Saturday, December 13, 2008

Recipe for Failure

Picture a small economic model where everyone works and produces a product and they get paid a fair value for what they produce. Let’s assume that the total amount of product adds up to one Trillion dollars. The cash eliminates the need to barter what you produced for someone else’s product.

Here is where I get shot again for oversimplifying, just imagine that the government steps in and spends 4 trillion dollars to bail out the economy. The net effect, you now have 5 trillion dollars chasing 1 trillion dollars worth of goods.

A lot of people have spent a lifetime saving for retirement. This introduction of new money is an effective 80% TAX on savings in the bank (using this model). If you are in hock up to your eyeballs, this is called debt relief. You borrowed hard dollars and pay back easy ones. It nice to know if you weren’t greedy and kept a level head through this whole mess you get to pay for the clean up.

The auto industry is caught in an impossible situation. Car sales are down drastically and with the layoffs, more used cars will be on the market competing for buyers. Financing will be the real issue. GMAC is not in the best of shape. Rumor has it some Bernanke "Fairy Dust" could turn them into a bank and make them eligible for a CRAP/TARP(your choice)loan.

Even with a government bail out of the big 3 autos, all the government is bailing out is the workers retirement pension plan. It’s these benefits that have put GM and Ford into a death spiral. An employer can promise the employees the moon and if the company goes bankrupt doing it, the government isn’t obligated to honor those commitments.

UAW president Gettelfinger is nothing more than a very slick poker player. He bet the farm on a government bailout and it looks like he may get it. We keep on hearing about how massive the unemployment would be if we let them fail. Question, do you still build cars if no one wants to buy one? If consumption of cars drops to 50%, doesn’t it follow that massive layoffs are in the future as a given? Unemployment is a function of consumption. The bail out will not stimulate car sales.

The whole theory of financial collapse has to do with the misallocation of resources. An example of that was the cattle speculation in Africa 30 years back. Everyone was breeding cattle and becoming wealthy (the more cattle you owned the wealthier you were considered). Then feed prices went up and the farmers couldn’t afford the cost of feed and started selling the cattle. The market collapsed, the cattle starved to death and the farmers followed them to the grave. A government feed subsidy would have only allow the problem to continue longer.

We have two problems here, misallocation of resources and the confiscation of real savings by printing money. Both are keeping the game going. California's state sales tax income from new car sales and the property assessment taxes collected on homes are both dropping fast. Public employees are being laid off. Congress needs to help out the state budgets; we need the police, firemen and teachers, the hell with Wall Street and Main Street! These bailouts for the car companies and the banks are a little like a hooker with VD. You’ll pay now for what you get, and pay later for what you got.

Copyright 2008 All rights reserved


Sackerson said...

Punchy stuff, Jim.

Anonymous said...

i like your site jim, mish has banned guests , our own english house price crash edited, in uk 2004 you got 800 oz of gold for average house, today its 298oz for same house, they say 10 to 15% down ,gold says 63% down whose lying. col utd 1

Anonymous said...


I know lots of people are blaming the UAW, but there's a screaming statistic to the contrary. Both Toyota and Honda have also seen sales plummet (Toyota 30+% decrease). Toyota has closed down their pickup truck factory here in Texas (it's only two years old).

So, labor costs are not the problem. With GM's skyrocketing quality, that's not much of an issue either (perceived quality may be an issue though). The real problem is that people have been "scared straight" as far as financial common sense goes. And to be honest, maybe that's not such a bad thing in the long run.

In other news, my wife got a layoff notice last week. She worked for a nonprofit that got most of its budget from contributions and an endowment that was in the stock market. Big budget slash.

Keep up the good work.

John in Texas

Jim in San Marcos said...

Hi John

I don't blame the the UAW. Those guys are real horse traders. The trouble with GM is the money being paid out in retirement benefits. There are 3 employees in retirement for every one working. The cash flow from selling cars will not support the retirement benefits that have to be paid out. Bankruptcy offers a partial solution, it would probably half the GM pension plan benefits. This could get them back on their feet.

Another thing to consider with the contracting economy, people are cutting back and a lot of people can't even qualify for a car loan anymore. Credit has tightened up.

Our own Social Security program has the same dooms day scenario and instead of 20 years down the road, it could be two or three years down the road with our economy in shambles.

i agree with you, labor costs are not causing this, it's retirement benefits that are killing them.

Sorry to hear that your wife got a layoff notice.It might not be that bad, home cooked meals and time to shop for value. Plus you pay less in taxes

Anonymous said...

