Are things as bad as they appear or have we just hit a soft patch in the road?

Recently, a good friend sent me an email with the following (in bold) observations and concerns asking for my take. He is concerned about the state of our country and, by implication, that of the world. He is one of the more thoughtful and reflective individuals I know. He is bright and not prone to hyperbole so when he becomes concerned then I believe it is worth thinking about his issues. Needless to say, I am flattered that he thought I might have some useful insights into these topics. They follow.

China – They are no ally but an intransigent competitor militarily and economically.

As the British Lord Palmerston said, “We have no eternal allies, and we have no perpetual enemies. Our interests are eternal and perpetual, and those interests it is our duty to follow.”
I believe that China thinks the same way. The well–being of mankind is irrelevant to them as long as they can sell another widget (the Germans fit this description, also). The leadership is trying to stave off the inevitable demise of totalitarian rule by clamping down on the internet, etc., but the genie is out of the bottle. As Marvin Zonis of the University of Chicago Business School has said, “the only ideology in China today is to get rich.” Eventually their army won’t shoot their fellow countrymen. In order to delay this from occurring the leadership needs a bad guy: the USA, as usual, is the easiest target. They have a problem, though, which is the flip side of ours. If our debt to them gets beyond our ability to service it, our economy will spiral downwards. Who, then, will the Chinese sell to? They have a vested interest in the robustness of the US economy. They are going to have to recognize that revaluating the Yuan will be required in order to maintain their economy; mercantilism doesn’t work any better today than it did 300 years ago.

Housing – So many in default.

I’m dismayed at the govt.’s response. The banks and the borrowers would have had the incentive to renegotiate the terms of the loans until the Feds stepped in. Everyone thought that the govt. could make them whole. They can’t; prices will take years to recover in some markets, especially those that the govt. intervenes in. Real estate needs to be removed from the politicization racket if we want to make properties affordable again. The fact that some mortgages are “under water” is not necessarily a reason to default or encourage default. If that was the case every auto loan would be defaulted on since they are almost always under water over its whole life. Those loans that were taken out by people expecting to ‘flip’ the property and now can’t shouldn’t be included in any bailout or loan forgiveness program. We don’t do that for individuals who buy shares of stock hoping to sell at a profit but wind up with shares worth less than they paid for them. If people are bailed out, guess what? We will encourage this practice in the future based on the belief that the taxpayers will make them whole. Not a bad racket: heads I win, tails you lose.

Real Estate and Commercial Real Estate – The banks have not told us what the real prospect of default is.

Where are the SEC, the FDIC, the Fed, and the accounting firms in all of this? Banks are supposed to write off assets when they know that the value is impaired. There are too many buildings that don’t cash flow sufficiently to support the mortgages and are unlikely to for years to come. The handful of banks that are big RE lenders are going to be in real trouble.

Consumer demand/sentiment – Remains low – people are holding back, and our businesses are so leveraged they need the few percent being cut by consumers.

The government’s policies are exacerbating this. Job creation has been anemic given the amount of stimulus. With weak job prospects people are not going to spend on durables or anything that smacks of extravagance. This will reinforce firms’ decisions to limit hiring.

Debt – Think it is controllable – but will be an ongoing drain.

See below under government

Fed – How long can Bernanke keep the economy up?

This will be the greatest feat of Central Banking virtuosity if they can drain the liquidity from the system without tanking it. The fiscal side isn’t making things any easier. Bernanke’s testimony on the inability to sustain this level of total government debt and annual deficits without substantially higher levels of taxation or, by implication, repudiation of the debt through inflation at Latin American levels, should be sobering to the Congress. It wasn’t, I’m afraid.  As Santayana said, “those who forget history are forced to repeat it.” The inflation in the Carter years almost tore this country apart. The ensuing recession to eliminate it was also costly.

Global Trade – Years ago thought it would go against us for the most part. How do you compete with billions of Indians and Chinese that will work for a $1 a day?

Their productivity and quality still are below ours. China is going to have to gradually revalue its currency (see above). I’m not so sure the anecdotal evidence about a worker being paid only $1.00 for making a sneaker that sells for $150 makes the case. At the local GM engine plant, the biggest and one of the most efficient in the world, one line produced 155 engines per hour. A worker was paid, including benefits, say $80/hr. That means he’s getting paid a little over $.50 per engine. And we know that GM wasn’t getting rich. In the 1930s and 1940s textile manufacturing migrated from New England to the South. In the 1970s and 1980s they migrated overseas. This process will continue especially if the US persists in piling mandates on employers.

Demographics – Europe and Japan and even China to an extent are coming disasters.

Europe would be classified as junk debt for its political cowardice. Again, they need to remember Santayana’s dictum. They have, in their midst, people who want nothing to do with their society or culture. These people, primarily Muslim immigrants and offspring of these immigrants, are taking advantage of the European intellectuals’ guilt (for God knows what) to sponge off countries they abhor. This is suicide on a continental scale. China is going to have an Islamist problem in its western provinces. They should not be playing buddy-buddy with an Iran who foments trouble everywhere. The Russians shouldn’t either since Jihadists are even a bigger problem for them, witness the recent Moscow subway bombing. I don’t know what Japan is doing and I’m not sure they do either. They seem to play everything by ear and fight fires as they arise.

Government – It is just unmovable.

It is stunning to watch Congress in action. They pass legislation that says any new spending has to be paid for with a cut somewhere. Along comes extending unemployment benefits, with a $10B tag, chump change by current standards, and they can’t even find that kind of money in a $4Tr budget. They just don’t get it. Years ago, when I was in Grad School and people were concerned about the US debt, the rebuttal was that we owed it to ourselves, so it wasn’t an issue. Well, today, we owe it to others and its size, and its projected size, are beyond comprehension. State governments are as bad or worse. Their implicit assumption in addressing their budget woes is that “a miracle will happen” and we will be relieved of having to make the decisions we were elected to make.

