February 8, 2012

Avoiding The Austerity Death Spiral

Posted in bail out, Banking, Bankruptcy, Ben Bernanke, Big Banks, Economy, Federal Reserve, Finance, government, investment advisor, investment banking, investments, Senate Banking Committee, taxes, Unemployment tagged adviser, advisor, ancora west, ancora west advisors, bail out, Banking, bankruptcy, Ben Bernanke, Bob Barone, economy, Federal Reserve, Finance, financial adviser, nevada, senate banking committee, Taxes, taxpayer, unemployment at 8:19 PM by Robert Barone

Over the past four years, the slow creep of government into the private sector has become a gallop.  Unfortunately, a high level of structural unemployment is the unintended consequence of social engineering, picking winners, over-taxing and over-regulating every aspect of the business process.

The conventional wisdom is that a balanced budget will be a magic solution to the sluggish economy and the employment situation, but if it is done with just austerity and tax hikes but without relief from an overbearing set of governments on the business sector, what we will get is an “austerity death spiral.”  Federal Reserve Chairman Ben Bernanke said as much to the Senate Banking Committee on Tuesday.

Intervention is the Norm

We now live in a world where government intervention in the business process is expected.  When any sort of economic issue arises, government is now expected to fix it.

• Financial institutions in trouble?  No problem – the taxpayers, via the government are expected to bail them out!
• Domestic auto companies historically made awful decisions around retiree medical and pension issues and, as a result, can’t compete and are staggering toward bankruptcy.  Again, no problem.  Ask the government to shore them up, even if it means trampling on bondholder contract rights like in the General Motors case.
• Some homeowners can’t, and others don’t want to make their mortgage payments.  That’s easy.  Ask the government to intervene, stop or slow the foreclosure process, and, perhaps, even require the lenders to reduce principal balances! This deal is in the works now with the government prepared to offer big lenders like Citigroup, Bank of America, Wells Fargo and JPMorgan Chase money to offset losses on short sales.

The markets now expect intervention.  When the government intervenes in an economic issue, the markets rise.  If the government doesn’t, it falls precipitously. On September 29, 2008, the Dow Jones Industrial Average (DJIA) fell 778 points when Congress failed to pass the initial TARP legislation; From the time QE1 began in November, 2008 until it ended in March, 2010, the DJIA rose 28% or  2,378 points.

QE2 elicited a similar market response, 1,199 points (10.7%) from November, 2010 to June, 2011, even more if you go back to August when Bernanke articulated the strategy in Jackson Hole, Wyo.

In late November, 2011, on the day when the Fed gave unlimited swap lines to the European Central Bank (ECB), the DJIA rose 490 points; it rose 337 points just before Christmas when the ECB opened its lending facility to 540+ European banks.

I suspect we will see similar market reaction if the Fed goes through with its hinted at QE3.

Unintended Consequences

Unfortunately, nearly every government intervention carries with it unintended consequences, and, if such interventions interfere with the free market processes, they have long-term negative implications on economic growth. Recent examples in the U.S. include the Keystone Pipeline and the National Labor Relations Board’s attempt to block Boeing from opening a plant in South Carolina.

Nearly every economic malady that exists today is directly traceable to the unintended consequences of government interference in the economic process or via its attempt at social engineering:

• Sub-prime and housing crisis:  It is widely recognized that this was caused by three concurrent factors: 1) an extended period of low interest rates engineered by Greenspan’s and Bernanke’s Fed; 2) the social engineering goals of the Community Reinvestment Act (CRA); 3) the political and monetary aspirations of Fannie Mae and Freddie Mac executives and sponsors;
• Social Security and Medicare unfunded liabilities: As the baby boomer generation reaches retirement age, unfunded liabilities will increase by more than $3.5 trillion each year.  To show how absurd this is, the payroll tax reduction, in effect since January 1, 2011, and currently an issue in the Congress, simply puts the Social Security system ever deeper into debt that cannot be repaid without hugely inflated dollars;
• Unfunded pension liabilities:  While some private sector corporations have unfunded pension liability issues, the bulk of the problem lies at the local, state and federal levels;
• High structural unemployment: As alluded to earlier, impediments to business from all levels of government, but especially from the federal government, are a huge issue.  Recent legislation, including Sarbanes-Oxley, Dodd-Frank, and Obamacare, is crushing small business.  In addition, business must be confident that the future environment will be friendly.  So, the notion of a “temporary” tax reduction doesn’t reduce business uncertainty, as businesses invest for the long-term.

This last item is particularly poignant.  In a three part op-ed series published by Bloomberg in mid-January, Carl Pope, former chairman of the Sierra Club, bemoans America’s loss of manufacturing jobs.  “It’s not the wages, stupid!”, he says.  If wages were key, how is it that Germany, where wages are higher and unions stronger, enjoys a growing manufacturing base?

For the auto industry, which in 1998 had over 70% of the U.S. domestic auto market but now has 44%, it was the health care and pension costs of its retirees that caused the industry’s economic crisis, he says.  Since the turn of the century, America’s manufacturing base has shrunk by one-third, not because of wages, which are similar to wages paid in the rest of the world, but the lack of support or even outright hostility on the part of government.  (When even the Sierra Club recognizes that government is choking free enterprise, the issue must be terribly obvious!)

Permalink Leave a Comment