Please note that today’s Wall Street Journal carries an editorial that makes exactly the same points concerning the decline in the value of the United States dollar that I made in my post yesterday. I refer to the comments made in “A Dollar Referendum” which can be found at http://online.wsj.com/article/SB122965017184420567.html?mod=todays_us_opinion.
Let me just summarize the points made in the Wall Street Journal article.
First, after the dollar rose earlier in the fall due to the international flight to quality to invest in Treasury securities, the value of the United States dollar has fallen precipitously in December as a result of the recent Fed actions opening the gate to flood the world with dollars.
Second, why should international financial markets have any faith in the Federal Reserve to restore discipline to the markets when it “has proven that it is far better at adding liquidity than removing it”? The editorial then refers to the Fed record in maintaining exceedingly low target interest rates earlier in the 2001 to 2003 period.
Third, the editorial discusses the flow of new United States government debt that will be coming to the market…approximately $1.0 trillion…related to the proposed Obama stimulus plan. The implication is that the monetary thrust of the Fed will basically monetize this debt.
Fourth, the concern is expressed that measures of inflation, such as the consumer price index are lagging indicators, and do not capture the market’s lack of confidence in international financial markets that the Federal Reserve will be restore order once the “deflation” psychology has been defeated. The decline in the value of the United States dollar represents this expectation of market participants.
In the words of the Wall Street Journal editorial: “The dollar’s decline is a warning about the future. Mr. Bernanke’s decision to flood the world with dollars will no doubt succeed in preventing a deflation. What everyone wants to know is whether he also has the fortitude—or even the desire—to prevent a run on the world’s reserve currency.”
Friday, December 19, 2008
Thursday, December 18, 2008
The Declining Dollar
The decline in the value of the dollar has gotten increasing headlines since the Federal Reserve Board of Governors released its new monetary policy efforts on Tuesday. Many short run reasons are being given for the recent decline in the value of the dollar, especially against the Euro and the Yen.
The most intriguing explanation for the decline, however, is a longer term reason. In this explanation, analysts argue that the decline in the value of the dollar is just a continuation of the trend which began in early 2002 and continued through until early August 2008.
The story that accompanies this explanation is that a series of events in 2001 and 2002 convinced international markets that the United States government had forfeited any discipline it had established over its fiscal and monetary policies. First, there was the huge Bush (43) tax cut that moved the government’s budget from one of surplus to one of deficit. This was followed by the war on terror and the Iraq invasion which exacerbated the amount of the budget deficit.
In addition to this the Greenspan Federal Reserve cut the target Federal Funds rate to very low levels, around 1% or so, for a period of about two years. Mr. Greenspan’s concern, apparently, was fear of an extended recession following the burst of the dot.com bubble in the stock market. The result was the creation of the housing bubble as well as smaller bubbles in other areas of the economy, including commodity prices.
As a consequence of these actions, massive amounts of debt were created. Fortunately for the United States…at the time…was that over 50% of this debt…both private and public debt…was financed outside of the United States…large amounts being placed in China, India, and the middle east…although as we found out…banks all over the world acquired huge quantities of mortgage-backed debt.
The interesting thing that was learned from this period is that consumer inflation (as measured by the Consumer Price Index) could be kept in check while inflation ran rapid in asset prices (particularly in housing prices and commodity prices at this time). The monetary authorities concentrated on consumer prices and did nothing with respect to asset prices.
The thing is that “self-reinforcing expectations” can get built into asset prices leading to a massive increase of financial leverage. Consumer credit can be expanded for purchases of the items individuals purchase, but this credit expansion cannot match the possibilities for increase that exist as asset prices go up substantially, year-after-year.
Foreign exchange rates capture the relative expectations of people that operate in these markets. The specific ‘relative expectations’ that are relevant here pertain to how market participants judge how the economies of different countries are expected to perform. Performance in this instance relates to the state of the economy, performance of government’s in terms of their conduct of their economic policies, and expected inflation.
In this respect, Paul Volcker, former Chairman of the Board of Governors of the Federal Reserve System, has stated that the price of a country’s currency is the most important price in its economy. The value of a country’s currency is, in a real sense, the “grade card” of the country’s economic and monetary policy, relative to the rest of the world.
Thus, as the value of the United States dollar fell more than 40% from early 2002 to August 2008, participants in international financial markets were indicating a belief that the government of the United States was showing little or no discipline over its budget and this was connected with an extremely “loose” monetary policy. To these market participants, the United States would have to “pay the piper”, sooner or later.
As the story continues, when the financial markets fell apart in September, the United States dollar became the “quality” asset in the world and investors flocked to the dollar as they repatriated assets from all over the globe in order to invest in U. S. Treasury securities. As a consequence of this rush to quality the value of the United States dollar rose.
This latter movement has apparently come to an end. There seems to be a number of short-run reasons for the recent decline in the value of the United States dollar…one of them being a move on the part of foreign investors to get back into their own currencies to dress up their year-end balance sheets.
But, there is another reason given for the drop in the value of the dollar and this is connected with the decisions of the Federal Reserve that were announced on Tuesday and the projected rise in the deficit of the federal government. For all intents and purposes, the target Federal Funds rate is now approximately zero. In addition, the Fed said that it would buy financial assets, long term U. S. Treasury issues and mortgage backed bonds and so forth in order to flood the financial markets with liquidity. And, they warned, they will continue to do this for as long as necessary…whatever “necessary” means. On top of this, the Obama team seems to be talking about adding roughly $1.0 trillion in expenditures to the federal budget to get the United States economy going again.
One can easily draw from this the assumption that the world will be flooded with dollars…millions and millions of dollars. How should one react to this in terms of the value of the dollar?
One could argue that this is exactly what world financial markets have been predicting would happen since early in 2002. (They did not, and could not, predict precisely the path of the collapse.) This is exactly the reason why the United States dollar has declined by about 40% since then!
The problem is that there are no “good” decisions left for the United States. This is the dilemma that must be faced when discipline in lost. When one sees the consequences of a lack of discipline, one does what one needs to do in order to get one’s life back in order. Getting discipline back into one’s life is a matter of one step at a time.
In terms of priorities…getting the economy going and avoiding a cumulative collapse is number one. Until this is accomplished, we may just have to see the value of the dollar continue to decline.
The most intriguing explanation for the decline, however, is a longer term reason. In this explanation, analysts argue that the decline in the value of the dollar is just a continuation of the trend which began in early 2002 and continued through until early August 2008.
The story that accompanies this explanation is that a series of events in 2001 and 2002 convinced international markets that the United States government had forfeited any discipline it had established over its fiscal and monetary policies. First, there was the huge Bush (43) tax cut that moved the government’s budget from one of surplus to one of deficit. This was followed by the war on terror and the Iraq invasion which exacerbated the amount of the budget deficit.
