The Recession and Relapse

2/3/09

Today is the 50th anniversary of the Day the Music Died. Those of us from the High School class of ‘60 truly understand the importance of this day. Yet rather than continue to morn, we rejoice in having our 50’s Rock and Roll station playing tunes where one can actually understand the words.

However, on a sadder note we all have some additional Points to Ponder. This time I ponder about the global recession. Regretfully, with yesterday being Ground Hog’s Day and its prediction, in spite of global warming, of 6 more weeks of winter, we must look at the state of global economy before one can really access what is going on with any other issue.

As much as I hate to admit it, the sub title of my report, Confessions of an Energy Price Forecaster: A 12-Step Program to Enlightenment is really relevant to this discussion. Any recession is no different than the penalty the drunk pays after a relapse into indulgence. Regretfully, recessions are the extreme downside ends of the business cycle, just as the unrepentant substance abuser will always suffer withdrawal from his highs. The difference here is that the business cycle, excluding its extremes, are normal, while the drunk should be able to do something to minimize his problem. It is really the extremes that cause the problems.

I see firms going from right sizing to down sizing to capsizing. How true the TV ad of the fellow standing in his yard with all of his toys saying with a big shit-eating grin that he is up to his eyes in debt and has no idea how he is going to escape. He did bring this upon himself and nobody hindered his view of the consequences. He just followed this path anyway.

The giant financial “margin call” was always hanging over this party. The deleveraging of our balance sheets is the cold turkey withdrawal that must be paid. Prandium gratuitum non exstat. (There is no such thing as a free lunch.)

As I note in way to many of these Points to Ponder, what does all of this have to do with energy? Again, I fall back on the underlying premise of all of these ramblings by noting how all of this reinforces the premise that energy, the economy, and the environment are interlocked and must be treated as a single subject. This Point to Ponder is simply to dig deeper into the economic issues of the current financial crisis.

Some observations

The fundamental cause of this global recession would appear to come from the global social behavior seen over the past decades of instant gratification of consumption without the ability to pay for it. This has created a false and unsustainably large economy represented by 70% consumer spending supported through debt from home equity and unsecured credit (cards).

When you’re faced with too much debt (credit crisis), you probably shouldn’t borrow your way out of it. With seemingly easy credit of “Approved, approved, approved” we here in a TV add, where’s the due diligence of both the lender and the borrower?

GDP measures count debt as a positive giving a false sense of grandeur, wealth and security. This requires outside funding of our debt because the debt amount is too large to be funded internally. This in turn forces our pain on the global economy that is hurting on its own from its internal excesses. Debt makes GDP volatile. With reduced debt, GDP must fall.

Saving and investment gave way to borrowing and excessive spending that, in turn, led to global imbalances in current accounts and distortions of governmental funding.

Our financial institutions have been the drug peddlers, with government encouragement, feeding this habit with debt.

The drug has been loose money policies that were net negative real interest rates in a growing economy. This drug was boosted with socially engineered policy such as:

  • Housing policy
  • Poor consideration, implementation and enforcement of regulations
  • Unregulated and poorly regulated banking
  • Fraud
  • Low short-term rates funding long-term speculation in search of high (risk) yield

We the People in general and our elected representatives in particular (who look at reelection rather than true problem solving) have desperately been clinging to this overloaded, capsized and sinking boat rather than swimming to shore. All parties seem to want to preserve these false and inflated asset values and avoid painful solutions. Nobody wants to accept a needed contraction in GDP to get back on a rationale track.

The AA Analogy

Step 1 in the AA program is to admit our addiction (to this debt lifestyle) to ourselves and to others and that our lives (via the recession) are unmanageable.

Facing the above points is this admission.

Step 2, in the AA program looks to a higher power to restore sanity. Here that higher power is We the People. The nature of our representative form of government requires We the People to direct those representatives’ actions to reflect our desires.

If we abdicate that responsibility, government becomes that sole and all-powerful higher power. This is the issue facing us today and really has always has been the debate in any society. As that great American philosopher, Pogo, once said, “We have met the enemy, and he is us.”

What’s Been Happening?

The Hydrogen Example

Action such as a “Hydrogen Economy” has consequences intended or otherwise. Policy must be based on sound science or at least the best science available. In this case government mandates cannot set aside the laws of thermodynamics that God himself created. In layman terms, it takes more energy to get hydrogen out of water or methane than can be recovered in using hydrogen as an energy source. If the energy in recovering hydrogen was so cheap and the social value of hydrogen was so high as to make this law of thermodynamic irrelevant, society would probably not need hydrogen.

So not only is it not nice to mess with Mother Nature, society better also respect the economics of Adam Smith. And heaven forbid that government address the obesity problem by mandating smaller clothing sizes. So are we on the right track with the current crisis?

