PRIVATE CLIENT LETTER
This letter is intended only for accredited investors who are clients of either Blackburne & Sons or C-Loans, Inc. Today we'll talk about the huge debate among economists over how best to fix this slumping economy. Their proposed cures are exact opposites! Removal instructions are below.
Joke Du Jour
An old guy was working out in the gym when he spotted an attractive young lady. He asked a nearby trainer, "What machine should I use to impress that lady over there?" The trainer looked him up and down and said, "I would try the ATM in the lobby."
The Hugely Important Debate
There is a fierce intellectual war going on right now between the two largest schools of macroeconomic thought, the Neo-Keynesians and the Austrians, over how best to end the current economic slump.
The Neo-Keynesians are a modern version of the macroeconomic theories advanced by John Maynard Keynes in the 1930’s. They represent the mainstream or majority view of current macroeconomic thought.
The Neo-Keynesians, arguably led by Professor Paul Krugman, the Nobel Prize winning economist, Princeton professor, and popular columnist for the New York Times, believe at this point in the economic cycle that the Federal government should be deficit-spending to stimulate growth and job creation.
Even though deficit-spending will lead to a short-term increase in the deficit, failure to deficit-spend will only lead to a slower economy, much lower tax receipts, and even larger deficits.
At the same time, the Federal Reserve Bank should, according to the Neo-Keynesians, lower interest rates to almost zero. (The Fed, of course, has already done this.)
Anniversary Joke
The gal wrote: It was our second anniversary, and my husband sent me flowers at the office. He told the florist to write "Happy Anniversary, Year Number 2" on the card. I was thrilled with the flowers, but not so pleased about the card. It read, "Happy Anniversary. You're Number 2."
The Austrian's View of the Economy
Subscribers to the macroeconomic theories promulgated by the Austrian School of Economics do not believe the Federal government should take on additional debt to fight the current economic slump. Federal deficit spending and an expansive Federal Reserve monetary policy are what caused our problems in the first place. Continuing a loose money policy will only contribute to the creation of new economic bubbles (possibly gold and farmland).
Bubbles almost invariably lead to malinvestments. In plain English, a malinvestment is a stupid investment that will never get paid back. For example, a company may buy a new widget machine to double its widget production. What makes this a malinvestment is that there may be absolutely no demand for additional widgets.
Roses Joke
The young man ahead of my father at the flower shop was taking an unusually long time to place his order. When the clerk asked how she could help, he explained that his girlfriend was turning nineteen and he couldn't decide whether to give her a dozen roses or nineteen roses - one for each year of her life. The woman put aside her business judgment and advised, "She may be your nineteen-year-old girlfriend now, but someday she could be your fifty-year-old wife." The young man bought a dozen roses.
The Cause of Malinvestments
What causes a malinvestment? Why would a widget factory owner make such a big mistake?
Malinvestments occur, according to the Austrians, during periods with an artificially low cost of credit and an unsustainable increase in the money supply, often caused by the central bank. The government is trying to stimulate the market, and as a result, capital gets misallocated.
For example, Greenspan flooded the market with liquidity after the attacks on September 11th. This led to the housing bubble, which subsequently burst and left us with a great many years’ supply of unsold homes. If an investor makes a malinvestment, and he is suddenly feeling poorer, providing him with a cheap, new loan does not really help his situation.
He’s feeling poorer because he is, in fact, poorer. There is nothing to be done, other than to allow asset prices and wages to readjust downwards.
Olympics Joke
"After all the rioting in London this week, officials are worried that it could mean security problems for the Olympics next year. On the bright side, the guy running with the torch will just blend right in." -- Jimmy Fallon
Andrew Mellon Quote
As Andrew Mellon, the famous banker and former Secretary of the Treasury, advised Herbert Hoover in 1929, “(We must) liquidate labor, liquidate stocks, liquidate farmers, liquidate real estate… it will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people."
(As you can imagine, these words did not make Andrew Mellon very popular with the people.)
New Power Source Joke
"A team of British engineers have developed a car that runs on human waste. I'll bet that new car smell doesn't last very long." -- Jay Leno (Eeeuuuu!)
Liquidating Labor?
It is very important that every investor understand the term, liquidate. When you liquidate an asset, you convert it to cash. You often foreclose on the asset and sell it at an auction.
In Andrew Mellon’s famous (but rather insensitive) quote, he talks about liquidating labor. Here he means dismissing workers from higher-paying jobs and then making them find new jobs, almost always at a much lower wage rate. He was talking about a sizeable, across-the-board cut in the pay of most Americans. Once the cost of labor comes down, companies can then afford to hire more workers, and the unemployment rate, in theory, comes down.
I'm Hearing Voices
Even if the voices aren't real, they have some pretty good ideas.
More on Liquidating Labor
Although his comments were incredibly cold and heartless, I suspect there is a lot of truth in Andrew Mellon's statement. Just look at General Motors and Chrysler. Those companies were only able to return to profitability once labor was liquidated.
I fear that the American job market will not return to a healthy equilibrium until labor is in fact liquidated. Unfortunately, the problem is that wages are sticky. As a practical matter, an employer cannot simply cut his wages. Once a worker gets used to receiving a certain wage rate, he would often rather quit than to take a pay cut. “It’s a matter of principle.”
Unfortunately American wages are too high, especially when compared to foreign manufacturers. Therefore manufacturing job growth is going to be very slow. A return to full employment could easily take another twenty years.
Scary Statistic
“The U.S. has the lowest percentage of people gainfully employed ever recorded.” – Bill Bonnor
Each of you should be reading Bill Bonnor’s blog on a daily basis. DailyReckoning.com
Zombies Everywhere
The word, zombie company, is showing up more and more often in the financial press. A zombie company is one that constantly needs a bailout. The company may keep its doors open and pay some salaries, but its usually not innovating, and its not doing much new business. I fear that the United States has now entered the Zombie Decades.
Interesting John Mauldin Quote
“I am bullish on income."
John Mauldin is a popular author and economic commentator. Well over a million accredited investors follow his free financial newsletter.
Conclusion
In summary, I fear that the country may be on the wrong track. We’re trying to use deficit spending and a loose monetary policy to correct the problem of several trillion dollars worth of malinvestments.
As I wrote earlier, we feel poorer because we are, in fact, poorer. There is nothing to be done, other than to allow asset prices and wages to readjust downwards.
This slump will probably continue until we finally liquidate labor, liquidate stocks, liquidate farmers, and liquidate real estate. It’s sounds cruel, but I am beginning to think Andrew Mellon was right.
But the U.S. is not likely to give up on Keynesianism without first giving it a chance. Therefore this slump is likely to last another twenty years, far too long to try to wait out. At least during this slump we have the FDIC, social security, unemployment insurance, and welfare. It shouldn’t be nearly as bad as the 1930’s, but zombie decade may follow zombie decade.
My Son, Tommy, Has Moved to Sacramento
Tommy and his fiancée successfully moved to Sacramento last week. They are renting a nice apartment just seven minutes from the office, and they both seem gloriously happy to be out of boring Indiana and now living in the land of excitement. What a thrill not having to drive two hours for sushi!
George IV and Tommy are happy to be living and working close together again. You must remember that my two sons are best friends, almost as close as twins.
Baby Story
Kelly, Tommy’s gorgeous fiancée, is busy planning their upcoming wedding. She posted the following on her Facebook page today: “I just asked Tommy how many babies he wants, and he said ‘Oh, no thanks, I'm not hungry.’”
He better have been joking. Cisca and I want lots of grandchildren.
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