In addition to this the Greenspan Federal Reserve cut the target Federal Funds rate to very low levels, around 1% or so, for a period of about two years. Mr. Greenspan’s concern, apparently, was fear of an extended recession following the burst of the dot.com bubble in the stock market. The result was the creation of the housing bubble as well as smaller bubbles in other areas of the economy, including commodity prices.
As a consequence of these actions, massive amounts of debt were created. Fortunately for the United States…at the time…was that over 50% of this debt…both private and public debt…was financed outside of the United States…large amounts being placed in China, India, and the middle east…although as we found out…banks all over the world acquired huge quantities of mortgage-backed debt.
The interesting thing that was learned from this period is that consumer inflation (as measured by the Consumer Price Index) could be kept in check while inflation ran rapid in asset prices (particularly in housing prices and commodity prices at this time). The monetary authorities concentrated on consumer prices and did nothing with respect to asset prices.
The thing is that “self-reinforcing expectations” can get built into asset prices leading to a massive increase of financial leverage. Consumer credit can be expanded for purchases of the items individuals purchase, but this credit expansion cannot match the possibilities for increase that exist as asset prices go up substantially, year-after-year.
Foreign exchange rates capture the relative expectations of people that operate in these markets. The specific ‘relative expectations’ that are relevant here pertain to how market participants judge how the economies of different countries are expected to perform. Performance in this instance relates to the state of the economy, performance of government’s in terms of their conduct of their economic policies, and expected inflation.
In this respect, Paul Volcker, former Chairman of the Board of Governors of the Federal Reserve System, has stated that the price of a country’s currency is the most important price in its economy. The value of a country’s currency is, in a real sense, the “grade card” of the country’s economic and monetary policy, relative to the rest of the world.
Thus, as the value of the United States dollar fell more than 40% from early 2002 to August 2008, participants in international financial markets were indicating a belief that the government of the United States was showing little or no discipline over its budget and this was connected with an extremely “loose” monetary policy. To these market participants, the United States would have to “pay the piper”, sooner or later.
As the story continues, when the financial markets fell apart in September, the United States dollar became the “quality” asset in the world and investors flocked to the dollar as they repatriated assets from all over the globe in order to invest in U. S. Treasury securities. As a consequence of this rush to quality the value of the United States dollar rose.
This latter movement has apparently come to an end. There seems to be a number of short-run reasons for the recent decline in the value of the United States dollar…one of them being a move on the part of foreign investors to get back into their own currencies to dress up their year-end balance sheets.
But, there is another reason given for the drop in the value of the dollar and this is connected with the decisions of the Federal Reserve that were announced on Tuesday and the projected rise in the deficit of the federal government. For all intents and purposes, the target Federal Funds rate is now approximately zero. In addition, the Fed said that it would buy financial assets, long term U. S. Treasury issues and mortgage backed bonds and so forth in order to flood the financial markets with liquidity. And, they warned, they will continue to do this for as long as necessary…whatever “necessary” means. On top of this, the Obama team seems to be talking about adding roughly $1.0 trillion in expenditures to the federal budget to get the United States economy going again.
One can easily draw from this the assumption that the world will be flooded with dollars…millions and millions of dollars. How should one react to this in terms of the value of the dollar?
One could argue that this is exactly what world financial markets have been predicting would happen since early in 2002. (They did not, and could not, predict precisely the path of the collapse.) This is exactly the reason why the United States dollar has declined by about 40% since then!
The problem is that there are no “good” decisions left for the United States. This is the dilemma that must be faced when discipline in lost. When one sees the consequences of a lack of discipline, one does what one needs to do in order to get one’s life back in order. Getting discipline back into one’s life is a matter of one step at a time.
In terms of priorities…getting the economy going and avoiding a cumulative collapse is number one. Until this is accomplished, we may just have to see the value of the dollar continue to decline.
Monday, December 15, 2008
Lessons on How to Beat Deflation Trap
As the United States is gearing up for additional massive efforts in both the areas of monetary and fiscal policy we need to listen to the experience of other nations who have gone through recent periods of economic distress. We need to understand, as well as possible, just how this modern recession/deflation thing works.
There is a very interesting interview with Masaaki Shirakawa, a governor of the Bank of Japan, in the Financial Times today (http://www.ft.com/cms/s/0/18086fba-ca0c-11dd-93e5-000077b07658.html). One of the important things about this interview is the emphasis it puts on understanding what is happening in different sectors of the economy instead of just focusing on aggregate information. This has importance in understanding how recessions begin as well as for understanding the depth and length of recessions.
One of the problems with modern macroeconomics, as discussed in my review of Paul Krugman’s “The Return of Depression Economics and the Crisis of 2008” appearing on Seeking Alpha on December 9, 2008, is that macroeconomists want to focus on aggregates and not what makes up the aggregates. For example, capital is defined by one of the most popular text books on macroeconomics as “the sum of all the machines, plants, and office buildings in the economy.” And, all these component parts are perfectly and costlessly interchangeable.
The difficulty with this is, according to Governor Shirakawa, is that it does not allow for an understanding of the “imbalances” and “dislocations” that evolve during an economic expansion or during asset bubbles. Thus, when the economy is expanding the monetary authority needs to “watch carefully whether the broadly defined imbalances are accumulating or not.”
Furthermore, during these times, risk-taking and financial leverage tend to expand dramatically. It is not just aggregate demand or supply that is important in understanding the evolution of the economy but also what is happening in various sectors of the economy and how the financial structure needs to unwind.
And, experience has shown that these imbalances occur even when things like the consumer price index is behaving well. “Very often in recent decades we experienced a situation in which imbalances are accumulating, despite the fact that the inflation rate is quite subdued.” He continues that “Inflation targeting is one part of a good framework to explain monetary policy. But if inflation targeting creates the social presumption that the central bank can look at consumer price inflation alone, then it might have some unintended effect of helping the creation of a bubble.” That is, asset prices in different markets, housing, stocks, and so forth, must be observed also.
Why is it important to understand this?
We need to understand this because it points to the fact that recessions or periods of deflation cannot be handled by just appeals to pumping up aggregate demand. We need to understand that the previous upswing created imbalances, bubbles, dislocations, over-investment and these previous decisions cannot just be dissolved by assuming that all capital investment is alike and that stimulating aggregate demand is not the only thing that needs to be done.
But, Governor Shirakawa argues, this does not mean that monetary or fiscal policies are not needed in combating deflation and turning the economy around. Both are a part of a sound strategy to get the economy going in the right direction.
