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mises
Joined: 05 Nov 2007
Location: retired
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 Posted: Mon Oct 13, 2008 12:54 pm Post subject: There Is a Silver Lining |
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http://www.newsweek.com/id/163449/page/3
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Some of us�especially those under 60�have always wondered what it would be like to live through the kind of epochal event one reads about in books. Well, this is it. We're now living history, suffering one of the greatest financial panics of all time. It compares with the big ones�1907, 1929�and we cannot yet know its full consequences for the financial system, the economy or society as a whole.
Amid all the difficulties and hardship that we are about to undergo, I see one silver lining. This crisis has�dramatically, vengefully�forced the United States to confront the bad habits it has developed over the past few decades. If we can kick those habits, today's pain will translate into gains in the long run.
Since the 1980s, Americans have consumed more than they produced�and they have made up the difference by borrowing.
Two decades of easy money and innovative financial products meant that virtually anyone could borrow any amount of money for any purpose. If we wanted a bigger house, a better TV or a faster car, and we didn't actually have the money to pay for it, no problem. We put it on a credit card, took out a massive mortgage and financed our fantasies. As the fantasies grew, so did household debt, from $680 billion in 1974 to $14 trillion today. The total has doubled in just the past seven years. The average household owns 13 credit cards, and 40 percent of them carry a balance, up from 6 percent in 1970.
But the average American's behavior was virtue itself compared with the government's. Every city, every county and every state has wanted to preserve its many and proliferating operations and yet not raise taxes. How to square this circle? By borrowing, using ever more elaborate financial instruments. Revenue bonds were backed up by the prospect of future income from taxes or lotteries. "A growing trend is to securitize future federal funding for highways, housing and other items," says Chris Edwards of the Cato Institute. The effect on the projects, he points out, is to make them more expensive, since they incur interest payments. Because they "insulate the taxpayer from the cost"�all that needs to be paid now is the interest�they also tend to produce cost overruns.
Local pols aren't the only problem. Under Alan Greenspan, the Federal Reserve obstinately refused to inflict any pain. Russian default? Cut interest rates. Worried about Y2K? Cut rates. NASDAQ crash? Cut rates. The economy slows after 9/11? Cut rates. Whatever the problem, the solution was to keep the money flowing and goose the economy. Eventually, by putting the housing market on steroids, the strategy created problems too large to untangle.
The whole country has been complicit in a great fraud. As economist Jeffrey Sachs points out, "We've wanted lots of government, but we haven't wanted to pay for it." So we've borrowed our way out of the problem. In 1990, the national debt stood at $3 trillion. (That sounds high, but keep reading.) By 2000, it had almost doubled, to $5.75 trillion. It is currently $10.2 trillion. The number moved into 11 digits last month, which meant that the National Debt Clock in New York City ran out of space to display the figures. Its owners plan to get a new clock next year.
"Leverage" is the fancy Wall Street word for debt. It's at the heart of the current crisis. Warren Buffett explained the problem in his inimitable way on "The Charlie Rose Show." "Leverage," he said, "is the only way a smart guy can go broke ... You do smart things, you eventually get very rich. If you do smart things and use leverage and you do one wrong thing along the way, it could wipe you out, because anything times zero is zero. But it's reinforcing when the people around you are doing it successfully, you're doing it successfully, and it's a lot like Cinderella at the ball. The guys look better all the time, the music sounds better, it's more and more fun, you think, 'Why the hell should I leave at a quarter to 12? I'll leave at two minutes to 12.' But the trouble is, there are no clocks on the wall. And everybody thinks they're going to leave at two minutes to 12."
If there is a lesson to be taken from this crisis, it's a simple and old rule of economics: there is no free lunch. If you want something, you have to pay for it. Debt is not a bad thing. Used responsibly, it is at the heart of modern capitalism. But hiding mountains of debt in complex instruments is a way to disguise costs, an invitation to irresponsible behavior.
