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2009: Why It Will Affect Everyone's Future For Generations To Come

Econophile's picture




 

From The Daily Capitalist

This has been a phenomenal year for the economy. There have been major, fundamental changes that will affect our lives for many years to come. I don't see these changes as a good thing for the short or long term.

These changes are generational in that they don't occur often and they will radically impact the economy and our well-being for decades. I thought of doing a decade review because it explains so much of why we are where we are today. But so much happened this year that I'm glad the year is over.

1. The Triumph of Keynesian Economics.

Liberals, Progressives, and Democrats were eagerly waiting for an economic crash so they could clip capitalism's wings. They got their wish.

When the crash happened, most people, including most Conservatives, scratched their heads and said, "Yup, it's capitalism. Bad, but necessary system. Got to control it even more." They ran to the Keynesian-New Deal play book.

Very few economists stood against this proposition and when the Democrats acted, it was right out of the Keynesian playbook: keep interest rates low, flood the economy with credit, pass spending bills to implement fiscal stimulus, and adopt more stringent rules to regulate financial institutions.

This is a result of 70 years of Keynesian economics education in America and the rest of the world. Paul Samuelson, who just died, was the father of the Neo-Keynesian econometrics movement in academia, and he and his fellow Keynesians are mostly responsible for this.

My fellow free market Austrian theory economists lost their seat at the policy table, and in fact have been banished to the back room. We need to do something about this. Our well being rides on it.

2. The Failure of Keynesian Economics.

The only problem with Keynesian theory and its policy applications is that it doesn't work.

I am not unaware that many commentators and economists are pointing to recent "Green Shoots" as proof that Keynesian policies work, but it doesn't. By their own admission, at least according to Paul Krugman and many other Keynesians, the fiscal stimulus has been insufficient to bring about a lasting recovery. Krugman worries about a second collapse when the stimulus runs out. He's right.

What we are seeing in the economy that is labeled "recovery" comes from two things:

a. The temporary effect of federal spending from the $787 billion American Recovery and Reinvestment Act of 2009; and

b. Normal recovery behavior that occurs after every crash and that is unrelated to fiscal stimulus.

Much to the chagrin of our Economic Czars there are nagging problems of deep concern. Unemployment. Falling asset values, especially in the real estate market. Lack of bank liquidity and bank failures. Lack of credit. Falling consumer consumption and rising savings. "But, it's supposed to work, dammit!" Keynesian theory was supposed to open the liquidity trap, create jobs, and stoke the economy by taking my money and give it to someone else to spend. It didn't work in Japan and it isn't working here.

The stimulus won't last.

3. New Deal v. 2.0.

The Washington--Wall Street Economics Complex is in full swing.

Too Big To Fail has been the motto of this Administration (as well as the last one). As always there are many political strings tied to economic policy coming out of Washington. While TBTF is not this year's story, the bankruptcy and bailout of GM and Chrysler in 2009 is. It is a bailout of the UAW and other auto industry unions and nothing more.

The bailout of the banks and major financial institutions is just the same. Yes, Citi didn't fail and AIG was taken over, but this temporary relief will just stall a recovery. Bankrupt institutions must fail; otherwise their balance sheets will remain fouled and valuable capital will be lost, mired in unprofitable loans.

The Administration and Congress are now putting forward new legislation to further regulate businesses and financial companies. These new laws are not re-regulations, but are increased regulations that will give the federal government even more control over the economy. By asserting itself further into commerce in order to wield greater power, the center of power has moved farther from the money and commercial centers like NYC, Chicago, and L.A. into Washington, D.C.

These policies are political expediencies and work to undermine the best interests of the American people because they reward the very companies that ought to fail. It will delay economic recovery by propping up essentially bankrupt companies who are now relegated to begging Washington for more money.

It will be a boon for lawyers.

4. Spending Unleashed.

Deficit spending will be a huge burden on our children, grandchildren, and generations of our great-grandchildren. It will be bad for the economy.

As the national debt becomes a greater percentage of GDP, the taxes required to support it will be a permanent drag on the economy. This year alone, the deficit will amount to about $1.8 trillion, depending on how you count it. In ten years, according to the Obama Administration, the national debt will double.

Considering that the debt is being incurred to fund dig-a-hole-and-fill-it programs that result in almost no long-term benefit, the cost to our descendants amounts to inter-generational theft.

