GM

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Supply Or Demand: Where’s The Problem?

We are all familiar with those old supply and demand curves so beloved of economists. Ever since Alfred Marshall introduced them to the world, economists have deployed them to illustrate and to help solve every problem imaginable. Yet the current crisis has opened up a chasm between the two. There are some who believe our crisis is driven by a shortfall in demand – fix that and all will be well. There are others who decry such a view and call for the bolstering of the supply side. These supply siders typically call for the easing up of corporate regulations, the elimination of wage restrictions like the minimum wage, reductions in payroll taxes, additional corporate incentives to encourage investment and so on. Their idea being that by freeing up businesses to generate profits we will simultaneously create the environment in which business starts to hire workers. Thus our unemployment problem will go away. To the supply siders the fact that we still have high unemployment is evidence that the market is being prevented from working its magic.

As you all know by know I find the supply side argument so weak that it is non-existent. It is vapor born of a belief in magic. The facts destroy it in an inkling, yet it persists.

Here’s a little evidence:

Corporate profits are booming. That’s right. Even though the economy remains mired in a no jobs malaise, business is wallowing in cash. This implies that the connection between productivity, profit, and wages has been undone. It was this connection that provided the engine for middle class comfort and wealth throughout the post war decades. As productivity grew, usually from technology improvements and the displacement of workers by machines, the profit generated was shared with the remaining workers. Wages rose in line with productivity. The perfect example of this from history is American agriculture: we produce far more now than we did a hundred years ago and yet the number of farm workers has shrunk to almost negligible levels. The labor thus freed up from the land went into other sectors of the economy, providing the workforce for industrialization and then the service economy we now have.

But corporate profits are booming now, and wages are flat. Not only that, but corporations are not hiring despite being flush with cash. They are hoarding instead. And many are contemplating raising their dividend payout to shareholders.

This means that providing extra incentives is completely unnecessary. Companies already have cash to invest if they wanted to. We don’t need to give them tax breaks or reduce red tape. They don’t want to invest. Giving them more cash is just a waste of time.

Plus, many of the big companies – GM is a good example – are creating more of their profit abroad rather than here. There’s no harm – perhaps – in that as long as we don’t provide the cash with which they go and generate jobs abroad. American taxpayer money should be used to bolster employment here not in China and elsewhere. GM now employs 52,000 workers in the US. It has 32,000 workers in China. It now sells more cars in China than it does here. In the old days a boom in a foreign market meant more jobs here and a similar boom in exports. No more. That surge in GM sales in China is met from production based there. Yet American taxpayers bailed GM out to save jobs here. The cash we infused into GM has gone towards building facilities offshore. Yes the skeleton of the old Detroit based GM was saved. But that 52,000 workforce today compares with a peak of 468,000 back in 1970. Now that’s a productivity gain. Coupled, as it turns out, with a ton of offshoring.

So GM’s shareholders are seeing a very different picture than its workforce. The two groups have a totally different perspective on the economy.

Profits are booming. Dividends are rising – Wall Street is clamoring for higher payouts rather than higher investments. And jobs languish. Capitalism flourishes while the middle class swoons.

The supply side argument has no impact on any of this.

Cutting wages, as many of them suggest, merely inflates profit. There is no evidence that business would hire more workers even if wage costs dropped. Why? Because there are no sales to justify expansion. Companies like GM are content to meet demand from current capacity. Even a near term growth in demand would be met from extending work hours of the current workforce rather than adding more workers. In other words GM would drive up productivity rather than add capacity. It’s more profitable in the short term.

That is where we are. Business is raking in the cash and simply sitting on it. Rather than boost capacity, and rather than make more stuff, they prefer to hoard cash or pay it out in dividends. That’s their right of course. My point is not to decry dividends – at least not in this discussion – but to argue that we obviously don’t have a supply side problem.

