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Friday, March 19, 2010

The Great Recession of 2011-2012

Are you ready for the Great Recession of 2011–2012? You should be, for it is getting under way even as you read this. Just as the 2009 “greatest economic crisis since the Great Depression” actually began back in 2007, so we are in the early days of the next cycle. Only this recession is going to be a doozy. And the aftershocks will be felt long after President Hillary Clinton leaves the White House in 2024.

The coming crisis should be no surprise, for we all have had plenty of advance warning. If it is a surprise, blame those chat-show economists who have become so politicized that they ignore the truths of their own science in order to acquire celebrity. Nor should we forget those politicians who deliberately suborn national interest for the security of zero-sum pork-barrel politicking. Combine it all with a news media largely made up of self-referential ignoramuses and it is small wonder that most of the world has been diverted as Dorothy was in Oz by the lightning bolts, explosions, and billowing smoke screen being generated by the men behind the curtain. The truth is our wizards dare not admit that the levers they pull are not really connected to the true crisis that confronts America or its place in the global market.

Despite the self-congratulatory assurances from the White House, Congress, and part of Wall Street that we have been saved from a slide into a 1930s depression, our most serious trials still lie ahead of us. We are unlikely to be able to get back to those halcyon days of perpetual prosperity and optimism that Americans (and most of the industrial world) enjoyed for the last 50 years. A tectonic shift is occurring beneath our feet and the world’s economic climate has shifted. We face not just a few abrasive years of getting back to normal, but a generational hard slog of constricted markets, limited resources, and rolling setbacks. And in each episode of crisis, some will prosper, the weak will suffer most, and radical visions propounded by political snake-oil salesmen of all persuasions will make rational discourse nearly impossible to conduct.

This is not to say that the Apocalypse is upon us, as morally satisfying as that might be to some. Nothing so dramatic is going to happen. The future offers no therapeutic collapse of civilization, with roaming bands prowling the rubble for Soylent Green. Folks will try to live just the way they have been but those lives will be more pinched, the opportunities more limited; caution and bitterness will replace the open-handed optimism that made it a wonder to be a 20th-century American, or even a Western European. If the stolid Swiss now quake at the sight of a minaret in Zurich, it is just one of the many new worries for all of us to fret over in the years to come. Civil privileges now considered “rights” will be up for renegotiation.

One has to feel a twinge of sympathy for the people who have chosen careers of service in government—not just in Washington but in all the capitals of the industrial West. Life just is not going to be as uplifting as it once was back when policy innovations were both credible and idealistic. But it must be especially hard for the crowd of wizards in Washington these days. Building consensus is hard when no one will talk to anyone else. Little wonder then that so much of the dramatic rescue being claimed by the White House in reality turns out to be merely putting rouge on the patient’s cheeks and exclaiming how well the poor soul looks.

Underscoring the difficulty in charting a new economic course is the truth that the government’s own statistics have become so distorted by age and the dynamics of change that they really don’t reflect the depth of the crisis that is upon us. So the wizards continue to twiddle the levers of stimulus and regulatory rules changes without realizing that the dials and barometers have long ago broken connection with what is going on. Houston, we have a problem.

CONSIDER JUST A FEW of the economic bellwethers one hears about on the evening news as proof that the crisis has been stabilized and recovery is imminent. Stock prices are up, true. But trading volume is way down and that is because retail investors—citizens making real investment choices— are on the sidelines. The price rises that swell the Dow Jones Industrial and other indices reflect almost pure speculation by Wall Street’s investment houses that are soggy with Washington’s cash injections. Just as Cash for Clunkers inflated Detroit’s hopes last summer, so the share price recovery is more of a sign of a new bubble inflating than it is of real value returning to share market prices.

The same for housing prices, only more so. It was headline news recently that house prices in “some” areas of the country had stopped declining quite as fast, while in some fewer areas there were even tiny increases in prices of houses sold, if not much increase in the volume. Yet there are uncounted hundreds of thousands of vacant houses, condominiums, and commercial office space for which there is no rational prospect of a buyer during 2010 or perhaps ever.

