Mittwoch, Januar 28, 2009

What the Recession Will Bring...

There's a chap in the FT whose column is buried way back in the paper - page 10 - and who doesn't write all that often. But Luke Johnson's column in today's FT is worth considering, especially in light of what I've already written here previously.

Let me comment on what he says. I'm only going to point out the most important things he says, please go read the rest. It's not long.

It is clear that as a society we must learn something painful and radical – how to live within our means – because the credit just is not there any more. The easy money is all gone, and there will be no more for a long time.

Bingo. This is good to see, because it is also accurate. The days of wine and roses are over: I'll take the sentiment one step further, and point out that this has some rather significant political impacts as well: living within our means also implies that the monies for extravagant social programs and financing silly pet projects that have no interest outside of some academic squabblers will simply not be there anymore, and the louder the protests are that such fripperies are no longer being funded, the larger the number of people who will say "good riddance" as well. Maybe not at first - it will take far too long for this realization to trickle down to the politicians - but within the next two years we should see a significant return to classic conservatism. The problem is that before that happens, much will happen that will make the backlash even worse and make things more difficult to get out of: give folks like ACORN a few billion - which is the boondoggle up before Congress - and you have created a monster that must first be slain.

Previous assumptions simply do not apply. Homeowners should forget about houses going up in value – all that is history. They are places to live in. So cut back on your outgoings. Pay rises are off the agenda. Wholesale pay cuts may yet become common. Put some cash aside if you possibly can; you might lose your job. I fear most citizens' plans for the future must be put on hold. This is not something happening to other people – we are all in trouble.

I have yet to see a more accurate assessment of the implications of the ... whatever it is we are going to call this crisis. In some ways I'd like to call this the Stupidity Crisis, because a lot of people who thought they were being awfully clever have, in fact, been rather stupid about this. But back to Johnson: he's right.

I don't own a house. I could, but I've chosen not to. Instead, I found a place to rent because I did not believe, as did so many of my colleagues, that I would get a decent return on any investment in housing besides speculative profits: given the demographics of where I live - Germany - I also recognized that when I might want to sell, it would be to a buyer's market, as German demographics argue against speculative success for all but the most desirable bits of real estate. A house is never an investment, unless you are renting it out: one of the problems we have created in the past is that people called speculative purchases "investments" instead of calling them what they were, i.e. speculative purchases with the hope of appreciation. An investment, a right and proper investment, generates a cash flow. Buying stocks isn't an investment, unless you are buying stocks for their dividends: buying a bond is an investment when you clip the coupons and take your profits. Anything that doesn't generate a cash flow is speculative: you're buying something in the hope that you can sell it for more than what you paid for it. If you want to do that, fine: just don't call it an investment. It's speculation, and only fools speculate when they should be investing.

What Johnson is pointing out isn't that the world is coming to an end: instead, he is pointing out that the old rules, the rules of your grandparents and your parents, never really went away. They were the boring rules, of living within your means, of saving before consuming, of deferred pleasures. You know what?

They were right. But the speculators, the banks, the loan companies, all gamed the system, denigrating the safe path in ways subtle and seductive, and then we all wonder why things suck so bad.

Business must adjust to the idea that this stagnation could last for many years. The age of free money from mad lenders is finished. The growth game is over. Whole swathes of industry are on life support. The banks are in desperate straits. If their management cannot see that, then they are even more incompetent than they are portrayed.

The banks are indeed in desperate straights because of the abject failure of risk management. The banks are what makes the economy actually work: anything else is barter (which has its place, but not here). The age of free money isn't actually over: the age of mad lenders is. Money, given the extremely low interest rates, remains basically free (and may show negative interest rates when you look at real exchange rates), but the banks aren't lending to anyone. That's the problem, and the reason is simple: it's because after 15 years of ignoring risk, all that the banks now see is risk. Of course, mark-to-market - the greatest crime that accounting has foisted on the public since mark-to-model - makes it virtually impossible for banks to take on any risks whatsoever.

Indeed, too many of us still fail to see just how severe conditions are, and how horrible things are likely to get. This is not a correction, a brief hiatus until the upward march once more resumes. At some point, the Japanese, Chinese and Saudi buyers of US and European government bonds will see just what miserable value they offer. Then governments may have to stop all the runaway state spending and bail-outs, and even put up interest rates.

Good point. But what are the alternatives? This is where I think that Johnson is too gloomy. The problem that the Japanese, Chinese and Saudi buyers have is that they have the dollars - and will continue to have them. Unless, of course, they start buying things with those dollars, things that can be used where they are (buying US real estate and US companies changes nothing about their dollar dependency, but simply prolongs any possible day of reckoning, if there is to be one).

Plenty of observers, including me, have criticised the media for being too gloomy. I am now beginning to believe that they have not been gloomy enough, if they want to reflect the true consequences of our profligacy and past conceit.

Here I think the writer is too British, too European: he fails to see how the US is really a developing country in many ways, and that the will to succeed - as opposed to the will to not work hard - is still alive and kicking. It is in England as well, but generally exorcised at an early age so that no challenge ever appears to the nanny state and to established interests. You simply can't invent an industry in the garage in the UK and Europe any more: they'd slap you with regulations that drive you out of business before you could even start.

After all, who wants to face up to the bleak reality that confronts us? The experts say we will not suffer a repeat of the 1930s slump. Indeed, we have to contend with fresh issues. Like the fact that there are 1.5bn recent additions to the capitalist workforce in China and India – hard-working, increasingly well-educated people, all keen to better themselves. Meanwhile, modern logistics and communications mean trade and production can take place almost anywhere if it makes economic sense.

