Economics

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10
Mar 10

Are We a Socialist Country?

Europeans and Russians are socialists.  Americans are staunch capitalists.  Maybe all it took was a financial crisis to reveal the slide toward socialism in America.  During the Cold War, faced with a military threat from the Soviet Union, Americans would rather have died than become socialists:  better dead than red.  Unwittingly, we now invite socialism into our lives.  Ironically Wall Street firms and large industrial corporations, the purported bastions of capitalism, have paved the way to socialism.  A left-leaning Administration has been only too happy to oblige.

The Slippery Slope

The road to hell is paved with good intentions.  I do not think any of the pillars of our economy intended that the country become socialistic.   Each entity was merely maximizing its own position, seeking to enhance shareholder value.   When financial crisis hit, our formerly capitalistic businesses could not rush to Washington fast enough to seek support, bailouts and guarantees from the government.   The government was only too happy to oblige with the passage of TARP and then an alphabet soup of government support and guarantee programs.  In one short crisis period from summer 2008 to spring 2009, the government ignored 200 years of American economic and constitutional history to save a group of greedy and profligate bankers and industrial corporations.   The end result: we privatized profit and socialized losses.

A Factual Progression

Here are the events that have taken us on the path to socialism:

  • The Federal Reserve’s active role in the forced sale of Bear Stearns to JP Morgan
  • The Government seizure of Fannie Mae and Freddie Mac
  • TARP:  Government purchase of troubled assets from private financial institutions
  • Goldman Sachs and Morgan Stanley become banks by expedited process  to obtain government guarantees
  • Government seizure of AIG and complete payback to private institutions for credit derivative losses
  • Federal Reserve intervention in broker mergers, with guarantees against losses (Washington Mutual with JP Morgan, Wachovia with Wells Fargo)
  • Federal Reserve intervention with $1.3 trillion in loans to companies outside the financial sector (GE).
  • Government removal of management at GM and Chrysler
  • Restrictions on executive pay for banks receiving bailout funds
  • Government restrictions on foreclosures unless there has been a Home Affordable Modification Program review.
  • Administration desperation to pass comprehensive health insurance program.   See Timeline:Global  Economy in Crisis

How Did We Get Here?

We invited the devil in the door.  Banks claimed that they could not withstand loan and derivative losses.  Unemployed Americans wanted extensions in unemployment benefits and stimulus programs.  Nobody wanted to see the stock market crash and their portfolios and retirement plans decimated.  Big business wanted the profit opportunity in universal health care coverage.  Insurance companies did not want to hurt their policy holders.  Auto workers wanted to maintain their rich union contracts.  The litany goes on.

Once we were a brave, independent and self-reliant nation.  Now when adversity strikes our first inclination is to blame others and call Washington for a bailout or a handout.  I do believe in the concept of welfare.  Welfare was meant for the truly dire circumstance, the impoverished citizen. Welfare was not meant for auto workers to maintain above market wages and job guarantees, banks to get paid in full for risky derivative bets, GE or GM, homeowners who falsified their income disclosures to remain in McMansions or every insurance policy to be paid in full.

Capitalism is about freedom, risk and failure.  Without failure there can be no progress.  The slide toward socialism is an escape from freedom and ultimately an end to progress.

My European immigrant grandfather lived through the Depression, World War Two, and into the 1980’s.  He once told me he was most proud that he never went on relief (welfare).  We should return to the ways of our forbearers, regain our mettle and become too proud to ask for a handout or bailout.   Our freedom and that of our children depend on it.

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1
Mar 10

Labor and Employment Laws: The Hidden Job Killer

When we ignore government sleight of hand, the real number of unemployed Americans is a staggering 26.9 million.  In For 15 Million Unemployed any Job is a Good Job; Questions for Pollyannas; Wishes Aren’t Fishes, Michael Shedlock (“Mish”) continues his excellent analysis of the unemployment situation.  Contrary to Bernanke and Obama Administration rosy projections, Mish predicts that official unemployment will remain greater than 9 % through 2015.  In a quote from Allen Sinai, chief global economist for Decision Economics, Mish describes corporate hiring behavior:

American business is about maximizing shareholder value…You basically don’t want workers. You hire less, and you try to find capital equipment to replace them.

Workers are expensive. Federal, state and local employment laws make them more so.

