The New Normal

The government’s efforts to save the economy have met to date with mixed results. On the positive side, the larger banks have shown profits, where even Citigroup has shown a profit of sorts. On the negative side, unemployment is increasing and underemployment is skyrocketing. The media has termed this the new normal. I would prefer the term what-the-hell-did-you-expect to describe the near-term prospects for the economy.

Here is the problem. The economic equivalent of Boyle’s Law is that you cannot create or destroy economic demand without creating wealth. The government cannot create wealth. The government can shift demand from one business to another by changing the relative cost of goods. It can shift demand from the future to the present by lowering the cost of consumption, ie interest. The government cannot create demand by itself, nor can induce economic prosperity with fiscal stimulus.

Stimulus without innovation is nothing more than borrowing prosperity from the future. It is unavoidable truth that when you create demand in one industry, say in autos with a cash-for-clunkers program, you are reducing demand somewhere else. When I spend $20,000 on a car, it is $20,000 that I am not spending elsewhere. In the case where I borrow the $20,000, it is $20,000 that I am not spending sometime else. The sum of the government’s effort is zero, where we are pushing demand from one business to another or from the future to the present.

I serve as an illustration of the problem. I am replacing perfectly workable air conditioners and heaters because the government is taking money from someone else to help me pay for it. The money that I am spending replacing the perfectly good air conditioners and heaters means that I am not doing the painting which actually needs to be done until next year. This is a zero sum game at best – and a negative sum-game should we find that good painters become bad air conditioner installers.

The government’s current approach to stimulus is far from a best case situation. We are heavily subsidizing the auto and lending industries. Both of these industries suffer from massive excess capacity. In the best case of the example above, a good painter becomes a good air conditioner installer because the increase in demand will lead to hiring. In the America in 2009, however, businesses aren’t hiring because the increase in demand serves only to soak-up excess inventory. So, the painters just become unemployed. This is why you see the GNP bottoming but unemployment increasing.

Price is the market mechanism for clearing inventory. Instead of allowing the price to clear excess inventory, the government is stealing demand from elsewhere to justify the existing price. The market works best when it is allowed to punish these people who cannot price products well. In this case, the market is punishing random people who had nothing to do with the poor decisions in the first place. The consequence is socialization of stupidity, in which the foolish benefit at the expense of everyone else.

This consequence is most clear in banking, where the government has decided to subsidize risk. We have lowered the cost of capital well below it true value. These subsidies have led many businesses to form a bank holding company. Subsidies in the case of health care and agriculture are of debatable merit, but they at least subsidize a public good. Comically enough, we are encouraging people to take risk during a credit crunch when capital should be treated with a premium. This is a level of stupidity that should be beyond even government bureaucrats.

The earnings report from Goldman Sachs is an unavoidable outcome of our folly. 80% of Goldman’s earnings came from proprietary trading. The report doesn’t indicate the amount of public assistance that Goldman received. But, as a bank holding company, it is entitled to borrow at the discount window. It can access the Treasury Auction Facility. It can issue debt backed by the FDIC. So while it may have paid back the TARP funds, Goldman Sachs has many lines of public assistance to subsidize its proprietary trading group. Is proprietary trading a public good?

Folks if you are wondering why we are seeing mixed messages in the economic results. It is because the government has one of the worst economic agendas since the Great Depression.
Even by government standards, this is simply stupid.