Our Rube Goldberg Economy

Holman Jenkins had another characteristically excellent column in the WSJ this week. Writing on the auto industry, as he has frequently done over the past few weeks, he pointed out that the Detroit crisis is truly a crisis that was hatched and nurtured in Washington. I recommend it to you, but there was another part of the article that caught my eye.

Jenkins had this to say:

There's a larger lesson here for the Obama administration. A whole lot of Rube Goldbergism is coming home to roost, in the auto business, in the mortgage market, in the health-care market, in farm policy. We need to simple-down. The economy has a giant adjustment ahead, paying off debts, going from a heavy absorber of foreign capital and goods to a rebalanced relationship with the world.

Rube Golbergism indeed! In fact, if you close your eyes you can easily imagine the gigantically monstrous, creaking, clacking, lurching machine that our economy has become. At its heart is an engine so strong, sleek and pure that it somehow manages to cart around all of the junk that has been bolted onto it over the years, yet as the machine wheezes and stumbles, it seems evident that the engine may be at the point of seizing. And the response in Washington is to bolt on more parts.

The evidence of misuse is everywhere. The tax code has become a cipher that men train for years to faintly understand and exploit. Farm policy rewards the rich for not producing a commodity in which we enjoy a worldwide advantage. Recoverable carbon based reserves are left in the ground as we bemoan our dependence upon foreign oil. Banks are simultaneously jawboned to lend more money into the teeth of a severe recession and to behave conservatively lest an army of newly empowered bank examiners shut them down. The list is endless.

Initially the Fed, Congress and the administration responded admirably to an incipient crisis. They recognized it and, albeit with some mistakes, moved rapidly to limit the damage. Since that time, however, the propensity of government or maybe just the hubris of the human species has tended to use the resources they granted to themselves to embark on more questionable crusades.

Ironically, at a time when we need to husband our resources for the task at hand, the impulse seems to be to use the situation as an opportunity to address all manner of perceived needs in the country. In fact, as Jenkins said, we need to “simple-down”. Work on the basics and let our basic strength take care of the details.

Left to its own devices, no economy ever behaves in such a self-destructive manner. The root of the problem lies in Washington with a political class that long ago recognized the power of the engine and used that power to further their own ambitions. The question we now face is whether those same men and women can recognize the damage they have done and right it.

Comments

[JJA1594:]

Congressional greed and corruption. Kickbacks from Fannie and Freddie. Subsidies and extortion (ACORN) to increase fraudlent loans and voter registration.

2008 Dec 03 08:55 AM

[Elaine Supkis:]

Good grief. The housing/buy out/commodity bubbles were GLOBAL. All sorts of economies suffered the same identical bubbles. The engine for all this was an out of control lending cycle. And the place with the cheapest credit rates was the BANK OF JAPAN.

The Japanese carry trade flooded the planet with excess credit. This creation of money was instantly translated into other currencies so the yen could hide behind this screen of other currencies suddenly surging in volume, in particular, the dollar.

This flood of currency then sought somewhere it could go and 'grow' in the form of 'investments'. Many countries had investors using pirate islands in the Caribbean and Iceland and other tiny principalities to 'grow' this flood of lending and this is why we had so many bubbles, suddenly.

When the Fed, trying to stem the tide, raised interest rates starting in 2004, this made the carry trade WORSE. And now, it is ending only because all central banks are rushing to make their interest rates the same level as Japan.

So in Japan, the carry trade has reversed. The yen is now getting stronger rather than weaker. And the flood of funny money has ceased. Now, the Fed is trying to be the carry trade! They are trying to flood the world with more debt when the world is drowning in red ink!

No one is drowning worse than the US. Since ALL systems, communist, anarchist, capitalist, democratic, autocratic, large and small are now floundering for the exact same reasons, we CANNOT blame Washington, DC for creating a system that doesn't work via tax laws, etc.

On the other hand, the true problem lies in the floating currency regime launched by Burns and Nixon in 1971. This started the flood of easy credit. This CAN be fixed. This MUST be fixed.

