Thursday, November 20, 2008

The Continuing Collapse

As some of us have continued to say, it will continue to get worse until fundamentals are addressed. Money was given to banks, but balance sheets were not restructured. As such it is only a temporary delay in financial troubles. As long as financial markets are stopped up, demand freezes, and the longer that persists the more impact it has on actual demand. A general slow down ensues, and real firms, the worst run, and most at risk, begin to falter. Voila, autos slump; retailers are next.

The financial bail-out has failed. Primarily this is indicated by the precipitous drop in selected financial stocks after they were infused with cash. Bank of America, Citigroup, and Goldman Sachs are off more than 50%. There was no need to hide which banks were in trouble, since the bailout wouldn't work, we were bound to find out by watching their stocks.

Some suggest that this is not yet as bad as The Great Depression, pointing at the jobless rate as a key indicator. However, we must remember that in the Depression our economy was much more self-providing than it is now. Most of our manufacturing has been moved off shore to places like China. If you look at what's happening to factories, and unemployment there, it is not pretty.

Our government continues to throw money at the problem, and attempt to improve things by stimulating consumers to buy. However, this is attempting to change the cause by stimulating the effect. It is doomed to failure. What does the Federal Government risk through this policy? It already is close to lowering interest rates as much as it possibly can (to 0% effectively). But that is absolutely the wrong thing to do. Lower rates are what got us into this problem, and it only encourages poor investing. Capital has already been destroyed. What we need is higher rates to spur conservative investing and capital preservation, but this does not fit with the stimulatory policy of the monetarist Fed. While sound policy guarantees a protracted recession, doing the opposite is now almost sure to guarantee a depression. The Fed has thrown so much money at this, that it now threatens the viability of the dollar as a currency of standard. If dollar confidence erodes enough, expect massive dollar flight and a significant decline in dollar values, making the problem even worse. We're in a deflationary period now, but that is due to real demand destruction. If the Fed continues its stimulatory policy, expect the deflation cycle to turn to rapid inflation.

We also do not need industry bail-outs. This phenomenon is nothing more than poorly run company "pigs" to an ever widening trough. The other half of the US auto industry is fine. Why do we continue to reward failure? Every bail-out, the financial one included, has done nothing but reward those who have failed to manage their companies well, and punished those who have succeeded. While some advocates of a bail-out continue to think that it can be structured in such a way as to force Detroit to restructure, Megan McCardle points out that things have become so cynical back in Washington, the those who support the auto bailout there now nakedly see it for what it is, a cash grab, "Hail Mary" play. Yet, they advocate it anyway. My God, what have we become!

Citi begs for help, and Wells Fargo has "help" forced upon it. A free market would work in reverse. Wells would gobble up Citi, but as long as the govt is in play, Citi resists, holding out for a hand-out. When strong banks suggest that they will use bail-out funds to make acquisitions, the one rational, helpful action in this crisis, tax payers howl.

This crisis could have been avoided. If the government had only stayed out when the banking sector worsened, and let the natural course of bankruptcy restructure sick balance sheets.

There are letters being penned to my congressmen, and I'm planning a few LTE's as well. Now more than ever, there is only one thing to advocate, lasseiz faire!


For those of you who believe today's crisis looks a lot like Atlas Shrugged, Zip has two prophetic passages from Rand's non-fiction. It's worth clicking through the links as well.