I don’t usually read and tell, but I am going to make an exception today. I am going to write about what is wrong with Roger Lowenstein’s premature eulogy of U.S. investment banking, which is appropriately titled The End of Wall Street.
As a piece of journalism, The End of Wall Street is a triumph. This book will be among the few that will be forever referenced by historians logging what has transpired in our economy and our society over these last several years. Believe me when I tell you that I have read too many books about the financial crisis; and after reading all of those, I believe that this one is the best piece of financial journalism among the lot. Well done Mr. Lowenstein.
Unfortunately, as high as it soars in this regard, it sinks just as low as an editorial piece. Throughout the book, you sense that it is coming. There are bits of scolding, judging, admonishing and sermonizing that peek through the story from time to time. You sense the journalist/author has something he wants to get off his chest, and you sense that you’re not going to be dismissed from school without first getting a lecture. I don’t want to ruin the suspense for you if you are planning on reading the book, but the lecture begins on page 273, browbeating the reader until parole arrives after page 298. The balance of the book is darned good, so maybe it’s worth sitting through the sermon. I would liken the whole experience to be something akin to reading In Cold Blood with an extra chapter tacked-on in which Truman Capote lectures the reader about society’s role in driving Perry to kill the Clutters. I think Truman was wise to have ended it where he did.
Nonetheless, it’s not as if I haven’t received this lecture before. Heck, I worked for Citi; maybe I deserve it. I just think it demeans the accomplishment of the book. And more importantly, I think the lecture is plain wrong…and it all comes down to page 288.
Mr. Lowenstein commits his cardinal sin when he writes, “That investors could be so blind refuted the strange ideology that markets were somehow perfect (“strange” because the boast of perfection is never alleged with respect to other human institutions).
Roger, the market is perfect; it is information that is imperfect. More to the point, the market is not a “human institution.” The market is our social environment, akin in every way to our physical environment. That lemmings run off of cliffs is not an indictment on topography in the same way that people investing in subprime mortgages is not an indictment on the econosphere. We may inhabit our market economy, but it is as natural an “institution” as is the biosphere that we inhabit. We are compelled to produce, consume and trade with one another because it is our instinct to do so. By labeling the market as a “human institution” and thereafter comparing it to our political process, you are suggesting that we created the market in the same way that we created Congress or the Presidency. We did not invent the market any more than we invented gravity, oxygen or the moon. The fact that we need to trade is a fact thrust upon us by the finite nature of our resources, skills and our very lifespan. We are compelled to make the best of these resources and we are guided by the market in the distribution of these resources. That we have booms and busts is evidence that we do not have all the answers, but says nothing of the ability of the market, nor does it suggest that the market is an imperfect creation of our own. If I drown, is it the fault of the tide? Can we regulate the tide such that it never rises above our heads? And if we could, should we?
I’m sorry you didn’t care for the recession Roger, I didn’t like it either, but the answer is not to fix nature; the answer is to understand nature. We need to improve information, not improve the market. Never should anyone think that they are clever enough to improve upon nature. Even if one is smart enough to write 270 pages of great journalism, one should not assume that he can or should remake the world to his tastes in a 30 page lecture.
Shhh....Larry's Sleeping
Did you ever feel sort of numb? I don’t mean physically numb, but rather mentally, emotionally and/or psychologically numb. Did you ever feel that sort of way? I kinda do.
Part of it is that the world seems to be moving in slow motion right now. I do believe that we are on the edge of a much more convincing economic recovery than we have experienced thus far, but it is a little late, and we are all mostly underwhelmed. We are just sort of waiting and preparing for it. It feels like all of the U.S. is at a bus stop. We anticipate that the bus will come, and deep down we’re really not all that worried. But, the bus is a little late and we’re just kind of standing at the bus stop, staring at each other, and otherwise occasionally looking down the road to see if the bus is coming yet.
We are waiting. People are waiting for an absolute bottom in the housing market, the return of jobs, for commercial properties to start trading again, for the next major consumer trend to begin, etc… Not that there isn’t a ton of prep to be done and strategies to be formed in the meantime, but all that work behind the scenes doesn’t make for a very exciting news day, nor does it necessarily make the phones ring. It kind of feels like late-June and the beginning of a meandering summer, but it’s only late-March!
The malaise has even robbed me of the desire to remark on the one place in the economy where there has been some action of late: Washington. How could there have been a massive healthcare bill passed, and yet I can’t seem to find the enthusiasm to remark on it? I think that it may not just be the slow current economy; the new programs themselves are designed to invoke malaise. They phase in so slowly that it will be a slow drip of change. Moreover, let’s face it; none of it has much to do with me, that is, until it’s time to pay the higher taxes. It wasn’t written to make my life better. It was written to make someone else’s life better. So, while I am happy for them, there isn’t much under the tree for me to open.
What can we say? Well, it is a very large new program designed to transfer some wealth from one cohort to another, and also a program that is designed to take some of the burdens of life off of every individual’s shoulders and onto the government’s shoulders. Health care is now supposed to be one less thing to worry about….kind of like retirement savings and Social Security. The new bill actually communicates the message to “go ahead and be a little numb,” we’ll take care of things if you get really sick. So I guess that’s nice. But I do wonder. Is it good for all of us to feel numb?
To examine that question, let’s look at Social Security. It is said that Social Security is the most popular Federal program ever, and I am apt to believe that. I think it is popular because it has retained its “you take out what you put in” aura—even if it is quite imperfect in that regard. People don’t see it as welfare or a redistribution program, so people generally do not begrudge paying into it. If I were to have to guess about the program’s future, I would guess that it is slated to eventually lose that aura entirely as the burden of the payroll tax becomes more progressive and benefits are eventually scaled back for the wealthy, but for the time being, people seem to like it, and maybe people will like the new healthcare laws, as well (though the healthcare’s redistributive qualities are much more apparent right from the onset).