Elaine Supkis, emsnews.wordpress.com

2008 Dec 03 09:26 AM

[derryl:]

Elaine Supkis makes good points but while the Japanese carry trade may have enabled the bubbling lending it was Rube Goldbergism that obscured what was happening. Like a 60000 page tax code, when systems we use are way too complicated for any user to understand we will get huge economic misallocations and other inefficiencies. Efficiency is largely a product of good use of information, but when there is conflicting information or massively more information than any human can assimilate our understanding breaks down and we basically guess about what we should do.

For example, readers of this site trade stocks. We are guessing right now about the future of stocks because information about the future is highly unpredictable. In this state of uncertainty people are paralyzed and trading volumes decline because nobody feels they know what they should do. The market becomes inefficient.

Markets that are beset by all manner of conflicting and counterproductive regulations are not "free" markets so the invisible hand is replaced by the guessing mind. I marvel that this monstrosity has managed to function as long as it has.

Holman Jenkins is right. We need to "simple down". Fanny and Freddy invented asset backed securities in the 1970s in order to sell high ratio mortgages into the free market via Wall St. In this case, where government policy demands more home ownership financed by new money created as mortgages whose principal balances will be reabsorbed only over 25-30 years, accelerated mortgage lending will be inflationary. ABS was designed to suck some of that money back out of the economy and lock it back into the mortgages.

The mistake here is not sucking out the money via ABS. The mistake is pumping too much money too fast into the system by promoting excessive home ownership beyond what the market on its own would support. This allowed creation of the real estate bubble when people who can't afford to own houses were enabled to do so by government policy.

Originating commercial banks and even mortgage companies would have never made those subprime loans if they had to hold them on their own balance sheets. Bankers practice self preservation just like any other business and they avoid making loans that likely will not be repaid. But they could just pass them along to Fannie and Freddie, collect mtg administration fees, and the GSEs then packaged the junk and handed it off to Wall St to flog onto investors holding too much money that is all seeking a rate of return.

Before ABS, originating lenders usually had to hold onto the loans they had made and this market discipline generally insured prudent lending. Government housing policy interfered with this and through complicated enabling legislation set up the conditions for subprime and its fall. The same enabling of complexities allowed Wall St investment banks to create CDS, CDO and all the other toxic initials that were bought and sold on huge margins like 30:1 and 40:1. Margin calls caused the 1929 Crash and CDS calls are causing this one.

Maybe we should blame democracy. Congress must pander to get reelected. If we think of democracy as a kind of political marketplace, then voters obey Adam Smith's call to pursue their private interests. If voters discover they can extract private benefits from the nation by demanding those benefits from their politicians, then the free market version of Adam Smith would say they should do so.

But there is no obvious "cost" side for the individual in the political pandering equation. Any goods that are "free" and "public" will enjoy unlimited demand exactly because the consumers of these goods do not have to personally pay the costs. There will be unlimited demand for health services, pensions, houses, and every other economic good that people want, if they don't have to pay for these.

In a mature or pandering democracy the economic market's invisible hand is subverted. Some participants play by the economic rules and make decisions based on personal cost-benefit. Other participants play by the political rules and make decisions based on subsidized or no-cost goods. Economic players see these political players as parasites, but the parasites are just pursuing their self interest in the way that works best for themselves.

How can you prevent this in a democracy? In the early years only landowners had the vote in America. This at least offered some hope of common interest among the electorate. But when a large portion of the voting population discovers they can vote themselves low or no-cost goods you get red state/blue state war of economic producers vs. political rent seekers. You get absolute divergence of interests, where the benefit of the rent seeker is directly extracted from the producer via taxes, etc. You want to keep the money you've earned; the rent seekers want their government to take that from you and give it to them at no cost to themselves.

This is where mature democracy leads, human nature being what it is. If we were all of high moral calibre and refused welfare that we know is taxed off our neighbor, then democracy could work indefinitely. But our morality has been subverted by "entitlement". There is no shame in receiving that to which you are "entitled", so there is no moral cost to the recipient and thus no incentive to improve yourself and earn your own living on this planet.

