Before returning to the central theme of this series, which gets back to the rise of laissez-faire capitalism in the eighties, Ronald Reagan and "share holder value," a few notes on other topics.
After massive intervention by the federal government in response to the housing meltdown, this morning markets appear to be calming somewhat. The market (as of the moment) is up, the price of oil and gold down from their recent highs and the dollar strengthening. I suspect we may be entering the "eye of the hurricane," and there will be increasing market volatility as we settle into recession. I am still waiting for the other shoe in the credit crunch - credit card defaults, which may make the housing foreclosures look mild.
Senator Obama has come out in favor of tapping into the strategic oil reserve to bring the price of gas at the pump down. Mistake. The reserve is held for national defense emergencies, not market adjustments. I am afraid this smacks of old time Democratic economics and doesn't measure up to the "change," he has been promising. So far, it isn't enough to change my vote, but stay tuned.
The argument herein is that the country under at least two Presidential administrations (Clinton and Bush) have pursued short-term economic policies that have long-tern negative effects, largely due to the failure to move to an effective New Economy (a service/idea-based economy), while departing from the Old Economy (a manufacturing based economy). The short-term problems lie primarily in the creation of a "credit economy" under Clinton and Bush, by which the failures of this movement from Old to New were masked or hidden. In other words, the major problem is "debt." Debt at the individual level, the state level, and in financial markets. Another way of describing over-indebtedness is to say we're over-leveraged, which in turn is another way to say, we're getting ahead of ourselves, and in a position where commitments have come to exceed resources.
And, the conclusion, I am slowly developing, is that the country will not be on sound economic footing until this is recognized and fixed. Use of the strategic oil reserve, aside from its national defense implications, is basically like the fed throwing money into the system to cover bad investment banking decisions - i.e. it's creating more debt; debt in oil, not dollars.
The thesis herein is that we need a new economic policy for a self-sustaining national economy, without giving up the "goal" of moving toward (or continuing in) a globalized economy. This will not be an easy task and will require some additional government intervention in the economy and government willingness to use the economic tools they have at their disposal: taxation, tariffs, interest rates, regulation and oversight, etc.).
The time for such a change is opportune; it is an election year and candidates and politicians always seem to be more responsive to populist arguments in such years. We have also just had a prime example of "investor error," within the context of the most laissez-faire environment since the late 19th century, in regard to the housing crisis.
Let's now turn back for a few more words on free trade in this context.
I am presently finishing a book titled: "The Bad Samaritans: The Myth of Free Trade and the Secret History of Capitalism." It's not as revolutionary as its title might suggest and based on considerable fact, as opposed to myth. It was written by Ha-Joon Chang, a Cambridge University professor of economics, with a Korean background.
There is a major debate among economists over the economic direction of countries with developing economies. Generally, economists representing the developing countries complain that international organizations such as the World Bank, the International Monetary Fund (IMF), and the World Trade Organization (WTO) are dominated by developed western countries seeking to impose economic hegemony. [The opposite argument, generally by western economists is that we've given up too much authority to these same organizations.] They also complain that the very economic ideas the west atteempts to force on the developing countries are largely "myths," which had nothing to do with the economic success of the developed countries in their own histories.
Most of Chang's book focuses on these topics, from the developing countries perspective. One passage, however, caught my attention:
"When economic prospects in a developing country are considered good, too much foreign capital may enter. This can temporarily raise asset prices (e.g. prices of stocks, real estate prices) beyond their real value, creating asset bubbles. When things get bad, often because of the bursting of the very same asset bubbles, foreign capital tends to leave all at the same time, making the economic downturn even worse."
Economic terms are relative and generally descriptive of multiple causation - ie. multivate analysis, wherein cause and effect holds true, but there are multiple causes leading to multiple effects, making analysis difficult. It strikes me that Chang's observation in the above regarding a problem within developing countries is equally true of developed countries in economic transition. The key is not "developing" or "developed," it is the degree and pace of economic transition.
Chang's observation may hold true equally for the United States, which although "classified" by economists as a "developed country," is in fact developing from the Old Economy to the New.
You may ask, so what? The significance of this perspective returns us to the two exceptions to free trade, generally recognized by economists as useful: protection of national defense industries and protection of new/infant industries. In other words, limited, selective tariffs (related to either foreign investment or goods and services) regarding both our defense industry and our high tech industries may be beneficial in helping to restore a sound American economy, through the creation of additional well paying American jobs.
Again, free trade, like globalization is a positive "goal," provided that development toward both is done in such a manner and pace that the pursuit of these goals do not destroy our national economy. But, the reckless pursuit of these goals is something akin to a policy of "pre-emptive war," wherein the risks of unanticipated consequences outweigh the tangible gains.
The point is that, without abandoning free trade goals, we must come to see selective tariffs as a tool of government to ensure the protection of both national defense and the elements of the new economy, upon which we expect to base our future economic success. In this, a selective tariff policy also is a tool by which to adjust the pace of globalization to protect our own internal economy (i.e. additional, better paying jobs for our citizens).
In the absence of the use of such tools, the cost of labor will seek an equilibium - i.e. developing countries wages will rise and developed countries wages will fall at "market rates." In a democratic society, the dramactic shift in such a fall can be sustained only by loose credit and the devaluation of currency.
More next time.
Thursday, March 20, 2008
Sunday, March 16, 2008
A Brief Update on Bear Stearns
A few posts ago, in reference to Wall Street nemesis ex-Governor Elliot Spitzer, I scored his fall from grace as: Masters of the Universe 1; Caped Crusader 0. This evening, the Masters of the Universe lost a point.
The collapse of Bear Stearns does not bode well for the rest of the market. As I understand the news, JP Morgan, Chase & Company have bought Bear for $2.00/share. At this point, I would imagine the shareholder base consists of three types of people: long term investors hoping to ride out the storm, partners of the firm, and a few who believed financial institutions had "bottomed out" and bought in at roughly the closing trading price on Friday, $30/share.
So, if you were in the latter category, which would be the best of the three groups, your losses would be only 1500%. If you bought in around Bear's high last year of approximately $160/share, your loss would be 8000%.
The buy-out price of $257M or so is for Bear itself. The Fed has promised JP Morgan & Chase to cover losses they may incur in assuming the Bear portfolio - i.e. the specific investments made for its clients, as well as help JP fund the buy, up to a total of $30B of our money...don't worry, they'll just add it to the national debt.
Since the Fed is the lender of last resort, one may assume some valuation of the Bear holdings had been completed prior to going to the Fed and that the holdings were found to be mostly worthless junk. That means JP Morgan will be calling on a substantial portion of the promised $30B. Bear was perhaps the investment bank most heavily into the subprime mortgage securitized debt instruments. Another bank heavily invested in the same is USB, United Bank of Switzerland. Expect them to take a heavy hit on Monday and be in a "touch and go" situation for the next few weeks.
The Bear failure brings up the question of who - if anyone - is next? Is this the beginning of a domino effect? The market may answer that question in the coming week. Some degree of unrest and uncertainty is highly probable, despite the Fed's eagerness to further reduce short term interest rates, beyond the additional quarter of a point they gave up with the Bear news today.
As I pointed out in the earlier post on Bear, my guess is that the banks are in the Phase II process of "revaluing" bad investments. That, coupled with an analyst prediction, I've read somewhere, that said we are only about half-way through the subprime mess, tells me that whereas Bear's demise may be the first, it won't be the last. A whole lot of over leverage and lousy management. Apparently, a few Wall Street CEO's made mistakes similar to those home mortgage borrowers who felt "things can only get better" when they signed up to ARM's.
I have a gut feeling, with nothing really to base it on, that we may see 2-3 additional bank failures; possibly one larger than Bear and one or two smaller failures. If that is the worse case then we may get through this with a recession lasting one-two years, before the house of cards gets repaired and re-building begins. If worse, however, then the underlying problems of the American economy are going to be exposed and the recession could conceivably go into depression, requiring 10 years for recovery...and a generation of very, very nervous and angry, but humbled people.
My preference is that we endure as mild a recession as possible, but take this as a warning of worse to come unless fundamental economic changes are made. The unfortunate thing is that a mild recession may not force policy makers to make the basic changes necessary (if I am right in my theory on the negative effects of globalization on the American economy).
Those necessary changes are what I am building up to in the New Economy posts, but a "preview" of those changes is: a step back from globalization and taking a more selective approach, while pulling back some of the jobs lost overseas, and creating a national economic policy that aims at a "Self-Sustaining National Economy," while not abandoning the longer term benefits of a global economy.
I don't think McCain can go there, given the constraints of Republican economic policies. Neither will Clinton, given the restraints of Wall Street. But, at the moment, Obama (from that great windy city in the mid-west) is still in a position to do so. He is new enough not to be a prisoner of his financial backers and ill-defined enough to still put forward significant changes in his platform.
Will he have the courage? Time will tell...and it will have to be sooner than later.
P.S. After all of this is over and the losses are totaled, I hope someone compares those losses to the amount of money involved in the Bush tax cuts.
The collapse of Bear Stearns does not bode well for the rest of the market. As I understand the news, JP Morgan, Chase & Company have bought Bear for $2.00/share. At this point, I would imagine the shareholder base consists of three types of people: long term investors hoping to ride out the storm, partners of the firm, and a few who believed financial institutions had "bottomed out" and bought in at roughly the closing trading price on Friday, $30/share.
So, if you were in the latter category, which would be the best of the three groups, your losses would be only 1500%. If you bought in around Bear's high last year of approximately $160/share, your loss would be 8000%.
The buy-out price of $257M or so is for Bear itself. The Fed has promised JP Morgan & Chase to cover losses they may incur in assuming the Bear portfolio - i.e. the specific investments made for its clients, as well as help JP fund the buy, up to a total of $30B of our money...don't worry, they'll just add it to the national debt.
Since the Fed is the lender of last resort, one may assume some valuation of the Bear holdings had been completed prior to going to the Fed and that the holdings were found to be mostly worthless junk. That means JP Morgan will be calling on a substantial portion of the promised $30B. Bear was perhaps the investment bank most heavily into the subprime mortgage securitized debt instruments. Another bank heavily invested in the same is USB, United Bank of Switzerland. Expect them to take a heavy hit on Monday and be in a "touch and go" situation for the next few weeks.
The Bear failure brings up the question of who - if anyone - is next? Is this the beginning of a domino effect? The market may answer that question in the coming week. Some degree of unrest and uncertainty is highly probable, despite the Fed's eagerness to further reduce short term interest rates, beyond the additional quarter of a point they gave up with the Bear news today.
As I pointed out in the earlier post on Bear, my guess is that the banks are in the Phase II process of "revaluing" bad investments. That, coupled with an analyst prediction, I've read somewhere, that said we are only about half-way through the subprime mess, tells me that whereas Bear's demise may be the first, it won't be the last. A whole lot of over leverage and lousy management. Apparently, a few Wall Street CEO's made mistakes similar to those home mortgage borrowers who felt "things can only get better" when they signed up to ARM's.
I have a gut feeling, with nothing really to base it on, that we may see 2-3 additional bank failures; possibly one larger than Bear and one or two smaller failures. If that is the worse case then we may get through this with a recession lasting one-two years, before the house of cards gets repaired and re-building begins. If worse, however, then the underlying problems of the American economy are going to be exposed and the recession could conceivably go into depression, requiring 10 years for recovery...and a generation of very, very nervous and angry, but humbled people.
My preference is that we endure as mild a recession as possible, but take this as a warning of worse to come unless fundamental economic changes are made. The unfortunate thing is that a mild recession may not force policy makers to make the basic changes necessary (if I am right in my theory on the negative effects of globalization on the American economy).
Those necessary changes are what I am building up to in the New Economy posts, but a "preview" of those changes is: a step back from globalization and taking a more selective approach, while pulling back some of the jobs lost overseas, and creating a national economic policy that aims at a "Self-Sustaining National Economy," while not abandoning the longer term benefits of a global economy.
I don't think McCain can go there, given the constraints of Republican economic policies. Neither will Clinton, given the restraints of Wall Street. But, at the moment, Obama (from that great windy city in the mid-west) is still in a position to do so. He is new enough not to be a prisoner of his financial backers and ill-defined enough to still put forward significant changes in his platform.
Will he have the courage? Time will tell...and it will have to be sooner than later.
P.S. After all of this is over and the losses are totaled, I hope someone compares those losses to the amount of money involved in the Bush tax cuts.
Free Trade - The New Economy II (Continued -5)
The central theme of this series of posts is what I believe to be the negative effects of globalization on the American economy. It may be a subtle point (and one difficult to make), but I am not against the long range goals of globalization - as I understand them - but only the means by which we are transitioning to this goal.
For one thing, globalization has for all practical purposes already occurred, although I would reverse some aspects. For another, given today's technology and future trends, globalization is pretty much inevitable. That inevitability is like the old, classic story about what do buggy whip manufacturers do with the coming of the automobile? Transportation, communications, global consumer trends, education, etc., etc. are all among the various forces driving globalization, in terms of a common global society.
This trend is neither unique or necessarily harmful over the long run. Prior to the Civil War, the United States was essentially one government with two regional economies. It was only following that War, in the late eighteen hundreds, chiefly through technological advances, that a national economy came together. The J.P. Morgan's, the Rockefeller"s, the Carnegie's, may retrospectively have been "robber barons," but they were also entrepreneurs, who sensed the commercial advantages in moving a politically re-united nation, through technology, to a national economy.
Most of these "advances," (and some would argue the Civil War itself) may be traced back to the beginnings of the industrial revolution in the early 1800s and the general movement in the western world from agriculturally based economies to "materialism." Materially, the world has moved further and faster in the last 200 years than in the approximate 9,800 years of human civilization that came before it.