But I do wonder what would it be like if there was no Social Security? For my household, I would prefer that Social Security didn’t exist. I would like to believe that I could do a better job investing those funds than does the government. Thus, I’d just as soon keep that cash with me. As for others who, perhaps, would rather not have the burden of personally saving fully for their retirement, Social Security is probably a great program. Certainly, Social Security has likely prevented extreme poverty among many thousands of elderly who might have saved too little or invested poorly—the likes of which is what prompted the creation of the program to begin with. So all things held equal, I guess we can see the program’s merit.
But things are never held equal! And I can’t help but think how the world might look if people were able to control more of the wealth that they create. How would the world look if we all had our payroll taxes back? Would there be more money available for college tuition? Yes there would. Would there be more investment capital? You betcha. Would banks be better capitalized and better able to lend freely? Yes. And once all that excess capital, free to find its highest use, finds all these now highly educated people, would the world be better off and more productive? Yes, it probably would be. The new wealth created could make the likelihood of poverty among the elderly far less likely. We could be robbing ourselves of a more productive, more dynamic economy by outsourcing our saving and investing to the government.
Still, with the government taking care of retirement and healthcare decisions, and maybe with new policies to protect consumers and homeowners, and who knows what else is in the pipeline, pretty soon we won’t have to worry about nearly as much as we used to. Sure, the economy may remain slow like it is currently, but we might be reasonably comfortable standing at that bus stop, waiting for the bus, or waiting for the mailman with our benefits check, and we’ll have time to stare blankly at each other and, well, be sort of quiet and subdued and mentally, emotionally and/or psychologically numb. It sounds kind of nice, sort of like being sedated. In fact, I already feel a little sleepy, and unengaged, and generally….zzzzzzzzzzzzzzz…..wake me when my check arrives…..zzzzzzzzzzzzzzz….
I despise the phrase “too big to fail.” There are people all over the world who are constantly looking for the thing that is going to end life on this earth. Global warming, nuclear weapons, pesticides, rap music, you name it, there is someone out there who thinks that something or other is going to end life as we know it. Well, I am one of those people and I hate to break it to the anti-nuke crowd, but far scarier than a dirty bomb are those four dreaded words, “too big to fail.”
They’re just four words (we can even shorten them to something cool looking like 2B2F). Someone probably just said them off the top of his or her head one day. So easy to say, but once they were said and once someone put some TARP muscle behind it, it changed everything. Four words threaten the one thing that allows us to prosper, our meritocracy.
Really, this issue isn’t new. We lived with this for years with Fannie Mae and Freddie Mac. Fannie and Freddie were set free, sort of, by Congress to live as private firms. The problem was that no one ever believed that they were really on their own. Despite their functioning as private sector mortgage servicers, the markets believed that their debt was backed by the federal government. This implied backing meant that their money was cheaper than any of their competitors’ money, which is really the key to understanding the problem at hand.
In the world of finance, there are only two ways to make above-average profits. The first way is to have smarter money; the second is to have cheaper money. Very few people have smart money (and Lord knows that Freddie’s and Fannie’s money wasn’t all that bright), but you only need one of the two, and they had cheap money. Cheap bottomless money meant that Freddie and Fannie could grab market share at will, and they did. Not only was that not fair to the competition, but it was an accident waiting to happen as their portfolios got larger and riskier (riskier not only because of scope and hubris, but also at the prodding of policymakers).
I was actually at a meeting in Washington DC years ago when the Treasury came to address the group and brought TV cameras with them. Representatives from Fannie were in attendance, and the Treasury (I think it was the Assistant Treasury Secretary) gave a very angry speech for the cameras admonishing Fannie and swearing that the U.S. would not back its debt.
Well, no one believed him for one second, and history has proven the doubters correct. When the sh*t hit the fan, the Treasury was on speed-dial and both Fannie and Freddie were taken back into the government fold. Not only did Freddie’s and Fannie’s implied government backing unfairly steal business from honest competitors for years, but it encouraged the kind of risk taking, concentration of assets and distortion of incentives that helped lead us into recession.
Keep in mind, Freddie and Fannie were not made in a day. These were serious entities that formed over the years and were the product of a good deal of legislation, monitoring and debate. They were a train wreck, but they were a slow moving train wreck. Flash forward to today; 2B2F has created a fast-track to Freddie and Fannie infamy. With just the utterance of a phrase, “too big to fail,” we have created how many new Freddies and Fannies? Who knows? In an instance, Citi is now a GSE (government sponsored enterprise). Bank of America is a GSE. GMAC is a GSE. GM is a GSE. Is Exxon a GSE? Is GE a GSE? Is Kraft a GSE? Are all the S&P500 companies now GSEs?
If something is too big to fail (and let me go on the record as stating that nothing is ever too big to fail), will its money be cheaper? Who will they be working for, their shareholders or their government backers? Do we break them up? Well where does the government find the authority to take something owned by shareholders and destroy it? What a mess…and all because of just a few uttered words.
And yes, I know that the Treasury has gone on the record saying that there is no such thing as too big to fail. But why should we believe them? No one at that meeting in DC years ago believed the Treasury was going to back away from Fannie, even as they broadcast their anger over the networks. So, why would anyone believe them now? The answer is that they won’t.
With just a few words, we’ve created 500 Freddie Macs. The horror.
This all kind of reminds me of another phrase that just about brought our meritocracy to its knees: “highly confident.” It was 1985, I believe, when Drexel Burnham Lambert sent out their first “highly confident” letter. At the time, Drexel’s Michael Milken just about owned the junk bond market. He created it, and he controlled it. As a result, Drexel’s money was the cheapest on the street, and no one doubted their ability to raise money in support of any hostile takeover. So unquestioned was their access to capital that at some point, they realized that they didn’t even have to raise any money at all; they would just send a letter to the quarry stating that they were “highly confident” that they could raise the money on behalf of their client to finance a takeover. Just the receipt of that letter would force the prey into the arms of their pursuer.
