Why Robert Reich is Wrong

Robert Reich claims that only government can get America out of the mess it is in. He’s wrong.

From the Guardian:

America’s ongoing jobs depression – which is what it deserves to be called – is the worst economic calamity to hit this nation since the Great Depression. It’s also terrible news for President Obama, whose chances for re-election now depend almost entirely on the Republican party putting up someone so vacuous and extremist that the nation rallies to Obama regardless.

The problem is on the demand side. Consumers (whose spending is 70% of the economy) can’t boost the American economy on their own. They’re still too burdened by debt, especially on homes that are worth less than their mortgages. In addition, their jobs are disappearing, their pay is dropping, their medical bills are soaring.

Businesses, for their part, won’t hire without more sales. So we’re in a vicious cycle. The question is what to do about it.

When consumers and businesses can’t boost the economy on their own, the responsibility must fall to the purchaser of last resort. As John Maynard Keynes informed us 75 years ago, that purchaser is the government.

Government can hire people directly to maintain the nation’s parks and playgrounds and to help in schools and hospitals. It can funnel money to help cash-starved states and local government so they don’t have to continue to slash payrolls and public services. And it can hire indirectly – contracting with companies to build schools, revamp public transportation and rebuild the nation’s crumbling highways, bridges and ports.

As I noted a few weeks ago who cares who does the things that the economy wants and needs, just so long as they get done? The problem is, that government very often has no clue what the economy wants or needs. Only the people out in the economy know what they want, and what they want to spend their money on. That’s why when government tries to pick winners and losers, it very often gets it totally and stupendously wrong.

Look at Solyndra.

Look at the fact that each job created costs $250,000 — money which use be taken from the productive apparatus of the economy and spent on projects which may or may not be helpful overall.

Look at the humungous cost of the wars and the corporate bailouts — all of which has to be taxed from the productive economy.

Here’s the reality. The more government spends, the higher the unemployment rate goes:


That’s a pretty strong correlation.

Now if the state is enlightened and lucky, sometimes government investment creates huge successful payoffs. But that correlation shows that in recent years government hasn’t been enlightened, and it hasn’t been lucky.

The way to create jobs in America is to end the corporate bailouts, end the crony capitalism, end the wars and give the money back to the American people. That would create a new wave of job-creating small businesses, raise demand, raise the ability of the poor and middle classes to pay for that demand, and (with the current tax load, but without the burden of the huge military spending) generate enough revenue to start paying down the humungous debt load.

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The Excesses of Crony Capitalism

That when government tries to play kingmaker in the markets is often disastrous is well known. Why is that the case? Well misallocation of capital is one reason: very often, the companies that government anoints are not very competitive. Another reason is false security: with the seal-of-approval of government, companies can excuse themselves for spending to high heaven on things they don’t need.

One anecdotal case is Solyndra.

From Bloomberg:

The glass-and-metal building that Solyndra LLC began erecting alongside Interstate 880 in Fremont, California, in September 2009 was something the Silicon Valley area hadn’t seen in years: a new factory.

It wasn’t just any factory. When it was completed at an estimated cost of $733 million, including proceeds from a $535 million U.S. loan guarantee, it covered 300,000 square feet, the equivalent of five football fields. It had robots that whistled Disney tunes, spa-like showers with liquid-crystal displays of the water temperature, and glass-walled conference rooms.

“The new building is like the Taj Mahal,” John Pierce, 54, a San Jose resident who worked as a facilities manager at Solyndra, said in an interview.

The building, designed to make far more solar panels than Solyndra got orders for, is now shuttered, and U.S. taxpayers may be stuck with it. Solyndra filed for bankruptcy protection on Sept. 6, leaving in its wake investigations by Congress and the Federal Bureau of Investigationand a Republican-fueled political embarrassment for the Obama administration, which issued the loan guarantee. About 1,100 workers lost their jobs.

The sad reality is that had Obama not intervened, Solyndra might still exist. If it had not ramped up production with the government’s help, it might have realised that its manufacturing process was no longer cost effective, and modified it to be so. If it had not received the loan guarantees, it would have constructed its factory more frugally, significantly lowering overheads and lowering the chances of insolvency. Spending the government’s money that you haven’t earned on flashy facilities is very easy. Spending the money of investors — who are expecting a return, and will watch your every move (and sue you for misfeasance) — is considerably harder.

I am still very optimistic about solar energy. Last month I wrote:

The solar energy hitting the earth exceeds the total energy consumed by humanity by a factor of over 20,000 times. More solar energy hits the world in a day, than we use in fifty years, at current rates.

So for me, solar is the future. Of course, there will be failures along the line. The story of capitalism is very much one of trying and trying and trying some more until a viable solution, product or system emerges. That’s why it’s a highly empirical and practical system.

But it is not for the government to take the risk, and taxpayers that take the hit. Nor is it for government’s denizens to create palaces of the absurd.