Bingo. This should be put up in giant Hollywood letters, with bright blinking lights and a laser show to draw attention. At some point - and while we haven't reached this point quite yet, it really isn't that far off - it really does make no difference where something is made, and the critical point will be reached when local designs - MP3 players, for instance, that are completely designed in India - have exactly the same attributes and panache that a California design house can achieve. We're quite a ways off from that point, yet the distinctions are shrinking as local markets become more sophisticated, and the day will come when the next great product, the next iPod, the next cell phone best-seller, the next consumer gotta-have, comes from Bombay, Shanghai or, horror of horrors, Cairo.

On the other hand, the world is not a zero-sum game. Human creativity in one place doesn't rule it out elsewhere, so that the developing countries, once they have developed a middle class - which I define as that group of people who have the ability to actually save meaningful amounts of money such that they can start to invest, instead of being condemned to consume everything they earn - that can finance new developments and consume high value-added items, can become industrialized countries. It has happened: Switzerland was once the poorhouse of Europe, with the lowest wages around for skilled workers; South Korea was an economic ruin and its people lived in abject poverty; China and India are coming out of this stage now.

However, Johnson's fundamental point has to be understood: countries like China and India don't need the West as markets. They need only to get their own populations out of the poverty trap in order to become economic powerhouses. China is getting close, but may fail due to its abysmal, self-inflicted demographics, which point to a major downswing in the number of Chinese just when they need those consumers to make it to the big times; India must transcend its bureaucracy and failure to overcome the prison of the caste system to achieve the same results. The point, however, remains: the challenge to manufacturing and services in the UK, for instance, isn't from Belgium or France, but from Pakistan, Egypt, China and India. The world is growing up, and while the older brothers and sisters - the developed world - have had their good times and their successes, the younger siblings are starting to wonder why they can't be the same.

So why should industrious Asians earn a tiny fraction of what citizens in the west earn? Especially when they have so much of the cash and productive resources, while we have deficits, high costs and poor demographics.

It's not so much that Asians earn only a tiny fraction of what workers in the West earn: it's much more that they also have significantly lower costs. Prices are, however, low because wages are so low as well: this is what has kept many countries in a low-wage universe. This changes with increasing skills sets for one reason only: because the demand for skilled labor outstrips supply. What we will see in countries like China and India isn't the creation of a services-industry-driven middle class as we know it in the West, but rather the recognition that the lowly factory worker will be the middle class in these countries, which is, after all, how the middle class developed in the West.

Prepare for a wrenching, unstoppable redistribution of wealth – and I am not talking about domestic taxes. For too long it has been more profitable in the west to finance consumption rather than production. That cannot continue. I am afraid that the west's credibility – and luck – has run out.

Here is perhaps where Johnson and I part paths. The world is not a zero-sum game, where if Indians are to become wealthy, that wealth must come at the cost of the West. Creation of wealth is the key, not the redistribution: if that were the case, then the Oil Arabs would have the strongest and most vibrant economies around, instead of some of the weakest (and places like Dubai don't count: those economies are only vibrant because of the consumption of capital at enormous rates, and I have yet to see the business model that can be sustained there).

What does run out is the idea that the West is somehow better suited or more clever than the emerging economies of Asia. The myth of brilliant financiers and advanced services compensating for the lack of manufacturing and the abandonment of the blue collar worker is exactly that: a myth.

The West will have to relearn the values of an honest day's work, will have to relearn the merits of thrift, will have to relearn fiscal and financial responsibility, and above all will have to relearn how to deal with risk. You can't manipulate risk off of your balance sheets, regardless of how clever you might think you are: systemic risks cannot be avoided, and anyone telling you that you can somehow magically game the system should be exposed for the feather merchants and frauds they are.

This vast reordering of our economic system has only just begun. We shall have to cancel all the self-indulgence of endless welfare spending and cultivate rather more of a work ethic and a sense of self-sufficiency. Expectations must be modified and attitudes altered profoundly. Expect years of negligible growth, permanent high unemployment, declining property prices, higher taxes, crumbling currencies and falling living standards.

This is true as well. Unless, of course, we see a major re-alignment that returns people to work by making those goods that were exported to China just as easily made back in the UK, the US or France. After all, the argument that goods can be made anywhere applies to the West as well: the problem is that these will not pay the same kind of wages that people want to be paid.

Failure to understand that is what will result in years of negligible growth, permanent strong unemployment, declining property prices, higher taxes and the rest. Simply put: if you want high levels of employment and decent growth, you cannot gut your manufacturing base. You have to create the jobs for yobs, so to speak, and most importantly you have to make living off the dole so onerous and so culturally unacceptable that you get people back to work voluntarily. This is the problem of the welfare state: it has destroyed the manufacturing base, it has destroyed the lower middle class, reducing them to utter dependence on the largesse of their betters (who are paying taxes and financing them). You have to restore the dignity of labor: without that, you have no chance to turn things around.

We shall look back on the last decade and think: we never realised what we had until it was gone.

I think that there will also be a political backlash: that our children and grandchildren will look at us and blame us for having been so incredibly stupid. Baby boomers, if you think that your children will pay for your stupidity, think again. You should have contemplated a retirement eating cheese sandwiches and rationed health care before you took on debt burdens that required miracles to come true. If you didn't, then your fate is richly deserved. There's this parable about the ant and the grasshopper...

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