Environmental concerns, the use of natural resources, and population growth, have added a tremendous impetus to globalization. Our collective advances in human knowledge - primarily science - have had an equal impact. But, this new awareness of global interdependency doesn't spread easily to the human consciousness. Just as regional oil producers were among John D. Rockefeller's foremost critics (and contributed to massing public opinion against Standard Oil), we have today many who find it difficult adjusting to new realities.
The enormous growth of scientific knowledge (both pure and applied) made the industrial revolution possible, just as it has made globalization and a post-industrial society possible.
In this process of what is really an exponential growth in human knowledge, science knows no religion; no national boundaries and, in a great sense, makes both obsolete, in terms of human organization.
It is this belief that causes me to conclude that "globalization," of virtually all aspects of human life, is a postive development for the progress of mankind. Ultimately, the alternative is sort of a Mad Max world, back to a point in human history in which life was "short and brutish."
In earlier posts I have tried to explain how the greatest challenge to global economics today is how to organize fast enough to incorporate the approximately 3 billion people added to the global labor market due to the fall of communism, without having these people face starvation and the resulting digression of their societies back into wars and revolutions.
So, I basically agree with President Bush that global democratic-capitalism is the best means of providing global peace and stability [although I have serious disagreements on how that is defined and how we get there]. Actually, initially, this was the same goal as communism. "From each, according to their abilties, to each according to their needs." In a moment, I'll try and show this is a position not too far different than the underlying principles of free trade, but first a few more words on the really Big Picture.
There are distinct differences between science and religion, but these differences are essentially in methodology and not in "truth." In both realms, "truth" changes with time and position. Generally, religious truth claims to be eternal, but if we look at the details in the history of religions, even they change in perception over time. These changes usually occur as the original teachings are passed on from one generation to the next and religious hierarchies evolve from their starting points. Hierarchies produce "experts" at interpretation, who differ slightly from the last generation of experts, and so forth and so on. The overall message may remain approximately the same, but as they say: "the devil is in the detail." And, it is in these detailed interpretations, changing in space and time, that produce events such as the Christian Crusades or present day Al Qaeda.
Unlike religion, science does not even pretend to offer eternal truth. The "truth" of science lies in proving functionality - i.e. what works - based on today. And science offers a temporary explanation of temporary truth, based on present knowledge. As that knowledge expands, essentially through our ability to "see" things differently through advances in measurement, the old "truths" are changed. The process of change is not usually easy, but probably a great deal easier than in religion because scientists as a group generally follow the same "religion" - the scientific method.
Perhaps, one of the foremost "shifts" in scientific truth lies in Newtonian physics versus the physics of Albert Einstein. And, not being a physicist, here is a layman's explanation.
Newtonian physics is essentially a three dimensional world: length, width, depth. Sort on physics based on Euclidian Geometry. And, if one isn't too precise about measuring, it works...here on earth...or "locally." But, you can't get to the Moon and back using Newton alone, for that task you need Einstein and the principles of "curved space" and time.
Before I get in too deep for my own good, let me say, the point is that science incorporated Einstein's thoughts into its "body of work" and we did get to the moon and back. If Newton had expressed eternal truths, true for all time, everywhere, we wouldn't have made it.
The two major attributes of science are, in my mind, its flexibility and its functionality. This is why, in attempting to look ahead, or to predict the future, I tend to place it ahead of religious belief. While both science and religion are capable of "change," the thrust of direction in religion is generally oriented toward the past, while science's is toward the future.
Change is biologically a tough proposition for human beings, as it is for all living organisms. One of the keys to our success as a species (to date at least...don't know about tomorrow) is "adaptability." This says, that while we may not like change, we'll accept it if it means our survival.
That is a long, roundabout way of explaining why I believe that globalization is inevitable. The global environmental problems we are facing today, some of which may be traced to the industrial revolution and our material success, cannot be resolved without global cooperation. Example: Solving pollution problems within the United States will not help us unless China, India, etc. also resolve their pollution problems. And, there are many other examples, the Amazon Rain Forest, Global Warming, etc.
Library shelves are filled with books on this subject: post-industrial society. In sum, however, the direction of science points in the direction of global interdependency. It won't help things if THIS society makes the transition to a post-industrial society; interdependency demands we move in the same direction - as a species.
The great question, however, coming back to economics, is what is the best means for achieving this transition? And, this question brings me back to the global economy, free trade and, fundamentally, the loss of American jobs.
There are two driving assumptions behind our present approach to globalization: lower cost labor and free trade. In my last post, I tried to explain that lower cost labor involved a "bet" that in the long run, "ideas" would be more valuable than "things." Thus, long-run wise, we "swap" a North Carolina textile worker for a computer programmer. It's brain power (New Economy) substituted for manual labor (Old Economy). That's not a bad cure, if the medicine doesn't kill you, and my point has been, the medicine is killing us.
The basic problem is that we can't train computer programmers for the New Economy fast enough to replace Old Economy workers. The result is alot of displaced people who must be "kept" through cheap credit and low cost imports; the means of which have been achieved largely through low interest rates, devalued currency and (now I'll add a third, coming to the topic) free trade.
Economics 101 on free trade. The underlying theory of free trade is economic efficiency. Global free trade, i.e. one that doesn't try to "balance" through tariffs/taxes, allows each country to do what they do best ("From each according to their abilities, to each according to their needs," providing they can pay the going market price.) By specializing in what they do best, they acquire greater efficiencies of production and bring the best product to the global market, at the lowest price. Without tariffs, these products find their "true value" in a free market. Until recently, the vast majority of free trade economists, qualified this general "rule" with two exceptions: 1) new, infant industries, which require temporary government help and protection to get started and 2) national defense industries, under the theory that no one knows what the future will bring and it is safer for a country to maintain a defense capability within its own borders, even if it isn't efficient to do so.
Most discussion of tariffs today revolve around 1) above. The exception of 2) above has generally been ignored for the past twenty years or so. A recent bi-partisan national committee on just this subject concluded that defense mobilization planning has virtually disappeared. In time of a serious war this neglect could be disasterous for the country, but even short of such a war, it probably severely handicaps our foreign policy options. [Note: We have essentially placed economic efficiency and globalization ahead of national security. This is a topic that gets virtually zero coverage in the media. I suspect the lack of attention is due primarily to the fact that neither major party wants to discuss it, because they both hold the same position.]
The United States, from its inception to WWII, grew economically through tariffs. Although there were ups and downs, particulaly in regard to specific industries, we were as a nation, "pro-tariff. " This isn't surprising, because generally net importers tend to be pro-tariff (i.e. they want to import goods, but at a competitive price to their own products), while net exporters tend to be free traders (i.e. they don't want the prices of their products driven up in foreign markets).
Our national position on tariffs pretty much follows the above rule. While we imported more than we exported, we were pro-tariff. We began becoming "free traders" following WWII, when we were producing approximately 50% of the world's manufacturing products and became net exporters. When we ceased to be net-exporters (e.g. when the trade balance in goods and services went negative) we should have given this position another look, but given the "bet" of the New Economy and the anticipated increase in the valuation of "ideas," we've remained free traders. There are occasional exceptions, such as steel, aluminum, auto, but they are usually short term and temporary responses to overwhelming lobbying pressures.
[Note: Many Republicans like to refer to the Smoot-Hartley tariffs of the nineteen thirties as leading to the Depression and WWII. Although, I need to do additional research, Smoot-Hartley may have played a part in the Japanese attack on Pearl Harbor, insomuch it was related to Japanese expansion in China and SE Asia and the availability and price of U.S. oil, but the act had nothing to do with the Great Depression, which started in 1929, before the tariffs.]
All else being equal, free trade is a positive goal in a global economy. The catch is in the first phrase, "all else being equal," which is not the case at the moment. The trade deficit is proof. If free trade was working for the United States, the trade in goods and services would be either far lower, balanced, or even a surplus. Today, we are giving away more than were getting and because of the "bet," this will not change under present economic policy until the "idea" products start selling. [Note: There are off-setting trade accounts that mediate the imbalance in goods and services, such as foreign investment. Until recently, the United States "invested" more abroad than foreigners invested here. That has changed, but is to some degree off-set again by improvements in the trade of goods and services through a weak dollar. Remember, that whereas a weaker dollar helps the trade deficit in goods and services, it also makes our foreign investment more expensive, in that it takes more dollars to buy foreign assets. I would suggest that "overall" over, say, a year, it won't get better and the total deficit will continue to rise.]
Free trade also, through the principle of each country doing what it does better than anyone else, assumes, at the macro - or Big Picture - level, a global division of labor. This division of labor, in turn, is based on the principle of the evolution of a skilled work force that results in a superior and low cost product based on economic efficiency, which competes on a more or less level playing field. Today, in China's case, this is not the situation. Cheap Chinese imported goods are based on an enormous surplus of Chinese labor, not subject to the same type of quality controls found in the United States and Europe, and controlled by a communist/socialized government. In the United States a CEO may fail and walk away from the company with tens of millions of dollars; in China, they are often simply shot. Perhaps, in our next round of trade negotiations, we could get the Chinese to institute better quality controls for products we are importing in return for our agreement to start executing errant U.S. executives?
The point is, that today "free trade" occurs between societies so different, it can scarcely be called "free trade." I would repeat: Free trade, in its totality is a positive attribute for a global economy, but when it becomes little more than a search for cheap labor it falls apart, with devestating consequences.
More in the next post.
For one thing, globalization has for all practical purposes already occurred, although I would reverse some aspects. For another, given today's technology and future trends, globalization is pretty much inevitable. That inevitability is like the old, classic story about what do buggy whip manufacturers do with the coming of the automobile? Transportation, communications, global consumer trends, education, etc., etc. are all among the various forces driving globalization, in terms of a common global society.
This trend is neither unique or necessarily harmful over the long run. Prior to the Civil War, the United States was essentially one government with two regional economies. It was only following that War, in the late eighteen hundreds, chiefly through technological advances, that a national economy came together. The J.P. Morgan's, the Rockefeller"s, the Carnegie's, may retrospectively have been "robber barons," but they were also entrepreneurs, who sensed the commercial advantages in moving a politically re-united nation, through technology, to a national economy.
Most of these "advances," (and some would argue the Civil War itself) may be traced back to the beginnings of the industrial revolution in the early 1800s and the general movement in the western world from agriculturally based economies to "materialism." Materially, the world has moved further and faster in the last 200 years than in the approximate 9,800 years of human civilization that came before it.
Environmental concerns, the use of natural resources, and population growth, have added a tremendous impetus to globalization. Our collective advances in human knowledge - primarily science - have had an equal impact. But, this new awareness of global interdependency doesn't spread easily to the human consciousness. Just as regional oil producers were among John D. Rockefeller's foremost critics (and contributed to massing public opinion against Standard Oil), we have today many who find it difficult adjusting to new realities.
The enormous growth of scientific knowledge (both pure and applied) made the industrial revolution possible, just as it has made globalization and a post-industrial society possible.
In this process of what is really an exponential growth in human knowledge, science knows no religion; no national boundaries and, in a great sense, makes both obsolete, in terms of human organization.
It is this belief that causes me to conclude that "globalization," of virtually all aspects of human life, is a postive development for the progress of mankind. Ultimately, the alternative is sort of a Mad Max world, back to a point in human history in which life was "short and brutish."
In earlier posts I have tried to explain how the greatest challenge to global economics today is how to organize fast enough to incorporate the approximately 3 billion people added to the global labor market due to the fall of communism, without having these people face starvation and the resulting digression of their societies back into wars and revolutions.
So, I basically agree with President Bush that global democratic-capitalism is the best means of providing global peace and stability [although I have serious disagreements on how that is defined and how we get there]. Actually, initially, this was the same goal as communism. "From each, according to their abilties, to each according to their needs." In a moment, I'll try and show this is a position not too far different than the underlying principles of free trade, but first a few more words on the really Big Picture.
There are distinct differences between science and religion, but these differences are essentially in methodology and not in "truth." In both realms, "truth" changes with time and position. Generally, religious truth claims to be eternal, but if we look at the details in the history of religions, even they change in perception over time. These changes usually occur as the original teachings are passed on from one generation to the next and religious hierarchies evolve from their starting points. Hierarchies produce "experts" at interpretation, who differ slightly from the last generation of experts, and so forth and so on. The overall message may remain approximately the same, but as they say: "the devil is in the detail." And, it is in these detailed interpretations, changing in space and time, that produce events such as the Christian Crusades or present day Al Qaeda.
Unlike religion, science does not even pretend to offer eternal truth. The "truth" of science lies in proving functionality - i.e. what works - based on today. And science offers a temporary explanation of temporary truth, based on present knowledge. As that knowledge expands, essentially through our ability to "see" things differently through advances in measurement, the old "truths" are changed. The process of change is not usually easy, but probably a great deal easier than in religion because scientists as a group generally follow the same "religion" - the scientific method.
Perhaps, one of the foremost "shifts" in scientific truth lies in Newtonian physics versus the physics of Albert Einstein. And, not being a physicist, here is a layman's explanation.
Newtonian physics is essentially a three dimensional world: length, width, depth. Sort on physics based on Euclidian Geometry. And, if one isn't too precise about measuring, it works...here on earth...or "locally." But, you can't get to the Moon and back using Newton alone, for that task you need Einstein and the principles of "curved space" and time.
Before I get in too deep for my own good, let me say, the point is that science incorporated Einstein's thoughts into its "body of work" and we did get to the moon and back. If Newton had expressed eternal truths, true for all time, everywhere, we wouldn't have made it.
The two major attributes of science are, in my mind, its flexibility and its functionality. This is why, in attempting to look ahead, or to predict the future, I tend to place it ahead of religious belief. While both science and religion are capable of "change," the thrust of direction in religion is generally oriented toward the past, while science's is toward the future.
Change is biologically a tough proposition for human beings, as it is for all living organisms. One of the keys to our success as a species (to date at least...don't know about tomorrow) is "adaptability." This says, that while we may not like change, we'll accept it if it means our survival.
