in a closed data format, creating switching costs.  As long as their software was truly excellent, industry beating, then customers would be happy, despite a premium price.  Instead, Palm abdicated, treated contact management software as an afterthought for 10 years, while third parties developed sync tools.

The tactical advantage is now long lost.  Game over, it seems.

—

Following up on recent posts about inefficient regulation, here are several specific examples to show how California could radically simplify its operations.  This would slash state expenditures, hugely reduce compliance demands on small businesses, reduce barriers to hiring and business formation, yet have little or no impact on existing tax and revenue structure.

1. No state-specific income tax rules.  Conform state tax to federal, without exception.  You simply pay 10 cents to Calif. for every dollar you pay to the IRS, minus any amount you paid to other states.
2. No “use tax.”  Place burden on the seller to charge and remit California sales tax for California buyers.
3. All state and county interactions are online and paperless by default:  taxes, licenses, etc.
4. No smog check on vehicles under 10 years old.  Gross polluters were all made before 1980 anyway.
5. Eliminate state investment advisor registration.  This is how most other states do it, because SEC already registers managers with over $30m AUM.  This is a classic 95/5 Pareto optimization:  by dollars, most fraud is concentrated in big scams like like Madoff and Allen Stanford;  meanwhile, registration has not been shown to reduce fraud, and the law still applies whether registered or not.

—