Twofish's Blog

May 15, 2009

Pain and Gain

Filed under: china, finance — twofish @ 5:44 am

http://blogs.cfr.org/setser/2009/05/13/not-putting-your-money-where-your-mouth-is/

WStroupe: Far too many people here and most everywhere evidently fail to see this crisis in its correct fundamental perspective, namely, the crash of the asset-based model itself.

I’m not seeing it because I don’t think it is true.  You’ve had asset booms and busts happening for the last 200 years, and I’m not seeing anything in this bust that is fundamentally different from what happened in the 1920’s.

In fact, I would argue that the big mistake that people made was the notion that the economy fundamentally had changed, when in fact it had not.

WStroupe: It’s about switching back to a more traditional income-based model. That will be a gut-wrenching process entailing far more pain and suffering than the U.S. has experienced so far, and it only gets worse the longer U.S. leaders waste precious time and money trying to revive the asset-based corpse.

I really don’t think so.  What the US has to do is to boost savings and cut consumption.

Annoying yes, but not the end of the world.  What happens when you boost savings, is that you increase productivity so the amount that you save comes back to you in higher wages.  OK, people go from -2% savings to 5%.  Moderately annoying, but no one is going to starve, and that money is going to come back to you.  You save 5%, a factory gets built, you get a higher paying job.

Take your 401(k), people were assuming 10% growth, now assume 3-5%.  The numbers that come out are somewhat ugly, but they aren’t disastrous.  What will cause massive financial disasters to most people is if they lose their jobs for an extended period of time.  If you are typical and the return on your pension goes from 10% to 5%, it’s ugly, but not the end of the world.

For most people under 55, if you are out of work for a year, then it is the financial end of the world.  Imagine what happens to you if you lose your job for three years.  You are never going to bounce back, so this is why it’s vital to get people back to work, because most people under 55 people have personal financial situations in which even if you have a massive boom after three years of unemployment, it’s not going to be of any help to you.

And God help you if you get sick during those three years.  Without fundamental changes in the social system, if you get hit by a car while unemployed, you are going to be in poverty for the rest of your life.

I don’t see anyone trying to revive the corpse.  If you disagree, go to a bank and try to get a subprime mortgage today.  The money and effort being spent involves burying the corpse, which can be frightfully expensive.

There is this very popular notion that in order to get something you have to undergo a lot of pain.  What that ignores is that you can undergo a lot of pain, and still get nothing.  I’m extremely skeptical of the idea that just because an idea is painful, you end up getting some benefit out of it.  It has something to do with Stalin, Mao, and the Great Leap Forward.  In the 1950’s, Chinese were told that if they sacrificed for the common good, there would be a few years of pain and then this economic boom.  So there was a lot of pain and then nothing.

So when someone says “you have to go through this pain to get to the boom” I’m really skeptical because I’ve heard that before.  There is also the early-1990’s when you had large number of people saying that Russia would boom and China would stagnant because Russia was taking strong medicine whereas China was not.  Things didn’t work out that way.  The first thing I ask, is “is this pain *really* necessary and if it is then what are the ways that we can reduce the pain?”

Also if you talk about getting rid of the old system and going for this wonderful new system, I keep thinking “wasn’t that what Mao and Stalin promised?”  OK, you claim you are different.  That’s fine.  Explain to me how you’ll end up with a boom, and give me numbers.  How much needs to be sacrifices, for how long, and at what point do you throw up your hands and say, well maybe I was wrong about what the problem is, and we need to do something different.

If what you propose will have me accept a 5% return on my 401(k) and a 5-10% tax increase if I hit the jackpot and make more than $250K, that’s fine.  Annoying, yes, but survivable.

If what you propose has me out of work for two years, at which point I lose my house and savings, and have no insurance, then this will not work because I’m busted even if the economy comes roaring back, and if you multiply me by fifty million, I don’t see how the economy is *ever* going to recover.

Also, this plan has another big, big problem.  If I lose my job for two years, I’m wiped out.  The ex-CEO’s of Bear Stearns, Lehman Brothers, General Motors, AIG, Citigroup, and Enron all can survive two years without a job or health insurance.  If you blow up the economy for two years and then you have a massive boom, I’m going to be in poverty for the rest of my life.  They aren’t, because they have enough money in the bank so that two years without work or health insurance is a vacation, and so a bust then boom is going to benefit them, not me.

If the choice is between is between two years of hell followed by a boom, and Japanese style zero-growth economic stagnation then I vote for zero-growth stagnation, and so will most people.  If this doesn’t work for you (and it doesn’t work for me), then come up with another choice.

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