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Scaling Problem

This week, we look at Treasury Secretary Timothy Geithner’s Op-Ed piece for the New York Times.

There are two reasons:

 

First, as one of the key dispensers of US economic policy and taxpayers’ money, what he thinks and says is important. If he says “Welcome to the Recovery”, one should try to figure out if he is right.

Second, there is an important lesson in this Op-Ed. Mr. Geithner’s arguments for a recovery rest on manipulations of scale, a common problem one confronts when making investment and other business decisions. Learning how to scale numbers properly will make you a more effective investor.

If you do not want to read the piece, it boils down to three points:

  1. The economy has suffered greatly. In fact, revised numbers are showing that the recession was worse than initially believed.
  2. President Obama’s administration recognized the problem and has been working to fix the problem.
  3. Green shoots of good news show that the US economy is turning the corner.

The first two assertions are statements of fact. The economy did fall much more sharply than consensus suggested at the time. And, President Obama has taken and continues to take the economic threat seriously as it will determine his and his party’s chances of re-election.

The third assertion, however, is the important one for investors. The transition points from growth to recession or from recession back to growth generally provide excellent investment opportunities as well as risks. If we are at one of those turning points, the investment imperative is clear. If we are merely at a resting place before going lower, however, a lot of money can still be lost.

So let's take a closer look

ScaleSecretary Geithner’s evidence of recovery rests on seven points. Five points are statements without much in the way of supporting evidence. None of the statements look false but perhaps we can judge whether they will impact the investment environment by providing a bit of context and scale:

Exports are “booming”?

Returning to normal is more like it. But weighing in at just under 13% of GDP (assuming a return to 2008 levels), will exports make up for the severe lack of domestic consumer demand (formerly just over 70% of GDP)? Possibly but remember that the GDP impact is exports minus imports. And who exactly is going to buy our “booming exports”?

Americans are “borrowing more responsibly”?

Or, have credit card companies stopped stuffing our mailboxes and banks (otherwise tied up with foreclosure proceedings) lost our telephone numbers? It’s too early to make this statement with any confidence.

Banks are “better positioned to finance growth”

Better than what? Bankruptcy or insolvency if we value assets properly? Bank closures threaten to set new records this year. The FDIC is not laying off staff.

The auto industry is “coming back”?

And how will that impact the 95% of Americans who are not involved in the auto industry? Approximately 1.4m (0.9% of a 150m workforce) are directly employed by the Transportation Equipment Manufacturers (BLS). Let’s assume that undercounts related parties and round up to a 5% impact on the workforce. With global overcapacity in auto manufacturing, do we really want to bet that the not so Big Three can get the economy back on track?

Businesses have “repaired balance sheets”?

Actually, in this recession, most non-financial companies did not get caught out in the rain. Even so, they slashed orders, inventories and jobs with brutal efficiency. Perhaps he is referring to the massive US$1.8 trillion (13% of GDP) cash pile? That will come in handy but only when capacity utilization numbers creep into the high 80’s from current low 70’s.

Not too impressive so far. But perhaps we are biased.

Let’s see how Treasury Secretary Geithner does with real numbers.Scale Issue #1: 136,000 new manufacturing jobs

“Private job growth has returned — not as fast as we would like, but at an earlier stage of this recovery than in the last two recoveries. Manufacturing has generated 136,000 new jobs in the past six months.”

Wow! That’s probably fewer than the number of people who call in sick on any given day! Great news for those new hires but does this figure really mean that “private job growth has returned”? Given that the US work force is roughly 150 million, this equals a 0.1% improvement over the last half a year. At this rate, a return to a more normal 4.5% unemployment rate will take decades! Sorry Mr. Geithner: 136,000 jobs is a lot for one company but when we are talking about an entire economy, it is a rounding error, not the start of a trend.

Scale Issue #2: $20 billion profit

”The government’s investment in banks has already earned more than $20 billion in profits for taxpayers”

Terrific! I am a taxpayer and the government has just made $20 billion on my behalf. That sounds like a lot of money! The kind of serious money a couple of whiz hedge fund gurus might make. Or is it? Since the US population is around 309m, the best case scenario is a check for $64 hitting my mailbox sometime in the future. Hmmm, perhaps I shouldn’t wait around for that one since there are still a few losses lurking in the system (AIG, Maiden Lane 1 and 2…and 3? TARP? TALF?). Reporting profits while hiding losses in non-transparent special purpose vehicles is just the kind of creative accounting that got the top brass at Enron into trouble a few years back. Perhaps someone should check with the SEC .

So, once we have added scale and context to the arguments, the case for a rebound is reduced to two vanishingly small datapoints, five unsupported assertions and a massive budget deficit to hold up the “Welcome to the Recovery” title.

The recovery will come but it will take a lot more than what has been presented by the Treasury Secretary to convince consumers, corporations and investors.

And just how big is that budget deficit?Scale Issue #3: $1.3 trillion

“The economic collapse drove tax revenue down, pushing the annual deficit up to $1.3 trillion by last January.”

Oh, that’s only 1.3 of a number that most non-scientists and non-mathematicians would have a hard time putting into context. But hold on! That number is 65 times the profit that my government made for me by investing in the banks. It is almost 10% of the sum total of all goods and service produced in the United States in a year (NYSEMKT:GDP), almost 40% of the Federal budget (nearly 65% as large as tax revenues) and around $4,200 per person. Since we have been promised a few more of these trillion numbers in the coming years (can’t strangle the recovery in the crib like we did in 1937), perhaps my $64 bank profits check is not in the mail after all.

I wonder who will get the bill for all of this?



Disclosure: No positions