Friday, November 28, 2008

How bad? How long?

Both of the points I’m making here seem pretty obvious but I haven’t seen anyone else make them quite the way I think of them so here goes. (Plus it’s possible that what seems obvious isn’t always. The Corner recently linked to an article by using the tag line “Bailout capitalism is crony capitalism”. While the article itself said more than just that, I would have thought the only possible reaction to The Corner line would be “Duh.”)

So how bad is the economic mess? It’s bad and I’m not going to try to argue otherwise. However, it strikes me that there are now an awful lot of people whose interests are best served by telling us loudly and often just how bad it is. The current administration wants to retain control of the $700 billion it’s already got plus get more; that won’t happen if things start to look up. The incoming administration knows that the worse things sound now the more credit they get for any turn-around that happens after January 20. State and local governments want money from the Federal government; the best way to get it is to point out just how much trouble they’re in. And as for corporations, how much bailout money do you think the financial system or CitiGroup or the automakers would get if they said, “Sure, things are tough. But we’ll cut back a little here, layoff a little there, slash some executive salaries, and we’ll be able to hang in there until things improve?” Not too much. And if painting the bleakest possible picture of their own financial woes doesn’t bring forth that money, they can always up the ante by reminding everyone that if they go down they take the rest of the economy with them.

I’m not claiming that things are rosy. I’m just pointing out that when the time comes to talk about the state of the economy it’s hard to find anyone who would benefit from passing along whatever good news or rays of hope actually exist. And it’s equally hard to find anyone who would benefit by making realistic claims about their impact on the rest of the economy. So while things are undoubtedly bad they may not be quite as bad as everyone is saying.

How long will the economic mess last? Actually, there are two aspects of the economic mess and we have to consider them separately. The first aspect is the crisis we’re in now where things are going from bad to worse. Unfortunately, I believe this part will get worse yet after the first of the year. Right now consumers are still spending money they really shouldn’t be for Thanksgiving and beyond that for Christmas and Hanukkah. They are unwilling to forego (or have already committed to) travel, food, liquor, gifts, and decorating for the holidays and they’re dipping into savings or loading up their credit cards to buy those items. Once the holidays are over, though, consumers will start cutting back and the crisis will deepen.

Nonetheless, I’m hopeful that this really terrible aspect of the economic mess will begin to subside by the end of 2009. This hope of mine is partly based on a general feeling about what I’m reading. It’s also partly based on politics. By the end of 2009, the new administration will have been in power for almost a year by which time they will “own” the economic mess. It will thus be in their interest to stop harping on how terrible things are and start talking about signs of improvement. Take, for example, the recent AP article titled “4 new reports reveal battered economy” which begins:

Jobless claims remain at recessionary levels, Americans cut back on their spending by the largest amount since the 2001 terrorist attacks, orders to U.S. factories plummeted and new-home sales fell to the lowest level in nearly 18 years.

That sounds terrible but if you drill down into the article you’ll find that the beginning could just as easily have been:

Initial and continuing unemployment claims fell; consumer spending is still not as bad as it was after 9/11; housing is becoming affordable again; and the Dow Jones is rising.

I expect that by late 2009 we’ll see more stories that look like the latter than the former. Even if much of the media isn’t still honeymooning with the new administration, Barack Obama as President will have a powerful bully pulpit to promulgate his views on a recovery. Since it’s pretty clear that Obama’s rhetorical gifts are such that he would be able to sell flame-throwers in Hell and since at least some of the economic misery is psychological, having him push the idea that the economy is on the road to recovery will help lead it there. And, of course, there’s always the possibility that his economic team will be able to effect real improvement.

Unfortunately, the second aspect of the economic mess will not show signs of improvement any time soon. A draggy economy, a slow-growing economy, an economy in the doldrums is going to be with us for quite a while. Why? Simple. Everyone is in debt: individuals, companies, local governments, state governments, and the Federal government.

When you’re in debt what you’ve really done is spend money you expect to get in the future. Let’s say you make $50,000 a year and you’ve got $25,000 in debt between credit cards and your car. Every year you pay off about $5,000 of that debt but you add a new $5,000. You’re constantly in the position of having spent five years worth of money you don’t have yet. That’s workable as long as everyone is willing to stay in debt. This year’s economic growth (aka, spending) is being fueled by money we all expect to get five years from now; next year’s economic growth will be fueled by money we all expect to get five years from then; and so on.

The problem arises when we’re no longer able or no longer willing to stay in debt. I’m pretty sure we’re at the point where many people are no longer able to stay in debt and I sincerely hope we’re at the point where hardly anyone is willing to stay in debt. I believe that’s good in the long run since we’ll start living within our means and probably even start saving for a rainy day. In the short run, though, it’s bad because it means we all have to get caught up with ourselves. That is we have to spend some number of years paying off all the debt we’re currently saddled with before we can start doing a significant amount of discretionary spending. That means that consumer spending is going to go way, way down. I say “way, way” because this is a double whammy: not only are we not going to be living beyond our means anymore by running up debt, we’re actually going to be living below our means to pay off existing debt.

How long will this second, “economic doldrums” aspect last? I don’t know. It depends on what the country’s total debt load is, how much income continues to come in, and how substantially people and institutions can cut back so as to devote more money to retiring debt. If I had to make a pure wild guess, I’d say five years. Five years for us all to dig out of the hole we’ve gotten ourselves into.

There are, however, two ways the economic doldrums period could be interrupted. First, the Federal government can simply pump more and more and more money into everyone’s hands: individuals, companies, state and local government. This would enable everyone to pay off their existing debt and thus avoid the period when people live below their means. In fact, by removing the pain of having to pay off that debt there’s a good chance this course of action would encourage people to go right back to living beyond their means. Of course, this would simply transfer the entire debt load to the Federal government and eventually there would be a day of reckoning either through runaway inflation or simply because the government would be so overburdened by debt it would eventually be unable to finance even its most crucial functions.

The other possible interruption of the economic doldrums period is a new economic bubble. I’m not sure how possible this is since a bubble apparently requires the ability to take on lots and lots of debt. However, the government has pumped a lot of money into financial institutions and that money may be ripe for bubbling. One excellent candidate for a bubble is carbon trading.

It’s pretty clear that the Obama administration wants to address Apocalyptic Anthropogenic Global Warming. Leaving aside what I think of the basic idea of AAGW (not much), we have to decide how to address it. If the country is stupid enough to go with a cap-and-trade system rather than a simple carbon tax, the bubble won’t even need the money already pumped into the financial system: it can form itself solely from all the new government “money” handed out in the form of carbon allowances. (I find it hard to believe the government is going to auction those off given the sad financial state of most corporations; it’s more likely they’ll be given away.) The markets can go crazy bidding them up - heck, someone will probably even create derivatives - and we’ll have another bubble.

Like massive Federal handouts, though, a bubble is a bad idea in the long run. By definition, a bubble creates imaginary profits and fake productivity. That means there’s always a day of reckoning. Do we really want to concentrate our hopes and our efforts on pushing that day off on our children and grandchildren? We created this mess. I think we should take the hit involved in cleaning it up.

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