Yesterday’s Follies

Nobody likes the guy who predicts calamity, especially when he turns out to be right. Beginning in 2004, I began to predict that the stock market was overvalued and was set up for a sizable fall. I said there was too much debt amongst consumers.

Most people I told this to either laughed at me or told me to “put my money where my mouth was.” That was rather hard to do as a guy just starting out, making a comfortable amount of money but not nearly enough to justify placing a bet by short selling an index.

There has been a lot of articles written about how the current economic environment came to pass, most of which were highly colored by the author’s political predilection. If you were a liberal you screamed about lack of governmental oversight, despite the fact that it was democrats who prevented the creation of new oversight organizations for Fannie and Freddie in the name of protecting “affordable mortgages.” If you were a conservative, you explained that the fundamentals were sound and we needed more tax cuts, although empirical evidence suggests that the tax cuts did not pay for themselves and conservatives failed to match those tax cuts with spending cuts as promised, exacerbating the debt level.

This current environment was born in the 1980s, after the last significant economic crisis, and was cultivated during the 90s during our economic apex. It is the curse of Gordon Gekko coming to settle accounts now. For far too long, both government and citizens have abandoned fiscal responsibility in exchange for shiny objects. So long as the economy kept rolling, no one wanted to look behind the curtain.

The current bailout is the bastard child of Keynsian economics, which allowed us our justification of deficit spending, and the Chicago School, which tells us the Fed is evil and government should get out of the way. The bailout in, its entirety, is meant to prevent another depression and uses the lessons we learned in the last. Keynes taught us that a government should deficit spend to protect jobs, so we are doing that. And Friedman taught us that the government’s influence during the depression contracted credit market which exacerbated it, so instead the government is acting to expand those markets. Combine that with talk of punitive measures as opposed to considering effective preventative regulations, and you have a typical heavy handed governmental instrument trying to regulate the economy.

So as a result, we have this abomination of a bailout. I cannot really blame the government for it, as the people’s demand for safety and desire for punishment of the perceived guilty is insatiable. As a republic, it is Congress’ job to give the people what they want. However, it is a Hail Mary pass in the dark. Who knows if it will work?

The crisis has been good for disabusing popular conceptions, at least if one pays attention. There is one notion in particular that people need to be disabused of: that the world economy, particularly China, has moved beyond the United States. While China has been talking a big game about “not helping out the US,” at least one fifth of their currency reserves are denominated in Fannie and Freddie Mac bonds. That was probably an oopsie on their part. All of Asia’s and Europe’s markets took a big hit and it appears that their own banks are facing large burdens, so Europe is beginning to push its own bailouts. In my own mind, it probably represents the first true, significant economic test for the Euro. We are already seeing the Euro drop precipitously against the dollar, and according to the geniuses on CNBC it should drop further. This is due to missteps by the European Central Bank which is exacerbating the crisis in the EU zone, and hurting Asia. As a result, despite the crisis in the US, it is the dollar that is becoming the global safe haven.

As a result of this high priced government intervention, the majority of the big ticket presidential campaign promises are probably not going to happen, at least not in the near future. No matter who is elected, look for stiff cuts in spending.

Now that I have provided the whiff of brimstone, here comes the glimpse of light.

We have learned from prior economic recessions and the Depression. One of the major issues that contributed to the Depression was run on the banks because people feared their money wouldn’t be available and currency concerns based on a fear of a sudden revaluing of the dollar in comparison to gold. By insuring deposits and decoupling the dollar from gold, the risk of a run has significantly decreased. Further, during the Depression the US and other nations closed off their trade to bolster national production. We now know that this does not work and will not make the same mistake twice. Granted this allows us to make a whole new range of mistakes, but you have to start from somewhere.

This is going to be harsh, but it is highly unlikely we are going to have soup lines on every corner and I don’t plan on practicing my sales pitch for pencils. While McCain’s “fundamentals” comment lacked sophistication and nuance, it was not entirely wrong. The same infrastructure and work force from the 1990s is still in place now, and in some respects it is even better. Our workforce and infrastructure will prevent us from toppling into a third world economy, as some have direly predicted.

While many believe that this crisis, combined with the Iraq War, and the American decline in influence (whatever the hell that means), represents the beginning of the fall of the United States, I do not believe that is necessarily the case. As noted in the Globe and Mail by Marcus Gee, this is hardly the worst of times for the United States. We have bounced back from worse. You think Iraq and the market is bad? Mainland China going communist was bad. Korea was bad. Vietnam was worse. Having run away inflation and unemployment at the same time was mind boggling.

That being said, it is not a sure thing. Absent significant steps to change the underlying issues that caused the problem, excessive debt on all level and poor regulation, we are just setting ourselves up for another comparable economic downturn in two decades. While a business cycle is a necessary evil, it can at least be mitigated to some extent by taking simple, common sense steps. If these issues are not addressed, all the bailouts in the world will not help.