doctormuse.com

Macro Economics 101: Lets not over think this.

Since October 2007, how many hours has the public logged listening to CNBC?  Ratings agencies probably could quantify the number, but my guess is the number is surprisingly if not shockingly substantial.  Take the number, do a cost/benefit analysis using variables like ad revenue generated, lost worker productivity cost, psychological trauma attributed to bad news, media jobs created, etc.  Take all these variables and come up with a positive or negative number.  A positive number implies the program has created value to the public and a negative means the program has left us worse off than had we never watched the program.

Singling out CNBC is unfair.  We could just as easily look at the War in Iraq, the porn industry, cosmetics, health care, etc. and conduct similar cost/benefit studies to determine overall value to society of each sector.  For example, had the conflict in Iraq been quick, efficient, low in casualties and resulted in a Democratic government that was self-sustaining one could argue the cost/benefit value was strongly positive.  On the other hand, judging from the overall outcome; dollar cost, lives lost, greater worldwide instability all in exchange for the ousting of a terrible dictator many would argue the cost/benefit reward of the war was strongly negative.

I don’t claim to have the highest IQ and I didn’t attend an Ivy League College.  Einstein fascinates me but I don’t apply his theories when balancing my checkbook.  So when I think about the War in Iraq it helps if I simplify my thought process.  A white fence surrounds my house.  The fence keeps my dog from running out into the street chasing cars and dogs.  It also keeps animals from coming in, thereby protecting my cat, dog and vegetable garden.  Occasionally, a rabbit or dear may breach the fence and look for a tasty meal of Hosta, Day Lily, or lettuce.  When the dog and cat are outside the dear and rabbit look elsewhere to satisfy their dietary needs.  It’s a pretty good balance, the fence cost me less than one percent of my annual income, it has some esthetic value, is not obtrusive and I feel a little safer with it in place.  Is it Star Wars, certainly not, but it works, and it adds value to my life.  February 24, 2009 President Obama assured US citizens that soon the dollar cost of the Iraq war would be transparent.  I am guessing, but one doesn’t need a high school diploma to predict the cost will be greater than one percent of our GDP. The question is how much greater will it amount to?  Did we realize any value for the expenditure and what are the consequences of overspending for this war?

How about Wall Street?  In 1976 the financial services sector grew to 6% of the S&P 500 index when 40 firms were added.  Three decades later the market capitalization of the S&P grew to an astonishing 21% of the S&P 500, by far the largest component of the index.

According to the skilled investor.com http://www.theskilledinvestor.com/wp/

“Financial services sector equity market values rose, crashed, and will rise again, in part, because the mass of American consumers are just like trusting, docile sheep regarding their personal financial affairs and the amount they are willing to waste on overpriced financial services.

Far too many US consumers pay far too much and get woefully little value in return from the financial services industry, including its securities and investment sector. The industry repeatedly scrapes the consumer excess off the table and stuffs it into its salaries, bonuses, and corporate earnings reports. Consumer overcharges just drive up the portfolio values of those who own its financial services industry equities. There really is no reason to believe that things will ever change.”

While industrial, agriculture, technology and service industries were plodding along making their products, financial firms were growing exponentially, creatively finding ways to extract value from businesses by dividing them up, repackaging them and selling them to the highest bidders.  The fees generated were enormous but nobody seemed to care because their client corporations were also benefitting with oodles of cash generated from stock and bond offerings.  The question people should have been asking and most certainly will be asking in the future is was the product provided by the financial services industry of intrinsic value to the public or was it self serving?  In hindsight, we now realize that a large part of the industry was selling financial packages to investors where the primary intent was creating revenue for financial firms.  Had we only taken to heart the lesson Richard Gere learned when he so masterfully portrayed a corporate raider wooed by Julia Roberts in the movie Pretty Woman maybe we wouldn’t be in this devastating predicament.