New Deal Labor Legislation

In the late 19th and early 20th century, rapid industrialization resulted in powerful owner/capitalists, virtually powerless workers, and deplorable working conditions.   Upton Sinclair’s The Jungle dramatized the deplorable state of affairs in the meatpacking industry.  In reaction, in 1935, Congress passed the Wagner Act to permit union organizing. Then it enacted the Fair Labor Standards Act to establish minimum pay, limitations on hours and pay for overtime work.  Perhaps labor legislation should have stopped at that point.

Nothing Succeeds Like Excess

New Deal labor legislation was just a springboard for greater federal control over the workplace.   Since 1964, there has been a flood of labor and employment legislation and Executive Orders.

  • The Civil Rights Act prohibits race, color, religion, sex or national origin and pregnancy discrimination.
  • The Age Discrimination in Employment Act prohibits age discrimination.
  • One Executive Order prohibits all forms of discrimination and requires affirmative action.  This includes training and outreach programs and other positive steps which must be incorporated in written personnel policies and a plan which must be updated annually.
  • The Equal Pay Act requires that men and women in the same workplace be given equal pay for equal work.
  • The Americans with Disabilities Act prohibits disability discrimination. The Rehabilitation Act requires most federal contractors and subcontractors to take extra measures to hire and promote qualified disabled individuals.
  • The Occupational Safety and Health Act requires employers to meet legal health and safety standards.
  • The Employment Retirement and Income Security Act (“ERISA”) sets uniform minimum standards to assure that employee benefit plans are established and maintained in a fair and financially sound manner.
  • The Workers Adjustment and Retraining Notification Act requires that covered employers provide notification sixty days before a plant closing or a mass layoff.
  • The Family and Medical Leave Act provides covered employees with entitlement to up to 12 weeks of job-protected, unpaid leave during any 12 months for the following reasons:

-Birth and care of the employee’s newborn or adoption or foster care of a child

-Care of an immediate family member (spouse, child, parent) who has a serious health condition

- The employee’s own serious health condition

These are the major pieces of federal labor and employment legislation, but there are additional enactments regulating the employment relationship.

Since we live in a federal system, state and even municipalities impose additional employment, benefit and labor obligations.  Moreover, the courts have intervened to create doctrines such as wrongful discharge to limit an employer’s right to dismiss an employee at will.

Real World Consequences

Much of the above legislation is grounded in noble sentiment: workplace fairness and employee protection.  But there are real world consequences: a loose definition of “serious health condition” allows employees to take large unpredictable amounts of time off, harming production schedules.  Affirmative action programs require lots of staff and recordkeeping, extra recruitment and training, and slower hiring.  ERISA imposes fiduciary liability on plan sponsors. With virtually every workplace sector protected, firing an employee is difficult, with the ever present danger of a discrimination or retaliation charge. And so the American workplace is now one of the most regulated areas of our economy.

Laws are often a hidden tax. See Ask Your Congressional Representative to Do Nothing.   Allen Sinai has reached the correct conclusion: why hire expensive workers who have a host of protections and entitlements when you can substitute cheaper capital (automated machinery, robots, computers, etc)?  In a globalized economy where a highly motivated, well-trained Chinese worker makes about $1 per hour, the over protected American worker may have priced himself out.

If the Obama Administration is serious about reducing the unemployment rate, it should be thinking about shelving expensive health care initiatives and the Employee Free Choice Act.  More employer cost will equal less American employment.

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24
Feb 10

The Mirage of a Financialized Economy

We have spent the last 30 years preoccupied by financial things.  Finance was once the handmaiden of productive enterprise.  That is, Wall Street served productive enterprise, raising and allocating capital for worthy endeavors.  Finance existed for helping railroads, utilities, builders and manufacturers to issue stocks and bonds.  Further, finance helped maintain orderly exchanges where stocks and bonds could be traded.

Building a successful business is difficult. Once an entrepreneur raises capital, he must deploy it properly.  He must hire employees, build factories, develop products, plan marketing strategies, manage production, packaging and shipping, and a myriad of other activities.

A recent concept, financialization is defined as:

…a term sometimes used in discussions of financial capitalism which developed over several decades leading up to the 2007-2010 financial crisis, and in which financial leverage tended to override capital (equity) and financial markets tended to dominate over the traditional industrial economy.

[It] describes an economic system or process that attempts to reduce all value that is exchanged (whether tangible, intangible, future or present promises, etc.) either into a financial instrument or a derivative of a financial instrument.  Source Wikipedia.

