Risk & Opportunity

A quarterly political and economic newsletter published by Michael Cuddehe

Q1 '09

Lifestyle Downsizing

The meltdown consuming the global economy is already the worst since the Great Depression. This fact does not necessarily mean we are going to experience another depression of that magnitude and length, although we may. What it does mean with certainty that life in America is going to be different, and considerably more modest, for the foreseeable future. However the specifics unfold, change is the operative word. I don’t think President Obama had any idea just how prescient his campaign theme was.

Since the collapse of the Soviet Union the world has been waiting for the other shoe to drop and now with the collapse of the global Capitalist credit bubble, it finally has dropped. Among the consequences has been a substantial loss of geopolitical power for the U.S. American influence on the global scene has been waning since the invasion of Iraq, and since the bursting of the credit bubble the pace of re-alignment has been picking up speed, seen most clearly in the increasingly aggressive moves by China to establish itself as a power player on a global scale. Allies and enemies alike no longer look to the U.S. position before pursuing their own interests, even if those interests directly conflict with those of the U.S. High profile efforts to solve intractable conflicts in the Middle East and Afghanistan notwithstanding, we are witnessing the end of the U.S. as global hyper-power and the beginning of what will soon be a retreat from Empire.

This re-alignment is in turn spawning a cascading raft of changes for the U.S. both globally and domestically. It is the end for American style laissez-faire capitalism, of the American consumer as the driver of the global economy, and the beginning of the end of the U.S. dollar as the world’s reserve currency, which is a much bigger deal than most people realize. At home it is the end of the long run of excessive consumption enabled by the status of the dollar, and it is probably the end of the Republican Party, which relentlessly promoted (and unapologetically continues to promote) the policies which have undone us.   

Chief among those policies is “trickle down” economics, otherwise known as Reaganomics, once appropriately called “voodoo economics” by George Bush Sr. Trickle-down economics has never been anything other than a pernicious fraud, and now the fraud is unmasked for all the world to see. It will be at least 50 years before it can raise its ugly head again, if ever.

Robert Reich wrote an excellent essay on this matter in the 3/28 Wall Street Journal entitled “Obamanomics Isn’t About Big Government.” In a very balanced presentation, Reich reviews the ascendance and consequences of trickle-down economics and highlights the sea-change in philosophy represented by Obamanomics.   

Where We’re Headed

The foundations of our economy have been rotted by decades of bi-partisan fiscal irresponsibility, and utterly destroyed by the excesses of the Bush era. The efforts of the Obama administration to arrest the collapse are akin to catching a falling anvil. These efforts will soften the blow for awhile at considerable cost, and may give us time to better manage the retrenchment; but ultimately the full price is going to be paid, one way or another.  

In the near term much of the change, or more appropriately — debt withdrawal — will continue to be painful, very much like the experience of a drug addict in withdrawal. Long term, just how long and painful the changes will be will depend on the policy decisions made by our leaders in Washington, and ultimately on ourselves. Are we the people able to accept the retreat from Empire and the inevitable lifestyle downsizing that goes with it with equanimity? Can we give up our toxic politics in order to come together as a nation to deal with our self-inflicted problems and build a better future?

Some are expecting the current difficulties to be fairly short lived and that we will soon see a return to business as usual, if somewhat less vigorous than normal for a few years. I’m afraid those people are destined to be disappointed, and I am concerned that Obama’s economic team appears to fall into this category. Treasury Secretary Tim Geithner and senior advisor Lawrence Summers, Director of the President’s National Economic Council, have both been deeply involved in the Wall Street culture of greed and in the implementation of policies that enabled the current debacle, and they are clearly intent on maintaining the institutional structure and primacy of the big banks that are directly responsible for it.  

Try as it might, even the U.S. government is not big enough to stop the balancing of accounts that is underway. The entire financial system is de-leveraging from the 40:1 madness of recent years, leaving a huge hole in the global capital structure, on top of the $4 trillion or so in outright losses at the big banks from their clever Enron style off-balance sheet investment schemes.

Meanwhile, consumers (70% of GDP), having doubled up on debt and saved virtually nothing over the past decade or so, are suddenly realizing that they actually have to pay for all that stuff they’ve been buying on credit. At the same time they are faced with double digit declines in the value of their primary asset, their homes, and unemployment steadily climbing toward double digits. Yikes! And if that isn’t enough of a drag on the economy, the corporate world is reeling from the severe recession and laboring under its own massive debt load and overcapacity in every sector as well.

Corporations are cutting back and spending less, consumers are pulling back to start saving and paying off debt, and the banks are just trying to stay alive. That leaves government to pick up the slack, which they have been doing by borrowing, printing and pledging trillions of dollars…over $12 trillion so far. However, all the new debt is not going to give us much bang for the buck. In 1966, one dollar of debt boosted GDP by almost one dollar. That was good value, but after 40+ years of relentless debt creation we now get less than twenty cents of GDP from every new dollar of debt. Clearly the creation of ever more debt is not going to get us out of the hole, and in fact will just dig the hole deeper. So what to do???....Anybody???      

The status quo cannot long be maintained at any price and we would be far better off to get ahead of the curve rather than be dragged along behind it. The changes that are coming are not going to be cosmetic or short lived. They are going to be sweeping and permanent, and few seem to understand just how much so at this time.

