Photo by: whatmegsaid

When it comes to government policy it is rarely acceptable for politicians to do nothing.  Even if it’s only to give the appearance of doing something and instilling confidence, the government actually does have a role to play.   While there is certainly a case for stimulus and crisis management, too much government intervention can completely upset the whole purpose of free markets.  Even worse, the fear of government intervention can inject the same uncertainty in the market that it is supposed to help assuage.

The 2008 Crisis

In retrospect there is a lot of criticism about the TARP-the Troubled Asset Relief Program.^[1] Some politicians complain that the prices paid for the equities were too high.  This criticism is somewhat problematic, since the whole purpose of the TARP was to pay more than the market was willing to pay for distressed banks.^[2] Others claim that it was unnecessary, and that the market would have sorted things out itself.  These criticisms conveniently forget the abject panic that had beset the markets when the idea was put forth.  There was a tremendous amount of uncertainty as to whether the banking system was going to completely collapse and how the world would react.

With all its flaws the TARP may very well have injected some confidence into the market.  The same can be said of Obama’s sweeping stimulus.  Investors and businessmen knew that a large dose of spending was coming and had broad ideas about what it would include.  Economists may argue, but a case can be made for all these changes, particularly when they’re done quickly and in a sweeping fashion.

The Problem

The problem arises when the government becomes a first resort instead of a last resort.  When people expect the government, instead of natural forces, to correct all the ills of the market, uncertainty is sure to follow.  The government can’t do everything, so the economy becomes a guessing game of trying to determine which programs the government will implement.  Even worse it can become a hotbed of cronyism, where the supporters of those in power get bailouts and the rest watch despairingly.

History has taught us that central decision making and governments controlling markets invariably leads to this cronyism.  Free markets, for all their faults, do a better job than any single body of making sure capital is allocated to the best places.  While they are subject to the foibles of the human motivations driving them, they at least have the counterbalance of self-interest.  Even the best intentioned government programs are going to be naturally biased for their own perpetuation and the benefit of their supporters.

Take for example the shares of General Motors leading up the bankruptcy.  People were buying and selling these stocks in a guessing game to see if the company would get a bail out.  This isn’t really market discovery of price, but instead simply a form of gambling based on the speculators read of the government.  The decisions of the government are driving the price of things and that does not have a good historical record.

Conclusion

While many are apt to decry the government’s actions on the current economic crisis, in the face of massive uncertainty the government has a role to play.^[3] During crisis also tends to be when government is the least self-serving and the most just.  While they are tinkering with the market, the idea is to cushion the blow.  It’s important to remember however that you cannot avert the blow; your goal is simply to soften it.  The government can be helpful in a crisis; they just have to know when to stop.

Post from: Personal Finance And Investing

The Problem with Uncertainty

1. Wall Street Journal - Panel Steps Up Criticism of Treasury Over TARP
2. The Economist – Carping about the TARP
3. The Economist – Big government fights back

Photo by: andjohan

In the period leading up to the realization of the current economic crisis, Green was booming.  Solar cell companies were stock market darlings, and the whole sector looked like it may have the makings of the next bubble.  Unfortunately the crash has of course taken some of the bloom off that rose and investment has decreased to 2007 levels.^[1]  But the crash is offset somewhat by the components of President Obama’s stimulus package that call for spending on renewable energy and other “Green” projects.

Why Green?

Generally the idea behind counter-cyclical spending is for the government to put people to work doing things that benefit the country as a whole-thus the idea of building roads, schools, or something else that will give a lasting benefit while helping invigorate the economy through the spending.  This is a win-win.  For those who are pro-Green, environmentally friendly projects seem like the perfect kind of project.  You can wean the country off oil, save the environment and fix the economy all at once.  But is this argument realistic?

Many will immediately cite skepticism over global warming as the first reason not to bother with this kind of infrastructure.  While I personally believe there is credible evidence of man-made climate change, I think there are other reasons to pursue renewable energy.  The first is to remove our dependence on oil, the price of which has a huge impact on our economy.  We can also bias our energy generation toward areas in which we have a natural advantage, like wind.  Even if you doubt that reducing our carbon emissions is a worthy goal, certainly those have some weight.

But is it Efficient?