It will get worse. Of the 47.4 million home mortgages in place today, nearly 10.7 million are “underwater,” that is, the money owed on the loan is greater than the value of the house. And that’s not counting the 2.3 million other mortgages that are “near-negative equity.” Most of these latter will face sharply higher upward ratcheting of their interest rates in 2010 and 2011 and that will automatically plunge those debts below the surface.

In Nevada already the amount of mortgages outstanding is estimated at $132.6 billion against property worth $116.7 billion, a loan-to-value ratio of 116 percent. Even another slight decline in prices in areas such as California (loan-to-value ratio of 72 percent), Arizona (91 percent), or Florida (87 percent) will swamp Washington’s promised next round of mortgage subsidy relief. The government’s own rescue agencies, Fannie Mae, Freddie Mac, and FHA, are dead in the water, and the government’s bank deposit insurance agency, the FDIC, says it has no more reserves to offset the coming next round of failing banks.

EVEN WHEN WASHINGTON ADMITS to a worrying 10-plus percent unemployment rate the real numbers are so far from reality as to be laughable. The recent headlined dip in the jobless rate turns out to have been caused by more than 50,000 already jobless people simply giving up and dropping out of the workforce. This has the statistically absurd result that the percentage of people deemed to be unsuccessfully seeking work is judged to have improved. When labor data is closely parsed for the measure known as “U-6,” which includes people forced to work part-time, those “discouraged” from seeking jobs, and those “marginally attached,” the rate trends above 17 percent.

But even that fails to accurately gauge the cold reality of the hopelessness facing folks at either end of the workforce demographic—the very young (where unemployment is trending above 60 percent) and those 55 and older who are forced back into job quests because their nest eggs vanished in the storm. Two-thirds of the job losses across the country have happened to the very blue-collar workers the Democratic Party has claimed for its own. For those Americans who still have hourly-wage jobs, their employment week would be the envy of a Frenchman—33 hours, on average. Sectors such as manufacturing, construction, and even retailing continue to shed workers; the only consistent gains over the last two years have been, no surprise, in government employment.

The policy response of all Western governments is to follow the failed Japanese model of trying to inflate one’s way out of a downdraft, pumping up another bubble. The theory is that if interest rates are forced low enough, and the money supply increased enough, and the government ramps up deficit spending to redistribute more wealth from the supposed rich to the supposed poor, a “multiplier effect” of economic growth will be sparked by consumers buying more, businesses investing more, and more jobs being created with prosperity spreading and growing. But if interest rates are already at zero, and the value of the dollar has been halved by doubling the supply of it, and the debt service burden of government spending is already suffocating the capital markets, how can one expect consumers to buy more (to buy more of what?), or businesses to invest more (for a new machine to do what?), much less to hire old workers back when the jobs they used to have are vanished, not to some Third World haven, but just vanished?

No one in Washington can say with a straight face just what the U.S. gross domestic product is except that we have been pushed back at least a decade and will probably be more than a decade in just getting back to where we were in 2006 (when GDP rose by an anemic 2.7 percent) just before the bubble burst the next year. Meanwhile new bubbles are forming all around us, in the commodity markets, in Hong Kong real estate, in the troubling data coming out of China and other Asian economies, all just waiting to buckle. Can you say Dubai? Greece?

FURTHER CONFUSING ANY ATTEMPT at a rational public analysis of the current crisis are the prevailing lies that the fault for the crisis lies in the failed economic theories propounded by the late Ronald Reagan and, more, that what we need is to return to the sound prescriptions of the even later John Maynard Keynes. Reagan, this slander says, set the financial markets off on an orgy of speculation and risk-taking by taking off the restraints of sound government regulation and by insisting on deficitbusting tax cuts. By returning to the true religion that Keynes revealed to Franklin D. Roosevelt in a dream, government, and only government, can return us to prosperity by even grander deficit spending coupled with a massive expansion of liquidity and the lowest interest rates possible. If that sounds confusing, it should; neither man prescribed any such thing.