That is a long, roundabout way of explaining why I believe that globalization is inevitable. The global environmental problems we are facing today, some of which may be traced to the industrial revolution and our material success, cannot be resolved without global cooperation. Example: Solving pollution problems within the United States will not help us unless China, India, etc. also resolve their pollution problems. And, there are many other examples, the Amazon Rain Forest, Global Warming, etc.
Library shelves are filled with books on this subject: post-industrial society. In sum, however, the direction of science points in the direction of global interdependency. It won't help things if THIS society makes the transition to a post-industrial society; interdependency demands we move in the same direction - as a species.
The great question, however, coming back to economics, is what is the best means for achieving this transition? And, this question brings me back to the global economy, free trade and, fundamentally, the loss of American jobs.
There are two driving assumptions behind our present approach to globalization: lower cost labor and free trade. In my last post, I tried to explain that lower cost labor involved a "bet" that in the long run, "ideas" would be more valuable than "things." Thus, long-run wise, we "swap" a North Carolina textile worker for a computer programmer. It's brain power (New Economy) substituted for manual labor (Old Economy). That's not a bad cure, if the medicine doesn't kill you, and my point has been, the medicine is killing us.
The basic problem is that we can't train computer programmers for the New Economy fast enough to replace Old Economy workers. The result is alot of displaced people who must be "kept" through cheap credit and low cost imports; the means of which have been achieved largely through low interest rates, devalued currency and (now I'll add a third, coming to the topic) free trade.
Economics 101 on free trade. The underlying theory of free trade is economic efficiency. Global free trade, i.e. one that doesn't try to "balance" through tariffs/taxes, allows each country to do what they do best ("From each according to their abilities, to each according to their needs," providing they can pay the going market price.) By specializing in what they do best, they acquire greater efficiencies of production and bring the best product to the global market, at the lowest price. Without tariffs, these products find their "true value" in a free market. Until recently, the vast majority of free trade economists, qualified this general "rule" with two exceptions: 1) new, infant industries, which require temporary government help and protection to get started and 2) national defense industries, under the theory that no one knows what the future will bring and it is safer for a country to maintain a defense capability within its own borders, even if it isn't efficient to do so.
Most discussion of tariffs today revolve around 1) above. The exception of 2) above has generally been ignored for the past twenty years or so. A recent bi-partisan national committee on just this subject concluded that defense mobilization planning has virtually disappeared. In time of a serious war this neglect could be disasterous for the country, but even short of such a war, it probably severely handicaps our foreign policy options. [Note: We have essentially placed economic efficiency and globalization ahead of national security. This is a topic that gets virtually zero coverage in the media. I suspect the lack of attention is due primarily to the fact that neither major party wants to discuss it, because they both hold the same position.]
The United States, from its inception to WWII, grew economically through tariffs. Although there were ups and downs, particulaly in regard to specific industries, we were as a nation, "pro-tariff. " This isn't surprising, because generally net importers tend to be pro-tariff (i.e. they want to import goods, but at a competitive price to their own products), while net exporters tend to be free traders (i.e. they don't want the prices of their products driven up in foreign markets).
Our national position on tariffs pretty much follows the above rule. While we imported more than we exported, we were pro-tariff. We began becoming "free traders" following WWII, when we were producing approximately 50% of the world's manufacturing products and became net exporters. When we ceased to be net-exporters (e.g. when the trade balance in goods and services went negative) we should have given this position another look, but given the "bet" of the New Economy and the anticipated increase in the valuation of "ideas," we've remained free traders. There are occasional exceptions, such as steel, aluminum, auto, but they are usually short term and temporary responses to overwhelming lobbying pressures.
[Note: Many Republicans like to refer to the Smoot-Hartley tariffs of the nineteen thirties as leading to the Depression and WWII. Although, I need to do additional research, Smoot-Hartley may have played a part in the Japanese attack on Pearl Harbor, insomuch it was related to Japanese expansion in China and SE Asia and the availability and price of U.S. oil, but the act had nothing to do with the Great Depression, which started in 1929, before the tariffs.]
All else being equal, free trade is a positive goal in a global economy. The catch is in the first phrase, "all else being equal," which is not the case at the moment. The trade deficit is proof. If free trade was working for the United States, the trade in goods and services would be either far lower, balanced, or even a surplus. Today, we are giving away more than were getting and because of the "bet," this will not change under present economic policy until the "idea" products start selling. [Note: There are off-setting trade accounts that mediate the imbalance in goods and services, such as foreign investment. Until recently, the United States "invested" more abroad than foreigners invested here. That has changed, but is to some degree off-set again by improvements in the trade of goods and services through a weak dollar. Remember, that whereas a weaker dollar helps the trade deficit in goods and services, it also makes our foreign investment more expensive, in that it takes more dollars to buy foreign assets. I would suggest that "overall" over, say, a year, it won't get better and the total deficit will continue to rise.]
Free trade also, through the principle of each country doing what it does better than anyone else, assumes, at the macro - or Big Picture - level, a global division of labor. This division of labor, in turn, is based on the principle of the evolution of a skilled work force that results in a superior and low cost product based on economic efficiency, which competes on a more or less level playing field. Today, in China's case, this is not the situation. Cheap Chinese imported goods are based on an enormous surplus of Chinese labor, not subject to the same type of quality controls found in the United States and Europe, and controlled by a communist/socialized government. In the United States a CEO may fail and walk away from the company with tens of millions of dollars; in China, they are often simply shot. Perhaps, in our next round of trade negotiations, we could get the Chinese to institute better quality controls for products we are importing in return for our agreement to start executing errant U.S. executives?
The point is, that today "free trade" occurs between societies so different, it can scarcely be called "free trade." I would repeat: Free trade, in its totality is a positive attribute for a global economy, but when it becomes little more than a search for cheap labor it falls apart, with devestating consequences.
More in the next post.
Saturday, March 15, 2008
Back to Eccles
It's time to return to the Eccles remarks on the Great Depression. Basically, Eccles contributed the Great Depression to inequality of wealth and income. This inequality put a disproportionate amount of capital into a few hands, who would NORMALLY have invested in new plants, to produce more product to be bought by an increasingly wealthier general population. But, since the distribution of income was disproportionate, the general population consumer market for additional products wasn't there and capital simply accumulated. On top of this, what spending was done was largely done on credit (credit used to even out the disproportionate wealth/income distribution). Eccles wrote: "When their credit ran out, the game simply stopped."
There are similar problems in today's economy with two variations: 1) today, "globalization" takes the place of the nineteen twenties "capital accumulation" and is the prime cause of the failure to build new plants in the USA. 2) cheap imports, combined with extraordinary access of the general population to credit markets, relative to the twenties, in the form of "new financial instruments" - ranging from credit cards to mortgage and home equity debt instruments - has obscured, until recently, the disproportionate wealth distribution.
In regard to 1) above: In other words, in today's global economy, wherein the American manufacturing sector has shrunk to 14% of the total GDP, and consumer goods are for the most part imports, capital spending on "new plant" simply isn't an issue. It's a guess (for which I need to do additional research), but I'd suggest that the trend in capital investment over the last twenty years has been toward foreign investment and commercial real estate (and at a different general population level, 401Ks, based on over-valued stocks and/or inflated housing prices) and that together, today, invested capital in these categories far exceeds investment for the production of consumer goods. The key word in the last sentence is "production." There HAS been substantial capital investment in high tech products related to improved distribution systems for foreign produced product. But, in sum, investment is going toward foreign "new plant," and domestic distribution.
The effect, however, is the same as in the nineteen twenties dealing with a national economy and low imports - i.e. whereas the giant suction pump of the twenties was in capital accumulation, that pump in nineties and early 21st century is globalization.
This brings us to 2) above. This pattern of investment only makes sense (from a populist national economy perspective) if the American consumer keeps consuming, otherwise the house of cards falls. Foreign plant investment and U.S. distribution systems are "valueless" to most of the U.S. population in the absence of mass consumption.
In the absence of an American consumer market, foreign plant will simply turn to production for domestic markets - to the extent possible and as wages adjust - the plant owner doesn't care who he sells to, as long as there is a sale. And, if that American consumer stops buying, we'll be left with a lot of unemployed "service economy" workers wandering among a lot of empty shopping centers and warehouses.
The point is that in the New Economy world, national economies cannot survive a global division of labor, without a single, global set of rules and regulations.
I am coming to the credit problem, but hang on a bit longer.
The bi-partisan American political approach to globalization and the global division of labor was to place a very, very high risk "bet." We bet our manufacturing base on a projected post-industrial society, wherein the United States would make its contribution to the global economy through "ideas." And, these "ideas" would be "packaged" as services. We did this without guarantees of international intellectual property rights; we did it while continuing to train, in our universities, new foreign elites (Note: 60% of science and engineering degrees granted by U.S. universities go to foreign students). We did it without an understanding that "ideas" transfer across borders without controls far, far easier than product production facilities and that it is much more difficult to "value" an idea than it is a hard product.
Sound pretty stupid? Well, I'd argue that this is one result of Eccles' theory of "disproportionate wealth." When that distribution becomes top heavy (and today it is as top heavy as it was in the twenties), you end up with an economy largely separated from most of its peoples. You end up with CEOs who worry a lot more about this year's bonus than how much the guy at the bottom of his corporation is making. Marie Antonite, just before the French Revolution, supposedly, when asked about how the general population would eat, said "let them eat cake," the line today would be, "let them shop at Wal Mart." There is another side to all of this, which I'll come to in a moment.
The big "bet" essentially failed...or, at least, wasn't coming true fast enough to hold the economy together and the answer to this problem was "cheap credit."
[Note: The next part "assumes" the "service economy" failed to replace the former manufacturing economy on a 1 to 1 basis and that cheap credit had to make up the difference. I need further research into this proposition regarding employment shifts in the economy over time. I am suggesting that such a study would show that much of the former economy moved into service jobs ranging from financial services, computer programming, fast food, retail sales, self-employment, etc., but that all of this did not raise household income consistent with overall economic growth. Without the research, at the gross or macro level, there are plenty of income statistics today to show household incomes have either remained flat or increased minimally over this time period.]
Few in either political party are today willing to step up and lay all of this out for the American people. With the current economic crisis most would probably go as far as saying: "the jury is still out." But, no one (other than Pat Buchanan and a few others on the outskirts of the political system) is willing to say: "We've lost the bet."
Instead, the United States poured more and more money into the system, via loose credit and low interest rates, to prop up an "American Consumer Society," which much of the developing world had come to depend upon. This wasn't entirely altruistic. American consumers bought cheap, foreign produced products, on credit. In turn, the importing countries recycled much of their profit back into the U.S., either directly, through the purchase of U.S. assets, or in market investments, pumping up overvalued financial markets. [Note: A few foreign firms actually built "new plant" in the U.S., generally automotive plants; largely to off-set a growing demand for tariffs to protect American industry. But, this is a very small portion of the national economy. Also, the argument that we have an "investor" or "ownership" society - i.e. we're all going to live off the rest of the world - just doesn't hold up to statistical analysis, as shown by the growing stratification of wealth.]
So, we are now verging on the "tipping point," which Eccles described:
"The time came when there were no more poker chips to be loaned on credit. Debtors thereupon were forced to curtail their consumption in an effort to create a margin that could be applied to the reduction of outstanding debts. This naturally reduced the demand for goods of all kinds and brought on what seemed to be overproduction, but was in reality under consumption when judged in terms of the real world instead of the money world. This, in turn, brought about a fall in prices and employment."
This is, basically, the situation in which we are in today - or will probably be shortly. There is one substantial difference, which is not good news. In the above Eccles quotation, the fall in prices mediates the severity of the fall in employment. True for the nineteen twenties. In the 1930s, after government invention, the coming of WWII and the transition of the United States into the "Arsenal of Democracy," created an opportunity for Americans to return to their plants, their factories. Today, there are no plants to return to, and there are other markets for importers to sell into. As already noted, foreign plant product may turn inward, improving their own economies, but doing nothing for us. Further, oil - still the energy source that drives much of the world economy, such as all of those manufacturing plants we shipped abroad - will probably remain at high prices due to increased non-U.S. foreign demand and a dwindling supply. [Note: Drilling in ANWAR and Canadian shale won't save the situation. ANWAR might delay the worst for a couple of years (of course, we may need those years) and processing of Canadian shale is very expensive at present. The "energy problem" long term may be handled; it is the immediate future, wherein its price and availability create enormous economic difficulties.
Before moving along, a word on "the other side of the picture" - the non-populist side. Culturally, I would suggest that much of the traditional American "elite,"(elite in terms of wealth), over a period of time, lost confidence in the country...in its politics, its peoples and in its declining values. To a significant degree, down at the nitty-gritty level, I believe this accounts for a large measure of the willingness to sort of "get out of town" via globalization. This is a factor most liberal economists simply do not want to address. Important as this perspective is, it is not the subject of the current set of posts on the economy. I am trying to avoid "value judgements," whether applied to Wall Street or Welfare. This is merely a series of thoughts on: how we got here, where I think we are, and where we need to go in the future.
I still have to return to "shareholder value," at some point, to show how the "Perfect Storm" arrived. But, first, in the next couple of posts, let's look at "Free Trade," and "How Bad Can It Become?"
There are similar problems in today's economy with two variations: 1) today, "globalization" takes the place of the nineteen twenties "capital accumulation" and is the prime cause of the failure to build new plants in the USA. 2) cheap imports, combined with extraordinary access of the general population to credit markets, relative to the twenties, in the form of "new financial instruments" - ranging from credit cards to mortgage and home equity debt instruments - has obscured, until recently, the disproportionate wealth distribution.