All the evidence contradicts the supply side argument. Yet we still hear it in influential circles. I am sure the Chamber of Commerce would like taxpayers to ante up more goodies for business. I understand why those folks want to press the supply side argument. But anyone else? That baffles me.

Meanwhile, back in the evidence based world of reality, our economy continues to suffer from a severe shortage of demand. That’s why corporations are forecasting poor sales volumes. With households using their incomes to cut debt rather than increase consumption, and with middle class wealth under siege from collapsed house prices, negligible wage growth, cuts in benefits, and perpetually rising health care and education costs I just cannot see a reason why consumption will accelerate much near term. Our lack of demand is set to be with us for a while.

So we have a demand problem. This, of course, screams out for more stimulus. But with serious minded people like Bernanke now warning about the size of our deficits the chances we will solve the demand problem is diminishing. That leaves us looking at the likelihood of a long slow and perilous climb out of our malaise. Along the way we will forego a massive amount of wealth we will never be able to recoup. The loss will fall mainly on those in the middle whose opportunities will narrow well below what they were even a decade ago. We seem determined to diminish ourselves. Quite why, when we know how to stop the rot, I cannot say. Our demand problem is tractable and solvable. We know how to deal with it. We just lack the will. In a sense we have capitulated to the scope and size of the problem. We imagine it too large, so we succumb.

That’s a shame.

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Cheer Up Obama

The fine line between economics and politics has frayed this last week in the aftermath of the Massachusetts election result. I never thought the line was substantial anyway, but that only served to place me on the edge of economics rather than invalidate what I thought. After all for the first hundred and fifty years of its existence the study we know simply call ‘economics’ was called ‘political economy’. The greats of the 1800’s – Ricardo, Marx, Bentham, Malthus, and John Stuart Mill – would all have thought of themselves as working within political economy. Indeed their primary motivation was to place economic thinking at the service of the burgeoning industrial societies of the western world. This began to end in 1870 with the beginnings of neo-classical economics and its founders – Jevons, Menger, and Walras – who conceived of economics as a science and dropped the political attachment to emphasize that point.

And what’s this to do with Obama?

Simple: the message, to the extent there is a coherent message, he should have received is that it is the ‘economy stupid’.

Fancy words and strategies in Iraq, Afghanistan, and anywhere else simply don’t count. People want jobs. Period. Survey after survey. Poll after poll, say the same thing: the number one issue in the minds of voters is the economy and its continued deplorable state. Foreign policy and even security is a minor side show by comparison.

And let’s get reasonable: Obama’s ratings are still very strong. He outpaces both Reagan and Clinton by good margins in his popularity. He is not about to collapse. If my memory serves me correctly both those gentlemen emerged as two term presidents. I expect Obama will as well.

So cheer up Obama.

There is one thing to focus on. Which makes life simple. Indeed the politics of the next year is uncomplicated.

Economic policy is the only battleground that the voters want to see energy expended on. So get to it.

The damage from that election is not all that great. Health care reform can still get done, albeit in roundabout ways. Indeed the loss of a seat may focus the Democratic leadership on being more inventive than they have been. A big ‘if’ I realize. Especially with the level of mistrust that has emerged between the House and Senate Democratic caucuses. All the Democrats have to do is copy the way in which George Bush forced through legislation. Use all the rules to your own advantage and marginalize the minority.

Simple.

Now about the economy …

Let’s begin by harnessing all that popular anger at the banks. Get out in front of it. Stop being seen as stooge of the banks. Too many of the administration’s key players are seen as bank insiders – Geithner in particular. His unfortunate comments after Obama’s speech last week introducing the ‘Volcker Rule’ as policy shows that he doesn’t get it. The days of playing nice with the banks are over. The public wants blood, they should get some. The key is to deliver what the public wants without ruining economic policy. My view is that the public is right on this one: the banks screwed up, they have shown no ability to self reform, and they continue to spit in the face of regular people. The banking industry has not cleaned up its act at all. None of the senior managers who oversaw the implosion have been fired. The only leadership change has been at Bank of America, and there it is only skin deep.

