s.yazicioglu@lycos.com
Cambiz hi wanted to add to my post in your blog... couldnt locate it.
one person's take.. stirs the debate?
"> On G-20 and GM: Economics, Politics and Social Stability
November 17, 2008 | 1840 GMT
By George Friedman
Related Special Topic Pages
Political Economy and the Financial Crisis
The G-20 met last Saturday. Afterward, the group issued a meaningless
statement and decided to meet again in March 2009, or perhaps later.
Clearly, the urgency of October is gone. First, the perception of
imminent collapse is past. Politicians are superb seismographs for
detecting impending disaster, and these politicians did not act as if
they were running out of time. Second, the United States will have a
new president in March, and nothing can be done until he defines his
policy.
Given the sense in Europe that this financial crisis marked the end
of U.S. economic supremacy, it is ironic that the Europeans are
waiting on the Americans. One would think they would be using their
newfound ascendancy to define the new international system. But the
fact is that for all the shouting, little has changed in the
international order. The crisis has receded sufficiently that nothing
more needs to be done immediately beyond "cooperation, " and nothing
can be done until the United States defines what will be done. We
feel that our view that the international system received fatal blows
Aug. 8, when Russia and Georgia went to war, and Oct. 11, when the G-
7 meeting ended without a single integrated solution, remains
unchallenged. Now, it is every country for itself.
From Financial Crisis to Cyclical Recession
The financial crisis has been mitigated, if not solved. The problem
now is that we are in a cyclical recession, and that every country is
trying to figure out how to cope with the recession. Unlike the past
two recessions, this one is more global than local. But unlike the
1970s, when recession was global, this one is not accompanied by
soaring inflation and interest rates.
All recessions have different dynamics, but all have one thing in
common: They impose punishment and discipline on economies run wild.
This is happening around the world.
China, for example, faces a serious problem. China is an export-
oriented economy whose primary market is the United States. As the
United States goes into recession, demand for Chinese goods declines.
Chinese businesses have always operated on very tight - sometimes
invisible - profit margins designed to emphasize cash flow and to pay
off debts to banks. As U.S. demand contracts, many Chinese firms find
themselves in untenable positions, without room to decrease prices,
lacking operating reserves and insufficiently capitalized. Recessions
are designed to cull the weak from the herd, and a huge swath of the
Chinese economy is ripe for the culling.
If the world were all about economics, culling is what the Chinese
would do. But the world is more complex than that. A culling would
lead to massive unemployment. Many Chinese employees live on Third
World wages; indeed, the vast majority of Chinese have incomes of
less than $1,000 a year. To them, unemployment doesn't mean problems
with their 401k. It means malnutrition and desperation - neither of
which is unknown in 20th century Chinese history, including the
Communist period. The Chinese government is rightly worried about the
social and political consequences of rational economic policies: They
might work in the long run, but only if you live that long.
Economic Restructuring vs. Stability
The Chinese have therefore prepared a massive stimulus package that
is more of a development program to make up for declining U.S.
demand. It aims to keep businesses from failing and spilling millions
of angry and hungry workers into the street. For the Chinese, the
economic problem creates a much larger and more serious issue. It is
also an issue that must be solved quickly, and the amount of time
needed outstrips the amount of time available.
This is not only a Chinese problem. Wherever there is an economic
downturn, politicians must decide whether society - and their own
political futures - can withstand the rigors recessions impose.
Recessions occur when, as is inevitable, inefficiencies and
irrationalities build up in the financial and economic system. The
resulting economic downturn imposes a harsh discipline that destroys
the inefficient, encourages everyone to become more efficient, and
opens the doors to new businesses using new technologies and business
models. The year 2001 smashed the technology sector in the United
States, opening the door for Google Inc.
The business cycle works well, but the human costs can be daunting.
The collapse of inefficient businesses leaves workers without jobs,
investors without money and society less stable than before. The pain
needed to rectify China's economy would be enormous, with devastating
consequences for hundreds of millions of Chinese, and probably would
lead to social chaos. Beijing is prepared to accept a high degree of
economic inefficiency to avoid, or at least postpone, the reckoning.
