Friday, July 23rd, 2010

The Economy: Why It Sucks

A sign indicating that the factory behind the gate on which it rests has been shutteredThe economy is terrible right now. Almost everybody seems to agree. The business community, as represented by the US Chamber of Commerce, the Business Roundtable and most Republicans, has some ideas as to how to fix it: cut taxes; reduce the deficit (!); rein in Big Government spending (except defense); stop over-regulating business so they can get on with business. The Democrats have their own idea: more stimulus, in the form of, for example, extending unemployment benefits. Who's right? If anybody?

As a corporate bond analyst, I get some perspective on this. My job is to analyze companies and try to figure out whether they can service their debt (pay interest and return the principal when it comes due), or, perhaps more often, how much of a loss their creditors (banks, bondholders, vendors, pensioners, etc) are going to take in the bankruptcy, and what the company is going to look like when it has screwed them all (except the lawyers and financiers) and emerges in a relatively debt-free state from Chapter 11. I spend a lot of time gazing at spreadsheets (in between ruminating over Solitaire, Hearts, Tetris and Bridge), corporate slide-shows and SEC filings. I listen to a lot of "earnings calls" (the conference calls given by management when their quarterly earnings numbers are released). I read the Financial Times every day. (Gave up the Journal a long time ago, fed up, finally, with the one-sidedness of its editorials).

There's a thread that runs through most of the calls I listen to: Demand is weak; we are responding by cutting the fat and becoming leaner and meaner; when demand picks up, we'll be in good shape.

Most of the companies I follow have a line in their income statements: Restructuring charges. When they close a plant and lay people off ("headcount reductions"), they have to pay severance and, for instance, break leases. And that's what restructuring charges are all about. Granted, I don't follow upper-class companies like Exxon or IBM or Microsoft; but pretty much every US company I do follow has this line in its income statement. And even most of the blue-chips have probably taken these restructuring charges at some point in the past two or three years. Yes, even Microsoft ($290 million in the March quarter of 2009).

Just as an aside here, there's a reason for them breaking it out like that as a separate line-item in their expenses: that way, they can present it as a "one-time charge". Analysts like me are supposed to discount it in looking at their "real" underlying cash flow and in forecasting their financial futures. It's a one-time charge. Trouble is, it almost never is a one-time charge. That line, Restructuring Charges, appears, for most of my companies, every single quarter. Sometimes you begin to wonder what's left to restructure.

Most CEOs and CFOs on earnings calls are not taking the big-picture view. They're focused on the details of their own particular business. Still, I often ask myself if they see the connection that's staring you right in the face: when is "the consumer" going to start spending again? Well, maybe when you stop firing him.

This really seems to be the root of the problem here in the US, and these earnings calls are like a microcosm of the whole US economy. You've probably read a hundred times that consumers are responsible for about two-thirds of GDP. (In the last four quarters up to 3/31/2010 it was close to 71%). So if they don't have any spendable money because they've been fired (or are afraid they're going to be fired), demand will be weak.

In other words: If I fire everybody, then who is going to buy the stuff I make? You can see how this turns into a vicious circle.

A corollary of this whole phenomenon, incidentally, is this: Private enterprise "surplus" as a percentage of GDP has stayed at a pretty high level-about 25% over the 12 months to 3/31/10. That's well above the trough in the last really big recession in 1980, when it ran about 20%. At the same time, perhaps not surprisingly, corporate cash is at $1.8 trillion, according to the Federal Reserve, which at 7% of assets is as high as it's been since the 1960s. There's probably another reason for that other than all the money they've saved by their "reductions in force": they're haunted by the ghost of the credit crunch, when cash was very hard to come by and you couldn't be sure your bank would survive. Still, there's obviously a connection.

You probably think this is all leading up to a big rant against the evil corporations. Not so. I mean, there's plenty to rant about, including the extraordinarily high salaries of the corporate managers and, particularly, the egregious parasitism of "financial services" companies whose contribution to our economy is minuscule in comparison to their cost; but staying "lean and mean" is just facing reality: keeping employees hired just for the good of US-kind is a short-term fix with bad long-term consequences.

The stock answer to this quandary is that we must invent new industries and re-train workers in the skills required to drive them; but, frankly, that's bullshit and I think we secretly all know it. The truth is, there is no good answer to this quandary.