When banks lose billions the entire executive team needs replacing. Even the blameless get thrown out.

Obama pulled the plug on GM’s febrile leadership, why not on Citibank’s? Especially since the social cost of Citbank’s failure is far greater than that of GM’s.

By failing to deal with the banks Obama has cast himself as an insider insensitive to the hardship that the greed of Wall Street flooded the country with.

Being a Wall Street insider is not a popular place these days. Hence the quick pivot on economic policy and the Volcker Rule.

But.

Words are easy. Sometimes too easy for Obama. Now he needs to force some action.

He needs to change his economic team to get it into line with popular demands. Geithner must go. So too must Summers.

The case for getting rid of Summers is even more clear in my mind than that for Geithner. Summers is tainted by his years as an advocate of banking deregulation under Clinton. His conversion to regulation appears skin deep. Plus his advocacy of caution last year when the stimulus was being put together was a major error: that failure alone has caused much of the political pain the administration is now feeling. A larger stimulus would have eased the unemployment situation. Instead we are now caught in no man’s land, with a new stimulus ruled out for political reasons – although I would like to see that tested – and the jobs market stuck.

Lastly we need honesty. The economic recovery will be slow. Let’s be straightforward about that. Voters know how tough it is. They want to make sure that the toughness is not focused on them while others make off with scarcely a scratch. But more than that the voters need to hear that all this pain will not be pointless. The adjustment in the economy that we are going through is to make a long term improvement: less debt reliance and less finance. More basic industry and investment in the future. Less trickery and more service. Less marketing hype and more useful stuff that people both understand and want.

And they need to be told that the economy cannot support all the things we want simultaneously. We cannot afford expansive foreign policies and an unreformed health care system. Offense Defense spending needs to be reined in and made more cost effective.

The middle class has been squeezed over the last two decades: health care, education, and housing costs have all escalated way more than wages. The stress of maintaining a decent standard of living showed up in those ludicrous real estate loans, and in ever increasing credit card debts.

One little noticed comparison in the current crisis is how similar education and health care costs are: both are driven up by industries in which normal incentives of cost control do not work. Both are essential to a middle class way of life, but both are impervious to change. As a result both are corroding the American dream.

Economic policy needs to address the realities that voters feel. Those realities extend beyond the short term erosion of work stability and jobs. It reaches into the destruction of the employment contract by employers who protect short term rather than nurture long term profit – the result being a more volatile work experience and heightened risk for average workers. This volatility came right at the time health care and education costs exploded without any real increase in service. The shift in the economy was asymmetric: workers were forced to absorb all the risks without getting any of the rewards. It is no accident that the only economic measure to match historic growth rates during the last decades was corporate profit. Shareholders offloaded risk onto the workforce who got nothing but short shrift.

A natural consequence was that voters turned increasingly towards self destructive pattern of behavior: voting for tax cuts that scarcely affected them yet bled the Treasury dry; attacks on government services that were badly conceived and delivered instead of seeking to improve them; a reliance on debt rather than equity; a mistrust of the soundness of safety net inherited from the New Deal; and an uninformed reliance on market magic as the salve for all ills. In short the Reagan illusion. People kept voting for policies that heaped responsibility on the individual, but which also stripped those same individuals of the power to compete. It was a doomed enterprise. They were doomed to drown as those with privilege raced ahead. The result is a return to pre-New Deal levels of inequality and an attack on the middle class. The voters forgot that the New Deal was the foundation upon which the post war middle class was built, and that free markets are vicious places for the relatively weak.

Obama now has the task of turning back that tide.

He can begin by harnessing the popular, and justified, anger at the banks and starting the long road toward re-establishing a better balance between regulation and laissez faire.