I never thought I would ever see another phrase as powerful and destructive as “highly confident.” Well, we have one right now that puts “highly confident” to shame. “Too big to fail” is the new “highly confident” and the U.S. Treasury is the new Michael Milken. They put Milken in jail and Drexel out of business. But what are we going to do with 2B2F? I don’t know.
Well-reasoned talk of why the euro should never have been is all the rage now that Greece has vividly illustrated the drawbacks to imperfect, ill-conceived currency areas. Even Paul Krugman is on the right track on this issue: http://nyti.ms/aeZfza! Dr. Krugman points out that there were many voices that questioned the wisdom of having Europe’s very dissimilar economies all fit into a one-size-fits-all currency. I’d like to think that I was one of them.
All of this reminds me of a very idealistic column that I wrote for the Dismal Scientist way back in 2002. The piece was inspired by the roll-out of the euro, but I expanded it to this side of the ocean, examining my lingering discomfort with the U.S. dollar. At the time, the dollar was trading sky-high due to the “flight to quality” following the Russian default, Asian currency crisis and eventual high-tech bust. The dollar’s value did wonders for the bi-coastal economy, and killed the manufacturing heartland. This result was because even the U.S., after all these years, continues to be an imperfect currency area.
I’m posting that old column here now partly because I think the euro’s woes make it particularly relevent, but mainly because it reminds me just how idealistic, and probably naive, I used to be (and how much I wish I still was).
I should also warn any “gold bugs” that may be reading this; you may not want to read any further, I doubt you’re going to like this idea one bit.
The U.S. Dollar Needs to Go
March 1, 2002
Nations around the globe are running for the safety of iconic, widely traded currencies. The U.S. dollar’s strength and popularity is held up as a model for all other currencies. The recent circulation of the euro is seen as the dawn of a new economic era in Europe. It is an ironic twist, however, that these currencies are rising in their use and prestige just as the global economy would be better off without them.
Talk of discarding economic deities such as the U.S. dollar or the newly minted euro is tantamount to blasphemy. Such statements fly in the face of commonly held doctrine, and frankly, my own esteemed colleagues have been more amused than impressed with this economic argument thus far. One must approach this with open eyes though, as speaking badly of the U.S. dollar to an economist is much the same as telling a child that there is no Santa Claus, and there is certainly apt to be a period of denial. Nevertheless, given the current economic situation, it is important to talk about this issue right now, and I hope to demonstrate why that is.
Let’s start with the recent adoption of the euro (we’ll assail the dollar later on). The euro is hailed as helping to eliminate transaction costs, improve capital mobility, enhance the liquidity of the European monetary base, and strengthen monetary policy. Without going too deeply into all of the flaws of the above assumptions, let’s go directly to the key setback: that euro countries will necessarily be worse off now that they have jettisoned the responsiveness of their own currencies while losing the ability to conduct unilateral monetary policy. The euro now reflects the overall economic health of the euro zone. As such, it is not particularly sensitive to regional economic variations.
From a purely practical standpoint, what will be the benefit of the euro if say Germany’s economy is floundering in a manufacturing recession, while other euro-zone nations are faring better due to their differing industrial structure? This scenario is, of course, not far-fetched, because it is taking place as I write this. Germany’s currency can no longer devalue against its major European trading partners, as they all use the euro. Also, Germany can no longer engage in unilateral expansionary monetary policy. As such, Germany is stuck; its hands are tied.
The current economic situation in the euro zone is mild enough, and the euro is new and exciting enough, that the situation has not become so critical as to threaten the euro itself. However, one has to wonder if the euro zone can hold together in a case where there are more extreme regional economic disparities. We may be dusting off the ol’ German mark before we know it.
Many here and in Europe hold up the U.S. dollar and its benefits to the U.S. as a glowing example of what a strong, widely circulated currency can achieve. “Look at how the U.S. economy benefits. Europe will enjoy these same benefits from a strong unified currency,” you can hear them saying. Well, let’s look closer at just how the U.S. benefits.
Several manufacturing dependent states in this country are being absolutely devastated by a long-running manufacturing recession. At the same time, other states with industrial structures heavy in services and finance have held up rather well. Moreover, the dollar’s value has remained sky high as a result of the U.S.’s good fiscal situation and its favorable debt markets.
Certainly, the strong dollar benefits the nation overall. However, and here’s the important consideration, wouldn’t the badly suffering manufacturing based states have fared better in the current climate had they been trading in a currency that was allowed to depreciate relative to other domestic and international regions? What if Michigan had its own free-floating currency, for instance? Would it not have already devalued relative to other currencies in such a way as to better reflect the state of its manufacturing industries? Wouldn’t that have helped shorten its recession? The answer is a very defendable and resounding “yes.”
Please don’t fall out of your chair when you read this, but it is time to consider the potential benefits of breaking up the U.S.’s monetary union–not break up the country, just its use of one federal currency. It makes perfect economic sense to pursue a system of 50 independent state currencies. Do you like those collectible state quarters? Well, now it’s time to do it for real!
The benefits of a system of 50 individual state currencies could potentially be immense, and certainly help shorten the ill-effects of the business cycle, as it would allow prices to adjust much more quickly than they currently are able. The dollar certainly had its day while the nation was developing. Now, however, all U.S. state economies are large and diverse enough to support a liquid, frequently traded currency, to be managed in a way that best benefits each state’s economy. Also, let’s not pretend that Washington has a monopoly on the intellectual capital needed to run a currency. I’m willing to bet that we can scare up 50 Greenspans that would jump at the chance (I call Pennsylvania).
