Driving the Economy with Your Eyes Closed

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.
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Update:
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.