Financializing the economy promised a short cut to making money.  We are now paying for that false promise.

Living through Financial Engineering

I started my corporate career in 1977.  I worked for a telecommunications and manufacturing conglomerate that served 27 million telephone customers, employed 250,000 people worldwide, manufactured products ranging from the humble incandescent light bulb to sophisticated microchips.  Leaders in the company were operating executives.  Executive compensation was moderate.

In the 1980’s and 1990’s the winds of financializing change swept through corporate America.  The underlying producing businesses were viewed as stodgy and unimaginative.  Paper mills, lighting plants, railroads and telecommunication companies were boring “cash cows.”   “White shoe” business schools preached financial innovation, or to give it a more professional sounding name, financial engineering. The CFO function dominated.  Executive compensation increased exponentially.

The number of engineering opportunities was boundless:

  • Terminate pension plans and pocket the surplus assets
  • Create leveraged employee stock ownership plans to make 401k contributions
  • Take out gigantic company owned life insurance plans on large swaths of the workforce
  • Issue huge amounts of debt and buy back the company’s equity
  • Create voluntary employee benefit trusts to pre-fund retiree health benefits for unionized employees.
  • Create leasing and realty divisions within the company for both internal and external needs
  • Take the firm private through a management organized leveraged buyout

These are but a few of the financial techniques employed to inflate company earnings or turn a quick profit. Most of these strategies involved taking on large amounts of debt and exploiting loop holes in the tax code. None of this enhanced the productive capabilities of the underlying business. The “cow” was slowly starving and the bricks and mortar of the enterprise were crumbling.

Enron and WorldCom

The beginning of the new millennium saw two major American corporations, Enron and WorldCom, disintegrate.  Accounting fraud was at the heart of these collapses.  Enron created off shore entities to hide losses and posted yet unrealized revenue as profit.  WorldCom underreported line costs by capitalizing items which should have been expenses.  They also inflated revenues through bogus accounting.  Not only did these entities hurt their shareholders, but also their competitors who had to compete again these fraudulent entities for scarce capital.

Sarbanes-Oxley was passed in 2004 to stop these accounting maneuvers and restore integrity.  The subsequent collapse of Bear Stearns and Lehman tells us that Sarbanes-Oxley failed, and that financial transparency still does not exist.

The Evils of Financialization

Financialization of the economy has become an evil unto itself.  Culprits in the 2008 financial crisis: sub-prime lending, mortgage-backed securities, collateralized debt obligations, off balance sheet structured investment vehicles, hedge funds, private equity,  excessive leverage are all the progeny of the 1980’s schemes and strategies to enhance corporate financial performance.

I have two observations.  First, many of these maneuvers are nothing more than alchemy applied to finance.  Old saws such as “there is no free lunch” and “you can’t get something for nothing” remain true.  Slapping a Nobel Prize or a prestigious business school imprimatur on a strategy does not change these universal truths.

Second, an early rule of investing I learned is: when one sector becomes more than 30% of the value of the S&P 500 index, sell that sector. This was true in the 1980’s when the oil sector passed that benchmark and in 2008 when the financial sector did the same. Too much of society’s resources and human capital are now tied up in one area of the economy. At least in the case of oil there was a real societal good.

The financial industry in 2008 and now has become a financial casino without the glitz or charm of the Mirage. In fact, it has become a mirage and that says a lot.

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16
Feb 10

Where Are We Now?

“Where Are We Now?” is my fiftieth blog post.  The purpose of a political and economic blog is to “connect the dots” looking for coherent patterns.  This post will attempt to do just that, warning you that the emerging pattern is disturbing.

Slow Motion Depressions

Policy makers in Washington and other western capitals are recently smug. They proclaim that, through coordinated monetary and fiscal response, we have averted the Second Great Depression.  More bluntly, all we have done is throw a lot of money at the problem through unprecedented monetary easing and a fiscal policy of bailouts and stimulus bills.  The core financial issue remains:  western countries and the US in particular have too much debt and insufficient income to service that debt.  Depressions have their own timetable. In my opinion, government intervention has only slowed the timetable, but definitely has not averted the event.