5. The Health Care Bill.

This is an economic game changer.

While the bill has not yet been passed by Congress, it will and it will mark the point in history when the U.S. joined the group of countries, mainly European, which blend market economies with the welfare state. These quasi-socialist Nanny-state systems have long-term issues with economic torpor, permanent high unemployment, and a lack of innovation. We will have the same experience.

Comparative economic studies of health care systems similar to the current proposed legislation reveal that even the best of them are running large deficits. More and more, these countries are seeking market-based solutions to bail them out as their citizens reject higher taxes. They are beginning to understand that their problems exist because their tax burdens are too high and their regulations are too rigid.

The rising federal cost of this program will be another huge burden for taxpayers, especially for young workers who will be disproportionately saddled with the cost of supporting their elders.

This bill also marks the beginning of the end of the finest medical system in the world. Just ask Silvio Berlusconi and other wealthy world leaders who come here for medical care.

6. Stock Market Gains.

If 2008 was the Year of the Crash, 2009 was the Year of Recovery. In October, 2007 the Dow hit its high of 14,279. In March 2009 it touched its low of 6,440. Today it closed at 10,548, a rise of about 46% from the low in March.

We can argue about whether the market is properly valued. I tend to agree with David Rosenberg of Gluskin Sheff that the market is overpriced relative to fundamentals as well as macroeconomic trends. Whatever. 

I have two points you may wish to consider:

a. Traders believe that Keynesian fiscal stimulus works; and

b. While market gains have traditionally created a feeling of wealth in the economy, this time is different.

With regard to the recovery based on Keynesian policies, see above.

Normally people feel better about themselves and their fortunes because their stocks have rallied. People with 401Ks feel better about their retirement. Retired people feel better about their portfolios.

I don't think its working that way this time. I sense a feeling of caution, if not dread about the future of the economy.

I live in a very wealthy community, Montecito, California. Money here comes from real estate, business people who have sold their companies, or financial guys (hedge funders, Goldman types). In the last two months our sluggish real estate market has seen a sudden and dramatic rise in listings. You would think that these folks wouldn't have a problem with their housing, but they do.

I think many of them took (and are still taking) big hits to all of their assets: typically, commercial real estate investments, aggressive stock trading programs, and venture capital deals. Combine this with falling incomes and a high debt load and you see homes on the market from $1.5 million (formerly $3 million) to $15 million (formerly $25+ million). Not everyone you think is flush, is.

No offense to the great unwashed out there, but these people are big, big consumers.

If it's not working with the "rich," you can imagine what regular folks feel.

7. Year of the Contrarian Investors.

I get a certain amount of guilty pleasure from the market success of the contrarian investors who made huge market fortunes as a result of economic turmoil. They strayed from the orthodoxy and made huge fortunes.

While this was also a 2008 story, the results of the Harvard University endowment fund is all 2009. I like to pick on Harvard because they are a center of econometric, Keynesian economics. So, you might ask, if they were so smart, why did they take a huge hit? Why did they invest in so many stupid deals at the top of the market? Some say that their portfolio is half of what is was.

Yet you have Universa Investments and John Paulson who made huge fortunes for betting against the crowd. It demonstrates that most economists and investment advisors don't think. They behave sheep-like because they know there is safety in numbers and they won't be criticized if they lose clients' money when everyone else is doing the same thing.

If you want to make money, think, don't copy. You might also want to read anything by Taleb and Mandelbrot.

Good luck in 2010.

8. The Inflation-Deflation Debate.

This is the great debate right now.

Everyone is looking at money base vs. excess bank reserves vs. M1 and are betting that either the Fed can sop up the money and credit or, they can't. This issue has been debated in the blogosphere at great length by all spectra of economists. Krugman sees inflation. Many Austrians are predicting inflation. Most Monetarists are predicting inflation. A few like Mike Shedlock (Mish) are predicting deflation.

The Fed is betting that if it pays interest on banks' excess reserves, that they can prevent the money from hitting the economy.

This is a huge issue. The government and the Fed would love to see inflation. Rising prices would show ephemeral profits, enable debtors to pay off debt with cheaper dollars, and the economy would be back to a growth and boom-bust cycle.