Healthcare – It is going to swallow us unless we are serious about cost control. That will be a tough fight – economic, religious, political, etc. In the end, I think, we have to ration – somehow cut expenditure near life’s end.

You are right. This current legislation won’t cut costs or really improve overall access to quality medical care in the US. We ration health care now but it will be more arbitrary and extensive in the future unless this bill is repealed. The biggest problem with health care costs is that the consumer is oblivious to them. Deductibles really aren’t high enough. There is no expectation that people have an obligation, to themselves, for their own health. Annual physicals, better diet, and more exercise should be expected of people. Insurance is not for piddling things. It is there to prevent an unforeseen event from bankrupting a family. Today it is viewed more as a Christmas club account.

Banks – I don’t trust them and wonder what the next shoe to drop is.

I have worked in banks at one time or another for over twenty years. While they have many bright people they are institutionally ignorant. They seem to have an extraordinary ability to engage in self-delusion. For all of their ability to access sound economic reasoning they persist in acting as if the laws of economics don’t exist or that they have somehow found the key to alchemy.

Countering all this is:

Maybe we’ll get tough with China on their low valued currency.

See above about their own need to confront this issue.

Our assets still exist – a house is a house even in default and prices will adjust.

This is an important point. The houses didn’t vaporize just the potential sales price. The fact that many have mortgages in excess of the potential sales price is no reason to interfere with this market. Houses still provide a stream of consumption services: a domicile to live in.

A few scientific things on the horizon – cheap gas, other forms of energy.

We could solve many problems, both domestically and internationally, if we would really allow oil and gas exploration in the US, as well as permit more nuclear power plants to be built. The environmental issues are grossly overstated. We have been drilling in the Gulf of Mexico for years with no problems, this, mind you, in spite of hurricanes like Katrina et al., occurring every year. The oil companies have been in the North Sea for years with no environmental problems even though that is one of the harshest places to explore. Allowing domestic exploration would cause the price of oil to drop under $50/bbl almost immediately. This would stop the activities of Hugo Cahvez, Vladimir Putin, and all of the rest of the OPEC crowd from fomenting problems outside their own borders. It would reduce our military expenditures, stop our pathetic fawning to these clowns, and increase employment and cash flow right here in the US.

We have the best military if we need it and can still impose some sense in the world.

Unfortunately, we currently have a president who is embarrassed by our ability to address problems. Even Hillary Clinton understands the need to occasionally project force at the bad guys. Who would have thought that she would be considered the hawk.

We still have reasonable measures of productivity and other things that produce wealth – aside from the fact that our 100 year old pipes are disintegrating.

You hit upon an important point. The private sector maintains its capital stock, the public sector doesn’t. The states and municipalities need to recognize the necessity to embark on a 10 – 20 year overhaul of the infrastructure. They can’t continue to ignore it while buying votes and thinking tomorrow will never come. It has arrived.

There must be some other good news – like a bit of international cooperation – if not altruistic – so we all don’t become Greece.

International cooperation be damned: we need to tell the rest of the world to get real. International law is a figment of peoples’ imaginations. It is like breaking a luncheon appointment.

Does this mean that the future is bleak and we are about to revert to a Hobbesian state of nature where “the life of man, solitary, poor, nasty, brutish, and short.” I do not think so. Americans, in particular, are resilient and inventive. It is clear that the majority of Americans have serious misgivings about the country’s current direction. As such, they will demand that we tack back. As long as the free market exists, individuals’ ingenuity will be rewarded and they will generate ideas and products that solve our current problems while setting the stage to address the wave of challenges. The key is that people our allowed free expression. If we get to the point that it takes a child to point out that the emperor has no clothes, then we will be in trouble because our media elite have abdicated their responsibilities, society’s that live a lie are doomed. I, for one, put my money and faith on the former: Americans can and will get the job done. Most importantly, the good news is that baseball season has started. As long as that happens, everything else will eventually come around.

posted by Jim

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2 comments on “Are things as bad as they appear or have we just hit a soft patch in the road?

  1. Unfortunately things go from bad to worse as Mickey starts playing by his own rules and the duo find they are heading for a whole lot of trouble. Melanie Economics

  2. buckeye9 says:

    I found Jim’s response to his friend’s concerns a useful and coherent overview of where we are and the dangers of where we are going. A few points, stimulated by Jim’s post.

    1. The market is a form of public good maintained by the selfish interests of the participants. It is nice to be friendly but unnecessary. As Oliver Williamson pointed out, relational contracts are maintained not so much by formal contracts (WTO, OECD, etc) as by the mutual interest of the parties to the relationships survival. China’s leadership senses this and acts accordingly. Ours is overly concerned with having friends and looks to formal contracts and treaties to govern relationships.

    2. Incentives (positive and negative) work. Creatures and institutions evolve to fit their environments. Banks are bred to act as they do, change the rules and environment and the survivors will be different. Failing to allow extinction saddles us with dinosoars.

    3. Citizens are not clients or wards of the state. The Road to Serfdom remains a valid analysis of letting our government, however well intentioned, assume responsibility we should bear. There is a fork in that road and I fear that we may have taken it last month with passage of Obama Care. There were so many untried market-based improvements we could have tried first.

    4. Baseball is, as George Will argues (online.wsj.com/article/​SB10001424052702303720604575169880413683248.html), the right sport for a democracy. Basketball is too star-centered.

    Bob

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