Economic Recovery Requires less Keynesian Spending and more Cutting the Cost of Employment

Posted by PITHOCRATES - September 26th, 2011

The Structural Defect in Keynesian Economics is that Sustained Inflation Creates Asset Bubbles that Must Burst

More bad news for the housing market.  And the American economy (see New-home sales fell in August for 4th month by Derek Kravitz posted 9/26/2011 on the Associated Press).

Sales of new homes fell to a six-month low in August. The fourth straight monthly decline during the peak buying season suggests the housing market is years away from a recovery…

New-homes sales are on pace for the worst year since the government began keeping records a half century ago…

Last year was also the fifth straight year that sales have fallen. It followed five straight years of record highs, when housing was booming.

The housing market is bad.  There’s no denying that.  And this affects everyone.  Not just homeowners.  Because where the housing market goes the economy follows.

While new homes represent less than one-fifth of the housing market, they have an outsize impact on the economy. Each home built creates an average of three jobs for a year and generates about $90,000 in taxes, according to the National Association of Home Builders.

Jobs and taxes.  Both of which the government is having trouble generating these days.  That’s why they are desperately trying to stimulate the housing market with all that easy monetary policy.  Getting interest rates to their lowest in years.  If not of all time.  Because new houses equals jobs.  And tax revenue.  Especially when housing values increase over time.

Home prices have dropped more since the recession started, on a percentage basis, than during the Great Depression of the 1930s. It took 19 years for prices to fully recover after the Depression.

But not so much when they don’t.

Worse than the Great Depression.  Now there’s something you don’t hear every day.

One of the missions of the Federal Reserve was to prevent another Great Depression.  In particular, preventing a devastating deflationary spiral.  Such as we’re seeing in home prices now.  Looks like they’ve failed.  Or rather, Keynesian Economics has failed.

The problem is the dependence on Keynesian Economics.  Which uses monetary policy to maintain economic growth.  By having permanent but ‘sustainable’ inflation.  But the structural defect in this model is that sustained inflation creates asset bubbles.  As people bid up the prices of these assets.  Like houses prior to the subprime mortgage crisis.  And when these bubbles burst these asset prices have to fall back to market levels.  Like house prices are doing right now.  And apparently will do for another 19 years.  Give or take.

It is the High Cost of Labor that is Hurting the Advanced Economies

Manufacturing has been better than the housing market.  But it’s not looking too promising right now (see U.S. manufacturing slowdown: 4 cities at most risk posted 9/26/2011 on CNN Money).

U.S. manufacturing has been one of the rare bright spots in an otherwise annoyingly slow economic recovery…

But expectations of slower growth could threaten the rebound and cities that have gained from it. The ongoing European debt crisis and efforts to curb worries over inflation in China have analysts predicting lower demand for everything from American-made electronics to machinery.

U.S. manufacturing grew 6% during the economic recovery after declining 13% following the financial crisis in 2007. IHS Global Insight economist Tom Runiewicz says the industry has grown 4.5% so far this year. While that’s still robust growth, he expects manufacturing growth to slow to 2.9% next year.

The American consumer may not have been buying but consumers in other countries were.  A good example of American exports is the delivery of the first Boeing 787 to ANA.  And Boeing’s 747-8, too.   Though the largest U.S. exporter, Boeing won’t be able to fix the economy alone.  Especially when they’re competing against Airbus.

It is the high cost of labor that is hurting the advanced economies.  The Europeans subsidize some of their industries to make up for this economic disadvantage.  Boeing charges Airbus with getting subsidies that lets them compete unfairly.  And Airbus, of course, accuses Boeing of the same.   To help gain a competitive edge over Airbus, Boeing wanted to expand production in South Carolina.  A right to work state.  Which the Obama administration has opposed.  In support of their union donors.

The lesson of the Boeing-Airbus rivalry is this.  They’d be able to sell more planes if they could cut their labor costs.

Listening to the Private Sector turned around the German Economy and is why they can Bail Out the Euro

Germany’s high cost of labor was crippling her economy.  BMW and Mercedes-Benz built plants in America to escape their high cost of labor.  But things are different in Germany these days.  In fact, the country is so rich that the hopes of saving the Euro common currency falls on the German economy.  The only European economy rich enough to save the Euro.  So how did they make this turnaround?  Through reforms (see Getting People Back to Work by Matt Mitchell posted 9/26/2011 on Mercatus Center at George Mason University).

