It's the Economy, it's Stupid!

This post is partly a response and analysis to Matthew and Bradley Haupt's Allied Tax Planners Special Report. I see in a number of analyses of the economic situation, what caused it, and what might cure it that contain contradictory statements and misfired deductions. I definitely enjoyed this report, and I encourage you to read it; however, while in spirit it has a lot of really well-founded conclusions, it misses the mark in a number of important ways. It does contain some good overview information of what has happened in the last year or so financially, and it provides a great bird's eye view of the economic turmoil.

For the record, the best way to describe my own educational filter on what is happening in the economy is that I follow Mike Shedlock's views. He has consistently correctly predicted the stages of the economic fallout, and his analysis is quite understandable and educational.

I'll address the report in a non-linear fashion, so this will not be point-by-point. For best reading, I suggest reading their report, and then come back for my comments. I'll refer to the Haupt's article as the ATP from here on out, for brevity.

Are we going into a depression?

This question almost essentially relies on one additional question: will we hit at least 10% unemployment officially? If so, then we most certainly will look back on this time as a depression. If not, then we'll probably have just considered it a bad global recession. Where are we currently? The latest governmental figure for October 2008 pins us at about 6.5% unemployment. That doesn't seem high, except for the fact that we haven't seen those numbers in a while, and the announced-but-not-implemented-yet layoffs are quite high. It is not inconceivable that we'll hit 7% by the end of the year. At the current pace, we're looking at somewhere around 8-9% by the end of next year. If it doesn't slow down by late 2009, we might just cross that ill-fated depression finish line. One interesting note is that while official unemployment is 6.5%, if you count all disaffected workers such as part-timers who want full-time work, those who gave up looking, and those whose unemployment benefits ran out, we're actually at a whopping 11.8% unemployment! This figure came out of the same goverment report that had the 6.5% number. If we hit 10% official unemployment, we're probably looking at 20% real unemployment. That is very, very bad.

ATP writes, "This is, in Alan Greenspan's own words, '...a once-in-a-century credit tsunami,' which could have been prevented, but, like all other crises before it, will pass." This is totally true, it will pass. However, the speed at which is passes by us is what is interesting.

The Causes

The first problem: ATP states that,

"The lesson here is that when government appears to be operating in the best interest of “the people,” they often are not. Free markets work only when they are free from tampering, whether or not the tampering is well-intentioned."

This is 100% correct. Government intervention, except for policing criminal activity, tends to have negative unintended consequences (as well as a few negative intended consequences). It doesn't work, and we agree on that. However, they then go on to say,

"We feel that the Bailout Bill (or “Rescue Plan” as it is now being called) was a good move, IF IT WORKED THE WAY IT WAS SUPPOSED TO and here’s why: as these companies are going bankrupt, the companies and institutions that hold their stock or bonds or other securities are not sure what they are worth anymore, if they are worth anything at all. So these companies suddenly are not sure how much cash they can raise for expenses, to meet obligations, or especially, if they are a bank, how much cash they can lend. The Bailout Bill allows the government to step in as a buyer of last resort of those securities. So for the companies that hold these securities, they can suddenly sell them to the government (yes, for pennies on the dollar, but something is better than nothing) and have cash to invest in other securities, or lend to make interest on their money. Liquidity would have been restored."

But herein lies the problem. You can't advocate that tampering by the government is bad, even if well-intentioned, and then state that a taxpayer-funded bailout would work, even if the intended functioning took place. The bailout was a stupid idea on a great many fronts, but here are a few reasons why:

• This isn't a liquidity problem. This is a solvency (capital) problem. Liquidity means there isn't enough money to go around, or that money isn't moving around. Money isn't moving around because the banks and businesses don't have enough capital anymore. The Fed has been flooding the markets with liquidity lately, and guess what? It hasn't done a dang thing. The banks are hoarding the money, because if they had to reveal their cards, they would be bankrupt immediately.
• The bailout's intended functioning is to fleece taxpayers and consolidate power among the largest banks in order to keep the US financial hegemony over the rest of the world. In other words, this is US Secretary of the Treasury Hank Paulson doing his friends a giant favor, at taxpayer expense.
• Taking money from taxpayers, either by taxes or by the potential whiplash inflation that could result, just devalues assets of the average people of the US whose savings are providing what precious capital the banks have. In other words, if you water down taxpayer's monetary power, you starve the banks of the very capital that would actually put them on firmer footing.

ATP then also states the following about what was done during the Great Depression and then more on the bailout:

"But a lot has changed since the Great Depression, and policies have been put in place so that a lot of things that happened then can never happen again. For example, the stock market crashed massively in 1929, the Dow Jones losing about 42% of its value, in large part due to margin trading (trading stocks with borrowed money). Margin trading has been amended and changed so that it doesn’t push the market down like this anymore. Short selling rules have been changed. At the time of the Great Depression, the government did not do enough to restore confidence, but this time, in order to conserve confidence in the economy, the Legislative Branch passed the Rescue Plan to buy up the assets of bankrupt institutions (such as auction-rate securities, subprime lending issues, collateralized mortgage obligations, structured investment vehicles, etc.). Later, when the market has stabilized, the government will sell these assets on the open, potentially making billions of dollars of profit; so this bailout will not end up costing the taxpayers $700 billion in the end."

