The situation of the American automobile manufacturers is just one of the symptoms of a recessional economy. While at first the connection between the obvious cause of the recession (supposedly the lackluster housing market, which itself is supposedly the fallout from rampant speculation–O, the speculator, scapegoat for every economic difficulty!) and some of the effects may seem spurious, careful consideration of the means and methods by which the economy is internally connected may provide insight into the cause for the apparently disparate effects, and may provide insight into why the situation may possibly be more tenuous than it appears on the surface.
Economies are somewhat cyclical: this is easily apparent to anyone with a decent memory who has lived through a couple of the usual economic cycles. There are cycles of growth and cycles of decay, each of which seems to follow after the other as inevitably as waves climbing the shore as the tide comes in. The cycles, during their duration, are somewhat self-reinforcing: when ‘times are good’ they tend to get better; when ‘times are bad’ they tend to get worse–and when the situation becomes alarmingly bad, the rate of negative reinforcement can become similarly alarming.
Examining the current difficulties may provide some insight into how this self-reinforcement works. Let us assume that the roots of the current crisis are based, at least in part, in the situation in the most recent prosperous cycle.
The most recent prosperous cycle was characterized by several different symptoms. The characteristic signs of prosperity tended towards a certain clade of accoutrements: a large vehicle (generally an SUV, usually marketed as being capable of versatile uses, capable of driving off paved roads, and marketed as being safe in an accident–though whether due to good design or through sheer mass is, perhaps, open to question), a large house in a carefully designed community (of a type sometimes referred to as a ‘McMansion’ in the updated, millennial equivalent of a housing tract), clothes of a fashionable cut (from various well-known brands such as Abercrombie and Fitch, Hollister, Calvin Klein, and others), regular grooming (and the associated patronage of salons), patronage of certain brands of consumables (witness the explosion in the number of Starbucks locations–though to be fair, the rise in the fortunes of the national coffeeshop chain is rooted in the dot-com prosperity cycle of the last decade), sometimes a number of children who, of course, require their own clothes and (eventually) automobiles, and various other symbols of conspicuous consumption. These symbols required their own maintenance: the SUV will require large amounts of gasoline to operate; the McMansion will require heating and cooling, power, light, and landscaping, not to mention furniture and furnishings; the designer clothing will require replacement on a regular basis as styles change; consumables, such as designer coffee, will necessarily require regular purchases to continue their consumption; and children will require their own toys and clothes as well.
This is all a sort of widespread “Keeping up with the Joneses”–that is to say, during prosperous cycles, there exists a societal pressure to display to one’s peers that one is also participating in the prosperity at at least an equal, if not greater, level than one’s peers. This is, of course, the same ‘peer pressure’ cited as the primary cause for minors beginning smoking, drinking, or other undesirable behaviors–it exists for all forms of conspicuous consumption, whether of alcohol or tobacco, popular media, sex, or any other metric by which one’s engagement in society is measured.
As the cycle of consumption progresses, more of the resources of the conspicuous consumers are spent in the consumption cycle, and an increase in consumption for each of the products consumed result in more demand for their precursors–things like steel, cotton, plastics, and the like. Further, there is demand for the consumables required for the operation of the products–things like gasoline and corn. Finally, there is an increased demand for land and infrastructure, for the newly conspicuously prosperous to build their houses, their businesses, their schools-and to service them.
As demand rises, there are two possible consequences: either businesses will produce more goods to meet the demand, or the price of what is demanded will increase. For some products, the requirement for more production is relatively easy to meet–most businesses do not operate at 100% capacity, so it’s possible to extend production without much difficulty. Other businesses, however, have certain bottlenecks in their supplies or their production lines that are difficult, if not impossible, to circumvent–petroleum fuels are one of these, as are housing developments. For these industries, the only change that can be made to balance supply and demand is to increase the price required to purchase the resource.
In the conspicuous consumption cycle of the beginning of this century, this resulted in some interesting consequences. Increased consumption of plastics and of fuel resulted in increased demand for oil–part of this increase in fuel being the result of increased consumption by larger vehicles, and part of it being an increase brought on by longer driving distances from the then-conventional wisdom that it was better to increase one’s commute in order to be able to afford a larger (and ‘better’) house. There were, of course, other factors that increased the price of oil–instabilities in oil-producing areas, conspicuously, as well as the greater demands for other oil products for manufacturing fertilizers for commercial farming. Increased demand caused more profits for the companies supplying these products, which, naturally, attracted investors to these companies and to the futures markets on these products, which further increased the prices in a self-perpetuating cycle.