The reckoning always comes, but for most of us, later is better than
sooner. Economic rationality takes a back seat to social necessity
and political common sense.
Every country in the world is looking inward at the impact of the
recession on its economy and measuring its resources. Countries are
deciding whether they have the ability to prop up business that
should fail, what the social consequences of business failure would
be, and whether they should try to use their resources to avoid the
immediate pain of recession. This is why the G-20 ended in
meaningless platitudes.
Each country is also trying to answer the question of how much pain
it - and its regime - can endure. The more pain imposed, the
healthier countries will emerge economically - unless of course the
pain kills them. Ultimately, the rationality of economics and the
reality of society frequently diverge.
Recession and the U.S. Auto Industry
For the United States, this choice has been posed in stark terms with
regard to the dilemma of whether the U.S. government should use its
resources to rescue the American auto industry. The American auto
industry was once the centerpiece of the U.S. economy. That hasn't
been true for a generation, as other industries and services have
supplanted it and other countries' auto industries have surpassed it.
Nevertheless, the U.S. auto industry remains important. It might
drain the U.S. economy by losing vast amounts of money and destroying
the equity held by its investors, but it employs large numbers of
people. Perhaps more important, it purchases supplies from literally
thousands of U.S. companies.
There can be endless discussions of why the U.S. auto industry is in
such trouble. The answer lies not in one place but in many, from the
decisions and makeup of management to the unions that control much of
the workforce, and from the cost structure inherent in producing cars
in the American economy to a simple systemic inability to produce
outstanding vehicles. There might be varying degrees of truth to all
or some of this, but the fact remains that each of the U.S. carmakers
is on the verge of financial collapse.
This is what recessions are supposed to do. As in China and
everywhere else, recessions reveal weak businesses and destroy them,
freeing up resources for new enterprises. This recession has hit the
auto industry hard, and it is unlikely that it is going to survive.
The ultimate reason is the same one that destroyed the U.S. steel
industry a generation ago: Given U.S. cost structures, producing
commodity products is best left to countries with lower wage rates,
while more expensive U.S. labor is deployed in more specialized
products requiring greater expertise. Thus, there is still steel
production in the United States, but it is specialty steel
production, not commodity steel. Similarly, there will be specialty
auto production in the United States, but commodity auto production
will come from other countries.
That sounds easy, but the transition actually will be a bloodletting.
Current employees of both the automakers and suppliers will be
devastated. Institutions that have lent money to the automakers will
suffer massive or total losses. Pensioners might lose pensions and
health care benefits, and an entire region of the United States - the
industrial Midwest - will be devastated. Something stronger will grow
eventually, but not in time for many of the current employees,
shareholders and creditors.
Here the economic answer, cull, meets the social answer, stabilize.
Policy makers have a decision to make. If the automakers fail now,
their drain on the economy will end; the pain will be shorter, if
more intense; and new industries would emerge more quickly. But
though their drain on the economy would end, the impact of the
automakers' failure on the economy would be seismic. Unemployment
would surge, as would bankruptcies of many auto suppliers. Defaults
on loans would hit the credit markets. In the Midwest, home prices
would plummet and foreclosures would skyrocket. And heaven only knows
what the impact on equity markets would be.
In the U.S. case, the healthful purgative of a recession could
potentially put the patient in a coma. Few if any believe the U.S.
auto industry can survive in its current form. But there is an
emerging consensus in Washington that the auto industry must not be
allowed to fail now. The argument for spending money on the auto
industry is not to save it, but to postpone its failure until a less
devastating and inconvenient time. In other words, fearing the social
and political consequences of a recession working itself through to
its logical conclusion, Washington - like Beijing - wants to spend
money it probably won't recover to postpone the failure. Indeed,
governments around the world are considering what failures to
tolerate, what failures to postpone, and how much to spend on the
latter. General Motors is merely the American case in point.
