Saturday, February 28, 2009

How to Get Out of This Mess Cheaply

Recently I have taken to telling friends that the most efficient way to get us out of the economic mess would be to spend several million dollars and use it to send all of the high government officials - in the White House, the Fed, the Congress, the Treasury, wherever they are lurking - on vacation for 18 months in some tropical paradise. There they could try doing something radical - namely, nothing - for a little while, and in the mean time buyers and sellers could sort out the mess, liquidating some businesses and rewarding others. Recognizing that these folks are used to living high off the taxpayer hog, we wouldn't want to stint on accommodation, food, etc. But really, it couldn't cost much more than $50 million, and it would be well worth that just to avoid all the sanctimony and ignorance to which we are about to be subjected, let alone all the horribly expensive mistakes now in the proces of being made.

But it turns out Iowahawk imagines an even cheaper option.


Friday, February 27, 2009

The 36% Solution

The government of the U.S. is now, merely a few months after assuring us that it had no such interest, about to become a major voting shareholder in Citibank. But it will not become a majority owner, converting its stake only to 36%. A lot of the financial-press attention has focused on the impact on the existing shareholders. Why did the government settle for less? The conventional wisdom, as the hourly radio news assures me as I am writing this, is that it is a sign that “the government hasn’t given up on Citi.”

I wonder. If you wanted to have control over Citi assets, and wanted to use them for controversial purposes, what would you do? You wouldn’t simply grab control, which would bring to mind the dreaded socialist phrase “nationalization.” But you would obtain enough control to have de facto veto power over major decisions. You could then use that power to increase diversity, cut the executives’ pay, increase the accountability to the “stakeholders,” and all that other stuff that will get you re-elected but end the bank’s effectiveness in performing its core historical tasks. Citi shareholders and managers have no credibility in objecting; they elected to dance with the devil, and now the devil is calling the tune.

But seeing it that way would be too cynical.

Saturday, February 14, 2009

Should the U.S. Be Making Cars in 2525?

The U.S. is about to name a "car czar," someone to supervise automotive restructuring as a condition of accepting government loans. The automakers are supposed to submit plans next week to satisfy congressional overseers. Barney Frank, Nancy Pelosi, etc., in other words, are to preside over the reorganization of major American businesses. It is too easy to point out that these are the same people who gave use the housing mess. (Mark Steyn once mocked 1970s Britain as a place where "the government made your car." It is not so funny now.)

So instead, here is a good starting question. Should the U.S. still be making cars in the tear of Zager & Evans, 2525?

If your answer is "No," how do you answer if I replace "in 2525" with "next year," "in 5 years," "in 20 years," "in 50 years" or some other value? The only honest answer to every question is "I don't know," with the probability at some level close to one if we substitute "next week," and declining toward zero beyond that.

This means that there is some year that the U.S. should stop making cars, and that no one knows what it is. And so to decide this question we have a procedure. If companies can produce cars in the U.S. and sell them at prices that exceed the opportunity cost of the resources needed to make them, the answer is "keep going," and otherwise the the answer is "stop." This procedure is generally known as "the market."

It is possible of course to substitute an alternative procedure, in which elected representatives vote, in response to political pressure exerted by various factions, via votes, campaign donations, blackmail, or whatever tools they choose to employ, on providing money extracted from taxpayers either now or later (the latter, of course, don't vote) to car companies until, one day, they stop providing it. Note that it is no answer to say that the companies, like Chrysler in the 1980s, will use the money to become profitable once again. Ultimately, one day, the time at which Americans ought to no longer make cars will come.

Which procedure produces better results? Which procedure has us ceasing to make cars at closest to the right time? We trust the market procedure to answer when the question is, "When should a hair salon close?", "When should Americans stop manufacturing horse-drawn carriages?", etc. What is the difference here? Scale, surely. The automotive industry employs huge numbers of people. But why does scale make any different with respect to the ultimate question - should American resources be tied up in this end, or reallocated somewhere else? No one knows the answer to this question, but there is substantial reason to think the market process will do a better job than the political process. Indeed, the result generated by the political process, so far, is that American companies will be asked to preserve existing collective-bargaining agreements as much as possible, despite their immense cost. They will be expected to meet very expensive emission requirements. And they will be expected to sell the results at a price American consumers will pay. This approach does not inspire confidence.

Alas, the politicians get to write the laws, and the workers, consumers, bondholders, shareholders and the competitors to U.S. car companies, whether they make cars or not, must merely obey them. And therein lies all the difference. Not in what should happen, but in what will happen.


Tuesday, February 10, 2009

The Road to Economic Hell

Our new Secretary of the Treasury, this morning:

"It is essential for every American to understand that the battle for economic recovery must be fought on two fronts," Geithner said in a speech in Treasury's ornate Cash Room where he unveiled the administration's new plan.

"We have to both jump-start job creation and private investment and we must get credit flowing again to businesses and families," he said.

I'll forgive him his "battle" metaphor, even though the rhetoric of war has been used in every catastrophic expansion of collectivism and the state in the last 100 years. I am more immediately struck by the use of the phrases "jump start" and (albeit as a clumsy mixed metaphor) "flowing again."

"Jump start" is what we do to dead car batteries. Someone unfamiliar with how a car works might view the turning of a non-functioning car into a functioning one merely through the application of those yellow cables as some sort of otherworldly miracle. The application of electric charges makes the car every bit as good as it was the night before, before we forgetfully left the lights on.

Alas, the economy is not a dead battery, nor indeed a single entity of any kind. To be sure, people are pessimistic, and for good reason, but the problem is not one of restoring their psychological health. The problem is not with "the economy." The problem is with a billion individual bad economic decisions, each of which must be resolved by buyers and sellers in its own way. Investors, as I have noted before, have to map out the financial landscape to find out where the problems are, and how deep they are, in an environment in which the Congress and President of the United States are just firing off every gun in the arsenal wildly, no matter the consequences in higher taxes for future Americans, in hopes that some bullet hits the target. Financial uncertainty plus vastly increased political uncertainty is not what one wants for an investment environment.

Our economic troubles boil down to a lot of resource-misallocation mistakes that have accumulated over time. The politicization of the housing and financial markets, a tremendous globalization-driven boom that created huge amounts of wealth but also allowed a lot of in-hindsight fiascos to accumulate, and the postponement of the day of reckoning through a futile Fed-led 24/7 running of the printing presses in the last few years has created an aggregate mess. But while the mess is macro, the solution is micro. The mistakes have to be weeded out. Once upon a time, in the era of great social transformation brought about by industrialization, booms and depressions were common. The government didn't imagine that it could do anything about them, and they were usually (although not always) short affairs.

But it is clearer every day that our politicians see themselves as messiahs. They are convinced, despite the utter lack of any historical evidence, not just that they but that only they can solve the problem. Thus, expect a lot of random political noise - bail out this but not that, no wait, spend another $500 billion, no wait, nationalize the banks, no wait, buy American - to make things a lot more uncertain, and therefore a lot worse.