By Daniel M. Ryan
As of the time of the writing of this piece, a preliminary agreement in Congress for the long-asked-for bailout of the Big Three was first announced. One of the oddities of the struggle for it has been the contrast between the relative speed of the Fed- and Treasury-backed bailouts of the financial-services sector and the relative slowness of approval for the auto sector. One reason is gun-shyness after the protest-induced Congressional balk when the TARP had first been brought to the House, but there's another reason.
The S & P 500, after a wild month, has closed at a level slightly above the one it was at when I called for a new, if mild, bull market. As November wore on, it became apparent that the U.S. equity markets' largely abortive rallies were not based upon an endogenous recovery, or upon a correction of previous overly pessimistic valuations. No, it's been hinged on the hope that the U.S. government would bail out the economy. As November has moved into December, this hope has now become more and more explicit.
As stimulus announcements have faded for the time being, the pessimists are being heard from again. The latest economic data released have tended to be below expected values, and some have been awful. And yet, the equity markets are in the process of taking them in stride. According to this discussion of the five signs of a new bull market, the only one missing as of the end of October was the market rallying on bad economic news. This shrug-off did occur as of last Friday afternoon, after the $3.5 billion October drop in consumer credit was released, but there have also been drops when other bad economic news came out. I evidently jumped the gun as of seven weeks ago, but later action (despite an unnerving plummet in mid-late November) has largely suggested a bottoming process. (A graph of the S & P index is here.)
There still is lots of grist for any of the now-more-vocal bears out there, especially since the bull case seems to have been reduced to "the government will save us." I'm sure it'll work this time ‘round, but it won't work forever. In fact, it's conceivable that the next bailout, or the one after next, might very well make things worse.
The "Gimme-Liquidity" Trap
Although "moral hazard" is a term well-known and oft-used, it still has a polite edge that puts a robe over the less salubrious details. Those details tend to be further concealed in times like now, when widespread cynicism regarding motives may encourage government officials to contemplate a completely different type of hazard: letting the one-horse-shay fall where it may, at the risk of a much more serious downturn. Those less skeptical of interventionism would undoubtedly substitute "playing Russian roulette with the economy."
Nonetheless, "moral hazard" is a refined term for gaming the system and aiming at a favorably rigged market. As the United States begins to more closely match Larry Kudlow's appellation "Bailout Nation," it has become opportunistically profitable to wait for a bailout when trouble comes. Instead of exhausting all alternatives, there's more of a temptation to exhaust all standard alternatives while claiming that "all" of them were tried. Again, this can't be helped in a real crisis; unconventional alternatives most closely resemble wishing for Superman at those times. This common-sensicality, though, does airbrush over the previously-well-sung entrepreneurial creativity that does come to the fore during crises.
It is hard to tell if businesspeople are frozen because of beggaring, or truculence, or plain fear. And, of course, a time like this one is ostensibly the worst, or most impractical, time to enquire. Most likely, any bailout gaming is largely admixtured by a well-informed sense of real doom – if there is any gaming at all right now. It's hard to avoid the conclusion, though, that Bailout Nation is giving rise to another kind of liquidity trap, one peculiar to an interventionist economy: the "gimme liquidity" trap. It works though businesspeople switching to fright mode when in real trouble, until they're saved by a rescue package from the government.
Permanent Deficits and Hansen's Revenge
There's an offshoot of liberal Keynesianism that's been sitting on the shelf for decades, because it's been almost completely crowded out by the new Schumpeterian mainstream. It's Alvin Hansen's theory of the mature economy. Once an economy becomes mature, according to Hansen, permanent unemployment and below-potential stagnation result; the only cure is for the government to run a permanent deficit.
This theory may seem fit only for the dustbin, given the creative destruction in the U.S. economy since the 1980s, but it's lodged in the attic for a good reason. The Information Revolution grew out of the United States at a time when the U.S. government had in fact been in near-permanent deficit mode. A Hansenite could emerge with enough brass to claim that the post-modern gales of creative destruction and innovation were caused by a budget-deficit economy, which ablated the stagnation enough to get new innovations off the ground. There's enough wiggle room between the late 1990s surpluses and the implosion of the tech bubble to make it sound plausible from a brassy Hansenite. Note how it speaks to, or speaks for, the huge deficits that the early Obama administration will be facing.
If this rationale for the innovation cycle should gain popular currency, then the quest for a U.S. government balanced budget might as well be crated itself. It might even end up being cratered – especially if those huge deficits do not provoke any crowding-out of capital or hikes in inflation. If that flip-around seems near-impossible, consider how legitimated the U.S. trade deficit has become.
"So Long, And Thanks For All The Investment!"
Back in the now-olden days on Wall Street, Merrill Lynch was famous for its new-hire training program. So famous, it became seen as a wise move to: get hired straight out of college by Merrill; stay for their training program; skip out after whatever interval the skipper-outer considered decent. The opinions of Merrill executives about the attenuation of their investments in training weren't quite made public.
In the U.S., the present-day analog to the Merrill training system is the university system. The same pattern has emerged: foreign students move from home to study in American universities, (possibly) work for a time in America, and then go back home to apply their knowledge for a home-grown company. Often, an additional benefit does come through said foreigners setting up factories on U.S. soil…while leaving engineering control to their own crew.
This pattern reveals a competitive advantage in those lands vis-à-vis the United States: a co-operative system of business regulation. I don't meant that the regulators and regulatees have regular summit conferences, attend touchy-feely sensitivity training courses, set up a revolving-door system through lobbyists, or sing "Kumbaya" together. By "co-operative," I mean that the regulatees take an interest in the regulations and the regulators take an interest in the industry they're overseeing. This system allows the regulatees to think and experiment without worry about regulatory banalization, and the regulators to avoid being caught flat-footed. Many financial-industry regulators have read far more about the financial industry than the works of Martin Mayer.
No starker contrast to this kind of cooperativeness is more evident than in the U.S.-owned part of the auto industry. Big Three auto execs have become notorious for gaming the regulators, and I would be surprised if any regulator over the auto industry ever set foot in a Big Three auto factory while accompanied by the plant manager. By contrast, there is a real spirit of cooperativeness between the SEC and Wall Street nowadays. There's also similar cooperativeness between banking regulators and the banking industry. Many Fed watchers go out of their way to be more than Fed gamers: they also try to help the Fed governors.
It's this difference, not any supposed divide between Wall and Main Street, which explains the speed of the financials' bailout versus the slowness of the Big Three's. If America has any answer to regulatory cooperativeness in the emerging powers' industrial-regulation system, it would be its financial sector. If it's to be a mercantilist age, then America's world-dominating privateers are to be found in the financial industry. Shiver your timbers if you choose to.