If Solyndra had failed in a less public and obnoxious fashion it would be just another startup that didn’t work out. Now, it might just stigmatise the solar industry in America for years to come. Companies that want investment for solar technologies will now find it harder to raise capital.

I hope the next administration learns that while investing in basic science and a level playing field for ideas is fine, picking winners and losers in markets is dangerous and damaging.

China is Not Ready to Pull the Plug on America

A very interesting article on alt-market asks a question I have been contemplating these past few weeks. In my view, America’s economic health is totally dependent upon two things: the flow of dollars to the middle east in exchange for oil, and the flow of dollars to China for consumer goods. Any disruption to either or both of these flows would result in sustained and significant disruption to America’s economy. That’s why America — absent of any real plan to move its energy generation, and its supply chains back to America — spends so much money policing the world.

So, that brings us onto the question: What would happen if China liquidated its dollar and bond holdings and moved its wealth into harder assets? And is China on the verge of doing just that?

From alt-market:

There are two mainstream market assumptions that, in my mind, prevail over all others. The continuing function of the Dow, the sustained flow of capital into and out of the banking sector, and the full force spending of the federal government are ALL entirely dependent on the lifespan of these dual illusions; one, that the U.S. Dollar is a legitimate safe haven investment and will remain so indefinitely, and two, that China, like many other developing nations, will continue to prop up the strength of the dollar indefinitely because it is “in their best interest”. In the dimly lit bowels of Wall Street such ideas are so entrenched and pervasive, to question their validity is almost sacrilegious. Only after the recent S&P downgrade of America’s AAA credit rating did the impossible become thinkable to some MSM analysts, though a considerable portion of the day-trading herd continue to roll onward, while the time bomb strapped to the ass end of their financial house is ticking away.

The debate over the health and longevity of the dollar comes down to one very simple and undeniable root pillar of economics; supply and demand. The supply of dollars throughout the financial systems of numerous countries is undoubtedly overwhelming. In fact, the private Federal Reserve has been quite careful in maintaining a veil of secrecy over the full extent of dollar saturation in foreign markets in order to hide the sheer volume of greenback devaluation and inflation they have created. If for some reason the reserves of dollars held overseas by investors and creditors were to come flooding back into the U.S., we would see a hyperinflationary spiral more destructive than any in recorded history. As the supply of dollars around the globe increases exponentially, so too must foreign demand, otherwise, the debt machine short-circuits, and newly impoverished Americans will be using Ben Franklins for sod in their adobe huts. As I will show, demand for dollars is not increasing to match supply, but is indeed stalled, ready to crumble.

We know from insiders in the Chinese government that China are looking at “liquidating more of our holdings of Treasuries once the US Treasury market stabilizes”, and “buying stakes in Boeing, Intel, and Apple and these types of companies… in a proactive way”, and of course gold. But does that mean China will be liquidating as soon as possible? After all Bernanke won’t stop printing, the dollar won’t stop being devalued, and America won’t stop burning through its productive capital on military spending.

I don’t believe they will. Wen Jiabao’s subtle and supportive public remarks during Joe Biden’s recent visit suggests that China wants a controlled and managed transition away from the dollar as the global reserve currency. Withdrawing support for the dollar right now would send China’s remaining dollar pile crashing into the earth.

From the Council on Foreign Relations:

China has accumulated a massive stock of U.S. dollar reserves in recent years. Statements of concern from China regarding the risk that U.S. economic policy might undermine the future purchasing power of these assets has fuelled the market’s concern that China may shift away from dollar purchases. Yet in the 12 months ending in July 2009 China accumulated more dollar-denominated assets, mainly U.S. Treasuries, than foreign assets in total. Despite its rhetoric, China has thus far taken no actions to wean itself off of the dollar.

And as I have noted numerous times, China has no interest in upsetting the global balance — under the current circumstances it is very rapidly strengthening, whilst America falters. And why change something that is working for China?

So when will China pull the plug? There are a few relevant pictures to watch:

  1. China’s gold reserves: currently at 1,000 tonnes, these would have to go significantly higher.
  2. China’s acquisitions of American industry: this would signify Chinese dollar-outflows.
  3. China’s holdings of U.S. debt: if Bernanke keeps printing, these would have to remain stable, or more likely tip-toe lower.
  4. Flotation of the yuan: if China wishes to curb domestic inflationary pressures, they will float the yuan on global markets. A successful yuan flotation would cut the relative value of China’s dollar holdings, lessening the incentive to hang onto U.S.-denominated assets

I expect all of these developments to take place over years, not months. And, in my view, the greatest threat to the dollar’s status as global reserve currency is a global oil shock, triggered by a new middle eastern war, or some black swan. And it is an oil shock that is precisely the event that might force China to accelerate offloading its dollar hoard.

