Finding The Bottom Of The Economic Downturn - By David Whitehead

PUBLISHER’S PERSPECTIVE

The Financial Crisis:

Finding the Bottom By David Whitehead “The recession is over!” So proclaimed our perpetually upbeat sales manager as he sauntered into an early morning meeting in the spring of 1994. The authority he relied on to substantiate this dubious claim was an overly optimistic news report. His dutiful employees, including myself, didn’t quite know what to make of this. We were still encountering enormous resistance while good customers continued to call on us to advertise their “going out of business” sales. This depressing stream of new business predicated on helping long-time companies liquidate their inventories in short order continued for some time. In fact, the national recession was officially over by the time Bill Clinton entered the White House in 1992. However, defense cutbacks following the 1991 Gulf War kept the pain lingering in the South Bay for several years. Most businesses didn’t see real prosperity take off again until 1997 when the dotcoms and a newly revitalized real estate market moved things up again. We had to wait for the recession to end and look back at the historical data to know where the bottom that mattered actually was. And I expect we will have to do that again in a few years when things settle down. Perhaps asking, “When will we find the bottom?” is the wrong question. Instead we should ask, “What is the bottom?” The “bottom” in an economic downturn is the point when enough money has been eliminated from the economy from interest paid on current and previous debts for the maestros of finance to orchestrate another money bubble to move things up again. That’s what the dotcom and real estate booms were really all about. And not surprisingly, both of these booms crashed as quickly as they rose. What’s different this time is the economy has become so bloated with debt that government officials and central bankers are hor-

The modern U.S. economy relies on foreign investment to provide the cash necessary to run the financial and service sectors where most Americans earn their living. ..The next four decades will require something entirely different that probably won’t involve our precious “dead presidents.” 18 S o u t h B a y B u s i n e ss I n s i d e r M a g a z i n e

rified to let the economy find the bottom on its own. Hence the unprecedented waves of multi-billion dollar bailouts and stimulus packages created out of thin air. If “bottom” is supposed to mean the lowest point the economy can fall, then what we are looking for is not really a bottom at all. It’s a low point in a continuous cycle that has had many low points. But it certainly is not the lowest point attainable. That means it is not inconceivable for the aggregate burden of debt to create the kind of “bottom” that is really a precipice for a greater fall. Could this be the bottom tantamount to Wall Street’s greatest nightmare? If the economy ends up where it appears to be going, the answer is a resounding “yes.” However, the same maestros of finance who brought us to this point have shown remarkable creativity in developing new economic models flashy enough to perpetuate lucrative business cycles for decades. The current model is undoubtedly reaching its end. So what could they do to save us from our impending oblivion? It certainly can’t be another stimulus that can never be supported by our economy. Or can it? Spring Blooms Uncertainty and Special Drawing Rights The only thing that bloomed this spring was more uncertainty. The first quarter of 2009 saw multi-billion dollar bailouts, reversals of fortune for global manufacturers and desperate anticipation for this economic crisis to find its “bottom.” However, consumer confidence soared in May as the Obama administration’s $787 billion stimulus packages started to take hold— at least in people’s minds. An industry group called The Conference Board told Reuters in late May that its index of consumer attitudes jumped to 54.9 in May, up from a revised 40.8 in April. This is well above earlier forecasts centered around 42.0. This represented the biggest one-month jump since April 2003, attributed to belief at the time that the Iraq war was coming to a rapid conclusion. However, does this mean a genuine recovery is in progress? Death and taxes are not the only things in life that are certain. We forget about interest due on the money we create through borrowing at the central banking level. That means the $787 billion stimulus is certain to lead to an even deeper bottom to be averted by, well, another multi-billion or perhaps trillion dollar stimulus the economy could never hope to support. This is a bad habit we just can’t seem to break. Does this mean the financial judgment day is close at hand? Can we expect to see Seven Horsemen from the Bank for International Settlements appear to reveal our final dispensation? The best financial experts cannot agree on this point. However, it would behoove us to examine some alarming events that have recently taken place. 2 n d I ss u e 2 0 0 9

Special Drawing Rights Paint Bleak Picture for the Dollar The G20 nations recently authorized the International Monetary Fund, the post-war global banking house run by Europeans, to inject $250 billion into the global economy using an obscure mechanism called “Special Drawing Rights.” SDRs bypass the leading reserve currency to instead issue funds based on a basket of major world currencies. This relic of the post-war Bretton Woods agreement is a tool that has “lain dormant for half a century.” In effect, SDRs create a super global currency to help relieve the financial crisis. But wait a minute; don’t we already have a super global currency? Well since the end of World War II at least, we did. It was called the U.S. dollar. Before that, it was the British pound. And as long as the dollar keeps its official designation as the world’s key reserve currency, it technically is the global currency of choice for international settlements. In fact, despite the dollar’s rapid decline, 64.5 percent of international settlements are still transacted in dollars. However, SDRs are a serious challenge to the status quo because they decrease global investment in U.S. dollars. This is not a hohum financial detail. It could be catastrophic for the nation’s economy if the dollar loses its special status. The modern U.S. economy relies on foreign investment to provide the cash necessary to run the financial and service sectors where most Americans earn their living. The last 38 years of deindustrialization made running the economy on foreign debt business as usual for the United States. The next four decades will require something entirely different that probably won’t involve our precious “dead presidents.” China has been pushing hard for SDRs to assist it in dealing with its “dollar glut” created by the massive imbalance in foreign trade. That means it would no longer be obliged to reinvest these excess dollars back into the U.S. economy. I know many people have the 2 n d I ss u e 2 0 0 9

misconception that China has accrued most of America’s wealth. The reality is that it is addicted to our currency to keep its own economy from collapsing, and it does hold most of our foreign debt, which may never be repaid. Remember, China created an enormous monster it needs to feed with a currency much stronger than its own. If dollar dope won’t cut it anymore, China will turn to the financial pushers in Europe willing to service its habit. If this sounds like the 18th Century opium trade reemerging in another form, you’re not far off. And don’t forget, this is the same monster that produces just about everything we use while Chinese workers earn less than a dollar an hour in our money for their efforts. In some ways, the Asian economies are worse off than we are. But the imbalances are more to blame than policies of any particular nation state that is trying to cope with the situation. Could SDRs signal the demise of the U.S. dollar? This of course depends on how and to what extent they are used. However, it is generally agreed the dollar can’t retain its value if foreign investment flees on a large scale. And the Achilles Heel of foreign investment is debt. That’s why the ability of central bankers and the US Treasury to deliver bailouts to deal with the financial crisis won’t address the underlying reasons why the financial system continues to collapse. The world’s nations cannot go on indefinitely investing in a currency so heavily laden with debt that it is no longer a sound investment by any practical economic standard. The paradigm is shifting because it must. But what form will the new global economy take? Read the column: “The Empire With the Invisible Throne” (page 16) for a deeper perspective.”n David Whitehead is the Publisher of Business Insider Magazine. He can be reached by email at [email protected]. S o u t h B a y B u s i n e ss I n s i d e r M a g a z i n e 1 9