The Magic Act

Politicians and central bankers are a bit like magicians.  While an observer is firmly focused on the right hand we miss the left hand’s activities, which are hiding in plain sight.   Just look at current economic and financial trends:

  • Increasing Risk of Sovereign Debt Default – In late 2009 a problem arose with the financial solvency of Dubai.  Much like the subprime crisis in the US, financial pundits assured the public that the Dubai default was minor and self contained.  Yesterday, credit protection for Dubai rose to a record high exceeding the November peak. See Dubai CDS Hits 652, Ploughs Through November Highs As Gold Jumps.   Greece too is on the verge of sovereign debt default and is seeking a European Union bailout.  Portugal, Ireland, Italy and Spain are reportedly in dire financial trouble as well.  The United States, Japan and United Kingdom are not immune from talk of default.
  • Crisis at the State Level – The Center for Budget and Politics has projected 48 of 50 states will have budget deficits.  Cumulatively, the Center estimates an $180b shortfall for this fiscal year.  All states with the exception of Vermont have a balanced budget requirement.  Some assistance to the states has been proffered through the American Recovery and Reinvestment Act, but it is questionable whether this aid can continue. See Recession Continues to Batter State Budgets; State Responses Could Slow Recovery. It is more likely that states will follow the lead of newly elected Republican Governor Chris Christie.  Recognizing that the state is on the edge of bankruptcy, Christie has declared a fiscal “state of emergency” and intends to slash $2.2b from the budget. See Chris Christie Declares Fiscal ‘State of Emergency,’ Paving Way for NJ Spending Cuts. The crisis in municipal finance portends trouble in the municipal bond markets.  The unsuspecting public has purchased municipals in search of yield and instead may receive an unpleasant surprise.
  • National Fiscal Irresponsibility – President Obama signed into law a $1.9t increase in the debt ceiling, raising it to $14.2t. As the administration has predicted deficits out to 2020, this ceiling will rise each and every year. Also, it does not include the Christmas Eve bailout of Fannie Mae and Freddie Mac which provided “unlimited financial assistance” to these two entities. We will likely exceed our previous limit of $400b on financial assistance under emergency bailout provisions.  See US Promises Unlimited Financial Assistance to Fannie Mae and Freddie Mac.  Moreover, how can we continue to finance these deficits without an increase in interest rates?  However, such an increase in interest rates could put the US in a “doom loop,” as interest payments become the dominant budget line item crowding out other federal spending programs.
  • China – Recently China has made a number of financial moves that do not bode well for the US and world economy. First, China has ordered its currency managers to withdraw from any US dollar denominated risk assets, such as corporate bonds, equities and only invest in US guaranteed assets.  Second, it has raised its reserve requirements on its own banks to dampen an over-inflated domestic real estate market.   Speculation in Chinese real estate has reached the point that Jim Chanos, a respected investor, predicts an economic collapse.  See Jim Chanos: China Bubble Ready to Burst. Given the size of our deficits, the US desperately needs China to continue purchasing US government securities. The world needs China as a growth engine to continue world trade and prevent a second leg of the recession.

Harbingers of the Economic Unraveling

Before the next phase of an economic crisis there are often clues to impending problems. Some harbingers to consider:

  • Junk Bonds – The Greek crisis has spurred investors to sell junk bonds, highly risky assets, at the fastest rate since 2005.  As a result credit spreads are widening between treasury and higher risk corporate bonds. See Junk Bond Spreads Widening: A Canary in the Coal Mine.
  • Problems in a Treasury Auction – Last week’s US 30-year Treasury bond auction was considered a failure.  Indirect bids, that is, foreign buyers, dried up and the government had to offer a yield of 4.72% compared to an expected yield of 4.687%.  See Dismal $16b 30 Year Auction
  • Credit Card Problems – Capital One, a major credit card issuer, reports that in January delinquencies rose and that expected unrecoverable loans have risen to 10.41% from 10.14% in December. See Capital One: Credit -Card Delinquencies Rose in January.
  • State and Municipal Finance –In its upcoming July 1 fiscal year budget, California expects a $20b shortfall.  Illinois has a $61b pension shortfall, and is borrowing to make contributions.   Harrisburg, Pennsylvania, is contemplating a March 1 bankruptcy filing.  These stories are the proverbial tip of the municipal finance debt iceberg. See Illinois Pension Fund $61b Underwater; State Borrows Money for 2010 Contribution; California $20b in the Hole Again.