On Solyndra

A few days ago Solyndra, a Bay Area maker of industrial solar panels, announced plans to file for bankruptcy.

From the L.A. Times:

It wasn’t just a blow for the company’s 1,100 laid-off employees or the investors who have pumped millions into the venture. It called into question the Obama administration’s entire clean-energy stimulus program.

Two important questions are raised by Solyndra’s failure: Should the government be in the business of picking winners and losers by providing loan guarantees to risky energy ventures? And is Obama using stimulus funds to reward his political contributors?

Now — to be clear — this isn’t solely Obama’s problem. George W. Bush, Bill Clinton, and many other administrations both in America and overseas have had lots of troubles with crony capitalism. Obama is by no means the worst next to twenty years of subsidised Japanese zombification.

So just what is the problem with crony capitalism, and with Solyndra in particular? Personally, I am the biggest supporter of solar technology out there. In my view, transitioning to solar energy is potentially the best thing that could happen to the US economy for reasons of energy independence, minimising carbon emissions, long-term sustainability, decentralisation and so forth. So I have no problem with solar energy, and I have no problem with the government supporting research into solar energy. But I still think this was a bad investment. It wasn’t supporting basic research, only a manufacturing process that was unviable in the market.

When it comes to marketable products, only the people out in the economy know what they want, and what they want to spend their money on. That’s why when government tries to pick winners and losers, it very often gets it totally and stupendously wrong.

From NBC:

Solyndra was touted by the Obama administration as a prime example of how green technology could deliver jobs. The President visited the facility in May of last year and said  “it is just a testament to American ingenuity and dynamism and the fact that we continue to have the best universities in the world, the best technology in the world, and most importantly the best workers in the world. And you guys all represent that.”

And why wasn’t Solyndra a winner.

From BusinessWeek:

All told, Solyndra raised $1.1 billion from private sources. The extra federal support ended up having the well-intended but unfortunate effect of letting Solyndra ramp up manufacturing in a hurry, even as evidence was emerging that the company had badly misread the changing economics of the solar panel market. A few years ago, prices for the silicon wafers used in most flat solar panels were soaring. Solyndra proposed building an entirely different panel, using cylindrical tubes coated with thin films of copper-indium-gallium-selenide that would pick up light from any direction.

In funding documents, Solyndra insisted that its tubes would be far cheaper than the silicon alternative. No such luck. Silicon prices have plunged nearly 90 percent from their peak in 2008, making conventional panels the better bargains.

So the government backed the wrong player, whose business model wasn’t economically viable. For the system to work, economically viable ideas have to succeed, and unviable ones have to be allowed to fail, and with government favouritism in the market, that just doesn’t work. Now that doesn’t mean to say that I don’t believe in some government role. In my view, the role of government is to create a level playing field for a free market to exist. Supporting basic research is the right role for the government in solar, so that solar efficiencies can be increased to a level where solar can compete on a level playing field with coal and oil.

Let’s move away from Solyndra (which is really a very small example), and onto the main target: the global financial system.

From Bloomberg:

Would you give money to a compulsive gambler who refused to kick the habit? In essence, that’s what the world’s biggest banks are asking taxpayers to do.

Ahead of a meeting of the Group of Seven industrialized nations’ finance ministers in Marseilles this week, bankers have been pushing for a giant bailout to put an end to Europe’s sovereign-debt troubles. To quote Deutsche Bank Chief Executive Officer Josef Ackermann: “Investors are not only asking themselves whether those responsible can summon the necessary willpower … but increasingly also whether enough time remains and whether they have the necessary resources available.”

Unfortunately, he’s right. As Bloomberg View has written, Europe’s leaders — particularly Germany’s Angela Merkel and France’s Nicolas Sarkozy — are running out of time to avert disaster. Their least bad option is to exchange the debts of struggling governments for jointly backed euro bonds and recapitalize banks. European banks have invested so heavily in the debt of Greece and other strapped governments, and have borrowed so much from U.S. institutions to do so, that the alternative would probably be the kind of systemic financial failure that could send the global economy back into a deep recession.

But the problem is the destructive and failed nature of the financial system itself. If government doesn’t allow banks that made bad decisions to be punished by the market, then the bailed-out zombie banks can rumble on for years, parasitising the taxpayer in the name of ever-greater bonuses for management, while failing to lend money, create new employment, or help the economy grow.

The global financial system isn’t working because there are fundamental structural problems with the global economy. These include over-leverage, the agency problem, trade deficits, failed economic planning, massive debt acquisition, Western over-reliance on foreign oil and goods, military overspending, systemic corruption, fragility and so forth. Stabilising the global financial system merely perpetuates these problems. The market shows that it needs to fail — preferably in a controlled way so that real people don’t get hurt — so that we can return to experimental capitalism, where sustainable ideas prosper, and unsustainable ideas don’t.