Another ill-conceived “rescue” package has been announced, this time in the US, with the new Treasury Secretary unveiling plans for a joint public-private sector fund to buy US$1 trillion in toxic assets and spend another trillion giving more credit to consumers and business. Sadly, it appears that the latest rescue plan announced by Tim Geithner is a mere expansion of the same fiasco perpetrated by George Bush and Hank Paulson. (Kevin Rudd is trying a similar expansionary tact in Australia with his $42 billion stimulus). Geithner’s latest plan, providing more debt to an over-leveraged economy, is much like trying to cure a heroin addiction by giving him a life-time supply of crack cocaine. It may solve one problem, but is likely to cause a few others.
Some politicians have dubbed the recent economic turmoil a crisis of capitalism or a failure of the marketplace — as if markets will only ever go one way. The contrary view is that the markets have performed admirably: those who paid too much for assets (like US and UK property or international shares) suffered losses, while the prices of assets are now returning to their intrinsic value. Similarly, the banks who lent people funds to purchase those overpaid assets (or who acquired pieces of the securitized debt) are incurring large losses.
This is not a crisis of capitalism at all. Rather, it is a market correction. Corrections may very well turn into crises for the foolish and greedy, the people who claimed that equity and property markets never fall, or that long-term investing will guarantee a ten percent annual return, but not for those who behaved responsibly, who didn’t borrow too much and who lived within their means.
However, instead of letting private and public balance sheets readjust after the sixteen year boom, governments have collectively panicked at the massive de-leveraging which has occurred. To prevent asset prices from adjusting, the US, UK and now Australian Governments are effectively creating public debt (through massive budget deficits and handouts) to replace the private debt.
Yesterday, it was revealed that as part of the first TARP plan, “the Treasury under the federal bailout had invested US$254 billion into companies but the preferred stock it got in return had a market value at the time of only US$176 billion, or 69 percent of what the government paid.” Basically, TARP involved a US$78 billion donation to banks (who then promptly gave the majority of those monies to employees in the form of bonuses). Whoops.
One of the people who was at Paulson’s right hand during that US$78 billion sacrifice of taxpayer monies was none other than Timothy Geithner (who was previously the President of the Reserve Bank of New York). Geithner took over from Paulson as the Treasury Secretary a few weeks ago and looks set to repeat Paulson’s mistakes with TARP2. The US markets didn’t exactly endorse Geithner’s bank, with the S&P500 slumping by 4.91 percent last night.
Legendary US investor, Jim Rogers, told CNBC that:
[Geithner] has been dead wrong about everything for 15 years in a row [and so was President Barack Obama’s economic advisor Lawrence Summers, who acted as Treasury Secretary at the turn of the century]…
If I were on your show 15 weeks in a row and was wrong, you’d probably never invite me back. These guys have been wrong year after year after year consistently and here they are making the same mistakes again. This is not going to solve the problem, it’s going to make it worse.
Instead of appointing those who oversaw the problems in the first place, perhaps politicians should be listening to some of those who predicted the doom. People like Peter Schiff, President of prime broker, Euro-Pacific Capital. In commenting on the current state of the US economy, Schiff told Fortune that:
We have an economy that’s based on the same principles as Bernie Madoff’s investments … it’s a Ponzi economy. It’s not real. We don’t save and we don’t produce anything anymore. We simply borrow from the rest of the world, and then we spend it. We’ve had a giant party. We bought all these plasma TVs and iPods. We remodeled our houses and took vacations. But you know what? The bills are coming in.
As for what can be done, Schiff noted that the “prescription for how the U.S. can dig out of our current mess comes straight out of the libertarian playbook: Shrink the government radically, cancel all bailouts immediately, take plenty of tough medicine, and let the free market do its job — however harsh it may be for, say, autoworkers in the meantime.”
Bill Bonner, of The Daily Reckoning, holds a near identical view. It is no coincidence that Bonner also correctly predicted the current economic turmoil, telling subscribers at the beginning of the decade to liquidate their stock holdings and starting acquiring gold.
Of course, Schiff and Bonner are not taken seriously in the halls of Washington or Canberra. In times like these, economic sense will too often give way to political expediency. And that involves trying to buy votes using borrowed money, all the while, blaming our problems on capitalism and the free market.
Adam Schwab claims that our present economic problems are not a crisis of capitalism but just the market doing its job and correcting. ‘Corrections may very well turn into crises for the foolish and greedy, ………but not for those who behaved responsibly, who didn’t borrow too much and who lived within their means.’ Yet later in his article he recognises that this will have harsh effects on autoworkers for example.
One of the characteristics of a modern economy is that the actions of the foolish and greedy do have implications for the ‘responsible’ and lots of other poor sods who have very little influence on those who exercise power in this or most other systems.
While I’m on my soap box – from what I’ve learnt the global banking system could have imploded in the second half of last year if governments had not intervened. The approach of ‘leaving it to the market’ seems similar to telling the health industry to ‘leave it to nature’ if we face a pandemic.
What does seem to be missing in the current conversation is a sensible debate about the type of policies governments can and should implement to get us out of this mess and help those who have been harmed. We might also try to discover why so few of those in positions of influence saw it coming and attempt to construct models that have better predictive ability. Personally, I am not a particular fan of Bill Bonner but we should see if he can contribute to our understanding.
You hold up Bill Bonner, of The Daily Reckoning as some sort of guru who Canberra should listen to. Lets look at your statement closely – “It is no coincidence that Bonner also correctly predicted the current economic turmoil, telling subscribers at the beginning of the decade to liquidate their stock holdings and starting acquiring gold”. The beginning of the DECADE (ie 2000). A loon running around in 2000 saying the sky is falling. Great prediction. Maybe if he had said it in 2008 you would have some credibility…
Politicians can’t see further than the 3 years til the next election. Forget about using this crisis to implement meaningful change, hype the doom and gloom then preach about doing whatever it takes to save us all from the doom and gloom. “Kevin oh ten” is well underway already.