Reality

Till now the policy direction of the Obama administration and other western leaders has been to “extend and pretend:”  we will ignore economic realities by permitting banks to suspend “mark to market accounting” and we will send various administration spokesmen to spread the fairy dust of “green shoots” to pacify an anxious public.  Essentially, we have an economic policy of faith and hope that willfully ignores reality.  Economics does respond to the laws of mathematics.  Like a termite that silently eats away the wooden supports of a house, excessive debt has eaten away the structure of the world economy.  There will be more troubled countries like Dubai and states like California before this Depression has run its course.

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5
Feb 10

It is All a Derivative of Productive Enterprise

The bulls on CNBC touted the increase in health care employment in the most recent Non-Manufacturing Institute for Supply Management Report on Business. Similarly, Fox Business News trumpeted growth in health care employment, but did point out these jobs paid substantially less than jobs in the manufacturing sector.  What both news outlets missed was that these jobs were derivative.  These positions are substantially funded by the productive sectors of the economy.

Economic Illiteracy

Michael Shedlock this week focused on a major theme plaguing America, economic illiteracy. See Are Teachers to Blame for Economic Illiteracy? Nowhere is this lack of economic literacy more evident than in the service sector in general and health care in particular.  If polled, most Americans would most likely answer that the government or insurance companies provide health care in the United States.  Medicare and the current debate on health care reform only add to this misperception.

Thank Goodness for the Private Sector

Health care money comes from the support of the private sector which directs a portion of a workers’ compensation to paying health insurance premiums for their employees.  Public sector employers also pay health insurance premiums for their employees.  However, in the case of the public sector, that employer is recycling tax receipts, real money, received from private sector activities.  In short, without a productive private sector there would be no health care support.

Restoring Economic Literacy

Americans have come to expect a “free lunch” from the government. Of course, this is fantasy; there is no free lunch.  Health care is paid for by our productive enterprises and manufacturing was the lynchpin.   Further, other service industries such as law, insurance, travel, leisure, entertainment, and others are derivatives of productive manufacturing enterprises.  When the economy turned down law firms were among the first to layoff partners and associates.  Without a vibrant private economy legal activity declined, with fewer contracts real estate transactions, mergers, acquisitions and frivolous lawsuits.  Corporations reduced their legal budgets.  Similarly, other service businesses contracted.

Outsourcing lucrative manufacturing jobs and global wage arbitrage have only worsened the unemployment situation in the United States.  Reliance on a service economy and public sector employment has been false bedrock for our system.  If we want first class health care, we must bolster the private manufacturing sector and reduce the public sector.  Government dominance of our health care system and other service sectors (think banking) only ensures larger deficits, continued recession, higher unemployment and an inadequate, underfunded, cheap, quick and dirty, band aid solutions health care system.

That is not a good prescription for anyone’s health.

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26
Jan 10

The President Wakes Up and Smells the Election Results

In Barbell Economy posted on January 21, I hypothesized that the Democrats lost the Massachusetts election because the Obama administration ignored the needs of the middle class.  The systematic destruction of the middle class is the most potent issue of 2010.  It appears the White House finally woke up and smelled the coffee.  President Obama yesterday proposed a series of initiatives to aid the middle class. The Christian Science Monitor reported the President’s remarks:

We … need to reverse the overall erosion in middle-class security so that, when this economy does come back, working Americans are free to pursue their dreams again,” said Mr. Obama Monday at a meeting of the administration’s Middle Class Task Force.

A White House fact sheet listed some of the specific initiatives:

Child care. The administration is proposing to nearly double the child-care tax credit for families whose income is less than $85,000 a year. For those folks, the percentage of child-care expenses eligible for reimbursement via the credit would rise from today’s 20 percent to 35 percent.

In dollar terms, the maximum credit for a two-child family making, say, $80,000 a year, would increase from $1,200 to $2,100. That’s a $900 benefit.

Families with incomes up to $115,000 a year would be eligible for at least some increase in their child-care tax credit, on a sliding scale.

The administration also is proposing to increase by $1.6 billion the amount of money in the Child Care Development Fund, which pays for child care for poor families, including those receiving public assistance.

Dependent care. The White House is proposing to add $52 million to the Caregiver Initiative, a Department of Health and Human Services program that provides temporary respite care, counseling, and referrals to critical services for hard-pressed families taking care of elderly relatives. According to the administration, this extra cash means the program will serve an additional 200,000 people.

The administration is also proposing to add a further $50 million to programs that subsidize adult day care, transportation, and aides who help seniors bathe and cook.

