November 21, 2024

Is The Economic Panic Justified?

Act In Haste, you know the rest…

How many of us have had a make a fast decision when panicked or stressed?   How many times have we heard, “I wish I had thought things out a little more before acting”?

Are we now about to make a poor and panicked decision as a nation?  I am extremely dubious of anyone who tells me that I must act on an imminent catastrophe and that I must do it quick, no questions asked, no thinking allowed.   I chose not to live with the consequences of such an ill conceived process.

We can agree that the economy is contracting.  The value question is what, if anything, should we do about it?    The corrective forces of a free market economy are not pleasant but they are necessary. The creative destruction of a recession wrings out the excesses that caused the bust and lays the groundwork for future sustained growth.    Poorly run and unprofitable companies die.   Capital is redirected to new healthy enterprises rather than being used to subsidize zombie operations.   Attempts to stop these self correcting economic mechanisms of capitalism are self defeating.

Two articles worth the read that consider these points are linked below.

Overact, Overthink

The Obama Administration is overthinking the current recession because, in a panic, its economic team sees no light at the end of the recessionary tunnel. This is despite the fact automatic stabilizers such as falling energy prices, falling home prices, falling interest rates, and diminished wage pressures are already beginning to reinvigorate the economy. Accordingly, the Journal’s editorial is correct that the Obama fiscal stimulus package is way overdone. The only fiscal stimuli that should be considered are ones that can get right into the pipeline through the rest of 2009 and ones that stabilize the housing market.

This observation leads naturally to the concern that the Obama administration is likewise overreacting to the credit crisis. This crisis does not require massive loan guarantees, big bad banks, or, the deity help us all, nationalization. Instead, the crisis really requires only one solution: Reducing the rate of home foreclosures. Most of the toxic assets on bank balance sheets represent mortgages gone — or going — bad. Focusing singularly on stability in the housing market would go a long way towards restoring these balance sheets and opening back up the credit spigot urgently needed by American business.

Accordingly, it will be exceedingly interesting as to how the bond market reacts first to the fiscal stimulus and then to the Big Bang solution to the credit crisis scheduled to come out this week from the Obama administration. At the long bond dives in price and goes up in yields, that’s a big bet that the Big Bang will be highly inflationary.

The End of Wealth Creation

The Roman Empire

The rise and fall of the Roman Empire is a classic example of Return On Investment (ROI). Rome essentially funded conquest through pillage, bringing rich treasures of gold and silver back to Rome. During the early years of the Empire, the ROI on conquest was very good and Rome prospered. It had plenty of coin to fund its Legions. As the years went by, however, it became more difficult to find lands worth conquering and the travel costs to send a Legion to remote lands increased. The ROI of conquest began to falter, and Roman Emperors finally concluded additional conquests were not worth the cost. Years of wealth creation came to an end. The Roman Empire shifted its attention to wealth preservation.

The Deterioration Of GDP

The American economy has an embedded structural problem. Our economic focus has shifted to the preservation of wealth. This is not a prediction of the future. It is already happening. The following chart shows the annual change in Current Dollar Gross Domestic Product (GDP) from 1968 – 2008. Note that current dollar GDP seldom exceeds 2% after Q2 of 1984. For the last 20 years, the average has been just over 1.2%.

This is why I am furious at the intellectually challenged thinking that has gone into the proposed “stimulus” bill. It does much to transfer wealth. It does a woefully inadequate job of providing the opportunity to create substantial new wealth.

Our government is currently trying to artificially elevate American Real Estate values and sustain economic activity by spending several trillion $$ of taxpayer money on “bail-outs” and “stimulus” packages. Although money flow will surge for a time, these efforts will ultimately fail because they do not address the fundamental underlying problem – we have slipped into preservation mode. If we want these programs to be successful, they have to either create wealth, or facilitate the creation of wealth. (Reference 2)