Saturday, May 16, 2009

Weekend Musings - Will Obama Magic Work?

Dear Readers,
Today I am posting here my thoughts on various "efforts" by govt , esp. Obama, the US President, in response to fighting ongoing Global Depression (some say its only a recession).

The Obama hope came into existence long back when he was campaigning for presidency of US. People (mostly Democrats and their supporters) believed Obama can be the only person who can help them out of this mess of economic downturn and his popularity was always increasing with every campaign round. Let me first outline what was and is being seen as "problem" -
  • Decreasing jobs nationwide
  • Decreasing housing prices
  • Decreasing stock prices and 401(K) value
  • Decreasing loan availability (credit crisis)
  • Increasing Loan Defaults, particularly in housing
  • and many more other things...
Whatever many people think, I just can not agree on these things being problem in the first place. This is simply a reversion to mean after big excesses in credit and asset prices for almost anything. After a breathtaking increase in leverage it was only "normal" to see the kind of deleveraging that is continuing today and will continue for good amount of time in future. Noble Prize winning economist Joseph Schumpeter termed it "Creative Destruction" in which old businesses and economic tradition get destroyed in order to create opportunity for new and relevant ones. If you watch closely, today exactly the same thing is happening - destruction of inefficient and unsustainable businesses in order to pave way for newer ones which would help reallocate capital efficiently.

People abhor nature taking its course and "correcting" the excesses so they turn to the govt - to do "something" that stops the necessary correction. They want something for nothing and pin their hopes on presidents, congress, feds etc etc. This is why Obama became the "man who can do this" as Americans wanted to continue with the excesses they had been doing - buying things NOT Required with money they DID NOT HAVE (all credit!). On seeing their pseudo prosperity disappearing, they shouted - SAVE US OBAMA!

Now let us put the reasoning aside and think on the core issue of this post - Will Obama Do "Something"? As we count various actions and expressed will of Obama, it seems he is really "doing a lot of things" - big stimulus with massive deficit, tax increase, protectionism - all the evils at once. Let us forget what is right or wrong, let us better concentrate on "Will Obama's Efforts Pay Off"?

A BIG FLAT NO.
Considering the circumstances and time when Obama took office, we can say he is either extremely unlucky or extremely lucky depending on what line we think. Some say he came at a time when everything was in total mess and so he was unlucky given the situation at hand. Others say he is lucky to enter office at such bad time because he has a chance to "correct" this mess and prove himself. I say he had the great opportunity of being lucky but his actions will prove otherwise. So, how could he possibly "be lucky"? My answer is simple - If he had done nothing! If he had let nature take its course and punish those who speculated on wrong things at wrong time, let the Creative Destruction do its work so that world would have brighter future. If he had stayed away and let the free market do its work, we could have really hit the bottom by now. It would be massive correction but it would be swift and would not get worse than it would owing to all this mess being created by govt.

"But we have already hit THE BOTTOM"! say many mainstream pundits today. They are producing so many evidences - unemployment number, GDP data, housing prices etc which according to them is not "that bad" and so recovery is underway meaning bottom is firmly in place. Even masses believe in these same pundits who had been saying "there is no reason to worry" before this crisis unfolded. One friend from BlogCatalog, a hardcore democrat and Obama fan was so furious when I raised this thing (Will Obama be Effective) and accused me of being a Republican! I never knew republicans were free-market minded people, they may have been just saying those words but their policies don't speak it. Bush left office with massive intervention in the form of short-selling rules to bailouts to stimulus packages - all signs of at least not free market!

Let me come to the data first. The "not so bad" data that is being interpreted as "bottom sign" is misleading. The unemployment number or GDP data are revised many times and if we look at recent past we see a trend of negative revision. Unless this trend is not reversed and revisions do not start in positive, there is no case for recovery. This data is actually irrelevant. The best we can use that data is by looking at "revision trend" and so far its negative.

Now the question is what "steps" Obama has taken or is planning to fundamentally "reform" the economy? Let us analyze one by one:

