Monday, August 23, 2010

The Economy: what happened, what's happening, and what will happen (Part 2)

Imagine you owned a hotel.  You typically kept the place 70% full and were making a pretty good living in the process.  Then, one day you suddenly got an unexpectedly large number of people that wanted rooms.  The next day, the same thing happened.  Now you are suddenly forced to turn people away because you are renting out all the rooms.  When this happened again on the third day you decided to take out a loan and build another hotel so you could double your capacity and not be forced to turn away customers.  All the extra money you were making would easily pay for your loan.  For the next 3 or 4 days you were filling up both hotels, hired a lot of extra employees, and business was really doing good.  But then the next day things went back to normal and you were only filling up 70% of the first hotel while the other one stayed empty.  It turns out that the circus was in town for a week and all the extra people in the area were renting out your rooms.  You misinterpreted all the sudden demand for hotel rooms as something other than a temporary bubble.  Once the circus moved on and the bubble popped, you suddenly found yourself with a loan you couldn't afford and employees you had to fire.

When it comes to a boom and bust cycle, it's a common misconception that the boom is the good part and the bust is the bad part.  That way of looking at things is simply wrong.  When the economy is booming, particularly in an inflated bubble economy, many things are actually being done wrong.  Business owners typically expect the boom to continue indefinitely and manage their business accordingly.  Good businesses will do this in a smart way and not get swept up in the hype, keeping their eye on the long-term instead of the short-term.  Bad businesses will try to cash in on the boom as quickly and as much as they can, paying no attention to the long-term consequences of their actions or planning for not-so-rosy days.  In the economic boom, far too many businesses get short sighted and begin to become mismanaged.  It's not until the bubble bursts that these bad business practices are exposed.  But, on the bright side, the bust creates a good and necessary opportunity for much needed changes to take place within poorly managed businesses.  That's why the bust is actually a good thing.  Businesses that were poorly managed fail and get swallowed up by businesses with smart management, thereby making the overall economy stronger and more sound in the long run.  At least, that's how it's supposed to work.

After the tech bubble burst at the end of the Clinton administration, it exposed a lot of poorly run businesses, and a lot of poor decisions made by individuals.  The recession that followed should have been a lot worse than it actually was.  What happened was the Bush administration, along with Fed chairman Alan Greenspan, made some extremely poor decisions in an attempt to prop up the economy.  Bush didn't want to be a one term president, and he knew he probably would be if the economy didn't recover.  So, in an effort to kick the can down the road, he told Americans to spend.  And Americans did spend, but they had to go into debt to do it.  In a typical recession, people spend less, save more and pay off their debt.  This time Alan Greenspan lowered interest rates and printed money which made getting credit far too easy and cheap, so we had a recession where people went into debt instead of paying it off.  And the federal government started spending money at an insane rate as well.  The national debt skyrocketed, as well as personal debt.  But the economy was recovering, housing prices were soaring, and wall street was booming.  The only bad thing was that it wasn't real.  It was all occurring on a pile of debt.  And far too many businesses continued to be poorly managed.  Effectively, we only made a down payment on the next bubble.


Then it happened again, only much worse.  Had the economy been allowed to tank the way it should have in 2000, the recovery would have been relatively quick and painless.  And, as a result, we would have emerged stronger and with a better foundation.  Instead, we just took on a lot of debt and artificially spent our way out of it.  Then in 2008 a similar economic collapse occurred, but this time it was far worse because we accumulated a lot of debt in the process and business practices weren't forced to change.  The housing and financial bubble I talked about last time only made the whole thing much much worse.


And then the federal government reacted in pretty much the same way as it did nearly a decade earlier.  Interest rates dropped to zero and the federal budget deficit went through the roof.  This time around, however, individuals and families decided to spend less and save more.  This was a good thing, but it cost a lot of people their jobs in the process.  But Americans were at least making some effort to build a sturdier financial foundation for themselves.  The problem is that the federal government negated what individuals were doing by spending their money for them.  A lot of cash was injected into the system thereby artificially propping it up and not allowing the systemic changes to occur that needed to occur while also putting the country deeper and deeper into debt.  The Bush budget deficits were terrible.  The Obama budget deficits are catastrophic.  They are a short-term solution that only makes the long term problem that much worse.  Government once again kicked the can down the road, leaving a bigger mess for some other day.