The increase in fuel prices resonated through other markets, as well. As fuel prices rose, those businesses for whom fuel was a significant portion of the budget–the transportation sector, the airlines, and other similar businesses. In order to maintain profits, each of these businesses needed to either raise the rates for their services or begin to implement fuel surcharges for their customers. When those customers were businesses requiring these services for, for instance, transporting goods to markets, the price to the end consumer for those goods began to rise to reflect the increase in expenses. When goods become more expensive, consumers can either buy fewer goods or are forced to find a method to increase their purchasing ability, such as credit.
Another market that saw quick inflation of prices was the market for housing. The self-resonating cycle in this case worked through a combination of the desire for conspicuous consumption, lowered restrictions to home ownership (through legislation originally intended to enable equal access to home ownership by minorities), a change in perception of home ownership from an ideal to an investment (in more than one way–both through appreciation of owned property and through the creation of securities backed by mortgages), and through a desire of self-betterment of the middle class.
This inflation of housing prices was also relevant to the increasing cost of goods: consumers who were unable to support their lifestyle of choice with a line of credit under normal circumstances would re-mortgage their house to make available liquid assets. Relatively lower thresholds for refinancing, the perception of a house as an investment that would be guaranteed to appreciate, and the creation of mortgage-backed securities (which, in order to be sold, required that the issuing agency find a number of mortgages to back the securities with) created an environment in which the use of a house as, essentially, collateral for a loan for the temporary extension of increased credit was encouraged. Indeed, throughout the middle part of this decade, advertisements encouraging homeowners to consult with either their bank or with a mortgage broker for this purpose became increasingly common. This increased perception of the house as an investment also influenced the opinions of those selling houses, who would then demand what they perceived as being a “fair” price for their house–and as each house in an area began to be sold for a greater amount, comparable houses in the area would then be appraised for similarly higher values. Through this reinforcing cycle, the prices of houses would increase because, essentially, the prices of houses were increasing.
This began to become a problem with the rise of high-priced sub-prime mortgages. Previously, before some of the previously discussed innovations in the financial markets became commonplace, sub-prime mortgages were less common and would tend to be for smaller amounts at high interest rates. Increasingly, though, the size of the mortgages began to get larger and larger, and banks and other lending institutions began to offer lower introductory rates (which would, after a time, “adjust” to much higher rates to better reflect the security of the investment)–this, combined with the perception that a house’s price would always rise (and thus smaller and smaller downpayments were required) set up the market, inevitably, for foreclosures en masse. The foreclosures themselves would not, perhaps, have been entirely catastrophic, save for the home-as-an-investment model’s modifications to the investment cycle.
The securities that had been backed by the mortgages that were rapidly failing had been somewhat obfuscated by the lending institutions that had originated them. Rather than reflecting the true risk and credibility of the loans, they had been packaged in such a way that they would rate a high quality rating from the agencies that provide such ratings–a sort of gaming of the system, the financial equivalent of adding melamine to watered-down milk to obfuscate the low nutritional levels with a falsely high protein reading. Just like in the Chinese milk scandal, the consumers of the tainted product ended up starving to death: as the borrowers whose payments provided the dividends for the investments defaulted on their loans, the investors who bought the securities that were backed by mortgages of lower quality found themselves starving with a far lower rate of return than they were promised. These investors were not all speculators out to make fast money, either; amongst the more widely reported investors who found themselves starving was a fund that was used for the investment of pensions for a Norwegian town.
As the investors began to starve, the lending institutions found themselves somewhat malnourished as well. The increasing defaults on mortgages and the subsequent difficulties with the securities that those mortgages backed led to a loss in confidence by the day to day investors, resulting in a market that began to look decidedly thin. Combined with the increased costs and decreased profits resulting from the inflation in the price of fuel, even a number of interest rate reductions by the Federal Reserve could not keep the market healthy.