7 comments only one remains why, this really getting an edited world.happens every where, if you are educated only a certain way are allowed to object, im odd make no bones, but do want a world where we are all the same.freedom is dying.

Anonymous said...

got to ask yourself if we are all turning into russia.col utd1

Anonymous said...

There are 3 employees in retirement for every one working.

Sounds like Social Security.

Also, there are too many police and teachers. We could cut 20% of the police force by ending the waste of money that is the war on drugs. We could cut 30% of teachers by returning to class sizes of 30 years ago. Smaller class sizes have done nothing to improve education.

Anonymous said...

Indeed anonymous 7:00 am -- I second that: end the war on drugs.

This is a rare opportunity in the federal/state budgets where an expense could actually be turned to tax income, if done in a fiscally responsible manner.

Unfortunately I don't have much faith it can be done in the short term, especially over the protests of hardcore drug warriors, prison guard unions, and other lobby groups for the prison/industrial complex.

Jim in San Marcos said...

Hi Anon 7:00 and 12:19

I do believe that legalizing drugs would eliminate the profit motive that makes it worthwhile for the criminal element today. But you solve one problem and create another.

One judge once said "Get rid of alcohol and you can get rid of 3/4's of the prisons and half of the judicial system. A majority of crimes are alcohol related.

In 1929 when the Great depression started, Booze was illegal as were other drugs like cocaine. From what I have read from anecdotal reports, cocaine abuse was a very severe social problem of the times, which surprised me. Cocaine use dropped to zero after the Great Depression set in. What happen in this case was you couldn't really make a buck selling drugs illegally. Booze became legal in 1933.

I don't think there are any simple solutions here, only trade offs. The ability tax the drugs does offer an enticing incentive to government to legalize it. Pot cultivation in Kalifornia is considered the number one cash crop of the state (you won't hear anyone really point this out though).

Thank you for your comments

RonHack said...

I am concerned about your statement that the retirement pensions under the automakers are the problem. Do remember that the automakers dug this hole themselves.

For the past 10 years or so, GM, Ford, and Chrysler were pushing SUVs as the solution for your transportation problem. Plenty of room, commanding view, luxury accommidations, illusion of safety for your family; gas is cheap, don't worry about the price at the pump!

Meanwhile, Toyota and Honda, the foreign biggies (and no stranger to lifetime employment and pensions) were putting together small cars and "mind-bending" vehicles (car-sized delivery vans, anyone?). Toyota's latest coup: the Prius. I checked the dealership: can you say "6 month backorder"? Since when is a small car back-ordered THAT far back? Word is, an American-based Highlander plant is being retooled to just crank out Priuses!

True, American cars are getting more reliable. Check your Consumer Reports back-issues, though, and you can see that the likes of GM and sundry have a long way to go. The word is out, and for quite a while now; Toyota and Honda are more on the road than GM now!

Not to diminish your viewpoint (although I like your website, a few things you say I do disagree with), but 20 years ago, the Big Three moved their concentration from making cars, to finance. Now they're starting to concentrate on cars again. Plus, even if all Big Three disappear, there are others that'll take their place in a heartbeat: Tesla's got some models out, based on GM's "discredited" "EV-1".

Such stupidity, in an industry this size, should only be awarded with bankruptcy. True, bankruptcy will eliminate the "pension problem", but how many customers do you think are going to buy from a company on the edge of closure? Plus, if throwing money at a problem didn't help Bank of America, how will it help GM?

Why do I feel that "too big to fail" is being applied here? Maybe I'm dreaming, but is logic on vacation here? Maybe it's been the eight years of Bush, or something.

Keep up the good work.

RonHack said...

Uh, sorry about the length of my post back there.

I didn't realize that my aggravation with any of the bailouts could be this long, and this was the amended version! I was only talking about the automakers. The banking industry you REALLY don't want me to get started on, I may end up typing pages about what's wrong with it! Fortunately, you covered many of the problems with it already.

Again, sorry.

I'm Not POTUS said...

FYI: On the effects of blowback on the Big 3.

FDR had controls on consumer prices AND also on WAGES so when labor was scarce during WWII the only way factories could hold on to workers was to offer "fringe benefits" that were not regulated. The solution worked, incentives were put off to the future so no harm, no foul was felt on the war effort. Skilled labor was not poached off by competing factories, productivity was manageable and stable. What it evolved into is the problem.

Did you know Detroit had the highest per capita ratio of Chiropractors in the world. If a benefit was offered it created it's own 100% maximized market.

Japan had a culture of jobs for life, they don't anymore. You can try to find another job but good luck finding another obligated funded pension.