At some point, the magical accounting had to stop. At some point, consumers had to stop using their homes as banks and spending money that they didn't have. At some point, the government had to confront its indebtedness. The United States�and other overleveraged societies�have now gotten the wake-up call from hell. If we can respond and change our behavior markedly, this might actually be a blessing in disguise. (Though, as Winston Churchill said when he lost the election of 1945, "at the moment it appears rather effectively disguised.")
In the short term, all the solutions to the current crisis require that governments take on more debts and larger obligations. This is inevitable and necessary. But that doesn't mean we should, as some noted economists advocate, stimulate the economy with more tax cuts. That would be only one more way to keep the party going artificially�like asking a drunk to go to AA next year, but in the meantime to have even more whisky. A far better stimulus would be to announce and expedite major infrastructure and energy projects, which are investments, not consumption, and therefore have a much different effect on the country's fiscal fortunes. (They are not listed separately in the federal budget, but that's just bad accounting.)
In the medium and long term, we have to get back to basics. Households, for instance, should save more. Governments should put incentives in place that make such savings more likely. The U.S. government offers enormous incentives to consume (the deduction of mortgage interest being the best example), and it works. We have the biggest houses in the world, the thinnest flat-screen TVs and the most cars. If we were to tax consumption and encourage savings, that would also work. Regulations on credit-card debt should be revised to ensure that people understand the risks and costs of these instruments. Moving in this direction would be good for families and for the government as well.
Wall Street will also need to change. Paul Volcker has long argued that the recent spate of financial innovation was nothing of the kind: it simply shuffled around existing resources while contributing few real benefits to the economy. Such activity will now be reduced significantly. Boykin Curry, managing director of Eagle Capital, says, "For 20 years, the DNA of nearly every financial institution had morphed dangerously. Each time someone at the table pressed for more leverage and more risk, the next few years proved them 'right.' These people were emboldened, they were promoted and they gained control of ever more capital. Meanwhile, anyone in power who hesitated, who argued for caution, was proved 'wrong.' The cautious types were increasingly intimidated, passed over for promotion. They lost their hold on capital. This happened every day in almost every financial institution over and over, until we ended up with a very specific kind of person running things. This year, the capital that remains is finally being reallocated to more careful, thoughtful executives and investors�the Warren Buffetts � of the world."
Volcker has also argued that the highly complex financial system was not nearly as stable as people believed and that far-reaching efforts were needed to regulate and stabilize it. Now these issues will get attention at the highest level. The fear on Wall Street is that a Democratic administration would overregulate. But look at who is advising Barack Obama�Buffett, Volcker, former Treasury secretaries Robert Rubin and Larry Summers. It is more likely that what will come from their efforts will be a better-regulated financial system that, while producing less-extravagant profits, will be more stable and secure.
The financial industry itself is likely to shrink, and that's not a bad thing, either. It has ballooned dramatically in size. Curry points out that "30 percent of S&P 500 profits last year were earned by financial firms, and U.S. consumers were spending $800 billion more than they earned every year. As a result, most of our top math Ph.D.s were being pulled into nonproductive financial engineering instead of biotech research and fuel technology. Capital expenditures went into retail construction instead of critical infrastructure." The crisis will stop the misallocation of human and financial resources and redirect them in more-productive ways. If some of the smart people now on Wall Street end up building better models of energy usage and efficiency, that would be a net gain for the economy.
The American economy remains extremely dynamic and flexible. Even now, the most surprising data continue to be how resilient the economy has been through all these shocks. That will not last, especially if the panic persists. But even so, it highlights the fact that the U.S. economy has underlying virtues and, after a tough recession, will probably recover faster than many can now imagine. The rise in emerging-market economies, which have been powering global growth, will not vanish overnight, either.
