Free Rise

Also from yesterday’s FT-sponsored Financial Services Marketing breakfast, Richard Waters dropped these Six nuggets of received wisdom that have been discredited by the financial meltdown.

• Stocks go up 10% a year. So what if you’re going to retire in a few years? Why miss out on more gains by preserving your savings in boring CDs and bonds?
• You can beat the market. Just ignore what Bogle and his adherents have been proving for years. Cramer will get you your returns.
• House prices only go one way. Waters told a story about a fight he and his wife had after a real estate agent in Marin tried to convince them of the truth of this. Fortunately for the Waters’, he won that fight. Millions of others were not so smart (like Suzanne’s hapless clients. What? What?).
• Financial innovation is good for you. Forget about how Orange County went broke investing in these newfangled “derivatives.” Go ahead and bet the whole financial system on incomprehensible instruments. It’s science, people!
• Big banks can’t go bust. They’re way too diversified, right?
• You can’t go wrong giving your life savings to a middle-aged white guy. Especially if he’s named Madoff or Stanford. Interestingly enough, this seems to describe the staff of the FT.

Killer quote from the Financial Times‘ veteran financial reporter Richard Waters, at yesterday’s (4/22/09) Financial Services Marketing breakfast, sponsored by the FT. (Great event by the way.)

“People say we are in challenging times now. And I think it’s obvious that ‘challenging’ hides a lot of sins.”

Challenging, and sinful, times indeed. What’s been most disgusting about this global downturn is that it’s turned our world upside down. Entities and enterprises that seemed beyond reproach and the envy of the world are now disgraced by their own failure and corruption. And the catechism of our markets has been proved a lie.

Next post: Six nuggets of received wisdom that have been proved false.

Thank heavens for the Washington Post’s Steven Pearlstein. I hope every Congressional staff reads his column today, where he lays out what “stimulus” means and how it affects the economy.

Wanted: Personal Economic Trainers. Apply at Capitol.

I have to agree with him; the economic illiteracy of Congress is staggering, and too much of the debate on the Hill is stuck in the Reagan years.

Of course “learn some economics” is a blunt argument. Plenty of men with impressive economic pedigrees are no more than shills for industries, the wealthy elites, unions, real estate. They’ll have you believe that cutting taxes raises revenues, or deficits don’t matter, or real estate only goes up, or farm subsidies create food security, or taxes on profits impede employment.

But the column still hits important points. Tax cuts increase debt to put some money into the economy. Spending increases increase debt to put more money in the economy than tax cuts do. And some spending on consumption may help the economy in the short term, but spending on investment helps in the short term and paves the way for tomorrow’s prosperity.

This is not hard. But it’s harder than “ungh, taxes always bad, ungh ugh ugh” or “ungh, buy more stuff so recession end, ungh ugh ugh” which is sadly what we’ve come to expect from Congress.

With the economy in a free-fall and a bottom still months if not years away, Washington has taken on a public debate about fiscal stimulus. And like most Washington debates, it’s being crushed by dead ideologies, false assumptions, and old-fashioned pork barreling.

The stimulus debate seems to falling along two primary lines of argument, both utterly predictable and useless:

(1) Spending vs. tax cuts. Falling into their stereotypes, the Democratic leadership wants to spend, and the Republican leadership wants to cut taxes. The former will have a direct impact on demand, the latter a greater relief to wage-earners. But to call the modern Republicans supply-siders is giving them too much credit. They just think it’s both politically popular and economically beneficial to reduce taxes. Most of them couldn’t draw a Laffer curve if you spotted them a cocktail napkin, a Uniball, and both axes.

(2) “Stimulative” spending vs. pork. This choice is about as false as you can get. All spending, if it’s spent in America and primarily on domestic labor (as opposed to imported goods) is stimulative. It doesn’t matter whether it sounds useful (freeway maintenance, subway construction) or frivolous (the National Endowment for the Arts). In the short term, spending is spending.

If anything, spending on arts — which would presumably pay people to teach and create art, and thus help develop the young creatives on whom real long-term economic growth depends — would be highly stimulative, both short and long term. Conversely, building another bridge to nowhere would require importing tons of materials from overseas, or igniting a disastrous trade war by requiring the projects to Buy American. And long-term, projects like exurban freeways hurt our domestic economy.