What is also important is a focus on the imbalances and dislocations that were created in the previous run-up. The policy makers need to understand how the various sectors are working themselves out and what, if any, bumps in the road lie ahead.
For example, the prime example of the ‘asset bubble’ just experienced is the housing industry. Until the summer of 2006, the housing market was ‘riding high’ with housing prices and housing starts seeming like they would never stop. Yet they did and housing prices have dropped steadily ever since. How far will they drop? Some analysts say that housing prices must drop to at least 50% of their peak value. Also, the picture gets even darker when one observes that there are still two major clouds hanging over the future. Both are related to the ‘financial innovations’ of the 1990s…major amounts of Alt-A mortgages and the Payment-Option ARMS are going to re-price over the next two to three years. The peak in housing foreclosures and personal bankruptcies is not expected to arrive for at least a year from now.
Another example is the financial industry. Tremendous losses have already been taken by banks and others, yet more are expected. The reason for this is that the banks still don’t fully comprehend the extent of the write-downs they are going to have to take on existing assets. Then, there is the fact that the banks have not yet seen the extent of the write downs connected with credit cards, auto loans, high-yield securities, and commercial and industrial loans. And, this doesn’t even consider the possible adjustments that will need to be made in the mortgage area mentioned in the previous paragraph. Mutual funds and hedge funds now are restricting investors who want to get their money back. And, then we are starting to see some of the fraud schemes surface that were a part of the recent credit inflation.
A further example is the auto industry (which also applies to other areas of manufacturing in the United States). I think everyone can agree that there are massive areas of imbalance and dislocation in this industry. Who is at fault? The auto executives? The labor unions? The politicians? The consumer? Everybody else? I don’t believe that any one person or group can be singled out as the cause of the problems in this industry.
But, I think that we can all agree that the problems are massive. These problems have to do with technology, innovation, out-of-date facilities, inappropriate pricing of resources, and other excesses that have been built into the structure over many years. Regardless of whether or not there is a bailout of this industry, it is going to take many years for the auto industry (and, I would argue many other areas of manufacturing in the United States) to really join the 21st century. Obviously, aggregate demand policies are not going to take care of the restructuring that is needed here.
Shirakawa summarizes: “Based on our experience, the world economy or the US economy needs the elimination of excesses. Of course the exact excesses vary from country to country…In today’s US for instance, housing is excessive; household debt is also excessive—I don’t know by how much, but anyways ‘excessive’ is there.”
“Negative feedback is now at work and I cannot give you a precise answer (to how long the global crisis is to run). What is crucial is to avoid a situation in which the adjustment leads to a serious downturn in the economy.”
In conclusion, there is no quick fix. The ‘excesses’, ‘imbalances’ and ‘dislocations’ in each sector must work themselves out. Monetary and fiscal policy may be able to soothe the pain…but they will not eliminate it. I tend to agree with Governor Shirakawa
There is a very interesting interview with Masaaki Shirakawa, a governor of the Bank of Japan, in the Financial Times today (http://www.ft.com/cms/s/0/18086fba-ca0c-11dd-93e5-000077b07658.html). One of the important things about this interview is the emphasis it puts on understanding what is happening in different sectors of the economy instead of just focusing on aggregate information. This has importance in understanding how recessions begin as well as for understanding the depth and length of recessions.
One of the problems with modern macroeconomics, as discussed in my review of Paul Krugman’s “The Return of Depression Economics and the Crisis of 2008” appearing on Seeking Alpha on December 9, 2008, is that macroeconomists want to focus on aggregates and not what makes up the aggregates. For example, capital is defined by one of the most popular text books on macroeconomics as “the sum of all the machines, plants, and office buildings in the economy.” And, all these component parts are perfectly and costlessly interchangeable.
The difficulty with this is, according to Governor Shirakawa, is that it does not allow for an understanding of the “imbalances” and “dislocations” that evolve during an economic expansion or during asset bubbles. Thus, when the economy is expanding the monetary authority needs to “watch carefully whether the broadly defined imbalances are accumulating or not.”
Furthermore, during these times, risk-taking and financial leverage tend to expand dramatically. It is not just aggregate demand or supply that is important in understanding the evolution of the economy but also what is happening in various sectors of the economy and how the financial structure needs to unwind.
And, experience has shown that these imbalances occur even when things like the consumer price index is behaving well. “Very often in recent decades we experienced a situation in which imbalances are accumulating, despite the fact that the inflation rate is quite subdued.” He continues that “Inflation targeting is one part of a good framework to explain monetary policy. But if inflation targeting creates the social presumption that the central bank can look at consumer price inflation alone, then it might have some unintended effect of helping the creation of a bubble.” That is, asset prices in different markets, housing, stocks, and so forth, must be observed also.
Why is it important to understand this?
We need to understand this because it points to the fact that recessions or periods of deflation cannot be handled by just appeals to pumping up aggregate demand. We need to understand that the previous upswing created imbalances, bubbles, dislocations, over-investment and these previous decisions cannot just be dissolved by assuming that all capital investment is alike and that stimulating aggregate demand is not the only thing that needs to be done.
But, Governor Shirakawa argues, this does not mean that monetary or fiscal policies are not needed in combating deflation and turning the economy around. Both are a part of a sound strategy to get the economy going in the right direction.
What is also important is a focus on the imbalances and dislocations that were created in the previous run-up. The policy makers need to understand how the various sectors are working themselves out and what, if any, bumps in the road lie ahead.
For example, the prime example of the ‘asset bubble’ just experienced is the housing industry. Until the summer of 2006, the housing market was ‘riding high’ with housing prices and housing starts seeming like they would never stop. Yet they did and housing prices have dropped steadily ever since. How far will they drop? Some analysts say that housing prices must drop to at least 50% of their peak value. Also, the picture gets even darker when one observes that there are still two major clouds hanging over the future. Both are related to the ‘financial innovations’ of the 1990s…major amounts of Alt-A mortgages and the Payment-Option ARMS are going to re-price over the next two to three years. The peak in housing foreclosures and personal bankruptcies is not expected to arrive for at least a year from now.
Another example is the financial industry. Tremendous losses have already been taken by banks and others, yet more are expected. The reason for this is that the banks still don’t fully comprehend the extent of the write-downs they are going to have to take on existing assets. Then, there is the fact that the banks have not yet seen the extent of the write downs connected with credit cards, auto loans, high-yield securities, and commercial and industrial loans. And, this doesn’t even consider the possible adjustments that will need to be made in the mortgage area mentioned in the previous paragraph. Mutual funds and hedge funds now are restricting investors who want to get their money back. And, then we are starting to see some of the fraud schemes surface that were a part of the recent credit inflation.