So why would 50 individual state currencies be better? Fifty currencies would work better because there are structural inefficiencies in our market prices that a floating exchange rate could overcome. Prices are sticky, and this stickiness unnecessarily creates competitive problems in business cycles that in turn prolong the economic pain. Manufacturing salaries are sticky; contracts are sticky; rents are sticky.
Midwestern manufacturing economies are at a disadvantage right now because the U.S. dollar is strong, and their price structure is not quickly responsive to declining demand. If each state had a free-floating currency, the declining exchange value would reflect declining demand for that state’s production and allow prices to adjust more quickly by instantly depreciating wages and product prices relative to other regional currencies. It is this greater price flexibility that allows the system to work more efficiently than the current one-currency system.
So, how would U.S. households guard against exchange rate risk, as their savings would be vulnerable to volatility? U.S. households would not necessarily hold their savings in individual state currencies, unless they chose to speculatively do so. Households would put their savings in managed or indexed currency funds. Just as we have greatly benefited from the creation of widely accessible stock funds and bond funds, a currency fund industry would quickly develop to help households balance their risk, as they would hold their wealth in shares of diversified currency funds (and as a side benefit, a new financial niche with immense potential would also be born). For the household, it would be no more complicated than putting money in the bank or a broker account, and there would be the benefit of a more flexible, productive economy that would, in turn, allow for greater wealth accumulation.
So what’s going to keep states from spending their money like it’s water and blowing up their currency? Well, it would not be in a state’s interest to spend and borrow frivolously. Nowhere in the world is capital and labor more mobile than within the U.S. If states do not want their businesses and residents to vote with their feet and leave for a more fiscally responsible state, then they will need to manage their books with great transparency and actively practice restraint. Also, most states are very used to balancing their budgets; it’s the federal government that usually struggles with staying within its means. And sure, the federal government can play IMF on the occasion that a state may run into problems (just as long as it doesn’t do it too often and risk moral hazard).
Well what about the higher transaction costs? Well, thankfully, technology and competition are already taking care of that for us. The move to individual state currencies will only accelerate the movement away from hard currency. Electronic transactions will take on an instantly greater role in household and corporate transactions. As such, currency exchanges will take place without much thought or effort on the part of the purchaser or vendor. Frankly, if we can trade stocks electronically on the Nasdaq, and trade power across a national grid, I’m willing to bet that we can handle 50 domestic currencies. Also, remember those new managed currency fund firms that were mentioned above? I’m sure they’ll be very willing to put some effort into speeding these transactions along smoothly; after all, they’ll be fighting for marketshare. Also, between you and me, currency “transaction costs” are more urban legend than powerful economic force, at least they will be in this century.
So what about all the other details? The other details will work themselves out. The devil is never in the details. Do you know where the devil actually is? The devil is there keeping us from questioning what is considered to be accepted logic, no matter how backward it may be. From the very beginning, the euro failed to pass theoretical muster because it was intended to make already rigid economies more rigid, all for the sake of lowering transaction costs. Along those same lines, if we are to question the merit of the euro, we must also look at the U.S. dollar and the impact that it is having at this very moment in prolonging a manufacturing-led recession in almost a third of the states.
The U.S. dollar should be allowed to give way to 50 independent state currencies, and frankly, once we get that system worked out, we may want to think about a New York City dollar, a Los Angeles dollar, a Chicago dollar, etc., etc.
The Econosphere is all about individuals spending their key raw material, their lifespan and all the potential, skill and energy within, to maximize their utility (aka. their happiness). This is what life is all about. This week, I was interested to see two of the most notable achievers of their generation, Steve Jobs and Bill Gates, maximizing their utility in very different ways. It got me thinking about individual preferences and how they differ, and also about information limitations. I can’t help but wonder if there is a growing information gap between these two men.
Steve Jobs, of course, revealed the much anticipated iPad. Apple is one of those companies that really intrigue me. It is incredibly rare that a firm, which is nothing but a fortuitous meeting of human and financial capital that combines in such a way as to produce a good or service that helps its clients maximize their own utility, can sustain such an incredibly innovative streak. I remember many years ago when Steve Jobs was quoted as dismissing companies, such as Microsoft, that failed to develop “culture.” He hit the nail right on the head. Somehow, he is able to cultivate a culture that allows his workers to collaborate across decades on a diverse array of products that seem to sustain and grow a community of customers whose lives are made better with every new innovation. It’s an extraordinary achievement and very rare.
So, this week came the iPad. I’m not a technology pioneer, so I can’t really say what its potential is. I don’t really care for video games, read books the old fashioned way, and the laptop that I am typing on right now has to be at least seven years old. So what do I know? I did, however, sense a little fatigue with this device. It’s hip, pretty, cool and was delivered with the snarky swagger that has served Apple’s marketing efforts well these last several years. However, it also looked like a really big iPod touch, and our society seems to only be impressed when our gadgets get smaller, not bigger. But who knows? Maybe I will be carrying one around in a few years and find it indispensible.
Contributing to that feeling of Apple fatigue that I alluded to earlier was, I think, the coincidence of Bill Gates’ appearance at Davos. Last week, Bill Gates announced that his foundation was going to donate $10 billion over the next decade for research on new vaccines for the world’s poorest countries. If that doesn’t make the iPad seem trite, than I don’t know what would. Steve Jobs announced a new gadget for the world’s richest people, and Bill Gates announced that he intends to save the lives of two million of the world’s poorest children. Instead of a commercial starting with “Hi, I’m a Mac. And I’m a PC.” One can imagine a commercial beginning with, “Hi, I’m a waste of disposable income. And I care deeply about the suffering of those who are less fortunate than I.”