It is true enough that Reagan, despite having studied economics in college, was singularly immune to economic theories. In the interregnum year of 1979, when he had left the governor’s office but before his 1980 campaign, I traveled with him in northern California on a speaking tour and found him far more concerned about what worked in the real world rather than on speculations about what ought to work. That summer he gathered the cream of conservative economic thought—from Arthur Laffer to Herb Stein—in George Shultz’s offices in San Francisco to consider the stagflation that gripped the nation. After hearing an entire day’s worth of philosophizing by the party’s greatest minds, Reagan closed the meeting with a decision to make tax cuts a policy point for his upcoming run for the White House.

“Nancy and I always believed that if you didn’t want the kids to overspend their allowances, you didn’t give them the money in the first place.” And so it was tax cuts, which did indeed provide the investment capital needed to work the nation’s way out of economic gridlock. If he was wrong in presuming that federal deficits would be reduced, it was because neither he nor any president since has been able to restrain the 535 members of the U.S. Congress from overspending. Please don’t e-mail me about the myth of Bill Clinton’s surpluses; they didn’t happen. The last federal budget to have a genuine surplus of tax revenues over outlays was Lyndon Johnson’s $3 billion budget surplus for fiscal 1969.

For more than 40 years successive U.S. administrations, Republican and Democrat, have failed to rein in a feckless Congress, which has run a giant Ponzi scheme that would make Bernie Madoff blush. Our lawgivers have routinely spent more than they take in, jiggling the tax rates to help constituents, and sucking in imports from abroad by paying off in a currency that has steadily declined in purchasing power to the point that dependent customers like China and Brazil are reduced to barter-style trade transactions with each other because the dollar is of no further use to them as a monetary intermediary. The real sucker is the American wage earner, who by the government’s own accounting has lost one-third of his purchasing power since the 1970s (probably closer to two-thirds if we are honest, and if he still has a job).

Neither Reagan nor Keynes today would approve of the TARPs for banks, the near doubling of the money supply, and the loans to major corporations and other bailouts of institutions deemed “too big to fail.” Indeed, in his 1936 oft-cited but rarely read General Theory of Employment, Interest, and Money, Keynes did in fact speak of raising demand in an economy by redistributing income, but only in times when a booming economy is just starting to falter. Once the bust has occurred, however, and industrial capacity and demand are slack, Keynes warned that simply pumping up liquidity and depressing interest rates are of little use; government’s role in such a case, he recommended, was to invest in “public works” that enhanced the economic infrastructure while providing employment. No bailouts, thank you very much.

ANOTHER THING I AM SURE OF is that both Reagan and Keynes would have been acutely aware of the seismic shifting of the underpinnings that support the Western-style global marketplace. As late as 50 years ago America had much of what it needed to prosper, and foreign trade accounted for a nickel of every dollar of gross domestic product. Our prosperity was mostly in our own hands. Now we are fully engaged not only with older, industrially mature trade partners but also with newer emerging powers in the struggle both for world markets and for key ingredients for manufacturing and agriculture—just as they all become in ever shorter supply and ever more expensive to obtain.

During my 1979 trip with Reagan he resolutely refused to talk about policy questions that dealt with the kind of specifics that Washingtonians love to parse. A kindly man, he also sensed my frustration and finally asked me to ask him the broadest economic question on my mind. So I pointed out that America was in the midst of an economic crisis with inflation and interest rates at frightening levels, with OPEC jacking up oil price, and economic activity stuttering. What did he think was going on and what could be done about it?

“Well, I can’t help but notice that while oil prices are going up, so are gold prices. And that tells me the oil producers are fed up with taking dollars that are worth less each day while the industrial world consumes their oil. So we either have to find a way to make our dollar worth more, or to find more oil of our own, or to learn to get more economic lift with the oil we can afford—and probably all three. Things sure can’t go on like this forever,” Reagan said. He did not need the Laffer Curve to see that.