Both methods of employment loyalty worked until they didn't. The trick is to figure out what to do when they stop working out for you.

The law of unintended consequences is strong in a ZIRP universe. Nobody in charge is thinking about what happens when ZIRP stops working??????

Jim in San Marcos said...

Hi Ron

No problem with the length, I agree that automakers signed off on these benefits. The benefits are just too rich for the company to survive.

Just about every pension fund has lost about 50% of their equity. Now each company is being called to contribute more money into their retirement funds to make up the current short fall. This isn't chump change, it's going to break a lot of companies.

All of the retirement promises made, were while the market was going up. The payout model for future retiree's is falling apart.
Business Week had a very eye opening article on it.

I agree that the bail out really makes no sense, government interference usually makes any recovery longer and more painful. What we say and think probably has little bearing on the decisions that will be made.

Thank you for your comments.

Jim in San Marcos said...

Hi Potus

You mentioned FDR. The biggest bubble we have to pop is going to be Social Security and Health care. Add in 2 to 4 Trillion of monopoly money bailouts and you have a case for something terminally ill.

The ZIRP (zero interest rate policy) is defiantly from the land of unintended consequences. What can they do for an encore, wet their pants? At zero interest rates what bank is going to lend to another bank for nothing? Normally you would borrow at the fed and mark it up a quarter point.

Of course a bank could take all of its crap down to the Fed covert it to cash and take the big plunge into the stock market. If you are going to crash and burn, have fun doing it--its not really the banks money--its "Uncle" Ben's.

The next few weeks could be very strange to say the least.

Anonymous said...

Anon on a California Mountain:

It is indeed unsettling for many to consider the fact that the force of this current deflationary motion (continually feeding upon itself as it spirals downwards, gathering more and more momentum) may at this point be unstoppable.

The Fed and US government will do everything and anything to prevent it (destroy what is left of the dollar—hyperinflating a la 1930's Germany; turn us into a socialist or minimally a "government or central bank controlled capitalist state"; and so on) but at this juncture the forces may be too great to mitigate or hold at bay.

Our government (one administration after the next) has been able to avoid, cover up and push economic maladies forward for decades... refusing to face the unworkability of the systems and stubbornly attempting to prop up the status quo and "protect it" from the natural forces and laws of economics.

Maybe amidst this current insanity of ad hoc govmt groups throwing out unusual and arbitrary solutions, and every tool they have in their tool box—no matter how dangerous the future ramifications are of their usage—and by possibly inventing new "tools", can prop things up for another decade or generation. Maybe they'll "work the magic" and postpone the threatening debacle again.

Natural market forces just want to punish excess, errant behaviour and unusual solutions (unusual solutions always become tomorrow's problems). Earlier, these forces wanted to purge the system of these unusual solutions. Now they may want to destroy the whole system so we can start anew... hopefully with ethics, a responsible view of the future and coming generations, and solid economic fundamentals.

(Keynesian economic theory was written when we were on a gold standard and before we had floating foreign currencies. It's obsolete theory! Govmt spending to stimulate the economy was only supposed to be an occasional tool, not de rigueur.)

The public's complete loss of confidence in the government, academia, corporate leaders, and the resultant crash of the system would be the necessary fodder for the creation of a "new civilization" as it were.

Unpredicted natural forces have unwittingly been put into play by actions implemented as early as 1913... such as: poor monetary and fiscal policies, government interference in business; the Marxist concepts utilized by FDR; Keynesian economics; corruption; excess of debt and consumption; de-industrialization; etc. etc. etc. ad infinitum.

We have made ourselves terribly "crisis prone". These multiple forces are beginning to bombard us all at once, forming a "perfect storm".

In my opinion, the government's actions over the next 1-2 years (or sooner) will let us know what direction America is headed towards for the intermediate and long term: a deep and long recession, like Japan's "lost decade"... or a depression.

I'm a boomer. I bet that the majority of boomers (raised in affluence and security) never thought there would ever be a depression in their lifetime.

I posit that we have a 50/50 chance of depression at this time.

In my mind, such a collapse will not bring us into a "dark age". Of course there will be chaos and pain in the short interim. Yet, I believe that a collapse will manifest into a long needed evolutionary step—an opportunity for integrity and knowledge to flourish, raising us up to a more responsible, civilized and survival oriented status with a long term world view.

This old Chinese proverb is quite relevant: "within each crisis lies a great opportunity".

We must stay positive and focus on peace and prosperity no matter the current conditions... and discover that opportunity.