I have been doing a lot of thinking about this lately and I will credit Mish for helping me to crystallize my thoughts. I plan to write an article on this soon. I don't think inflation is imminent, but I think it's coming sooner than Mish thinks, and not for the exact same reasons some of my fellow Austrians think. And I'm not just trying to synthesize the two poles. See No. 9.

Like Mish, I don't see these reserves as being "excess." They are being held by banks because they are unsure of their capital positions and they see too much risk in lending money. So, these reserves serve an economic purpose and aren't excess, just sitting out there because the Fed forced money on them. It won't be that easy to pry them loose from the money.

9. The Great Real Estate Reflation.

The government is trying to reflate the real estate market with fiscal policies.

It is clear that fiscal measures are having an impact on the housing market. The government through tax policy and lending requirements (Freddy, Fannie, and the FHA) are already starting to put a floor under the housing market. New rules related to commercial real estate loans ("extend and pretend") may help stabilize the commercial real estate market.

This is not to say that the real estate market won't have continued weakness, but I believe that these policies will have a positive impact on real estate and it will stabilize the market and banks will be able to account for the risk in their loan portfolios. Remember that 90% of the working population have jobs.

I would expect this impact to take effect by late 2010. Yes I understand the shadow market and the problems in the housing market. But don't underestimate the power of the federal carrot.

Banks, especially the regional banks who finance most of commercial real estate and small business, will be bailed out of massive losses. This is what is holding back credit. 

Combine this with inflation and we will see the beginning of the next boom-bust cycle. It won't end well.

10. Bloggers Are Taking Over the Economic Media.

Anyone can blog. Few get noticed. But great upheaval drives people to find explanations they don't seem to get in the mainstream media. I think the Wall Street Journal, Bloomberg, and The Financial Times are great at reporting the news. But people want more and different analysis than they offer and they also want a forum where they can express their opinions.

It is refreshing to see the bloggers that I admire do well: Calculated Risk, Barry Ritzholz's Big Picture, Mish's Global Economic Trend Analysis, and the Naked Capitalist are now the big dogs in the blogosphere, getting 50,000 to more than 100,000 page views a month. It is also wonderful to see the Mises Institute get 1,000,000 page views per month as people are finding that the Austrians have something to say.

I am also pleased to report that my blog, The Daily Capitalist, continues to grow. I am also proud to be a part of Zero Hedge, which has quickly become a very popular and rising blog star.

Thanks for reading Zero Hedge and The Daily Capitalist. And best wishes for 2010.

 

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Thu, 12/31/2009 - 14:24 | 179131 Anton LaVey
Anton LaVey's picture

No +666? You just hurt my feelings, Daedal.

Thu, 12/31/2009 - 12:16 | 178908 Daedal
Daedal's picture

Your analysis shows great disdain for Keynesian economics, yet if you look just north of the border, Canada did not suffer as bad of a recession as the U.S.

Leo, you're resorting to a strawman argument. We could give 100% credence to your claim, and it could still be argued that Austrian economics is superior to Keynesianism.

Fri, 01/01/2010 - 12:23 | 179833 Anonymous
Anonymous's picture

Leos whole investment thesis depends on a prop job from the government

Extend pretend and hyperinflate

Thu, 12/31/2009 - 12:02 | 178886 mikla
mikla's picture

I agree with "sometimes".  However, the housing downturn preciptated the decline in the US, and Canada is lagging its correction.

Tell us what you think of the Canadian system in 24 months.  They will be in serious trouble -- housing corrections, bankupt pension systems, failed healthcare, declining tax base, wholesale societal decline.

No, it's not entirely their fault (demographics are what they are), but no, Canada will *not* dodge this bullet, and Keynsian economics merely promise more bridges to nowhere.

Thu, 12/31/2009 - 19:13 | 179472 KevinB
KevinB's picture

You're a fool. You know nothing about the Canadian economy.

US housing started to fall because it was artificially inflated by demand that wasn't backed up by real money. Canada, in contrast, requires you to actually have income and assets before you get a mortgage. We don't need a correction because we didn't get into the same stupid problems as America did in the first place.

Failed healthcare?! You mean the Canada that spends less on health care as a % of GDP than America, but gets better outcomes? Some failure.

Bankrupt pensions? Unlike the US scheme, the Canada Pension board actually holds real, marketable securities, not IOU's from Treasury like Social Security does. It's on considerably better actuarial standing than SS.