One thing does seem clear, though. The US Chamber of Commerce, Business Roundtable and Republicans generally have the wrong answer. The reason businesses are not hiring is not that their taxes are too high or that they're over-regulated or that their healthcare costs are too high or that they don't have enough cash or that they can't borrow. The reason is that there's fewer and fewer people left to buy their stuff (except the Chinese, but that's another story). It's not even clear, really, that's there's anything government can do. But if we have to pick between the Republican solution and the Democrat one, well, the Democrats win by default.

Carl Hegelman (a pen name) is a corporate bond analyst and a connoisseur of leisure.

40 Comments / Post A Comment

NicFit (#616)

Here's an idea: our national infrastructure is outdated and falling apart. Why don't we hire a bunch of people to fix it?

kneetoe (#1,881)

Unprecedented! Socialist! Etc!

Morbo (#1,288)

Its what no one talks about. The m3 money supply continues to shrink. Banks don't have have any good projects to lend to….so work isn't done. Jobs aren't created…and the velocity of money grinds to a halt.

We can cut as many taxes (as one side proposes), or pass out as much stimulus as you can(as the other side proposes), but until people do actual work- build things, sell things, provide services, – and feel safe that tomorrow they will be asked back to do that job, the cycle will continue.

Its a crisis of confidence, and does not have a ready, easy fix.

Instead, we are apparently hiring interns to play SimCity.

HiredGoons (#603)


brent_cox (#40)

That would be waay too new of a deal.

BlinkyMcChuck (#202)

This may be the first honest and intelligent piece of writing I've read about what's happening to the economy, and what HAS been happening.

BlinkyMcChuck (#202)

I.e., if it isn't the first, it's the first in a long time. I feel like most of what I read is euphemistic or ideological or based on pointless speculation, since most news outlets now basically publish and broadcast speculative fiction, a.k.a. "opinion".

Annie K. (#3,563)

Also, the writing is CLEAR. I mean, I really can't understand most financial writing and I understood this. What job! Ok, given the subject, not joy. But clarity is better than nothing.

Annie K. (#3,563)

Not "What job!", silly. "What joy!"

laurel (#4,035)

No, really: what job?

the Loud Coast (#1,362)

Every six months or so an article shows up in Scientific American speculating on whether there could be a functional economy that dosn't rely on endless growth. Its a radical idea that seems impossible from a practical perspective, but it's an interesting thing to think about in light of this perspective.

LondonLee (#922)

Yes, I've never understood the need for companies to continually make more money from year to year: "Wal-Mart stocks tumbled today after they reported $3 billion in profits, less than the $3.5 billion analysts were expecting"

Screen Name (#2,416)

David Harvey talks about this concept; something beyond capitalism. His book, The Condition of Postmodernity, traces the transition from Fordism and Modernity to flexible accumulation and is worth reading for anyone interested in post-capitalist society and what it might look like. I think he has a new book out, The Enigma of Capital, and there are lectures by from Cornell and other places available on YouTube.

Two more books worth considering are Baudrillard's The Consumer Society, which, incredibly, was written in 1970! And more recently, Mark C. Taylor's book, Confidence Games, about the erosion of meaning from financial markets where .

Those two books tie together neatly the concept of the precession of simulacra Baudrillard wrote about in later works. If we think about this precession and the successive phases of the image as might be applied to financial markets and securities pricing, then the most recent crisis can be seen as the culmination point where pricing structure begins to break down because it, literally, has no relation to anything tangible. In other words, securities markets now exist as a pure simulacrum from which the concepts of higher and lower are relations to something without meaning; a hyperreal market.

the Loud Coast (#1,362)

well people dont profit from investment unless the investments grow.

Im not an economist, but I think the underlying mechanism is that there has to be a motivation for Wall Mart profiteers to invest that $3 billion back into the market after they "make" it. If there wasnt the possibility that the capital could grow, they would just send the employees home and spend all the cash on luxuries (which stimulate in the short term but have a diminishing return over time) and then that wealth has basically evaporated.

Thats why the "economy without growth" thing is such a wide-open speculation, because it gets down to a behavioral question of what fundamentally motivates people.

LondonLee (#922)

I understand the need for profit (they still made $3 billion!) it's the constant need to grow at some pace decided by Wall Street from quarter to quarter that causes a chase for profits at the expense of long-term planning.

But I'm not an economist either.

Mindpowered (#948)

Ehh.. Stocks are forward looking, hence why they trade @ multiples to their earnings.
These multiples are usually 10 – 20 times (hi tech!) their quarterly earnings hence the issue about whether they meet or don't meet the analyst expectations.