He is helped by the fact that his opposition is embedded deeply in the Reagan world: the GOP has no economic policy other than that we just saw implode. They should be easy targets. As long as Obama frees himself from Wall Street.

This was never going to be an easy year: all the evidence pointed to a jobless recovery. That Summers and Geithner failed to respond with strong action and preferred the safety of the trade methods tells me that they misjudged the depth of the problem. They want to tinker, when we need reform.

So three things will save the day. Three actions. Three steps and Obama is assured of two terms.

One: get a jobs program now.

Two: go after the banks. Reform them and cut them down to size.

Three: replace Geithner and Summers.

It’s the economy stupid. It always is.

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Bank Bashing

Sitting, as I was this morning, reading the Financial Times an ill-informed reader could have been excused for feeling sorry for bankers. After all the sudden burst of populism at the White House seems to have caught the industry off guard. Time will tell whether the administration is serious about following its words with action – it doesn’t have a very good history in that regard – but even so the stories in the FT gave the distinct impression that bankers feel downtrodden.

Poor bankers. How on earth did that happen?

A major article ends with a longish quote from someone at UBS:

“The public mood now is that banks shouldn’t be at the cutting edge of complex financial innovation, and should be scaled back to more utility-type functions with no risk of social costs in the event of failure.”

That just about sums it up.

How do we tell the banks?

They absolutely need to get away from all those innovative things they were playing with. Why? Because if there’s one thing we now know about banks it is that they are horrifically ill suited to playing those games. Those innovations blew up. They sank Bear Stearns and Lehmann. They sank AIG which wasn’t a bank. They cost the public trillions in bail out money, lost jobs, GDP collapse, and other forms of economic mayhem.

Those innovations we want the banks to step back smartly from were about as pernicious, toxic and downright nasty as it is possible to get.

So, yes, let’s move the banks back. Stand well away! You clearly are not grown up enough to play those games.

Besides just how innovative is it to spill toxic stuff all over the place? Derivatives of derivatives stuffed to the gills with assets that everyone knows are high risk is hardly a innovation that an industry entrusted with fiduciary responsibilities should be proud of.

Nor is running a book of business at 40 to 1 leverage particularly innovative. I suppose we are not supposed to notice that one.

Nor is shorting or hedging against assets that you don’t even own very clever. Innovative yes. Border line ethical? Not even close. Way unethical in my book.

Oh, and betting that the assets you just foisted off onto a pension company will go down in value immediately hardly constitutes cutting edge innovation. Complex. I’ll concede that. So complex that stories are continually emerging that no one knew what was going on.

The problem with these ‘bankers’ is that they were confused. They thought that ever increasing and obscure legal language and accounting trickery was actual financial innovation. It wasn’t. It was trickery. Duh. But the dopes still cling to the absurd idea that securitization documents three feet thick with neat legal loopholes and phraseology straight from a the pen of ‘Kafka meets Dickens’ is something to do with finance. The entire point of that kind of ‘innovation’ is to hide the fact that the bank was being taken for a ride by the people who charged it huge fees and took massive bonuses while making sure their hands were clean when the proverbial hit the fan.

It wasn’t innovation. It was parasitism.

Be that as it may. Now the poor bankers feel misunderstood.

Having laid waste to the economy they feel as though they are being unfairly treated by the very public who just bailed them out. How odd.

Just a year later the banks are making good profits and are back to their old tricks. They are paying themselves nice bonuses and trying to make sure we all forget what occurred.

Here’s a hint why that might happen: there are millions – a record number to be accurate – of regular non-banker folks who are now unemployed for more than a year. In the same time it has taken the banks to get themselves back to payola time, millions of the peons whose taxes supported the banks on their moment of need are struggling to pay their bills. Why?

Why is it that this catastrophe haunts so many regular people?

Complex innovation. A cutting edge so sharp it sliced clean through the economic life lines of millions of folks who surely have a right to be a little upset at the banks.

Never has cause and effect been so sharply defined.