College expenses. …[T]he administration is proposing to limit the amount of student loan money that a borrower must repay to 10 percent of the borrower’s income, over and above a basic living allowance.

The proposal would also cap the total amount of money a borrower must pay. For borrowing students who enter a field of some kind of public service, all remaining debt would be forgiven after 10 years of payments. For others, forgiveness would follow 20 years of payments.

Retirement savings. About 40 percent of working heads of households don’t have any kind of employer-sponsored pension or retirement plans. The administration thus is proposing to require employers who don’t offer such plans to enroll their workers in automatic, direct-deposit IRAs (individual retirement accounts).

Employees could opt out if they wanted to. All contributions would be voluntary.

The administration also wants to streamline the process by which workers enroll in 401(k) retirement plans.

Where are the Jobs?

While providing some benefits to the middle class these initiatives do not create jobs.  The Administration seems to miss the larger point, perhaps the only point:  we have too much debt, too little savings and too little demand.   Economically it is impossible to return to the pre-2007 level of prosperity because we have not liquidated or paid off our massive debt.  Zero interest rates misprice risk.  Banks are hoarding money to reserve against future losses in their loan portfolios. There are few credit-worthy borrowers.

And so, both parties remain guilty of legislative gimmicks.  Bailouts and tax credits do not get to the heart of our problem, too much debt. When will we reach a moment of recognition that there are no quick fixes?  Debt must be liquidated or paid off, savings must become more important than spending, and we will all have to be more productive.

What we need now are leaders who understand these truths.

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25
Jan 10

Freedom to Fail

In his 1941 State of the Union address, President Franklin Roosevelt articulated four iconic freedoms:

  • Freedom of speech
  • Freedom of religion
  • Freedom from want
  • Freedom from fear

In our current situation, capitalism needs a fifth freedom, the freedom to fail

The Systematic Destruction of the Freedom to Fail

In the 1950’s, Dr. Benjamin Spock’s child rearing advice focused on a child’s self-esteem rather than discipline, performance, success or accomplishment.  This emphasis correlated to a new and pervasive permissiveness which sought to prevent failure as a childhood experience rather than process it for personal growth when it inevitably occurs.  And so the advent of the “Lake Wobegon effect:”

where ‘all the women are strong, all the men are good looking, and all the children are above average,’ … used to describe a real and pervasive human tendency to overestimate one’s achievements and capabilities in relation to others. The Lake Wobegon effect, where all or nearly all of a group claim to be above average, has been observed among drivers, CEOs, stock market analysts, college students, parents, and state education officials, among others.

And so we coddled the Baby Boom Generation.  If our child failed a course, get a tutor.  If College Board scores were not high enough, enroll the child in a review course.  Everyone was entitled to a college education, a house and a good paying job. Originally, affirmative action was designed to overcome discrimination.  It morphed from its original intent, equality of opportunity, to equality of outcome.   In the corporate environment, one’s status (that is, minority, female, disabled among others) many times trumped one’s accomplishments. I am in favor of the original purpose of affirmative action, but not its wrong-headed incarnation.

The Financial Crisis and the Freedom to Fail

The government stepped into the breach to prevent major institutions– AIG, GE, American Express, Capital One, GM, Chrysler, Fannie Mae and Freddie Mac– from failing.  In an economic analogy to Dr. Spock parenting, the Fed reacted as a permissive and nonjudgmental parent to a child eminently deserving of a failure experience from which to learn something.  By not permitting these institutions to fail, we may have exposed ourselves to much larger systemic failure with a default or devaluation of our currency.

Failure is Integral to Success

We should think about our own personal life paths.  Did we learn more from success or failure?  If we are honest with ourselves, we would admit that we learn much more from failure.  It builds resilience, humility and,  if we absorb the lessons, a path to success.  It is almost immoral to take away the ability to fail and learn.

Joseph Schumpeter, an Austrian economist, in Capitalism, Socialism and Democracy, theorized that “creative destruction” was integral to capitalism:

the same process of industrial mutation–if I may use that biological term–that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism. It is what capitalism consists in and what every capitalist concern has got to live in. . . .

Failure is an excellent teacher.  Permitting smaller failures after the internet boom would have saved the country the anguish of millions of people losing their houses, the near destruction of our banking system and the collapse of the stock market.

Now the government would be prudent to permit business failures regardless of business size or political connections.  Sparing the rod of failure only spoils the childlike business with more reckless behavior.  Without the “hell” of failure, there can be no “heaven” of success.