In regard to 1) above: In other words, in today's global economy, wherein the American manufacturing sector has shrunk to 14% of the total GDP, and consumer goods are for the most part imports, capital spending on "new plant" simply isn't an issue. It's a guess (for which I need to do additional research), but I'd suggest that the trend in capital investment over the last twenty years has been toward foreign investment and commercial real estate (and at a different general population level, 401Ks, based on over-valued stocks and/or inflated housing prices) and that together, today, invested capital in these categories far exceeds investment for the production of consumer goods. The key word in the last sentence is "production." There HAS been substantial capital investment in high tech products related to improved distribution systems for foreign produced product. But, in sum, investment is going toward foreign "new plant," and domestic distribution.
The effect, however, is the same as in the nineteen twenties dealing with a national economy and low imports - i.e. whereas the giant suction pump of the twenties was in capital accumulation, that pump in nineties and early 21st century is globalization.
This brings us to 2) above. This pattern of investment only makes sense (from a populist national economy perspective) if the American consumer keeps consuming, otherwise the house of cards falls. Foreign plant investment and U.S. distribution systems are "valueless" to most of the U.S. population in the absence of mass consumption.
In the absence of an American consumer market, foreign plant will simply turn to production for domestic markets - to the extent possible and as wages adjust - the plant owner doesn't care who he sells to, as long as there is a sale. And, if that American consumer stops buying, we'll be left with a lot of unemployed "service economy" workers wandering among a lot of empty shopping centers and warehouses.
The point is that in the New Economy world, national economies cannot survive a global division of labor, without a single, global set of rules and regulations.
I am coming to the credit problem, but hang on a bit longer.
The bi-partisan American political approach to globalization and the global division of labor was to place a very, very high risk "bet." We bet our manufacturing base on a projected post-industrial society, wherein the United States would make its contribution to the global economy through "ideas." And, these "ideas" would be "packaged" as services. We did this without guarantees of international intellectual property rights; we did it while continuing to train, in our universities, new foreign elites (Note: 60% of science and engineering degrees granted by U.S. universities go to foreign students). We did it without an understanding that "ideas" transfer across borders without controls far, far easier than product production facilities and that it is much more difficult to "value" an idea than it is a hard product.
Sound pretty stupid? Well, I'd argue that this is one result of Eccles' theory of "disproportionate wealth." When that distribution becomes top heavy (and today it is as top heavy as it was in the twenties), you end up with an economy largely separated from most of its peoples. You end up with CEOs who worry a lot more about this year's bonus than how much the guy at the bottom of his corporation is making. Marie Antonite, just before the French Revolution, supposedly, when asked about how the general population would eat, said "let them eat cake," the line today would be, "let them shop at Wal Mart." There is another side to all of this, which I'll come to in a moment.
The big "bet" essentially failed...or, at least, wasn't coming true fast enough to hold the economy together and the answer to this problem was "cheap credit."
[Note: The next part "assumes" the "service economy" failed to replace the former manufacturing economy on a 1 to 1 basis and that cheap credit had to make up the difference. I need further research into this proposition regarding employment shifts in the economy over time. I am suggesting that such a study would show that much of the former economy moved into service jobs ranging from financial services, computer programming, fast food, retail sales, self-employment, etc., but that all of this did not raise household income consistent with overall economic growth. Without the research, at the gross or macro level, there are plenty of income statistics today to show household incomes have either remained flat or increased minimally over this time period.]
Few in either political party are today willing to step up and lay all of this out for the American people. With the current economic crisis most would probably go as far as saying: "the jury is still out." But, no one (other than Pat Buchanan and a few others on the outskirts of the political system) is willing to say: "We've lost the bet."
Instead, the United States poured more and more money into the system, via loose credit and low interest rates, to prop up an "American Consumer Society," which much of the developing world had come to depend upon. This wasn't entirely altruistic. American consumers bought cheap, foreign produced products, on credit. In turn, the importing countries recycled much of their profit back into the U.S., either directly, through the purchase of U.S. assets, or in market investments, pumping up overvalued financial markets. [Note: A few foreign firms actually built "new plant" in the U.S., generally automotive plants; largely to off-set a growing demand for tariffs to protect American industry. But, this is a very small portion of the national economy. Also, the argument that we have an "investor" or "ownership" society - i.e. we're all going to live off the rest of the world - just doesn't hold up to statistical analysis, as shown by the growing stratification of wealth.]
So, we are now verging on the "tipping point," which Eccles described:
"The time came when there were no more poker chips to be loaned on credit. Debtors thereupon were forced to curtail their consumption in an effort to create a margin that could be applied to the reduction of outstanding debts. This naturally reduced the demand for goods of all kinds and brought on what seemed to be overproduction, but was in reality under consumption when judged in terms of the real world instead of the money world. This, in turn, brought about a fall in prices and employment."
This is, basically, the situation in which we are in today - or will probably be shortly. There is one substantial difference, which is not good news. In the above Eccles quotation, the fall in prices mediates the severity of the fall in employment. True for the nineteen twenties. In the 1930s, after government invention, the coming of WWII and the transition of the United States into the "Arsenal of Democracy," created an opportunity for Americans to return to their plants, their factories. Today, there are no plants to return to, and there are other markets for importers to sell into. As already noted, foreign plant product may turn inward, improving their own economies, but doing nothing for us. Further, oil - still the energy source that drives much of the world economy, such as all of those manufacturing plants we shipped abroad - will probably remain at high prices due to increased non-U.S. foreign demand and a dwindling supply. [Note: Drilling in ANWAR and Canadian shale won't save the situation. ANWAR might delay the worst for a couple of years (of course, we may need those years) and processing of Canadian shale is very expensive at present. The "energy problem" long term may be handled; it is the immediate future, wherein its price and availability create enormous economic difficulties.
Before moving along, a word on "the other side of the picture" - the non-populist side. Culturally, I would suggest that much of the traditional American "elite,"(elite in terms of wealth), over a period of time, lost confidence in the country...in its politics, its peoples and in its declining values. To a significant degree, down at the nitty-gritty level, I believe this accounts for a large measure of the willingness to sort of "get out of town" via globalization. This is a factor most liberal economists simply do not want to address. Important as this perspective is, it is not the subject of the current set of posts on the economy. I am trying to avoid "value judgements," whether applied to Wall Street or Welfare. This is merely a series of thoughts on: how we got here, where I think we are, and where we need to go in the future.
I still have to return to "shareholder value," at some point, to show how the "Perfect Storm" arrived. But, first, in the next couple of posts, let's look at "Free Trade," and "How Bad Can It Become?"
Friday, March 14, 2008
Bear Stearns and Bush Speech
Another quick interruption of the main theme for comment on the news of the day.
This morning, JP Morgan and Chase and the Fed of NY announced a "bail-out" for Bear Stearns. Forty-eight hours ago, the Bear CEO was assuring CNBC that everything at Bear was great and there were no problems. Another indication that financial institutions are approaching panic?
OK...the way I see it, is that the financial markets are now in an "unraveling" phase - i.e. they are slowly working through their valuation problems with mortgage backed securities. Phase I was to determine what they actually held and the details of what those holdings contained. This phase, Phase II, is now valuing the holdings and it's "hot potato" time...i.e. trying to get rid of a lot of the mortgage stuff they've determined has about the quality of junk bonds.
As the extent of Bear holdings and problems spread on the street, other banks closed their doors to Bear (some undetermined European Bank and Goldman Sachs, according to rumors). The refusal of these banks, most notably Goldman, threatened to throw Bear into default and bankrupt the company. Enter the Fed and JPM&Chase. As I understand it, the Fed will loan Bear sufficient funds to meet its obligations, but through JPM&Chase. That's curious. Two possibilities: 1) JPM&Chase is about to take over Bear, or 2) the situation at Bear is so desperate that the Fed is expecting them to go under, regardless of their support, and required a third party to essentially step in and take over managing Bear. As part of the deal, JPM&Chase will NOT be held liable for Bears' losses, which - if any - will be presumably be borne by the Fed. In other words, it is a "bail-out."
All of this is consistent with the Fed Chairman's testimony before Congress about two weeks ago, wherein he stated that he thought it possible that some banks would fail before the subprime crisis was over. Of course, big question is: Who else?
I suspect that as of this moment no one can answer this question. However, as the valuations of mortgage backed securties continues, expect further losses and the strong possibility of additional failures. Bank write-offs to date apparently were based on sketchy information regarding their own holdings. If they were overly conservative...then one might expect a reasonably quick "recovery" (and we continue building the house of cards, if my theory of a generally overvalued economy is correct). If they initially underestimated their losses...there is more to come. Unless we are willing to tackle what I believe is the real underlying problem (the pace of globalization), either way we lose.
All in all, having lacked necessary oversight all along, valuation is a tough cookie, because ultimately those valuations depend on what is going on at the other end of the problem - the homeowners who are facing default. First tier lenders and the government are supposedly working through this end of the problem. To date, about 120,000 home owners have done "something" to work a deal to avoid foreclosure. By the end of this year, the government expects this number to rise to 300,000. Ah...300,000 out of the 2 million that may go into default as their ARMs roll-over.
Sound like the government's response to Katrina? Well, there is a significant difference, because it won't be individual home-owners pressuring the government for a work-out; it will be Wall Street.
Bush addressed the Economic Club of NYC this morning. Nothing really new...still in denial. Tax cuts, free trade, etc. No recession, just a small down-turn. Economy is actually great. Clearly, in his mind, society is a sub-set of the economy and not the reverse. His answer to the lost of American jobs? More training. If he considered the reverse, the economy as a sub-set of society, then the economy would reflect the capabilities of the work force. Training is certainly part of the solution to job losses overseas, but the shift has to be over a greater time span, and quite possibily is generational. Current policy is "we're totally changing our economy and you (the former textile or steel or automotive worker) better keep up with it or you're screwed and it will be your fault." And, of course, once the present crisis rolls out add to the un-or underemployed, textile, steel and automotive workers, a sizable army of "financial service workers," who have probably already re-trained once or twice. The alternatives are reasonable government policies, which protect American workers (and the economy) as we move through this global realignment, but such clashes with Bush economic philosophy.
He did mention, in passing, that the government (including the Fed) was moving to increase "oversight" of the mortgage business, although he went on to link the "oversight" with the necessity to ensure that borrowers could still find loans in the housing market. Right. Sort of like curing your headache by banging your head against the wall harder.
Two Administrations, over sixteen years, have refused to stand up and tell the American voters the truth, while hollowing out the American economy, with cheap, feel-good credit. But, more on all of that with a return to the central theme - The New Economy.
This morning, JP Morgan and Chase and the Fed of NY announced a "bail-out" for Bear Stearns. Forty-eight hours ago, the Bear CEO was assuring CNBC that everything at Bear was great and there were no problems. Another indication that financial institutions are approaching panic?
OK...the way I see it, is that the financial markets are now in an "unraveling" phase - i.e. they are slowly working through their valuation problems with mortgage backed securities. Phase I was to determine what they actually held and the details of what those holdings contained. This phase, Phase II, is now valuing the holdings and it's "hot potato" time...i.e. trying to get rid of a lot of the mortgage stuff they've determined has about the quality of junk bonds.
As the extent of Bear holdings and problems spread on the street, other banks closed their doors to Bear (some undetermined European Bank and Goldman Sachs, according to rumors). The refusal of these banks, most notably Goldman, threatened to throw Bear into default and bankrupt the company. Enter the Fed and JPM&Chase. As I understand it, the Fed will loan Bear sufficient funds to meet its obligations, but through JPM&Chase. That's curious. Two possibilities: 1) JPM&Chase is about to take over Bear, or 2) the situation at Bear is so desperate that the Fed is expecting them to go under, regardless of their support, and required a third party to essentially step in and take over managing Bear. As part of the deal, JPM&Chase will NOT be held liable for Bears' losses, which - if any - will be presumably be borne by the Fed. In other words, it is a "bail-out."
All of this is consistent with the Fed Chairman's testimony before Congress about two weeks ago, wherein he stated that he thought it possible that some banks would fail before the subprime crisis was over. Of course, big question is: Who else?
I suspect that as of this moment no one can answer this question. However, as the valuations of mortgage backed securties continues, expect further losses and the strong possibility of additional failures. Bank write-offs to date apparently were based on sketchy information regarding their own holdings. If they were overly conservative...then one might expect a reasonably quick "recovery" (and we continue building the house of cards, if my theory of a generally overvalued economy is correct). If they initially underestimated their losses...there is more to come. Unless we are willing to tackle what I believe is the real underlying problem (the pace of globalization), either way we lose.
All in all, having lacked necessary oversight all along, valuation is a tough cookie, because ultimately those valuations depend on what is going on at the other end of the problem - the homeowners who are facing default. First tier lenders and the government are supposedly working through this end of the problem. To date, about 120,000 home owners have done "something" to work a deal to avoid foreclosure. By the end of this year, the government expects this number to rise to 300,000. Ah...300,000 out of the 2 million that may go into default as their ARMs roll-over.
Sound like the government's response to Katrina? Well, there is a significant difference, because it won't be individual home-owners pressuring the government for a work-out; it will be Wall Street.
Bush addressed the Economic Club of NYC this morning. Nothing really new...still in denial. Tax cuts, free trade, etc. No recession, just a small down-turn. Economy is actually great. Clearly, in his mind, society is a sub-set of the economy and not the reverse. His answer to the lost of American jobs? More training. If he considered the reverse, the economy as a sub-set of society, then the economy would reflect the capabilities of the work force. Training is certainly part of the solution to job losses overseas, but the shift has to be over a greater time span, and quite possibily is generational. Current policy is "we're totally changing our economy and you (the former textile or steel or automotive worker) better keep up with it or you're screwed and it will be your fault." And, of course, once the present crisis rolls out add to the un-or underemployed, textile, steel and automotive workers, a sizable army of "financial service workers," who have probably already re-trained once or twice. The alternatives are reasonable government policies, which protect American workers (and the economy) as we move through this global realignment, but such clashes with Bush economic philosophy.
