Five myths about the economy hopefully cured by the recession
Sep 14th 2009 4:10PM
Updated Dec 3rd 2009 2:44PM
- Myth #1: Savings is good -
One picture is worth a thousand words:
(source: US Federal Reserve).
From 1980 to 2000, the U.S. Savings rate went straight down. As we know, the economy and stock market boomed during this time. Did people go bankrupt from lack of savings? No, of course not: They became more productive, they started more businesses, they made more money and they enjoyed the fruit of those riches by spending more. A cycle which fed on itself, leading to more income across the economy. Look at when saving last spiked, in the mid-70s, during the worst recession, until now.
- Myth #2: Inflation is bad
Uncontrolled Zimbabwe-style inflation is bad. Producers that make product today need to know what they are going to charge for it tomorrow. Else production stops. But if inflation was steady and highly predictable, as it has been in our economy for largely forever (except for in the mid 70s) then here are some of the benefits of inflation (as opposed to no inflation or deflation). A) Our goods become more attractive to foreign economies, making our exports go up. B) Consumers wish to buy at cheaper prices today than more expensive prices tomorrow, so our spending goes up. C) The dollar gets a little weaker so a small amount of inflation acts as a way of subtly defaulting on our debt without actually defaulting. D) Tax revenues go up because of "A" and "B", making it also easier to pay down our debt. E) We feel more flush as the value of our assets (houses and stocks) and our income goes up with inflation, even if this is an artificial feeling of being flush.
- Myth #3: Debt is bad
For 4000 years, debt has fueled the growth of any capitalistic economy. Most people reading this have a high percentage of Debt / Assets since we were all able to buy our houses with debt. When interest rates are low and inflation is low (as it is now) it's good to borrow and put the money in real assets. Eventually inflation roars back and those assets have gained considerably in value. The thing that kills capitalism is persistent deflation, as happened in the Depression. Fortunately we have a Fed that learned from the mistakes in that period (See Bernanke's book, "Essays on the Great Depression").
- Myth #4: Mark to market accounting is good
The economy began to spiral down in November, 2007 with the advent of FAS 157, the accounting rule requiring banks to mark their debt to market rather than to a more subjective notion of fair value. Admittedly, the banks had abused that subjectivity. But here is a simple example of why mark to market in illiquid asset classes could be bad: Let's say your neighbor buys a house for $300,000 and his house is very similar to yours. Let's say two years later he gets a divorce and now he has to sell his house in a fire sale and can only get $200,000. Did your house really just go down in value to $200,000? No, of course not. But that's where all the banks would have to mark your house now according to FAS 157. And if enough houses get marked down like that then suddenly the banks assets are not high enough according to regulatory standards and the bank fails.
- Myth #5: Unemployment is bad
The other day I was at a restaurant and it took 20 minutes for the waiter to get me my water. That guy should be fired. Or my lawyer's assistant forgot to give my lawyer a message from me. She should be fired. For years, because the economy was moving up, that waiter and that assistant were not fired. Companies couldn't fire them because they were either afraid to (I've managed hundreds of people - it's hard to fire people. You feel bad afterwards) or because they would be too short-handed if they did. Well, that period is over. The "Great Recession" has given employers the excuse they need to fire everyone ("sorry, it's the recession"). Consequently, productivity has shot up considerably. This is a good thing that will have long-term positive effects on the economy. And as businesses replenish their inventories, companies will be forced to hire good people to help them create those inventories.
I'm excited. The next phase of this economic cycle is beginning and my gut tells me we're going to be pleasantly surprised at the outcomes. What myths am I missing?