Download On G-20s and GMs: Economics, Politics and Social

On G-20s and GMs: Economics, Politics and Social Stability
The G-20 met on Saturday. They issued a meaningless statement and decided
to meet again in March or perhaps later. Clearly, the urgency of October is past.
First, the perception of imminent collapse is past. Politicians are superb
seismographs for impending disaster and these people did not act as if they were
running out of time. Second, the United States will have a new President in
March, and nothing can be done until he defines his policy.
It is ironic, given the sense in Europe that this financial crisis marked the end of
U.S. economic supremacy that the Europeans are waiting on the Americans.
One would think that they would be using their new found ascendancy to define
the new international system. But the fact is that for all the shouting, little has
changed in the international order. The crisis has receded sufficiently that nothing
more needs to be done immediately save “cooperation,” and nothing can be
done until the United States defines what will be done. Our view that international
systems received a fatal blow on August 8, when Russian and Georgia went to
war, and October 11 when the G-7 meeting ended without a single integrated
solution, remains unchallenged, from our point of view. It is every country for
itself.
That is exactly what is happening. The financial crisis has been mitigated, if not
solved, and the problem now is the fact that we are in a cyclical recession, and
that every country is trying to figure out how to cope with the recession. China,
for example, faces a serious problem. China is an export oriented economy
whose primary market is the United States. As the United States goes into
recession, demand for Chinese goods decline. Chinese businesses have always
operated on very tight—sometimes invisible—profit margins, designed to
emphasize cash flow and pay off debts to banks. As U.S. demand contracts,
many Chinese firms find themselves in untenable positions, without room to
decrease prices, without operating reserves and insufficiently capitalized.
Recessions are designed to cull the weak from the herd and a huge swath of the
Chinese economy is ripe for the culling.
If the world were all about economics, culling is what the Chinese would do. But
the world is more complex than that. A culling would lead to massive
unemployment. Many Chinese employees live a third world wages. Indeed, the
vast majority of Chinese have incomes of less than $1,000 a year.
Unemployment to them doesn’t mean problems with their 401k. It means
malnutrition and desperation—neither unknown in 20th century Chinese history,
including under the communists. The Chinese government is correctly worried
about the social and political consequences of a rational economic policies. They
may work in the long run—but only if you live that long.
The Chinese have therefore prepared a massive stimulus package—over $500
billion whose purpose is to stimulate domestic conception to make up for
declining American demand—but whose purpose is really much simpler. It is to
keep businesses from failing and spilling millions of workers into the street, angry
and hungry. For the Chinese, the economic problem creates a much larger and
more serious issue and the time frame for solving the economic problem
outstrips the amount of time available.
This is not only a Chinese problem. Whenever there is an economic downturn,
governments must make decisions as to whether society—and their own
personal futures—can withstand the rigors a recession is meant to impose.
Recessions occur when—as is inevitable—inefficiencies and irrationalities build
up in the financial and economic system. The resulting economic downturn
imposes a harsh discipline that destroys the inefficient, encourages everyone to
become more efficient, and opens the doors to new business using new
technologies and business models. 2001 smashed the technology sector in the
U.S., opening the door for Google.
The business cycle works well, save that the human costs can be daunting. The
collapse of inefficient business leaves workers without jobs, investors without
money and society less stable than before. The pain needed to rectify China’s
economy would be enormous, and devastating to hundreds of millions of
Chinese and probably leading to social chaos. The Chinese are prepared to
accept a high degree of economic inefficiency in order to avoid, or at least
postpone, the reckoning. The reckoning always comes, but for most of us, later is
better than sooner. Economic rationality takes a back seat to social necessity
and political common sense.
Every country in the world is looking at the impact of the recession on their
economies, measuring their resources, and deciding whether or not they have
the ability to keep business that should fail going, what the social consequences
of business failure would be, and whether they should try to use what resources
they have to avoid the immediate pain of the recession. This is why the G-20
ended in meaningless platitudes.
Each country is now focused on the recession and each country is looking inward
to try to answer the question of how much pain their countries—and regimes—
can endure. The more pain they impose, the healthier they emerge
economically—unless of course they die from the pain in the meantime. Each
country is looking inward, measuring their resources, their threshold of pain and
the next election. The rationality of economics and the reality of society
frequently diverge.
For the United States, has been posed in stark terms: should the U.S.
government use its resources to rescue the American auto industry. The
American auto industry was once the centerpiece of the economy. That hasn’t
been true for a generation as other industries and services have supplanted it
and other countries have come to excel at it. Nevertheless, it remains an
important industry. It may drain the economy by losing vast amounts of money
and destroying the equity held by its investors, but it employees large numbers of
employees and—perhaps more important—purchases supplies from literally
thousands of companies in the United States.
There can be endless discussions of why the U.S. auto industry is in such
trouble. The answer is not in one thing but in many, from the decisions and
makeup of management, to the unions that control much of the work force, to the
cost structure inherent in produce cars in the American economy, to a simple
systemic inability to produce outstanding vehicles. There may be truth to all or
some of this, but the fact is that each of the car makers is on the verge of
financial collapse.
This is what recessions are supposed to do. As in China and everywhere,
recessions are intended to reveal weak business and destroy them, freeing up
resources for new enterprises. This recession has hit the auto industry hard, and
it is unlikely that they are going to survive. The ultimate reason is the same one
that destroyed the U.S. steel industry a generation ago. Given U.S. cost
structures, producing commodity products is best left to countries with lower
wage rates, while more expensive U.S. labor is deployed in more specialized
products requiring greater expertise. Thus, there is still steel production in the
United States, but it is specialty steel production, not commodity steel. There will
still be specialty auto production in the United States, but commodity auto
production will come from other countries.