The banks deserve everything and more. Their complaints are not simply pathetic. They are laden with a contempt for the real economy.

The sad part is that the bankers whose anonymous comments litter the media nowadays don’t even understand banking.

They claim that populist revulsion is being whipped up for political reasons or that re-regulation is creeping socialism. They complain that we are seeing banking as a mere utility.

That’s because it is.

Banks are vital to our economy. We need them. They run the payment system we all benefit from. They mediate short term money into long term assets.

The first of these two functions is absolutely a utility. Go to any large bank data center and what you see is a vast utility company managing huge flows of paperwork and electronic cash. The credit card companies are great examples of this: their entire business is to facilitate economic transactions. That is a good definition of a utility.

The problem for bankers is that running a utility is not much fun. In fact it is very dull. So they try to sex it up with marketing tricks. After a while they convince themselves that the fluff of marketing is the core of the business. The utility gets hidden behind a veil of marketing jargon and the social value of what they are doing falls victim to various fads and fashions that sweep through marketing minds periodically.

The second function of banking, mediation of short to long money, is also a utility. A more complicate one, but still a utility. It involves financial risk, and therefore judgement. The problem is that mediation also gives banks access to low cost funds – through things like commercial paper as well as through standard demand and savings deposits. Those low cost funds entice the banks to play. They look for fun and profitable things to do with all that cash. If lending to companies looks too risky and complicated, as it always does, there will be a sharp employee sitting on a trading desk eager to convince bank managers that he or she can make more money at less risk. Before you know it the bank is running a proprietary trading book and being exposed to the ebbs and flows of Wall Street.

The rest, as we say, is history.

And as for the claim about creeping socialism.

Because the two major functions of a bank are utilities, society has always taken a great interest in their provision. This interest extends to the massive and continued safety net that undergirds the entire banking industry. Without that safety net bankers would have to exercise much greater caution than they do nowadays. They would have to be paragons of honesty and integrity, committed to the careful evaluation of risk. Which is exactly what most of want bankers to be.

Which leads us to the great paradox of banking: the more we protect ourselves from the inadequacies of bankers the less they behave like bankers.

In fact they become spoiled children.

Afterthought:

Much the same hubris and misunderstanding cause the downfall of the American auto industry. GM’s rise to dominance over Ford was on the back of neat marketing prowess and a steady disdain for Ford’s boring emphasis on simple engineering. GM wanted to build cars to suit people’s tastes rather than cars that were reliable and actually worked. After Ford fell for the same error the entire industry imploded as it management became more and more inbred and hyped over the message rather then the engineering. The decline of the American industry can thus be traced all the way back to Alfred Sloan – the irony being that Sloan is held up as an icon of American management genius.

Sometimes innovation can have unintended long term consequences far greater than the short term benefit. I call this the delusion of management and it affects us all. The Reagan delusion still prevents many people from seeing the enormous damage that his sound bite attacks on government, and his supply side economics still have on our economy. Marketing is useful, but when it becomes the only thing, companies and countries are doomed. Somewhere there has to be substance.

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Weekend Update: GM, Health Care and GDP

After all the chaos of the past few weeks, the ‘green shoots’, bankruptcies, inflation fears, and the onset of the health care reform campaign, this weekend seems rather quiet. That makes it a good time to recap some thoughts relating to the headline events.

