2008 the Watershed year

The malls were filled the Saturday before Christmas.  Last minute shoppers in Cincinnati, bundled up against a howling wind, were now sweating it out in long lines waiting to make their purchases.  While waiting in those lines, it was hard to miss the furrowed brows of mothers looking at the cheap gifts along the lines.  The smaller children were scampering around in eager anticipation.  But the look on Mom and Dad's faces told a different story.  The smiles were a bit quicker to fade this year, have you noticed? 
The scene should not have been unusual.  If it were a week before Christmas, it would have been the norm.  And of course there is always a mad dash at the last minute. The procrastinators always muck up the works those last couple of days.  The week before Christmas the malls were busy, but not bustling.  The parking lots were crowded, but not full. And perhaps the most telling sign this Saturday was the type of shopping.  People were filling shopping carts.  This wasn't the normal last minute, pick up something quick for Aunt Mary.  No this was real shopping.  Done with a frenzy, and done because fear had kept many of these shoppers home until the last minute.

2008 will be the most important year in a generation, and perhaps many generations.

The first crisis, economics.

The sub-prime lending collapse has brought out some old familiar terms.  We hear the economic fundamentals are still strong, this is not true.  We hear from the brilliant economic pundits that the Fed must “restore liquidity” to the markets.  This is also misleading.

Liquidity by definition is the ease at which assets can be converted in to cash.   But “Cash” is a loaded word.  When the fed lowers interest rates, it isn’t creating liquidity, it is creating inflation. Yes, you can increase liquidity by pumping huge amounts of cash in to the economy.  So what?  The liquidated $500,000 home is now worth $250,000.  The fact that we have papered over the loss makes no difference to the bottom line. 

Somewhere along the line, even the experts forgot how to grow an economy.  You increase cash (real purchasing power) by increase productivity.  Not just flooding the economy with hundred dollar bills.

Even more shocking, I have heard more than one of these economic gurus talk about how the sub-prime collapse really doesn’t affect all that many people.  I guess “many people” is a relative term these days.  Let me tell you the specific people in the United States who this affects:  every last one of us.  If you have owned a home for ten years, bought it on good credit, and make your payments on time, the crises effects you.  Do you have a job? The crisis affects you.  Are you on unemployment, welfare, or social security?  The crisis affects you.

This is so simple.  If there are two hundred houses in your neighborhood, and ten of them are for sale, there is competition.  This translates in to price pressure.  When the economy is growing, the pressure is limited.  With many buyers in the market, the pressure eases.  When the economy is slowing, the pressure is more intense.  Now add in the fact that one in ten of these home owners trying to sell has a loan with a rising interest rate.  More downward pressure.  In a matter of a few months, housing prices in your neighborhood go way down.  When prices go down a few things happen.  You have less equity, so you can’t borrow against your home.  The value of your house goes down, so the tax base goes down, and local governments have to scramble to try and raise your taxes.  People who were planning on building a home, now find it is much cheaper to buy an existing home, or stay where they are, this puts construction workers on unemployment, which raises the need for more taxes. The construction workers, stop buying cars, refrigerators and Ipods, which puts more people out of work.

In short, if this sub-prime issue isn’t fixed, we’ve got real problems.

The blame game.  In the twenty-first century, the first thing we do when a crisis hits is to strike a political pose.  Do we blame George Bush?  Many Democrats have blamed Bush for the attacks of September 11^th, so an economic crisis can be blamed on him as well.  How about Bill Clinton? We can also blame congress, the federal reserve system, or governors. We can blame the economic pundits on television, the liberal media, the corporate media. 

But this won’t fly will it? When it gets right down to it, we all know who is to blame. We are.  We, who had to have granite counter tops in our kitchens. We who just had to have a bigger house to entertain in.  We who bought a Lexus, when we would have gotten the exact same utility out of a Chevrolet. 

So how do we fix it?

Instead of having the wizards at the fed pump fiat currency in to the economy let’s fix it the old way, by increasing productivity. If there is one thing the government does well, it creates laws.  These laws aimed at regulating business fall on small business the hardest. Yet small businesses employ most people.  Most of these regulations provide little or no benefit or relief to the average American. Yet they cost the average American thousands of dollars per year in pay.  Particular attention should be paid to regulations that are a heavy financial burden, and sap productivity. 

We should also fix the spiraling cost of health care. Everyone knows what the problem is, and everyone is afraid to say it, ok I’ll say it. We need to stop the lawyers and bureaucrats from skimming off the top.  The lawyers do it with ridiculous law suites, the bureaucrats do it by forcing health care providers to spend billions of dollars complying with a literal mountain of paper work.  An exemption should be created for any drug that is approved by the FDA.   The paper work mountain should be drastically reduced, and oversight budget and penalties for fraud, drastically increased.

These few little things will stimulate the economy and productivity.  If we’re going to paper over a problem with more cash, we should at least insist the cash be real, and not just printed.

Planning for the worst case scenario.

If things do go terribly awry in 2008 the government can still borrow money.  The debt is a towering 9.2 trillion dollars, but with a Gross Domestic Product at just over 13 trillion, we are still viewed as credit worthy.  But it is getting close. A severe recession or economic depression would lower that GDP at the same time pressure is put on to increase the debt. Our public debt is currently about 65% of GDP. Japan, by contrast has a public debt that is nearly 200% of GDP.  As our debt starts to spiral towards 100% to 150% of GDP, the cost of continued borrowing sky-rockets. A cut of government spending immediately in the range of 15% to 20% would go a long way towards softening the blow of a severe economic downturn. 