We not only need Science Savvy Citizens, but also Science Savvy Policy makers. This is not the Great Depression, although it could come to look like it if this is mismanaged.

Wall Street may say the crisis is over, however, Main Street says my 401 K is still in the tank. Becoming whole will take a long time. Former home and 401 K values may have been a windfall and not reality.

TARP, etc.

Bailouts are nothing but methadone, hopefully postponing worse pain, but with no efforts at correcting the situation. Perpetual (unsustainable) growth was the anchoring phenomena trap that the trend today will go on forever. Rapid growth in leverage was assumed as an acceptable means to feed our materialistic addiction. This was accomplished through opaque and ill conceived financial instruments and the lack of due diligence.
Banks must disclose their “toxic” assets. Stimulus must convince the receiver of a long-term horizon. With a one time shot or the perception of it being one time the stimulus will be saved and not spent. However, saving could be a good start, just not stimulus.

Many thought that the supply side policies of Regan were voodoo. Now those in power are pushing a Keynesian (voodoo?) policy that has yet to work in history with the promise of even greater multipliers than Keynes would have ever imagined. (Note: At best a 0.8 multiplier has been seen at times of war with massive DOD spending.) A dollar spent by government comes at the expense of that dollar from the private sector. FDR’s Treasury Secretary, Henry Morgenthau, said in 1939, “we have tried spending money and we have just as much unemployment and a lot more debt.” Government does not create wealth or money through productivity.

The Economy

The best measure of the standard of living is productivity. The US must not fall into the protectionist trap in addressing the recession. Protectionism is also counter to our ability to get foreign support for our debt. With global interdependence, protectionism is out of the question. This is mutually assured economic destruction (MAED). Solutions to this global recession will take cooperative global actions. One country cannot expect others to pick up its tab.

Policies cannot have parochial political motivations. This will be a tough nut to crack. In the US, it is reelection politics. In Russia, China, etc. its command economics or “State Capitalism.” Other forms are State Oil Companies with politically driven economic decisions, NGOs and sovereign wealth funds, etc. The fear is that the financial capital of the world is no longer New York but Washington DC.

Let’s remember that the Fed can only go so far in printing money. But if everyone keeps that money in his mattress, there is no boost in consumption or in investment. It’s the velocity of money in spending or investment that is the measure of an economy.

Finally, Joe the Plumber must see that any productivity gains he can create will be rewarded.

A Cultural Change is Required.

The one silver lining that I’ve seen comes from energy and the public’s response to the prices seen in the past few years. The Gallup study “Despite Cheaper Gas, New Driving Habits Sticking” is the source of this observation.

“64% of Americans reported changing their driving habits due to the high gasoline prices of mid 2008. Only 12% said they had returned to their former driving habits at the end of 2008, even though prices had collapsed to levels well below $2 per gallon.”

Is this a cultural change in American society? Only time will tell. However, will such a change be compromised by governmental policy? What will fill any remaining demand for big SUVs if the auto industry is precluded from fill that supply? Can taxes or mandates meet the needs of all drivers across the nation?

While this cultural response was to a price shock, even though it had been building since 2000, is there an analogy to the build up of the acceptance of debt? Has the financial crisis been deep enough and long enough to drive a similar cultural change? Can the US economy, and perhaps the global economy, evolve to bring more balance of savings and investment?

Step 12 suggests that having had a spiritual awakening as the result of these Steps; ---- We the People will practice these principles in all our affairs.

This last step is yet to be taken. While this is a part of the current debate, the level of pain and sacrifice needed today and the amount of the bill that our children will have to pay must be primary.

The Real Points to Ponder

  • So I sit here at my computer and ponder just how this recession will play out. I worry about the short-term mentality that exists in even the energy industry and if the ability to finance our future energy needs will add to future price rises and volatility. Energy will still fuel the global economy. It’s just a question of at what price.
  • Will the economy that arises from this crisis increase savings and investment? Can society evolve from the “he who dies with the most toys, wins” attitude?
  • Can our society live with the freedom and the risks of a government and the rule of law that establishes very broad boundaries within which society has the right, but not the guarantee to succeed? Does society need more control?
  • A man who is not a socialist at 20 has no heart. A man who is still a socialist at 40 either has no head or pays no taxes – Arthur Brooks WSJ 4/30/09. We are facing a cultural war over the concept of the market economy.
  • It’s our choice. We the People need to speak up, hopefully based on informed, well-reasoned thought.
  • The last words on this subject?
    - “Freedom is the right to fail.” — Winston Churchill
    - “Most people, after a little freedom, have preferred authority with the consoling assurances and economy it brings”. — Walt Lippman
    - And on a more positive note: “Rave on!” — Buddy Holly

Click here for more information about Confessions of an Energy Price Forecaster: A 12 Step Program to Enlightenment

Click here for John Tobin's full bio

 

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