Misallocation of Everything

Following our supposed novel of the 2007-8 great crash as an epic tragedy with Barack Obama as Othello we go next to the underlying causes of what happened and compare his administration’s policies to rectify things with what should be done. So before we proceed with the plot – what he does once he gets all the secret memos that first day in the White House and acts – we need to look at some neutral person’s explanation to bring ourselves up to speed.

Why are investment communities around the world reducing their purchases of US Treasury bonds – do they fear something the administration is doing? In order to structure the plot of our possible novel “Follow the Money” we need to find out.

First we might ask Doug Noland, a market strategist for the Prudent Bear Funds.
“It is more certain, however, that the great benefits commanded to our economy and markets over the decades from governing the world’s reserve currency are drawing to an end. Our policymakers still believe they can inflate credit and manipulate interest rates – and not have to pay a price for it. But the new global reality may be that currency markets will protest against massive US fiscal deficits and activist monetary policy, while global markets come to dictate US market yields. Over the past two weeks, we have seen the dollar and US Treasuries/MBS come under significant pressure. Is this the beginning of global markets disciplining Washington?”

The following comes from another article in Asia Times Online. This one by W Joseph Stroupe, a strategic forecasting expert and editor of Global Events Magazine.

“Bigger trouble looms, regardless of this Wall Street rally and other “green shoots”. Geithner’s toxic asset removal plan hasn’t worked yet, and it and other government plans face huge obstacles. Fears over the size of US debt are swiftly mounting, while China has “cancelled our credit card”, according to US Senator Mark Kirk, referring to the fact that China’s investors have radically slowed their purchase of US Treasury bonds in the past three months.”

“Income-based model versus asset-based model
At fundamental issue here is the new asset-based economic/financial model (as contrasted with a traditional income-based model) which the US and Britain in particular have progressively adopted over the past couple of decades, and whether that new model is really workable and revivable in the light of its massive collapse that began with the emergence of the subprime crisis in late July of 2007.

The US economy has rapidly converted from a traditional, income-generating machine to a so-called “new economy”, an asset-inflating one. An income-generating machine derives wealth from the production and sale of goods and services, while an asset-inflating one derives wealth from accelerated asset appreciation, or targeted inflation of assets – in other words, by the creation of serial asset bubbles. In this new model, traditional wealth generation takes a back seat to “paper” wealth generation via serial asset bubble creation.

In the traditional income-based economic model, the financial sector serves to support the real economy, where the vast bulk of real income is generated, by providing credit and other traditional financing services aimed at sustaining existing and fostering new income-generating business ventures, and supporting consumer spending via traditional credit services. The income generated in the financial sector is not of major proportions, but is a distant second to that generated in the real economy.

The asset-based model is radically different. In this new model, innovative and grandiose opportunities arise for the generation of gigantic sums of “paper” wealth from within the financial sector itself, thanks to what can only be called the fostering of an incestuous relationship between government and Big Finance.”

In the pre-Reagan/Thatcher/Mulroney days the Western economic model was one where we made things if we needed them. We saved up for them (at least in part) if we wanted to buy them, and we cautiously built up our nest-eggs for a possible rainy day. That all went by the board when the three irresponsible idiots named above went to work.

We no longer needed to dig coal, or smelt iron, or build things in factories – we sent all that overseas for others to do the dirty work. We wouldn’t want to soil our manicured hands or wrinkle our Armani suits, would we? If we wanted to become rich we merely found enough suckers to buy our invented derivatives and lived off the proceeds. It worked for awhile, but now the suckers and the poor devils in the dirt, working for peanuts, are wising up.

What have we done with our greatest resource –  the manpower, woman power, and brain power of our recent generations? We have misallocated it all.

A couple of examples. European and Japanese autos have become technologically far superior to those built in North America and there is one prime reason for that. While the others employed their most brilliant and creative technology graduates in automobile engineering, the US shunted them into another industry that produces nothing of social value – the military-industrial complex. Instead of producing super-reliable energy efficient autos they are creating computer game military hardware that can murder around the world remotely from the safety of Langley, Virginia. Today, the bright and ambitious never even study in disciplines where work is done and things made – all they know is how to code computer games, to dream up even more exotic ‘investment’ schemes, and to produce ever more complex and fragile IT systems.

Why hasn’t the Obama administration taken steps to put our society back on the rails – employing our graduates to build, to create, to save? Because the people he has appointed wouldn’t know what to do with such graduates – even if such appropriately trained ones existed. If we, the public, are looking for some bright and creative brains to pull our societies out of this mess – we might have to look to someone else.

So, while Othello is spending his effort at shoring up the last gasp of the asset model with every phoney dollar he can print, the underlying rot is getting worse. What likely time-scale will this work out over? Everyone whose forecasts seem credible admit that this is almost impossible to predict. The current bear rally may last until the end of 2009 and everyone credit the US administration with saving the ‘world’, but down in the basement the termites are still munching away. If, under the worst possible scenario, Othello manages to create a new phony dollar bubble so that asset prices once again attain completely unrealistic heights – the whole shebang may not crash again for five years or more. But that crash will be an even bigger disaster than this. That’s great for a novel – a humdinger of an ending – but not so good for the people left to pick up the pieces.

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