Three economic principles

by Ian Campbell July 7, 2020

Economic downturns are natural.  They come in waves and rebalance runaway exuberance.  They need a spark—in this case a pandemic— but they are always followed by a crest.  Nucleus is built on the economic foundation of assessing value and when looking into the future, we like to refer back to a few core principles:  

Economics is the strongest force in nature.  Now some will say gravity but I’ll point out that while we can break the bonds of gravitational force at any time, it is economics that keeps us mostly earthbound.  In the long run it is value that drives all decisions. Restaurants and stores will open when there is an opportunity to generate a return.  That will always happen, regardless of how many go out of business today.  Likewise, products that do not deliver value will die off, as will initiatives such as poorly structured green efforts.  It doesn’t matter what it is, in the long run, if there’s no positive value, it eventually dies.  That’s a truism.

The average house will always sell for what the average person can pay.  Seems obvious but this rule is broken whenever thre’s a run on something.  We see it in the housing market on a regular basis when we hear people say if they don’t get into the market now they never will.  That’s just not true.  The market may stretch a bit (look for that opportunity to sell) but it will always snap back.  It has to.  Without buyers there are no sellers. And everything sells for what the average person in that market can pay.

A Home Depot bucket can tell you everything you need to know about the flow of money.  I know I’m putting a lot on a 5 gallon orange bucket but hear me out.  Money is like water flowing into a 5 gallon bucket.  Water flows into the top of your bucket, usually in the form of a salary, and flows out through the bottom in a series of small holes in the form of expenses. There’s no real end, only a continuous flow of water.  For example, one of your small holes likely flows to Amazon, only to flow back to you when an Amazon employee uses part of their salary to purchase goods at your store, which then flows back to you as salary for working in the store.  

Here’s the problem:  The bucket can’t run dry and always needs some water to keep the flow going. The level of the water we need in the bucket is our savings amount and that’s based in large part on our comfort about the future:  

  • When our jobs are stable and things are going well we buy more, letting the level in our bucket drop, and even borrowing water from others to fill our own.  
  • When we’re fearful, we close off some of the holes and save a bit more, raising the water level in our buckets and reducing the amount of water that flows to others.  
  • If everyone is fearful the flow of water in the system slows to a trickle, and that slowdown can happen quickly.  

Companies act the same way and that’s how uncertainty becomes the killer of an economy.  

When business owners feel good about the economy they decrease their corporate reserve of water, hiring more people and building more factories.  When business owners feel uneasy, either due to a decrease in sales or uncertainty about government actions or taxes, they increase the reserve in their corporate buckets, either by reducing costs, usually through reductions in staff, or increasing prices.

The more certain we are, both as individuals and corporations, the closer to the bottom of the bucket we will go and the faster the flow in the economy.  

Uncertainty forces us all to build reserves, slowing the flow.  When things start to run dry Keynesian economics tells us that a splash of water from the government can prime the pump— but it doesn’t really matter where that splash goes since it will always end up at the top of the flow. How much of that $1,200 stimulus check was only a single click away from Jeff Bezos’s pocket? 

The problem is not adding more water into the system as much as it’s about confidence in the future. With confidence the flow starts to increase as each person in line takes a tentative step to open up a little.  It could take a few iterations before the flow gets back to normal but it will.  

The economy will recover and products that deliver tangible value will always recover first, but none of that will happen if confidence in the future isn’t there.