Keynes would have agreed. Indeed, much of his fabled theorizing about the certainty of uncertainty in the marketplace and the awareness of risk came from his having been an early and highly successful hedge fund manager who speculated in both currencies and commodities during the turbulent times following World War I. His fund partnership with a friend known as “Foxy” Falk corralled seed money from chums among the Bloomsbury literati and began in 1920 to go long in U.S. dollars while shorting the mark, franc, and lira in a play that lost more than $300,000 in today’s money before it collapsed. Later, as the linkages between raw materials, trade, and currencies became clearer to him, he not only repaid his friends’ losses but accumulated great wealth for himself and for his college at Cambridge, which made him its trustee.

The new certainty that both men would have recognized, and that we must confront, is that the era of cheap resources is over. The plentiful and extremely profitable supplies of everything—petroleum, metals, minerals, water, yes, and even air—have been exhausted. While we had them in abundance for a period of nearly three centuries the world was an ever-expanding place, a cornucopia that human ingenuity fashioned into ever more wonderful machines and the human spirit used to subsidize the expansion of opportunities and entitlements we call “rights” to all mankind.

THIS IS NOT TO SAY the lights are suddenly going to go out all over the world. Those who use the “peak oil” argument to say we have exhausted the globe’s oil reserves are wrong. It does not really matter whether there are two trillion barrels left or (more likely) 10 trillion barrels of petroleum still lurking under polar ice caps or offshore Brazil or in the South China Sea. We will have petroleum energy supplies aplenty from shale and other high-tech processes too. But it will be expensive and hard to get, and it is that extra expense of the getting that robs us of the subsidy that made so much of the industrial West’s prosperity—and indeed its political culture and civil promises—so possible.

Put another way, oil at $73 per barrel (the price at this writing) can readily be found in any number of offshore deep deposits. Most industrial metals and minerals can still be obtained if the price rises enough. But neither they nor the likely $100 barrel can produce the same economic lift that a barrel of $3 Saudi Arabian oil did in the 1950s. At the historically low costs of both energy and available ingredients it was possible to be intellectually lazy when it came to estimating the true cost of most of our human activities. Those days are over, and old solutions are increasingly disconnected from critical new challenges dressed in familiar terms—the need for new jobs, new products, market regulation, environmental responsibility, and truly global prosperity for all instead of competing regional advantages that disenfranchise entire races of people.

What this means is we must begin to look at public policies and economic choices from a “net energy” framework; that is, to apply hard analysis as to the true cost of everything we undertake. Will the energy and raw materials we invest in any undertaking yield a greater return or a lesser one? As an example, at some point in a coal mine it takes more energy to lift a ton of coal to the surface than that ton of coal will produce. There may be reasons to keep the mine open (to preserve jobs) but there should be recognition that that decision will require some other part of the economy to subsidize that losing operation.

The “net energy” concept explains why, despite the cries for alternative sources to our dependency on petroleum, there has not been a general shift to wind, solar, or other alternatives. This is because even at $100 a barrel, oil (and natural gas) still provides an extraordinary lift to economic activities while most “alternatives,” when fully costed-out for the technology, expensive materials, environmental impact, maintenance, and (in the case of nuclear power) the after-cost of tearing down and waste management, often absorb more energy than they produce over their operating life.

Nor does one have to buy into the suspect environmental warnings of Al Gore and the data fudgers of Copenhagen to realize that we also have subsidized our world by using our water supplies and the very air we breathe as an industrial sewerage system in ways that subsidize a wasteful way of life. That subsidy also cannot continue.

To have a conscious recognition of this truth is just the first step. Like any other addict, the policy prescribers in Washington (or any other capital) cannot be expected to easily acknowledge the new realities. So we see the familiar stages: there is denial that we will never get back to “normal”; Wall Street, insurance companies, drug makers, Rush Limbaugh (seriously) are all such easy targets for anger and the need to blame others. I mean, Rush Limbaugh, really.