A new discipline would benefit America in a more general sense, too. Ever since the collapse of the Soviet Union, the United States has operated in the world with no constraints or checks on its power. This has not been good for its foreign policy. It has made Washington arrogant, lazy and careless. Its decision making has resembled General Motors' business strategy in the 1970s and 1980s, a process driven largely by a vast array of internal factors but little sense of urgency or awareness of outside pressures. We didn't have to make strategic choices; we could have it all. We could make blunders, anger the world, rupture alliances, waste resources, wage war incompetently�it didn't matter. We had more than enough room for error�lots of error.
But it's a different world out there. If Iraq cast a shadow on U.S. political and military credibility, this financial crisis has eroded America's economic and financial power. In the short run, there has been a flight to safety�toward dollars and T-bills�but in the long run, countries are likely to seek greater independence from an unstable superpower. The United States will now have to work to attract capital to its shores, and manage its fiscal house better. We will have to persuade countries to join in our foreign endeavors. We will have to make strategic choices. We cannot deploy missile interceptors along Russia's borders, draw Georgia and Ukraine into NATO, and still expect Russian cooperation on Iran's nuclear program. We cannot noisily denounce Chinese and Arab foreign investments in America one day and then hope that they will keep buying $4 billion worth of T-bills another day. We cannot keep preaching to the world about democracy and capitalism while our own house is so wildly out of order.
It's a fundamental American belief that competition is good�in business, athletics and life. Checks and balances are James Madison's crucial mechanisms, exposing and countering abuse and arrogance and forcing discipline on people. This discipline will be painful for a country that has gotten used to having it all. But it will make us much stronger in the long run. If we can learn the right lessons from this crisis, the United States will once more be playing by its own rules. And that cannot be bad for us. |
What he is trying to stay is that recessions are good. It has been Fed policy for a long while now to try and prevent a recession at almost any cost via monetary "loosening". This has made things worse, created the mother of all bubbles and we will not see it pop. Best, just let the economy cycle. What is good will stay, and what isn't won't. |
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Ya-ta Boy
Joined: 16 Jan 2003
Location: Established in 1994
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| Posted: Mon Oct 13, 2008 1:49 pm Post subject: |
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| Quote: |
Amid all the difficulties and hardship that we are about to undergo, I see one silver lining. This crisis has�dramatically, vengefully�forced the United States to confront the bad habits it has developed over the past few decades. If we can kick those habits, today's pain will translate into gains in the long run.
Since the 1980s, Americans have consumed more than they produced�and they have made up the difference by borrowing.
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I disagree with your conclusion about the author's intent. He was very clear about it upfront--the part I copied above. He's talking about fiscal responsibility and common sense. |
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mises
Joined: 05 Nov 2007
Location: retired
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| Posted: Mon Oct 13, 2008 2:02 pm Post subject: |
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Forcing necessary change and breaking bad habits is the good of a recession. Cleans out the pipes.
Anyways, no sense in arguing about that. The article is quite good all around. |
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Ya-ta Boy
Joined: 16 Jan 2003
Location: Established in 1994
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| Posted: Mon Oct 13, 2008 2:36 pm Post subject: |
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I'll agree with you there.
People's spending habits, profligate as they were, played a part in this mess. That will have to change. So far, neither candidate has mentioned it. No doubt there is the danger of over-compensating and becoming a nation of misers, which wouldn't be good either. |
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Gopher
Joined: 04 Jun 2005
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| Posted: Mon Oct 13, 2008 2:52 pm Post subject: |
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| There is a silver lining, Mises. Every cloud, as you know, has a silver lining. And B. Obama also knows this. In fact, Obama is going to mine that silver and make us all rich. He is going to bring the Sun back. Obama is going resurrect the lost pre-Columbian civilizations. |
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ddeubel
Joined: 20 Jul 2005
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| Posted: Mon Oct 13, 2008 3:13 pm Post subject: |
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I hereby declare that we shall term these half way regular drops in market value and financial turmoil - "contractions".
