“Consumer confidence” won’t fix the capital shortage.
It was Black Monday, Sept. 15, 2008. Major financial institutions were sliding into bankruptcy and the Dow Jones average was plummeting. Sen. John McCain, however, was speaking confidently. “The fundamentals of our economy are strong,” the Republican presidential candidate told supporters at a Florida campaign rally.
A chorus of GOP mouthpieces echoed their candidate’s assertion, but four days later, after Treasury Secretary Henry Paulson outlined the Bush administration’s bailout plans, conservative blogger Michelle Malkin erupted in fury. “I have had it with Pollyanna conservatives who continue to parrot the ‘fundamentals of the market are great!’ line,” Malkin declared. “The fundamentals of the market suck. The fundamentals of capitalism have been sabotaged.”
Malkin was right. The market closed that day with the Dow at 11,388.44, nearly 3,000 points below its October 2007 peak, but if you had sold all your stocks that day…
Well, “if” is the biggest two-letter word in the language. Five weeks later, the Dow closed at 8,378.95, a 26-percent loss from Sept. 19. By March 6, the Dow was at 6,626.94, a mere 46 percent of what it was worth in October 2007.
The past two months have seen a bounce in stock prices (the Dow closed Friday at 8,212.41), leading some to speculate that the “bottom” of the recession is now in the rearview mirror, and that we will see nothing but economic fair skies ahead. Unfortunately for the optimists — and nowadays, the Pollyannas are mostly liberals — the fundamentals still suck. Indeed, the fundamentals suck much worse now as a result of the misguided policies pursued by the Obama administration and the Democrat-controlled Congress.
To explain what’s wrong with the economy, and why the Keynesian “stimulus” approach is only making matters worse, is a difficult task even for trained economists to accomplish in the limited space of an analysis column.
The Atlantic Monthly’s Megan McArdle (MBA, University of Chicago) took a stab at it last week and was only able to boil it down to 1,070 words. A mere amateur at economics, but a professional editor, I was able to condense the problem to two sentences totaling 69 words: “The stimulus-and-bailout policies have not addressed the fundamental problems of the economy — namely, an excess of debt and a shortage of capital to spur job creation — while the entitlement trainwreck of Social Security and Medicare looms immediately ahead. By piling on new trillion-dollar deficits, at a time when the recession will result in significant tax revenue shortfalls, the Democrats are steering the economy into a stagflation trap.”
The key words in all that are “a shortage of capital.” The capital shortage affects the federal government as much as it affects you or me as individuals. Although capital is created constantly by economic production, it is still true that, at any given time, there is only so much capital in the world. Washington’s deficit-spending spree represents increased demand for capital at a time when the supply has been shrunken by 18 months of meltdown in asset value.
Suppose you’re an investor who, in October 2007, had a stock portfolio valued at $5 million. If your portfolio is typical, today it is worth slightly less than $3 million. Your $2.1 million loss represents a 42-percent decline in your portfolio’s value.
Ah, but you have other assets, including your primary residence and a cottage by the lake. These, too, have declined in value — so much so that, if you wanted to sell your lakefront home today, you’d have a hard time getting 70 percent of what it might have sold for at the peak of the housing bubble in 2006.
Your total loss in asset value, whatever its size, is quite real. Even rich people have monthly expenses and even rich people borrow money, so you likely have mortgages and other accounts that require payments every month. In good times, you might have made these payments from the return on your investments, but now your portfolio has been losing money for 18 months.
Are you, our hypothetical millionaire investor, now in any position to make new investments, the kind of investments required to fuel job creation? Of course not. In fact, if you wanted to switch some of your investments over to the relative safety of government bonds, your ability to purchase bonds has been diminished by your previous losses in asset value.
Yet the deficit-spending spree in Washington means that the federal government is trying to sell lots of bonds, as Bloomberg reported in March: “President Barack Obama’s government is selling record amounts of debt to revive economic growth, service deficits, and cushion the failures in the financial system. Debt sales will almost triple this year to a record $2.5 trillion, according to estimates from Goldman Sachs Group Inc.” And, as Bloomberg also reported, the Federal Reserve had to buy $7.5 billion of unsold bonds to compensate for weak demand.
This is why the Keynesian demand-side obsession with “consumer confidence” — e.g., Yale University’s Robert Shiller — is utterly useless for economic forecasting in the current situation. Psychobabble about the “mood” of consumers can’t fix the inescapable reality of the capital shortage, a shortage that will only be worsened by the deficit-driven flood of new government debt into the bond market. Yet in January, Shiller actually argued that more deficit spending is needed.
As if Keynesian theory had not been completely discredited by the “stagflation” crisis of the 1970s, just wait and see what happens now, as unprecedented government deficits siphon already scarce capital supplies away from private-sector investment.
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