The Economy

A bit late, but some comments on the economic events of the last few weeks are in order.

First, the Bear Stearns deal is starting to unravel. In the first few days after the crash and subsequent takeover were announced, I sat back in awe, as I would in some major catastrophe. I heard the events unravel with the rest of the public, knowing that there was more going on underneath the surface, and that we wouldn't know the real story for some time. We now know that Ben Bernake, the Fed chairman, stepped in to facilitate this deal. Also, the price of the takeover has risen, as stockholders threatened to block in favor of some sort of management buyout (not that they should really trust their current management to buy anything). But the biggest insight has come from reading the blog of Clinton's first Labor Secretary, Bob Reich (now included in my links).

Basically, Reich's argument is that the American taxpayers are paying yet again. The Fed used its heavy hand to force stability on the market, just as it was created to do. However, the cost of this stability was exposure to a larger bailout down the line, with no direct compensation for a prosperous deal other than a general "trickle down" through stable markets (well, no compensation for the taxpayer... one wonders what other compensation is occurring).

This alone is alarming. But the housing crisis is starting to crown, as well. Foreclosures are soaring, unemployment is at 5.1% (!!!), the White House released a plan to streamline government agencies (completely neglecting the actual issue, as usual), housing price indices are down by double digits in some accounts, and commodities are soaring.

This last point merits explanation. When people believe the economy is in trouble... specifically, that inflation will increase and stock prices won't, they place their money in alternative assets, or commodities like gold, land, and even food. I believe this increase in commodities was a major harbinger two years ago, just when the federal government was treating the increase in housing prices as a credible source of income for a strong economy. Now, we see that the housing boom had little foundation, and it joins the list of bad investments, along with stocks and currency. Other commodities, however, are soaring. This week, the Economist's commodity price index showed a 30% increase over last year, and the food index was up 60%.

So what does this all mean? The problem with using commodities for speculation is that most commodities also have intrinsic value. Food has nutritional value, oil is used for transportation, heating, and electricity, and minerals are used for things ranging from steel (iron ore) to electronics (silicon). Many of these intrinsic values are the staples people rely on to live. Thus, this crisis will be felt heavily by the people most concerned with the cost of basic staples... not your typical wall street banker.

This is the rainy day that the government usually intervenes in. This is when we use our reserves from more lucrative times to inject money into the economy, through tax cuts, public projects, and careful use of government bonds. However, poor fiscal policy over 7 years has reduced the potency of these fallbacks and, more importantly, reduced our government's credibility to assuage skeptics.

However, I am optimistic. First, a change in January should restore some credibility. Obama delivered a wonderful speech on fiscal policy (transcript available on Real Clear Politics), although I still believe that his strength lies in other aspects of economics (what he calls, "reducing poverty"). Second, the commodities rising are actually ones the government has a large supply of... gold, land, and oil. While I certainly hope this administration isn't stupid enough to cash out on these, such assets provide for a stable long term outlook. Third, the Bush administration is essentially a lame duck. I sincerely hope that we are now seeing the effects of poor choices, instead of continuing to make them at such a rapid pace.

I like to compare our situation to our nervous system. If we place our hand on the stove, we feel pain. Normally, this causes us to pull our hand back. However, the Bush administration's reflexes haven't worked properly, and they put their other hand in ice water, because they've heard that's good for burns. After a while, their nerve endings burn away, and the pain diminishes, but the tissue still burns. Luckily, the body has shock mechanisms for large injuries, which equates to our current situation. Unfortunately, shock is not pleasant, and it can have some long term effects if not handled properly. But it is a coping mechanism, and, as a capitalist democracy, we have such natural coping mechanisms. The most important of which comes every four years.