So we are going through a series of "contractions" which will lead to more "birth". Let's toss the term, "recession".
DD |
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Jandar
Joined: 11 Jun 2008
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| Posted: Mon Oct 13, 2008 4:47 pm Post subject: |
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Contraction is the opposite of expansion.
Recession, and depression all can occur with a contraction.
Stagnation is the absence of expansion and contraction.
Recession has a definition that has not yet been met.
Recession occurs before depression.
I expect there will be a lull in the contraction that will lead to stagnation (as the neo-regulation comes into effect). The stagnation will be followed by a recession that will lead to inflation that will lead to an expansion.
Now I am expecting some peaks and valleys in the market. Highs in the 10000 range again, bouncing between 10K and 7K over the next year. There will be a final dip somewhere around 5K in the 3 - 4 year mark.
Now there is a likely hood that the regulations will be balanced enough to prevent the 5K prediction and depression scenario above, however the recession (that hasn't happened yet) will occur starting next year, then you will know what a recession really is.
I think too much regulation as well as not enough regulation will cause a further slide.
Things I expect, no new Free Trade agreements, possible modifications to present FTAs. GM Chrysler merger followed by a bailout loan of the new entity. Ford will be nationalized in some respect.
Some large insurance company will be nationalized and will become the focal point for administering the new National Health care system.
Airline mergers will continue, 'open skies' will be repealed.
Big changes in the EU. England will drop out of the EU followed by Ireland.
Russia will create a new economic union with at least three other countries, starting with Iceland.
Stagflation is cause by over regulation (too much certainty) today's economic condition is caused by over deregulation, basically there is too much uncertainty or a lack of trust in market conditions, there isn't really name for it yet maybe nervflation or gagflation.
The cause seems more transparent the solution is tricky, yes regulation and in some cases drastic changes, a paradigm shift is in order, the impact may be painful.
Good luck to all. |
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Juregen
Joined: 30 May 2006
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Ya-ta Boy
Joined: 16 Jan 2003
Location: Established in 1994
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| Posted: Mon Oct 13, 2008 7:31 pm Post subject: |
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In Spring Quarter 1970, my Econ 101 prof said a recession was just a new word for depression since the word depression held such strongly negative connotations. Since then, it seems to be the word of choice for 'mild depression' in the media.
On the other hand, it was an 8am class and I wasn't particularly interested in it. I might have missed some of the nuances. |
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Adventurer
Joined: 28 Jan 2006
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| Posted: Mon Oct 13, 2008 7:38 pm Post subject: Re: There Is a Silver Lining |
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[quote="mises"]http://www.newsweek.com/id/163449/page/3
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What he is trying to stay is that recessions are good. It has been Fed policy for a long while now to try and prevent a recession at almost any cost via monetary "loosening". This has made things worse, created the mother of all bubbles and we will not see it pop. Best, just let the economy cycle. What is good will stay, and what isn't won't. |
Misses, couldn't you argue that a depression would be good as well since it would force a correction of the system, force people to change their spending habits, bring in people with different ideological persuasions into the government who are actually interested in a more stable, entrepreneurial order, that's not based on speculation, deficit financing, all things that Keynes opposed.
Yes, a recession caused by the speculators associated with investment banks and houses and others should, hopefully, lead us to some positive changes before it's too late. I do not have a credit card, and I hope I am wiser about debt than before, but in the U.S. the government treats debt by your regular people as bad, but they bail out Wall Street. It's harder for struggling people to declare bankruptcy, but these guys can knowingly enter into huge risk and receive a bail out, because they are too big to fail, and we are maybe too small to matter. I hope that changes, because we are actually too big to fail, and I hope people realize that. |
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mises
Joined: 05 Nov 2007
Location: retired
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| Posted: Tue Oct 14, 2008 8:28 am Post subject: Re: There Is a Silver Lining |
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| Adventurer wrote: |
Misses, couldn't you argue that a depression would be good as well since it would force a correction of the system, force people to change their spending habits, bring in people with different ideological persuasions into the government who are actually interested in a more stable, entrepreneurial order, that's not based on speculation, deficit financing, all things that Keynes opposed. |
It is all about proportion. Balance, etc. A depression is largely undefined anyways. |
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Jandar
Joined: 11 Jun 2008
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| Posted: Tue Oct 14, 2008 8:05 pm Post subject: |
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I always understood recession to mean a period of negative growth (GDP) in the economy, and depression to be negative growth for a prolonged period of time.