Unfortunately, the basic functioning of free markets has not changed since the Great Depression. The assertion that "the government did not do enough to restore confidence" in the Great Depression is erroneous. They're blinded by Fed Chairman Ben Bernanke's academics (but I don't blame them, that's an easy trap to fall into), because he says the same thing. He claims he was a student of the Depression, yet he is making precisely the same mistakes the government did back then.

Here is the mistake: the Great Depression was caused by excessive debt, not a lack of liquidity. The loss of confidence, and the ensuing difficulty in restoring it was because, in a very real sense, the whole stinking world was in a giant debt hole. As long as prices kept climbing (inflationary pressures), the big ponzi-scheme party kept up and the music kept playing. It was fueled by easy money (low interest rates and large amounts of liquidity from the Fed), and as soon as one even marginally important bubble popped, the whole scheme came crashing down.

When you have a nation built on extreme debt, the only way out eventually is for the debt bubble to pop and for there to be large defaults. People think that the stock market crash of 1929 was the beginning of the Great Depression (Black Tuesday). But it wasn't. It was housing, and it started in 1928 or so when house prices started to plummet. The stock market was a symptom. During the depths of the Depression the stock market had rebounded and appeared healthy, yet the economy hobbled along for years after that. Ask Japan how that feels in a modern world. But if you hold on for very long, you'll get to see it for yourself.

But why did it hobble along? Was it that the government didn't do enough to restore confidence? Did they not provide enough liquidity? The answer is simple: they did too much. President Hoover made a number of strategic mistakes, but he was smart enough to know that he needed to not meddle too much and let it take its course. People blame him for causing it, but I think that if his policies had continued the Depression would have ended sooner (and wouldn't have taken a war to re-energize the economy). The fatal mistake that made it drag out forever was made by our beloved FDR. The government under his watch began doing exactly what our government is now doing: meddling, and trying to inflate its way out of a deflationary collapse. Another way to look at this is that debt created the Depression, and they threw more debt at it to make it go away. I believe it was Einstein that told us that insanity is applying the same wrong solution to a problem expecting a different outcome each time. Our government is obviously insane.

All these interventions did during the Depression was lengthen it out, as the much-needed correction was hobbled in its ability to take its course quickly enough. Then, the interventions didn't produce the hoped-for 'recovery,' and confidence dipped ever lower, hobbling recovery even more. Does this sound familiar? The government has had unprecedented interventions in the last 18 months in the economy, as have foreign governments. What has it bought us? Nothing, except a giant bill that our future selves and children will have to pay for. We now have a crashed stock market (43% down from peak), a crashing housing market (around 25% down from peak, and falling), crashing manufacturing, rising exports (which is deflationary), crashing commodity prices, crashing retail sector, crashing auto sector, etc. Government intervention does not work.

ATP also points out that we have successfully bailed out institutions before. I don't buy it; this does nothing but create the oft-mentioned moral hazard that will plague free markets. If the government bails anybody out, then they have less incentive to do the right thing, because they get rewarded for bad and stupid behavior. One group he mentions are the S&L institutions (the Savings and Loan crisis of the early '80s). Let it be known that the S&L bailout was hardly 'successful' as far as the taxpayer is concerned. They properly shut down the failing S&Ls, and liquidated their assets. That was good. The problem is that the very same investors who drove the S&Ls into the ground turned around and bought the fire-sale priced assets, and then made a killing off of them starting up a new set of S&Ls. The real problem? The markdown hit was taken by taxpayers. In other words, they ran things into the ground making incredible profits with risky investments, cried to the government, who had the taxpayer take his lumps, and then bought the really cheap assets back and began fleecing savers all over again. They fleeced savers on the way up, and taxpayers on the way down. Good work, if you can get it.

What do we do now?

ATP gives some advice, much of it very sage. Don't panic -- yes, panic only tightens the downward spiral. But be careful...if everyone else panics, and you don't, well, they end up with their money out and you don't. Which means you lose. So, keep your ear to the ground, and be deliberate, and watchful, but yes, don't actually panic.

The next bit of advice -- "Now is the time to buy." Hogwash. This is a form of bottom-calling. The bottom in the housing market over the last two years has been called about once per month, each time the housing data comes out. Guess what? There's no bottom in sight. Same goes for the stock market: it's very volatile, but according to many theories, there is a real chance it'll break it's supports around 8000 points in the DOW. If it does, who knows where it'll bottom out at. Buying now is like catching a falling knife. If you're not a professional and aren't properly equipped, then trying it is really not smart. Of course, the same goes for not selling: hang on to your assets long enough, and you might just finally panic and lock in your losses. You can get some gains back later, but it's hard, so be careful.

ATP notes that Warren Buffet has been buying lately, and to follow his pattern to diversify. This is good advice. However, Warren Buffet was recently heard on the media telling people to "buy now, even I'm buying!" If he says that, then don't walk, run to the exits. He is a master at this, and if he tells you to buy, he'll buy a little, and everyone will jump in the spree, and once everyone is buying, he is selling and screwing all the buyers. He isn't worth the billions he is for nothing.

ATP's subsequent 5 important lessons are spot on. Take them to heart.