Wednesday, November 19, 2008

The Invisible Hand vs Government Gauntlet

The Market continues to cascade in a downward plunge....why?

Markets are driven by and react to perceptions, and perceptions are formed by age old basics....word of mouth....watching what others are doing.  The Democrats spent most of the past few years attempting to talk down the market in their attempt to defeat George Bush.  As they came into 2008, they intensified their rhetoric yelling "recession" at every down-tick in the stock market.  They even resorted to tactics like causing runs on banks and insurance companies a la Chuck Schumer and Harry Reid.  Barack Obama beat the drum mercilessly, with a constant up-tick in his negative rhetoric as November 4th approached.

Well, people listened, and coupled with the economic fatal flaws that the Democrats had legislated and encouraged; Fannie, Freddie sub-prime mortgage encouragement; and mark-to-market legislation, the Democrats finally got their wish....the market tanked, and all the institutional machinery they established kicked in and drove it down further.

Between panicked selling and legal requirements to raise capital to cover ever shrinking assets declines, we're in a "fine mess" as Oliver Hardy used to say.  And like Humpty Dumpty, all the kings horses and all the kings men can't seem to put it back together again.

The big questions have been "what will Obama do", "who will he appoint?", "what taxes will he raise", "what costs will he mandate?"  Uncertainty, on top of uncertainties......the market continues to react, and like a perpetual-motion machine, it feeds on itself, going further and further lower.

Now the news the past few days has been about the "Big Three" U.S. car companies petitioning the government for a loan of $25 Billion in order to get them through to the end of this year (approx. 45 days).

Sides have been drawn, with the Democrats, "Big Three"  Management, and the Auto Unions all on one side, and with many Republicans, and other's on the other.  Much rhetoric is flying around about "economic fairness", "jobs will be lost", "White Collar vs Blue Collar", "looking out for the working guy", "there's been enough Union give-backs", etc....  This situation is yet again the beginning of another chapter in the "How Government Can Screw Up The Economy" manual.  The question is how will it end up?

The invisible hand, a metaphor coined by Adam Smith in The Wealth of Nations, symbolizes that, in a free market, an individual pursuing his own self-interest tends to also promote the good of his community as a whole through a principle that he called “the invisible hand”.

The theory of the Invisible Hand states that if each consumer is allowed to choose freely what to buy and each producer is allowed to choose freely what to sell and how to produce it, the market will settle on a product distribution and prices that are beneficial to all the individual members of a community, and hence to the community as a whole. The reason for this is that greed will drive actors to beneficial behavior. Efficient methods of production will be adopted in order to maximize profits. Low prices will be charged in order to undercut competitors. Investors will invest in those industries that are most urgently needed to maximize returns, and withdraw capital from those that are less efficient in creating value. Students will be guided to prepare for the most needed (and therefore most remunerative) careers. And all these effects will take place dynamically and automatically.  

Unfortunately, as we're now witnessing, governments, have a tendency to get involved, and when they do, politics plays a strong part.  

The Democrats have significant markers to pay off with the Unions because of their support in this past election, and the Union's don't want to have the manufacturers forced to operate under bankruptcy law.  A bankruptcy court  would undoubtedly force the unions to give up their existing sweetheart contract provisions.... that just happen to be one of the primary causes of the "Big Three's" distress.  The top management of these companies also want to avoid bankruptcy, as they'd most likely lose their jobs.
And, in this play, as in many other high-tension drama's, there's a third the shadows.  The Environmentalists.....
Look closely and you can see that what's really going on is an attempt to use taxpayer money to remake Detroit in the image of the modern environmental movement. Given a choice between greens and blue-collar workers, Congress puts the greens first.  This political contradiction has come into sharp relief since President Bush offered a significant compromise late last week on the use of taxpayer cash. Earlier this year, Congress had approved $25 billion in loans to the car companies for "green retooling," and the White House said Friday that Detroit could tap that money quickly for more general purposes with a couple of conditions. The companies merely have to present a business plan to the Energy Secretary showing how the cash would keep them "viable," which is to say competitive as profit-making concerns. This could be a proposal to renegotiate labor contracts, or perhaps a merger proposal, or other plan of action. But here's the real catch for Congress: Mr. Bush said Democrats would also have to remove the green strings that they themselves had attached to that $25 billion.
"The Bush Administration's proposal is unacceptable," declared Senate Majority Leader Harry Reid. "The Administration's plan would require additional legislative action in the House and Senate and the President's signature -- but there is no reason to start at square one when Secretary [Henry] Paulson can protect millions of American jobs in one of our most important industries with the stroke of a pen." 
Yet if the problem is so urgent, why keep the green chains on that first $25 billion? GM in particular is saying that it may have to declare bankruptcy by the end of the year without a taxpayer capital injection. Aren't jobs at stake?
 If Congress wants to ease the immediate burden on Detroit, it could also ease the onerous fleet-mileage standards (CAFE rules) that force the companies to make cars domestically that are unprofitable. A mere tweak would help a lot -- for example, simply allow Detroit to meet CAFE standards by counting the cars it makes at home and abroad. This alone might save Chrysler from bankruptcy. But Congress won't budge on that simple change.Once Congress starts investing in its green visions for Detroit, it isn't likely to give up easily or stop at $50 billion. If the Environmental Motor Company's cars don't sell well enough to earn a profit, then something else would have to be done to vindicate the investments. Taxpayer loans and other subsidies would have to float the companies until Americans wise up or Congress forces consumers to buy them. Taxpayers should get ready to own a piece of Detroit for a very long time.
 The more realistic alternative to this utopian green vision is to let GM or Chrysler file for Chapter 11 like any other company that can't pay its bills. The immediate costs would be severe, but at least bankruptcy would provide the political and legal means for them to evolve into smaller, more competitive companies. Taxpayers shouldn't be asked to finance a green industrial policy promoted by lobbyists and Congressmen who know nothing about what it takes to make a car -- much less make a profit.
But, our elected Representatives in Congress not only don't know how to make cars, they don't know how to make loans either.  Barney Frank, who's leading the charge to fund the bottomless pit called the "Big Three" and the Unions, feels comfortable gifting $25 Billion now, without any real sense of being able to get it back, and acknowledging that it might really take another $100Billion!

That $25 to $100 Billion doesn't come out of the air, it comes forcibly out of other citizen's pockets.  It's $100 Billion that could be invested in more productive areas of the economy instead of being forced by the heavy hand of government to prop up non-sustainable labor contracts and ineffective corporate management.

Now, given the strong win of Barack Obama, there's more and more allusion to, FDR-like "New Deal" government schemes.  The schemes all represent a bigger and stronger gauntleted-government hand throttling and squeezing the economy.    

The Market continues to fall....any wonder why?


Can't think of a better candidate.....


Photograph by Lucian Read

When General David Petraeus arrived in Iraq, it was a disaster. Now he’s leaving, and it’s something else entirely. Lisa DePaulo travels to Baghdad on the eve of his departure to find out how he did it (“You’ve gotta live with the people to protect the people”) and who the hell he is (for starters, he likes Phil Collins)

Read Lisa DePaulo's article here ;

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