This advice moderately offends me when separated from its rationale, so I thought it would be a good idea to expound on this a little. It’s actually eerily simple.

The way we measure growth (or contraction) in the US economy is to use gross domestic product numbers. GDP is the total value of goods and services produced within the borders of the country for final consumption. (I’ve typed that phrase for Jim about a thousand times by now.) Since 70 percent of the goods and services that make up GDP is produced for US consumers to buy, if consumers don’t buy, production (and therefore GDP) goes down.

So, if consumers stop shopping, it is literally true that the economy will start dropping and so, in times like these, it is not only sensible but important that consumers return to their buying ways. You buy something and that means someone else gets to keep their job. As long as they have a job and buy stuff, other people have jobs, etc.

Now, how does this reconcile with the seemingly opposite advice to increase savings? Well, it doesn’t. Turns out it’s just a difference in timing. If the economy is heading south (like now), shopping is really the way things pick up. Once things are more or less back to normal, it then becomes prudent to start saving. If you do it gradually, and not during a recession, you are doing your best to help the US economy.

So, to paraphrase both Smoky the Bear AND James F. Smith, economic forecaster, “Only YOU can prevent the economy from slipping further!” Go shopping. Please?

Among all the irritating things of this current campaign, the one that stands out for me is the silly and dangerous notion that our President should be just like Joe the Plumber (or as noted on Comedy Central–Bob the Builder or Dora the Explorer).

I want my President to be well-educated, worldly, thoughtful, articulate, well-mannered, well-dressed, fair-minded, and strong. S/he SHOULD be part of the elite segment of the population who leads well. (A definition of elite: “the choice or best of anything considered collectively”) Yes, that’s who I want to be President.

Why do I want a “regular” person? It makes no sense. Stop it!

All right, I’m going to confess. I’m voting for Obama, thereby cancelling Jim’s vote. We do this all the time so it’s nothing new. (And as an aside, we don’t talk politics much in the house under the theory that a marriage thrives by emphasizing the things we share, not our differences. However, I CAN report that Jim is more or less a one-issue voter and he believes that McCain better matches his worldview of how the economy works.)

So, because I’m tuned to economic issues, here’s what I believe about Obama, as articulated by Fareed Zakaria in the October 20 Newsweek:

“Paul Volcker has long argued that the recent spate of financial innovation was nothing of the kind: it simply shuffled around existing resources while contributing few real benefits to the economy….Volcker has also argued that the highly complex financial system was not nearly as stable as people believed and that far-reaching efforts were needed to regulate and stabilize it. Now these issues will get attention at the highest level. The fear on Wall Street is that a Democratic administration would overregulate. But look at who is advising Barack Obama–Buffett, Volcker, former Treasury secretaries Robert Rubin and Larry Summers. It is more likely that what will come from their efforts will be a better-regulated financial system that, while producing less-extravagant profits, will be more stable and secure.”

Of course, this doesn’t mention the ridiculous additions that Congress will make to ruin any good idea (I’m getting cynical, can you tell?).

Still, I don’t think Obama will cause ruination and more importantly, I think he will even out things a little, making them a bit fairer for the lower income earners.

I know it feels scary, but the current economic mess is not unprecedented. The exact details of it are all new (hence the scary part) but the general outline is as old as capitalism. Here’s a brief review of Jim’s current most-recommended book: Manias, Panics, and Crashes: A History of Financial Crises (5th Edition) by Charles P. Kindleberger and Robert Aliber (ISBN 978-0-471-46714-4). The book covers the history of financial panics around the world from Kipper-und-Wipperzeit of 1619-1622 and the Dutch tulip bulb episode in 1636-1637 through the Asian collapse in 1997 as well as the Russian default and the collapse of Long Term Capital Management in 1998 and the corporate scandals of 2001-2003 (Enron, Worldcom and so on). It was first published in 1978; the current 5th edition was published in 2005. Undoubtedly a new edition is in the works!

So, everything from here on is me quoting the book with my own comments in italics.

“The features of…manias are never identical and yet there is a similar pattern. The increase in prices of commodities or real estate or stock is associated with euphoria; household wealth increases and so does spending. There is a sense of ‘We never had it so good.’ Then the asset prices peak, and then begin to decline.” [page 10]

And remember, this has happened historically all over the world, not just in the U.S.

“The big ten financial bubbles [It will be interesting to see which one gets dropped in Edition 6!]
1. The Dutch Tulip Bulb Bubble 1636
2. The South Sea Bubble 1720
3. The Mississippi Bubble 1720
4. The late 1920s stock price bubble 1927-29
5. The surge in bank loans to Mexico and other developing countries in the 1970s
6. The bubble in real estate and stocks in Japan 1985-89
7. The 1985-89 bubble in real estate and stocks in Finland, Norway and Sweden
8. The bubble in real estate and stocks in Thailand, Malaysia, Indonesia and several other Asian countries in 1992-97
9. The surge in foreign investment in Mexico 1990-93
10. The bubble in over-the-counter stocks in the Unites States 1995-2000” [page 8]

Some speakers I have heard (remember, I hang out with economists a LOT) have mentioned the resemblance of the current mania/panic to the one in Japan in 1985-89. This is not good as Japan has never done what it needs to do to fully get over the thing. Their stock market has never recovered (the high was around 39,000 in 1989, it had gotten back to about 14,000 before this panic and is now running around 8,000).