Don’t nail the financial firms to the crucifix so fast.  These firms serve a useful function especially in a society vastly dependent upon currency exchange.  Managing transactions, lending for startup companies, financing expansion in existing companies are all necessary for economic growth.  Somewhere, however, the scales began to tip in favor of the financial companies.  When the banks, lending institutions, brokerage houses and insurance companies discovered they could collateralize debt and sell it as derivatives their profits began to skyrocket.  As profits escalated investors bought more shares in the companies.  Insiders made millions and bonuses became entitlements.  Wall Street argued what was good for Wall Street was good for the economy.  Millionaires spent their millions, stimulating other businesses, and the cycle continued.  The only problem was the financial companies weren’t servicing the public with a product commensurate with what they were being paid.  They were serving themselves more than the public.  The companies had no tangible assets and in effect their value was based on expectations the cycle would continue.  When so much of our economy’s asset base is contained in a sector whose value to the public is significantly less than its value to stockholders an unsustainable imbalance will eventually occur.  In simple terms it was a pyramid business model.

Several of my friends and clients are “trust fund babies.”  Some consider them blessed and others call it a curse.  Although they live with little financial duress, many function outside normal parameters of society because they don’t work.  When I’m having a bad day I think they’re lucky and on a good day I feel sorry for them.  If a disproportionate number of  “trust fund babies” made up our population the system would fail.  Inadequate supply of services and products available for consumption leads to inflation and currency devaluation.   For example, if every person capable of entering the work place decided they didn’t want to work because they had trust funds to support them a dearth of product, entrepreneurial activity, and GDP would result.  The argument that they support the economy with their spending doesn’t hold water.  It’s the same argument Wall Street bonus people used and it’s the same answer.  Their “trust fund economy” is self-serving and fails to generate anything of value to the overall population.

I never was a big fan of Mario Cuomo while he served as Governor of New York.  Don’t ask me why because it was too long ago for me to remember.  Recently however, On February 5, 2009 Tom Keene of Bloomberg radio interviewed Governor Cuomo about President Lincoln.  The interview revealed Cuomo’s in depth knowledge as a historian and in particular of President Lincoln.  He described Lincoln as the greatest president of our nation using terms like “common sense and benign pragmatism.”  Towards the end of the interview the subject switched to religion and the two common ingredients of every religion.  Simply stated they are:

1.         To love one another.

2.         To work to make the place better.

Cuomo’s simple yet elegant description is relevant to this essay because of the similarities between “making the place better” and creating products and services of “value” to the population.  Looking at the big picture, economies thrive when people work to create a better quality of life for the populace.  When Bill gates and Steve Jobs competed to bring personal computing to the general population economies prospered, communication was enhanced and most would agree the world became a better place.  On the other hand, whereas drug trafficking sales support economies of several third world countries, the worldwide destructive cost of illegal drug use greatly outweighs the benefits of prosperity it creates in miniscule sects of the drug trafficking countries.

Bush signed onto and Obama inherited a large fiscal stimulus package.  Journalists were quick to recognize the significance of the legislation.  Where private enterprise and capitalism had failed, the US government now had an opportunity to succeed.  Media’s advice to Obama was “spend the money wisely.”  CNBC has invested hundreds of hours debating where the money should be spent.  Should the money be spent bailing out financial institutions, automakers, homeowners or the very taxpayers who will eventually pay for the stimulus?  There doesn’t appear to be a clear consensus, however, most agree the money’s purpose is akin to applying defibrillator paddles to a patient in cardiac arrest.  The sooner the patient’s heart begins to beat on its own the sooner the economy can recover.  Congress and Wall Street are duking it out over utilization of the money for short-term or long-term initiatives.  Wall Street wants all the money put to use right away and Congress is reverting back to Macro-economics 101. 

The public is left wondering who to believe, a private capitalist sector responsible for mismanaging its people’s future or a government caught sleeping while the kids raided the cookie jar.  The answer, and unfortunately, at least for the time being rests with government supervision.  Wall Street’s reaction to Congress’s long-term initiatives was more pain, albeit necessary pain to clear the path for gain.  The message is clear. Businesses lacking relevance and devoid of meaningful value will be stressed.  Their long-term viability will be challenged even if their balance sheets are currently viable.  Mismanaged industries that are paramount to our culture’s continuity will be jump started, restructured and reinvented with our government’s supervision and blessing.

CNBC’s thousands of hours spent beating this crisis to death should be captioned. “Macro-economics 101: Let’s not over think this.”