WHAT NOW

Well. we have a new president and hope springs eternal. We have a bunch of problems and the hope is Barack has the solutions. Now the auto companies and insurance companies have their hand out. Pelosi wants to pass another stimulus bill even though its pretty much agreed that the first one did not work. Jobs and consumer spending are falling off a cliff and everywhere, everyone feels the need to take some kind of action. Infrastructure spending is the new cry. Eventually, most will come to the realization that there is no quick fix that will return us to the prosperity we just so recently enjoyed. Has everyone forgotten? Governments cannot legislate prosperity. They can only foster conditions for it at best. That does not stop them from trying. They have to get re-elected after all.

We need to step back a moment and consider how we got here to evaluate possible solutions. I believe three major secular trends contributed to where we are today and are not being discussed in terms of finding solutions to our current crises.

The first major trend of the last 15yrs, discussed often and in depth by Stephen Roach of Morgan Stanley has been the migration of jobs to the emerging economies as a result of labor arbitrage, as Roach calls it. This has led to the hollowing out of our industrial base, our huge trade deficit, and our stagnant wages. So first and foremost we have to protect any jobs we still have left while we try and create new ones. If that means bailing out the automakers so be it. Look, just like energy, where we are engaging in an enormous transfer of wealth that is unsustainable, if we lose our domestic auto industry , we will have another major transfer of wealth, mainly to Asian countries getting or auto money while the middle east gets our oil money. The point is. we can not buy everything we need from someone else. We have to pay for it. We earn it or we borrow it, and we're already in hock up to our eyeballs.
I think Obama has got this figured out. He seems to want to accommodate the automakers and he describes himself as a fair trader not only a free trader. So I think he will try to hang on to some jobs that would otherwise go overseas.

The second major trend has been the inexorable decline in the savings rate, year after year after year. Savings became passe over the past quarter of a century as first stocks and then our homes values marched inexorably higher. Why do you need savings when your getting 500 credit card offers a year. There are many reasons that have caused the age of thrift to vanish, down payments to become a thing of the past. Saving up for something-how quaint. But here, let it suffice to say we are at zero.

Third and most important, has been the rise of debt. In 1981, total credit market debt was about 5 trillion with GDP of about 3 trillion, by 2002 debt had grown to 31 trillion while GDP had only grown to 10 1/2 trillion. Debt was 3 times greater than GDP. As a comparison, in 1930 debt was about 2 1/2 times GDP the all time high until 2002. Since 2002, it has only increased with all the war spending adding billions to the debt and the recent bailout spending will cause this to accelerate and explode. It was of course the final folly of extending credit without any due diligence to those who couldn't repay that was the spark that lit the fuse of the sub-prime crises that has spiraled into what we have today.

To recap, the housing market starts to crumble as teaser rates are reset and the first defaults occur. Housing prices stop rising, inventory increases, adjustable rates are reset, the spiral continues. When prices continue to fall that undermines all the securities and derivatives associated with mortgage securities, causing catastrophic losses for holders of those instruments. The consumer whose real wages have been stagnant for a decade and whose net worth is mainly held in his home which has declined by 20% is also hit with stock market losses of 40%. As a result the economy weakens, job losses rise and without any savings to fall back on it becomes harder for Joe consumer to pay his bills. Mortgage, auto loan, and credit card delinquencies increase creating a negative feedback loop. Pretty scary stuff.
Many people compare us to Japan. At least the public had savings to ride it out. When unemployment benefits run out, what will happen then. As far as infrastructure spending goes, I remember Japan approving one supplementary budget after another building roads to nowhere. All it got them was the highest government debt to GDP ratio in the developed world.
At which point they had to stop.

As I said before, the government cannot legislate prosperity. It also cannot make the ramifications of living beyond our means for decades go away. Look at all the programs FDR put into place during the depression and unemployment was still 20% in the mid thirties. The public needs to fix its balance sheet. Debt can only be repaid or not. To help repay debt we have to keep and create as many jobs as possible. We have to buy time for people to pay their bills by extending unemployment insurance and enacting some type of mortgage help. Some one will have to break the bad news that sacrifice and belt tightening will be necessary, a message not heard since the war. Debt reduction and saving will become the watchwords. As far as not paying debt, some kind of liberalization of the bankruptcy laws might be in order to help people get a fresh start. Debt deflation's and deleveraging take so long because it is so hard to reduce debt service with diminished revenues and low asset prices. Finally, government Manhattan projects, that lead to innovations that create new industries and new jobs in which we can lead.