Paper or Plastic? Or both?
Ben Stein, the economist/actor, used his column in the New York Times today to echo a theme that resonates with many of the neoconservatives, namely, that the current jitters in the market are not meaningful. After all, the reasoning goes, only a portion of the sub-prime mortgages are in default, and the sub-prime loans are only a portion of the mortgage market, and the mortgage market is only a portion of the total economy, and the total economy is sound, so what's the problem and why the panic? Ben is certainly right that the sub-prime mortgage market, considered in itself, is not a large part of the economy. And indeed, if you look at overall numbers—corporate profits, unemployment, inflation, etc.—the economy does look good. On paper. And the economy should look good on paper, since it is an economy made out of paper. And plastic. The paper of loan notes and the plastic of credit cards. And we may add to the this the hyper-Keynesian policies of financing the govmint on mega-debt, and a trade deficit dependent on the largesse of the Chinese government. So what is the real state of the economy, and are the markets right to be worried?
A Two-Tiered Economy
In the last 25 years, the productivity of the average worker has greatly expanded, but the wage of that same worker has stagnated; the majority of the rewards have gone to the top. This means that there are a lot more goods produced then the worker can possibly buy on his/her stagnant wage. In other words, there is insufficient purchasing power to clear the markets. At the same time, the people at the upper end have more money then they could possibly use for consumption, no matter how conspicuous that consumption is. The solution was simply for those at the top to lend their vast amounts of excess funds to those at the middle and bottom so that there would be sufficient purchasing power to clear the markets. In other words, we entered an economy of pure usury—The Utopia of Usurers about which Chesterton wrote.
But utopia has it problems, even for the usurers. With wages stagnant, the real market—the market minus consumer debt—does not really expand. This means that there is a more limited pool of decent investments and a larger amount of money chasing those investments; hence the price goes up and the returns go down. This means, in turn, that investors who wish to get a decent return on their money must accept higher and higher levels of risk. Hence we see the proliferation of hedge funds, private equity firms, leveraged buy-outs, sub-prime loans, consumer credit at usurious rates, etc.
High risk lending was encouraged by the govmint. Alan Greenspan encouraged the banks and mortgage companies to lower their lending standards (just as he did before the S&L crises of the 80's) and to offer “alternative” products (a euphemism for high-risk and adjustable-rate loans). He lowered interest rates, thereby flooding more money into the markets. And the economy, working with high-risk, borrowed money, seemed to be in good shape. But can we really borrow ourselves into prosperity? Does not the bill one day have to be paid? The top players really aren't worried about this. After all, they have the example of the savings and loan debacle of the 80's before them, when there were a few prosecutions but a large amount of profits, and the govmint bailed out the miscreants by transferring a half-trillion dollars of public wealth into private hands. Not a bad wage for failure. After all, if a $30 billion dollar hedge fund goes under, the manager may be left with only a $100 million or so for his trouble; the losses go to the investors. If the govmint is willing to take all the risks for the richest, there is no reason why the richest should not be risky with the public's money. Indeed, the Fed has pumped another $38 billion into the banks to shore up the risky loans. This is entirely new money, newly printed. Congress did not appropriate it nor did we borrow it; the Fed just prints it (today, its largely done with computers.) But it is fair to ask if this is just more of the medicine that made us ill in the first place?
A Market Meltdown?
So, getting back to Ben Stein, are the markets over-reacting to a few bad loans, or do they correctly perceive a wider problem? After all, most of the men in the market are not among the super-rich who will be bailed out by the govmint; their risks are real and their worries justified. They perceive a larger problem, and they can't be entirely wrong; sooner or later, a debt-ridden economy must suffer a severe correction. What “correction” usually means is that the guilty will be rewarded and the innocent—all the rest of us—will be “corrected,” and corrected at great cost and suffering. I cannot say that today is the day that this will begin, but I do know that the day it begins will look very much like this day, and since this day is so very like itself it could very well be the day.
We forget how common these days are in the history of capitalism. After all, it has been 78 years since the great depression, long out of the memory of most living men. And the downturns since then have been comparatively mild. However, if we look at the period from 1853 to 1953, we find that the economy was in recession or depression fully 40% of the time. That's a huge number. Since 1953, the economy has been “managed” by the Federal govmint using Keynesian and monetarist techniques and we have been in recession only 15% of the time. But can such hyper-Keynesiansism—a perversion which would have appalled even Keynes—be sustained? Is capitalism about to revert to type, a type which involves chronic instability? Time will tell. But while time is telling, I think this may be a good time to hold a little gold, or a little field, or a few tools with which to make your own living; something, that is, to tide you over these telling times.