A further example is the auto industry (which also applies to other areas of manufacturing in the United States). I think everyone can agree that there are massive areas of imbalance and dislocation in this industry. Who is at fault? The auto executives? The labor unions? The politicians? The consumer? Everybody else? I don’t believe that any one person or group can be singled out as the cause of the problems in this industry.
But, I think that we can all agree that the problems are massive. These problems have to do with technology, innovation, out-of-date facilities, inappropriate pricing of resources, and other excesses that have been built into the structure over many years. Regardless of whether or not there is a bailout of this industry, it is going to take many years for the auto industry (and, I would argue many other areas of manufacturing in the United States) to really join the 21st century. Obviously, aggregate demand policies are not going to take care of the restructuring that is needed here.
Shirakawa summarizes: “Based on our experience, the world economy or the US economy needs the elimination of excesses. Of course the exact excesses vary from country to country…In today’s US for instance, housing is excessive; household debt is also excessive—I don’t know by how much, but anyways ‘excessive’ is there.”
“Negative feedback is now at work and I cannot give you a precise answer (to how long the global crisis is to run). What is crucial is to avoid a situation in which the adjustment leads to a serious downturn in the economy.”
In conclusion, there is no quick fix. The ‘excesses’, ‘imbalances’ and ‘dislocations’ in each sector must work themselves out. Monetary and fiscal policy may be able to soothe the pain…but they will not eliminate it. I tend to agree with Governor Shirakawa
Thursday, December 11, 2008
Should Banks Start Lending Again?
Banks aren’t doing a lot of lending these days.
Why not?
The Federal Reserve System has bent over backwards dumping liquidity into the financial system. The United States Treasury Department has provided the banking industry with a lot of new ‘capital’. Why aren’t the banks’ lending? Why aren’t the banks even lending to themselves…
My question: Why should the banks be lending?
My answer: they shouldn’t…not right now!
A good reason for this is that United States financial institutions still do not have a firm grasp on the value of a large portion of their assets. “The biggest US financial institutions reported a sharp increase to $610 billion in so-called hard-to-value assets during the third quarter…” (“Financial groups’ problem assets hit $610 bn”, http://www.ft.com/cms/s/0/ea576c7c-c729-11dd-97a5-000077b07658.html.) These assets, primarily mortgage-backed securities and collateralized debt obligations, don’t have active markets at the present time and they are difficult to value. I should be noted that the assets so identified “are many times bigger than the market cap of the banks.”
If you were a banker right now, where would you be focusing your resources at the present time? Would you be attempting to put new loans on the books that would pay off over several years’ time…or…would you be trying to get your arms around the value of these ‘level-three’ assets and see how you can minimize the damage they might cause…in the immediate future?
As long as these assets are on-the-books bank managements are going to muddle around, attempting to minimize the information that is released, and ask for the government to protect them from the downside through asset purchase programs that shore up asset price and the like.
This only distracts efforts and prolongs things! Until the banks are forced to write down their assets to realistic (some form of market) values and take their hits…they will be unable to focus on business and get on with their lives.
But there are other things looming on the horizon. Why would you want to put on new loans when you have people talking about the rising level of foreclosures? Elizabeth Warren of Harvard who is leading the oversight of TARP stated on television last night that in the next two years 8 million houses will be in foreclosure, an amount that is about 16% of the housing stock. That is one out of every six houses in the United States will be in foreclosure within the next two years!
And, why would you want to put on new loans when you have people talking about the rising level of charge-offs related to credit cards? (See “Charge-offs Start to Shred Card Issuers”, http://online.wsj.com/article/SB122895752803296651.html?mod=todays_us_money_and_investing.) All the statistics in this area point to a surge in charge-offs that will be faced by credit card issuers in the future.
Furthermore, there is still the unknown number and size of business defaults that are coming down the road. Of course, there are the auto companies…but, the condition of the credit wings of the auto companies reinforce the concern. Ford Motor Credit Co. is teetering on the brink of bankruptcy…as is GMAC. (“GMAC Bondholders Balk at Debt Swap”, http://online.wsj.com/article/SB122891574162094585.html?mod=todays_us_money_and_investing. Also see “Doubts on GMAC bank holding plan”, http://www.ft.com/cms/s/0/3ccf9eb4-c727-11dd-97a5-000077b07658.html.)
Financial institutions cannot make loans when they are so uncertain about the loans that they have already made. Financial institutions cannot make loans when there is so much uncertainty about the length and depth of the recession, the rise in layoffs and the falloff in employment. (Just released: Jobless Claims hit a 26-year high!) Those individuals and businesses that are seeking loans want to refinance or restructure…to gain control over cash flows so that they don’t run out of cash. Borrowing related to expanding business or creating jobs is almost non-existent. (“Executives Are Grim on Economy”, http://online.wsj.com/article/SB122896532391397279.html?mod=todays_us_marketplace.)
Should banks be lending now?
The answer to this is no…they are not social institutions.
Yes, it would be helpful to the economy if all banks opened their doors and started flooding the market with loans. Everyone would benefit…right?
OK, then…who wants to be first?
Why not?
The Federal Reserve System has bent over backwards dumping liquidity into the financial system. The United States Treasury Department has provided the banking industry with a lot of new ‘capital’. Why aren’t the banks’ lending? Why aren’t the banks even lending to themselves…
My question: Why should the banks be lending?
My answer: they shouldn’t…not right now!
A good reason for this is that United States financial institutions still do not have a firm grasp on the value of a large portion of their assets. “The biggest US financial institutions reported a sharp increase to $610 billion in so-called hard-to-value assets during the third quarter…” (“Financial groups’ problem assets hit $610 bn”, http://www.ft.com/cms/s/0/ea576c7c-c729-11dd-97a5-000077b07658.html.) These assets, primarily mortgage-backed securities and collateralized debt obligations, don’t have active markets at the present time and they are difficult to value. I should be noted that the assets so identified “are many times bigger than the market cap of the banks.”
If you were a banker right now, where would you be focusing your resources at the present time? Would you be attempting to put new loans on the books that would pay off over several years’ time…or…would you be trying to get your arms around the value of these ‘level-three’ assets and see how you can minimize the damage they might cause…in the immediate future?
As long as these assets are on-the-books bank managements are going to muddle around, attempting to minimize the information that is released, and ask for the government to protect them from the downside through asset purchase programs that shore up asset price and the like.
This only distracts efforts and prolongs things! Until the banks are forced to write down their assets to realistic (some form of market) values and take their hits…they will be unable to focus on business and get on with their lives.