Germany’s unemployment rate is only 6.2 percent today. This is pretty remarkable given the severity of the recent recession, the slow growth of Germany’s trade partners (including the U.S.) and the unfolding fiscal crisis in the Eurozone.

NPR’s Caitlin Kenney attributes Germany’s relative success to a number of reforms adopted a decade ago. Kenney reports:

To figure out how Germany got where it is today, you need to go back 10 years. In 2002, Germany looked a lot like the United States does now, they had no economic growth and their unemployment rate was 8.7 percent and climbing. The country needed help, so the top man in Germany at the time, Gerhard Schroder, the German chancellor, made in an emergency call to a trusted friend.

So who did he turn to?  A government bureaucrat?  Or someone from the private sector?

The friend was Peter Hartz, a former HR director whom Schroder knew from his VW days. Schroder put Hartz in charge of a commission, the mission of which was to find a way to make Germany’s labor market more flexible. The Hartz commission made it easier to hire someone for a low-paying, temporary job, a so-called “mini job”:

A mini-job isn’t that great of a deal for workers. In these jobs, they can work as many hours as the employer wants them to, but the maximum they can earn is 400 Euros per month. On the plus side, they get to keep it all. They don’t pay any taxes on the money. And they do still get some government assistance.

He went to the private sector.  To get advice of how to create jobs in the private sector.  And he listened to what they said.  The cost of labor and regulatory costs were crippling job creation.

Generous unemployment insurance and regulations that add to the cost of employment tend to make for a static, unhealthy labor market. Though designed to make life better for workers, these policies may do them more harm than good.

Listening to the private sector turned around the German economy.  Made it the dynamo it is today.  And it is why that the German economy is the only economy that can bail out the Euro.

Economic Recovery Requires New Jobs

The economy still looks like it’s going to get worse before it gets better.  Whereas the Germans are doing so well that they may single-handedly bailout the Eurozone from their sovereign debt crisis.  And a lot of Americans are saying that should be us.  Not the bailing out the Eurozone part.  But having the ability to do that.

And that could have been us.  And should have been.  Like it used to be.  When America led the world in creating jobs.  So what happened?  The same thing that had happened in Germany.  The cost of employment grew.  And as it grew new job creation declined.

Economic recovery requires new jobs.  The Germans understood that.  And they did something about it.  So should we.  And the sooner we do the sooner we will see that economic recovery.

www.PITHOCRATES.com

Share

Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,

LESSONS LEARNED #24: “You cannot lobby a politician unless he or she is for sale.” -Old Pithy

Posted by PITHOCRATES - July 29th, 2010

BUILDING A RAILROAD ain’t cheap.  It needs dump trucks of money.  Especially if it’s transcontinental.  And that’s what the Union Pacific and the Central Pacific were building.  Starting during the Civil War in 1863 (the year Vicksburg fell and Lee retreated from Gettysburg).  The Union Pacific was building west from Iowa.  And the Central pacific was building east from California. 

For the most part, Protestant, English-speaking Americans settled Texas.  Mexico had encouraged the American colonists to settle this region.  Because few Mexicans were moving north to do so.   The deal was that the colonists conduct official business in Spanish and convert to Catholicism.  They didn’t.  These and other issues soured relations between Mexico and the American Texans.  The Republic of Texas proclaimed their independence from Mexico.  America annexed Texas.  Mexico tried to get it back.  The Mexican-American War followed.  America won.  Texas became a state in 1845.  And that other Spanish/Mexican territory that America was especially interested in, California, became a state in 1850.  Hence the desire for a transcontinental railroad.

The U.S. government was very eager to connect the new state of California to the rest of America.  So they acted aggressively.  They would provide the dump trucks of money.  As America expanded, the U.S. government became the owner of more and more public land.  The sale of new lands provided a large amount of revenue for the federal government.  (Other forms of taxation (income taxes, excise taxes, etc.) grew as the amount of public lands to sell decreased.)  Land is valuable.  So they would grant the railroad companies some 44 million acres of land (i.e., land grants) for their use.  The railroad companies, then, would sell the land to raise the capital to build their railroads.  The government also provided some $60 million in federal loans.

