"The Plot Against America" Redux

Schwarzman's "Nazi's" Comparison

We have met the enemy, and he is . . . us.

--Pogo

Stephen Schwarzman, a Wall Street honcho, made headlines last month for comparing President Obama's proposal to raise (the absurdly low) tax rates on hedge fund compensation -- called "carried interest" -- to Hitler's invasion of Poland.

Funny, I had another Hitler reference in mind.

Specifically, Philip Roth's provocative and very unsettling "The Plot Against America."

No George Bailey's

The book's central premise is that a politically weakened FDR is defeated by Charles Lindbergh, a Nazi sympathizer. Once elected President, Lindbergh first appeases, then cooperates with Hitler in what is effectively a bloodless takeover of America (sorry, Lindbergh relatives).

In my economic version of Roth's nightmare, I imagine what The Great Depression and the following decades would have looked like if there'd been no FDR, no New Deal, no Securities Act of 1933, no Glass-Steagall, etc.

Instead of reform and recovery, Wall Street uses its financial and political muscle to lay claim to the (remaining) public resources it hasn't yet appropriated.

And the result would have been what?

Potterville, writ large?

Unfortunately, as you read today's headlines discussing Too Big to Fail financial institutions, (still) obscene Wall Street pay, devastated savers, etc., this alternative, nightmare scenario hardly seems imaginary at all.

Re-read your Pogo, Mr. Schwarzman.

A Brief History of Unemployment

(Re-)Defining "Full Employment"

"Jobless Filings at Highest Point Since November"

--headline, The New York Times (8/19/10)

One year ago, 90% of you were in the top 10% of your class. Today, 90% of you are in the bottom 90% of the your class.

--Stanford Dean of Admissions Fred Hargadon, to the incoming class of '82 (which I was in), at freshmen orientation in Fall, 1978

What makes me think of Fred Hargadon's quote is today's especially charged debate about high unemployment -- for official purposes, just under 10% nationally* -- and what to do about it.

Ten Millennia of Progress -- in a Nutshell

A good starting point would seem to be to note that cavemen didn't have unemployment (though they had many, many other problems, such as predators, disease, and lives that generally were "nasty, brutish, and short").

That's because, ten thousand years ago, it took the collective efforts of 100 people to feed 100 people (through primitive hunting and gathering).

Thanks to advances in agriculture and technology, by the 18th century (1700's), only 75 people were needed to grow enough food to feed 100 people.

As productivity and science advanced apace, that ratio gradually fell from 25 : 100, to 10 : 100, to as little as 3 : 100 in "advanced," western countries today.

With luck, in a century (or three), that ratio will fall to 1 : 1,000.

As Martha Stewart would say, "that's a good thing."

Productivity Gains

Such productivity gains are hardly limited to agriculture.

They also characterize computers, construction, manufacturing, communications, and dozens of other fields.

Thanks(?) to technology, even modern warfare requires less (wo)manpower: witness the rise of "drone" technology, fighter jets with ever-higher (more lethal) payloads, etc.

Over time, then, it would certainly seem that the natural order of things is for advanced economies to need progressively less labor -- at least to produce society's basic necessities.

So, economic convulsions like today's aside, one would anticipate what economists call "structural unemployment" to incrementally rise.

Policy Responses

To go back to agriculture, when one person can feed 99, what are the other 99 supposed to do?

Unless the foregoing analysis is wrong, it would seem that society has four possible responses:

One. We can all dramatically increase our consumption ("demand").

God knows, when it comes to food, plenty of people seem to be trying to do just that.

But over-consumption isn't good for you; and collectively, it isn't good for the planet (amongst other things, it leads to depletion of key resources, pollution, etc.).

So, no, adding a couple billion more (overweight), SUV-driving people isn't going to solve anything.

Two. Society can keep otherwise unemployed people busy through any number of economically dubious diversions.

That includes ever-bigger "make-work" projects designed to soak up surplus labor; creating low-wage service jobs ("McJob's") with little value-added (what economists derisively call "taking in each other's laundry"); or that most destructive activity of all, war.

For all its horrific consequences, World War II effectively ended the Great Depression (and no, I don't think that that was its purpose -- but it was certainly a side effect of global economic collapse, and equally clearly, an antidote to it).

Such diversions aren't just limited to society's less educated or capable: one of the ultimate causes of today's financial mess is that, roughly 25 years ago, Wall Street found its traditional business model -- helping clients raise and invest capital, otherwise known as investment banking -- under assault from increasing competition and advancing technology.