The second crisis:

Should a severe recession turn in to an economic depression we will no doubt witness social unrest that will make the sixties look like a tea party.  The broad middle class, who have paid so much in to the social safety net over the last fifty years, will wonder where that net has gone now that they need it.  The first casualty will be the illegal immigrants, but the legal immigrants will be a close second.  The pressure put on politicians to deport all non-citizens will be too much to bear.  The bad news is, this will work.  The illegal immigrants will be quickly shuttled out of the country, freeing up a few million jobs, and unemployment will go down.  When businesses have to start paying higher wages to citizens, and the associated cost of compliance is factored in, prices will go up.   The jury is still out on whether or not this will be good.  All things considered, inflation is generally better than deflation. With inflation your dollar of course doesn’t go as far.  With deflation, you don’t have any dollars.  The jobs created by a mass exodus of low skilled, low wage immigrant workers, won’t necessarily help the economy become more productive.  They will stop the bleeding of government debt by lowering the number of people on relief.  The entire illegal immigrant issue is riddled with complexities.  The rule of law, the damage done to the tax base by the underground economy, and the potential for violence to erupt when the government tries to give the boot to four or five million people all will need to be considered thoughtfully.    

The social unrest will ultimately turn not on racial or ethnic status, but socio-economic status.  Those that have been on the dole for years, or generations will be attacked politically.  If the well runs dry, those that have paid to fill that well for so many years will demand that those receiving public aid are worthy of that support.  How far this will go is anyone’s guess. 

Other issues to watch in 2008.

The United States has always been a nation prone to short bouts of hysteria.  From the Salem witch trials, to prohibition and now to Global Warming.   Every day it seems another scientific head pops up and says, “Wait a minute, this may not be right.”  Gore and his supporters in the media have played a very dangerous game with this issue and a backlash could spell disaster for the environmental movement.  Pollution is still a bad thing last we checked.  If C02 is proven not to be the main factor in global warming, who will listen when a real environmental crisis hits?

The Middle East may finally reach the point of meltdown.  While the insurgency in Iraq appears to be softening, we still have a few big problems to contend with.  Unrest in Pakistan is almost certain to grow, and spread.  The intelligence on Iran and the bomb have become comical.  In Iraq Bush was roundly criticized for putting too much stock in reports of weapons of mass destruction.  In Iraq, a single report declares that the threat has largely been overplayed, and Bush is criticized for not believing it.  Errors on the side of safety have always been considered prudent. Today, intelligence is used as a political tool by both sides.  Unless the more intelligent members of congress step up, we are in for a rough ride.  Perhaps the most unsettling bit of news in the world over the last few weeks has involved Israel.  Two articles caught my eye.  The first was about younger Jews leaving Israel. The second was about a fairly large slow down in immigration to Israel.   While some may applaud these developments, they are not looking at the big picture.  The government of Israel may be forced in to a dark corner.  If the citizens are so fed up with the violence that they are leaving, there is not much reason for restraint.  This will get ugly for everyone involved.  The only hope may be that everyone is just tired of fighting.  I spent a week in Los Angeles over the summer. I’m not one for driving in slow traffic, so I hired a car and driver.  My driver was a former Israeli soldier who had decided to leave for America.  When I ask him why, he said he was just tired of all the fighting. He told me that the Palestinians he knew felt the same way.  They just wanted to be left alone to live their lives.  Whether this evolves to a much needed peace in the region, or finally pushes the radicals on both sides in to the big showdown remains to be seen.

Oil prices will start to come back down.  The price of a gallon of gas is going to push the Democrats to open up Anwar, and begin more drilling in the Gulf of Mexico.  Other exploration across the globe is starting to bear fruit, and this crash is going to be monumental.  2008 may be a bit early, but by the end of 2009 oil will be well below $50 per barrel.  If you factor in a slowing economy, we could see an oil price crash that costs some of the speculators billions.  It may be a small stretch but I wouldn’t be surprised to see oil at $25 a barrel for a short time.

The consumer driven economy is going to slow down. If the economy starts to slow seriously, a lot of people are going to realize that much of the money they’ve spent over the last ten years has been wasted on things they really didn’t need. Five dollar cups of coffee and five hundred dollar game systems will go first.  Fifty thousand dollar cars will be a close second.

We close 2007 at a cross road in all of our lives.  If we come through the sub-prime crisis the way we did the savings and loan mess, we may be in for the longest ride of prosperity the world has ever witnessed.  The information revolution still has a long way to go and productivity increases could become astronomical.  Even small businesses are starting to run their operations much more efficiently.  If the government frees up the entrepreneurs and small businesses even just a little, we could be in for a great ride. But this is a long shot.  Politicians like to create legislation, all laws and regulations have price to be paid.  For thirty years now we’ve overcome that cost with increases in productivity tied directly to the microchip and the software the runs them. If we elect sober, forward thinking people in 2008, the world will be a much better place.  If we elect leaders who put the economy first, who think long term about the debt, business regulation, and the infrastructure that makes it possible, all on the planet will see a healthy rise in their standard of living.  I’m not holding my breath.