These analysts are gods among mortals who at single stroke can encompass the totallity of the kitty litter industry and determine what the company should be earning for shipping 1,000,000 bags of cat bathroom accouterment.

so they assign the value, the people by shares in it, and the value of the share approximates the real worth of the company as determined by the analyst.

Now there is the expectation by the shareholders (namely large pension funds, who are scared shitless they will grow broke servicing boomer trips to laughlin Nevada) that ever more cat litter will be sold and the company will be worth ever more, and they will be able to dump their shares at later date for more money(booking anise cut for their services). Hence the constant pressure to expand and grow until you blockout the sun and every single cat on earth is shitting on your product.

Not to mention making the bevy of analysts, brokers, investment banks, funds of various sorts, and other people, look good and fatten their own purses.

Mindpowered (#948)

Yes. Thanks Ipad. The famous "anise cut".

scrooge (#2,697)

Analysts look at companies as at a black box which will produce a stream of cash in the future. Obviously, the faster the cash will grow, the more valuable the future stream of cash. Hence, high-growth companies are worth more than low-growth companies, other things being equal. If there are signs that growth may not be as high as previously thought… kaboom!

Art Yucko (#1,321)

@WaltonFirm: "There will be fat years, and there will be lean years. But either way, gentlemen… it's going to rain."

-Don Draper


davidwatts (#72)

Traditionally, a service economy like ours is supposed to be the most "evolved" form of economic development. Does the rise of China's manufacturing-heavy economy to the second-largest in the world combined with our absolutely terrible balance of trade, debt level, slow jobless recovery, and incredibly high unemployment show that in fact service economies are bullshit and shutting down all america's factories over the last 30 years was a terrible fucking mistake?

DoctorDisaster (#1,970)

But Daddy, I don't want to work on the assembly line!!

migraineheadache (#1,866)

What interests me about manufacturing is the role that branding and shareholders play in it. Private companies like Carhartt, New Balance, Grado, etc. seem to survive while making things in the US, so it makes me think that it isn't the workers' wages that are the issue, but being able to pay them on top of dividends and huge advertising budgets.

Art Yucko (#1,321)

Yes, interesting subject, Private companies. This is a subject that interests me too. On the face of it you would naturally think that absent shareholders, a company could do more with all that extra profit that doesn't have to be doled out to the toe-tapping, impatient shareholders.

The downside and the occasional reality of this, though, is that such companies and their management are technically accountable to no one- and if their presence is big enough in a community, any strategic or financial missteps on their part can have just as negative an effect on that community as a publicly held corporation's would.
We have one such private company here, whose base product is a product that many people in America just aren't purchasing anymore. (-cough-rhymeswithballpark.) If we want to talk about "black boxes"… the company's finances are a complete cypher. Layoffs are frequent there, even during good times, and this is well-known throughout the community. Employees seem to be in a constant state of either unknowing, denial and/or fear about what's going to happen to them or their department. They are constantly forced to relocate their offices to other areas and vast stretches of the corporate headquarters complex sit empty. The company's manufacturing presence in this area has shriveled to a wisp of what it once was… meanwhile it buys brands and gets into the content-licensing game and there are a number of who-knows-what-is-going-on-behind-the-curtain-here scenarios involving real-estate properties and smaller businesses that they own "indirectly"… probably an elaborate collection of tax-write-offs, no doubt?
This company occasionally informs a media outlet or two of "the current state of things that we have decided you should probably know" yet there is no real way to know exactly how much or how little profit they are making and what their financial future looks like. They may not have shareholders they are beholden to, but in a sense, their shareholders are this very community itself. Without their presence, this city would suffer pretty severe economic fallout and everyone here knows it.

Art Yucko (#1,321)

oh, and this was a great article, btw! Very succinct and informative.

Crantastical (#4,127)

About a month after I was laid off my the US Chamber of Commerce, they sent a regional small business membership representative to my parents' HOME to try and interest them in joining.

The Chamber has been laying people off since Apple left. Nobody can afford to be a member or doesn't want to because of their stance on global warming AHEM climate change.

Yes, it's the Death of Fordism.

Creating a boom in the housing market was one way Greenspan kept the economy expanding in an era when wages were flat – wealth had to be created somewhere for people to spend, and stocks and housing were each 'it' for a short period.

jfruh (#713)

Thanks for bringing up the "one-time charges" thing. I am sort of fascinated by the airline industry for reasons I cannot fathom and it seems that every quarter all the airlines numbers are "we'd be profitable if not for these pesky one-time charges." You really do begin to wonder if it isn't just accounting jujitsu (hint: it is).