He did mention, in passing, that the government (including the Fed) was moving to increase "oversight" of the mortgage business, although he went on to link the "oversight" with the necessity to ensure that borrowers could still find loans in the housing market. Right. Sort of like curing your headache by banging your head against the wall harder.
Two Administrations, over sixteen years, have refused to stand up and tell the American voters the truth, while hollowing out the American economy, with cheap, feel-good credit. But, more on all of that with a return to the central theme - The New Economy.
Thursday, March 13, 2008
The New Economy - Part II (Continued - 4)
Before continuing with the train of thought in the last post, a few comments on the "news of the day." On Eliot Spitzer...Masters of the Universe 1; Cape Crusaders 0. Or, one could subtitle the Spitzer Story as "More Irrational Exuberance." If he'd been some obscure Congressman (or U.S. Senator), maybe he could have ridden it all out. But, not as CEO of New York State. What he apparently did was certainly wrong, but it was the hypocrisy that got him, not the crime.
Ferraro comment on Obama...stupid comment from a stupid person. Does not reflect well on Clinton, even though she disavowed it. For those not following the news: Ferraro (Walter Mondale's VP running mate, formerly an obscure Congresswoman) said essentially, Obama would not be where he was today if he wasn't black. Hmmm? While that may certainly be true of Obama's victory in the Mississippi primary, she didn't say that. Her statement was all-inclusive. Old time Democrats (largely Hillary supporters) don't get it. Outside of the Deep South, it's his message and not his skin color. To most blacks, his candidacy may be "racist," in the sense they will not pass up the chance to vote for a person of color, with whom they can agree and one can hardly blame them for that stance. But, Black America isn't going to get Obama elected...they have neither the numbers or the money needed. Obama is beating Clinton for three reasons: 1) he captured the "Change" theme and made it his own); 2) the ABC fear - i.e. "Anybody But Clinton" - that Hillary will bring Republicans out of the woodwork to vote against her; Republicans that might otherwise sit the election out; and 3) The Clinton Years never lived up to their promises - NAFTA, Greenspan, Rubin, the dotcom boom, balanced budget, surplus, etc. may have been good for a minority of the Party, but were viewed by many as a betrayal of the Party's ideals. "Change," in these people's minds, means change not only from Bush, but from the Clinton's as well.
It may be abit of a stretch to call Hillary "Bush Lite," but many of the Obama supporters view her as such. Bush took policy so far to the right, that even "center" today is further to the right than where most Obama supporters feel we need to be. Hillary's big mistake is to try and play to the "New Center."
Broadly, Franklin Roosevelt redefined the center of American politics, by moving it considerably to the left (Keynesian economics, banking controls, government work projects, increasing national debt, etc., etc.). Although Republicans are loath to admit it, I believe that without FDR's policies the country may have well moved farther to the left to some form of radical socialism. Roosevelt, through his policies, largely prepared the country for war and saved the rich from themselves.
Bush has moved the loci of the center of American politics back to the right...sort of the pre-Roosevelt "center." Clinton is now playing to this center. Obama supporters see a McCain-Clinton race as returning to the days of "choosing the lesser of two evils." Sort of which group do you want to vote for: rich Democrats or rich Republicans?
In Obama, they see the "potential" for radical change...IF such change is necessary to hold the country together ala 1933. In this, he has the charisma of both JFK and FDR...the ability to move the country beyond "business as usual." And, of course, it is this feeling that makes "recent experience in American politics" a drawback, not an attribute.
Very little, if any, of this has to do with his skin color.
Speaking of 1933...the Feds have, as a CNBC commentator put it this morning, thrown everything but the kitchen sink, at the subprime mortgage crisis without much effect. Government, as we know it, is running out of options. Did anyone think that a Bush appointee would ever call for additional government regulation? Well, Secretary of the Treasury Paulson did this morning. And to top it off, Paulson is the former head of Goldman Sachs.
It is becoming increasingly clear that the underlying prime mover behind the crisis isn't "liquidity," but confidence. Flooding the market with money doesn't mean a damn if people don't want to spend it. Meanwhile, in large measure, driven by this "flood," the dollar continues to fall and oil and gold continue to rise. Global markets are sensing that the barn door is being closed after the horses have left.
Paulson's speech, which was basically a repudiation of Bush economic policy, will I believe have a positive long term impact. He said, today, what has been obvious for some time and echoed much of what I wrote about in a recent "Guest Commentary" in the local paper. Econ 101: The prime purpose of free markets is to establish value. That value is established by transparency, or "equal information to all market participants."
Many of the new financial instruments do provide a benefit to the market as a whole, but their dangers may off-set their value, through the loss of transparency and being beyond the scope of oversight and regulation. Sort of like, the tail beginning to wag the dog.
Your typical Las Vegas casino contains approximately 30 games of chance. "New financial instruments" probably offer three or four times that number.
Let's say you're a typical Vegas toursit, who is in town primarily to see the shows and eat lots of cheap food, and put a few coins in the slot machines. You know that slot machines are pretty much luck...that the casino operators, by law, have a range of returns (odds) they must obey, and a further range, by specific machines, which they must meet, within the overall range.
The first type of advice you want is which machines give you better odds at this casino (a financial advisor). This person tells you pretty much what you could figure out for yourself - i.e. try the machines by the restaurant...or the machines by the reservations desk. So, you go to one of those machines and gamble a few coins. Ah, but there is another player sitting beside you and that player says: You aren't doing it right; you've got to pull the lever a certain way, or play a certain way...doubling down, etc. So, while you're trying these various methods of playing, another person comes up and tells the person sitting next to you, "I'll bet you he losses on the next play." The person takes the bet; then a third person walks up and tells the person sitting next to you, "I just saw your side bet; I'll let you hedge that bet, by betting that you win your bet, so if you lose, your side bet won't be a total loss."
And, so forth and so on. In a short time, there are numerous bets riding on your next quarter. One person has been watching your particular machine for a year, calculating each outcome; another has inside information on the odds set, by the casino, on that particular machine an hour ago. Another person who is absolutely certain they know the outcome of the next play, but doesn't have the money, borrows to place their side bet. Etc. In sum, you have a lot of money wrapped up on the outcome of your next play. Then, you remember that the show you came to see starts in five minutes and walk away. There is no next play. And, when you get out of the show two hours later, you find you no longer have a room, because the casino has gone into bankruptcy...all because you failed to play a quarter.
I believe that the market today is in a similar unraveling. Like Chaos theory and the butterfy effect, someone, somewhere thought: "I don't want to play anymore; let them foreclose," and walked away. The rest followed. What failed? No regulation of the side bets and no one who questioned: "What if he doesn't want to play?"
[I've gone "off topic" again. I'll continue "on topic" in next post.]
Ferraro comment on Obama...stupid comment from a stupid person. Does not reflect well on Clinton, even though she disavowed it. For those not following the news: Ferraro (Walter Mondale's VP running mate, formerly an obscure Congresswoman) said essentially, Obama would not be where he was today if he wasn't black. Hmmm? While that may certainly be true of Obama's victory in the Mississippi primary, she didn't say that. Her statement was all-inclusive. Old time Democrats (largely Hillary supporters) don't get it. Outside of the Deep South, it's his message and not his skin color. To most blacks, his candidacy may be "racist," in the sense they will not pass up the chance to vote for a person of color, with whom they can agree and one can hardly blame them for that stance. But, Black America isn't going to get Obama elected...they have neither the numbers or the money needed. Obama is beating Clinton for three reasons: 1) he captured the "Change" theme and made it his own); 2) the ABC fear - i.e. "Anybody But Clinton" - that Hillary will bring Republicans out of the woodwork to vote against her; Republicans that might otherwise sit the election out; and 3) The Clinton Years never lived up to their promises - NAFTA, Greenspan, Rubin, the dotcom boom, balanced budget, surplus, etc. may have been good for a minority of the Party, but were viewed by many as a betrayal of the Party's ideals. "Change," in these people's minds, means change not only from Bush, but from the Clinton's as well.
It may be abit of a stretch to call Hillary "Bush Lite," but many of the Obama supporters view her as such. Bush took policy so far to the right, that even "center" today is further to the right than where most Obama supporters feel we need to be. Hillary's big mistake is to try and play to the "New Center."
Broadly, Franklin Roosevelt redefined the center of American politics, by moving it considerably to the left (Keynesian economics, banking controls, government work projects, increasing national debt, etc., etc.). Although Republicans are loath to admit it, I believe that without FDR's policies the country may have well moved farther to the left to some form of radical socialism. Roosevelt, through his policies, largely prepared the country for war and saved the rich from themselves.
Bush has moved the loci of the center of American politics back to the right...sort of the pre-Roosevelt "center." Clinton is now playing to this center. Obama supporters see a McCain-Clinton race as returning to the days of "choosing the lesser of two evils." Sort of which group do you want to vote for: rich Democrats or rich Republicans?
In Obama, they see the "potential" for radical change...IF such change is necessary to hold the country together ala 1933. In this, he has the charisma of both JFK and FDR...the ability to move the country beyond "business as usual." And, of course, it is this feeling that makes "recent experience in American politics" a drawback, not an attribute.
Very little, if any, of this has to do with his skin color.
Speaking of 1933...the Feds have, as a CNBC commentator put it this morning, thrown everything but the kitchen sink, at the subprime mortgage crisis without much effect. Government, as we know it, is running out of options. Did anyone think that a Bush appointee would ever call for additional government regulation? Well, Secretary of the Treasury Paulson did this morning. And to top it off, Paulson is the former head of Goldman Sachs.
It is becoming increasingly clear that the underlying prime mover behind the crisis isn't "liquidity," but confidence. Flooding the market with money doesn't mean a damn if people don't want to spend it. Meanwhile, in large measure, driven by this "flood," the dollar continues to fall and oil and gold continue to rise. Global markets are sensing that the barn door is being closed after the horses have left.
Paulson's speech, which was basically a repudiation of Bush economic policy, will I believe have a positive long term impact. He said, today, what has been obvious for some time and echoed much of what I wrote about in a recent "Guest Commentary" in the local paper. Econ 101: The prime purpose of free markets is to establish value. That value is established by transparency, or "equal information to all market participants."
Many of the new financial instruments do provide a benefit to the market as a whole, but their dangers may off-set their value, through the loss of transparency and being beyond the scope of oversight and regulation. Sort of like, the tail beginning to wag the dog.
Your typical Las Vegas casino contains approximately 30 games of chance. "New financial instruments" probably offer three or four times that number.
Let's say you're a typical Vegas toursit, who is in town primarily to see the shows and eat lots of cheap food, and put a few coins in the slot machines. You know that slot machines are pretty much luck...that the casino operators, by law, have a range of returns (odds) they must obey, and a further range, by specific machines, which they must meet, within the overall range.
The first type of advice you want is which machines give you better odds at this casino (a financial advisor). This person tells you pretty much what you could figure out for yourself - i.e. try the machines by the restaurant...or the machines by the reservations desk. So, you go to one of those machines and gamble a few coins. Ah, but there is another player sitting beside you and that player says: You aren't doing it right; you've got to pull the lever a certain way, or play a certain way...doubling down, etc. So, while you're trying these various methods of playing, another person comes up and tells the person sitting next to you, "I'll bet you he losses on the next play." The person takes the bet; then a third person walks up and tells the person sitting next to you, "I just saw your side bet; I'll let you hedge that bet, by betting that you win your bet, so if you lose, your side bet won't be a total loss."
And, so forth and so on. In a short time, there are numerous bets riding on your next quarter. One person has been watching your particular machine for a year, calculating each outcome; another has inside information on the odds set, by the casino, on that particular machine an hour ago. Another person who is absolutely certain they know the outcome of the next play, but doesn't have the money, borrows to place their side bet. Etc. In sum, you have a lot of money wrapped up on the outcome of your next play. Then, you remember that the show you came to see starts in five minutes and walk away. There is no next play. And, when you get out of the show two hours later, you find you no longer have a room, because the casino has gone into bankruptcy...all because you failed to play a quarter.
I believe that the market today is in a similar unraveling. Like Chaos theory and the butterfy effect, someone, somewhere thought: "I don't want to play anymore; let them foreclose," and walked away. The rest followed. What failed? No regulation of the side bets and no one who questioned: "What if he doesn't want to play?"
[I've gone "off topic" again. I'll continue "on topic" in next post.]
Sunday, March 09, 2008
The New Economy - Part II (Continued -3)
I keep getting sidetracked from my thoughts on our economic development from the late eighties to the present.
Basically, my theory is that various pressures took the economy from one similar to a bowling ball to a balloon and much recent "growth" has been little more than that which causes a balloon to expand and rise...a lot of hot air.
But, in this post, I want to borrow a lengthy quote from Marriner Eccles, Chairman of the Federal Reserve from 1934 to 1948, and the principal architect of the post-Depression safe guards built into the banking system to avoid another Depression.
In his memoirs, "Beckoning New Frontiers," Eccles gives his own explanation of the Great Depression:
"As mass production has to be accomplished by mass consumption, mass consumption, in turn, implies a distribution of wealth - not of existing wealth, but of wealth as it is currently produced - to provide men with buying power equal to the amount of goods and services offered by the nation's economic machinery. Instead of achieving that kind of distribution, a giant suction pump had by 1929-30 drawn into a few hands an increasing portion of the currently produced wealth. This served them as capital accumulations. But by taking purchasing power out of the hands of mass consumers, the savers denied to themselves the kind of effective demand for their products that would justify a reinvestment of their capital accumulations in new plants. In consequence, as in a poker game where the chips were concentrated in fewer and fewer hands, the other fellows could stay in the game only by borrowing. When their credit ran out, the game stopped.