It's like if you have a heroin addiction.  When you first start to mess up your life, kicking the habit would suck but it is necessary for your long term survival.  But instead of sobering up and throwing away the needle, you just do more of the drug.  Sure, it feels good right away and you're not putting yourself through the pain of cleansing your system, but you're only guaranteeing that when you do kick the habit it'll be far worse.  It's the same with our economy.  There are fundamental flaws.  Most notably, we borrow too much, spend too much, and produce too little.  What we need, and what a recession would provide for us if we allowed it to happen, is to actually produce more goods, save more of our money, and consume less.  But the federal government continues to entice us to spend, consume and borrow.  We're shooting up with the same drug that's causing our problems and the only thing we'll accomplish is to guarantee that the crash will be far worse when it strikes again.


This "recovery" we're experiencing is not a real recovery at all.  It's all occurring on borrowed money.  Nobody is hiring workers, business is stagnant, and the consumer isn't spending (relatively speaking anyway).  This is actually supposed to be happening, and should be happening, but in a far more devastating way.  It's a hard pill to swallow, but we need the catastrophic to happen in order to purge out the toxins and rebuild a much more sturdy economy.  The sooner we allow it to happen, the less severe it'll be.  By trying to fight it, all we're doing is guaranteeing that it happens even worse the next time around.  All of this government spending is designed to keep the economy from doing what it needs to do (cut jobs, reduce consumption, etc).  If we had a stronger foundation, then the spending and stimulus of the past 2 years would have had better short-term results.  The fact that the economy is not seeing the results that Obama is striving for, despite unprecedented spending, should tell you something about how fundamentally bad the economy is.

Far too many economists feel that Americans need to simply consume more.  After all, 70% of our economy is based on consumption.  That's the idea behind the government programs that give people money to buy a house or to buy a car.  That's why we're spending so much money to keep jobs.  It's not the jobs that they're trying to save, it's the money that the employee gets to spend after earning a paycheck that we're trying to save.  Do whatever it takes to keep people buying shit.  What they don't realize is that it's not a good thing to have 70% of an economy to be based on consumption.  We need to actually produce things.  Consuming goods is the reward someone gets for producing something and earning a paycheck.  Instead, we're having the Chinese workers produce all our good so we can consume them.  And on top of that, we have to borrow the money the Chinese make from those goods in order for us to consume those goods.

Imagine 6 people, 5 Chinese and 1 American, are stuck on an island.  They immediately start to divide up the jobs so they can survive.  One Chinese fishes, one hunts, one farms, one gathers firewood, and one cooks.  The American, meanwhile, hangs out on the beach all day and consumes everything the Chinese people have created.  He eats as much as he can and leaves just enough left over for the Chinese to stay healthy enough to gather his food again the next day.  Most modern economists would say that the American is the key to the whole system.  Were it not for his consumption, the 5 Chinese people would have nothing to do.  Well that is patently absurd.  Were it not for the American getting fat off the work of the Chinese, the Chinese would be able to consume what they create.  They could even spend less time gathering food and more time enjoying the fruits of their labor or perusing other interests.

But politicians don't like to tell their potential voters that they have been living beyond their means.  And voters don't like to hear that from their politicians.  Nobody is going to vote for the guy who says "We're fucked.  We could spend a ton of money and it might help us for a little bit, but eventually we just need to let the economy tank.  We've consumed too much, produced too little and gotten into a pile of debt in the process.  It's time for Americans to live within their means, and right now that means a lower standard of living.  It sucks but we need to take the medicine, no matter how hard it is to swallow."  I'd actually like that to be part of the next Presidential Inaugural Address, whoever it might be.  But it won't happen, because we don't want to hear it even if it's the truth.  Instead, we'll get "Here, take this money and buy yourself something shiny!  Everything is fine, just fine!"  Perhaps we're just getting what we deserve.

No comments:

Post a Comment