“Make no mistake. We are selling off our future and the future of our children to prevent the bondholders of US financial corporations from taking losses. We are using public funds to protect bondholders of some of the most mismanaged companies in the history of capitalism, instead of allowing them to take losses that should have been their own.” -John Hussman

The most illuminating commentaries I have read on this matter are Mauldin’s most recent Outside the Box newsletter entitled “The End Draws Nigh” by Dr. Woody Brock, and a piece by Steve Waldman on Seeking Alpha entitled “Banking Reform: Value for Value.” Please read these articles and forward them to your representatives in Congress and anyone you might know in the Obama Administration. Here is the money quote from Waldman:

“If we “get past this crisis” by restarting a consumer-credit-based, indiscriminate-investor-financed, current-account-deficit-making, income-inequality-expanding economy, we will have increased, not diminished, the likelihood of a major collapse.”

Getting From Here to There

It is ironic that America is the primary promoter of democracy globally when a critical issue we face at home is repairing our seriously degraded political process. The foundation principle of democracy is that an informed electorate will make the best choices. But in the current environment of spin, counter-spin and deliberate misinformation campaigns it is impossible for the average person to know the truth about anything, let alone be adequately informed about the critical issues of the day.

If there is any hope of favorable resolution of our problems we need at a minimum a political process grounded in truthful dialogue and mutual respect, and political leaders who are genuinely committed to public service rather than to their personal and party advantage. (See Q2 ‘05 Risk & OpportunityAmerica’s Truth Deficit”) It is clear that Obama is trying to foster this essential change, and his election against all odds is confirmation that the majority support him in this effort. So far his opponents are having none of it.

Since the election Republicans have been acting like mad people, ranting endlessly about a wide range of paranoid fantasies and attacking any and every action of President Obama, to the extent of publicly wishing for the failure of a sitting President. If this behavior persists and gains traction, America is going to be in for some very bad times. We can only hope that the current hysteria emanating from the Republican Party is the death cry of the lunatic fringe, and that soon the adults will reclaim ownership of their party, or start a new one.

The corrupted values and boorish behavior of our elite are not limited to our political leaders. Our B-schools have raised up a vast army of economically and technically savvy but culturally and spiritually impoverished business leaders who have foisted their pirate culture onto the world. We need to start cultivating business leaders who understand the place of business within the context of society, not separate from it, and who recognize that the proper function of business is to serve the aspirations and needs of society, not exploit them.  

Some will reflexively reject such a notion as “socialism.” This is an unrealistic and outmoded concern. The reality is that 20th century socialism has clearly proven itself a failure and is not on the menu going forward. However, laissez-faire capitalism has also proven itself a failure. We need to find the middle way that allows the creativity and vitality of capitalism to support and grow the whole of society, not just the fortunate few at the top, and which at the same time enables the public sector to do the things that only it can do, without crowding out private initiative. Finding this middle way is entirely within our capacity.  

Summary

We are still nearer to the beginning of the debt-withdrawal process than to the end. For decades government has been pushing the day of reckoning down the road, but at each turn of the cycle the amount of force (debt) required to stem the downturn has been greater, and the response (recovery) has been less robust. The Bush regime doubled the national debt after the dot-com meltdown and produced a substandard recovery by every measure. Obama will likely double up again, but this time the recovery will be even weaker. The overhanging debt load is becoming so great that without fundamental changes in the way we make policy and conduct our affairs, the next downturn will not be supportable.  

Once a secular bear market begins, it will run its course until the last excesses are wrung out of the system and the last holdouts have sold out. This is by nature a gradual process. Hope springs eternal and every bear market sponsors numerous rallies which draw the unwary back into the market, only to be disappointed again. This bear will take its own time. The massive stimulation will have its effect, and we should have a recovery / consolidation period that could last some months or even years, but however events unfold in the near to intermediate term, it should be clear to anyone who is paying attention that the process is far from complete.  

John Mauldin sums up the situation very clearly in his recent newsletter, “Sell in May and Go Away”:

“The Fed and the Obama administration are playing a dangerous game. The Fed is going to print trillions of dollars to forestall deflation and try to re-ignite the economy. But for a variety of reasons we will go into next week, a real, sustainable recovery may be a few years away. What happens when the market start balking at high and unsustainable national deficits? What happens when inflation (finally) does return? Can the Fed remain independent and take back the money it is printing in the face of what will likely be a tepid recovery? And if they don’t, what happens to the dollar?”

As individuals, how can we prepare ourselves for the inevitable? Here are Richard Russell’s thoughts on the matter:

“What to do? I’ve done a lot of thinking on this question, and my conclusion is as follows — hold a fairly large quantity of physical gold (coins), hold cash, hang on to your house, and you might even buy a bargain-priced foreclosed home if you wish — but above all, cut back on unneeded expenses (cut back on coffee, vacations, movies, fast food, and other non-essentials). Cash is for deflation if it continues, gold is insurance against future inflation, a bargain-priced foreclosed home is good value and it’s also a tangible asset.”

As a nation, our challenge going forward is primarily political. There are no problems that Americans cannot solve if they come together with focus and intent. As the recognition of our lost wealth and status dawns on the nation, we will see if we have the maturity and political will to set aside our differences and do the right thing. I am confident that Obama is the right man to guide us through this difficult period of adjustment…his unshakeable cool, moral character and superior intelligence have won the trust of the American people. We can only hope that he can sustain that trust through the difficult times to come and convince the American people to keep their cool and come together to create a balanced and sustainable recovery. Regardless of our conservative or liberal tendencies, we should all be rooting for that outcome.

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