But there are other things looming on the horizon. Why would you want to put on new loans when you have people talking about the rising level of foreclosures? Elizabeth Warren of Harvard who is leading the oversight of TARP stated on television last night that in the next two years 8 million houses will be in foreclosure, an amount that is about 16% of the housing stock. That is one out of every six houses in the United States will be in foreclosure within the next two years!
And, why would you want to put on new loans when you have people talking about the rising level of charge-offs related to credit cards? (See “Charge-offs Start to Shred Card Issuers”, http://online.wsj.com/article/SB122895752803296651.html?mod=todays_us_money_and_investing.) All the statistics in this area point to a surge in charge-offs that will be faced by credit card issuers in the future.
Furthermore, there is still the unknown number and size of business defaults that are coming down the road. Of course, there are the auto companies…but, the condition of the credit wings of the auto companies reinforce the concern. Ford Motor Credit Co. is teetering on the brink of bankruptcy…as is GMAC. (“GMAC Bondholders Balk at Debt Swap”, http://online.wsj.com/article/SB122891574162094585.html?mod=todays_us_money_and_investing. Also see “Doubts on GMAC bank holding plan”, http://www.ft.com/cms/s/0/3ccf9eb4-c727-11dd-97a5-000077b07658.html.)
Financial institutions cannot make loans when they are so uncertain about the loans that they have already made. Financial institutions cannot make loans when there is so much uncertainty about the length and depth of the recession, the rise in layoffs and the falloff in employment. (Just released: Jobless Claims hit a 26-year high!) Those individuals and businesses that are seeking loans want to refinance or restructure…to gain control over cash flows so that they don’t run out of cash. Borrowing related to expanding business or creating jobs is almost non-existent. (“Executives Are Grim on Economy”, http://online.wsj.com/article/SB122896532391397279.html?mod=todays_us_marketplace.)
Should banks be lending now?
The answer to this is no…they are not social institutions.
Yes, it would be helpful to the economy if all banks opened their doors and started flooding the market with loans. Everyone would benefit…right?
OK, then…who wants to be first?
Wednesday, December 10, 2008
Auto Bailouts and Other Things
I have tried to stay out of the auto-bailout thing but I find that I need to add my two cents to the issue. I have done three successful turnarounds in my professional career and have consulted on quite a few more. It is from this perspective that I am making my comments. So hear goes.
First, Ford says that it can make it through the near-term without any assistance from the Federal Government. Good. Let them go for it!
Second, Chrysler…is owned by Cerberus Capital Management, LP…a private investment firm who boasts, “strong corporate governance is the cornerstone of our business.” This is a private investment firm that recently took a risk, made a big investment, has access to billions of dollars of capital…and is coming, hat-in-hand, to the Federal Government asking for money to carry Chrysler through this mess.
Come on…
Sounds like we have a new model for private equity investment!
Third, General Motors…”What’s good for General Motors is good for the United States,” as a former CEO of General Motors put it.
We bailout General Motors and then we bailout the United States? Hmmmmmmmmmmm…I don’t think that is what was meant.
General Motors is a turnaround situation!!!
In a turnaround situation you get rid of the existing management and you bring in new management!!!
Robert (Bob) Lutz says GM should stick with “Rick” Wagoner, Chairman and Chief Executive Officer, because he knows the business and knows what the current situation is and doesn’t have to be brought “up-to-speed” with the situation at GM.
I remember taking a thrift institution public during “the S & L crises” and going to numerous “dog-and-pony” shows of other companies taking their institutions public. I was especially taken aback by managements that would say…”Sure we were the management of this institution for the last 10 years in which the performance of this company got worse and worse…BUT, we have learned our lessons…we can make this bank work going forward!!!” And then they raised quite a few million dollars from people who were willing to bet on this story.
Guess what? Most of them didn’t make it!
We have also heard that the top engineers and other top management want Wagoner to stay. “He can do it!” they say.
Sure these employees want Wagoner to stay! He is the safest thing for them and their positions. A turnaround specialist would take a long, hard look at these people and what they have done and are doing and that is exactly what the top engineers and other top management don’t want!
General Motors is a turnaround situation! If anyone (the Government) is going to invest money in this organization they need to demand the appropriate leadership…and the existing CEO and his top management IS NOT the leadership that is needed.
The bailout of the auto industry is not just about thousands or millions of workers being employed. I, personally, hope that these workers do not have to experience a great deal of suffering.
The question is about whether or not any effort made by the government will have a fair probability of success. Thinking of these efforts as a bailout is not helpful when the situation calls for a turnaround. The issue, in my mind, is not being framed correctly.
OTHER THINGS
Information is starting to come out concerning the efforts to restructure mortgage debt…and the results are not encouraging.
Let me just say one thing about restructuring mortgages…or, for that matter, any debt in the present environment.
Generally, when the restructuring of debt takes place, the situation of the borrower and the situation in the economy are relatively stable. That is, any restructuring that takes place can count on income, employment, prices, sales, and so forth to remain relatively constant in the future. That way, the debt can be restructured in a way that presents the borrower with some likelihood that he or she will be able to pay off the debt.
In an environment that is not stable the situation of the borrower and the situation within the economy is constantly ‘going South.’ And, there is no certainty about ‘how far South’ these things will go. Consequently, any debt restructured in this environment has a relatively low probability of being paid off. Those restructuring the debt are just postponing the day of reckoning and continuing to put these borrowers in a position of almost assured failure.
In essence, within the current environment, those that have been foreclosed upon have gone from borrowing using a sub-prime loan to borrowing using a sub-sub-prime loan.
As I have said in many other posts…once discipline is lost…there are no good solutions to the problems created by the loss of discipline.
First, Ford says that it can make it through the near-term without any assistance from the Federal Government. Good. Let them go for it!
Second, Chrysler…is owned by Cerberus Capital Management, LP…a private investment firm who boasts, “strong corporate governance is the cornerstone of our business.” This is a private investment firm that recently took a risk, made a big investment, has access to billions of dollars of capital…and is coming, hat-in-hand, to the Federal Government asking for money to carry Chrysler through this mess.
Come on…
Sounds like we have a new model for private equity investment!
Third, General Motors…”What’s good for General Motors is good for the United States,” as a former CEO of General Motors put it.
We bailout General Motors and then we bailout the United States? Hmmmmmmmmmmm…I don’t think that is what was meant.
General Motors is a turnaround situation!!!
In a turnaround situation you get rid of the existing management and you bring in new management!!!
Robert (Bob) Lutz says GM should stick with “Rick” Wagoner, Chairman and Chief Executive Officer, because he knows the business and knows what the current situation is and doesn’t have to be brought “up-to-speed” with the situation at GM.