Now the term being bandied about seem to be a contraction, which I am understanding as something contrary to expansion, yet I see figures that say the expansion has slowed into the less than 1% area, has actual shrinkage occurred?
Also from what I recall of other recessions, one of the primary indicators was unemployment into the double digits, though we haven't seen this yet I am sure it's right around the corner. |
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KOREAN_MAN
Joined: 01 Oct 2006
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| Posted: Wed Oct 15, 2008 2:40 pm Post subject: |
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The author of the article sounds like a guy who's thinking that he will get back together with his girlfriend when she has already left him for good. Seriously though, he's being way too optimistic about the current situation. He's telling readers what they want to hear and ONLY what they want to hear. "No, those pants don't make your heiny look fat," he seems to be saying.
It's one thing to learn lessons and another to actually change things around. Currently, Americans are spending more than what they are earning; so to speak. (I'm talking about the trade deficit.) The difference is made up by getting loans or printing up money. But one day when there is no more "loans," what do you think is going to happen? World peace? 
Of course, there IS a solution to this mess. (Even though it probably is too late now.) Stop consuming so much, demand less, make less money, pay more taxes, stop devaluing the dollar, stop outsourcing, stop merging into gigantic corporations, actually regulate companies, and end political corruption and war. But, unfortunately, I'm probably being too optimistic here as well. |
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Kuros
Joined: 27 Apr 2004
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| Posted: Wed Oct 15, 2008 3:43 pm Post subject: |
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| KOREAN_MAN wrote: |
It's one thing to learn lessons and another to actually change things around. Currently, Americans are spending more than what they are earning; so to speak. (I'm talking about the trade deficit.) The difference is made up by getting loans or printing up money. But one day when there is no more "loans," what do you think is going to happen? World peace?
Of course, there IS a solution to this mess. (Even though it probably is too late now.) Stop consuming so much, demand less, make less money, pay more taxes, stop devaluing the dollar, stop outsourcing, stop merging into gigantic corporations, actually regulate companies, and end political corruption and war. But, unfortunately, I'm probably being too optimistic here as well. |
And when is the rest of the world going to account for its role?
Why is there a credit bubble? Partly because of the massive inflow from aging and miserly populations in Old Europe and Asia. It wasn't just the Baby Boomers who thought the housing bubbles were actually appreciable gains, so did everyone in the world who invested in them directly and indirectly.
When the Asian crisis hit, everyone blamed the Asian countries first, ignoring the role of the West in throwing so much money at Asia so quickly. Now the same thing is occurring. People are wagging their fingers at America as if they committed a moral failure. There was a surplus of old money in the hands of retirees and a deficiency of young people to put it to good use. Bubble!
Old countries. There's no free lunch. If you want to retire comfortably, have children. |
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blaseblasphemener
Joined: 01 Jun 2006
Location: There's a voice, keeps on calling me, down the road, that's where I'll always be
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| Posted: Wed Oct 15, 2008 3:53 pm Post subject: |
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| Ya-ta Boy wrote: |
In Spring Quarter 1970, my Econ 101 prof said a recession was just a new word for depression since the word depression held such strongly negative connotations. Since then, it seems to be the word of choice for 'mild depression' in the media.
On the other hand, it was an 8am class and I wasn't particularly interested in it. I might have missed some of the nuances. |
God you're old!  |
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