Another Bad Week for the Economy

I’ve been able to keep up with little snippets of the news when I’m not fishing, hiking or canoeing up here in the north woods. There’ve been several items of interest this week.

First of all, Treasury Undersecretary Ryan pronounced that it may be in our best interest to let some financial institutions fail. What this means is that the Federal Reserve is out of ammo for Bear-Stearns like bail-outs for stockholders. One of my long-shot predictions for 2008 (see “2008 Predictions“) was the failure of a major financial institution. Well, hold onto your hats because there may be more than one coming! The mortgage default mess has ravaged the balance sheets of banks. Only a day or so later, Citigroup announced that it will have to take yet another $9 billion in write-offs. By and large, these mortgage defaults and foreclosures are by average folks like you and me who just can’t make ends meet anymore, thanks to the failure of wages to keep pace with inflation, thanks to the millions of job losses due to our enormous trade deficit.

Then came the Federal Reserve’s decision to leave interest rates unchanged, and the accompanying announcement that it’s worried about inflation. The Fed has found that it’s interest-cutting campaign of the past few months has been totally ineffective in restoring the economy because the low rates haven’t translated into reduced lending rates at the consumer level. Why? Because treasury yields didn’t drop a bit. Why? Because the Fed’s bond auctions have gone poorly. Investors won’t buy them when they can get better interest rates elsewhere which, currently, is almost anywhere. This is why credit is drying up, seizing up the economy. Why does the government need to keep selling more and more treasury bonds? To finance its budget deficit, largely due to programs to offset the negative consequences of our trade deficit.

So if the Fed’s interest cutting has all been illusory, will the Fed now raise rates to fight inflation? It may, but it knows that it’s equally powerless here as well. The inflation we’re experiencing is due to the decline in the dollar. Interest rate moves by the Fed will do virtually nothing to affect this. The decline in the dollar is due to our persistent, enormous trade deficit. We’ve been flooding the world with dollars and the over-supply is steadily eroding their value. One third of the trade deficit is due to oil imports and two thirds is due to imports of manufactured goods. You may ask, “won’t the decline of the dollar help reverse the trade deficit?” That’s what economists would have you think, but it’s not true because the value of the dollar has nothing to do with the trade deficit. The trade deficit is due almost entirely to the collision of economic forces I warned of in Five Short Blasts – the inability of overpopulated nations to bring to the trade table an equivalent market in exchange for access to ours. The fact that the trade deficit has held steady while the dollar has declined dramatically is proof of this.

So the Fed is caught between a rock and a hard place. It’s only recourse to affect the direction of the economy is the one that its chairman, Ben Bernanke, may find the most distasteful (for him) of all: admit that free trade (what I call blind trade) is a failed economic model and press the President and Congress to begin imposing tariffs as necessary to eliminate the trade deficit. Failing this, the U.S. economy will continue to unravel, which is now happening at an alarming rate as the financial, manufacturing and construction sectors of the economy are simultaneously nearing collapse.

One final item of interest is that Barack Obama had a meeting with CEO’s of major U.S. companies. This is significant because the deteriorating economy assures that Obama will soon be president. Such a meeting calls to mind a similar meeting that Dick Cheney held with energy industry leaders soon after election to seek advice in formulating energy policy. We all know how that turned out. Let’s hope Obama’s meeting doesn’t yield similar results. What did the CEO’s tell Obama? Only Ford CEO Alan Mulally (sp?) was talking afterwards and made some vague reference to emphasizing the importance of government and industry working together.

So no one’s talking, but I can tell you exactly what each one of them told Obama: 1) “We need tax breaks,” and 2) “Beware of protectionist trade sentiment. Everything will be alright if we just have more free trade.”  Frankly, I don’t worry that much about tax policy. It takes a certain amount of revenue to run an orderly society and, regardless of how it’s collected, in the end it will be paid by you and me, either directly to the government or indirectly, in the form of higher prices paid for goods. But, regarding the second item above, we can only hope that Obama can see through the smoke and mirrors of free trade pushers and cheerleaders and put the nation’s interests ahead of those of global corporations. He’d better. He certainly doesn’t want to leave the economy in far worse shape than he found it, as his predecessor has.