I remember taking a thrift institution public during “the S & L crises” and going to numerous “dog-and-pony” shows of other companies taking their institutions public. I was especially taken aback by managements that would say…”Sure we were the management of this institution for the last 10 years in which the performance of this company got worse and worse…BUT, we have learned our lessons…we can make this bank work going forward!!!” And then they raised quite a few million dollars from people who were willing to bet on this story.
Guess what? Most of them didn’t make it!
We have also heard that the top engineers and other top management want Wagoner to stay. “He can do it!” they say.
Sure these employees want Wagoner to stay! He is the safest thing for them and their positions. A turnaround specialist would take a long, hard look at these people and what they have done and are doing and that is exactly what the top engineers and other top management don’t want!
General Motors is a turnaround situation! If anyone (the Government) is going to invest money in this organization they need to demand the appropriate leadership…and the existing CEO and his top management IS NOT the leadership that is needed.
The bailout of the auto industry is not just about thousands or millions of workers being employed. I, personally, hope that these workers do not have to experience a great deal of suffering.
The question is about whether or not any effort made by the government will have a fair probability of success. Thinking of these efforts as a bailout is not helpful when the situation calls for a turnaround. The issue, in my mind, is not being framed correctly.
OTHER THINGS
Information is starting to come out concerning the efforts to restructure mortgage debt…and the results are not encouraging.
Let me just say one thing about restructuring mortgages…or, for that matter, any debt in the present environment.
Generally, when the restructuring of debt takes place, the situation of the borrower and the situation in the economy are relatively stable. That is, any restructuring that takes place can count on income, employment, prices, sales, and so forth to remain relatively constant in the future. That way, the debt can be restructured in a way that presents the borrower with some likelihood that he or she will be able to pay off the debt.
In an environment that is not stable the situation of the borrower and the situation within the economy is constantly ‘going South.’ And, there is no certainty about ‘how far South’ these things will go. Consequently, any debt restructured in this environment has a relatively low probability of being paid off. Those restructuring the debt are just postponing the day of reckoning and continuing to put these borrowers in a position of almost assured failure.
In essence, within the current environment, those that have been foreclosed upon have gone from borrowing using a sub-prime loan to borrowing using a sub-sub-prime loan.
As I have said in many other posts…once discipline is lost…there are no good solutions to the problems created by the loss of discipline.
Thursday, December 4, 2008
Financial Indicators of the Deteriorating Real Economy
More and more we see concern being expressed about the deteriorating real economy and less emphasis being placed on the crises within the financial sector. The concern about the growing weakness in the real economy points to a longer and deeper recession than had been anticipated.
The current recession, as defined by the NBER, is in its 12th month and trails two other recessions which lasted 16 months as the longest post-World War II downturns on record. As economists revise their forecasts, most seem to believe that the 16 month period will be exceeded and many are saying that the current recession will reach the 20-24 month time span.
Economists only have to point to the daily release of employee layoff announcements to support their increasing pessimism. Companies are restructuring and these efforts are accompanied by reductions in workforce by 5,000 and 10,000 and more, per firm. AT&T announced today that they are going to lay off 12,000 employees and are taking a $600 million charge in the fourth quarter to cover severance payments. And, given recent experience, there will be two or three other companies announcing layoffs today. There will be more tomorrow…and Monday…and…
Then these layoffs must work their way through the rest of the economy. Lower spending…credit card defaults…additional decline in sales…more layoffs…and so on and so on. The effects are cumulative.
The policy problem is how to stop the cumulative contraction so that the downward spiral is broken.
The potential effects of this downward spiral in the real economy are being translated into the financial markets and the warnings are rather severe. For example, take the article in the Financial Times, titled “Record number of companies at risk of default”: http://www.ft.com/cms/s/0/490a8668-c154-11dd-831e-000077b07658.html. This article focuses on the Markit iTraxx Crossover index which measures the cost of protecting junk-grade companies against default. This index rose above 1,000 basis points for the first time ever indicating that “a record number of companies are on the verge of default because of deepening financial problems.”
The authors also write that “Some of the world’s leading investment-grade companies look in danger of default, according to CDS prices.” The point being that the future shows nothing but dark clouds now. As these firms continue to restructure to avoid default on their debt the situation, at least in the short run, can only worsen because the layoffs lead to lower incomes which results in lower spending which results more restructuring and so on.
This deterioration in the real economy is also being transmitted to the government sector. There are two concerns being expressed in terms of the government securities. First, at local and regional levels…state and local governments…there is a restructuring gong on as government revenues drop and attempts are made to bring government budgets into balance…or at least into manageable level of deficit.
Second, governments at the national level are attempting to protect financial markets and combat the deterioration in their real economies. As a consequence, national deficits are ballooning and concern is being raised over the possibility of default on the part of sovereign nations. Another article in the Financial Times speaks to this concern: “Sovereign CDS prices soar as debt mounts”: http://www.ft.com/cms/s/0/c441907a-c1a3-11dd-831e-000077b07658.html. “Credit default swaps, which insure against bond defaults, rose to all-time highs on the US, UK, France, Spain, Italy and Germany yesterday…The dramatic rise is due to investor concerns over the amount of bonds the government will have to issue to bail out the banks and stimulate the economy.” The concern relates not only to the current economic and financial difficulties but also to the possibility that these governments will not be able to stem the downswing and will have to issue more and more bonds in the future.
Retail sales figures for November have just been release and the story reads that November retail sales are amongst the weakest in many years.
The difficulty that any government faces in attempting to compose a monetary or fiscal policy that can turn this situation around is that it is in the best interests of most economic units in the economy, individual, family, business, or non-profit, to get back to basics, to restructure what they do, to cut back their living standard, and to reduce debt. Consequently, government efforts are like “pushing on a string”…there is nothing to push against.
The current recession, as defined by the NBER, is in its 12th month and trails two other recessions which lasted 16 months as the longest post-World War II downturns on record. As economists revise their forecasts, most seem to believe that the 16 month period will be exceeded and many are saying that the current recession will reach the 20-24 month time span.
Economists only have to point to the daily release of employee layoff announcements to support their increasing pessimism. Companies are restructuring and these efforts are accompanied by reductions in workforce by 5,000 and 10,000 and more, per firm. AT&T announced today that they are going to lay off 12,000 employees and are taking a $600 million charge in the fourth quarter to cover severance payments. And, given recent experience, there will be two or three other companies announcing layoffs today. There will be more tomorrow…and Monday…and…
Then these layoffs must work their way through the rest of the economy. Lower spending…credit card defaults…additional decline in sales…more layoffs…and so on and so on. The effects are cumulative.
The policy problem is how to stop the cumulative contraction so that the downward spiral is broken.