In my opinion the need to improve ourselves in order to live on this planet is what motivates us to develop ourselves "spiritually". Democratic pandering replaces natural motivations with political motivations to our spiritual detriment as we are prevented from learning life lessons that are beneficial to us. So besides the economic carnage created by pandering, I think entitlement is a spiritual travesty.

2008 Dec 03 11:01 AM

[derryl:]

PS
There is a big difference between personal charity where you open your heart as you open your wallet, and the bureaucratic welfare state financed by extorted taxation. The former is spiritually beneficial; the latter has negative if any spiritual content.

2008 Dec 03 11:12 AM

[Jason Rines...:]

Excellent comment and rings true Derryl. Such cycles have occured in American history until the economy breaks down and the producers/innovators can reap the larger benefits of there efforts. That is the beauty of a capatalist society, it self remedies. No, it's not perfect and it really sucks if your at the tail end of the corruption cycle and not connected. But it will change, yes the hard way and this hardship creates solid leadership for a couple of decades. The only way to break the pattern of human imperfection of such cycles is through genetics. Mankind is now fully on that pathway when the U.S. deciphered our genetic code in 1998. Give it a few more decades, we'll reach global utopia but our final societal evolution must also occur (one last final world war and consolidation to reach consensus).


On Dec 03 09:26 AM Elaine Supkis wrote:

> Good grief. The housing/buy out/commodity bubbles were GLOBAL. All
> sorts of economies suffered the same identical bubbles. The engine
> for all this was an out of control lending cycle. And the place with
> the cheapest credit rates was the BANK OF JAPAN.
>
> The Japanese carry trade flooded the planet with excess credit. This
> creation of money was instantly translated into other currencies
> so the yen could hide behind this screen of other currencies suddenly
> surging in volume, in particular, the dollar.
>
> This flood of currency then sought somewhere it could go and 'grow'
> in the form of 'investments'. Many countries had investors using
> pirate islands in the Caribbean and Iceland and other tiny principalities
> to 'grow' this flood of lending and this is why we had so many bubbles,
> suddenly.
>
> When the Fed, trying to stem the tide, raised interest rates starting
> in 2004, this made the carry trade WORSE. And now, it is ending only
> because all central banks are rushing to make their interest rates
> the same level as Japan.
>
> So in Japan, the carry trade has reversed. The yen is now getting
> stronger rather than weaker. And the flood of funny money has ceased.
> Now, the Fed is trying to be the carry trade! They are trying to
> flood the world with more debt when the world is drowning in red
> ink!
>
> No one is drowning worse than the US. Since ALL systems, communist,
> anarchist, capitalist, democratic, autocratic, large and small are
> now floundering for the exact same reasons, we CANNOT blame Washington,
> DC for creating a system that doesn't work via tax laws, etc.
>
> On the other hand, the true problem lies in the floating currency
> regime launched by Burns and Nixon in 1971. This started the flood
> of easy credit. This CAN be fixed. This MUST be fixed.
>
> Elaine Supkis, emsnews.wordpress.com

2008 Dec 03 12:07 PM

[ebworthen:]

Most complicated contraptions collapse sooner or later.

No need for talk or analysis; we've failed and the price to pay is big.

2008 Dec 03 12:51 PM

[axelrod608:]

As an investor I've had to "simple down" in this mess of a market. I no longer understand the relationship(s) between value and market forces of most equities. I'm down to two relatively knowable items - gold and oil/gas. Regardless of the chaos in the market, both will continue to have worth and value and if either or both cease having value, it really won't make any difference where I put my money. It'll be over.

Government can't run itself. The idea that it can run an economy is patently absurd.

2008 Dec 03 02:33 PM

[carey_jim:]

Our problems are immense and our resources are small. I can see, in my mind's eye, a small group of men, women and children accompanied by a few old people, half naked and circled round an open fire, with the blackness of night all around them.

Those were our ancestors and that was their predicament.

And it is us and it is still our predicament.

2008 Dec 03 05:23 PM