Tuesday, March 17, 2009

And So Begin the Trade Wars...

The Obama administration is taking directions straight from the playbook, "How to Turn a Recession Into a Depression." It was written about 80 years ago and has recently resurfaced at the White House. Step one is protectionism.

The U.S. fired the first shot, rescinding the ability of Mexican truckers to operate here. The retaliatory strike was received yesterday - higher tariffs on American goods exported down South. The result is that everyone loses.

There is no more universally accepted concept in economics than the benefits of free trade (and, of course, the harmful effects of protectionism). Though there might be some isolated beneficiaries of a protectionist agenda, both economies are worse off. Resources are distributed less efficiently, and perhaps more importantly, consumers pay more for goods. Real wages go down. Yes, the poor are generally hurt most by barriers to free trade.

The United States should be moving in the opposite direction. We need more free trade, not less. Congress has already inexplicably stalled free trade agreements, such as the one with Colombia. What should be done is a unilateral free trade agreement, whereby the United States assumes the role of leader of the free (market) world and drops all of its barriers to free trade.

While protectionism provides a siren song, it is free trade that promotes economic growth and job creation. It is free trade that benefits consumers and increases real wages. A vociferous free trade policy will be enormously helpful in facilitating this economy out of recession.

Friday, March 13, 2009

Congratulations, You’re Broke: Down 20% and $11 Trillion Vastly Underestimate Wealth Destruction

The Federal Reserve released data yesterday showing a 20% drop in household wealth from a peak in the second quarter of 2007. The wealth loss for the year of 2008 was $11.2 trillion, $5.1 trillion of which came in the fourth quarter. As astounding as the numbers are, they almost certainly vastly underestimate the magnitude of wealth destruction the country is experiencing.

Part of the differential is obvious – the markets have continued to plummet in the first quarter of 2009. One estimate, given the decline in stocks and housing prices, lops another $2.5 trillion, or 5%, off of household wealth. Leaving all prediction of future stock and housing market movements aside, the Fed number still likely comes under the reality. Given the leveraged nature of home ownership, the actual wealth decline from an absolute drop in price is magnified.

Much more importantly, though, the Fed calculation misses a vital side of the wealth ledger – liabilities. The “New Era of Responsibility” budget entails a deficit for next year that is greater than the previous eight years combined. It also projects similar deficits as far as the eye can see. The estimates of GDP growth are suspect, but the spending bonanza is certain, and gargantuan. Trillions upon trillions of new debt to finance the spending is slated for the next several years. A household’s credit card debt represents a net reduction in overall wealth. The government’s debt represents a net reduction in the country’s collective wealth. The massive projected increase in government spending is essentially a repugnantly awe-inspiring obliteration of household wealth.

Yet it gets worse. There are several aspects of household wealth that are difficult to put a number on, but are nonetheless a vital aspect in the calculation, even if the amount itself is theoretical. A household’s wealth includes the present value of its projected future income stream. To the extent that potential future income has been squashed, there is a corresponding reduction in household wealth. Unemployment is on the rise, millions of jobs are being lost, and wages and bonuses are being suppressed. Exacerbating the loss of potential future income is the decreasing value of what little money households have left. As the government prints more and more dollars to satisfy its corpulent spending habits, the value of that money decreases.

From the theoretical to the abstract, the picture gets even uglier. There is a wealth value associated with simply being an American. Sadly, this value is diminishing. Again, while the computation of the number is vague, the logic is clear. The American way of life has intrinsic economic value. It comes from the rule of law, the natural resources, the technology and infrastructure, and our core fundamental values. It is a major part of what causes millions to flock to our borders and seek entry. The level of economic freedom we enjoy is a vital component of household wealth. But it is on the wane, and headed down a terrifying path.

Thankfully, all of the above aspects of wealth destruction can be reversed. To do so, we must get government to about-face from socialistic tendencies to pro-growth fiscal sanity. And we must right the ship towards economic freedom. We must drastically change the course we are on, lest the phrase cometh, “Congratulations, you’re broke!”

Tuesday, March 3, 2009

The Good News: Rich-Poor Gap Has Been Obliterated

Is there a light amidst the economic darkness? Those who have for years been excoriating the widening of a rich-poor gap should now be ecstatic. As countless trillions of dollars of wealth has been wiped out in the bursting of the housing bubble and the ensuing financial market meltdown, there can be no question the difference in wealth between rich and poor has shrunk considerably. Be careful what you wish for.

Nobel Laureate Paul Krugman is one such cheerleader. Back in the day, Professor Krugman was expounding on the technicalities of comparative advantage, and how free trade is one rising tide that lifts all boats. Since then he has become unhinged. Krugman has borrowed with enthusiasm the phrase Great Compression to describe the period from 1933 to 1945. Many have been and currently are enamored with the concept of economic woes leading to higher equality of wealth - or lack thereof.

This obsession with the rich-poor gap should seemingly be satiated by the massive destruction of wealth in the present. No need to worry anymore about private jet travel – that mode of transportation is now reserved for only government officials. Are Wall Street bonuses a thorn in the side? No longer – modern finance has one foot in the grave (the cemetery being lower Manhattan). The dreaded McMansions are becoming a novelty of a previous way of life. Got 401(k) envy? Now it must be only half the jealousy.

Yes, the economic meltdown and present march towards socialism is evening the playing field. As unemployment rises, by definition more people are earning similar wages (a number that trends towards zero). While the stock market continues to free fall, the collective lack of wealth increases. As economic growth disappears, the dimming of prospects becomes more universal.

The debate over trickle-up or trickle-down economics also diminishes. The slowing of economic activity means there is no trickling in any direction. The real bright side is that hopefully we can dispel the notion that getting rich is bad and that it is desirable to have as narrow a rich/poor gap as possible. The means certainly do not justify the ends, but actually create a self-fulfilling prophecy whereby all get poorer. The desire might be good-hearted, but it is simply wrong-headed. Everyone suffers. Only sound economic principles will lead to economic growth and enhanced prosperity for all.