The Recession in Context
The people arguing for postponement aren't foolish. The financial
system is still working its way through a massive crisis that had
little to do with the auto industry. Some traction appears to be
occurring; certainly there was no crisis atmosphere at the G-20
meeting. The economy is in recession, but in spite of the inevitable
claims that we have never seen anything like this one before, we
have. There is always some variable that swings to an extreme - this
time, it is consumer spending - but we are still well within the
framework of recent recessions.
Consider the equity markets, which we regard as a long-term measure
of the market's evaluation of the state of the economy. In March
2000, the S&P 500 peaked at 1530. This was the top of the market. In
October 2002, 18 months later, the S&P bottomed out at 777. Over the
next five years it rose to 1562 in October 2007, the height for this
cycle. It fell from this point until Nov. 12, 2008, when it closed at
852.30. This past Friday, it was at 873.29.
We do not know what the market will do in the future. There are
people much smarter than we are who claim to know that. What we do
know is what it has done. And what it has done this time - so far -
is almost exactly what it did last time, except that in 2000-2002 it
took 18 months to do it, while this time it was done in about 16 and
a half months (assuming it bottomed out Nov. 12). But even if the
market didn't bottom out then, and it falls to 775, for example, it
will have lost 50 percent of its value from the peak. This would be
more than in 2000-2002, but not unprecedented.
The point we are making here is that if we regard the equity markets
as a long-term seismograph of the economy, then so far, despite all
the storm and stress, the markets - and therefore the economy -
remain within the general pattern of the 2000-2002 market at the 2001
recession. That recession certainly was unpleasant, what with the
devastation of the tech sector, but the economy survived. At the same
time, however, it is clear that things are balanced on a knife's
edge. Another hundred points' fall on the S&P, and the markets will
be telling us that the world is in a very different place indeed.
A massive bankruptcy in the automotive sector could certainly set the
stage for an economic renaissance in the next generation. But at this
particular moment in time (it's no coincidence that the crisis in the
U.S. automotive industry comes as we enter a recession), a wave of
bankruptcies would dramatically deepen the recession. This probably
would be reflected by the destruction of trillions more in net worth
in the equity markets.
There is a powerful counter argument to bailing out the U.S. auto
industry. This argument holds that the auto industry is a drain on
the U.S. economy, that it will never be globally competitive, and
that if it is dragged back from the edge, no one will then say it is
time to push it to the edge and over. The next time it will be on the
brink will be during the next recession, and the same argument to
save it will be used. In due course, the United States, like China,
will be so terrified of the social and political consequences of
business failure that it will maintain Chinese-like state owned
enterprises, full of employees and generation-old plants and business
models. Clearly, short-run solutions can easily become long-term
albatrosses.
The only possible solution would be a bailout followed by a
Washington-administered restructuring of the auto industry. This
causes us to imagine a collaboration between the auto industry's
current management and Washington administrators that would finally
put Detroit on a path to where it can compete with Toyota. Frankly,
the mind boggles at this. But boggle though we might, hitting the
economy with another massive financial default, a wave of
bankruptcies, massive unemployment surges and another blow to housing
prices boggles our mind even more.
The geopolitical problem confronting the world at the moment is that
it has been forced to offer massive support to the global financial
system with sovereign wealth - e.g., via taxes and currency printing
presses. The world might just have squeaked through that crisis. Now,
the world is in an inevitable recession and businesses are on the
brink of failure. A wave of massive business failures on top of the
financial crisis might well move the global system to a very
different place. Therefore, each nation, by itself and indifferent to
others, is in the process of figuring out how to postpone these
failures to a more opportune time - or to never. This will build in
long-term inefficiencies to the global economy, but right now
everyone will be quite content with that.
Thus the financial crisis became a recession, and the recession
triggered bankruptcies. And because no one wants bankruptcies right
now, everyone who can is using taxpayer dollars to protect the
taxpayer from the consequences of mismanagement. And the last thing
any one cared about was the G-20 concept for the future of the
economic system."
EMAIL
PRINT
100 COMMENTS