  1. Tax Increase: One of the biggest tool in Obama's hands is increasing tax on profiting businesses so that the budget deficit can be narrowed. This line of thinking is basically flawed - if you tax too much, total tax return is going to suffer in the medium to longer run and in a bad situation of economy when businesses find it hard to generate sustainable profits, it is going to be disastrous. Contrary to popular thinking, its not biggest firms that employ most people, in fact, small businesses are at the core of employment to the masses and today they are the ones who suffer most on credit crunch. You can't do worse than raise taxes on these businesses when they are already reeling under pressure. Increased taxes means increased costs and increased costs means more cost cutting measures and laying off employees that are "not that important" is one way of effective cost cutting. So what is going to be actual effect of this "tax change" thing? Sure its going to deteriorate situation further. Govt whenever tries to play the role of "distributor" of money, it fails.
  2. Closing "loopholes" in US Tax Code to close foreign "Tax Havens": US firms have been benefiting and saving good amount of tax by using tax havens in foreign countries (Cayman Islands is more in news) and this is undoubtedly unfair. I do not support this practice as free market theory can not overlook such "out of box" ways to avoid tax. However, the timing of Obama's decision is not good. Today when US businesses are already under pressure for profit and margins, this crackdown will break their back. Consider a firm ABC using this method to save taxes which result in higher profits. If ABC finds it suddenly that it can no more do it, then its already falling profits / increasing losses will be worse as it would need to pay more to produce same thing it was producing yesterday. What will ABC do? what options does it have other than "cutting costs the other way" - firing more people? So, this action is not the demand of time at least and is going to do more harm in the short to medium term.
  3. Climate Change policy: Obama's intention on Global Warming and Climate Change is plausible and this is one reason I admire him. He has a plan to curb greenhouse emissions by enforcing "cap and trade". Undoubtedly this is a welcome thing as the biggest danger for life on earth is increasing emission of greenhouse gases. However, once again, the problem is in the circumstances. Obama is bold enough to take this action NOW but this could mean rendering US companies not competitive to that of non-conforming countries like China and India and other developing world. Because its hard time in terms of economic growth, the chances of a global enforcement of such rules is almost non-existent and this brings the bad luck for US firms. Coal-burning firms in China and other developing countries will not stop it for the sake of "responsibility" and US firms will find it better to shift business toward such countries. This may also prove to be detrimental to US recovery. The better option would be a global understanding on the issue but that looks almost impossible. I have a better solution and that is once again - "DO NOTHING". Yes, if Obama stays away from all these "reforms" then Depression will take care of this greenhouse gas emissions issue. Slowing consumption is the best answer and gradually by the time recovery starts, there will be a permanent shift toward "rational consumption" which will be the best thing for earth and its climate.
  4. Fiscal Stimulus: Obama has outlined a big fiscal stimulus plan of spending on infrastructure. He says it will create around 3.5 million jobs and will lift economy out of contraction. While I am strongly against fiscal or monetary stimulus of any kind, there are more supporters of this scheme than opposing ones. The line on wall seems good enough to lure us into thinking that such a program will save us from economic downturn but the fact is opposite. Govt turns out to be very bad when it runs businesses and running big infra projects is no exception. Moreover, these kind of measures stop the natural remedy of "reallocating" capital to better businesses through private firms. Then there is an added issue. Even if this program creates 3.5 million jobs, how many of them will accommodate those from retailing, financials, autos etc where there is bigger job loss? Can a Wall Street person help laying out a bridge or highway? This creates a BIG question mark on the efficiency of this program as job provider. However, even if this program does work out to be a good job provider, where will the money come from? the printing press? as there may not be enough lenders left. This brings to my next point - Monetary Stimulus.
  5. Monetary Stimulus: Although this is a project by "Helicoptor Bernake" and Obama has limited role in it, the FED is off limits in combating this ongoing crisis and in its last meeting the result was "monetary easing" - a euphemism for "printing money" without any backing. This is effectively being done to stop deflation and start inflating dollar supply so that asset prices can be "reflated". The biggest danger for a central bank is deflation and they do their best to stop it. Today when US is already under big debt and running big deficit, the question is what happens if they really are successful? that is, if they manage to ignite the spark of inflation. So far deflation looks very strong and the rising dollar against euro and falling asset prices are evident of this fact. But if and when they are successful in turning things around, it will be immediately out of control and chances of "that 70's show" of stagflation will be highest. Any recovery has to be stopped because FED will need to "do something" to stop the inflation menace then. What an exam for FED!
Apart from these five above mentioned things, there may be smaller "actions" by Obama to stop this downfall but looking at current situation and analyzing the facts I just can not see how these will work. To make things worse, there are so many other things to look at.

One of the biggest problems in US is Social Security obligations. The US govt published two important reports on budgetry trends this week - both implying that US is on an unsustainable path that will almost certainly result in massively higher taxes. By 2016 US will have to fund Social Security out of general revenues, as the surplus will be gone. And there are no trust funds. They are a myth. It as if I wrote myself a check for $2 trillion and then declared I was worth $2 trillion. The money is just not there. Social Security makes Bernie Madoff look like a small-time crook!

And, then comes Medicare, which is in even worse condition. Bruce Bartletts has this to say - taxes will have to go up by 81% if we are to pay the obligations as they now stand. Sustainable? LOL. That's the abbreviation we use in internet chat for Laughing Out Loud. Now that is unsustainable. It won't happen. And as the saying goes, if something is unsustainable, at some point it will stop. No getting around it. Long before we get there, change you will not like will be forced on the US.

Then, there comes the classic problem of PROTECTIONISM. Head of a govt thinks he can make his country safe if he can close "outer" shell. He can do this in one way - protectionism. He hikes tariff on imported cheap items, devalues currency and urges his citizens to buy products made by local firms. Truly Anti-Globalization. While this looks impeccable at superficial view, the fact is such measures deteriorate free global trade and undermine global growth which in turn directly affects that protectionist country very badly. The very reason behind globalization and free trade efforts were to counter this force. But, in times like these political call of the day is to be protectionists. Masses like it and masses vote. Please read this for how is the latest trend of protectionism.

Can Obama resist the forces of protectionism? I don't think he can. Very soon we are going to read news of US hikes on various imports as well as crackdown on outsourcing.

Although there are a lot more issues I can throw light upon, I think it is already enough for the debate. I am a big admirer of Obama for his pro-science and pro-climate attitude, but the circumstances may not be willing to support him for long. The best thing he can do now is postpone this crisis to beyond next elections. The opportunity he had to let nature run its course of correction is already over.

My BEST WISHES to the man-in-charge.


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