You're talking out your ass; don't drink and post.

Thu, 12/31/2009 - 20:29 | 179523 mikla
mikla's picture

You're a fool. You know nothing about the Canadian economy.

Methinks thou dost protesteth too much.

It's true that the structure of the Canadian housing bubble is different than that in the US because of how taxes are treated (e.g., US mortgage deductions) and how houses are purchased in Canada (typically with securitized NHA-insured products in Canada).  So, the bubbles will present differently.

However, Canadian home prices are up more than 20% over the past year (are at a record high last month), Canadian homeownership is the highest in four decades and higher than the US (so it can only go down), home-price-to-rent is at 2-3 standard deviations, residential mortgage balances have risen 7% over the past year, and mortgage debt relative to Canadian household incomes is now over 70% for the first time ever.

Canadian housing is in a bubble.  It will pop, and Canada will be caught up in worldwide deflationary collapse like every other country.

Of course, not a problem, because Canadian taxpayers insure many of those mortgages.  Yes, those same taxpayers that insure all those Canadian pensions.  Good luck with that.

We agree that the US will default on its promises to its people regarding Social Security.  We disagree that Canada will default on its promises to its people regarding pensions.

Since Canada's health care system is so awesome, please tell your friends to stop coming to the US for medical care.  I know of nobody going from the US to Canada for medical care.

 

Fri, 01/01/2010 - 21:49 | 180243 KevinB
KevinB's picture

It's true that the structure of the Canadian housing bubble is different than that in the US because of how taxes are treated (e.g., US mortgage deductions) and how houses are purchased in Canada (typically with securitized NHA-insured products in Canada).

Good lord, you're stupid. The lack of mortgage interest deductibility is a point in Canada's favour. Banks look at your proposed mortgage payment as a percentage of your after-tax income. If it's too high, you DON'T get a mortgage. This means Canadians, in general, are in a better position to support their mortgages. 

NHA insurance applies to fewer than half the mortgages granted in Canada. That's a red herring.

It's not that we haven't had real estate bubbles in Canada, or that they're impossible to have here. Certainly, in Toronto and Vancouver in the early 90's, we lived through one, when people were buying condos to flip. That's not what's happening now. The fact that prices are up from a panic low is another red herring.

If you can make it through the registration process (I doubt it; it involves typing in your name and address), why don't you visit Gluskin-Sheff's site, and look up Dave Rosenberg's "Triple-C" report from the end of October? In it, he has excellent charts comparing, oh, I don't know, the US/Canada federal debt/GDP ratios, among other things. Guess who comes out looking better?

Here are FACTS, dickhead: Canada, which is run by a whip-smart economist, never got into the problems the US did, chose better solutions than bailing out a bunch of bankers and abrogating contract law, has not quasi-nationalised a bunch of industries, and does not have to purposefully understate unemployment, etc. to hide the fact that a recovery is not underway. This is what happens when you have experienced, intelligent people running the shop instead of community organizers.

Is everything rosy in Canada? Of course not. There's still a lot of unemployment. After nearly a decade of federal surpluses, we're back in deficit, and that's not going to turn around overnight because we're still tied so closely to your struggling economy. But I'd rather be living here than there.

Sat, 01/02/2010 - 09:30 | 180468 mikla
mikla's picture

Good lord, you're stupid. The lack of mortgage interest deductibility is a point in Canada's favour.

We agree.  I merely pointed out that difference in support of the assertion, "...the bubbles will present differently."

IMHO, it would be better for the US if mortgage interest were not tax-deductible.

<snip, Rosenberg's Triple-C report>, In it, he has excellent charts comparing, oh, I don't know, the US/Canada federal debt/GDP ratios, among other things. Guess who comes out looking better?

Yes, Canada looks better than the US.  However, Canada will still face a deflationary unwind, and yes, it's unfair the US is somewhat protected from its own stupidity because it's the world reserve currency.

If ratios were all that mattered, the US would have defaulted before Iceland.

Here are FACTS, dickhead: Canada, which is run by a whip-smart economist, never got into the problems the US did, chose better solutions than bailing out a bunch of bankers and abrogating contract law, has not quasi-nationalised a bunch of industries, and does not have to purposefully understate unemployment, etc. to hide the fact that a recovery is not underway. This is what happens when you have experienced, intelligent people running the shop instead of community organizers.