That sounds easy and bloodless, but in fact, the transition will be a bloodletting.
Current employees of both the automakers and suppliers will be devastated.
Institutions that have leant money to the automakers will suffer massive or total
losses. Pensioners may lose pensions and health care benefits and an entire
region of the country—the industrial midwest—will be devastated. Something
stronger will grow, but not for most of the current employees, shareholders and
creditors.
Here the economic answer—cull—meets the social answer—stabilize. This have
to make decisions. If the automakers were to fail now, their drain on the economy
will end, the pain will be shorter if more intense, and new industries would
emerge quicker. If, however, they fail now, their drain on the economy would end,
but the impact of the failure on the economy could be measured with a
seismograph. Unemployment would surge along with bankruptcies of many auto
suppliers. Defaults on loans would hit the credit markets, home prices in the
midwest along with foreclosures would surge, and lord knows what the impact on
equity markets would be.
The healthful purgative of a recession could potentially put the patient in a coma.
There are few if any who believe that the auto industry can survive in its current
form. But there is an emerging consensus in Washington that the auto industry
must not be allowed to fail now. The argument for spending money on the auto
industry is not to save it, but to postpone its failure until a time that is less
devastating inconvenient. In other words, Washington like Beijing, afraid of the
social and political consequences of a recession working itself through to its
logical conclusion, wants to spend money—the probability of recovering it is
small—on postponing the failure. Indeed, around the world, governments are
considering what failures to tolerate, what failures to postpone, and how much to
spend on it. GM is merely the American case in point.
The people arguing for postponement aren’t foolish. The financial system is still
working its way through a massive crisis that had little to do with the auto
industry. Some traction appears to be occurring—certainly there was no crisis
atmosphere at the G-20 meeting. The economy is in recession, but in spite of the
inevitable claims that we have never seen anything like this before, we have.
There are always some variable that swing to extremes and this time its in
consumer spending, but we are still well within the framework of recent
recessions.
Consider the equity markets, which we regard as measure of the markets
evaluation of the state of the economy. On January 4, 2000, the S&P 500 was at
1498.58. This was the top of the market. On July 3, 2002, 18 months later, the
S&P bottomed out at 858.52. Over the next five years it rose to 1526.75 by July
2, 2007, the height for this cycle. It fell from this point until November 12, 2008,
when it closed at 852.30. This past Friday, it was at 873.29.
We do not know what the market will do in the future. There are much smarter
people than us who claim to know that. What we know is what it has done. And
what it has done this time—so far—is almost exactly what it did the last time save
that in 2000-2002 it took 18 months to do it, and this time it was done in about 16
and a half months, assuming that it bottomed on November 12. But even if it
didn’t, and it falls to 775, for example, it will have lost 50 percent of its value from
the top, more than in 2000-2002 but not unprecedented.
The point we are making here is that if we regard the equity markets as a long
term seismograph of the economy, then thus far at least, for all of the storm and
stress, the markets and therefore the economy remain within the general pattern
of the 2000-2002 market at the 2001 recession—which was certainly unpleasant
what with the devastation of the tech sector, but something we survive. But at the
same time, it is clear that this is balanced on the knife’s edge. Another hundred
points fall on the S&P and the markets will be telling us that we are in a very
different place indeed.
A massive bankruptcy in the automotive sector could indeed set the stage for an
renaissance in the next generation. But at this particular moment in time—and its
no coincidence that this crisis comes at this particular moment in time—a wave of
bankruptcies would dramatically deepen the recession, a fact that would likely be
reflected in the equity markets destroying trillions more in net worth.
Now, there is a powerful counterargument to bailing out the auto industry, which
is that it is a drain on the economy, it will never be globally competitive, and if
dragged back from the edge, no one will then say it is time to push it to the edge
and over. The next time it will be on the brink will be during the next recession
and the exact same argument will be used. In due course, the United States will
be like China, so terrified of the social and political consequences of business
failure that it will maintain Chinese like state owned enterprises, full of employees
and generation old plants and business models. Short run solutions can easily
become long term albatross.
The only possible solution would be a bailout followed by a Washington
administered restructuring of the auto industry. This would cause us to imagine a
collaboration between the auto industries current management and Washington
administrators that would finally put Detroit on a path where it can compete with
Toyota. Frankly, the mind boggles. But boggle though we might at that idea,
hitting the economy with another massive financial default, a wave of
bankruptcies, massive unemployment surges and another hit to housing prices,
makes us boggle even more.
The geopolitical problem of the world at the moment is that it has had to
massively support the global financial system using sovereign wealth—taxes and
printing presses—to do so. We may just have eked through that crisis. Now the
world is in an inevitable recession and business are on the brink of failure. A
wave of massive business failures on top of the financial crisis might well move
the global system to a very different place. Therefore, each nation, by itself and
indifferent to the others, is in the process of figuring out how to postpone these
failures to a more opportune time—or to never. This will build in long term
inefficiencies to the global economy, but right now everyone will be quite content
with that.
And so the financial crisis became a recession, and the recession triggered
bankruptcies, and no one wants bankruptcies right now, so everyone who can is
using taxpayer dollars to protect the taxpayer from the consequences of
mismanagement. And the last thing any one cared about was the G-20 concept
for the future of the economic system.