Just crazy enough to work...

"When depression economics prevails, the usual rules of economic policy no longer apply: virtue becomes vice, caution is risky and prudence is folly."
Paul Krugman, Nobel Prize Winning Economist in a New York Times Op-Ed Piece

"What you see in FDR that I hope my team can emulate is not always getting it right, but projecting a sense of confidence, and a willingness to try things. And experiment in order to get people working again."
Barack Obama, President Elect in a interview on 60 Minutes

Auto Response

I must admit, I got scared when I watched this video. No, it's not one of those videos that you watch for a while before something pops into frame screaming. It's the GM-sponsored video that argues for the auto industry bailout. Currently, Congress is looking to give the Big 3 US automakers around $25 billion in low cost loans.

This would amount to spending $104,000 per job saved at those companies. Sounds like an awful deal when you put it like that and I'm betting GM knows it. That's why in the videos they expand their influence to all of the jobs in all of the sectors that they buy parts from (electronics, plastics, steel, etc). In order to keep jobs in those industries, the US auto industry needs your money now.

The worst thing is, is that it all seemed so reasonable. Even a dyed in the wool economist like me even got worried. So I started doing a little research. Here's what I found out:

The Big 3 pays its employees an average of $70 an hour or $140,000 per year. Japanese companies pay their employees $44 an hour or $88,000 a year. This is a result of the union control at these plants. It makes our companies extremely uncompetitive.

Also, the bailout money is being given with restrictions. Essentially, the money can only be spent to research more fuel efficient cars. That's not going to help most of the employees. They're still going to be fired while the industry waits to invent something the public will buy.

I also found out on the radio that this isn't the first time that the US auto industry has received low cost loans from the government. The problem is, the news is swamped with stuff on the current bailout, so I can't find out anything about it, but I have a conjecture. I bet it was probably around 1981. In 1981, the US and Japan reached a Voluntary Restraint of Trade agreement. The Japanese knew the government was going to put a tariff on imported cars and offered the restraint instead. I bet the reason the US government was considering the tariff was the original bailout. The government knew that raising the import tax on foreign-made cars would help the auto industry. The auto industry had to be propped up in order for the government to get its money back. The quota raised car prices by $1,600 (just like the tariff would have) and cost US consumers $7 billion dollars.

In the end, the government made money off of the deal, helped by the quota. I bet a current bailout would be accompanied by tariffs or quotas again. The government would hate to look like it invested money in people who couldn't pay us back*. The same thing is going to be true of the finance industry. The government is going to become majority share holders in some of those companies and will probably change the rules to make sure the industry is able to pay back those loans.

The whole thing makes me extremely nervous. I don't think the government can pick a winning company better than private investors can. I know things are tight in the credit market, but these companies have been hemorrhaging money for a long time now. Something has to be done to make these companies more efficient, and government money doesn't seem like the way to do it.

*Again

-----------***-----------

Update: My guess was right. In 1979, Chrysler petitioned the government for $1.5 billion in low cost loans which were approved by President Carter in January of 1980. The loans were repaid in 1983-earlier than they had to be-and the government made a tidy $350 million. Clearly, the government knew it had a stake in auto industry and went out of its way to help it by hurting everyone else.

-----------***-----------

Update 2: Economist, Robert Lawrence, talks about how the auto industry could fail in the future by doing what Congress forces it to do. Article here.

Simple Macro

I've been teaching the Macro part of 200 lately and I've used a post from Mankiw to illustrate a class example. Pretty simple stuff, but I think it describes what is happening to the economy today.

Uncertainty about the future has caused banks to stop lending and thus excess reserves have skyrocketed. This causes the money multiplier to fall creating a short run recession with deflation. The Fed is trying to counter the deflation by increasing the monetary base.

My prediction is that once banks get back to normal lending the money multiplier will rise. As a result, the money supply is going to rapidly increase due to all the money that the Fed put into the system. This will create an expansion and inflation. The Fed knows this is likely to happen and will try to counter it, but my guess is that they'll act too late and we'll still see significant inflation. By trying to stop the run-away inflation (which it created in the first place) the Fed will put the breaks on the economy causing some bubble that was created by the inflation to burst sending us into an other recession.

What should we look for to see if I'm right? The Fed will announce increases in the interest rate. Currently, the Fed's discount rate is around 1.75 (the lowest its been since November 2002; the end of the last recession). I predict that the Fed will raise rates up to around 5% or 6% within two years.

Not a very optimistic outlook, but I think its at least reasonable.