The Ignorant Investor

I've been seeing a lot of talk about the liquidity trap. This occurs when people cut back spending in times of a slowing economy due to fears over losing jobs and needing to build a cushion against future financial stress. Because everyone is cutting spending, there's less economic activity and so more people lose jobs, leading more people to save more money, causing less economic activity. There's a spiraling downwards, and that's the point where Keynesian economists say government stimulus is needed to push the economy up and out of the liquidity trap.

The difficulty with applying that model to our economy comes from the wastralized, debt-ridden rake's life Americans have been living for the past 10-20 years. A liquidity trap that occurs after people have been leading normal financial lives- i.e., saving a portion of their wages, investing money prudently, borrowing within their means- can be solved by a short term jolt of government medicine. But when people are addicted to spending through debt, strung out on consumptive highs, and have no savings to rely on- cutting back on spending is part of the cure for what ails the body, not a disease that needs to be corrected by government action.

Reading about the Great Depression, I'm struck by how much debt people carried in the 1920s and how a sudden crash in demand followed years of wild spending by Americans.

Today's business headlines at the NY Times look grim:

Microsoft Plans to Cut 5,000 Jobs
Home Construction Ends Worst Year Since 1959
Sony Expects $3 Billion Loss For Year
Profit Decline at Nokia Comes With A Warning

Everything is falling apart, right? But an alternate view is to look at these headlines as a natural part of the business cycle. A recession is supposed to clear out weak players and expose the flaws in business models. Do these stories reveal a systemic disaster, or something more localized? Microsoft is a poorly run company that struggles every time it leaves the safety of its near monopoly on PC operating systems of office productivity software. Home construction should decline the most in generations after making its way through the biggest booms in housing in generations. Sony is another terribly-run company that is living on a reputation built in the 1970s and 1980s. As for Nokia- it's a cell phone company. The industry is saturated with new products, and a new phone is a purchase that is easily put off for another year or two. Cell phone companies, like computer companies, are bound to suffer in cyclical downturns.

So we know we're in a recession. But how bad is it really?

I hear a lot of talk about FDR and the New Deal coming from democrats these days. I'm looking around at the economy, and I see a standard recession aggravated by the collapse of the banking system caused by deflating asset bubbles. Is the situation really as bad as the Great Depression? It occurs to me that democrats have every reason to invoke the memory of the Great Depression to scare people into accepting an expansion of social services they've longed favored but could not hope to get passed in post-Reagan America. This is politics. Truth counts for nothing.

The banking system needs to be fixed, and government will need to help out the folks who aren't working. But there is so much talk of FDR and his first Hundred Days that I feel like I did when Bush was pushing for the Iraq War. Like the threat of impending disaster is being used to rush headlong into new radical policies without consideration of the long term consequences. We've just traded neocons for neo-Roosevelts.

Since the decline and fall of American civilization began several months ago, I haven't posted at all. I wasn't in any form of shock. It was something a lot of people I'd been reading over the past couple of years had talked about. The carnage in the banking system was maybe one of the most widely predicted financial events ever to arrive. And what do we get from the government? Warmed over new deal econospeak and calls for massive stimuli to jump start a sick economy. We are told we need emergency measures, the need for which could have easily been avoided with a few policy choices at anytime over the past two decades.

Watching the Obama campaign transition, I was struck at how little Obama wants to break from the past. We get Larry Summers as a formal adviser, Bob Rubin close by someplace, and a guy from the Federal Reserve who is a disciple of both Rubin and Summers as Treasury Secretary. In other words, Obama has decided that all we need is more tricks from Wall Street to get us back on track. It's as though he's decided to ignore the past 20 years of financial history. So my guess is that we are pretty screwed.