Friday, October 3, 2008

The Bailout - Foolishness Triumphs

Are you a first time visitor to the blog? If so, then you might want to visit here if you want to understand what is really going on in the world economy. If you doubt the credibility of blogs, you may want to read my (rather long) essay here, and hopefully this will help give the rest of what I write some credibility. Main post continues below.....

After many false starts (including on this blog) it looks like the bailout has finally passed. It took a considerable amount of 'pork barrel', but it has passed (does anyone know the origin of the expression 'pork barrel'?). The fact that it required the dishing out of pork barrel is, of itself, a telling condemnation of both the bailout, and a system that is built upon delusion.

I will not restate my arguments against the bailout, as I have covered this from many angles in previous posts (click here for one example, in this case the 'common sense' argument). However, I will just raise one point in the Telegraph article on the bailout:
'But Mr Bush cautioned that "it will take time before the legislation's full effect on the economy" was felt. Acknowledging public concerns about the sums of their money that will be spent, he expressed optimism that the "tax dollars we invest will be paid back".'
There is a simple answer to this optimism. Why, if these assets are undervalued, are the sovereign wealth funds and other sources of finance not snapping them up at their distressed valuations? They stand to make a killing if they are undervalued, and they have the necessary capital to buy them.

Now that the bailout is being enacted, what happens next? According to the FT (sorry no link) the initial reaction was further falls in US stocks, which goes against the script of what was supposed to happen. Not being within these markets it is is difficult to see how sentiment will move. However, if there is a rally in markets, it will be short lived. It is just a question of weeks, or a couple of months at most, before it becomes apparent that the magic wand of borrowing will not solve the underlying problems in the US and UK economies.

The New York Times, for example, reports that in the 9th month in a row there have been job losses in the US, with September seeing a loss of 159,000. In the same edition, a commentary points out to those who are enjoying the discomfort of bankers that the bankers will take the rest of the economy down with them. As usual, they are getting it the wrong way round, in thinking that the financial system is taking the economy down, when in fact it is the economy outside of finance that is causing the problems within finance (although they are both in mutual feedback systems).

As an interesting note, over the last couple of years, I have been reading several articles in the Economist pointing out that, in the US, many states are also in deep debt. In other words, it is not just the federal government that has been loading up on debt. I have just seen an article that reports that California may need to turn to the federal government for finance. If the Economist reports were correct, this is the first of many. As such, on top of servicing the federal deficit, bailing out the financial system, it is likely that there will be more call for federal aid to the States in the coming months. In one of my previous posts I linked to an article that suggested that the US government was insolvent. In the coming months I think that this idea will be tested.

Meanwhile in the UK, the John Lewis Partnership reported a dramatic fall in trading (a bell weather of middle class spending), there are reports of shrinkage in the service sector. I predicted an end to the service economy, and the result is going to be very ugly indeed, as it constitutes such a large part of the economy. Meanwhile the UK government has extended the deposit guarantee to £50,000, a rather pointless move as it is not enough to restore confidence whilst exposing the government to greater liabilities (regular readers will know that I do not support such guarantees in any case).

Around Europe, the crisis plods on with its own momentum, with the Icelandic boom turning to bust, more and more banks falling over, and so forth. I will not bother listing all of the bad news, and will just point out that it is just one problem after another emerging.

Regular readers will know that I do not just post rehashes of the latest news, so I should come to the point that I am trying to make here. Kecske has left a comment with a link to a very interesting article in the Guardian (thanks for the link, by the way). In my last post I discussed how the 'mainstream' of media, economists, bankers and politicians just do not 'get it', by which I mean understanding the fundamental change in the world economy. In the article it is very clear that China is calling the economic shots and, reading the subtext, it is clear that there is a sense of shock, as people are finally waking up to the shift in economic power.

In other words, the delusions are starting to evaporate. It is becoming very clear that China is winning the economic race. Whilst it is still not a wealthy country, it is racing to the top, and that it is a zero sum game - China is rising as the West falls. In the news I have posted above, I have given some examples from the news that illustrate several points.

