As posted on Huffington Post
Sandwiched around the election of the first African-American president of the United States we find the debacles associated with the collapse of the international financial sector and the imminent end of the American automotive industry as we’ve known it for decades accompanied by the scurrying of would-be leaders and experts around the world attempting to patch holes in the badly leaking dikes with hastily applied band-aids.
It’s abundantly clear that the world has changed drastically. In my view, we’re now in the midst of truly historical sea changes, although the biggest implications of these dramatic changes are very unclear and may not become fully apparent for some time to come.
But the world spins on, waiting for no one. Unable to stand still until clarity emerges, how can one make sense of what has happened in the relative blink of an eye? Here’s what I’ve been able to cobble together so far:
The Now-Dubious Ascent
For the past fifty years, the United States has implicitly pursued a social/industrial policy based on consumer largesse powered by low-cost energy. As outlined in a thoughtful December 4 USA Today opinion piece entitled “Blame and the Big 3″ by Alan M. Webber, the government decades ago instituted what gradually became a fundamentally unsustainable social compact.
The two prongs of the compact were, first, to Detroit: Make big, powerful, low-cost and disposable vehicles, hire employees at high wages, and customers will flock to your products; we’ll ensure there’ll be plenty of cheap gas and cheap credit.
The second prong, to Joe & Jane Six-Pack: Work in factories at high wages, keep buying bigger new cars every few years, build big homes in the suburbs; we’ll build you roads and ensure cheap credit so you can live a good life.
For a while, it seemed to work pretty well. Sure, we had a tough patch in the 1970s, but with the demise of the Soviet Union and the Eastern Bloc in the late 1980s and early 1990s, we felt secure in our market-oriented supremacy.
At that moment in time, American hegemony looked limitless. It was, we were told, the end of history. The so-called “peace dividend” allowed us to enjoy a decade of almost unparalleled bliss, unburdened by any intrusions on the national consciousness more existentially serious than sexual peccadilloes in the White House.
Then 9/11 happened. It was shocking and horrifying, but amazingly it didn’t become any wake-up call. Rather than altering the compact, the Bush Administration in effect told Americans not to worry: ignore the war, keep on going as you were, only more so.
And, boy, did we binge. For most of this still-young century, the United States has been borrowing money from lenders abroad, based on the expectation of ever-increasing housing values, to buy all sorts of stuff from China to fill their too-big and too-remote houses, and to buy oil from the Middle East to fuel their mega-vehicles and driving patterns. (Thanks to Thomas Friedman in a brilliant set of New York Times columns over the past several months for getting at the gist of this logic.)
American automakers went along for the ride, even encouraged it, with the shift to SUV’s. As has been long and widely documented, the Big Three focused heavily on SUVs largely because their ongoing and legacy cost structures made them uncompetitive in small cars, and their lingering brand weakness made them uncompetitive in performance and luxury cars. The only niche left for them were the big beasts.
In DC, our fearless leaders doubled-down on the bet, by simultaneously waging two wars while cutting taxes. How to pay for this strategy? By cutting interest rates, printing money, and mortgaging the future. Dick Cheney said that deficits didn’t matter, and Treasury Secretary Paul O’Neill was given the axe for daring to suggest otherwise.
With all of the positive feedback loops in force – gas less than $1.50/gallon, home values increasing 10% a year, ample supplies of debt at low interest rates – the social compact held together… at least at a superficial level, at least for a time.
The Rapid Decline
But for those sufficiently observant, the warning signs were increasingly obvious. By 2005, what was considered a strong year economically, the aggregate savings rate for the U.S. went negative, which had only happened before in 1932 and 1933 in the midst of the Great Depression. Americans financed their profligacy by increasing their borrowing on what-they-thought-were-appreciating balance sheets.
As long as the asset base increased, and as long as there were lenders, the bubble kept growing. But, clearly, it couldn’t last.