But it didn’t end there.  The federal government came up with incentives to speed things up.  They based the amount of loans upon the miles of track laid.  The more difficult the ground, the more cash.  So, what you got from these incentives was the wrong incentive.  To lay as much track as possible on the most difficult ground they could find.  And then there were mineral rights.  The railroad would own the property they built on.  And any minerals located underneath.  So the tracks wandered and meandered to maximize these benefits.  And speed was key.  Not longevity.  Wherever possible they used wood instead of masonry.  The used the cheapest iron for track.  They even laid track on ice.   (They had to rebuild large chunks of the line before any trains would roll.)  And when the Union Pacific and Central Pacific met, they kept building, parallel to each other.  To lay more miles of track.  And get more cash from the government.

PAR FOR THE COURSE.  When government gets involved they can really mess things up.  But it gets worse.  Not only was government throwing dump trucks of American money down the toilet, they were also profiting from this hemorrhaging of public money.  As shareholders in Crédit Mobilier.

Thomas Durant of Union Pacific concocted the Crédit Mobilier Scandal.  As part of the government requirements to build the transcontinental railroad, Union Pacific had to sell stock at $100 per share.  Problem was, few believed the railroad could be built.  So there were few takers to buy the stock at $100 per share.  So he created Crédit Mobilier to buy that stock.  Once they did, they then resold the stock on the open market at prevailing market prices.  Which were well below $100 per share.  Union Pacific met the government requirements thanks to the willingness of Crédit Mobilier to buy their stock.  The only thing was, both companies had the same stockholders.  Crédit Mobilier was a sham company.  Union Pacific WAS Crédit Mobilier.  And it gets worse.

Union Pacific chose Crédit Mobilier to build their railroad.  Crédit Mobilier submitted highly inflated bills to Union Pacific who promptly paid them.  They then submitted the bills to the federal government (plus a small administration fee) for reimbursement.  Which the federal government promptly paid.  Crédit Mobilier proved to be highly profitable.  This pleased their shareholders.  Which included members of Congress who approved the overbillings as wells as additional funding for cost overruns.  No doubt Union Pacific/Crédit Mobilier had very good friends in Washington.  Including members of the Grant administration.  Until the party ended.  The press exposed the scandal during the 1872 presidential campaign.  Outraged, the federal government conducted an investigation.  But when you investigate yourself for wrongdoing you can guess the outcome.  Oh, there were some slaps on the wrists, but government came out relatively unscathed.  But the public money was gone.  As is usually the case with political graft.  Politicians get rich while the public pays the bill.

(Incidentally, the investigation did not implicate Ulysses Grant.  However, because members of his administration were implicated, this scandal tarnished his presidency.  Grant, though, was not corrupt.  He was a great general.  But not a shrewd politician.  Where there was a code of honor in the military, he found no such code in politics.  Friends used his political naivety for personal profit.  If you read Grant’s personal memoirs you can get a sense of Grant’s character.  Many consider his memoirs among the finest ever written.  He was honest and humble.  A man of integrity.  An expert horseman, he was reduced to riding in a horse and buggy in his later years.  Once, while president, he was stopped for speeding through the streets of Washington.  When the young policeman saw who he had pulled over, he apologized profusely to the president and let him go.  Grant told the young man to write him the ticket.  Because it was his job.  And the right thing to do.  For no man, even the president, was above the law.)

THE FINANCIAL WORLD fell apart in 2007.  And this happened because someone changed the definition of the American Dream from individual liberty to owning a house.  Even if you couldn’t afford to buy one.  Even if you couldn’t qualify for a mortgage.  Even, if you should get a mortgage, you had no chance in hell of making your payments.

