Surely You're Kidding, Mr. Friedman

It amazes me how people continue to view the Friedman Twins (Milton and Thomas) as gurus.  Milton's gospel of deregulation left the foxes guarding the henhouse (We tried that once, you know.  It resulted in the 1929 Crash.  And now, rewind and replay.) and resulted in our current mess.  Brilliance.

And Thomas?  Well, today's editorial is just too typical.  He condemns giving money to auto manufacturers and advocates giving it to venture capital firms that will then finance bleeding edge technology that will save the economy from its current free-fall.  Uh huh, pull the other one.

Let me make it clear that I have opposed the bailouts from the start, and I'm no fan of the Big Three.  I've always thought that, if the government wanted to throw money their way, it should take over their pension funds, thus keeping a pile of retirees off the welfare rolls and making it easier for well-managed auto companies to buy them out.  But Thomas's approach is just noodles.

First, another "New Economy" theory?  Please.  Remember 10 years ago when we were all being told that the Dot Com Boom had changed all the rules?  Turns out it hadn't.  And none of the innovations Thomas is banging the drum for now will change them either.  New tools?  Yes.  New rules?  No.

Second, just what kind of crystal balls do you think the venture capital people have, Thomas?  I remember reading one of the tech tabloids that were all around Seattle during the Dot Com Boom and looking at a cartoon of a scruffy teenager announcing that he had created a website for his cat and then watching the suits line up to dump money on him.  It was about that bad.  And of course the VC people also made the real estate bubble possible.  Let's just say they haven't proved infallible in locating long-term investments.

Third, and here's the kicker, your economy isn't even real, let alone sustainable, if all it produces is electrons and documents.  We have a textbook case in the United Arab Emirates right now: Dubai and its "New Economy" are having to be saved from ruin by Abu Dhabi and that dirty, old school dinosaur stuff it pumps.  If you want an economy that lasts more than ten years, you need to make stuff: food, tools, stuff you can touch, stuff you can pick up, and yes, stuff you can drive around in.

Problem is that the US (and the UK for that matter) has gotten pretty weak in the "making stuff" department.  You see, in order to make stuff, you need people who can make stuff.  You need pattern makers and tool-and-die operators and folks like that.  We haven't been paying attention to that, though.  While Europe and Asia were making sure of their next generation of engineers and lab technicians and skilled trades, we were making sure we'd have an endless supply of lawyers and investment bankers.  The closest anyone got to science was computer programming, which amounted to little more than retraining classes teaching people to cut and paste code someone else had written.  Everybody in the US was going to work behind a desk.  Not possible.  Not even desirable.  All those desk jobs can be moved to Mumbai with the push of a button.  Which Thomas has argued is a good thing.

And so here we are, needing to make things ourselves because we can't afford to buy them any more, and we've nearly forgotten how.  Meanwhile, Thomas drives his Lexus past the olive trees on his way to an exclusive country club outside Calcutta, oblivious to the slums he passes and to how they are reflected more and more by the spreading slums back in the US.

The Rate Cut Is No Fix

The headline in today's Trib screams, "Rate cut won't be a quick fix." I beg to differ. It won't be any kind of a fix. Time for a lesson every business owner should sit through: the difference between liquidity and solvency.

A rate cut reduces the cost of money and encourages people to borrow. This would be a fix if the problem were lack of demand, but that isn't the problem. There's plenty of demand, but people can't find credit.

So the problem must be supply, right? And you encourage supply by encouraging lenders to lend more, such as by providing them with cheap capital to land and guaranteeing their loans (Which is what the recent bailout does, except it goes a step farther and says, "We'll guarantee you loans no matter how idiotic they are." Also, the federal government, by encouraging both demand and supply, is now moving in opposite directions simultaneously, which should surprise no one.). But the problem isn't supply, at least not that kind of supply. The problem isn't that the supply is there but the pump needs primed to get it flowing so everything can get back on track.

The problem isn't liquidity. The problem isn't that the system is strapped until pay day and needs something to cover until then. The problem is solvency: There aren't enough assets to cover the liabilities. The only way you can get a lender to bring more to the table in those circumstances (to allow you to increase your liabilities) is to bring more assets. And we're talking about hard assets, not IOUs and other paper.

For example, my cousins in Iceland have ridden the finance boom like Viking raiders. Unfortunately, the longship has sprung a leak, and they might not be able to bail fast enough. Iceland's three main banks are all in trouble, and the government shut one of them down yesterday. Personally, I think they're going to have to go back to herding sheep and eating rotten shark for a couple of generations, but in the mean time they're desperately trying to maintain the status quo. They've even asked Russia for money, but Russia wants real assets, not paper. Iceland has offered the old, US airbase at Keflavik. Think a bit about the irony of that one. But that's the way it will be, even for the US. In order to increase our liabilities (budget deficit, trade deficit), we shall have to give up assets (land, factories, companies). That's the difference between being illiquid and being insolvent. You can paper over illiquidity, remain intact, and move on. If you are insolvent, people will take pieces of you until there is no more you.

Liquidity problems are short term. There is no such thing as long term illiquidity (Back to the Trib headline. If the rate cut doesn't solve things quickly, it won't solve things at all, because the problem isn't liquidity.). If you are constantly borrowing to cover operating costs, your problem isn't illiquidity but pending (or existing) insolvency, and if you don't correct it right away, you're spinning in.

Coincidence?

So Wachovia agrees to be taken over by Wells Fargo instead of Citi. And unlike Citi, Wells won't use FDIC assistance for the takeover (At least not yet. Watch for something down the road when all the dust has settled and it can slip under the radar.). And now Wachovia has put partial freezes on Commonfund's Short and Intermediate Term Funds.

How does all this tie together? 1) The FDIC can say, without needing Botox to maintain a straight face, "See, the system works. We aren't insolvent. (Yet.);" 2) Instead of three banks (JP Morgan Chase, Citigroup, and Bank of America) holding nearly one third of the deposits in the US and Citi weighing in at over 11%, you will have four (Add Wells.) at nearly 40% and none over 10% (Appearance is everything when looking at market concentrations.); 3) The presidents of the 1,000 or so colleges and universities with investments in Commonfund will be calling Congress today screaming, "Do something!"

All this just in time for the House revote on the bailout.

Coincidence?