Repricing Risk and our Economy

From Morgan Stanley’s Richard Berner:

In our view, housing activity is clearly at risk, and we see no real recovery until 2009.  We believe that the economic costs of subprime loan defaults largely will be borne by lenders rather than borrowers because such borrowers have scant equity in their home.  Thus, the spillover risk to the economy depends on whether lenders tighten lending standards significantly further.  We do expect that the tightening in lending standards will crimp demand; indeed, the downdraft in June home sales to new lows suggests that the tightening in mortgage credit is already starting to bite.  The ongoing buildup in inventories of unsold new and existing homes points to a mismatch between supply and demand that will require at least a 20% decline in 1-family housing starts to correct; that drop is already built in to our forecasts.  In addition, we estimate that foreclosures over the coming year could add 7% to the inventory of homes available for sale and put further downward pressure on home prices and thus, potentially, on consumer spending.  Likewise, the increase in the cost of capital and tighter standards for business borrowers means that the sluggish capex expansion is also at risk. 

But there are also several reasons to be suspicious that such forces will materially weaken the economy.  First, magnitude and duration both matter for assessing the extent to which any such credit tightening will affect growth; this episode has been modest and recent — so far.  Second, other dimensions of financial conditions are moving in the opposite direction.  Third, and contrary to the pessimists’ claims that the US economy’s sole source of fuel is a high-octane credit market, we continue to think that strong overseas growth and hearty domestic income gains will support overall US growth in general, and consumer spending in particular.  Indeed, while market participants are ignoring past economic data on the theory that they don’t reflect the recent changes in financial conditions, initial economic conditions do matter.  In particular, net exports have added 0.4% to overall US growth over the past year for the first time in a decade, and prospects for global growth remain strong.  And US real disposable income rose by 3.2% over the past year — faster than the pace of spending. 

Exactly.  The economy needs one year’s grace for housing and consumer spending to get back in line.  That is what it needs, and happily, that is what it will have.  And the dollar will help.

In the long run though, government spending, especially in huge apportionment programs like social security, must be resolved to some semblance of sanity.  And there’s one other spending spree that’s really being hidden in the numbers; the politicization of the military.  What proportion of the military budget is really just politics finding a way to get a local income stream?  Put another way, if you were king for a year, how much could you shrink military spending and actually increase the effectiveness of the best men and women in the country while providing in capital and research and wages for their future?  Is it as high as 50%?  There’s some smart military folks around who could make a pretty good guess.

Tags: Economics, Globalization, Taxes

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Globalization or Isolation

Here’s an unsurprising poll by the Financial Times:

It appears clear that the western world’s citizens are unimpressed by the benefits of globalization, whether it has provided increased choice, lower costs or more value to their lives.  So much for free markets.  People are losing their jobs, especially at the lower levels.  And everyone knows that a lot of that free market theory is just a load of malarkey anyway, designed to give fat cat owners and managers of big companies a good reason to go take advantage of the bare-foot Chinese at $2.00 a week.  And all at our expense.  Right?

What does globalization, corporate governance, pay caps and the like all have in common, other than an “Us vs. Them” or “Capital vs. Labor” kind of Marxian perspective of the world.  Isn’t that the way we’re taught to think?  Isn’t that the only way to see it?  After all, the Man is out to get you and this really is a zero sum game, just like Marx and Engels said it was.  Clearly most folks agree in every country that these people need to be reigned in.  They are taking it all, and at our expense. 

It appears the only hope for the free market proponents is the last question, in that about half the people sort of support the general idea of free competition.

But let’s come at this from a little different perspective.

1. What’s the largest and freest market in the world?
2. What market has the highest standard of living?
3. What are some of more closed markets in the world?
4. What are their standards of living?

“So,” you say, “I understand USA is much richer than North Korea, buy I still don’t cognitively appreciate the theoretical connection between free markets and high standards of living.”  Then consider this example:

Let’s say you live in Chicago.  And I tell you that you can not buy anything from anyone who didn’t go to your highschool.  What kind of life do you think you’d have, compared to the one you have now?  What about if you could just buy things from Chicagoans, or better yet, people who live in Illinois?  What kind of life would you have now?  But wouldn’t you prefer to be able to buy things from all over the world?  That’s the inherent power of globablization.  You must have faith in free trade.

Still not convinced?  Hmmm.  I’m beginning to doubt your sincerity.  But here’s another example.  What countries are getting richer the fastest?  Forget the rich people.  They are in every country, and there will always be rich people.  I mean for the average, everyday Joe.  Who’s getting richer fastest?  The answer is obvious; the countries that have embraced globalization.  Countries like Ireland, China, India, Chile and the USA.  By the way, the opposite is true also (just go visit Venezuela).

On a subtler note, compare the EU with the States of the USA.  Compare size of markets, populations, educations, culture, freedom of speech, etc.  One might argue that the biggest difference between the two markets is that the USA is one large, free market, unlike the EU where the barriers between neighboring countries is comparatively large.

Now compare the standard of living between EU countries and the USA.  Go on.  Ignore the western press and its often  prejudiced opinion.  For your average, middle class guy, who’s better off?  Where is life just pretty darn good and getting better, not worse?  Forget what you hear in the press.  What does your gut say?

If the answer to the question is not absolutely, positively, clear, ask yourself this question: “What country does everyone want to move to?”

Maybe our corporate business managers should get a big lesson in fiduciary duty.  OK.  I heartily agree.  But does that mean we want government bureaucrats playing games with their wages?  Not OK.  And what does any of this have to do with globalization?  I do not have a clue.

But back to the matter at hand, which is the power of free markets to raise the standards of living in the country where you live, and generally help make you richer.  Forget the fact that globalization is literally pulling 2 billion people (1B each in China and India) up into the middle class (as defined by indoor plumbing, no longer worried about food and clothing).  Forget that stores like Walmart make everything more inexpensive for you to buy. 

Just consider whether in the last twenty years, life is getting better for you or not.  And if you’re too young to answer that question, but you’re working, ask yourself if you’d rather be in your shoes, or your parents when they started out.

So, do you still want free markets?