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 playbook.
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’m 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:
» The temporary effect of federal spending from the $787 billion American Recovery and Reinvestment Act of 2009
» 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 General Motors and Chrysler in 2009 is. It’s a bailout of the United Auto Workers 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 such as New York City, Chicago and Los Angeles 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 that 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 10 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 United States joined the group of countries, mainly European, that 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 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 percent 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:
» Traders believe that Keynesian fiscal stimulus works.
» 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 401(k)s feel better about their retirement. Retired people feel better about their portfolios.
I don’t think it’s working that way this time. I sense a feeling of caution, if not dread about the future of the economy.
I live in the very wealthy community of Montecito. Money here comes from real estate, business people who have sold their companies, or financial guys (hedge-funders, Goldman types). In the past 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-plus). 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 it’s a center of econometric, Keynesian economics. So, you might ask, if it was so smart, why did it take a huge hit? Why did it invest in so many stupid deals at the top of the market? Some say its portfolio is half of what it 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 advisers 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.
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 it 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 such as 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 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’s clear that fiscal measures are having an impact on the housing market. The government, through tax policy and lending requirements (Freddie, Fannie and the FHA), is 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 percent 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 that 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’s refreshing to see the bloggers that I admire do well: Calculated Risk, Barry Ritholtz’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 million page views per month as people are finding that the Austrians have something to say.
I am also pleased to report that the new kid on the block, The Daily Capitalist, is growing, and now gets about 13,000 views a month. I am also proud to be a part of Zero Hedge, which has quickly become a very popular and rising blog star dealing with market dynamics and economics.
Thanks for reading The Daily Capitalist. And best wishes for 2010.
— Jeff Harding is a principal of Montecito Realty Investors LLC. A student of economics, he has a strong affinity for free-market economics. This commentary originally appeared on his blog, The Daily Capitalist.