This is what happened to us in the twenties. We sustained high levels of employment in that period with the aid of an exceptional expansion of debt outside of the banking system. This debt was provided by the large growth of business savings as well as savings by individuals, particularly in the upper-income groups where taxes were relatively low. Private debt outside of the banking system increased about fifty per cent. This debt, which was at high interest rates, largely took the form of mortgage debt on housing, office, and hotel structures, consumer installment debt, brokers' loans, and foreign debt. The stimulation to spending by debt-creation of this sort was short-lived and could not be counted on to sustain high levels of employment for long periods of time. Had there been a better distribution of the current income from the national product - in other words, had there been less savings by business and the higher income groups and more income in the lower groups -- we should have had far greater stability in our economy. Had the six billion dollars, for instance, that were loaned by corporations and wealthy individuals for stock market speculation been distributed to the public as lower prices or higher wages and with less profits to the corporations and the well-to-do, it would have prevented or greatly moderated the economic collapse that began at the end of 1929.
The time came when there were no more poker chips to be loaned on credit. Debtors thereupon were forced to curtail their consumption in an effort to create a margin that could be applied to the reduction of outstanding debts. This naturally reduced the demand for goods of all kinds and brought on what seemed to be overproduction, but in reality was under consumption when judged in terms of the real world instead of the money world. This, in turn, brought a fall in prices and employment.
Unemployment further decreased the consumption of goods, which further increased unemployment, thus closing the cycle in a continuing decline of prices. Earnings began to disappear, requiring economies of all kinds in the wages, salaries, and time of those employed. And, thus again the vicious circle of deflation until one third of the entire working population was unemployed, with our national income reduced by fifty percent, and with the aggregate debt burden greater than ever before, not in dollars, but measured by current values and income that represented the ability to pay. Fixed charges, such as taxes, railroad and other utility rates, insurance and interest charges, clung close to the 1929 level and required such a portion of the national income to meet them that the amount left for consumption of goods was not sufficient to support the population.
This then, was my reading of what brought on the depression."
Eccles, of course, lived in a different era. The late twenties and early thirties of the 20th century were in a totally different time frame, with apparent differences in economic fundamentals. Eccles' pre-WWII economy was essentially a national economy, not a globalized economy. American imports comprised less than 5% of the GNP. And, of course, the Depression occurred prior to an overhaul of the U.S. banking system, in which Eccles played a major role; an overhaul that created numerous safeguards to avoid another Depression.
However, in my next post - delaying the return to "stockholder value" a bit longer - I hope to show how similar our situation is today with the situation Eccles described above...albeit with new terms and on a much larger playing field, namely "a globalized economy."
Basically, my theory is that various pressures took the economy from one similar to a bowling ball to a balloon and much recent "growth" has been little more than that which causes a balloon to expand and rise...a lot of hot air.
But, in this post, I want to borrow a lengthy quote from Marriner Eccles, Chairman of the Federal Reserve from 1934 to 1948, and the principal architect of the post-Depression safe guards built into the banking system to avoid another Depression.
In his memoirs, "Beckoning New Frontiers," Eccles gives his own explanation of the Great Depression:
"As mass production has to be accomplished by mass consumption, mass consumption, in turn, implies a distribution of wealth - not of existing wealth, but of wealth as it is currently produced - to provide men with buying power equal to the amount of goods and services offered by the nation's economic machinery. Instead of achieving that kind of distribution, a giant suction pump had by 1929-30 drawn into a few hands an increasing portion of the currently produced wealth. This served them as capital accumulations. But by taking purchasing power out of the hands of mass consumers, the savers denied to themselves the kind of effective demand for their products that would justify a reinvestment of their capital accumulations in new plants. In consequence, as in a poker game where the chips were concentrated in fewer and fewer hands, the other fellows could stay in the game only by borrowing. When their credit ran out, the game stopped.
This is what happened to us in the twenties. We sustained high levels of employment in that period with the aid of an exceptional expansion of debt outside of the banking system. This debt was provided by the large growth of business savings as well as savings by individuals, particularly in the upper-income groups where taxes were relatively low. Private debt outside of the banking system increased about fifty per cent. This debt, which was at high interest rates, largely took the form of mortgage debt on housing, office, and hotel structures, consumer installment debt, brokers' loans, and foreign debt. The stimulation to spending by debt-creation of this sort was short-lived and could not be counted on to sustain high levels of employment for long periods of time. Had there been a better distribution of the current income from the national product - in other words, had there been less savings by business and the higher income groups and more income in the lower groups -- we should have had far greater stability in our economy. Had the six billion dollars, for instance, that were loaned by corporations and wealthy individuals for stock market speculation been distributed to the public as lower prices or higher wages and with less profits to the corporations and the well-to-do, it would have prevented or greatly moderated the economic collapse that began at the end of 1929.
The time came when there were no more poker chips to be loaned on credit. Debtors thereupon were forced to curtail their consumption in an effort to create a margin that could be applied to the reduction of outstanding debts. This naturally reduced the demand for goods of all kinds and brought on what seemed to be overproduction, but in reality was under consumption when judged in terms of the real world instead of the money world. This, in turn, brought a fall in prices and employment.
Unemployment further decreased the consumption of goods, which further increased unemployment, thus closing the cycle in a continuing decline of prices. Earnings began to disappear, requiring economies of all kinds in the wages, salaries, and time of those employed. And, thus again the vicious circle of deflation until one third of the entire working population was unemployed, with our national income reduced by fifty percent, and with the aggregate debt burden greater than ever before, not in dollars, but measured by current values and income that represented the ability to pay. Fixed charges, such as taxes, railroad and other utility rates, insurance and interest charges, clung close to the 1929 level and required such a portion of the national income to meet them that the amount left for consumption of goods was not sufficient to support the population.
This then, was my reading of what brought on the depression."
Eccles, of course, lived in a different era. The late twenties and early thirties of the 20th century were in a totally different time frame, with apparent differences in economic fundamentals. Eccles' pre-WWII economy was essentially a national economy, not a globalized economy. American imports comprised less than 5% of the GNP. And, of course, the Depression occurred prior to an overhaul of the U.S. banking system, in which Eccles played a major role; an overhaul that created numerous safeguards to avoid another Depression.
However, in my next post - delaying the return to "stockholder value" a bit longer - I hope to show how similar our situation is today with the situation Eccles described above...albeit with new terms and on a much larger playing field, namely "a globalized economy."
Friday, March 07, 2008
The New Economy - Part II (Continued - 2)
This a series of blogs regarding our present economic status and how we got here. Before continuing that subject, a brief word on election year politics.
Congressional Democrats are going to come under intense pressure to maintain the House of Cards Economy by prematurely voting to make the Bush temporary tax cuts of 2002 and 2003 permenant. Republicans will argue strongly (and incorrectly) that fear of losing these cuts under a Democratic Administration and Democratic Congress are playing a part in the virtually freezing credit markets; thus, shifting the blame to the Democratic Congress. To withstand the onslaught, Democrats are going to have to begin marshalling arguments to the contrary; in some aspects this is going to bring them smack up against The New Economy, which they've largely supported since the Clinton presidency, and their supporters on Wall Street.
Although the next series of posts will attempt to show the fallacies of The New Economy, namely the rush to a post-industrial society and globalization, the principal counterargument is that expecting tax cuts to resolve our economic problem is like pouring money down a dry hole (Texas parlence for pouring good money after bad) and that, as temporarily painful as it may be, it is time to move the total economy back on firmer ground through improvements in classic fundamentals (the strength of the dollar, national debt, trade imbalances, improvement of infrastructure - including the military - and the restoration of reasonable regulation and oversight).
The theory herein is that while the goals of The New Economy are in themselves admirable, and eventual globalization of the economy virtually inevitable, the error lies in the rapid pace by which we are trying to reach these goals. In order to restore fundamental economic sanity, we are going to have to move, through government policy, back to a better "balance" between a manufacturing and service economy (currently at approximately 20% manufacturing and 80% service), make hard choices regarding current entitlement programs, move rapidly toward alternative energy forms, restore national infrastructure, revise the tax code and restore government regulation and oversight, largely ignored for the past eight years. The following posts will, hopefully, show that the movement from maufacturing to service, at too rapid a pace led to a "fee/credit based" economy that essentially became far, far overextended.
In the late eighties and early nineties, the separate elements of the "Perfect Storm" began arriving on the economic scene: the fall of communism, the large scale disenfranchishment of organized American Labor, the explosion of information technologies (largely made possible by the personal computer), the decline of OPEC and an undervaluation of oil, Alan Greenspan, the rise of the "business press"(based largely on phony social science), and "stockholder value."
I'll continue, beginning with the latter, in the next post.
Congressional Democrats are going to come under intense pressure to maintain the House of Cards Economy by prematurely voting to make the Bush temporary tax cuts of 2002 and 2003 permenant. Republicans will argue strongly (and incorrectly) that fear of losing these cuts under a Democratic Administration and Democratic Congress are playing a part in the virtually freezing credit markets; thus, shifting the blame to the Democratic Congress. To withstand the onslaught, Democrats are going to have to begin marshalling arguments to the contrary; in some aspects this is going to bring them smack up against The New Economy, which they've largely supported since the Clinton presidency, and their supporters on Wall Street.
Although the next series of posts will attempt to show the fallacies of The New Economy, namely the rush to a post-industrial society and globalization, the principal counterargument is that expecting tax cuts to resolve our economic problem is like pouring money down a dry hole (Texas parlence for pouring good money after bad) and that, as temporarily painful as it may be, it is time to move the total economy back on firmer ground through improvements in classic fundamentals (the strength of the dollar, national debt, trade imbalances, improvement of infrastructure - including the military - and the restoration of reasonable regulation and oversight).
The theory herein is that while the goals of The New Economy are in themselves admirable, and eventual globalization of the economy virtually inevitable, the error lies in the rapid pace by which we are trying to reach these goals. In order to restore fundamental economic sanity, we are going to have to move, through government policy, back to a better "balance" between a manufacturing and service economy (currently at approximately 20% manufacturing and 80% service), make hard choices regarding current entitlement programs, move rapidly toward alternative energy forms, restore national infrastructure, revise the tax code and restore government regulation and oversight, largely ignored for the past eight years. The following posts will, hopefully, show that the movement from maufacturing to service, at too rapid a pace led to a "fee/credit based" economy that essentially became far, far overextended.
In the late eighties and early nineties, the separate elements of the "Perfect Storm" began arriving on the economic scene: the fall of communism, the large scale disenfranchishment of organized American Labor, the explosion of information technologies (largely made possible by the personal computer), the decline of OPEC and an undervaluation of oil, Alan Greenspan, the rise of the "business press"(based largely on phony social science), and "stockholder value."
I'll continue, beginning with the latter, in the next post.
Wednesday, March 05, 2008
The New Economy - Part II (Continued)
Before I begin this post let me state a caveat. To emphasis a point, much of the following may sound conspiratorial. While I am sure that, as in most aspects of our human society, there are thousands of "conspiracies" going on constantly within our financial institutions, there is no single overarching conspiracy and that much of "my explanation" is simply a perspective, utilizing the benefit of hindsight. So, please keep in mind, that I believe much of this "just happened," perhaps driven in certain directions by free market forces. Indeed, the principal advantage of the free enterprise system is that it is an economic expression of free choice and democracy, neither of which are particularly "efficient." We are free to be "wrong," as defined by hindsight. Economic "bubbles," are the price we pay for free markets, just as government inefficiency may be the price we pay for democracy. Neither is "perfect."
However, I believe that over the past twenty years or so, we as an electorate have been led to believe that "free, unrestrained, markets" are intrinsically "good," while government is intrinsically "bad." This attitude reached a peak with the Bush Administration. Rather than leading the government, Bush has largely been a competitor to the government. In numerous non-partisan, reasonably objective studies, which show a given task of government could be accomplished at less cost by the civil service than private enterprise, privatization moved ahead based on principle, rather than efficiency.
As a result of this ideological approach to management, much of our national strength (and capital) has been sapped up in "free enterprise economic bubbles." I would include Iraq in this category, wherein the invasion and occupation seems to have stimulated more through venture capitalists than a clearly thought out instrument of American foreign policy.
I believe that it is time to give the other side equal time. To try and make Americans understand that national greatness cannot be solely measured by an over-valued GDP; that much of our greatness comes in the strength of our institutions, our infrastructure, and our democratic processes, as inefficient as they at times may be.
Economic strength IS largely concerned with efficiency and the productivity such efficiency produces. However, "economics" is a subset of society and not vice versa. The point of my own "economic interpretation," is to call for a pull back in the national march to a globalized economy, without abandoning that ultimate goal; to call for a greater balance between a manufacturing based economy and a service economy, rather than reliance on a global division of labor; to call for more national investment in deteriorating infrastructure; to call for improvement in health care and education; to call for a reform of our political system to return it to "original intent" and rid it of the graft and corruption spawned largely by the run away costs of our electoral system; to call for a sensible solution to saving social security and medicare by improving its efficiency, cutting benefits and moving toward some method of graduated means testing; to call for an overhaul of our tax code, without abandoning the principle of "progressive taxation," which is nothing more than an admission that no matter how much wealth you've acquired, that accumulation was, at least in part, due to the society in which you live; to call for an overhaul of our armed forces to adequately meet the anticipated threats to our national security in the 21st century.
And so forth and so on...the point is that I believe there is a viable and practical "middle course" between a socialized state from the left or an oligarchy from the right, but "common sense" has been obscured through political polarization. To begin to find this middle way, it might behoove us to postpone our rush to globalization for a bit and do some entrenchment at home; to shore up the very aspects of our society that have made us great and which, I believe, we are on the verge of losing.
I'll return in the next post to how our financial institutions "reformed" corporate power and put us on the road to globalization with "stockholder value."