Meanwhile, the dollar weakened, and weakened, and weakened. Given the insistence for low interest rates and the persistence of demand for borrowing capital to fund ever-increasing imports of oil and other stuff, the only way that foreign investors would lend to the U.S. is if they could also gain from their currency strengthening in relation to the greenback.
In other words, the world was screaming to the U.S. that the key measure of its relative economic standing on the planet the almighty dollar is on the wane. The fundamental forces underlying the U.S. economy may have been invisible to many Americans, but in retrospect, foreigners were the first to pierce the veil.
All of the fundamental precepts underlying U.S. vitality started eroding badly, and in an escalating death spiral, in the last two years.
First, due to a combination of tightening supplies and a weakening dollar, gasoline prices followed oil prices up to extraordinary levels. According to a March 2008 Petroleum Intelligence Weekly article, it was projected that the U.S. would send $400 billion overseas in 2008 to buy oil, an increase of 300% relative to just 6 years previously.
With cheap oil, Americans had been lulled into buying inefficient vehicles and locking into inefficient commuting patterns and now with much higher priced oil on the market, we were saddled with our prior decisions. By May 2008, Gal Luft had seen the future very clearly: “Oil Dependency is America’s Financial Ruin”. Jeff Rubin of CIBC is similarly on record with the opinion that spiking oil prices were the true trigger for the recession to follow. High fuel prices pinched consumers, and they had to borrow more money to continue fueling their lives. But alas, they couldn’t take out second (or third, or fourth) mortgages, because housing values were no longer appreciating to enable additional financings. Indeed, housing prices began falling, as speculative demand for real estate began to waver.As housing values fell, more and more loans went “underwater,” which as they accumulated and exacerbated by extreme leverage, through collateralized debt obligations and other repackagings of mortgages in secondary trading eventually tipped many of the banks (and hedge funds) into insolvency. And so it was that we started circling the drain in late 2007 and early 2008.
The wipeout of Bear Stearns, acquired for virtually nothing by J.P. Morgan Chase at the end of March, was widely thought to be the turning point, after which we could all go back to normal. During the summer, we became distracted and enthralled by the McCain-Obama campaigns and the Beijing Olympics, but behind the scenes, the economy was in fact gulping its final death gasps.
As profiled in a December 29 Wall Street Journal article titled “The Weekend That Wall Street Died”, the mid-September decision by the feds to step back and allow the stunningly rapid collapse of Lehman Brothers put the world’s financial markets on brutally vivid notice that all bets were off, nothing was safe anymore. This had everyone running for the exits, and in the financial world no one has stopped running since. Securities of virtually all flavors and nations have been routed.
Meanwhile, the so-called “real” economy is now stuck at a standstill. In the U.S., car sales are off about 40% from the previous year, housing values continue to slide because there are few viable buyers, new real estate development has been terminated, manufacturing is at the lowest levels in decades, steel production has fallen by 50 percent since August, and businesses can’t get financing.
Oil prices – what had been a leading indicator of our troubles – have crashed back to historical norms, falling by about 75% from $147/barrel on July 11 to the mid-$30s by December, even though demand is off just a few percent from their highs. (For various reasons, it is probably wisest to view this decline as a temporary phenomenon, as the inescapable growth of oil requirements to fuel the slowed but nevertheless major economic growth in China, India and elsewhere in the developing world will quickly chew up the demand-destruction that has occurred in the U.S. and developed economies. But this is a story for another day.)
Taking Stock of the Debris
Before problem-solving on how to stop the panic, it’s worth reflecting upon the fundamental priorities that the U.S. had set over the past few decades that has culminated in us spinning and sinking inside this financial black hole.
There’s lots of blame to be spread around. It’s easy to finger the capitalists on Wall Street for our woes, and certainly they deserve their share of hostility directed toward them. Clearly, plenty of executives in the banking sector were key enablers to our present morass with their often dubious (or worse) ethics and practices, leading to lots of economic activity that is now revealed to have been essentially fictitious.