Now, I realize that my little commercial parity is a bit simplistic. While each of us are equally utility maximizers, each of our utilities are maximized in different ways. Typically, utility maximizing is some combination of work and play, but that is where the similarities end. Steve Jobs and Bill Gates are among the worlds richest, so they’re a lot less concerned with paying the mortgage, but nevertheless, they’re still people, and they go through the same personal calculations as do we. Obviously, Bill Gates’ is deriving significant pleasure from turning his fortune toward contributing to the world’s greatest humanitarian causes, and Steve Jobs is turned-on by creating the most innovative consumer technology that the world has ever seen. The world is definitely better off with both of these guys in it; otherwise, we wouldn’t have handed over so much of our hard-earned cash to Apple and Microsoft over the years.
Still, if I may share my opinion, after so many years of Steve Jobs seemingly having Bill Gates’ number when it came to culture and innovation, I wonder if Bill hasn’t emerged as the one with the better information at his disposal. Steve Jobs is famous for telling John Scully “come with me and change the world.” Decades later, who’s changing the world now?
If Bill Gates succeeds in creating a healthier third world, those healthier people will be able to increase their productivity and create additional value that will lift their nations from poverty. Moreover, healthy productive people do not dedicate themselves to causes such as terrorism. They are more apt to see that their best path is a peaceful and productive one. Meanwhile, if Steve Jobs sells a whole lot of iPads, we will have one more way to look at the Internet and send e-mail, but I don’t think the world necessarily changes for the better.
Each man is doing great things, but from where I’m sitting today, it would seem that one man has regained his stride and may well “change the world” once more. The other, I’m afraid, is failing to take his own advice and “think different.”
Ugh. Our collective national discourse actually seemed to get a bit coarser and certainly less thoughtful after Scott Brown won Ed Kennedy’s old seat in the U.S. Senate. Apparently the shocking election result was not a “teachable moment.”
Thankfully, politics is not always important to our economy. In fact, quite often, it’s a lot of saber-rattling and name-calling that adds up to pretty much nothing, and we can go about our lives unimpeded. However, sometimes politics does matter to the economy and to our personal lives. The government is, after all, one of the biggest consumers in our economy, not to mention the rule-maker, and thus can make big waves when it wishes. In my book, The Econosphere, I compared the government to Nelson of The Simpsons. Not necessarily a bad guy, but big, and when Nelson sets his sights on a nerd’s milk money, that nerd better take heed. Well, today, we “everyday Americans” are that nerd.
I’m not a pollster or a pundit, but if I may go out on a limb and state my opinion, I believe that Scott Brown was elected because the electorate in Massachusetts was alarmed at the big hairy mess that is health care “reform.” Whatever good is left in that bill, it seems to now be outweighed by the bad. After all, if it was a good bill, then its creators would not have had to buy off as many people to get it this far. A good bill passes because it’s good. It’s that simple. Since the optics on this one are so poor, Massachusetts said “whoa.”
Unfortunately, when Massachusetts said “whoa,” the President got mad. He started making speeches. His speeches were sharp and negative. He pointed out the enemy; big oil, health insurers and Wall Street were called out by name. He drew a line and promised to fight, fight, fight, fight, fight, and fight (he actually said ‘fight’ more times than that, but in the interest of space, we’ll leave it at that).
What did that call to arms yield? The Dow Jones Industrial Average dropped by over 4% in two days. He stuck it to Wall Street, eh? No, he stuck it to everyday Americans’ 401(k)s, IRAs, and pension funds. He stuck it to the same companies who are expected to create jobs either directly or indirectly through their activities. He drew his line in the sand; he’s going after big targets on behalf of the “everyday Americans.” Well, do you know who holds the shares of companies in the Dow Jones Industrial Average? Everyday Americans do.
Little people, everyday Americans, the middle-class, or whatever your favorite term for us, we own shares in big oil companies, in Wall Street banks and in insurance companies. Do you know what else, everyday Americans work in these companies. They get up in the morning, they kiss their families good-bye, they travel to their jobs and they spend the whole day trying to do a good job for their customers such that they can return home with the means to provide for themselves and their loved-ones. These are not bad people.
I spend a good deal of my time working in regional economics studying local economies, and wouldn’t you know, just about every major city in the U.S. counts banks and health insurers among their largest employers.
These companies are owned by “everyday Americans,” are staffed by “everyday Americans” and exist to serve their customers, who are also “everyday Americans.” Now, these everyday Americans unfortunately find themselves behind enemy lines.
The President plans to fight, fight, fight, fight against big companies, Wall Street, insurers, and whoever else is the enemy du jour. But given that these firms are owned by us, staffed by us and create products for us, if he succeeds, who will win? Is it reform and economic recovery, or is it vengeance for Scott Brown that he’s now after?
Moreover, when he makes more speeches this week, am I going to be poorer as a result? Will you be?
Happy 2010! It has taken a few weeks for the Econosphere to get off the couch and get going again, but now that we know that Alabama has won the BCS title, I guess we’re out of excuses. It’s 5:20AM in Pittsburgh as I write this, and in a few hours we will know the December payroll number. Of all the economists I know, I’d say that it is a 50/50 split as to whether this one will be a positive number or not.
Are you holding your breath to see if we gained or lost jobs in December? …I didn’t think so. But it will be a big deal for the markets today and among the talking head class.
By the way, I was only kidding about getting off the couch. The economy was humming this holiday season. It started to become clear in August that the back-to-school shopping season was going to get off to an okay start, and then as the Fall moved on, the market continued to rally, house prices stabilized and manufacturing output started to expand again, it seemed pretty clear that we were going to have a good holiday season (good relative to 2008’s disaster). We won’t know for sure exactly how good it was until February, but early signs show that most of us were out there playing out part, responding to better economic incentives, and making the holidays a bit merrier than last year. And this holiday season may be the gift that keeps on giving if it turns out that December is the month that kicks off a long period of net job gains.
I am not too wrapped up in whether December’s number ends up positive; the economic indicators have now turned broadly positive such that if it wasn’t in December, we will definitely see job gains sometime in the first quarter of 2010. That achievement is just about baked-in now.