The question then becomes, is Green spending an efficient way to create jobs.  According to the Peterson Institute of International Economics, green projects produce 30,100 job-years per billion spent, vs. 25,200 for road construction and even less for tax cuts.  The pivotal caveat to these numbers is that they assume quite a bit of private investment stimulated by the government’s stimulus.^[2]  Green projects have a lot to offer in this area, but that caveat is still important.

In a normal economic condition, that private investment could very well come at the expense of another, more efficient project.  So you may see 30,100 job-years created by the project, but at the expense of some number from another sector where the private investment would have flowed anyway.  This makes it very difficult to estimate whether it’s efficient in normal circumstances.

Why Now?

These are not by any stretch of the imagination normal circumstances.  While those Green projects may be questionable in times when private investment money is flowing, in these deflationary times where capital is literally being destroyed, the economics are different.  Instead of these Green projects pulling money from other private enterprise, they may be essentially pulling that money from mattresses.  With the government investing in Green, people may see that as a safe bet, and that investment money may be money that would have been allocated much less beneficially. 

While this is all supposition, it at a bare minimum suggests that the current deflationary, contracting environment represents a better opportunity for Green spending in other times.  Whatever the costs to private industry may have been in other times of that kind of stimulus, they are almost certainly reduced in this environment.  Thus even the harshest eco-skeptic might consider the idea that now is a good time to retool our energy production and distribution, among other Green projects.

Post from: Personal Finance And Investing

Why Now May Be the Right Time for Green Stimulus

1. Forbes - Venture Capital Investment in Renewable Energy Exceeds $836.1M in Q1 2009
2. Economist – The Grass Is Always Greener

Photo by: Mel B.

2009 is a dreadful year to try to invest.  While we have seen a massive rebound in stocks, there are a variety of factors that make long term planning very difficult.

Asset Class Difficulties

The first thing that makes the current economic climate so difficult is the correlation between asset classes.  Under normal circumstances declines in one asset class involve money moving to another asset class.  Thus when stocks go down, bonds or gold or another asset class is usually the beneficiary.

What makes the current economy so difficult is that you see capital essentially being “destroyed” by the deflationary spiral.  Forced liquidation on the part of many funds caused by redemptions and margin calls contribute to this problem as well.  While this problem was particularly pronounced in 2008, you continue to see deflationary pressures affecting all asset classes.

Government Intervention

One of the most obvious difficulties of building a long term plan in 2009 is the frequency and fervor of government intervention.  Policy makers are attempting to walk several fine lines and thus are constantly exerting strong forces upon the market.  In their zeal they make it very difficult to draw long range conclusions about what makes sense.

Take for example the Treasuries market.  One might be inclined to think that prices would drift lower in this market, given the massive amount of debt the government is planning on issuing.  The Federal Reserve however, is actively purchasing some of these treasuries, driving prices up.^[1] The dramatic influence of the government on the markets is a serious deterrent to investing in 2009.

Differing Long-Term and Short-Term Dangers

This problem is particularly severe and affects both investors and policy makers.  We are faced with the exact opposite problems in the long term and the short term.  Right now the government is facing deflation and economic slowdown.^[2] Under normal circumstances, this suggests increased spending, even at a deficit.  At the same time in the long term we have an incredible debt burden which is just part of a number of reasons to fear inflation.^[3]

Thus the government wants to stimulate our consumer driven economy in the short term, but doesn’t want rampant inflation to destroy us in the long term.  At the same time the massive amount of total credit market debt our country has may make inflation unavoidable.  This can affect the ways in which the government interferes with the markets as well as how the markets themselves price assets.

The government can seem to affect the market very capriciously because they are trying to walk a fine line.  Because our economy is highly consumer driven, they want to stimulate spending and consumption.  At the same time we have to get our debt under control before it buries us.  Thus they can appear to make conflicting policy decisions.  As we’ve already discussed, the scope of this interference is vast, so it’s particularly distressing for it to be so difficult to predict.

For an investor it is difficult to price assets, even without government interference.  For example, let’s discuss gold.  Its long term prospects may be fairly good because of the dire threat of inflation.  However with the short term calling for deflation, you have no idea how much your asset might depreciate before the inflation kicks in.  It’s very difficult to tell when that corner will be turned, and markets are erratic accordingly.