While the price of housing had been constantly increasing, obtaining credit for and from houses had been a relatively easy prospect–in fact, entire companies were formed to take advantage of easily-obtained mortgages and high costs of living to leverage the high values of homeowner’s houses to consolidate their debts into a single, hopefully lower, mortgage payment. For those situations where the owner had significant equity in their home, this scheme had some promise, especially in a market with increasing prices. However, as the number of defaulted mortgages began to rise, housing prices began to drop–a large supply of relatively cheap houses essentially flooded the market. Many people who had purchased houses with small downpayments (and who had acquired large loans to do so) found themselves owing the bank more money than the house was worth–in some cases, a lot more money. This led to further foreclosures as people walked away from these mortgages–and another self-reinforcing cycle, about the opposite of the previous one, began to form.
As banks’ investments soured, they began to lose money–and some of the banks that had invested heavily in subprime mortgages found themselves on increasingly precarious ground, to the point where a number of them had to either close their doors or find someone to buy them–especially in the case of Washington Mutual, where the Federal Reserve took the unusual step of more or less assigning it to JP Morgan for a comparative pittance. The banks responded by tightening their lending requirements, which caused some businesses to find themselves unable to continue to do business due to a lack of a credit line–without the liquidity provided by a line of credit, most businesses will be unable to pay their suppliers and their employees.
This leads to further resonances as companies go out of business–not only are the employees not being paid (leading to further mortgage defaults and less consumer demand) but their suppliers find themselves with nobody to supply, meaning less demand and fewer profits, not to mention a more precarious business position which may cause liquidity problems should their lending institution decide that the new circumstances mean the company is too much of a risk to lend to.
Businesses are not the only entities suffering from a lack of credit, either–as the position of the banks has grown more precarious and the long-term credit market has become stricter, lenders have also begun re-evaluating the short-term credit market–that is, credit cards. In some cases, credit line reductions have taken place without warning to the consumer. This, too, resonates within the market, as a reduced credit line means a reduced ability to buy goods, and a reduced demand for goods in the market. Not only that, but a credit line reduction for a consumer can become a self-reinforcing cycle to some point, as, rather than being based on income vs. expenses, creditworthiness is evaluated by lenders based on income and the ill-documented metric of the ‘credit score,’ one component of which is the percentage of the consumer’s credit line that is in use. A reduction in a line of credit will mean that a greater percentage of the line will be in use (and possibly cause an overdraft) and hence lead to a lower credit score–which may cause other lenders to re-evaluate the consumer’s lines of credit with their institutions.
These effects are not limited to the free-market economy, either: the effects of the recessional feedback loops resonate within governments at all levels, as well. Governments rely on taxes to fund themselves and their social programs. As the income and consumption decline, the taxes collected on income and sales decline; as houses enter foreclosure, taxes collected on property decline as well. Governments that are far in debt generally cannot find further funds at a reasonable rate, given that high debt indicates a riskier—and thus more expensive—investment for lenders. As debt mounts, each dollar borrowed costs more and more in interest payments in the future to borrow, leading to a further feedback loop.
This leads to further difficulties, as the greatest demand for social programs, such as food assistance and housing assistance grow in inverse proportion to the state of the activities that fund the programs. Education, too, suffers, as without the income provided by local taxes, schools cannot continue to be staffed at optimal levels. This causes ineffective education, which will lead to a less educated and less-competitive workforce in the future, setting the stage for future difficulties in competing within a global economy: a worker’s worth is proportional to their skill, which is a function of their education. Unskilled workforces are cheap (which is the primary motivation for outsourcing unskilled manufacturing to third-world countries), and the United States is, at this point, beyond the point at which unskilled labor can be a really viable career choice–nor has it been for many years, since companies began to outsource unskilled labor to third-world countries where it could be performed cheaply. Many of the unskilled jobs in the United States are performed either by migrant workers (for agricultural jobs) or by high school and college students (for service-oriented and office-oriented jobs). None of these jobs is suitable for a career for most Americans, as the rate of pay is generally far below what the cost of living would demand.
This low rate of pay is compounded further by the increases in the cost of living that are not matched by pay increases. The minimum wage is not tied to any inflation rate, official or otherwise; hence, as prices increase year after year, unskilled laborers are left with less and less purchasing power, and are thus unable to contribute to and participate in the economy to a useful extent. While this is not as much a problem for students (who usually live at home and have at least some of their expenses cared for by their parents), it becomes a fairly severe problem for older unskilled workers–or workers who are unable, for whatever reason, to find a job within their skillset and must resort to an unskilled job.
