Wednesday, June 25, 2008

A Time of Transitions

Let’s start with the bad news first. I believe that we are in for an extended period of economic adjustment. This will take time for we are at a point where the foundation for the world economy has to be restructured so as to bring us to the start of a new era.

The good news is that the adjustment is taking place in a relatively orderly fashion. Yes, there still remains a lot of work to be done on repositioning portfolios and on the structure of industries. Yes, there will still be some surprises along the way. But, people are systematically working things out. People have, by-and-large, stopped hiding things and are finding out that within the current environment it is best to identify problems, disclose them, and then get to work on them. It just seems that the issues are deep and broad and will take an extended period of time to fully accommodate them.

In the United States, and some other developed countries, a lot of wealth has been lost. Layoffs are taking place or will take place in many major industries…I’m thinking of financial services and motor vehicles as starters. The housing industry is depressed and some experts think that house sales and the decline in housing prices may continue in and through 2009. Prices for oil and other commodities continue to rise. Consumer confidence has reached a 16-year low. This is a time of transition.

Perhaps the greatest transition underway is that in the field of energy. Transitions always hurt a lot of people. Major transitions are just that much worse. Yet, many agree…this transition has to take place…sooner or later. The United States, and much of the world, has done almost everything it can to postpone the day of reckoning, have band-aided the existing system here and there, and have protected the current economic structure as much as it could. Maybe that day is here.

Transitions hurt. Did I say that before? It is going to hurt many, many people to move on to the new way to power the world but maybe it is time for the United States, and others, to deal with the energy problem seriously and encourage the transition. Humans are problem solvers. Humans are great innovators. Look what has happened in terms of Information Technology over the past 50 years! Look what has happened in terms of the biological and physical sciences over the past 50 years! We can only be optimistic about what humans can do to solve problems.

Yet, over the last 50 years, politicians have provided incentives to the energy industry to maintain existing energy platforms. In doing so, they raised the “switching costs” of moving on to other energy platforms because the incentives have been structured away from innovation and change. Sure, the day would come when new sources of energy would be forthcoming, but the politicians creed is to keep getting re-elected in the current environment…the transition to these new sources and the disruption accompanying the transition will come on someone else’s watch.

Maybe we should celebrate oil selling for $135 per barrel. Maybe we should celebrate gas at the pump selling in excess of $4.00 per gallon. Maybe we should hope that prices go even higher! The transition is here! Let it happen!

My concern is that efforts will be made to alleviate the short run pain of the energy problem and drug the world once again so as to maintain the status quo for a little longer. It seems that the United States, and the world, only move on issues like this when there is a crisis. It seems as if times like this are the only times when pain is sufficiently wide-spread to gain the attention of politicians and others in positions of leadership. Do we really want to provide another narcotic release from the pain and postpone attacking the real problem? Drugs are addictive but if health is to be achieved the addiction must somehow, sometime be broken.

The new energy platform…whatever that platform will be…will result in a substantial change in the way people live their lives. I can’t predict what the new platform will look like. I don’t believe that anyone can predict what the new energy platform will look like. As an economist all I can say is that relative prices will change, incentives will be altered, and innovation will take place. What exactly this will mean for life on this planet is currently a mystery.

Individuals, as early as the 18th century talked about computing machines. But, who predicted the changes in life that the mainframe computer brought about in the 1950s and 1960s? Who predicted the creation of the personal computer and how it would alter how people worked in the 1980s? Who predicted the development of the Internet and how it would change how people lived and worked in the 1990s and beyond? And so on, and so on…

This adjustment will take time and the transition will be painful for individuals, for businesses, for industries, and for governments. I talked about a 50-year periods in terms of other transition cycles. Maybe…just maybe…we need to bite-the-bullet and move on into the future.

There is another transition that needs to take place and this is as good a time as any to accept the need for it and move forward with it. This is the transition the United States must make to become a full economic partner of other nations in the world of the 21st century. Other nations have gone through the transition the United States must go through and it is painful. But, why should the people of the United States postpone this adjustment if it can be accomplished from where we are now? Why can’t the United States move from where it is and change its way of conducting economic policy?

The period of the liquidity crises has been passed in this policy cycle. It appears that further adjustment of portfolios and expectations are proceeding in an orderly fashion. However, the full adjustment back to robust economic health is expected to be slow and painful. The United States government must not disrupt this transition back to health. But, it must act in a way that allows this adjustment to take place while bringing discipline back into its operations. The value of the dollar must be protected and supported, especially during this time when other central banks throughout the world will probably be raising their short term interest rates. Thus, the Federal Reserve must walk a fine line between not further disrupting the economic re-alignment going on and fully supporting the value of the United States dollar. Trust must be re-established in international financial markets that the Federal Reserve is fully cognizant of its responsibilities with respect to its currency and will fight the good fight against inflationary pressures. The relatively weak economy should help in this fight although the battle against worldwide commodity inflation will make the adjustment just that much more difficult.

The new President and his administration must also bring fiscal discipline back to the government. Again, this will be difficult and cannot be fully achieved in the near term. It is hard to see how the Bush tax cuts can be rescinded within the current environment. It is hard to see how other tax cuts can be implemented anytime soon. New programs? Well, prudence must rule the day. Any new president is going to be limited in what can be accomplished in the near term if this fiscal discipline is going to be achieved. If the transition is going to be made, however, it should be done now and not postponed indefinitely.

The reality of the situation is one in which the United States is going to have to work with others in the world. It cannot act independently of other nations in either energy policy or in terms of economic policy. Our period of transition is here…in many areas. The past is no guide at this time and we must not try to hold onto it. We must be open to the future while helping people through the pain of change.

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