GM:

  1. GM’s bankruptcy is a watershed event for the US. Think of the size: GM employs about 210,000 people worldwide and 91,000 here in the US. It has a staggering 463 subsidiaries scattered across 34 countries. Its monthly payroll bill is $476 million. It provides pensions and health care benefits to 493,000 retirees. It has 11,500 vendors and spends $50 billion a year here in the US on parts etc. Its collapse will ripple throughout that entire mess.
  2. I have doubts about its survival even when it emerges from bankruptcy. This is because GM needs more than a financial re-organization, it needs a brand revitalization which is far more difficult to accomplish. When GM entered bankruptcy it had assets of about $82 billion and debts of about $172 billion. That’s a dead company by any stretch of the imagination. More to the point: even though some of its recent cars have attracted critics adulation – the Chevy Malibu for instance – it suffers from a severely depleted brand reputation. Producing good cars now after decades of undifferentiated duds may not help in the face of the competition now ramping up for the kill.
  3. The entire auto industry is a mess. It suffers from chronic over-capacity and needs to reduce itself to a more profitable size quickly. Presumably the emerging markets of China and India will eventually outpace demand from more mature markets and so innovation and scale advantages are likely to shift similarly. GM’s strong presence in China may aid survival if that is the case.
  4. Offsetting that is the likely continued collapse of its brand here in the US. Its appeal to younger Americans is virtually non-existent. Honda, Toyota, Nissan and now Volkswagen have emerged as the suppliers of choice to younger Americans. Volkswagen is building a new factory here to produce 250,000 cars a year as it seeks to double it market share at GM’s expense.
  5. GM remains a very dull company. The word is that Obama’s auto task force were shocked at the poor quality of GM’s management. It is old fashioned, lacks focus, and too attached to the plethora of brands that sank the ‘old GM’. Heads will have to roll before we can expect a vibrant new GM to succeed.
  6. Even with the drastic reduction in costs that bankruptcy will allow – GM expects to shut fourteen factories – it is still not a low cost producer of cars. It is still burdened with huge pension and health care costs that its competitors do not have to carry, the latest estimate is that each car it will make after bankruptcy will still have to earn $300 just to pay for workers who no longer produce anything.

Overall then I see GM as a 60/40 proposition going forward. All that taxpayer money is designed to give the company a window of opportunity. The macro economic conditions it faces remain daunting. I would not be surprised to see GM going through another bankruptcy procedure a few years from now. Let’s hope not.

“The trade-off between wages and health care costs is the key to getting the average voter’s attention: they are already paying a huge price for the system’s failure”

Health Care:

  1. The interesting fact here is that we have no choice but to fix health care. It simply costs too much. The latest estimates I have seen put the total cost of health care at around 18% of GDP this year. That’s an astonishing number. Worse: no one expects it to get cheaper without radical surgery [sorry about the pun]. Indeed as the baby boomers all age and if they consume health care services at the rate their parents did, that 18% is set to become around 40% within a couple of decades. That will bankrupt the country. So something has to be done and quickly.
  2. A key fact to remember: the impact of health care on wages. It has been catastrophic. Because the US system depends on employers giving health care as a benefit its rising cost has squeezed employer’s ability or willingness to give pay raises. Businesses look at wages and benefits as a sum cost. If the cost of health care goes up that leaves less cash available for raises. Looking at the trend over recent years the aggregate of wages and benefits has risen quite steeply. But practically all that increase has gone to pay for health care costs. None has gone to wages. So incomes have stagnated. Without controlling health care we can expect wages to stagnate, and even have to fall to accommodate the expense. That is not tolerable. The trade-off between wages and health care costs is the key to getting the average voter’s attention: they are already paying a huge price for the system’s failure. They need to stop that getting worse.
  3. The fight will come from the insurance companies who do not want a government provided alternative. In order for them to win that argument it looks as if they will have to offer significant compromises. In particular they stand to lose their ability to refuse ‘pre-existing’ conditions. I am deeply skeptical of the insurers: they have no incentive to offer the kind of comprehensive cost cutting the system needs. Nor do doctors. Somehow if we are to avoid a mandated system, incentives have to be introduced to force rationalization, office cost reductions, reduced test frequencies and duplications, and a better focus on prevention rather than cure. How this can be accomplished without government fiat is very unclear.
  4. Paying for the changes will be easier than many people think. First: the system already costs a vast amount, we can accomplish a fair bit of reform by re-allocating what we already spend, rather than by spending more. Second: there is a growing consensus that health care benefits should be taxed. One of the reasons the current system is so bad is that consumers do not bear its costs directly. So they have no incentive to push back against doctors who over prescribe, or against the waste of insurers bureaucracies. By taxing benefits not only do we raise money for reform, but we focus consumers on the cost of the services they are using. Hopefully consumer activism will disturb doctors and insurers enough for them to provide cost effective rather than lavish service.

