Thursday, January 22, 2009

The Law of the Jungle

David Roche in an article in the Wall Street Journal (1-22-09) says this:

It's natural for policy makers to say, "We know where the problem at the heart of the credit crisis is: it is a lack of lending and we must get credit flowing." If only it were that simple. What policy makers on both sides of the Atlantic desire is to sustain household leverage and consumption at any price, when the only exit from the credit crisis involves a return to thrift by the over leveraged. That cannot be achieved painlessly.

This paragraph succinctly captures the heart of the credit crisis and its aftermath for this feeble mind. Essentially governments want their citizens to splurge again and continue to rack up debt. They are operating under the mistaken belief that this is the only way to keep their economies healthy. They appear not to have learnt that poorly regulated and over abundant credit led to the problem in the first place, and, as the article points out - thrift - and a return to sanity in terms of personal consumption is the only way out.

The governments are caught in a vice. Through a series of developments spanning multiple decades, the share of manufacturing in the GDP has declined and services especially financial services have gained share.

At its very core, even the most sophisticated economy today is not very dissimilar to a primitive system of bartering. There exists a symbiotic relationship between the extractors (e.g. miners) to the producers (i.e. factories) to the consumers (i.e. us) to the providers (i.e. banks, retail etc.).
There is a give and take between these sectors and there is an intermingling of roles. In a global economy, these roles are not all represented equally in all economies as some (U.S.) consume more and take a hyper consumer/provider role, while some (China) take on the producer role. Granted this is an oversimplification, but this is all this feeble mind can grasp and it provides a framework for the money flow in societies.

A miner may sell his ore to a factory and buy a car from a dealer after taking a loan from a bank. When the extractor/producer sector is in decline in an economy, the provide/consumer sector races in to fill the void. However in the absence of the former, the latter turns to cannibalizing itself trying to create prosperity without offering any tangible goods or service but merely by manipulating its instruments - be they stocks or real estate or derivatives. This results in a bubble that inevitably bursts.

When we disturb the equilibrium by focusing one sector - finance - at the cost of another, a period of turmoil inevitably follows. This is not dissimilar to the law of the jungle. There exists an equilibrium between the predator and the hunted. However if due to some reason, the predators get an advantage that makes them multiply, they will exhaust the forest of its food and will be forced to dwindle to a more sustainable level.

As stated in the article, consumers have splurged. The predators have hunted and decimated the forest. To nurse the forest back to health, you do not send in helicopters to drop food to the predators to sustain their numbers, but you let the chips fall as they will so that the predators slowly dwindle and other animals make a comeback.

However as a developed and humane society, we help the citizens affected so that the recovery as it happens does not end up making them destitute and they emerge stronger in the future.

And the recovery has to bring about some sanity in sectors. If post recovery, the financial sector continues to dominate other sectors, the relief will only prove to be temporary and the precursor to a longer famine.

How the global economy recovers is anyone's guess. A painful scenario would be that a combination of lowered standard of living, fuel prices and credit tightening would result in manufacturing making a comeback. Another, more plausible scenario would be the recently talked about separation of toxic assets that would free up the good economy to return to business as usual. However, the toxic assets will cast a shadow and its effects may touch us all in terms of taxes and currency fluctuations. It would be a successful resolution however, if the private sector is allowed to thrive again without too much government intrusion because in the ultimate analysis, they are the only sector that has shown that it can consistently build wealth.

Thursday, January 8, 2009


So what will 2009 hold for us? In these early days we have
  1. Fed interest rates at close to zero.
  2. Fighting in Gaza/Israel.
  3. Somalian pirates still holding a tanker and a few ships.
  4. The DJIA around 8600, the S&P around 900 and the Nasdaq around 1600.
  5. Scandals that are still brewing from Madoff to the Illinois senate seat controversy.
  6. Gas at around $1.60.
  7. Anticipation on Obama's inauguration.
  8. Money, job and home value worries.
  9. Uncertainty about the economy - will it get worse or will it get better?
  10. Ongoing conflicts in Iraq and Afghanistan.

A lot depends on whether a person is an optimist or a pessimist.
And a person's optimism or pessimism really depends on whether he has an income coming in and if he/she can make ends meet.

This feeble mind this that, that is the key to success in 2009. It includes
  • Live within your means.
  • Pay off all your debts including mortgage.
  • Save a year's worth of living expenses. This should include estimated Cobra payments, home, car, flood, umbrella insurance, car and mortgage payments, school/activity fees for children, any estimated co-payments, food and clothing allowances and up to $10K as an emergency reserve on top of the other estimates. This is a tough goal and may not be achieved in one year but we need to get realistic on what a year's living expense really means.
  • Hold on to you job in any way possible.
  • Don't cave in to impulses small ( a new cellphone) or large ( a car or a pool).
  • Stop looking at ads. You are not helping the economy by spending, you are only hurting yourself. The economy will find ways to adapt.

I guess the above proves that I have a pessimistic view, and to be honest I suppose I do. I am not overly so but just like companies tighten their fiscal policies and curtail spending in tough times, so should you.

I am however hoping that the year turns for the better

  • That the economy stabilizes after the job losses and contraction.
  • The middle class get some safety net that prevents them from going destitute after a illness or job loss.
  • The government goes after hedge funds and regulates them better rather than imposing more burden on a regular business a-la Sarbanes-Oxley.
  • The big 3 automakers produce vehicles that people buy for their mechanical merits rather than for patriotic reasons.
  • We get some closure of a successful nature in our overseas military undertakings.
  • We end the year with cautious optimism.

So...happy new year!