Its response?

It created a dysfunctional, highly leveraged shadow economy of incredibly complex financial instruments.

We all know how that turned out (and, amongst other things, what it did to the housing market).

Three. Society can decide to retard or even scrap labor-saving technology.

Want everyone working?

Easy.

Just idle our heavy, mechanized ditch-diggers and go back to shovels (or spoons, if we really want full employment).

Four. We can honestly acknowledge the foregoing, and devise a social safety net that takes into account economic reality, while at the same time balancing it with people's inherent need for growth and fulfillment.

How to do that in a fair, just way is what we should be talking about.

*"The Furlough Factor": count me amongst the "officially dubious" regarding government-reported unemployment statistics.

That's because, amongst other reasons, the official statistics don't account for all the companies "asking" their employees to take furlough -- otherwise known as unpaid time off -- to forestall outright layoffs.

If you assume that that furlough averages two weeks per employee per year, that translates to an unemployment rate of 13.5%.

"Bloodletting" Economists

Economic Theory, Then & Now

The U.S. is now 234 years old, and yet over half the nation’s money supply was created since Helicopter Ben took over the flight controls four years ago.

--David Rosenberg; Chief Economist, Gluskin Sheff

It's hardly a saving grace for today's financial mess, but it HAS been gratifying to see an entire generation of muckety-muck economists abruptly lose their hubris regarding their colleagues of yore.

As epitomized by the last two Fed Chairmen, Alan Greenspan and Ben Bernanke, the prevailing mindset amongst contemporary economists has been that their Depression-era peers were little more advanced than medieval doctors, who went in for bloodletting and other harmful quackery.

The reason for that belief?

Those in charge during the Great Depression ignorantly presided over a collapse in the money supply, with a consequently ruinous effect on credit availability, debt repayment, and wages and prices generally (indeed, the Depression was characterized by a devastating deflation).

Fighting the Last War?

Fast forward to today.

"Helicopter Ben" Bernanke and the U.S. Treasury have now injected -- depending on how you count -- somewhere on the order of $10 trillion in liquidity into the U.S. economy.

And that's just since 2008.

Zero percent interest rates. TARP. Son of TARP. Federal guaranties. Bailouts. Direct equity infusions. Subsidized mortgage rates. Quantitative easing. And on and on.

The result?

No Great Depression II, but certainly not a robust recovery. And at the cost of trillions in potentially crippling, new U.S. debt.

In fact, by printing so much money, Mr. Bernanke has ushered in what economists call a "liquidity trap": monetary policy has eased so much -- in fact, to 0% -- that further easing has no effect.

In fact, it's impossible (cue, quantitative easing).

Back to the ???

So, where do we go from here?

Not necessarily 'back to the '30's.

Personally, I'd settle for the '50's.

Needed: Glass-Steagall . . . for the Housing Market

Life after Life Support

There are no atheists in foxholes.

--Famous aphorism

There are no free market Republicans in today's housing industry.

--Real estate version

When it comes to the housing industry today, even the Republicans sound a lot like Democrats.

For now, at least, people of all philosophical stripes understand that the housing market is functioning in large part due to governmental support.

That includes providing the capital for mortgages; insuring mortgages once they're created; and providing the credit for investors to buy the resulting securities that the mortgages are bundled into.

No one is eager to see what happens if that support is scaled back precipitously.

The focus of the upcoming debate, then, is how much support to withdraw, how fast.

Reason(s) for Hope

One overlooked possibility, however, is that the housing market might actually need less help than is commonly believed.

Take, for example, the Federal Reserve's now-concluded purchase of $1.25 trillion in mortgage-backed securities -- undertaken to assure continued low interest rates, and thereby support the fragile housing market.

What happened to mortgage rates in the almost two months since the program was discontinued?

They've gone down.

Thanks, Eurozone (in point of fact, they were declining before that).

Producing "Financial Foie Gras"

Obscured by the "recent unpleasantness" is the fact that the U.S. housing market functioned successfully for more than half a century.

What changed?

Two things:

One. From 2003-2004, the Federal Reserve dropped nominal interest rates to near-zero (negative, in real terms), unleashing a tidal wave of demand for securities that paid a respectable return.

Two. Wall Street got a hold of the housing market.

If the demand was created by the Federal Reserve, the supply was provided -- on a truly breathtaking scale -- by Wall Street.

In effect, Wall Street stuffed the housing market "goose" with capital to be turned into financial foie gras.

Or at least what the ratings agencies promised was foie gras.