Solving our health care mess is a high priority for a number of reasons. We need a better return on our investment: right now we have the least efficient system in the world. We need to spend less in absolute terms: we are on a path towards bankruptcy currently. We need to determine whether we want to have our entire population covered: if so, how? If not, why? Even with the difficulties and entrenched opposition there seems to be widespread support for change. I doubt that the resolution will be bipartisan, but this seems to be one area where Obama has the nerve to use the Democrat’s majority. Let’s hope he gets this sorted out this year. We don’t have the money to keep up the current pace of things.

GDP:

  1. There is far too much focus on short term numbers and not enough on the long term trends. My fear is that all the talk of ‘green shoots’ will distract us from digging into the sources of our problems and therefore stop us from eradicating them.
  2. The banking system needs fixing. It is in an awful mess. It is badly managed and runs on business models that are now proven dangerous. One look at the headlines about government ‘interference’ – usually in the Wall Street Journal – and we can see already that the industry has successfully avoided either taking responsibility for the crisis it started or undertaking reform. The breathless criticism of the FDIC’s suggestion that heads should roll at places like Citigroup, as if that wasn’t blindingly obvious, is an example of this. Indeed the banks have so successfully co-opted government that everyone seems scared to suggest doing much by way of fixing them for fear of failure. failure, that is, of one of the banks. From my perspective the collapse of the banks was a failure of their managers, boards and regulators.
  3. On the subject of banks: I urge you all to read John Lanchester’s excellent article in the latest issue of The London Review Of Books. Apart from being an outstanding summary of the crisis it offers up an actual bank balance sheet from The Royal Bank of Scotland. This balance sheet was released to shareholders just two weeks before the bank fell into the abyss where it currently wallows. The lesson I want to highlight is that nowhere in this balance sheet is there a single clue of the impending disaster. None. That the bank’s auditors, managers, and regulators are not all in jail for publishing such an obviously misleading document is beyond me. Without accountability we will not fix the banking system. That means we will not fix the economy.
  4. Employment. The outburst of optimism that greeted Friday’s employment report is testimony more to our depressed mindset than to any rational thought. It was awful. Just not as awful as the last few. That is no triumph. For anyone to trumpet a turnaround based on one month’s data is just plainly irresponsible. It is silly.
  5. All the vexation about rising US bond rates is similarly off center. There are those who are already despondent over inflation: they are arguing that the uptick in US bond rates over that last few weeks is a sure indicator of the bond market’s anxiety over the level of US debt. That anxiety supposedly is so solidly based that we should stop increasing our debt and start reducing it right now. That’s absurd. These are the same folks who sat back and told us that running up debt was not a problem when the cause was tax cutting. Apparently government spending as a cause throws them into a tizzy. Yes: we will need to cut back as soon as the economy is back on track. No: that’s not yet. A steeper yield curve helps the banks. A modest inflation rate helps deal with debt loads. And until we have an economy operating back near capacity all that increase in money supply gets absorbed as demand and not as inflation. Duh.

Nonetheless we can expect the inflation fear mongers to be out in force over the next few weeks. I imagine this is set to become a regular topic for us to talk about.

So the trilogy of issues to watch for in the next phase of the recession: structural reform of the health care and banking systems; the balance between monetary and fiscal policy; and capacity – which includes the employment outlook.

That’ll keep us busy.