DEMANDING NEW RULES to prevent financial excesses puts the bartender in charge of trying to ration the drunks and keep his tip jar filled at the same time. Congressional hacks like Nancy, Harry, and Barney will never admit to any blame for their insistence that Fannie Mae and Freddie Mac pressure the home mortgage industry into making home ownership available to people who were in no economic position to carry the burden. And don’t expect the career regulatory agencies that oversee the financial marketplace to acknowledge fault for turning a blind eye when banks bundled up those dodgy mortgages into even more dodgy securities, or when Wall Street took the government guarantees of that paper as being dependable. Nor will Alan Greenspan (or Ben Bernanke) fess up that the devaluing of the dollar caused the world’s key commodity markets to boost prices so sharply that ever more dollars were needed to pay for the same ingredients and that the rush for that liquidity made the dodgy mortgage paper irresistible to buyers from Norway to Beijing.

Yet until there is a general acknowledgement of government’s blame in compounding this upcoming recession on the back of the earlier slump, how can we expect Washington to seek a new approach to the global marketplace?

It would have been a comfort, of course, if there were a viable opposition force in Washington (or elsewhere) to the pervasive government-fix-all philosophy that exists. But a coherent Republican Party led by folks of stature who offer meaningful solutions has vanished from our scene as abruptly as did the Whigs in the 1850s. What’s left is a hologram of a political party, dominated by second-raters who obsess over moral doctrine in an appeal to some hypothetical “base” that will keep them in the few offices they still cling to.

The result, I fear, is more sham solutions that will merely interfere with the harsh corrections that are to be forced on us by a world economy that is losing traction even as the wheels spin faster. What that means is that instead of finding a way to get the 750,000 residents who have fled Detroit’s ghost-suburbs back in their homes and in new jobs, Washington will continue to mandate auto company executive suite changes and offer capital bribes to produce a government-mandated new generation of cars that Americans can scarcely afford to buy. And Wall Street’s bankers will still be able to get ever more funds on demand from their friends in the Treasury, even though most borrowers still can’t afford to borrow.

It will get ugly, make no mistake. How ugly? Wait until those things we consider “rights” start to get squeezed in the interest of what our ruling politicians decree as the national interest. The uproar that greeted the mere suggestion that health care resources for the elderly might be circumscribed was genteel debate by contrast with what’s ahead. The notion that rights can be rescinded as easily as they have been obtained is not a happy thought. Case in point: my mother recalled that she and my father had to marry in secret and she continued to live with her parents throughout 1936 because the New Dealers who controlled the Pennsylvania state legislature had decreed that no married woman could be a public school teacher or hold another state job when a jobless married man could take her place. Try that out on the next dinner table debate you attend and see how many bread rolls get thrown at you by women who are convinced that it can’t happen again; times have changed, they’ve come a long way, baby. Well, yes. Nowadays most women don’t have the option not to work.

HOW LONG WILL THIS DARK AGE LAST? Ask the Japanese, who have been at it for nearly 20 years. Ask the Chinese, who are just making a heroic jump out of a medieval time-warp into a modern industrial urban society only to teeter on the brink for lack of enough food, water, and arable land even as they accumulate piles of American dollars that lose value every day. How long? As a teenager growing up in Tampa in the 1950s I recall traveling south through a ghost town called Sun City on the way to Sarasota. This abandoned village had streets, municipal buildings, sidewalks, even steps up to residential lots, all laid out during the Florida land boom of the 1920s. What it lacked were houses and residents. And so it stayed for nearly 40 years, until Del Webb developed the retirement community and resort nearby and appropriated the name. Now people are fleeing Florida once again, and ghostly, empty high-rise condos dot the landscape.

Now ask yourself, how long will it take to reclaim the empty neighborhoods in Detroit, the empty condos in Las Vegas, or Phoenix, or, for that matter, in the McMansion-style suburbs that surround Washington, D.C.? What new jobs can be created to absorb the millions who have not only lost their jobs but who have stopped looking? What will those jobs make, and who will buy what is being offered?

Buddy, can you spare a dollar? Or maybe a Krugerrand?


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