Aloysius (#1,808)

I hate this line where we have to rein in government spending EXCEPT defense. We're spending $700 billion this year on defense, a number that includes $10 billion on missile defense, $5 billion on military PR. Contrast that to the next highest defense spender, China, at $150 billion. I mean it's cool that our military can play with awesome jets and everything, but the money spent on developing them could be invested in our infrastructure or in health care or NASA or basically anything that doesn't have the economically counterproductive objective of killing people.

barnhouse (#1,326)

Yes. The author is being facetious, I think. On the other hand, though, Robert Reich opened my eyes about this when he wrote that defense is essentially a "jobs program."

I think the author is wrong, though, about our not being able to invent new industries. That's just what happened when the Internet came along. And it will happen again, with any luck.

Aloysius (#1,808)

Dude wasn't being facetious, he was restating the views of the Chamber of Commerce and basically the entire conservative movement. And you can call it a jobs program, but you might as well be paying people to dig up and fill in holes for the productive effects that it has on the rest of the economy (contrast to infrastructure projects, which increase overall economic productivity by increasing speed/reliability of transportation/communication/commerce).

barnhouse (#1,326)

Oh sure, I don't disagree with any of that. It would be very difficult to cut a lot of the defense budget because of the jobs it would cost, is all I'm saying.

barnhouse (#1,326)

p.s. Also I suggested the author was being facetious because ordinarily the defense budget it sacred, but recently, not so much. With the recent Post revelations of insane waste in the intelligence agencies, it is pretty clear that the tide is finally going to turn, there (unless the Dems suffer a huge defeat in the midterms, of course.)

KarenUhOh (#19)

The slow drip of the truth teaches us that a whole lot of our "wealth" is built on clouds; and that, when we wake from our dream, the ground finds us.

laurel (#4,035)

That was an economical poem.

barnhouse (#1,326)

I love this poem. Reminds me of Wallace, and his love of that conceit of being 'attacked by the floor.'

sallytomato (#549)

Carl, please contribute more. I'm an economic dummkopf who found your precis incredibly clear in explaining what's up with the economy.

alannaofdoom (#4,512)


droskill (#6,275)

What a relief to read such a well-written and thought out piece. It consistently amazes me that Republicans continue to push the idea of tax cuts when the last round of tax cuts resulted is very poor job growth coming out of the last recession. As others on the thread have pointed out – the growth (and wage increases) never appeared except in the housing bubble.

And I also want to say I really appreciate the comments on this article. My god, how nice to see a well-reasoned article and not have it be followed by people shouting about an Kenyan dictator, or how tax cuts pay for themselves.

Scum (#1,847)

Advocating stimulus to boost consumer demand because consumer demand is two thirds of GDP is rather like a doctor trying to treat a patients fever by throwing the thermometer in an ice bucket. GDP is a metric of dubious value to begin with, it can become positively damaging when people begin confusing the measurement with what we are attempting to measure. GDP is an attempt to measure economic growth(and a bad one at that), it is NOT economic growth.

The obsession with GDP is symptomatic of a broader problem. Over the course of the twentieth century Macroeconomics because the branch of economics which assumed economics doesn't matter. The allocation of scarce resources barely enters into the modern macro framework. $20 billion spent on building homes is of equal value to $20 billion spent on destroying homes and spending $40 on building homes and immediately destroying them is twice as good as either.

This implied homogeneity is also what is wrong with stimulus. The reason the world is in shit street is is because it has just discovered that for decades it has been engaged in huge amounts of unproductive economic activity. The whole reason that so much crap has been allowed to accumulate is because most of the worlds governments have been operating on the principle that the important thing is the total aggregate amount of economic activity and the kinds of economic activity are either irrelevant or can work themselves out. In every crisis they intervene and in every crisis they intervene predominately on the behalf of those companies and industries that engage in producing things that are worthless. The economic structure becomes more flakey and deranged over time, dwindling productive areas of the economy supporting the growing unproductive areas of the economy until the whole thing collapses in on itself.

Patrick Carlson (#6,379)

I completely agree with the article.

A country that switches its primary industry from manufacturing to the service sector has no real physical products to export. Once those jobs are outsourced, which they are, then unemployment goes up and our cash cow is gone

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