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    GM: Done For

    Saturday night’s agreement between a significant group of GM’s creditors, the company, and the US government has sealed the deal: GM will file for bankruptcy, most likely Monday. Thus ends an iconic chapter in American history. GM once was emblematic of American manufacturing prowess. It generated a full 3% of the country’s GDP back in the 1950’s. It was credited, more than once, with staving off national recession simply by cranking up its own production. And, of course, there was the famous rejoinder from its CEO Charles Wilson [a.k.a.’Engine Charlie’] when he was before a Senate conformation hearing: ‘What’s good for the US is good for GM, and vice versa.’

    Now, not so much.

    In truth the decline and fall of GM is a story worthy of the great Edward Gibbon whose ‘Decline and Fall of the Roman Empire’ is a mammoth read even in an abridged form. The tale is familiar: its cars were criticized as unsafe, it failed to adjust to higher oil prices, it could not compete with more nimble and cheaper foreign manufacturers, and above all else it failed to adapt its fundamental business model to the global market. It became a poster child for the bygone years of American industrial dominance in an era of high technology and service industry growth.

    It’s failure is also the failure of middle America to adapt. The 1950’s model of high wage blue collar jobs, good benefits, and job security backed by big union clout served a couple of post-war generations well. It has left their heirs high and dry in run-down industrial towns shorn of income, hope and purpose. All that GM and the people who ran it for the past few decades have left is a shadow of what was once a mighty empire.

    Will GM re-emerge?

    Most likely. But there are very strong opponents of its bankruptcy plan even after the majority of bondholders have caved in. The main resistance will come from the dealership network where the economic deprivation and political clout converge in a potent way. Many dealers are local leaders in Chambers of Commerce dotted across the country. They spend big money at election time. Now might be a good time to collect on their largesse. The main approach of attack against the company’s plan is to claim that it is illegal. The veracity of this claim rests on the way in which GM is planning to re-emerge. When it moves out of bankruptcy there will be two GM’s: and “old GM” consisting of all the shuttered factories, the old debts, and discarded brands; and a “new GM” consisting of the remaining four brands and the infrastructure needed to make them. The bondholders have accepted a 10% share in the “new GM” while their debt goes with the “old GM”. They have thus contributed nothing to the newer company and may still collect a few cents on the dollar as the bits and pieces of the old company is sold off. This ‘something for nothing’ is what persuaded the bondholders to go along with the plan, but also means that they have been treated preferentially over and above other creditors with an equal claim in liquidation. A court may view this as illegal and render the whole plan improper. This would obviously trigger a round of heated negotiation and slow the entire process to a crawl.

    And time is not in GM’s favor.

    The company is bleeding cash at a prodigious rate, losing market share, and, most importantly, losing its share of customer loyalty. The longer the slow death lingers on the more difficult it will be to restore even a trimmed down GM to long term profitability.

    As it is I am not sure that the “new GM” will have what it takes to survive in a world auto industry that still suffers from a vast over-capacity. The deal made in Germany Friday to sell GM’s European operations to Magna of Canada rather than to Fiat works against GM in the long run: Fiat would have consolidated the industry and shut down capacity. Magna is a new entrant. It is one of the world’s largest auto parts makers and currently assembles cars for other makers – it builds BMW SUV’s as a sub-contractor – but its acquisition of Opel from GM doesn’t help rationalize the auto industry at all. So, while over capacity looms over all the current car makers, it will have a disproportionate effect on the weaker: the “new GM” being on of them.

    But that is all for the future.

    Right now is time to mourn the passing of GM, and along with it a huge element of the post-war American success story.

    These are odd times.

    Addendum:

    One reason that some bondholders may fight the GM plan in court is that they have insured themselves against loss of value in their bonds by purchasing credit default swaps. They would thus lose nothing. As long as their credit default swap counter-party is solvent and can pay-up. Then I suppose the counter-parties might support the GM plan so as to avoid having to pay out. Oh, what a tangled web this recession has become! Ugh.

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