How to React

One approach is to simply “go to cash.”  Unfortunately that is not a neutral decision.  If you have the majority of your net worth in cash you are betting against rampant inflation.  What all these competing factors suggest to me is a balanced and conservative approach.  It may be time to add some variety to your portfolio, including both inflation and deflation hedges.  I also think it is pivotal to take a long range view and not try to maximize in the short term.  This is an economy without historical precedent, so it makes sense to take a defensive approach.

It is a good time to start learning about how to hedge your stock market positions.  While you may have only invested in stocks up to this point, the time may have come to learn about other opportunities.  ETFs in particular can offer an easy way to create some balance in your portfolio.

Post from: Personal Finance And Investing

The Difficulty of Investing in 2009

1. Fed To Buy Long Term U.S. Governmnt Debt – Reuters
2. Fed Warns of Global Slowdown That Adds to U.S. Deflation Risk – Bloomberg.com
3. US debt sets stage for inflation – MSN Money

Photo by: Aaron Escobar

Right now Barack Obama is dealing with resistance to spending trillions of stimulus dollars to help offset reductions in consumer spending.^[1]  While it seems likely that this debt will create a burden for us to deal with later, the notion that we need to put out the fire seems at least somewhat compelling.  While many may question the Obama Administration’s reported claim that this government spending will have wide-ranging benefits, many economists feel that there is a need to replace the decrease in private sector spending.^[2]

When the spending in question is for something that improves the country in the long term, the proposition seems even more appealing.  When we build roads, schools, or even electronic medical records, we’re creating infrastructure that should do long-term good.  It may not be the optimal use of the funds, but it seems a good way to inject some spending into a timid economy and reduce the risk of deflation.

However, while all of this spending is being debated and ramped up, we are simultaneously effectively cutting defense spending.^[3]  This seems both counter-productive and distasteful for several reasons:

Soldiering Is a Shovel-Ready Job

One of the key complaints of Republicans about the spending in the stimulus bill is that it does not take effect quickly enough.^[4] Military spending, specifically increasing the pay of soldiers and recruiting more, can take immediate effect.  We could start paying our service men and women more tomorrow and that money would flow through the economy.  It would also certainly be a project of less than 1 year to increase recruiting.

Soldiering Is a Public Good

While studies on the effects are rare, anecdotally many soldiers report increases in personal discipline and responsibility due to time in the military.  If young men and women improve their qualities as citizens from military service, it is of great benefit to society.  Additionally, it certainly seems more beneficial than unemployment. 

Obviously having a strong military also benefits our ability to implement foreign policy and maintain peace around the world.  Given that we already have troops in active combat, it seems realistic that additional help would not hurt and give troops a better chance to get out of harm’s way.  It is pivotal however that this spending be on manpower, and not on new technology or other programs.  Modern warfare is rarely the kind of conflict for which stealth bombers were invented, and the goal is to quickly create jobs defending our country.

The Real Boon of an Increased Military

In a time of seeming moral hazard, it seems like a fine time to reward people of service and merit.  While we may have to bail out banks and Wall Street firms with taxpayer money, we can’t feel overly good about it.  Providing bonuses, increased pay, and other perks to our service men and women would not only be more appealing morally, it would have the benefit of creating a notion that the right people get rewarded sometimes.  Much like after World War II, where we rewarded our veterans with perks and programs designed to help them benefit in life, the time seems right for similar spending. 

Rather than cutting defense spending, we should be essentially directing a good portion of our stimulus into rewarding our soldiers that have given us such valiant service, and recruiting more to strengthen our ranks.  The turnaround time on the investment is nearly immediate and it will have long reaching benefits, as our military becomes stronger and perceived as a better destination for young men and women.  It has all the desirable characteristics of a good stimulus plan, with the additional perk that it feels good.

Post from: Personal Finance And Investing

A Different Kind of Stimulus – Rewarding Our Troops

1. SFGate - Obama touts $3.6 trillion spending outline
2. Wall Street Journal - Government Spending Is No Free Lunch
3. The Weekly Standard - Senators Raise Concerns about Defense Cuts in Letter to Gates
4. CNN Money - Stimulus will take a while to work