Driving the Economy with Your Eyes Closed

Wednesday, April 29, 2009

On April 14th, Obama himself touted that there were “signs of economic progress." Now, I’m not a Nobel Prize economist or even a vaunted one. In fact, I'm a disgrace because I work in the real world as opposed to sitting in a college office running complex and unrealistic econometric models. For what it's worth, I believe we are sitting in the eye of an economic hurricane and whether the next half of the storm hits us up to the President.

Let’s dissect what has happened and what could happen. To do so, I will break down this recession into 2 phases. We are at the end of phase 1 and inching close to phase 2.

Phase 1:

At phase 1, the recession was mostly in the financial industry. Bad mortgages and increasing foreclosures caused banks to run out of money to lend businesses. This is called a problem of liquidity. The timing of the economic downturn is important. You see, phase 1 really started to impact economy in the 4th quarter. In response, companies sought to tighten their financial screws to salvage their financial statements for the year. Being that the whole year was not a bad year, the financial wizards in most companies saw an opportunity to make quick sweeping moves to pad the only quarter that looked abysmal, their last quarter. As a result, we saw large increases in unemployment, but not many companies closing their doors. The problem for companies right now is there are no more screws to turn. Companies threw all their eggs into 2008 in the hopes that the recession will subside by the end of 2009. Why wouldn’t CEOs have a bullish outlook on the future? They see that their consumers still want their products and are still buying, they are just buying less. Keep in mind, many of today’s CEO has never had to steer their company through a serious recession. In fact, if you look at the MBA programs of today and there is an overwhelming focus in managing market competition, not market collapse.

The Calm before Phase 2:

Right now we see consumer spending dropping, but not as quickly. This is being padded in part by the time of year. Many people are receiving their tax refunds. Also, this is the time of year that most companies give raises and bonuses. It’s common to see spending pick up a little in the retail business this time of year. We’ll need more than a seasonal boost to pull out of this recession.

Phase 2:

In this phase the recession seeps into the consumer market. Yes, we’ve seen consumer spending fall, but there is still a long way to go. When you loose millions of jobs in a few months, you are most certainly going to see a sudden drop in consumption. In 1929, consumer spending ground to a complete halt instantaneously. This was because most people only had access to cash. So far consumer spending has been greatly padded by credit cards. If you are paying attention to news stories, there have been a number of articles on the beginning of a consumer credit crunch.

Smartmoney.com has an article regarding the growing credit balances that card companies are seeing. According to the article, credit card balances have nearly doubled from 4% lows over the last 4 years to 7% today. It sounds small, but it is huge! With unemployment on the rise and no equity in their homes, people are turning to their credit cards to finance their spending. The problem is that credit card companies are running out of money to give to consumers. Part of the problem is that Obama and Geithner have been doing a poor job of fixing the first part of phase 1. We are starting to see a battle between companies and consumers over who will get the little cash still flowing out bank vaults. The article, incorrectly downplays the problem, but at least recognizes the storm brewing.

Phase 2 will either be triggered by an increasing unemployment rate or a persistently higher than normal unemployment rate. As I stated in phase 1, people are buying, just not as much. The trouble with current levels of unemployment is that we can sustain our current level of consumer spending for only so long. Once consumers run out of cash, spending stops. Once spending stops, companies are going to fail. Thus begins a never ending chain where companies fail and lay people off, causing further drops in consumer spending, causing more companies to close their doors and so on.

Recent polling data shows that of the people currently approving of the Obama administration, their approval is based primarily on his economic policies. This shows two things. First of all, Obama now owns what happens in the economy (He has instituted policies and he is getting credit for them). However, it also shows his downfall. Although he has most certainly taken actions regarding the economy, he has not enacted, proposed, or taken any action that would stem this recession in a meaningful way. His stimulus plan is an utter failure. In fact, I was surprised to see how quickly it could fail. The $13/week “tax cut” is on the chopping block for his budget and has done nothing to change and increase consumer spending. Infrastructure spending is turning into a nightmare. Sure there is spending on infrastructure programs, but not new programs. No, the spending is going to programs that States were going to fund in the first place, but are using government funds instead as a way to fill in their budget gaps. The green jobs investment has also been proven a failure. Vestas, the largest wind power company in the world and the sole supplier of wind blades to the US has gone out of business. Even in the face of UK subsidies, the promise of US green jobs stimulus spending, and Cap and Trade the company has decided that there is no money to be made in wind energy (read the UK Guardian Article). In the US, the same story is being played out. In fact an Ohio company who makes wind turbine bolts and was visited by Obama himself to promote his stimulus, laid off workers in February (read the article).

Where Obama’s stimulus was a poor effort to create jobs, his budget agenda is aimed at eliminating jobs. Cap and Trade will result in lost jobs from coal miners and carbon based power companies and manufacturing. The higher energy costs passed on to businesses as a result of Cap and Trade will be offset by companies in the form of unemploying labor. Arthur Laffer estimates a family of four will pay about $10k/year for Cap and Trade, further stifling spending. Likewise, Obama’s healthcare will cost thousands of jobs in healthcare. Obama’s education will create new jobs in education, but how many? Education is already saturated with consumers since all children go to school and most people go to college. The gains will be more than offset by losses from Healthcare and Cap and Trade.

