Monday, September 29, 2008

Bailing Out the Leaky Boat

by Larry Mongoss, guest blogger

(Photo by nikok)

Everyone keeps talking about the bailout, but it is interesting to me that nobody continues with the analogy to talk about the leaks in the boat. On the water, when you bail out a boat because something has gone wrong, it only makes sense to do so if you can get the water out faster than it is coming in. If that is the case, you get to keep bailing until the boat gets to shore, or it can be repaired. So, if we are going to have to keep bailing in order to forestall catastrophe, the real question people should be asking is how long that 700 billion will last.

On and off over my lifetime I, like many other people with a background in economics, have spent a great deal of time thinking about the great depression, its causes and ways it might have been avoided, even the desirability of avoiding it. On the financial side, some of these are obvious and fairly well understood. Large scale insider trading, which was business as usual at the time, loose credit, and a general adolescent feeling of invulnerability caused a remarkable run up in stock prices that eventually collapsed. On the real side – what politicians are calling Main Street these days – things are a lot more muddy, a funny thing in a time we associate with the dust bowl. While there is some consensus that there was not enough demand to keep up economic activity, why is not so obvious. Some say there was simply not enough money. Others point to a disconnect between what America was tooled to produce, and what people wanted.

The bailout is, to my mind, an absolutely fascinating, and incredibly expensive, test of the theory that there was not enough money. A long time ago, back when Paul Volker was heading the Fed, there was a great headline in the wall street journal that read something like “What happens if you throw a credit crunch and nobody comes?” The reigning assumption then, as now, was that easing credit will allow people and businesses to borrow money and get things moving. But really, beyond a few anecdotal assertions, there has not been much evidence presented that those who want to borrow money can’t. Just listening to the radio, and the ads from banks that want to lend me money, seems to suggest otherwise to my simple mind. If credit is eased, and still nobody borrows, what then?

While people in America are painfully aware that the price of gasoline is high, all of the talk is about how to make it lower. Almost nobody wants to acknowledge even the possibility that there is a new game afoot. But what if it is just that, a new game, rather than the turmoil in the financial markets, that is really driving down Main Street. What if, what we are feeling now, is the fundamental mismatch between and unlimited ability to consumer and a finite ability to produce. Mark Twain is often attributed with the saying “buy land they aren’t making any more of it,” and in his time others were buying people. Well guess what, they are still making people and in the world of supply and demand that means they should be getting cheaper.

Stepping out of slavery, all this boils down to less going into the hands of those that do the work. While this effect can be lessened, potentially even avoided, by rapid changes in technology, there is no guarantee, or evidence, that this will be sustained. In fact, if you look at the last 20 years in America, the amount earned by most people has not allowed them to lead increasingly better lives. More ironically, if you look at China over the same period, land is probably the single biggest factor in concentrating the wealth into a tiny fraction of the population. It is ironic, because the land was socialized when the communists took over precisely in order to prevent that.

So perhaps the bailout can be paid for by the Chinese who are now rich because land, in fixed supply, is getting progressively more expensive while labor, with unlimited supply, is relatively cheaper and thus Wall Street can keep itself intact while the residents on Main Street and Renmin Road work their butts off just to survive.

A postscript on this. After reading through the proposed bailout bill, the whole activity is being put under the acronym TARP for Troubled Asset Recovery Program. I am not sure if the new metaphor is intentional. But if it is, apparently those in the know think all of this is simply the result of too much rain, and has nothing to do with a leaking boat. Funny though, I did not see anyone named Noah involved in writing the bill.


chamberoftenthousandflowers said...

There isn't much I can add to this item as I have only the most basic understanding of the financial world and my gut instinct to guide me. However there is nothing I would in this I would disagree with. I'm unconvinced that pumping large amounts of money/credit into a failed system will do much good, only prop up businesses which in any other circumstances would have disappeared. A change of system and imposing regulations to curb irresponsible behaviour rather than let people go their own way sounds a better idea.

Xujun Eberlein said...

Thanks CoTTF. Theoretically, I agree with Larry as well, but it's quite painful to see the market going down so much right now.