Monday, January 16, 2012

Occupy, Trouble in Europe

Greetings from the Unrepentant Capitalist.  I've been MIA for a few months, but it's time to get back to the important business of capitalism and economics.  The fact that my absence almost perfectly overlaps with college football season is purely coincidental.  Side note, the Unrepentant Capitalist's alma mater had a pretty good season and won an upper tier bowl game.

So what were the big stories of the Fall?

Occupy Wall Street

The Occupy movement set up their first tent city in the Manhattan Financial district which was quickly copied in numerous cities across the country.  The Occupiers have never been able to clearly articulate what they are for, but seem to generally be against Wall Street and the top 1% of income earners.  It’s always easier to be against something, but harder to be for something.

As I've said in this space before, pinning blame for the great recession of 2008-2009 on any single group ignores reality.  The Occupiers want to fix blame solely on Wall Street, and not consider significant contributions from the federal government (encouraged low or no down payment loans which led to over-borrowing), house flippers (bought homes with low or no down payments to quickly sell at a profit), the Federal Reserve (held interest rates too low for too long), mortgage brokers (compensated to originate loans that were quickly sold), homebuyers (buying more house than they could afford), and the consumer in general (in total, consumers have taken on too much debt). 

Wall Street and the financial community certainly contributed to the problem, but by no means created the problem alone.  A sore point with the Occupiers is the bail outs the banks received from the Feds.  Ben Bernanke (Chairman of the Federal Reserve) and Henry Paulson (former Secretary of the Treasury) said they were troubled by the bail outs, but at the end of the day, these guys were pragmatists and understood the unique role the banks play in our economy, so they bailed away.  Ours is a credit driven economy, and with credit frozen (and that's where we were headed in the fall of 2008) serious trouble was right around the corner.

The bail outs were also troubling to the Unrepentant Capitalist.  The Federal Reserve is designed to be the ‘lender of last resort’ to provide liquidity to the banking system during times of crisis.  There’s a big philosophical problem with this—the moral hazard question.  Does the Federal Reserve bailing out banks today fuel reckless banker behavior in the future?  When looking at a risky deal somewhere down the road, would a banker ever think, ‘This deal I’m looking at is a big risk, but hey, they bailed us out before.’  If enough bankers think this way, problem.   

The wealth and income of the top 1% are also in the cross-hairs of the Occupiers.  If the top 1% makes their money at the expense of the 99%, the anger would be justified.  I don't think that's what's happening.  It's important to remember that the economy is not a fixed pie where one person's gain is someone else’s loss.  Ours is a growing economic pie where the 1% contributes, the 99% contribute, and the pie gets bigger.

I spent some time in the consulting business where I had the opportunity to interact with a number of the wealthy people.   The 1% I’ve met have been bright and hard working.  Shrewd, driven, hard nosed? Yes.  Lying, cheating, exploiting?  I haven’t seen it.  I did see people who worked hard, risked a lot of their own money, and built successful businesses that brought goods and services to the market and created lots of jobs along the way.  We should be encouraging the 1% instead of going after them with torches and pitchforks.  Have some rich folks cheated?  Of course.  There are cheats among the 1%, among the middle class, and among the lower income group.  I think there's a segment of the population that feels better about themselves if they think the rich have become so through unsavory means.   Demonizing the rich also gives politicians justification to raise their taxes.

Debt Problems in Europe

The other big story has been the debt crisis in Europe which has been unfolding like a slow moving car wreck with no end in sight.  

The problem started when a few European Union (EU) member states—Portugal, Italy, Ireland, Greece and Spain—hit excessive debt levels and lenders started to wonder if these debts would be paid.  The EU seems to have taken steps to avert a similar crisis in the future, but have not yet come up with a market satisfying plan to pay off the current debt.  The markets are wondering how strong the 'Union' in EU is and if the financially stronger members (like Germany) will bail out the weaker members.  No surprise, but the average Joe (or maybe Johann) on the streets of Munich is not keen on bailing out the others.

The crisis seems to be pushing the EU towards one of two outcomes—splitting up or doubling down on the union bet with even tighter economic integration.  Euro leaders keep choosing 'none of the above' and the crisis continues.  

Splitting the Union would lead to currency chaos and would be a painful end to a 20 year experiment.  Tighter economic integration would mean EU members would have to submit their budgets to bureaucrats in Brussels for approval and face penalties for not meeting spending and debt guidelines.  No wonder they keeping choosing 'none of the above'.

This mess has the Unrepentant Capitalist wondering why they organized the Union to begin with.  Economists warned European policy makers of the very problems the Union is currently facing.

Asking Euros why the EU is a good idea is typically answered with something along the lines of 'the EU gives Europe the scale to compete with the US and China.'  The Euros are operating under the misguided notion that size and scale translates into economic advantage and success.  As a rebuttal, the Unrepentant Capitalist would point to the white space on the EU map called Switzerland.  The Swiss don't join much of anything (they do send a nice ski team to the winter Olympics) but the country of 8 million is a  long standing economic success story.  

Far from helping, the current crisis shows how the currency union has severed an important monetary feedback loop that can help countries recover from economic downturns.  When a country goes into a recession, its currency weakens relative to other countries and its stuff (exports and assets) become cheaper to the rest of the world.  Cheaper stuff stimulates demand from the rest of the world, and the rest of the world's money flowing in helps pull the country out of its recession.  Monetary union tends to pull member countries towards the average.  So where Spain, for example, would normally be helped out by a weak currency, they have a stronger Euro instead, and no one is buying Spain.

I'm not sure how this story ends, but we should use the crisis in Europe as motivation to fix our own budget problems.  Does anyone think the Euros got into their current jam by spending too much or taxing too little?  For years, they've spent too much and taken on too much debt.  Unfortunately, their economies have now become too dependent on government spending, so the spending cutbacks currently being contemplated will keep their economies in low gear for several years to come.

We need a long-term plan (10+ years) that backs off the spending throttle, simplifies our tax code, and repairs our financial position.

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