Early in his Presidency Obama stated, “We can handle multiple problems at the same time.” However, the real question is, “should he tackle them at the same time?” It’s the equivalent of building 10 bridges halfway across the Grand Canyon. Sure there are now ten bridges, but we still end up jumping off the cliff at the end. The time is running out for Obama. Every policy he enacts brings us closer to a “phase 2” recession. It’s already on its way and Obama is responsible.

Read my earlier post on why Obama's stimulus plan won't work.
I found this little nugget of a story on MSNBC. Proof that occasionally they do have interesting stories. The article talks about the problem of counting stimulus jobs. Of course, the administration can inflate the job number as much as they want, having the stimulus work is what is most important.


CG - you said “We can handle multiple problems at the same time.” (re: Obama)
As to which I refer you back to Chief of Staff Rahm Emmanuel, "Never let a good crisis go to waste'' This quote explains so much of what we see. Great post here, one of your best so far! How much time does it take for you to put a post like this together?

April 29, 2009 at 8:50 PM
The Law said...

Interesting stuff. I'm usually on board with your financial analysis. Phase one and two seem spot on to me.

And you are also 1000% correct, this whole economic kit n kaboodle is ALL Obama's now. I've heard less of the "we inherited this mess" in his speeches, an frankly, it should go because we all know that now.

Where we break in agreement (you know me... gotta start something ;-) ) is the stimulus and energy passages.

Now I think it is VERY important to note the difference between the federal allocation of funds and the state usage of the funds.

I say this because I see the stimulus money at work in California. Before the stimulus was passed, construction on the highways had halted, and in some areas posed a very real saftey threat. Abotu 2 weeks after the bill passed, the connstruction workers were back to work on the 405 freeway, and started construction in some new places as well. California is also building a solar power plant that should be ready in in a couple of year. Finally, SoCal Edison sent us a memo that informaed us they were updating their emmissions system and grid. The grid part was finsihed 2 months ago, and my bill has already decreaed by 10 bucks.

This doesn't by any means discredit the sources you provide. I just think that some states failed to use the money as intended. That is a problem that the federal governemtn should address, because if we use the stimulus to balance the budget rather than stimulate, then it becomes a big waste of money.

Remember, you can make a profit by lowering expenses (tax cuts) OR increasing revenue (growth via stimulus), and really, a combination of the two is the best way to go.

April 30, 2009 at 1:33 AM


I really appreciate your comments. I am a big fan of your blog. It's hard to really quantify time. I've pulled some information from my education, some from work expirience, some from the articles and blogs I've read. I work in the credit business and before that in the mortgage world so part of my job is having an understanding of economic trends. However, I usually have a few topics for posts in mind and I keep a look out in the news for press related to them. That usually leads me to very good sources and often good topics for later.


It wouldn't be any fun if we didn't have some disagreement :) I think you have a real point though. I don't prefer government spending as stimulus, but I have no problem admitting that it can work. As you well know, I have a big disagreement with Obama on the effectiveness of the spending he chose. I also think you are right about the States making or breaking whether the stimulus money turns out to be stimulus, but as I pointed out in the past this is one of the reasons why I thought it was a mistake to go that route. I think that States should try and make the money as stimulative as they can.

Going to your California examples, I think still there are mixed stimulus success. While I'm sure the construction on 405 is keeping people in work, it isn't really creating new jobs for the unemployed to fill. That's really what stimulus means. A new power plant is a good example of stimulus...so long as they didn't close an older one...because it's creating new jobs and new business. To stimulate isn't to just fill in the holes to prevent people from unemployment, it's supposed to get people off of unemployment.

It does like Cali is having more success than NY. We're still debating on how to use the money (ie high speed passenger rail). It doesn't seem like the debate is ever going to end.

April 30, 2009 at 7:53 AM
The Law said...

I'm actually a bit surprised, and not so surprised at the same time. California, is a pretty forward thinking state, if a bit very weird (I swear I think I'm in a different country sometimes!).

I think the difference is both Californian elite and middle class want these things to happen... the building of solar power plants, the usage of bio fuels, etc. In NY, the elite class tend to be slow to accepting big changes, while the middle class screams for it. There's of course more middle class people, than elite, but the elite of unlimited money to get their point of view on the table. And I guess you get a tug of war that results in inaction.

April 30, 2009 at 5:07 PM
Devrim said...

tL, remind me again, which state has the highest income tax, highest sales tax ?

You know that $10 savings on your electricity bill was funded by the $10 Billion I paid in taxes. I think you should mail $5 to me, $5 to CG and $5 LCR. In 200 or 300 years you might be able to pay what you borrowed back.

Ohhh !!! LCR is on the left coast too, so we'll give him the Chrysler deal, you may pay just 33 cents on the dollar to him.

May 1, 2009 at 6:33 AM

Great post CG,one of the itmeizations of the Obama budget, cap and trade, the situmlus, etc.

May 5, 2009 at 7:37 PM

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