The potential effects of this downward spiral in the real economy are being translated into the financial markets and the warnings are rather severe. For example, take the article in the Financial Times, titled “Record number of companies at risk of default”: http://www.ft.com/cms/s/0/490a8668-c154-11dd-831e-000077b07658.html. This article focuses on the Markit iTraxx Crossover index which measures the cost of protecting junk-grade companies against default. This index rose above 1,000 basis points for the first time ever indicating that “a record number of companies are on the verge of default because of deepening financial problems.”
The authors also write that “Some of the world’s leading investment-grade companies look in danger of default, according to CDS prices.” The point being that the future shows nothing but dark clouds now. As these firms continue to restructure to avoid default on their debt the situation, at least in the short run, can only worsen because the layoffs lead to lower incomes which results in lower spending which results more restructuring and so on.
This deterioration in the real economy is also being transmitted to the government sector. There are two concerns being expressed in terms of the government securities. First, at local and regional levels…state and local governments…there is a restructuring gong on as government revenues drop and attempts are made to bring government budgets into balance…or at least into manageable level of deficit.
Second, governments at the national level are attempting to protect financial markets and combat the deterioration in their real economies. As a consequence, national deficits are ballooning and concern is being raised over the possibility of default on the part of sovereign nations. Another article in the Financial Times speaks to this concern: “Sovereign CDS prices soar as debt mounts”: http://www.ft.com/cms/s/0/c441907a-c1a3-11dd-831e-000077b07658.html. “Credit default swaps, which insure against bond defaults, rose to all-time highs on the US, UK, France, Spain, Italy and Germany yesterday…The dramatic rise is due to investor concerns over the amount of bonds the government will have to issue to bail out the banks and stimulate the economy.” The concern relates not only to the current economic and financial difficulties but also to the possibility that these governments will not be able to stem the downswing and will have to issue more and more bonds in the future.
Retail sales figures for November have just been release and the story reads that November retail sales are amongst the weakest in many years.
The difficulty that any government faces in attempting to compose a monetary or fiscal policy that can turn this situation around is that it is in the best interests of most economic units in the economy, individual, family, business, or non-profit, to get back to basics, to restructure what they do, to cut back their living standard, and to reduce debt. Consequently, government efforts are like “pushing on a string”…there is nothing to push against.
Tuesday, December 2, 2008
Trying to Understand the Recession
It is official now…the United States has been in recession since December 2007! Right now the current recession is the third longest recession since World War II and most economists believe that this recession will at least tie the other two recessions in terms of duration…a period of 16 months.
Among the major factors behind such a belief is that housing prices are still declining, housing sales are still falling, layoffs have just started to takeoff and financial institutions are still reluctant to lend…even if people and companies are willing to borrow. Some feel that the real recession is just starting to hit.
Growth-wise, real GDP rose, year-over-year, at a 0.7% rate in the third quarter of 2008, down from 2.8% in the third quarter of 2007 and 2.3% in the fourth quarter of that year. Real GDP declined in the third quarter of 2008 from the second quarter of 2008 and is expected to decline once again going from the third quarter to the fourth quarter.
The extent of this recession has even got some people talking about deflation!
Now that is something! It is something because the year-over-year rate of change in the Implicit Price Deflator of GPD, although it drops when there is a recession, has only become negative once since World War II and that was in the 1948-49 recession. (See chart from the Federal Reserve Bank of St. Louis, http://research.stlouisfed.org/fred2/fredgraph?chart_type=line&s[1][id]=GNPDEF&s[1][transformation]=pc1.) Over the past seven quarters the Implicit GDP Price Deflator has averaged a 2.5% year-over-year rate of increase and increased by 2.6% in the third quarter of 2008 over the third quarter of 2007.
It is important to talk about what is happening to prices at the same time one is talking about what is happening to economic activity because that gives us a clue as to what factors are dominating economic activity. If both prices and output move in the same direction then one can say that demand factors are dominating the market. If prices and output move in opposite directions then one can say that supply factors are dominating the market. To understand what is happening in the economy, one must get some feel for which side of a market is dominating.
As the rate of growth of the economy has dropped from the rate of expansion that took place in the four quarters ending in the third quarter of 2007 (2.8%) to the four quarters ending in the third quarter of 2008 (0.7%), the rate of inflation for the same periods remained roughly constant or has declined modestly. To get such a result the drop in the demand for goods and services would have had to been roughly matched by the decline in the supply of goods and services over this time period. That is, neither side of the market strongly dominated the behavior of the economy over the past year or so.
As I have written in several posts over the past year, supply factors seem to be just as important as, or even more important than, demand factors in the current slowdown. That is, an adjustment is taking place on the supply side of the economy that must be reckoned with if we are to fully understand what is going on in the economy and respond to the situation as effectively as possible.
A possible reason for the shift in supply is that transitions are taking place in the economy or need to take place in the economy and this is impacting cost structures and organizational patterns in a way that is altering how people do business. For example, the increase in the cost of oil during the 2007-2008 period may have caused the transportation and energy industries to begin adjusting to a new world of alternative products and services that rely less on fossil-based resources. The subsequent reduction in the cost of a barrel of oil may have little impact on decisions because of the ‘price shock’ that people absorbed through the summer of 2008. The problems in the automotive industry are just one consequence of this. And, we are seeing a lot more adjustments coming in different segments of the transportation area that are not getting such a high profile. Also, new efforts to build ‘green’ industries may result from this.
Another transition is occurring in the financial industry where thousands of people are being laid off due to the downsizing that has resulted from the collapse of the financial markets. Financial institutions, I believe, are going to go through a substantial restructuring that will be based on information technology. In the past thirty years, the financial industry has shown how it can use the computer to design financial products. Now, along with the call to restructure the regulation of financial institutions, the financial industry is going to have to use the emerging information technology to control risk and enhance the openness and transparency of the industry. In moving in this direction the financial industry will become a real leader in the creation of information markets on which the rest of the economy will model itself.
Information technology continues to transform itself and in so doing will continue to create opportunities for other industries to transform themselves. The spread of information is going to accelerate with search being an integral part of this expansion along with greater and greater connectivity between users throughout the world. Computer networks will more and more become decentralized rather than centralized.
Another area where substantial transitions are taking place is in the area of State and Local governments. The model that has been used in this arena developed after World War II and is in need of a vast overhaul. In all likelihood, the current financial difficulties are going to result in these governments modernizing their function and structure while at the same time they help rebuild the infrastructure.
These are just a few of the major transitions that are taking place in the economy right now and that predominantly affect the supply side of the economy rather than the demand side. In all the efforts to “get the economy going again” we must not restrict or prevent these changes. That is, the government programs that are designed to stimulate the economy must not “lock us into” the old way of doing things. A bailout of the auto industry that keeps things “as they are” will not be helpful in the longer run.