However, I believe that over the past twenty years or so, we as an electorate have been led to believe that "free, unrestrained, markets" are intrinsically "good," while government is intrinsically "bad." This attitude reached a peak with the Bush Administration. Rather than leading the government, Bush has largely been a competitor to the government. In numerous non-partisan, reasonably objective studies, which show a given task of government could be accomplished at less cost by the civil service than private enterprise, privatization moved ahead based on principle, rather than efficiency.
As a result of this ideological approach to management, much of our national strength (and capital) has been sapped up in "free enterprise economic bubbles." I would include Iraq in this category, wherein the invasion and occupation seems to have stimulated more through venture capitalists than a clearly thought out instrument of American foreign policy.
I believe that it is time to give the other side equal time. To try and make Americans understand that national greatness cannot be solely measured by an over-valued GDP; that much of our greatness comes in the strength of our institutions, our infrastructure, and our democratic processes, as inefficient as they at times may be.
Economic strength IS largely concerned with efficiency and the productivity such efficiency produces. However, "economics" is a subset of society and not vice versa. The point of my own "economic interpretation," is to call for a pull back in the national march to a globalized economy, without abandoning that ultimate goal; to call for a greater balance between a manufacturing based economy and a service economy, rather than reliance on a global division of labor; to call for more national investment in deteriorating infrastructure; to call for improvement in health care and education; to call for a reform of our political system to return it to "original intent" and rid it of the graft and corruption spawned largely by the run away costs of our electoral system; to call for a sensible solution to saving social security and medicare by improving its efficiency, cutting benefits and moving toward some method of graduated means testing; to call for an overhaul of our tax code, without abandoning the principle of "progressive taxation," which is nothing more than an admission that no matter how much wealth you've acquired, that accumulation was, at least in part, due to the society in which you live; to call for an overhaul of our armed forces to adequately meet the anticipated threats to our national security in the 21st century.
And so forth and so on...the point is that I believe there is a viable and practical "middle course" between a socialized state from the left or an oligarchy from the right, but "common sense" has been obscured through political polarization. To begin to find this middle way, it might behoove us to postpone our rush to globalization for a bit and do some entrenchment at home; to shore up the very aspects of our society that have made us great and which, I believe, we are on the verge of losing.
I'll return in the next post to how our financial institutions "reformed" corporate power and put us on the road to globalization with "stockholder value."
Tuesday, March 04, 2008
The New Economy - Part II
[Note: A post on this same subject was posted on a second blog inadvertently. The second blog was set up in error at approximately the same time as this one. I've deleted the second blog just to clear up the clutter.]
There is an old "New Yorker Magazine" cartoon of two guys in a dungeon. They are both suspended in mid-air, side by side in their cell, by chains from each of their arms to the roof and from each of their legs to the floor. One guy turns to the other and says: "Now here's my plan."
Another favorite, also from the New Yorker, pictures two guys in suits walking down a busy and crowded street in New York. One guy's pants have fallen down to his knees. The other guy leans over and whispers in his ear: "Just bluff it through."
Both of these cartoons remind me today of Federal Reserve Chairman Ben Bernanke and U.S. Treasury Secretary Paulson.
Welcome to The New Economy - Part II. Part I was the dotcom bubble; Part II is the present housing crisis, which I'll get to in a couple of posts, after re-reviewing Part I.
The term New Economy refers to the shift, beginning in the late eighties, in the U.S. economy from one based on manufacturing to one based on service. The motivation for this shift was, supposedly, due to technological advancements ranging from massive reductions in shipping costs to personal computing. Our future, we were told, lay in a high-tech, post industrial society, which would create less pollution and make everyone rich. All the old nasty stuff would go to the developing Third World, who would feed manufactured products to us, the inhabitants of the "Shinning City on the Hill."
If you thought about it much, it was all sort of Orwellian "1984" stuff (or perhaps more accurately Huxley's "Brave New World") and it virtually mandated one global economy, with a global division of labor. The idea, I suppose, was that the United States would become the World's "bank" and global regulator, providing a safe harbor for the world's wealth, overseeing its investment and distribution (in part through international institutions such as the World Bank, the International Monetary Fund and the World Trade Organization). Key's to maintaining this position were a strong dollar, a strong military, strong financial institutions and strong graduate education at our universities, the latter of which allowed us to maintain our high-tech lead and educate the World's elite to the "American Way."
The driving force behind all of this was relatively simple: Technology had opened the door to an inevitable "globalization" of the world's economy and it was far better for us to be leading this process rather than following it. Additionally, the end of communism offered an enormous opportunity in expanding western free markets globally. The trick was to bring literally billions of people (the former Soviet Union, China, India, SE Asia, etc.) into the free market system before their failed communist systems drove them into anarchy and chaos, thus endangering all of us via the rise of new dictatorships and war.
Overall, this was not a bad plan; there were, however, a few problems that were overlooked.
The first was the underestimation of how easily the new technology (our advantage) transferred across borders. It's one thing to build a factory; it's another to transfer software over a global internet. The second was an underestimation of one of the few benefits of communism, universal education and, as a result of that education, how quickly the ex-communist countries would be capable of assuming our former role. Third, we transferred our manufacturing base (the Old Economy) before securing our high-tech position (the New Economy) with effective global intellectual property rights agreements - lower labor costs trumped common sense. Fourth, we underestimated the importance of our dependency on middle eastern oil and its linkage to fragile dictatorships, facing a fantical religious awakening. Fifth, we overestimated the ease of transition of American Labor from the Old to the New Economy. And, sixth, we allowed our "real power," military force, to deteriorate within the context of the "peace dividend" provided by the fall of the Soviet Union and China's move toward a fledgling market economy.
In sum, the "plan" required far, far more control over the global economy than we actually had. This rise in a "Masters of the Universe," American mentality came, I think, from several sources, but most significantly from the belief that we "beat the Russians." In turn, this interpretation strengthened the Goldwater/Reagan/Bush brand of economic conservatism, which in turn distorted our perception of the global reality (partially genuinely believed, partially for political gain).
By the time Ronald Reagan won the Presidency, the Cold War had practically ended. Reagan largely, in his mind, "fought" the Soviet Union of the fifties and sixties, not its reality in the eighties. It was sort of like applying the coup d grace after the firing squad had finished their work. With or without RR, it is difficult to see how the Soviet Union could have carried on much longer without the same type of economic changes as those being embraced by China. Fundamentally, the people of the Soviet Union brought down the Soviet Union themselves. I suspect, with a little more distance from the actual events, historians will find that economic pressures, not from the West, but from the successes of Communist China and an unwanted war in Afghanistan, contributed more than RR to the dissolution of the "Evil Empire."
But, the American public perception was it was a Reagan victory and therefore the rest of the stuff must really work as well...such as supply side economics, etc.
I was in Europe during this period working with the European automobile industry. A few days after the wall in Berlin came down, I was having lunch in the Executive dining room of Mercedes-Benz. I was the only American at the table; the others were customers and friends from Mercedes, with whom I'd worked closely for two-three years. We were discussing the impact of the end of the Cold War and Communism and, of course, the problems in integrating East Germany into West Germany. I noted that this would be an enormous task requiring vast resources from the entire western world (referring to the larger problem, not just East Germany). One of my friends at the table spoke up: "East Germany is a German problem, not an American one." And, everyone else at the table agreed. I went back to my office thinking, "the end of the Cold War and Communism probably also means the end of U.S. hegemony in the West." I don't think this thought computed well with Goldwater/Reagan/Bush Republican economic planning. Rather, it was "to the victor go the spoils."
William Jefferson Clinton inheirted the "plan" and the problems. The first two years of his Administration were pretty much lost on universal health care. For the remaining six years of his Presidency he was faced with a Republican Congress, so it really didn't matter too much whether he spent his time conjuring up programs he knew he couldn't get past Congress or defending himself against ill-considered personal behavior.
Following the failure of the health care plan, he basically pursued economic policies not too different from the Republicans, with the occasional rheotical crump thrown to the Democratic base. In fact, off-hand, I can recall only three "accomplishments." He balanced the budget, supported NAFTA and took us militarily, via NATO, into the Balkans. The other side of the coin to each of these was balancing the budget through a reduction in government spending, largely at the expense of the military, and raising taxes; the formation of NAFTA as a counter to the European Union; and the commitment of U.S. forces abroad, without Congressional approval. However, as long as casualties in the Balkans were kept low through a predominately fought air war and everyone was getting rich, the Republican Congress was content with its efforts to impeach him over lying to a grand jury regarding his personal sexual behavior. Republicans were actually so happy with an impotent (perhaps the wrong adjective in this case) Democratic Presidency, they were kind enough to run Bob Dole against him in the second term election.
During the Clinton Administration, however, the modus operanti for the "phony economy" was established. With the help of Alan Greenspan and Robert Rubin (and the zeitgeist of The New Economy, which all three pushed heavily) Clinton was effectively able to practice a Democratic version of supply side economics without the down side; an economic approach his predecessor, George Bush Senior, had labelled as "voodo economics."
Embracing the "Plan," through support for NAFTA and free trade, and masking the impact of American jobs being shipped overseas through new ways of accounting for unemployment and cheap money, the Administration provided the "fuel" for the dotcom bubble. It was during the Clinton years that I first noticed it seemed that as the national economy became stronger and stronger, the middle class became weaker and weaker. Ultimately, under Bush II, Clinton would look like a piker, but turning the American economy into a giant Ponzi scheme, sustainable only through devalued currency and overvalued assets, to mask the impact of globalization, begin with the Clinton years.
As the manufacturing based economy transitioned to "The New Economy" - essentially a service economy, $20/hr jobs were lost overseas to be replaced, basically with $10/hr jobs. The impact of this on the bulk of the American workers was lessened through the flow of cheap goods from abroad and a generous monetary policy at the Fed.
National growth in gross domestic product is generally a leading indicator of a nation's economic health. If the economy grows at 4% a year, in 18 years (or about a generation), the economy will approximately double in size and if you look at the statistics you'll find this overall trend in American economic history, with slower or even negative growth occasionally, and faster growth occasionally. All economics is comparative, so the final judgement on our economy is how fast or slow we're growing compared to other nations. Given the "plan" of bringing heretofore absent nations into the global economy (China, India, the Soviet Union, etc.), successfully developing nations grow at roughly 6-9%, while most of the developed world, grows slower, in the 3-5% range.
This, however, says nothing about the nature of the growth or how the added wealth is distributed. Through the Clinton and Bush years growth floated around the 4% figure. If that wealth had been distributed equally throughout the population, household incomes would have approximately doubled. Instead they remained essentially flat for the middle class, slightly improved for the poor and skyrocked for the top 10%. The stratification or dispersion of wealth in the United States is now approximately what it was during the Age of the Robber Barons (the late 1800's and early 20th century). This growing stratification was certainly intentionally promoted via supply side economics and the urgency in expanding the global economy; it also conveniently fit the replacement of those $20/hr jobs with $10/hr jobs. National poverty improved abit under Clinton and got a bit worse under Bush; middle class income rose with the dotcom bubble, flattened and lost ground under Bush, recovering slightly in 2006-07. However, middle class households today are still approximately $1500/yr behind where they were in 2001.
This isn't that unusual in times of significant economic shifts. The Robber Barons may have taken a bit more than their fair share, but they also moved the country from essentially a regionally based economy to a national economy, from which we've all benefited. Capitalism does work. Today's "Masters of the Universe" (the new Robber Barons) are taking us from a national economy to an international economy via globalization. While I have no qualms about that in itself, my concern is that we are moving at too fast a pace in this transition and that both the pace and method will not result in an ultimately stronger nation, but descent to Third World status.
Much of this is due to the "phony economy," I noted above. Unlike the period in the late eighteen hundreds and early twentieth century, today's growth consists of very little substance.
Instead of expanding national infrastructure, our existing infrastructure is declining. Our assets are being bought by foreign importers and the only new factories that are being constructed are by these same importers seeking to find some way of evening out trade imbalances and getting rid of their value declining dollars as fast as possible.
Instead of "genuine growth," we have through the dotcom and housing bubbles grown largely through low interest rates, cheap money, overvalued product and loose credit; credit for consumers, credit for the nation. If one takes away the effect of the bubbles, I suspect growth over this period would be either flat or negative. U.S. household savings fell throughout this period and are now negative - i.e. America is not only dependent on foreign oil, but on credit. Once this is obvious, global confidence may fail and the house of cards fall. In this respect, I suggest we are rapidly arriving at the "tipping point."
A fundamental tenent of free markets is that they behave "rationally." This is a cornerstone to generally Republican arguments for small government, deregulation and free markets, as opposed to higher taxes and "government planned economies." Much of our national economic policy from Ronald Reagan on, including the Clinton years, has rested on the fundamental belief that free markets behave rationally. As a result of this "rationality," buyers in the market will search for the best products at the lowest price, thus forcing efficiencies upon competing sellers. Lacking in these motivations, government will perform inefficiently and so the less money the government receives, the more efficient the economy as a whole becomes. In a nutshell, that's pretty much Republican economics (or was until Bush II, who managed to bring the worst of both worlds. I blame much of it on his Harvard Business School training).
But do markets really behave rationally and are they really "free?" In a recent appearance on CNBC (the business channel), Warren Buffet, who was rejected by Havard Business School and who would be the last person on earth to call himself an "economist," when asked for a prediction on where the stock market would be in a year, replied: "Oh, I don't know. I don't pick stocks on market trends; it's hard to know where a market will go, they're so irrational."
Instead, Buffet's method, as he described it, is a bit of an obsolete Mid-West-Main Street approach. Buffet buys companies, not stocks. [Buffet's own company, Berkshire Hathaway's stock has done reasonably well, with Class A stock now trading at approximately $140,000/share.] In other words, Buffet looks for soundly managed companies with a competively priced, quality product and tries to sort out the clutter that has come to dominate our "free market." He dosen't worry about stock appreciation or the influence of pension fund managers or, in a curious way, "stock holder value," yet achieves just that by largely ignoring it in the day-to-day conduct of his business. And, his stock holders, who at $140,000/share must be among the world's most sophisticated investors, leave him pretty much alone to do "his thing."