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21
Jan 10

The Barbell Economy

Political statements come in all shapes and form.  Tuesday it arrived with the election of Republican Scott Brown of Massachusetts to the United States Senate. Pundits conjured instantaneous rationales for this upset: the proposed health care bill, bailout of the banks, high unemployment rate, rise in the price of gasoline, declining home prices among others.

We can attribute Brown’s victory to any or all of these rationales; however, we are describing the symptom and not the disease.  The disease is the “barbell economy.”  On one side of the barbell we have the rich who have been rewarded with bailouts, large bonuses, hedge fund profits, at the expense of taxpayers.  These people appear to be insulated from the recession. On the other side of the barbell are the growing numbers of poor people who utilize our many social safety nets: welfare, food stamps, loan modification programs, Medicaid and others.  The dwindling middle class, the fulcrum of American society and the bar that holds up the barbell, is being disenfranchised and economically destroyed.

The Destruction of the Middle Class

We have witnessed the slow destruction of the middle class over the last 30 years.  Two wage earners were needed to maintain a middle class life style.  Then middle class wealth was destroyed in the stock market crashes of 2000 and 2008.  Easy credit and low interest rates mired the middle class in a cycle of debt.  Good paying jobs were outsourced to low wage foreign countries.  Unemployment soared and wage growth was eliminated.  Inflation in necessary commodities such as gasoline siphoned off more income.  The coup de grace was the implosion in house prices.

Albert Edwards, Global Strategist for Societe Generale, opines that the Federal Reserve has destroyed the middle class:

Some recent reading has got me thinking as to whether the US and UK central banks were actively complicit in an aggressive re-distributive policy benefiting the very rich. Indeed, it has been amazing how little political backlash there has been against the stagnation of ordinary people’s earnings in the US and UK. Did central banks, in creating housing bubbles, help distract middle class attention from this re-distributive policy by allowing them to keep consuming via equity extraction?  The emergence of extreme inequality might never otherwise have been tolerated by the electorate (see chart below).  And now the bubbles have burst, along with central banks? credibility, what now?

He cites the Census Bureau analysis that median income failed to rise in real terms for the entire decade, the first time that median income did not rise in all US history. See Scandal Edwards Alleges Central Banks were Complicit in Robbing the Middle Classes.

The middle class is now left with 10% percent unemployment (effectively 17% or more), decimated retirement income, skyrocketing health insurance premiums,  rising state and local taxes, a high debt load and a house with zero or negative equity.  Further, middle class tax payers are not stupid.  They know that taxes will soar to pay for these deficits and expansion of entitlement programs.  Promised a new political regime of hope, change and transparency, the middle class has endured a year of betrayal.

The Politics of Anger

Both Democrats and Republicans misread the current situation.  Middle class voters feel abandoned by both parties.  Backroom deals on health care legislation are only symptomatic of a deeply flawed and corrupt political system where the rich and connected obtain special favors and ignore the middle class.

The middle class is the bedrock of America.  Paraphrasing George Bailey’s defense of his father’s character in It’s a Wonderful Life, the middle class “does most of the working and paying and living and dying” in America.   The middle class needs real hope, not false promises of hope.  The two parties need to pay immediate attention to the middle of this economic barbell.  If they do not, more of this current group of elected officials might just be added to the unemployment rolls.

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18
Jan 10

Government Intervention and Bowmar Brains

In 1971, Indiana-based Bowmar Instruments introduced the first hand-held LED (Light Emitting Diode) calculator.  The “Bowmar Brain” was a huge success.  Other manufacturers developed cheaper calculators, and when the company could no longer compete, it went bankrupt in 1976.

What if the Government Intervened?

Starting with Chrysler in the 1970’s to GM and Chrysler in 2009 government has intervened to either prevent bankruptcy (Chrysler) or to distort the bankruptcy process (GM and Chrysler).  It has justified its intervention by touting the vital importance of these businesses to economic recovery, the need for jobs in severely depressed Midwestern states or national security.

What if the government had intervened in the Bowmar bankruptcy? After all, the first hand-held LED calculator was economically important to both Texas and Indiana.  Texas Instruments supplied Bowmar’s calculator chips.  Further, the hand-held calculator and LED technologies had important scientific and military importance.