It could be that the economy of the United States, and the world, is now going through a major restructuring, a restructuring that seems to occur every 60-80 years or so. In a sense, we are going from one age into another. One could say that the United States went through another major restructuring in the 1930s when the country was transitioning from an economy based predominantly upon agriculture to one that was based predominantly upon manufacturing. Maybe this is the time of transition from manufacturing to (you insert your term for it). Maybe the world of the ‘manufacturer’, and all that supports it, has significantly passed its peak and government props can no longer sustain it.
Two things can be drawn from this. First, government programs that just rely on stimulating demand will not prove to be very effective. The transitions must take place. They will take place relatively rapidly or they will take place at a much slower pace if the government supports the status quo. We…the government…must be careful here.
Let me state this again…the adjustments are going to take place…whether or not the government slows them down!
Second, these areas of transition are going to create major new opportunities for investment to those that are lucky enough…or wise enough…to choose the right companies. Referring to the 1930s once again, one can reference many investments that provided exceptional returns to those that sought them out and committed to them during the period in which the economy was adjusting to the brave new world that was coming. It is my belief that there will be numerous such opportunities available to us in the near future.
Among the major factors behind such a belief is that housing prices are still declining, housing sales are still falling, layoffs have just started to takeoff and financial institutions are still reluctant to lend…even if people and companies are willing to borrow. Some feel that the real recession is just starting to hit.
Growth-wise, real GDP rose, year-over-year, at a 0.7% rate in the third quarter of 2008, down from 2.8% in the third quarter of 2007 and 2.3% in the fourth quarter of that year. Real GDP declined in the third quarter of 2008 from the second quarter of 2008 and is expected to decline once again going from the third quarter to the fourth quarter.
The extent of this recession has even got some people talking about deflation!
Now that is something! It is something because the year-over-year rate of change in the Implicit Price Deflator of GPD, although it drops when there is a recession, has only become negative once since World War II and that was in the 1948-49 recession. (See chart from the Federal Reserve Bank of St. Louis, http://research.stlouisfed.org/fred2/fredgraph?chart_type=line&s[1][id]=GNPDEF&s[1][transformation]=pc1.) Over the past seven quarters the Implicit GDP Price Deflator has averaged a 2.5% year-over-year rate of increase and increased by 2.6% in the third quarter of 2008 over the third quarter of 2007.
It is important to talk about what is happening to prices at the same time one is talking about what is happening to economic activity because that gives us a clue as to what factors are dominating economic activity. If both prices and output move in the same direction then one can say that demand factors are dominating the market. If prices and output move in opposite directions then one can say that supply factors are dominating the market. To understand what is happening in the economy, one must get some feel for which side of a market is dominating.
As the rate of growth of the economy has dropped from the rate of expansion that took place in the four quarters ending in the third quarter of 2007 (2.8%) to the four quarters ending in the third quarter of 2008 (0.7%), the rate of inflation for the same periods remained roughly constant or has declined modestly. To get such a result the drop in the demand for goods and services would have had to been roughly matched by the decline in the supply of goods and services over this time period. That is, neither side of the market strongly dominated the behavior of the economy over the past year or so.
As I have written in several posts over the past year, supply factors seem to be just as important as, or even more important than, demand factors in the current slowdown. That is, an adjustment is taking place on the supply side of the economy that must be reckoned with if we are to fully understand what is going on in the economy and respond to the situation as effectively as possible.
A possible reason for the shift in supply is that transitions are taking place in the economy or need to take place in the economy and this is impacting cost structures and organizational patterns in a way that is altering how people do business. For example, the increase in the cost of oil during the 2007-2008 period may have caused the transportation and energy industries to begin adjusting to a new world of alternative products and services that rely less on fossil-based resources. The subsequent reduction in the cost of a barrel of oil may have little impact on decisions because of the ‘price shock’ that people absorbed through the summer of 2008. The problems in the automotive industry are just one consequence of this. And, we are seeing a lot more adjustments coming in different segments of the transportation area that are not getting such a high profile. Also, new efforts to build ‘green’ industries may result from this.
Another transition is occurring in the financial industry where thousands of people are being laid off due to the downsizing that has resulted from the collapse of the financial markets. Financial institutions, I believe, are going to go through a substantial restructuring that will be based on information technology. In the past thirty years, the financial industry has shown how it can use the computer to design financial products. Now, along with the call to restructure the regulation of financial institutions, the financial industry is going to have to use the emerging information technology to control risk and enhance the openness and transparency of the industry. In moving in this direction the financial industry will become a real leader in the creation of information markets on which the rest of the economy will model itself.
Information technology continues to transform itself and in so doing will continue to create opportunities for other industries to transform themselves. The spread of information is going to accelerate with search being an integral part of this expansion along with greater and greater connectivity between users throughout the world. Computer networks will more and more become decentralized rather than centralized.
Another area where substantial transitions are taking place is in the area of State and Local governments. The model that has been used in this arena developed after World War II and is in need of a vast overhaul. In all likelihood, the current financial difficulties are going to result in these governments modernizing their function and structure while at the same time they help rebuild the infrastructure.
These are just a few of the major transitions that are taking place in the economy right now and that predominantly affect the supply side of the economy rather than the demand side. In all the efforts to “get the economy going again” we must not restrict or prevent these changes. That is, the government programs that are designed to stimulate the economy must not “lock us into” the old way of doing things. A bailout of the auto industry that keeps things “as they are” will not be helpful in the longer run.
It could be that the economy of the United States, and the world, is now going through a major restructuring, a restructuring that seems to occur every 60-80 years or so. In a sense, we are going from one age into another. One could say that the United States went through another major restructuring in the 1930s when the country was transitioning from an economy based predominantly upon agriculture to one that was based predominantly upon manufacturing. Maybe this is the time of transition from manufacturing to (you insert your term for it). Maybe the world of the ‘manufacturer’, and all that supports it, has significantly passed its peak and government props can no longer sustain it.
Two things can be drawn from this. First, government programs that just rely on stimulating demand will not prove to be very effective. The transitions must take place. They will take place relatively rapidly or they will take place at a much slower pace if the government supports the status quo. We…the government…must be careful here.
Let me state this again…the adjustments are going to take place…whether or not the government slows them down!
Second, these areas of transition are going to create major new opportunities for investment to those that are lucky enough…or wise enough…to choose the right companies. Referring to the 1930s once again, one can reference many investments that provided exceptional returns to those that sought them out and committed to them during the period in which the economy was adjusting to the brave new world that was coming. It is my belief that there will be numerous such opportunities available to us in the near future.
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