“During the mania the increases in the prices of real estate or stocks or in one or several commodities contribute to increases in consumption and investment spending that in turn forecast perpetual economic growth.” [page 9]

Do you remember hearing that house prices can’t fall? That the run-up in prices was due to demand pressures and that they would continue? I don’t think the stock price problem is the same however. Stocks are going down simply(?) because of the panic. They may have been slightly overpriced according to historic averages of P/Es but the sell-off is strictly a panic response to the loss of confidence in the global financial system.

“During these euphoric periods an increasing number of investors seek short-term capital gains from the increases in the prices of real estate and of stocks rather than from the investment income based on the productive use of these assets. Individuals make down payments on condo apartments in the pre-construction phase of the developments in the anticipation that they will be able to sell these apartments at handsome profits when the buildings have been completed.” [page 9]

Well, doggone, this is EXACTLY what happened in one of the two hardest hit areas of foreclosures, namely the Sun Belt. There was a lot of speculation or purchase of second homes and these are the places that are being foreclosed. The other area of many foreclosures is the Rust Belt and that’s caused more by the basic economic factors of higher unemployment and generally depressed incomes of people who were able to get mortgages in the time of “easy credit.”

“When asset prices tumble sharply, the surge in the demand for liquidity may drive many individuals and firms into bankruptcy, and the sale of assets in these distressed circumstances may induce further declines in asset prices. At such times a lender of last resort can provide financial stability or attenuate financial instability. [page 13]

This is the reason the Fed and Treasury and the world’s central banks have stepped in to add massive amounts of liquidity and “save” some firms whose defaults would have caused even more massive disruptions to the world financial system.

“The dilemma is that if investors knew in advance that governmental support would be forthcoming under generous dispensations when asset prices fall sharply, markets might break down somewhat more frequently because investors will be less cautious in their purchases of assets and of securities.” [page 13]

This is called ‘moral hazard’ and it’s the reason that the Fed did not do anything to save Lehman Brothers. It is a very tricky business to decide what to save and what to let fail.

“The standard model of the sequence of events that leads to financial crises is that a shock leads to an economic expansion that then morphs into an economic boom; euphoria develops and then there is a pause in the increase in asset prices. Distress is likely to follow as asset prices begin to decline. The pattern is biological in regularity. A panic is likely and then a crash may follow.” [page 77]

The problem with this panic was that the quicker and larger the helping response was from the world’s central banks, the more people panicked, I guess assuming that if the governments are doing so much to fix things, they must REALLY be broken. It’s perfectly possible that the real estate bubble might have deflated slowly, without a panic and without taking the stock market with it if there hadn’t been the complication of the mortgage-backed security problem.

“The change in the mind-sets of investors from confidence to pessimism is the source of instability in the credit markets as some borrowers—individuals as well as firms—realize that their indebtedness is too large relative to their incomes. These borrowers begin to adjust to their new perceptions about the economic future by reducing their spending so they will have the cast to pay down debt or to increase saving. Some firms may sell divisions and operating units to get the cash to pay down debt. The lenders recognize that they have too many risky loans and so they seek repayment of outstanding loans from borrowers that they deem most risky; they become reluctant to renew these loans as they mature. The lenders also raise the credit standard for new loans.” [pages 77-78]

Egads. This sounds like a news story from this morning’s paper and not something written in 1978 (I’m betting this paragraph was written in the first edition). So, like I said, IT’S NOT NEW!!!

Woo-eee, are we having fun yet? At least things have slowed down since the weekend. Now major news is only breaking once or twice a day. Even Jim has felt compelled to write frequent(!) blogs.

I, of course, remain confused as ever. At first I assumed it was obvious that some sort of package that helped stabilize banks would be a good thing. Especially with that mark-to-market stuff I wrote about the other day. Well, they did change the mark-to-market rule, at least temporarily, so we have staved off a nasty bank experience. But, then, Congress added a whole bunch of bad gunk along with some good stuff when they wrote the bill. So, passing it would not necessarily have been a good thing at all, since it was all so messed up by the time they voted on it. Now the Senate is playing the same game, so it’s not at all clear if their messed up bill is actually better than no bill.

Could we just start over again, stick to the problems at hand, and produce a streamlined bill? No, I thought not.

And then one of my favorite writers, Allan Sloan, currently writing for Fortune, noted that, since nothing that the Fed and Treasury and global central banks have tried so far has worked, there’s a chance that this enormous fix-it plan won’t work either. Yikes.

The rest of the economy is all a-jitter, so even though MOST of the problems stem from fear, well, we’ve got plenty of that which just makes everything worse. I think I have a stomach ache.