Glass-Steagall for the Housing Market

Which catches us up to today.

Used and abused by Wall Street, the housing market is temporarily a ward of the state.

Fortunately (unfortunately), something like this has already happened.

Before Wall Street got a hold of the housing market, it got a hold of the banking system

The direct result of that was something called The Great Depression.

But note society's response then.

Wisely, it wasn't to socialize the banking system in perpetuity.

Rather, it was to throw Wall Street out of the banking system for a long, long time, by separating "investment" from "bank."

In fact, the Glass-Steagall Act served the banking system -- and U.S. -- well for over 60 years, until its repeal in 1999.

What the housing industry needs now is a real estate version of the Glass-Steagall Act.

There's no reason the U.S. housing market of 2010-2070 cannot be as stable, functional, and largely independent as the housing market that prevailed from the 1930's to the 1990's.

Gold Bulls and Bears

That's the Bearish Case??

Though gold performs well as a defensive asset in times of global economic strife, its long-term record is spotty. Over $1,040 an ounce is only a record if you leave inflation out of the picture. Factor that in and gold prices haven't gotten near prices from the early 1980s.

--Melinda Peer, "Gold: High Risks And High Prices"; Forbes (10/7/09)

Let's see . . .

Today's ongoing economic crisis is supposedly the worst since The Great Depression.

At $1,040 per ounce, gold is making nominal highs, but is nowhere near it's all-time, inflation-adjusted high -- reached during the now-eclipsed, early 1980's recession.

Isn't this actually the bullish case for gold??

Factor in that gold is a smaller, thinner market than oil; and that commodity speculators now have mega-capital at their disposal (how else do you explain $160 a barrel for oil more than a year ago?) . . . and it sure seems like conditions are favorable for an epic run.

1930's vs. 1990's

Fascinating Juxtaposition

The two photos above, from today's New York Times, present a fascinating juxtaposition.

The photo on the left shows FDR signing legislation -- known as The Glass-Steagall Act -- separating the nation's investment banks from its commercial banks. It was the latter that held ordinary Americans' savings deposits, and it was the former's plundering of same that played a big role in causing The Great Depression.

The photo on the right shows Bill Clinton signing legislation in 1999 dismantling Glass-Steagall.

Study in Contrasts

But for the fact that the people in the two photos are exclusively older, white males, the contrasts couldn't be more startling.

The Congressmen and senior government officials surrounding FDR look sombre, if not grim. Their demeanor suggests that they had just witnessed a horrific financial accident (if not crime) -- one which they are determined not to ever let happen again.

Of couse, they had, and they (mostly) did. To their credit, their efforts to safeguard the nation's financial system succeeded for more than three-quarters of a century.

By contrast, Bill Clinton and the officials around him -- luminaries such as Fed Chairman Alan Greenspan, SEC Chairman Arthur Levitt, Texas Senator Phil Gramm, and Treasury Secretary Robert Rubin -- look like they're re-filling the punch bowl at an especially raucous party.

Which of course, they were.

Less than 2 years later, the stock market cratered.

Less than a decade later, a lethal combination of investment bank risk and leverage -- just like in The Great Depression -- created the greatest financial crisis since the 1930's.

Recession "Name Game"

"The Little Depression"? "The Great Recession"?

Think of [the U.S. economy today] as Alien in reverse: lurking inside a dysfunctional, steroid-stuffed "monster economy" is a healthy, sustainable, and yes, market-driven one struggling to get out -- albeit a smaller, slower-growing, and certainly simpler and more transparent economy.

--"Financial Crash Instructions"; City Lakes Blog (12/12/2008)

Up until the 1940's, World War I wasn't known as "World War I," it was simply "The Great War."

Similarly, we call what happened in the 1930's "The Great Depression" because there's never been a sequel. At least not yet.

The latest batch of economic numbers, for the fourth quarter of 2008, show economic activity falling off the proverbial cliff. Consumption, production, home sales, car sales, retail sales -- you name it -- all showed declines not witnessed since . . . yup . . The Great Depression.

What we're experiencing now may very well qualify as "The Little Depression." Or, as Barron's Alan Abelson proposes, "The Not-So-Great Depression."

If it persists, with economic activity continuing in free fall and unemployment rising well above 10%, it may qualify for another, more ominous name.

Alternative Scenario

Personally, I doubt that that will happen, if for no other reason than life today is so different than the 1930's.

Namely, it's much faster and interconnected, thanks to technology.