I don't dispute your point -- the US is behaving more irresponsibly.  While I'm not partial to Central Planning (no human exists that is smart enough to keep that going), I concede that socialist countries exist, and people vote to continue socialist policies.  So, at some level, socialism is "stable" (unlike the current US policies that are absolutely unstable).

My point is that it's a good thing Canada is rich in natural resources, because like all countries in the world, it is in a bubble.  When deflation comes to a country near you, that is only because things were previously priced badly.  Deflation is not destruction -- the destruction occurred long before assets were re-priced.

Canada is in trouble because its real estate and pension assets will be re-priced to a disappointing number that will not support future obligations.  There will be much defaulting.  We are all very sorry about the demographics.

And yes, we agree the US is in worse shape, but with more options (larger country, standing military, more resources, world reserve currency).  The biggest issue, however, is after default, can the economy grow its way back into prosperity?  That is a projection of future productivity, which is historically less-than-optimal in socialist countries.

 

 


Sat, 01/02/2010 - 22:02 | 180910 WaterWings
WaterWings's picture

So, at some level, socialism is "stable" (unlike the current US policies that are absolutely unstable).

Yes, as long as a politician can promise a big bag of free shit! to the troublemakers then there shall be stability.

Sat, 01/02/2010 - 17:06 | 180768 Econophile
Econophile's picture

Mikla,

You handled this discussion very well. I wish more people would respond in the same manner. Polite, articulate, and backed up with facts.

Thu, 12/31/2009 - 12:26 | 178922 Daedal
Daedal's picture

I agree with "sometimes".  However, the housing downturn preciptated the decline in the US, and Canada is lagging its correction.

Mikla, you're being roped into an argument that is completely devoid of the content that's being discussed.

Let's say instead of Austrianism vs Keynesianism we're discussing Air Travel vs Railway Travel. You allege Air travel is faster, and then Leo counters by saying that some trains are faster than others.

Thu, 12/31/2009 - 12:30 | 178950 Anton LaVey
Anton LaVey's picture

You could also say this: using a high-speed train is faster - in some circumstances - than traveling by air.

For instance, a high-speed train that drops you off right in the middle of a city could be - in some circumstances - faster than going to an airport outside the city, going through the security checkpoints, boarding the plane, wait for hours on the tarmac because of bad weather, then take off and fly to the other airport, etc... etc...

Frankly, this whole notion of "Austrianism vs Keynesianism" is getting a bit tired, don't you think? The world is a lot messier (and more interesting) than most ideologues think it is.

Thu, 12/31/2009 - 13:25 | 179046 WaterWings
WaterWings's picture

Frankly, this whole notion of "Austrianism vs Keynesianism" is getting a bit tired, don't you think?

Politicians speaking economics are justifying taxes. You're right, it's tired - to the point of the revolution of power to the people. But if you say, 'alter or abolish', in the spirit of the founding fathers, you must be a terrrrist.

Thu, 12/31/2009 - 12:51 | 178982 Daedal
Daedal's picture

LoL. Yes you could say that. I was impacting my point about a logical inconsistency with a metaphor. Clearly the theory of economics cannot be reduced to 2 methods of transportation.

Frankly, this whole notion of "Austrianism vs Keynesianism" is getting a bit tired, don't you think? The world is a lot messier (and more interesting) than most ideologues think it is.

Yes it is tired. Exhausting, in fact. I cannot understand how Keynesianism continues to be the economic policy of choice considering its track record. Even more aggrevating is that Austrian economics gets blamed for the failures of Keynesianism.

Fri, 01/01/2010 - 14:34 | 179930 Anonymous
Anonymous's picture

A plausible answer as to "...how Keynesianism continues to be the economic policy of choice considering its track record." is that its basic premise of fiscal and monetary intervention by the public sector (can't trust the private) is a rationalisation for greater government control. I can imagine the inside trading, Alexander Hamilton and Jefferson having the same deabate, with the latter being the Austrian.

Thu, 12/31/2009 - 16:18 | 179294 Anonymous
Anonymous's picture

Lots of folks would rather have the gov.
take responsibility for them (Keynesian)
than take responsibility for themselves (Austrian)?

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