The first is that the bailout is just a continuation of the delusion that the UK and US can continue to borrow their way out of economic reality. The other posts are just a series of illustrations that economic reality will have its way (sorry, I am giving an abstraction intentionality here, but you will know what I mean). The service economy is collapsing, and it will take with it large swathes of the US and UK economy with it. As just one example, it is likely that we will see the collapse of at least one of the major US car manufacturers. The US manufacturers have, even during the good times, been struggling for survival, and now that times are tough, they will be in real trouble. The first reports of serious drops in their sales have started.

I pick on the car industry for good reason. In particular I am thinking of Ford, as this is not just another company, but is symbolic of the past successes of the US economy. It might even be argued that Henry Ford invented the modern world of manufacturing. I highlight this, as the failure of a company like Ford will finally create the shock that will really snap the minds of people in the West into the reality of how bad the situation actually is. It is also an illustration of all that is wrong in the Western economies. Ford, and the other US car manufacturers, have been trying to survive with both hands tied behind their backs. I forget the actual figures, but the US car companies have to load into their cost structure something like $1300 (it may be more, I do not have the Economist article to hand) per car, to pay out on pensions, health care etc. There have been numerous negotiations with unions to try to deal with these problems, numerous compromises. However, the unions have never really accepted the severity of the competition that the companies were facing. In the back of their minds was the belief that the companies could not really fail, they were too big and had been there so long...

So it is with the belief about the US and UK economies. We can see the growing competition from places like China in the abstract, but we still insist on our generous welfare and benefits, and insist on loading costs onto our economy. We simply do not believe that we can fail. But we can.

As I look at the potential new leaders on both sides of the Atlantic, I do not see anyone who has yet given any indication that they have the courage to deal with the reality of the economic crisis. I do not hear from any of the politicians serious consideration of real reform, reform of the kind that is needed to return the economies of the US and UK back to competitiveness. All I see is more burying of heads in the sands of easy solutions, of borrowing more money when the answer is cutting back and repayment of the debt....in other words facing the reality that our infrastructures are like that of Ford, that they are bloated and will eventually destroy the source of wealth that we take for granted.

2 comments:

  1. Overall I am pleased and inspired to read such a deeply thought and maverick piece by the blogger.

    Like the blogger, I too am unschooled in economics. However, I would differ with him in his pessimism of the West and his deferrence of China to such a high degree.

    Firstly, I believe the bailout is a necessity simply because the patient, whose heart is what the US economy constitutes, is in real need of resuscitation. Whether the patient had prior to this gone on an irresponsible binge resulting in a heart attack is beside the point.

    Secondly, I have qualms about the blogger's assertion that the service economy is illusory because it is debt-fuelled. Are not the underpinnings of a capitalist economy both consumption and capital? Is not the boom of the industrial economy also underpinned by consumption and capital i.e. faciliated with debt from a functioning financial system?

    Thirdly, I am a believer of market regulation. Like nature, like human society and with many other situations, it is simply too dangerous to let forces reign in disorder. Market forces alone without an impartial regulator would eventually be dominated by greed, excesses and malevolent intent.

    Finally, China is indeed booming and it is indeed catching up. But its rigid, export-dependent, top-down controlled economy may not be resilient enough in the face of shifting markets, waning demands and an increasingly aware citizenry. In fact, it is West and the US in particular that has shown deftness in the ability to retool and adapt to such shifting sands.

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  2. 1. The disease might kill the patient but the cure is guaranteed to kill the patient. When the economy goes wrong people cry "Something must be done!" - and politicians scramble to answer them. The best thing to do is rarely the popular choice.

    2. The problem with the debt that we have burdened ourselves with is that it wasn't to purchase assets, it was wasted on liabilities like new cars and overpriced houses.

    3. I believe in free markets and when government starts to interfere in the markets, this is where we see problems develop. If interest rates hadn't been held artificially low for so long then people wouldn't have borrowed so recklessly, bank bonus structures would be directed towards quality rather than volume and we probably wouldn't be in this mess. This latest interference is driven by politics as always and is not the right way to solve the problem, but to tell the electorate that we need to cut back massively on public spending is not popular so we'll burden ourselves with more debt until there is no other option but to cut back or the currency fails.

    4. At least china can produce things and although demand is obviously going to drop after they stop lending people the money to buy them, there will still be demand from other parts of the world for their products. The US can adapt too but if this bailout (and the series of bailouts that will no doubt follow) destroy their currency through inflation then that becomes an awful lot harder to deal with than a deflationary depression.

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