There is a further feedback loop as regards jobs within the retail sector, familial income, and large chain stores entering a community, but that loop is only tangentially related to this particular cycle of resonances.
It is not only unskilled workers who have been hurt by comparatively stagnant wages compared to inflation: many skilled workers, as well, have not seen wage increases commensurate with the rate of inflation. During the cycles of prosperity, the lessened purchasing power of these consumers is mitigated by readily-available credit. This credit is not infinite, however, and leads directly into the cycle of deepening debt and lessened home equity described above, thus feeding into the refinancing cycle of debts.
The official rate of inflation is only part of the story regarding inflationary pressures against stagnant wages: the official rate given is, by some agencies, estimated to be as little as half or less of the real rate of inflation. By some accounts, the government has, for years, disguised the real rate at which the cost of living has risen through a variety of misdirections and renumbering of metrics. If these accounts are accurate, then the average consumer in the United States has been in a troubling situation for quite some time and has only just begun to realize it, as obvious signs show up. This ostrich-like posture is not only the province of mere ignorant consumers, however; reports recently state that the United States’ economy has been in recession for a year now–a year during which the current administration made many pronouncements of the economy’s strength and the country’s prosperity, displaying an ignorance of the real state of affairs that might be described as laughable save for the needless suffering it has caused. While nobody can claim to know with any accuracy how the situation might have changed if those in charge of setting fiscal policy had risen to the occasion before the situation had come to a head, it is fairly certain that a quick response would probably have not made matters any worse.
In summary, there are a number of feedback loops in this economy that are not only self-reinforcing, but resonate with each other to achieve greater strength. These cycles are rooted partly in the excesses of the past cycle of prosperity, and partly in the inflationary pressure brought to bear against relatively static wages, and these cycles will continue to worsen in the future if they are not stopped.
How, then, may they be stopped?
There are many proposals being floated currently with different methods of halting the downward spiral. Many of the more popularly supported plans favor spending significant amounts of money in order to loan funds to businesses (such as automobile manufacturers) that require them to continue to operate. Other plans have proposed vast public works projects, much like Franklin Roosevelt’s “New Deal” that was used to assist the United States in recovering from the Great Depression of the 1920s. All of these plans require funding–funding that is difficult to find, given the lowered tax revenues and the vast amounts of money required. Further, the state of the finances of the United States is somewhat precarious, given the enormous expenditures made in recent years on military action and other programs both necessary and unnecessary. There are also a number of obligations that the United States has committed itself to for other countries, to assist and aid them with divers matters of humanitarian, economic, and military nature. Further, there are recent large expenditures that have been made for the rescue of the financial industry and (potentially, at the time of writing) the automotive industry.
Any overall program to assist the economy would, in order to be effective, require a number of factors to be present. It must fully interrupt a majority of the self-reinforcing cycles that contribute to the recessional cycle. It must introduce further self-reinforcing cycles that lead to a sustainable period of prosperity. It must be equitable, if not slightly progressive—that is to say, it must distribute benefit across the entirety of the economic spectrum, perhaps weighted slightly towards the poorer segments who are being harmed the most by the current situation, rather than providing benefit for corporate officers and rich investors (who, to be frank, will have no difficulty in profiting off of any economic turnaround—they need no assistance to make money, as they prove by virtue of having made significant amounts thereof). A viable plan must not only provide short-term economic stimulus, not only set the country on what the President-elect has called a “glide-path to prosperity,” but provide a foundation for extremely long-term prosperity and growth. It must further serve to increase morale amongst consumers—the perception of the populace, irrespective of the actual merit of a proposition, is the only way to ensure that they will participate in the plan rather than disregarding it for their own devices (which is one of the chief reasons for Franklin Roosevelt’s “fireside chats” where he exhorted consumers to deposit their funds in banks, rather than hoarding them under their mattresses). Further, any program must be able to be repaid within a reasonable amount of time, as without assurance of prompt repayment, it will be difficult to effectively raise funds. It must be apolitical, deriving from the agendas of neither major party nor adhering to their agendas, both to ensure broad-based support and to prevent the program from being co-opted as another tool for political gain rather than being used to help the populace. It must be versatile, able to change effects as required by changing situations; and it must be agile, able to change quickly should fast change be required. It must be publicly transparent, so the public can see how the operations are being carried out and have confidence in how and how well it is being managed—and to mitigate the corruption that is inevitable with a project of this size and scope. Finally, it must be robust, so that failure of any one part will not impact the success of the project as a whole.