But really, both of these above debates are ridiculous, because such is the premise of “stimulus” — that the a shrinking economy can grow again (or shrink more slowly) by encouraging people to buy more stuff.

That’s a 20th-century economic model — dig minerals out of the earth in country A, ship it country B for processing and manufacturing, and then ship it again to the USA for retailing and consumption. Country B gets paid in US dollars, which they then use to buy American assets, which the Americans then rent back from country B. (Warren Buffett calls this phenomenon “a sharecropper’s society.”) Meanwhile, in America, lenders lend to other lenders, who lend endlessly to consumers, who can keep borrowing to pay off past debts. But the global housing bubble brought debt to its breaking point, and defaults are still working their way up the debt stream.

What we’re witnessing now isn’t just the downswing of the business cycle; it’s a reckoning of our debt dependency. And it will result in the restructuring of our industries, whether we like it or not. Big Auto is probably terminal. Many retailers are definitely terminal. Many banks have already died.

Or as Umair Haque puts it so brilliantly: “20th century capitalism is eating itself… Today’s leaders are plugging dikes, bailing out industries and banks as they fail. Yet, what negative global growth suggests is that the problem is of a different order: that we have reached the boundaries of a kind of growth.”

True. Our economy as a whole is restructuring, becoming something else by necessity. So what should the purposes of a “stimulus” bill be?

(1) Expedite America to the next economic model. This means a model that reduces our dependence on oil and other minerals, restores sanity to borrowing, and gets our trade closer to balance. It means a model where we spend more on investments like renewable energy, sustainable food, general research, shared transportation, and education, and where our growth comes from doing things smarter instead of just making more. Because “more” is becoming less of a viable option.

(2) Support Americans through the transition. The new global economy requires that millions of workers move from 20th-century jobs to 21st-century ones. People will still need to grow food, sew clothes, fix machines, and lay pavement, but not in the same places or manners they once did. The upheavals that will result from this transition are massive and obvious — think America during and after WWII — and people need help to make it through this shift.

We need to get serious about this as a nation. The current spending/tax cut bill contains some elements (like home weatherization) that address both these points.

But America’s borrow-from-abroad-to-buy-from-abroad economy isn’t just down in the dumps. It’s doomed. Any bill that focuses on consumer spending for its own sake is only prolonging the inevitable, and extending the pain for the worse.

Citi could not have found a more appropriate way to identify the location of their ATM.

From my Flickr.

I recently counseled a good friend who was enduring a tough financial situation. He was supporting his family on his middle-class income with no health care benefits. That’s a precarious enough situation in America today, but he and his wife had also run up a whole lot of debt.

My friend was embarrassed about his largesse, but I assured him that it’s an all-too-common situation around the world these days. Although I tried to focus on his next steps, I couldn’t help wondering about the financial system that created this mess. Somehow multiple lenders decided to keep extending them more and more credit, well beyond their ability to pay.

The average household does not have a subprime mortgage, but it does bear more than $10,000 in credit card debt. The failure of subprime mortgages is thus the mere tip of the credit iceberg. As layoffs and foreclosures mount, credit card defaults will presumably increase as well. While each default will be much smaller than a mortgage foreclosure, the potential volume is beyond scary.

The NY Times Executive Suite blog exposed an insider’s view last week in the self-explanatory “The Worst is Yet to Come: Anonymous Banker Weighs in on the Coming Credit Crisis.” It’s well worth a read, just in case you think you’re seeing light at the end of the economic tunnel.

It’s a rough time in the global economy, and the knowledge that we’re still a couple gloomy Xmases from a recovery doesn’t make this season any merrier. But at least we beat inflation, right?

Oil prices have collapsed faster than the value of an unfinished Miami condo. Commodities are down across the board as demand slumps. It just was just a few weeks ago that economists and gold-hoarders were predicting American hyperinflation due to Fed profligacy. But suddenly the dollar is up and the watchword is deflation.

Worry not. Prices aren’t really going down that fast. They’re just being reclassified and hidden. Have you bought an airline ticket lately? Or… a t-shirt?

Check this out. Pretty sweet, eh? Plastering the wisdom of legendary SF eccentric Frank Chu across your chest makes you look and feel smarter.

Wanna buy it? Thirty bucks. That’s right, 30 smackeroos. Now there’s some inflation. I paid 1/3 of that for an original Frank Chu sign a few months ago. But here comes the real kick in the perineum.