In fact, my gaze is turning toward what the end-story of this cycle will be. Who will claim responsibility for ending the recession?
Public policy went way over-the-top in this cycle. When it comes to policy, we absolutely threw the kitchen sink at this recession. When I think of all the players, just about every party with a hand in counter-cyclical policy essentially threw their play books out and just went, for lack of a better term, nuts. I think the only exception I can think of is the FDIC, which was very aggressive, but to their credit stuck to their playbook, taking over insolvent banks as they surfaced and auctioning off the assets to the highest bidder.
You see, the problem with throwing out your playbook is that once you have thrown it out, you don’t have a playbook anymore. Playbooks are nice to have after all. With a playbook, everyone knows what they are supposed to do, and generally everyone else knows what to expect from you. Without a playbook, you’re starting from scratch every day.
Does anybody know what monetary policy will look like after this is over? I don’t. Monetary policy has come to mean anything and everything that is done by the Fed; it’s not just the Fed funds target rate and discount window lending anymore. Is the Treasury now in charge of, well, everything in the private sector? Is it their job to take over poorly run banks? Will TARP now exist in perpetuity? Will we actually have to live with the dreadfully naïve notion that there are companies that are “too big to fail?” What’s a stimulus? We didn’t have a very good definition of that before, but now it seems to be any old thing that Congress wants to spend money on. Even crucial things like the rights of senior bond holders have been thrown out the window. Is no investment safe from the whims of the U.S. Treasury?
Essentially, a good number of the rules, mores and tenets that we lived by very successfully for a long while have been thrown out the window. These types of understood and accepted roles and responsibilities take generations to form and solidify. Now we are going to have to start over from scratch. This constitutes an information problem, in that we have created uncertainty that will hold the economy back during the recovery.
But aside from the self-inflicted wounds, since we did do so much on the policy side, I’m wondering which of these policies will get credit for ending the recession? I can already see the narrative of this recession setting in: Wall Street got greedy, Lehman Brothers went out of business, it was “too big to fail,” so we fell into recession. I can picture the history books being written now, never mind that the timeline doesn’t quite work; and I would also point out that the market didn’t crash after Lehman, it crashed after Congress passed TARP amid a particularly pointless several days of finger pointing, all of which was kicked off by Paulson’s and Bernanke’s ill-advised and televised testimony. But that’s beside the point.
Who is going to claim that they saved the world? Will it be Congress? Will it be the Fed? The Treasury? Maybe it will be an “unprecedented coming together of interest around the world that worked tirelessly for the good of free people everywhere.” Whoever takes credit, it won’t be the correct ones; I can assure you that.
It was you who ended the recession. It was every person who saw the writing on the wall and chose to pay down debt and spend less—that change in behavior was swift and dramatic. It was every homeowner who swallowed the loss in homeowner equity and moved on with his or her life. It was the business owner or manager who made the tough decisions to close locations, downsize and refocus. The people who ended the recession were the ones who took a sober look at their industry or their city, and made the tough decision to change vocations or move to where they could be more productive. We have never seen such a dramatic change in personal spending habits, nor have we ever seen such a dramatic drop in business inventories. These were the tough decisions that needed to be made, and you made them, aided by the economic signals that we have trained ourselves to read and react to for the benefit of ourselves and our families.
Will you get any credit? Heck no. But that’s not your fault; it’s just because you don’t have a Press Secretary.
There are two frequently stated points that have absolutely no basis in fact, theory or even in common sense. They are being repeated so often that many may assume them to be fact. Some people repeat them because they do not know better. Others repeat them because they want to convince others that these points are true, even though they know them to be otherwise. The first one is simply problematic, and a bit shameful. The second point is not only witless, but potentially evil. It makes my head hurt to think too much about either of these things, so let’s keep this relatively brief and to the point.
1. China’s Currency Peg Is Perpetually Unfair to the U.S. and Other Trading Partners
China pegs its currency, sometimes loosely, usually not so loosely, to the U.S. dollar. The U.S. has a tremendous trade deficit with China, and so it has been said that the yuan is pegged at too low an exchange rate relative the U.S. dollar. Much political tongue-wagging is based on the above stated assumption. Said tongue-wagging can sometimes be unhelpful, other times dangerous in that it aggravates relations between the U.S. and China. I worry greatly about any tongue-wagging that may start a conversation that ends in tariffs and quotas.
Let’s spell out the issue: a nation can allow a currency to float, or it can peg it. Floating is optimal. A floating currency can adjust in value more quickly than can wages and asset prices. Floating currencies adjust for really good reasons, such as when a nation’s debt rises (subsequently increasing money-supply without creating value) or incrementally as its workers become marginally more or less productive relative others. These price adjustments can help in the process of ending recessions, slowing a booming economy, and generally reducing economic volatility.
Fixed currencies do not allow such flexibility; subsequently promoting more volatility. For instance, in the absence of currency fluctuations, actual wages and asset prices are likely correct in a more disrupting fashion, both on the downside and the upside.
This brings us to China. If China does not allow its currency to appreciate relative the dollar, and if it is truly undervalued, than real prices will appreciate instead. Prior to the global recession, inflation in China was running at over 8.7%. During its period of high inflation, China lost its status as the cheapest place in the world to make things, and asset prices spiked upward. The recession put an end to the bubble briefly, but China is again expanding. The CPI has again turned positive in recent months and will likely accelerate once more. Asset prices are already rising. The yuan peg is stopping none of this from happening.
If the currency is truly undervalued, either China’s currency will appreciate, or real prices in China will rise sharply. In the absence of a flexible exchange rate, real prices will rise. From the vantage point of the U.S. economy, the U.S. is generally indifferent whether there is currency appreciation or wage and asset prices appreciation, the end results are similar. From the vantage of the Chinese, there would be a lot less volatility in their economic future if they let the currency fluctuate. But who are we to tell them how to run their currency?