Another example of the point I will eventually make here was in the recent film, "American Gangster," based on the true story of a black businessman, whose "business" happened to be drugs in Harlem. As he watched the "trade," he decided that the best way to grow his business was to eliminate the "middlemen" (figuratively and literally). In this way, he also eliminated the commissions and fees and controlled his own product. His success was that he sold a better quality product, with less costs and at a lower price. [He was eventually caught by the newly formed DEA, who themselves were, in a different way, shaking up the old trade, with all of its police payoffs, MAFIA connections, etc.].
The message, in both Buffet and "American Gangster," is that free markets are often corrupted over time and fail to serve their original reason for being...bringing a quality product to a buyer at a reasonable price.
In the wake of the end of communism and the rising economies of a post WWII Western Europe, and the Third World, American financial institutions sought to expand their markets globally and to somehow remain "on-top," a position they had been in since WWII. In my next post, I will show how they accomplished this during the eighties, by taking control of Corporate America through "bribery" and the phrase: "stockholder value."
There is an old "New Yorker Magazine" cartoon of two guys in a dungeon. They are both suspended in mid-air, side by side in their cell, by chains from each of their arms to the roof and from each of their legs to the floor. One guy turns to the other and says: "Now here's my plan."
Another favorite, also from the New Yorker, pictures two guys in suits walking down a busy and crowded street in New York. One guy's pants have fallen down to his knees. The other guy leans over and whispers in his ear: "Just bluff it through."
Both of these cartoons remind me today of Federal Reserve Chairman Ben Bernanke and U.S. Treasury Secretary Paulson.
Welcome to The New Economy - Part II. Part I was the dotcom bubble; Part II is the present housing crisis, which I'll get to in a couple of posts, after re-reviewing Part I.
The term New Economy refers to the shift, beginning in the late eighties, in the U.S. economy from one based on manufacturing to one based on service. The motivation for this shift was, supposedly, due to technological advancements ranging from massive reductions in shipping costs to personal computing. Our future, we were told, lay in a high-tech, post industrial society, which would create less pollution and make everyone rich. All the old nasty stuff would go to the developing Third World, who would feed manufactured products to us, the inhabitants of the "Shinning City on the Hill."
If you thought about it much, it was all sort of Orwellian "1984" stuff (or perhaps more accurately Huxley's "Brave New World") and it virtually mandated one global economy, with a global division of labor. The idea, I suppose, was that the United States would become the World's "bank" and global regulator, providing a safe harbor for the world's wealth, overseeing its investment and distribution (in part through international institutions such as the World Bank, the International Monetary Fund and the World Trade Organization). Key's to maintaining this position were a strong dollar, a strong military, strong financial institutions and strong graduate education at our universities, the latter of which allowed us to maintain our high-tech lead and educate the World's elite to the "American Way."
The driving force behind all of this was relatively simple: Technology had opened the door to an inevitable "globalization" of the world's economy and it was far better for us to be leading this process rather than following it. Additionally, the end of communism offered an enormous opportunity in expanding western free markets globally. The trick was to bring literally billions of people (the former Soviet Union, China, India, SE Asia, etc.) into the free market system before their failed communist systems drove them into anarchy and chaos, thus endangering all of us via the rise of new dictatorships and war.
Overall, this was not a bad plan; there were, however, a few problems that were overlooked.
The first was the underestimation of how easily the new technology (our advantage) transferred across borders. It's one thing to build a factory; it's another to transfer software over a global internet. The second was an underestimation of one of the few benefits of communism, universal education and, as a result of that education, how quickly the ex-communist countries would be capable of assuming our former role. Third, we transferred our manufacturing base (the Old Economy) before securing our high-tech position (the New Economy) with effective global intellectual property rights agreements - lower labor costs trumped common sense. Fourth, we underestimated the importance of our dependency on middle eastern oil and its linkage to fragile dictatorships, facing a fantical religious awakening. Fifth, we overestimated the ease of transition of American Labor from the Old to the New Economy. And, sixth, we allowed our "real power," military force, to deteriorate within the context of the "peace dividend" provided by the fall of the Soviet Union and China's move toward a fledgling market economy.
In sum, the "plan" required far, far more control over the global economy than we actually had. This rise in a "Masters of the Universe," American mentality came, I think, from several sources, but most significantly from the belief that we "beat the Russians." In turn, this interpretation strengthened the Goldwater/Reagan/Bush brand of economic conservatism, which in turn distorted our perception of the global reality (partially genuinely believed, partially for political gain).
By the time Ronald Reagan won the Presidency, the Cold War had practically ended. Reagan largely, in his mind, "fought" the Soviet Union of the fifties and sixties, not its reality in the eighties. It was sort of like applying the coup d grace after the firing squad had finished their work. With or without RR, it is difficult to see how the Soviet Union could have carried on much longer without the same type of economic changes as those being embraced by China. Fundamentally, the people of the Soviet Union brought down the Soviet Union themselves. I suspect, with a little more distance from the actual events, historians will find that economic pressures, not from the West, but from the successes of Communist China and an unwanted war in Afghanistan, contributed more than RR to the dissolution of the "Evil Empire."
But, the American public perception was it was a Reagan victory and therefore the rest of the stuff must really work as well...such as supply side economics, etc.
I was in Europe during this period working with the European automobile industry. A few days after the wall in Berlin came down, I was having lunch in the Executive dining room of Mercedes-Benz. I was the only American at the table; the others were customers and friends from Mercedes, with whom I'd worked closely for two-three years. We were discussing the impact of the end of the Cold War and Communism and, of course, the problems in integrating East Germany into West Germany. I noted that this would be an enormous task requiring vast resources from the entire western world (referring to the larger problem, not just East Germany). One of my friends at the table spoke up: "East Germany is a German problem, not an American one." And, everyone else at the table agreed. I went back to my office thinking, "the end of the Cold War and Communism probably also means the end of U.S. hegemony in the West." I don't think this thought computed well with Goldwater/Reagan/Bush Republican economic planning. Rather, it was "to the victor go the spoils."
William Jefferson Clinton inheirted the "plan" and the problems. The first two years of his Administration were pretty much lost on universal health care. For the remaining six years of his Presidency he was faced with a Republican Congress, so it really didn't matter too much whether he spent his time conjuring up programs he knew he couldn't get past Congress or defending himself against ill-considered personal behavior.
Following the failure of the health care plan, he basically pursued economic policies not too different from the Republicans, with the occasional rheotical crump thrown to the Democratic base. In fact, off-hand, I can recall only three "accomplishments." He balanced the budget, supported NAFTA and took us militarily, via NATO, into the Balkans. The other side of the coin to each of these was balancing the budget through a reduction in government spending, largely at the expense of the military, and raising taxes; the formation of NAFTA as a counter to the European Union; and the commitment of U.S. forces abroad, without Congressional approval. However, as long as casualties in the Balkans were kept low through a predominately fought air war and everyone was getting rich, the Republican Congress was content with its efforts to impeach him over lying to a grand jury regarding his personal sexual behavior. Republicans were actually so happy with an impotent (perhaps the wrong adjective in this case) Democratic Presidency, they were kind enough to run Bob Dole against him in the second term election.
During the Clinton Administration, however, the modus operanti for the "phony economy" was established. With the help of Alan Greenspan and Robert Rubin (and the zeitgeist of The New Economy, which all three pushed heavily) Clinton was effectively able to practice a Democratic version of supply side economics without the down side; an economic approach his predecessor, George Bush Senior, had labelled as "voodo economics."
Embracing the "Plan," through support for NAFTA and free trade, and masking the impact of American jobs being shipped overseas through new ways of accounting for unemployment and cheap money, the Administration provided the "fuel" for the dotcom bubble. It was during the Clinton years that I first noticed it seemed that as the national economy became stronger and stronger, the middle class became weaker and weaker. Ultimately, under Bush II, Clinton would look like a piker, but turning the American economy into a giant Ponzi scheme, sustainable only through devalued currency and overvalued assets, to mask the impact of globalization, begin with the Clinton years.
As the manufacturing based economy transitioned to "The New Economy" - essentially a service economy, $20/hr jobs were lost overseas to be replaced, basically with $10/hr jobs. The impact of this on the bulk of the American workers was lessened through the flow of cheap goods from abroad and a generous monetary policy at the Fed.
National growth in gross domestic product is generally a leading indicator of a nation's economic health. If the economy grows at 4% a year, in 18 years (or about a generation), the economy will approximately double in size and if you look at the statistics you'll find this overall trend in American economic history, with slower or even negative growth occasionally, and faster growth occasionally. All economics is comparative, so the final judgement on our economy is how fast or slow we're growing compared to other nations. Given the "plan" of bringing heretofore absent nations into the global economy (China, India, the Soviet Union, etc.), successfully developing nations grow at roughly 6-9%, while most of the developed world, grows slower, in the 3-5% range.
This, however, says nothing about the nature of the growth or how the added wealth is distributed. Through the Clinton and Bush years growth floated around the 4% figure. If that wealth had been distributed equally throughout the population, household incomes would have approximately doubled. Instead they remained essentially flat for the middle class, slightly improved for the poor and skyrocked for the top 10%. The stratification or dispersion of wealth in the United States is now approximately what it was during the Age of the Robber Barons (the late 1800's and early 20th century). This growing stratification was certainly intentionally promoted via supply side economics and the urgency in expanding the global economy; it also conveniently fit the replacement of those $20/hr jobs with $10/hr jobs. National poverty improved abit under Clinton and got a bit worse under Bush; middle class income rose with the dotcom bubble, flattened and lost ground under Bush, recovering slightly in 2006-07. However, middle class households today are still approximately $1500/yr behind where they were in 2001.
This isn't that unusual in times of significant economic shifts. The Robber Barons may have taken a bit more than their fair share, but they also moved the country from essentially a regionally based economy to a national economy, from which we've all benefited. Capitalism does work. Today's "Masters of the Universe" (the new Robber Barons) are taking us from a national economy to an international economy via globalization. While I have no qualms about that in itself, my concern is that we are moving at too fast a pace in this transition and that both the pace and method will not result in an ultimately stronger nation, but descent to Third World status.
Much of this is due to the "phony economy," I noted above. Unlike the period in the late eighteen hundreds and early twentieth century, today's growth consists of very little substance.
Instead of expanding national infrastructure, our existing infrastructure is declining. Our assets are being bought by foreign importers and the only new factories that are being constructed are by these same importers seeking to find some way of evening out trade imbalances and getting rid of their value declining dollars as fast as possible.
Instead of "genuine growth," we have through the dotcom and housing bubbles grown largely through low interest rates, cheap money, overvalued product and loose credit; credit for consumers, credit for the nation. If one takes away the effect of the bubbles, I suspect growth over this period would be either flat or negative. U.S. household savings fell throughout this period and are now negative - i.e. America is not only dependent on foreign oil, but on credit. Once this is obvious, global confidence may fail and the house of cards fall. In this respect, I suggest we are rapidly arriving at the "tipping point."
A fundamental tenent of free markets is that they behave "rationally." This is a cornerstone to generally Republican arguments for small government, deregulation and free markets, as opposed to higher taxes and "government planned economies." Much of our national economic policy from Ronald Reagan on, including the Clinton years, has rested on the fundamental belief that free markets behave rationally. As a result of this "rationality," buyers in the market will search for the best products at the lowest price, thus forcing efficiencies upon competing sellers. Lacking in these motivations, government will perform inefficiently and so the less money the government receives, the more efficient the economy as a whole becomes. In a nutshell, that's pretty much Republican economics (or was until Bush II, who managed to bring the worst of both worlds. I blame much of it on his Harvard Business School training).
But do markets really behave rationally and are they really "free?" In a recent appearance on CNBC (the business channel), Warren Buffet, who was rejected by Havard Business School and who would be the last person on earth to call himself an "economist," when asked for a prediction on where the stock market would be in a year, replied: "Oh, I don't know. I don't pick stocks on market trends; it's hard to know where a market will go, they're so irrational."
Instead, Buffet's method, as he described it, is a bit of an obsolete Mid-West-Main Street approach. Buffet buys companies, not stocks. [Buffet's own company, Berkshire Hathaway's stock has done reasonably well, with Class A stock now trading at approximately $140,000/share.] In other words, Buffet looks for soundly managed companies with a competively priced, quality product and tries to sort out the clutter that has come to dominate our "free market." He dosen't worry about stock appreciation or the influence of pension fund managers or, in a curious way, "stock holder value," yet achieves just that by largely ignoring it in the day-to-day conduct of his business. And, his stock holders, who at $140,000/share must be among the world's most sophisticated investors, leave him pretty much alone to do "his thing."
Another example of the point I will eventually make here was in the recent film, "American Gangster," based on the true story of a black businessman, whose "business" happened to be drugs in Harlem. As he watched the "trade," he decided that the best way to grow his business was to eliminate the "middlemen" (figuratively and literally). In this way, he also eliminated the commissions and fees and controlled his own product. His success was that he sold a better quality product, with less costs and at a lower price. [He was eventually caught by the newly formed DEA, who themselves were, in a different way, shaking up the old trade, with all of its police payoffs, MAFIA connections, etc.].
The message, in both Buffet and "American Gangster," is that free markets are often corrupted over time and fail to serve their original reason for being...bringing a quality product to a buyer at a reasonable price.
In the wake of the end of communism and the rising economies of a post WWII Western Europe, and the Third World, American financial institutions sought to expand their markets globally and to somehow remain "on-top," a position they had been in since WWII. In my next post, I will show how they accomplished this during the eighties, by taking control of Corporate America through "bribery" and the phrase: "stockholder value."
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