4 Responses to Another Bad Week for the Economy

  1. Clyde Bollinger says:

    I totally agree with your assessment of the current situation with respect to trade but I still don’t see the linkage to the mortgage mess. Approximately 94% of mortgage payments are current, according to the latest figures I’ve seen. I don’t know a single person who has one of those goofy deals that is in the news all the time. I appears to me that many of the people making the news are folks who made a good faith purchase of a house, took on a maximum mortgage with a marginal capacity to make the monthly payments fully expecting the appraised value to rise fast enough to allow for a second mortgage big enough to gain a little relief and also buy a boat. Instead of rising in value the property has fallen in value. There goes the boat. Understandably, no one wants to be ‘under water’ on any deal and certainly on one of such magnitude. Most of them are still making the payment and holding their breath fully expecdting the lender to make a margin call since the underlying asset is not of sufficient value to cover the outstanding balance. The others, those in the news, have pushed the panic button fully expecting a ‘bail out’. And why not, the lender who borrowed the money to loan them has his hand out for a ‘bail out’. At least those who still exist have their hand out.
    I fault the lenders who in effect were only shell companies operating with borrowed money that came from other shell companies using borrowed money. No value actually existed, it was all a a house of cards.
    Many stable companies have been dragged down by this mess, since they had the actual money loaned to the shell companies and couldn’t get much if any of it back.
    It kind of makes one long for the ‘good old days of the gold standard’ doesn’t it? When our currency or our debt paper has nothing to back it up this is the sort of out come to be expected from time to time.

    I have absoutely no confidence in Obama or any of his advisers knowing or caring about any of this. Just because someone has a plan, as the girl in the commercial says, Obama is for change or in other words “he will not leave things unchanged” doesn’t make him competent. They will continue expanding the entitlement programs while operating the printing presses at warp speed to pay for them. All the time dragging us closer and closer to Socialism. The continuing result will be sending more less valuable dollars abroad so foreigners can loan them back to us at higher and higher rates of return.
    I don’t have much more faith in McCain and his advisers than I do Obama but when push comes to shove, I’ll give the experience, bad as it is, the edge.
    Hope the north woods fresh air is having a rejuvinating effect.

  2. Pete Murphy says:

    Clyde, the connection between trade and the housing mess is a subtle one but, I believe, very real. Because wages were (and still are) falling ever more behind the cost of living, lending institutions found it necessary to get more and more creative with finance terms in order to prop up the housing industry. Government oversight agencies knew full well what was going on but, since it was a top priority of the Bush administration to boost home-ownership, chose to give it a wink and nod. Now the chickens have come home to roost.

    Speaking of our currency mess and the gold standard, click the “EZ Reading Money Matters” link on the right. It’ll take you to a blog devoted to this subject.

    Yup, the north woods are definitely doing me some good!

  3. Hi Pete,

    The housing debacle was orchestrated to revive a near dead economy. And as you stated in your article, the government knew full well what was going on…they were the orchestrator’s.

    The one thing that went wrong was that the purposely induced inflation that drove housing was also intended to drive wages. That is how the increasing loan payments, interest only, and negative amortization loans were counted on being paid. Believe me, the banks did not plan to intentionally go broke.

    The term “betting on the come” is borrowed from the game of craps and like craps, the dice sometimes refuses to come up a winner. Inflation based wage growth is not a reasonable expectation when unemployment is high and trade deficits are setting new records.

    Yet, our leaders needed something to keep the economy from tanking, and housing was a last ditch effort. Residential housing is shelter…nothing more and cannot be substituted for broad based agriculture and manufacturing on an ongoing basis. The mess that we find ourselves in is living proof of that premise.

  4. Pete Murphy says:

    The only thing that drives wages faster than inflation is a demand for labor that outstrips the supply. I don’t know how the government could believe that wages could be driven higher any other way. Like you said, it isn’t reasonable to expect that wages can go higher in an environment of rising unemployment and trade deficits.

    The American economy has truly been painted into a corner. The government needs to take immediate action to restore a balance of trade. Otherwise, a depression is imminent.

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