2. Authoritarian Rule Has an Advantage over Democracy
The wonders of authoritarian rule! It has definitely caught the fancy of many pundits these days. To name two, Thomas Friedman wrote a few months back that one-party autocratic rule by enlightened leaders can be advantaged over democracy (http://bit.ly/VzJNx). Robert Reich, on This Week, a few weeks back, opined that authoritarian rule has an advantage over democracy. Both pundits, and others of a similar feather, have opined similar such thoughts of late; all lament democracy’s obsolescence, but look forward to the day when our enlightened leader need not worry about such things as consensus. Tears for Fears ought to re-release, “Everybody Wants to Rule the World.” It would be timely.
Look, I know why they are seeing authoritarian rule as the promised land. It’s plain as day. If our current President didn’t have to mix it up with the Republicans or independent thinkers within his own party, then we would have a clean health bill, cap and trade, alternative energy and a new tax code with which to pay for it all by now. Meanwhile, said pundits look oversees longingly to witness China’s perfectly executed Olympics, not to mention Singapore’s seemingly effortless rise to a peaceful, prosperous and pleasant city-state and ask, why can’t it be that simple here? Let’s pray that no one in the U.S. ever picks up that ball and runs with it.
Let’s forget for a moment that pundits longing for a dictator probably have a particular dictator in mind already. They’re not hoping for someone they don’t like to become our permanent leader, obviously. Now, let’s also point out the fact that no one is so smart to be correct 100% of the time. Just as a leader with a good idea can accomplish great things, that is not to say that said leader will always make the right decision.
It is a stated tenet in The Econosphere that “Many brains working on small problems beat few brains working on big problems.” If we have many people working on small problems, that means two things. First, individuals working on personal, local or company problems with which they are intimate give us a better chance of getting it right; we are each the expert within our own frame of reference. Second, if we are making many micro-decisions, than the fallout of getting an answer incorrect is much smaller than if, say, our mighty overlord decides that we should all run our cars on pig waste, and we subsequently become overwhelmed by our massive hog-energy complex. If someone wants to run their car on pig poop, let him try it out first on his own, and then we can each decide whether that’s the way to go.
This article recently appeared on The Dismal Scientist (www.dismal.com). The Dismal Scientist is the absolute best source of global economic indicators, insight and commentary on the web! Thank you to Andrew Cassel for his help in editing.
I don’t need to tell you that the recent recession was a drag. It hit each of us where it hurt. We saw the wealth that we diligently saved in our homes all but vanish; watched equities plummet and experienced lost bonuses, reduced salaries, and the disappearance of entire vocations. It has been a rough time.
There appear to be reasons for hope: The economy is expanding again, including manufacturing. Corporate earnings are on the mend. Some of what was lost in the stock markets has returned. Home values appear to have stabilized, and even retail spending has shown signs of life—general merchandise sales are positive year over year. The world is looking a tad brighter.
But job growth remains elusive. Even if we see a month of expanding payrolls soon, it will be but a single step in a long journey to recreate what has been lost. I do miss 2007.
We’re here to help
Fortunately, some smart people in Washington have a plan to cure what ails us. Here’s how it goes:
First, prop up a few companies—companies deemed so important that they must not fail. Once saved, these companies can become forces for good. Next, purchase and insure debt no one else wants, which prevents massive insolvencies and lowers borrowing costs. Those low costs let Washington borrow billions, some of which it gave people to buy new cars, provided they turned in their clunky old ones to be junked. And although our troubles began after many people purchased homes they could not afford, we now offer people who haven’t yet bought homes thousands of dollars to do so.
And while they’re fixing things, these same folks have a few other ideas such as: Borrowing money to subsidize good technologies, so they will compete against and maybe even eliminate bad ones. Adjusting the pay of some people so they don’t make so much more than other people. Changing trade rules to favor home-grown production over imports. In hopes of assuring good healthcare for everyone, taxing people who already have good healthcare. Cutting checks for old people, because they are old. And on and on.
The goal, evidently, is to remake the world the way it would have been made in the first place, if only the people who made it had been more enlightened. It’s to create an economy that does what it is supposed to do, once and for all.
Back to the future?
Such aspirations remind me of the 19th and 20th century futurists who promoted the idea that the natural world was made for man to conquer. Cruel, random Nature was to be made rational, predictable and benevolent. Dam every river, fill every wetland, pave whatever needed paving; nothing could stop us.
Now, of course, we spend billions each year fixing the damage caused by trying to tame rather than adapt to our environment. We restore wetlands, decontaminate polluted earth, try to coax back sustainable populations of fish, birds, mammals, even insects. And we treasure those places where we can feel the grass under our toes, hear the waves lapping against clean shores, or smell air untainted by industrial fumes.
Meanwhile, those enlightened visionaries of the past—who turned out not to be so enlightened after all—have been replaced by a new bunch. Instead of remaking the ecosystem, this group wants to re-engineer what I call the Econosphere—our natural economic environment.
Economic ecology rules
Simple rules govern the Econosphere. Each of us is a utility maximizer; we do what can each day to maximize happiness through the pursuit of avocations and relationships. To obtain food and shelter we trade goods and services valued by others. Market prices tell us where to channel our time and effort, enabling us to help complete strangers half a world away maximize their own happiness as they help us.
In a land of infinite demand and finite resources, it is the Econosphere that provides the tools to do this efficiently and successfully. Of course many efforts run off the rails, but it is not the Econosphere that needs fixing, any more than nature needed fixing in the 19th century. Imperfect information is the usual culprit: When we overbuild, overinvest or overborrow, it is because we did not have the right information.
For example, why would homebuyers take on unaffordable loans? Maybe because they were told houses never lose value. Why would investors buy securities built of such poorly conceived loans? Maybe they believed mortgages are the last things Americans default on. Now, because of the bad information that led to such decisions, we have to dig out of an economic hole. And to do that, a healthy Econosphere is essential.
