2008/10/06

The lethal diseases that didn't kill

It's quite amazing how much the media and almost everyone focuses on the financial markets in this crisis. I believe that this could lead to suboptimal reactions.

It's similar to a man's mortality. A disease wins the race and kills him first. That's inevitable. That disease may be defeated with drugs, but then another disease would win the race for the kill, slightly later.

It's quite the same with this crisis - the mortgage crisis is the winning disease, it's not mortality itself. An economic disaster would have happened as well if mankind never invented mortgages.

The underlying problem is in my opinion a sustained mismatch of income on the one hand and consumption/investment on the other hand. The imbalance was unbearable at that extent. Neither government nor the Fed attempted to re-balance it gracefully, thereby leading to a rough landing.

That mismatch/imbalance could be considered as a cultural phenomenon - it happened on the individual (mortgage, credit card debts, low savings rate) level, on the state level (budget deficits) and on the national level (trade balance deficit).
To live beyond one's means had apparently become a national trait (of course not for every individual).

Foreigners are also at fault, as they (especially the East Asians) supported this and were even happy about their trade balance surplus (a bad habit that's also wide-spread in Germany).

The short-term measures to soften the crisis may work or not - every crisis ends sooner or later anyway. The really interesting question is "what happens afterward"?
Will the culture of overspending survive?

This has an important consequence for global military affairs: The state consumption that has been much too high during the GWB administration includes a completely bloated 'defense' budget and equally bloated other military-related and para-military budgets. The belief in the ability to sustain such a level of military spending is still intact among many people who focus on military affairs.

The wasteful military spending is equally unbearable as was the mad sub-prime market. It was a disease that didn't win the race.

A reduction of the military spending (even beyond just saving the current war costs) seems to be inevitable.
May this change the foreign policy attitude that's being regarded by many as arrogant, will it prevent new stupid wars? Will the USA pull out of Iraq ASAP, maybe in early 2010? Maybe the war in Afghanistan could be finished? Maybe U.S. meddling in Eastern Europe and Asia might come to a full stop, enabling the Europeans to negotiate win-win deals with Russia?

The economic crisis helps to recognize the lack of sustainability of the past U.S.military strength.
This happens at a time when the inventories of army, navy, air force, coast guard and national guards are rather old and worn-out, a problem that was caused by a terrible procurement administration and policy in the past two decades.
It's very unlikely that a modernization to match the own expectations could be done with a much-reduced budget without a huge cut in force sizes. The attempts to increase the army personnel strengths is extremely antagonistic.

The U.S.Americans might believe that their country is "exceptional", but it's really just large and had a lot of goodwill among other countries. The debt-based illusion of power and wealth is being torn apart these days, and we will certainly not see the USA during 2026 in a similar position as in 2006.

Sven Ortmann

edit 2008-10-12:
I saw a discussion on CNN International an hour ago - about how the nation got to this point. The bottom line of the pundits was that the state deficit spending wasn't sustainable and foreigners are not willing to finance U.S. deficits anymore (an indirect reference to the trade balance deficit).
The conclusion: The nations needs to "grow up" and "pay taxes again", especially "the rich people". The age of Reagan is finally over in their opinion.
They did discuss how remarkably little influence the financial crisis had on the real economy so far. Well, they seem to ignore the well-known lags. Upturn and downturn in the real economy influence the unemployment rate - not instantly, but increasingly over the next two years. One per cent less growth equals (rule of thumb) a half per cent more unemployed after two years (ceteris paribus).
The near-collapse of the automotive sales (depending on source and company something like 16-30% less turnover) shows that private consumption is likely finally scaling down towards a sustainable level.

edit: 2008-10-16:
The insight is dawning. I just saw Peter Schiff (Author "Crash Proof") on CNN International making the exact same point; to way out of the crisis is about producing/saving more and consuming less. It's not about re-starting the bubble-creating lending machine or about pushing the domestic consumption.

3 comments:

  1. You make some excellent points. I liked the analogy to disease.

    The question that interests me is: "Will Asia become the new center of world politics?"

    I suspect we're heading for a multi-polar world, not a rise of unipolar China, but clearly China has ambitions.

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  2. The Asia question is in the medium term only about the PRC in my opinion. The PRC had based its new industries on export, especially export to the USA. Furthermore, some of its industries flourish because they produce investment goods - like the steel industry.

    They will become huge and easily number one economy-wise if they manage the change to more domestic consumption well.

    Some people suggest that the PRC would exploit its power as seen in the examples of USA and Soviet Union - but I'm not sure. The country has a history of only dominating the region and struggling to not fall apart - maybe it won't use its power beyond East Asia if others don't block its access to raw material markets.

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  3. As a German I don't mind trade surplus or deficits. You buy foreign stuff because it's worth the money more than homegrown products. So you get more bang for the buck and improve your economy buying for example German machinery or cars that are much safer and protect you from harm. Despite a trade deficit both sides profit because the economies of both sides can run more efficient. This blame on trade deficits is rather a nationalistic reflex in order to not see the homegrown problems.
    Homegrown problems are the erosion of the taxc base by exemptions of wealthy and rich who in other countries foot a more substantial part of the bill and the lack of employment of skill.

    What can the US do? Well, the US exports services worldwide and they aren't sufficiently accounted for in the trade balance. So the real trade deficit is much less or non-existent. And that's what Americans can best do, develop services to find solutions. One product could be a kind of AutoCAD for enhanced engineering (that the Germans will use to design the machinery they export to the US). It will take the USA a long time to reestablish the industrial base, but American software (like computer games) and interfaces between hardware and software are still highly regarded worldwide. The US products will be rather knowledge than mass-production with objects of little weight with lots of know-how to their production.
    Software and interfaces are the fast answer. The structural answer that will require more time and money, but is unavoidable, is changing the way of life in order to be once again an emulated icon. Obama got it right, the US needs to go green. It needs a green fuel production for a sustainable carbon cycle instead of life-threatening carbon emissions. This new economy of the carbon cycle instead of carbon emission will contain the most significant changes to the way of life mankind will embrace in this age of globalization and the Asian rise.
    Another option to American industry could be producing for an emerging market and developing the right financial tools for the customers. All across the world increasing human wealth goes hand in hand with more profitable samll scale farming that creates an income and food security as the basis of human development. The best thing one can do is embrace and support this market wholeheartedly and re-erect America's position as the leading developer in agriculture.

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