A $5 charge for “Economy”? Have things gotten so bad that companies are tacking on surcharges just for business conditions?

Oh wait… that’s for “economy” shipping. Hmm, maybe this could be clearer, CafePress.

But with e-tailers vigorously discounting themselves out of existence, maybe it’s only a matter of time until we see the “DJIA decline surcharge.”

For the first presidential debate, I’d like for the moderators to flash this chart on the screen.

Questions:

1. What does this chart mean?

2. What happened during the Clinton years that was different from the Reagan, Bush, and Bush years?

3. Every American citizen now owes about $30,000 for past federal spending. How will you reduce that?

4. Since 1980, the federal goverment has raised income taxes twice. What effect did those tax increases have on the economy?

From private equity demigod Ted Forstmann, in yesterday’s WSJ:

After Sept. 11, 2001, the Federal Reserve pumped so much money into the financial system that it distorted the incentives and the decision making of everyone in finance. He illustrates this with what he calls his “little children’s story”: Once upon a time, when credit conditions and the costs of borrowing money were normal, the bank opened at 9:00 a.m. and closed at 5:00 p.m. For eight hours a day, bankers made loans and took deposits, and then they went home.

But after 9/11, the Fed opened the spigot. Short-term interest rates went to zero in real terms and then into negative territory. When real interest rates are negative, borrowing money is effectively free – the debt loses value faster than the interest adds up. This led to a series of distortions in the financial sector that are only now coming to light. The children’s story continues: “Now they [the banks] have all this excess money. And they open at nine, and from nine to noon or so, they’re doing all the same kind of basically legitimate things with it that they did before.”

So far, so good. “But at noon, they have tons of money left. They have all this supply, and the, what I would call ‘legitimate’ demand – it’s probably not a good word – but where risk and reward are still in balance, has been satisfied. But they’re still open until five. And around 3:30 in the afternoon they get to such things as subprime mortgages, OK? And what you guys haven’t seen yet is what happened between noon and 3:30.”

When bankers can only lend what they can borrow at a reasonable rate, they consider risk and opportunity cost. When bankers can borrow money at negative real interest rates, and then sell off or syndicate the loans so they don’t even have to care about risk, they’ll lend to anyone with their hand out. Whoops!

From this morning’s NY Times, “For Many, a Boom That Wasn’t“:

In 2000, at the end of the previous economic expansion, the median American family made about $61,000, according to the Census Bureau’s inflation-adjusted numbers. In 2007, in what looks to have been the final year of the most recent expansion, the median family, amazingly, seems to have made less — about $60,500.

This has never happened before, at least not for as long as the government has been keeping records. In every other expansion since World War II, the buying power of most American families grew while the economy did. You can think of this as the most basic test of an economy’s health: does it produce ever-rising living standards for its citizens?

Seven years is not a blip. It’s a trend. And there’s no denying the unstoppable forces that created this stagnation:

• The opening of the American economy to global supply competition has forced manufacturing and increasingly value-added services jobs overseas
• The opening of the American workforce to large inflows of immigrants, and the ubiquity of the two-career household, increased the labor supply and pushed wages downward
• Global economic development also put demand pressures on commodities. Oil, food, and materials have never been more expensive
• And America’s three most serious household expenses — housing, health care, and education — were goosed ever upwards by systems that thwarted market forces

But there’s also one input that is utterly discretionary and susceptible to the whims of humankind: taxation. The philosophy of our governments — not just federal, but all levels — has been to regress their tax systems so that the rich pay a lower share of their income than they did before. Economic conservatives promote low and flat taxes as the drivers of economic growth. And they’ve won their battles: As a percent of GDP, US taxation ranks 34th of the 36 largest economies.

Low taxes, however, are not enough to grow an economy. You also need investments. And my family is getting a whopping tax refund this year — one that we didn’t really need — while our neighborhood school slashes its staff, while our freeways clog up, and while the middle class faces higher bills for college, cancer treatments, and dirty energy.

In short, America’s government treats this country like a cash cow business, like AOL or RJ Reynolds. We should be a growth play. But you don’t grow your organization by paying out all your profits as dividends. You have to plow them back into the org.

So let’s invest in America. Let’s redirect our spending to tomorrow’s projects. And let’s fund these investments not from those who can afford it least (or with more debt), but from the ever-wealthier people who have benefited most from this American system.