None too big to fail
We need market prices to show us what the world does and doesn’t value. We need enterprises that are no longer viable to fail quickly and completely, no matter how big they are—no firm is so big as to hold sway over the Econosphere. We need firms that can make better products or manage balance sheets more intelligently to be rewarded for doing the right thing. We need prices to fall until demand balances supply. We must have lending rates that reflect real risks. Perhaps most important, we need laws and regulations that are clear, fair and predictable. Uncertain rules drive up the cost of borrowing, investing or hiring.
Yet just when we need a blooming, robust Econosphere most, our economic ecology is being manhandled by those who would re-engineer it to further their own interests. In the process, the latter-day conquerors of nature threaten to pave over markets and fill in the wetlands of trade. Our metaphorical Cuyahoga River is aflame.
As we have gone green toward the natural ecosystem, we need a similar attitude adjustment about the Econosphere. Just as the tree-huggers of past decades spearheaded the environmental movement, we need modern-day “price-huggers,” to stand in front of those planning to bulldoze what’s left of our benevolent, natural market economy.
Did you ever feel like you’re the guy in that old Keep America Beautiful TV commercial? You know, the one where he comes across all the garbage, and sheds a tear for the environment that he loves (here it is on YouTube: http://bit.ly/17dZ0N). I certainly have been feeling a heck of a lot like him these days.
Now, while I’m a big fan of our physical environment, that’s not what I have been crying about. I have been shedding tears for our social environment—our Econosphere. The garbage in our Econosphere is harder to see, but it is no less polluting. I wish more people could see it. We have learned our lessons about trying to mold, manhandle and manipulate our physical environment to suit our whims; but we don’t seem to have learned the same about the Econosphere. If we don’t like where a river is running, we no longer divert it without thinking about what else we may be affecting or what dangers we are creating. But, if we don’t like the way, say, capital is flowing, we have no qualms about creating policies to divert it—no matter what the unintended consequences. When will we learn? Not any time soon apparently.
I really don’t like harping on such things, but in the last few days, there has been a lot of garbage thrown about. There are a few things like Senator Dodd’s proposal to freeze credit card rates, the activities of the pay czar (oops, I mean the special pay master), and the ongoing efforts to make healthcare cheap, universal and high quality (and well, you know what’s wrong with trying to do all three of those things at once: http://bit.ly/1w3tGF). A few of these things hit at my industry, so I don’t really feel comfortable addressing them here; let’s just let them be. But there seems to be no end to the parade of aggressive incursions into the Econosphere.
Heck, let’s just look at the next one on the agenda: Too Big to Fail. What the heck is that supposed to be? I don’t care how many times Ben Bernanke and Tim Geithner repeat that phrase, it doesn’t make it so. I swear to you, there is no firm so big that it can take down the Econosphere. You may say, what about Lehman Brothers? Well, what about it? Lehman Brothers ceased to exist on September 15, 2008. And what happened? Nothing. Barclays had the signs changed over on Lehman’s Midtown headquarters in just a few days, and the equities market was completely ambivalent that entire week. In fact, the Dow didn’t suffer its 778 point one day drop until September 29th.
What happened between the 15th and the 29th? Well, I would point to the period beginning with Ben Bernanke and Hank Paulson asking Congress to pass TARP on the 23rd, with Paulson infamously improvising at the end of his prepared remarks, “It’s gotta be done this week!” Congress then spent the week arguing among itself and in the press, failing spectacularly to pass TARP on its first try, and eventually passing the bill on a rushed and panicked second attempt, and in the process, to take a phrase from the fine film “Days of Thunder,” looking like a monkey humping a football.
Was it Lehman that caused investors to pull their money out of the system, or was it the monkey with the football?
Regardless, the “too big to fail” proposal heading to the table will seek to allow the government to seize any faltering (or perceived to be listing, drifting, wobbly, insubordinate, smelly, top-heavy, bottom-heavy, in bad taste, proceeding with too much haste, or generally obstinate) firm that is considered so large as to be systemically important. Once seized, the government would have the ability to wipe out the stockholders and bondholders, rewrite or nullify existing contracts, and well, do whatever else it wishes. What kind of incentives would this create? God only knows. Would a firm’s management choose to not grow if it sensed that it was reaching some arbitrary threshold? Would bondholders require higher yields for firms as they get larger, for fear that they could be wiped out by “too big to fail.” Would we hobble our largest employers by requiring them to hold more capital than their smaller rivals or foreign competitors, or place undo burdens on them in the maintenance of costly “living wills.” And certainly, “too big to fail” would be a very effective reminder for all large firms of any stripe to get those political donations flowing.
But let’s also not forget, there is only one reason why firms get large in the first place; it is because they are good at what they do! Are we to begin putting our best firms on notice just for succeeding?
Moreover, every large firm eventually does fail or shrink no matter what one might wish, because very large firms generally cannot remain nimble enough to innovate. There is a lifecycle for firms, and it is wrong to impede that process. Successful firms must be allowed to grow when they are creating goods and services craved by their clients. And when these firms eventually falter, we also have to let them die a natural death. This is the process affectionately known as “creative destruction,” and it is what allows our standard of living to rise from one generation to the next.
To impede this process is extreme environmental degradation. It’s pollution. And for those folks who are doing these sorts of things, I don’t know that they are bad people, I think they just don’t understand that our economy, our Econosphere, is an ecosystem that needs the same respect as does our natural environment. We know to be green in our physical environment, but we have not yet had our green moment with regard to our Econosphere.
So, in the meantime, while I hope for the best, I do feel a lot like the Native American gentleman in that Keep America Beautiful commercial. But instead of shedding a tear while looking at trash on the side of a road, I’m watching a monkey hump a football.