One possible method to ensure these goals would be to incorporate the economic stimulus as a hybrid entity, having both governmental and corporate natures. It would have backing from private investors and public funds, from speculators and from corporations—indeed, part of how it would maintain transparency and ensure equity would be that it would actively solicit participation by the populace in parts of the decision-making process, and that the citizens would have a real and tangible interest in ensuring its success.
The idea is, at its basis, to organize various infrastructure projects as a sort of corporation. The projects would be funded at least in part by the population of the area that would benefit from the project, via the issuance of financial instruments, similar to stock in the project or already common construction bonds. The purchases of the instruments would provide the necessary capital to produce the infrastructural project in question, which would as part of its construction be provided with a means to repay the funding instruments with interest—for instance, projects related to roads or bridges would be provided with toll lanes, and fines for speeding or reckless driving or other vehicular misdemeanors would be applied to the operating budget of the infrastructural corporation; projects related to telecommunications access would rent the lines to companies desiring access to the market; projects relating to schools may institute programs providing preferential access by recruiters to graduates or possibly be bundled with other infrastructural projects of more obviously profitable nature. Once the project is completed and the funds made available to repay the bonds, the option would be made available to convert the bonds into stock in the infrastructural corporation at a favorable rate; the stockholders would then be called upon at regular intervals to vote for members of a board of directors, and would be further given the option to vote upon propositions for improvements or changes in the system—though there would be limits set on the proportion of funds allowed to be used for various facets of the project, and there would be certain restrictions on the nature of expenditures that would be made clear in the infrastructural corporation’s charter. As with most stocks, if the infrastructural corporation found itself making a profit, the shareholders would be paid a dividend—thus encouraging further participation on the process, as every shareholder would necessarily have an interest in ensuring their profits. It may be possible to designate a proportion of the dividends to fund social programs for the area served by the infrastructural corporation. Whether persons not residing primarily in the area affected by the infrastructural corporation and persons moving into or out of the area would be allowed to purchase or sell stock, and the conditions under which such trading would be allowed, would need to be carefully considered at the outset—it may be in the best interest of everyone involved if it were mandated as part of the charter that some majority fraction of the total stock be held by local residents.
This approach allows the stimulus for the economy to be funded without the need to resort to expensive borrowing from external sources. It sets the stage not only for immediate stimulus from the construction projects themselves, but for long term stimulus from infrastructure and for extremely long-term sustainability by ensuring the active interest of the local populace in ensuring the continued success of the infrastructural program, as well as setting the stage for the overall sustainability of the area with the management of funding for social programs. While not immune to politics—this particular form of organization is bound to be affected at least in part by local politics, though minority ownership of stock by out-of-region entities may serve to mitigate this—this method takes advantage of human nature, rather than working against it, to ensure its survival and self-perpetuation. By providing for inexpensive ownership of interests in the infrastructural corporation, both rich and poor can benefit from the activities as well as influence the direction of the infrastructural corporation. Further, failure of any individual infrastructural corporation, while certainly an undesirable event for the area it serves, would have relatively little effect elsewhere in the country. Finally, by encouraging self-reliance, the confidence of the stockholder-residents would be restored, providing not only a boost to consumer confidence, but to the overall morale of the area.
Encouraging the initial funding could be accomplished in a manner neatly consistent with last year’s economic stimulus—by the vehicle of the annual income tax. Providing the option on the income tax form for all or part of an individual’s refund to be placed in the bonds for the nearest infrastructural corporation due to be formed in their area gives the potential for hundreds of billions of dollars in initial stimulus funds; combined with a suitable advertising campaign and the inevitable tidal wave of media coverage that such an action would produce would inevitably lead to widespread recognition of and participation in the program.
In the end, the surest way to extricate the country from the recession is to help people to help themselves. While infrastructural corporations may not be the ideal answer, they are a potential starting point for many great works.