The Trainwreck Picks up Steam (and How to Avoid It)

I really dislike writing rants like the one you’re about to read – mostly because I’m an optimist by nature and because frankly nobody wants to read a blog post that reads like a Shakespearian tragedy. That said, the economic trainwreck is picking up speed – and it has everything to do with the US-China axis.

Let’s go back in time to right before the Christmas and New Year holiday, to about December 20th. That was the date the Federal Reserve bank cut the federal reserve lending rate to zero. The Federal Open Market Committee in Washington continued with this snippet: “weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.” Let me translate that into plain english for those who aren’t sure what this means: The federal reserve is willing to print an unlimited amount of money for the foreseeable future. Let that sink in a minute as you think about what to do with you sitting on Dollars.

Why? Well deflation is a big concern for them consumers think prices will go down (and let’s face it, that’s already happening), then there’s little incentive to buy anything right away. So to keep the economy going, instead let’s hit the prudent folks who are sitting on Treasuries – which are returning virtually nothing in interest – forcing them to plunge into buying in the housing market instead, which then frees up equity for people to spend on consumption. Smells like a bit of a Ponzi scheme, doesn’t it? Now hold that thought – I’m going to head off on a bit of a tangent here, but I promise it’ll all come together.

The  New York Times reports how South Korea has posted a rising balance of payment surplus of 2.06 billion, up from 1.67 billion a year ago. This was after payment deficits for most of the year mostly due to rising energy prices. They’re not alone either. The Vietnamese have devalued the Dong (the funniest currency name you’ll ever see on this blog) about 3% to keep its export-dependent economy afloat. This adds to the Chinese running a payment balance surplus up 18% to $191 billion just in the first half of 2008, as reported from the party’s media frontman, Xinhua. The press release added with a bit of flair to the message: “the government should stick to the flexible and prudent macro-economic policies and create a good environment for pursuing the balance of payments.”

In other words, China will continue to foster social and economy stability through exports, and countries who were feeling the pinch now want to export the economic upheaval in the form of gadgets you can buy on sale at your local Fry’s. With the fed printing money as fast as they can, you can pretty much imagine where these exports are headed. As financial commentators speak about trust in the market and how the financial market is about to undergo its biggest change in modern history, you really have to wonder if we need to go back to the fundamentals of real domestic productivity here as a means of restoring that trust. The financial markets aren’t going to point us in the right way – we need real production to occur here to support an expanding economy. Now I’m not suggesting we’re about to run up another Holly-Smoot tariff war. The conditions here are completely different today than they were in 1930, and anyone with a brain understands that we have structural problems we must correct, even if the rest of the world hopes we prolong our consumption as long as possible to keep their own houses in order.

So dropping the federal funds rate to zero won’t help – Japanese central bankers watched in frustration as timid banks took central bank money and sat on it … sort of like what’s happening now as U.S. banks cut off credit card access and buckle down on mortgage holders. We’ve learned some of the lessons drawn from Japan’s economic crisis, but we’re still making some of the same mistakes. It doesn’t need to be this way of course, and the New York Times’ Martin Fackler puts this better that I can:

“Economists say the United States faces a similar situation, after the sudden collapse in September of Lehman Brothers created fears of additional failures. Economists also fault Washington for its inconsistency in dealing with the financial crisis, leaving the impression that it does not have a clear strategy for dealing with ailing lenders.

In Japan’s case, economists and former bankers say, credit began to flow freely again only after 2003, when regulators adopted a tough new policy of auditing banks and forcing weaker ones to raise new capital or accept a government takeover. Economists said the audits finally removed paralysis in credit markets by convincing bankers and investors that sudden failures were no longer a risk, and that the true extent of problems at banks and other companies was finally being revealed.”

In other words, prudent lending stimulating investment in real assets and real productivity, and strict financial oversight which restored lender confidence eventually opened up the credit spigots.  Banking minister Heizo Takenaka’s policies of strict audits and “good housekeeping” seals on lending institutions brought back a specter of credibility to a financial system which was devoid of it. That alongside fiscal spending targeted in the right areas brought back the patient from near oblivion. Paulson and his discredited Ponzi scheme need to be jettisoned. We have to stop thinking like a hegemon and start balancing our checkbooks. It took Japan about 4-5 years to get out of their funk, and should take us considerably less to reboot our economy if we begin to investing at home, ditch our addition to cheap Chinese chotchkies we don’t need, and leverage solid accountability principles. The Chinese, who hold lots of Dollar-denominated assets, will be happier in the long run too.

This entry was published on January 2, 2009 at 5:16 PM. It’s filed under Uncategorized and tagged , . Bookmark the permalink. Follow any comments here with the RSS feed for this post.

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