Tuesday, April 22, 2008

seven foolish years...

there are many things you can say about george bush's years in the white house. I think they have been foolish for many reasons... mainly foolish for getting distracted with things like terri schiavo, unneeded tax cuts and an a poorly planned war in iraq. these issues have depleted his political capital and may condemn him to being considered one of history's worst presidents ...

but I see bush as sympton of a larger phenomenon... we as americans in general have taken a collective leave on responsibility during the last 7-10 years ... as a country and a political system we have foolishly ignored major problems growing in our midst. I believe that some five decades of easy living allowed us to neglect problems rather than solving them. this complacency bubble seems to have hit an apogee in the bush years and the subprime mortgage crisis.

decades of error and negligence are finally coming home to roost. these two charts illustrate what I consider two of the central problems that really exploded during these seven foolish years...

these two charts essentially show two interconnected changes in our economy since the 1980s emerge...

1- a growing reliance on debt to spur demand

2- a growing reliance on foreign suppliers to meet that demand

on top is our trade balance as a percentage of GDP. for most of the 20th century, the U.S. ran a vast trade surplus. we started the 20th century as the biggest exporter of everything from steel to crude oil. we financed allied victory in two world wars and transferred trillions of wealth to other countries .. incomes rose in most of that period, making americans the richest people in the world.

but, we also started consuming more than we produced, and imported more than we exported. by late in the rah-rah reagan years, the trade gap was 3% of GDP, the highest since at least 1952 ... it subsided in the late 1980s and early 1990s, before exploding to 4% of GDP by mid-2000. when bush came to office, it kept widening... by late 2005 we were transferring 7% of our economy to other countries every year...

as we consumed more than we produced, our culture came to value consumption more than production. I personally think this was tied to the deterioration of public education as unions came to assert control and devalued hard sciences in favor of inclusivity and diversity... I believe many apparently innocuous causes are behind this change. for example, the government subsidized loans for college students regardless of what they were studying. taxpayers shelled out cash as some youths ran up six figures of debt studying economically worthless disciplines such as english. not only has this made education costs rise at more than twice the overall rate of inflation ... it has also passed along the perverse incentive of encouraging people to incur debt and pursue education without considering whether it's a worthwhile use of time and money.... this is just one example ... our entire body politic is rife with such foolish and negligent policies...

the second chart shows how this lifestyle was funded ... household debt as a percentage of personal income... it showed big growth between 1952 and 1964, then basically held at 50-60% until 1986, when it started growing again. household debt to income kept creeping up throughout the clinton years and exploded higher starting in 2000 -- surging from 80% of income to about 115% by late 2007.

the current credit crunch marks the end of that era. I have heard much talk about the fiscal stimulus plan. while such a scheme may have worked previously, I contend that we've entered a new era. after being burned on subprime and seeing gasoline approach $4 a gallon, americans will never go back to spending blithely as they did in the 2002-2006 period.

this is why I am bearish overall on the economy. as old habits die hard, trillions of dollars of assets and millions of jobs will be destroyed. entire shopping centers and subdivisions need to be razed and returned to nature.... the economy needs to absorb these blows and relaunch in a new direction. that takes time, and probably some political direction.

speaking of poltical direction: one of the most annoying things to me about conservatives is they ignore how essential the government has been to the economy -- and I have often considered myself "conservative." for example, carroll quigley brilliantly observed that the same laissez-faire republicans who opposed FDR's public works like the Tennessee Valley Authority gladly supported nuclear weapons -- even though the manhattan project would have been impossible without cheap hydroelectric power in places like Oakridge TN ....

in the same way, conservatives forget how the government promoted the post-WWII consumer economy by subsidizing sprawl, building highways and directly transferring wealth from established northeastern states to the sunbelt.

there are many other examples... for instance, the New York state government built the erie canal in the early 1800s, opening the midwest to commerce -- and thus settlement. and in the 1860s, washington encouraged railroads... everything from the airplane to the internet, more or less, was created or massively promoted by the government.

in another posting, I discussed how the state can move advance a new form of development we should consider. but now, I'd like to show a few more charts to illustrate the problem as I see it.

in the first, we see the quarter on-quarter change in corporate profits, smoothed with a four-period moving average. it illustrates the great profitability surge of the last few years, which resulted from merchandise-price deflation, globalization, currency devaluation and leverage. after a steady expansion, it's clearly subsiding.

second, we see the earnings yield of stocks ... basically, profits divided by price. the lower this number is, the more expensive stocks are ... I think all bulls should study this chart closely... it shows that stocks are still relatively expensive in the long term... high stock multiples are always worrisome when inflation comes.

let me just say I don't think this is just like the 1970s. I think we can keep higher multiples because companies are more global and are still growing fast. but higher inflation, merely as a phenomenon, will push all yields -- both bond yields and stock yields -- higher. that means that even if companies grow earnings fast, they might still get cheaper.

finally, let's top it all off with my favorite chart of all. this is all financing-related debt as a percentage of GDP. it includes securitized home loans, credit cards, plus the unsecured debt of banks and finance companies that levered up as earnings grew...

this chart shows an unsustainable and essentially insane process. since 1997, this debt almost doubled from 60% of the GDP to 110%. now that banks are recapitalizing and writing down assets, it seems safe to conclude this chapter is over. we've had some foolish years as an economy, as a society, as a body politic and as citizens. the 1990s bull market was the culmination of the triumphant cold war american economy, and was 40 years in the making. we now need to find a new direction... one that's based on intelligent health care, intelligent people and intelligent regulation of financial markets. I think it will take at least one more presidential election before these issues are addressed seriously. as a result, I think it's still far too early to get truly bullish about the market. it may take years for the ingredients to converge perfectly once again for U.S. stocks.

1 comment:

Clown George said...

i see your points. i agree that it's certainly not just gwb, as much of an ass as he is, that is the problem, and the stuff about debt (and education) make a lot of sense.
not sure all laissez-faire republicans, at least during FDR's time, had no problem with nuclear weapons. plenty of the "old-right" types in congress back then were isolationists and anti-war -- it was buckley who remade the conservative movement in the 50s by accepting the "military-industrial complex" as essential to keeping the commies at bay. regardless, you're right that today, many free-market minded people -- myself included, probably -- sometimes forget that the government has had a large role in promoting a good deal of the way the country has developed, and some of those developments have been beneficial.
but a lot haven't, as i'm sure i don't need to remind you. and is the state going to adopt any of your ideas? i'm not hopeful. you've said a millions times how inept the government is -- washington DC in particular. it was the government that promoted all the easy credit and pushed banks, through things like the Community Reinvestment Act, to make all the bad loans that led to this subprime mess. it's the state that's now responding to energy issues with the asinine ethanol mandates and subsidies (which i've read more about since we discussed it, and it is insane). perhaps some of FDR's projects helped development, but his new deal did quite a bit to screw up the economy even more and keep us in a nasty depression for 10 years (as well laying the ground work for a lot of other nonsense, such as the appalling farm policies we're still stuck with). and do you really think subsidized sprawl was a good thing? i'll only mention in passing the horrible wars
the state has gotten us involved in. the list can go on and on.
this isn't me just being libertarian and disregarding the beneficial things the government might have promoted or helped along. but would all of those beneficial things not have happened without the state? i dunno.
what do you think of this article? not the guy's ideology about government, but his contentions concerning the potential of solar power? i don't have time to read the links at the moment, but you've talked about this before and seem interested. the guy seems pretty enthusiastic about the possibilities. you think the hopeful picture he envisions is possible? i should investigate the links and other points of view at some point, but just wondering what your reaction is.