In 2010, it seems absurd to even raise the possibility that government should have “saved” Bowmar.  However, we know from our current circumstance that government is whimsical and has indeed prevented private entities from going bankrupt.  This prompts us to consider “what if?”

In the 1970’s calculators were expensive: more than $100 for a Bowmar and $500 or more for HP business and scientific models.  Government intervention would have kept prices artificially high.  Today calculators are included at no extra cost in the basic Windows computer package and banks give away inexpensive calculators as promotional items.

Government intervention would have stunted development of LED technology. Today LED technology is ubiquitous; it is used in signage, energy efficient illumination and in photo optical applications such as remote controls.  See Wikipedia LED. Would the government have been able to innovate?  I would suggest not.

The Heavy Hand of Government

Today we witness the spectacle of the government intervening in numerous traditionally private activities:

  • Banks
  • Money Market Funds
  • Auto Manufacturers
  • Health Care
  • Mortgage Lending

Even conceding that the current Administration never intended to socialize broad swaths of private industry, the speed and scope of current federal involvement has put us on exactly that road. Financial media and the White House credit these measures with saving the economy and condition us to accept government solutions to private economic problems. This role is more than that of a regulator.  Government has become a major operator in direct competition with other domestic and foreign private enterprises.

What is the Real Cost?

One cost is the recent proposed special tax on large banks who accepted TARP funds. Government largesse is an inappropriate “free lunch,” but even this mistake is not the greatest harm.  Government intervention encourages investment based on political rather than economic considerations.  Did we really solve the problem of costly union collective bargaining agreements when the government took control of Chrysler and GM?  That would have jeopardized union support for Administration policies. See The Greediest Generation – Where Has Shared Sacrifice Gone?

Will these companies produce cars that consumers want to buy, or cars that meet the government’s environmental agenda?  The heavy hand of government will ultimately stifle all industries that it touches.   In the health care industry, this is of more than academic interest. We may pay with our lives.

If current governmental policy was in force in 1976, we all might be using very expensive and very large hand-held Bowmar Brains.  It is a worrisome trend that we should all be concerned about.

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American Society / Economics / Financial / Political — 0 Comments
11
Jan 10

The Organic Economy

Paul Samuelson, Nobel Prize winning economist, MIT professor and innovator of the mathematical approach to economics passed away last month.  See NY Times obituary.  Economics: An Introductory Analysis is still the leading textbook for introductory college economic courses.  Samuelson’s mathematical approach was the antecedent of econometric modeling wherein economic theory is combined with statistical methods to analyze and test economic relationships. Many of Obama’s advisors are proponents of mathematical modeling. Unfortunately, the real word is messier than Dr. Samuelson and his protégés would have you believe.

Economics and Hubris

An ivory tower economist who mixes math, economics and high powered computers as likely as not cooks up a stew full of hubris.  I have a friend who studied with Lawrence Klein, another Nobel Prize winner.  Econometricians believe that if one has enough statistical inputs and a big enough computer we can predict and control the economy.  From the public pronouncements of Obama’s economic team and endless reassurances of recovery, this hubris is alive and well in Washington.

The Human Equation

Mathematics overlooks the human element, with all its unpredictability:  fear, greed and yes – hubris.  We over borrow and take excessive risks in good times and over save avoid risk and hoard in bad times.

We have just had the financial equivalent of a heart attack.  What would an economic doctor prescribe to a post-heart attack patient?

  • Rest – save, don’t spend
  • Go on a diet and lose weight – get out of debt, don’t take on new debt
  • Exercise – engage in economically productive activities; don’t speculate, merely trading in financial claims
  • Quit smoking and drink in moderation – banks should avoid toxic lending and regulators should prosecute predatory lending practices

You Can’t Fool Mother Nature

Administration policy makers believe that their technocratic skills can immediately revive the economy.  Since the economy is the sum of human actions, it is perhaps more organic, lifelike and anthropomorphic than policy makers would like.  Armed with mathematical models and Keynesian dogma, technocrats believe they can accelerate recovery without harm to the patient.  Their prescription is to add more debt at every level, inviting our “patient”, the consumer and the profligate financial institutions return to their errant ways. These habits caused the financial heart attack in the first place.

Instead the Administration could have encouraged the patient to do the hard work of economic rest, weight loss and exercise, creating a path to long term recovery and preventing a relapse. We came close to the second Great Depression.  The actions of the Administration in short cutting much needed lessons can only lead to a worse and this time possibly fatal financial heart attack.

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