Home ownership would be the key to American prosperity.  Per the American government.  Build homes and grow the economy.   That was the official mantra.  So Washington designed American policy accordingly.  Lenders came up with clever financing schemes to put ever more people into new homes.  And they were clever.  But left out were the poorest of the poor.  Even a small down payment on the most modest of homes was out of their range.  Proponents of these poor said this was discriminatory.  Many of the inner city poor in the biggest of cities were minority.  People cried racism in mortgage lending.  Government heard.  They pressured lenders to lend to these poor people.  Or else.  Lenders were reluctant.  With no money for down payments and questionable employment to service these mortgages, they saw great financial risk.  So the government said not to worry.  We’ll take that risk.  Fannie Mae and Freddie Mac would guarantee certain ‘risky’ loans as long as they met minimum criteria.  And they would also buy risky mortgages and get them off their books.  Well, with no risk, the lenders would lend to anyone.  They made NINJA loans (loans to people with No Income, No Job, and no Assets).  And why not?  If any loan was likely to default it was a NINJA loan.  But if Freddie or Fannie bought before the default, what did a lender care?  And even they defaulted before, Fannie and Freddie guaranteed the loan.  How could a lender lose?

Once upon a time, there was no safer loan than a home mortgage.  Why?  Because it would take someone’s lifesavings to pay for the down payment (20% of the home price in the common conventional mortgage).  And people lived in these houses.  In other words, these new home owners had a vested interested to service those mortgages.  Someone who doesn’t put up that 20% down payment with their own money, though, has less incentive to service that mortgage.  They can walk away with little financial loss.

ARE YOU GETTING the picture?  With this easy lending there was a housing boom.  Then a bubble.  With such easy money, housing demand went up.  As did prices.  So housing values soared.  Some poor people were buying these homes with creative financing (used to make the unqualified qualify for a mortgage).  We call these subprime mortgages.  They include Adjustable Rate Mortgages (ARMs).  These have adjustable interest rates.  This removes the risk of inflation.  So they have lower interest rates than fixed-rate mortgages.  If there is inflation (and interest rates go up), they adjust the interest rate on the mortgage up.  Other clever financing included interest only mortgages.  These include a balloon payment at the end of a set term of the full principal.  These and other clever instruments put people into houses who could only afford the smallest of monthly payments.  The idea was that they would refinance after an ‘introductory’ period.  And it would work as long as interest rates did not go up.  But they went up.  And house prices fell.  The bubble burst.  Mortgages went underwater (people owed more than the houses were worth).  Some people struggled to make their payments and simply couldn’t.  Others with little of their own money invested simply walked away.  The subprime industry imploded.  So what happened, then, to all those subprime mortgages?

Fannie and Freddie bought these risky mortgages.  And securitized them.  They chopped and diced them and created investment devices called Collateralized Debt Obligations (CDOs).  These are fancy bonds backed by those ‘safe’ home mortgages.  Especially safe with those Fannie and Freddie guarantees.  They were as safe as government bonds but more profitable.  As long as people kept making their mortgage payments.

But risk is a funny thing.  You can manage it.  But you can’t get rid of it.  Interest rates went up.  The ARMs reset their interest rates.  People defaulted.  The value of the subprime mortgages that backed those CDOs collapsed, making the value of the CDOs collapse.  And everyone who bought those CDOs took a hit.  Investors around the globe shared those losses. 

Those subprime loans were very risky.  Lenders would not make the loans unless someone else took that risk.  The government took that risk in the guise of Fannie and Freddie.  Who passed on that risk to the investors buying what they thought were safe investments.  Who saw large chunks of their investment portfolios go ‘puff’ into thin air.

SO WHAT ARE Freddie and Fannie exactly?  They are government-sponsored enterprises (GSEs).  They key word here is government.  Once again, you put huge piles of money and government together and the results are predictable.  In an effort to extend the ‘American Dream’ to as many Americans as possible, the federal oversight body for Freddie and Fannie lowered the minimum criteria for making those risky loans.  Even excluding an applicant’s credit worthiness from the application process (so called ‘no-doc’ loans were loans made without any documentation to prove the credit worthiness of the applicant.)  To encourage further reckless lending.  Ultimately causing the worst financial crisis since the Great Depression. 

And, of course, members of Congress did well during the good times of the subprime boom.  They got large campaign contributions.  Some sweetheart mortgagee deals.  A grateful voting bloc.  And other largess from the profitable subprime industry.  Government did well.  Just as they did during the Crédit Mobilier Scandal.  And the American taxpayer gets to pay the bill.  Some things never change.  Government created both of these scandals.  As government is wont to do whenever around huge piles of money.  For when it comes to stealing from the government, someone in the government has to let it happen.  For it takes a nod and a wink from someone in power to let such massive fraud to take place. 

www.PITHOCRATES.com

Share

Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,