Even if the banking system is in worse shape than is now feared -- and the fears are pretty high -- it's hard to imagine modern day Americans raised on PC's, microwaves, ATM's, instant messaging, etc. tolerating that degree of economic dislocation that long.

Policymakers also have Japan's "Lost Decade" (in the '90's, following the Nikkei's crash) to serve as a case study in what not to do.

When a PC crashes, you "re-boot." Yes, you may lose a lot of data, and it's a big headache, but it's not life-altering (usually!).

Similarly, when an over-leveraged, unstable financial system crashes, the solution is to replace it with . . . one's that better-designed (and to minimize the fallout from the crash).

When President Obama says the country will ultimately emerge stronger from this period . . . I think he's absolutely right.

"10 . . 9 . . 8 . . 7 . . "

George Bush's Role in
Today's Economic Car Crash

Everyday Americans -- if not historians -- are likely to remember George W. Bush as the President who crashed the family car (the economy).

However, it would be too easy to simply lay it all on #43 and move on (or try to -- right now we're all sort of waiting for Triple A -- Obama and team -- to show up with the tow truck).

If we're honest about it -- and there will never be a better time than Inauguration Day -- we have to allow that there were other, contributing factors. Such as:

--The car Bush got the keys to had major flaws and defects, at least a few of which were non-obvious (at least to people other than Warren Buffett). The role of credit derivatives, the shadow banking system, the (far too) interdependent global banking system and the consequently high risk of financial contagion -- all these phenomena are only now clearly being understood and dealt with.

--The family "car" wasn't in such good repair. In fact, its chassis and fundamental design date back to The Great Depression. As economic systems go, that's the equivalent of a car with 200,000 miles on it. The economy Bush inherited had none of the latest, technologically advanced safety equipment (like air bags, electronic sensors, etc.), and the basic ones it did have -- like brakes -- were old and poorly maintained.

(In fact, there's ample evidence that, in what can only be called an act of economic sabotage, the brakes were intentionally disabled by the very mechanics hired to fix them.)

--The car crashed not just because the driver was inept -- although that's clear -- but because of poor weather and road conditions. Specifically, visibility was poor, the road was slick, and safety features such as guard rails and proper lighting were sorely lacking.

--Unfortunately, we let the insurance premiums partially lapse. The reason people buy insurance is to make them whole in the unlikely event of a catastrophe. We're now in the position of owning a totaled car, without all the money needed to replace it.

What Would Lincoln Do?

So what do we do now?

The first step is to attend to those passengers and innocent bystanders most severely harmed (financially) by the current crack-up. That includes, but is not limited to, people who've lost their homes, their savings, and their jobs. Over time, we must also attend to those who've lost less tangible but no less real things: their faith, their trust, and their hope.

The next step is to make sure that the current driver is the best possible person for the job. On that score, thank God for -- and God bless -- Barack Obama.

Once those two pieces are in place, the last step is to set about re-designing a brand new car.

As Lincoln understood at Gettysburg, the best (and only way) to honor an otherwise unfathomable sacrifice is for the survivors to rededicate themselves to the completion and perfection of the cause at the heart of that sacrifice.

In this case, that means designing a better, market-based, capitalist economy -- one that's fairer, more productive and even more durable than the one FDR bequeathed us (and LBJ and Reagan adjusted).

FDR Redux?

The Financial Crisis So Far

The country -- and world's -- biggest financial crisis since the 1930's has reopened a long dormant debate regarding 1930's economic policy.

Democrats today subscribe to the notion that FDR did too little during The Great Depression, unnecessarily prolonging it. Had he used even more fiscal stimulus (public works, capital spending, etc.), they believe, the economy would have recovered faster.

Republicans today subscribe to the notion that FDR did too much during The Great Depression, unnecessarily prolonging it. According to them, government overreacted to the 1929 Stock Market Crash and subsequent downturn, greatly exacerbating it.

In retrospect, about the only thing that everyone agrees on is that FDR didn't end the Great Depression -- World War II did.

That said, it seems unassailable that FDR was a beloved figure to many, many Americans. If voters thought he was doing a poor job, their actions belie it: they re-elected him a record three times (of course, future generations may wonder how George W. got elected twice!)

Fast forward to today.

Given an incoming Democratic President and continued deterioration in the banking system and broader economy, you'd certainly bet on more intervention -- and more aggressive intervention -- rather than less. As Americans, we can only hope (and pray) that whatever course of action President Obama chooses is effective.

To paraphrase what Santayana (not to mention Nietzsche) would say of our current predicament: those who disagree about history's big lessons . . . get to repeat them.