What You Should Know About Today's Economy

Written by Hank Brock

The following excerpt is taken from a conversation between Hank Brock, President of Brock and Associates, LLC and his daughter Andrea in February of 2008.   It is in question/ answer format, and will be followed in the next posting by an in-depth commentary on current economic conditions, and how to prepare for the future.

Q.    Dad, if it is good for one family to save money against misfortune, why is it not then good for a nation to save money?
A.    Depends: In your question does "nation" mean government? If so, then no, a government should be neutral, and not taxing us to a surplus and then saving our money for us. But neutral also doesn't mean spending us into debt, especially if it becomes too much of GDP (% of total economy). If "nation" means the people, then yes, you are right--the people should save. Some would argue this slows the consuming economy, but only short-term. It provides capital for investment, some of which is going to be deployed in R&D, increased efficiency & productivity, lower inflation, and expansion long-term. But, which politico, or stock analyst, is interested in the long-term?

Q.    It seems a little bit like Pharaoh and Joseph in Egypt. Why is the government letting the grain out of the store house when the famine has yet to hit? (These rebates are intended for people to consume, NOT save, pay bills, etc…).
A.    Yes, exactly. Get your seven-year supply of wheat. (The spending will mean very little).

Q.    I just read an AP article that said this will add 117 billion dollars to our national deficit. So much for good economic sense.
A.    And $117 billion is a tiny impact on a $14 trillion economy (approximate). Worse, it is inflationary. Incidentally, a $10 increase in the cost of oil has the same drag on the economy as a $200 billion tax increase. Both are bad on jobs, inflation, lowering tax revenues in the long-term, and increasing the long-term deficit.

Incidentally, cost of oil, adjusted for inflation, today’s prices = 1988, the last time we had shortages. Oil & utilities have been the two dog sectors of stock market from 1989-2004. The companies are just catching-up. The increased cost is due to (1) China/India’s 25% annual increase in demand to produce cheap goods for us, and (2) refinery capacity at 100% - no refineries built since 1970's, one generation ago. Refinery cost = so great not even Exxon builds one alone, but only joint ventures with other oil companies. Remember: profits = money to build refineries. Building a refinery cannot be taken as an expense against income. It must be capitalized and then depreciated/expensed over decades.

Q.    What is the deal with the government buying people out of their bad decisions when it comes to mortgages?
A.    You may not remember the 1989-1991 mortgage crisis when congress had to borrow to bail out the FSLIC (Federal Savings and Loan Insurance Corp). S&L's failing, Frank Keating, etc. This time, it is the FDIC, the banks, that are in trouble, many, many multiples the size.

Q.    Everyone knew the day would come when these mortgages would be due. Everyone knew there would be problems. I think the banks were counting on this and factored it into their loan approval process. But now, great, like a parent, the government is bailing people out of their bad decisions.
A.    Yes. "Compassion" delivered en masse is just more government welfare.

Q.    I guess I'm just a little bitter because we didn't take advantage of the bad loans that were available four or five years ago . . . we recognized them for what they were, and didn't get ourselves into the situation. If we did, we'd have 3x's the house and the government would essentially take away the consequences of a bad mortgage decision and let us stay in our home that we never could legitimately afford. So what about the rest of the country?
A.    We will pay for it in higher taxes or higher inflation (which is another tax engineered by the government so it can pay off its debts with pennies on the dollar.)

Q.    Does this smell a little of socialism?
A.    Not just a little.

Q.    So, without the clarity of actual conversation to sort out my thoughts - aren't these two acts basically yet another step of big government to push us into socialism (from which we will never be able to revert due to the complacency of technology--but that's another conversation all together).
A.    It was all put into place under Franklin Roosevelt’s "New Deal," expanded under Lyndon Johnson’s "War on Poverty," and maintained by both parties ever since. Goes back to Thomas Jefferson’s comment about the demise of the Republic as soon as the people discover they can vote themselves largesse from the government treasury. Really started with the 16th Amendment to the Constitution when the people & States voted on the government's ability to tax income, and the 17th Amendment when Senators began getting elected by the people instead of the state legislatures--until then they represented the states, were accountable to state legislators, we had federalism, and we would not have the concentration of power and government programs/solutions in Washington. The Founding Fathers don't get enough credit for their genius/ inspiration.

Q.    If you can explain the economic sense (or in my opinion nonsense) that drove these bills to pass, let me know.
A.    Sorry, I can't explain it. But, even though the fed is "lowering" interest rates, actual long-term rates are (or must very shortly) skyrocketing, hence the falling stock market. We are living in 1977, maybe 1978. To understand that, you need to look at 1979-1981 just before Ronald Reagan took office: inflation rate (13%), unemployment rate (13%), interest rates (21% prime), mortgages (17%), gold ($800), silver ($50), money market funds (18%), new construction or home selling (0%), etc. The Jimmy Carter years--one generation ago--the last time the Democrats had control of all 3: House, Senate, and Presidency. Democrats had House & Presidency for the first 2 years of Bill Clinton’s Presidency in '92--'94. November '08 has: Senate, current Democratic majority 51 to 49. Seats up for re-election in Senate: 9 Democrats and 23 Republicans-- guess who'll lose seats? House: currently 31 more Democrats--seats up for re-election in house: all but 28 Republicans are retiring. Problem = House, Senate, President in same party. People don't like gridlock? Wall street/economy likes gridlock. Polls may say McCain over Hillary or Obama 47% to 45%. Percentages don't elect. Twice as many Democrats are showing up at their primaries as Republicans.

Q.    I’ll ask you: Who are those that can veto the laws passed by congress? Veto the President's policies? Veto the Fed's policies and actions? And make them null & of no effect? Are many of those with veto power even U.S. Citizens?
A.    The freely-traded bond market-- those that finance the deficit, and allow us to spend and spend without a day of reckoning. And those voters have been the Chinese, the Saudis, and the Japanese, in that order. With the plummeting dollar (down 50% in past 2-3 years), they want much higher interest if they are going to continue to use their surpluses to finance our deficits instead of Euro deficits, because they want their dollars returned to them adjusted for the currency exchange rate. Ultimately, inflation = value of the dollar, hence current gold & silver prices. No matter what, government will not default on its T-bonds, even if it means 13% or 15% unemployment and deep, deep recession, because then it couldn't borrow any more. So it must (no choice about it) raise interest rates, which will slow economic activity even more. When Bush Sr. was voted out of office in 1991, the recession had unemployment at 7%, which is 2% above "full employment" (5% of pop are changing jobs at any given time anyway. 13% is 8% above full employment, or 4x as much as the 2% that lost Bush Sr. the election of ‘91.)

In about 1995 Sweden’s parliament (socialist) passed a bill and within days free-market interest rates on their government bonds jumped to 200%. No government can survive on 200% interest rates. Parliament reversed itself within few days. No-one has to buy our U.S. Government bonds. They'll only buy at what price they decide. So, the Fed is band-aid short-term stuff. Watch the bond market especially & stock market to predict what's going on.

"The economy is resilient." --Bush, January 31, 2008. "The economy is a fragile thing." --Hinckley, October 3, 1998. (In credit to Bush, his responsibility is to say that, because he cannot contribute to a market- public panic.)

Well, just a few thoughts on your questions…