But as the preceding text indicates, the list of foundational culprits must truly begin with the U.S. societal devotion to cheap energy, inefficient autos, outsized homes, sprawl, roads in lieu of public transit, and excessive materialism.
In other words, many of the things that make the U.S. economy environmentally unsustainable are what have also made the U.S. economy financially unsustainable.
We have met the enemy, and it is us.
These are not factors that are simple or quick to change, so the way out of our current conundrum will not be an easy one. Barack Obama inherits an incredibly daunting set of challenges. Perhaps this is the rare historical confluence of the right man at the right time, true leadership rising to meet challenges that only historically gigantic leaders can surmount.
Some of you may know that I was academically trained as an economist. Actually, I was almost certainly the least motivated student ever under the tutelage of current Fed chairman Ben Bernanke (while he was at the Stanford Graduate School of Business, 1984-85), so it would be presumptuous to say that I have found the yellow brick road out of this economic nightmare. And for sure, I’m not in any particularly influential position to offer advice. (”Hey, Ben! Remember me, your worst pupil? Listen up: I’ve got the answers!” Yeah, right.)
The few macroeconomic fundamentals I dimly remember suggest, to me at least, that any economic recovery will need to be driven by a boost in aggregate demand. With interest rates offered by the Federal Reserve Bank now essentially at zero, monetary policy tools will have limited power. Thus, fiscal tools will need to carry the load to spur aggregate demand.
As widely reported, the Obama Administration is angling for a major economic stimulus package of nearly a trillion dollars (how fondly I remember the days when a few billion dollars was a lot of money) that will focus on new infrastructure and energy projects.
Given the “Green Team” that the President-elect has picked to lead the nation’s energy and environmental agenda, sustainability appears well-positioned to become the essence of an Obama Doctrine. A true test will be if the administration’s economic plan leads the country to pursue only projects that will help us reverse direction from the trajectory we’ve been headed since World War II.
Even if the Obama plan is large and properly pointed, it’s not likely to be enough to restore the American economy and put it on a financially (and environmentally) sustainable path. More will be needed.
Given that the average consumer is far overstretched, there is little scope for increased consumption (and, indeed, lots of evidence to suggest a need for reduced consumption). Thus, any additional demand stimulus needs to come from promoting private-sector savings (which translates to investment), along with the near-certainty of increased government spending.
Bluntly, along with the economic stimulus package that the Obama team is now concocting, we need to cut capital gains taxes and expand R&D to accelerate the turnover to the future, and we need to increase consumption taxes to end the era of living beyond our means.
This is especially the case on the cleantech front.
Investments in new cleaner energy technologies – both to develop them and to deploy them – will need to grow dramatically, perhaps even by an order of magnitude. This isn’t gonna happen on its own.
Certainly, a cap-and-trade program on carbon dioxide emissions will help, and Obama promises this. However, the magnitude of emission reductions likely to be compelled by any legislation that can get passed through Congress will not cause enough of a tilt in favor of clean energy to drive any rapid shift to a sustainable economy. Additional impetus will be needed.
The capital markets are so broken right now, and savings rates so low, that investment in the U.S. must be more aggressively encouraged. Possible solutions: slash capital gains tax rates, and make R&D expenditures tax-deductible.
And as politically unpopular as it certainly would be, taxes on fossil fuel-based energy must be raised. We’re not going to wean ourselves from our addictions if we don’t make it more economically burdensome to maintain the status quo. And if we raise government expenditures and reduce tax-based disincentives against investment, Uncle Sam is going to need to collect more revenue somehow, some way.
Given the recent freefall in oil prices, many have argued (including a Dec. 8 editorial in the Washington Post headlined “Start Making Sense”) that the time is now to put in place taxes that set a floor on the prices paid by consumers for gasoline. This will not only stimulate more far-sighted decisions and behavior by drivers and vehicle suppliers, but will also provide more certainty for investors in alternative fuel technologies and projects that are so badly needed.
A New Beginning
Some might say that we’re poised on the edge of a precipice. For instance, the current environment looks like the early days of what James Howard Kunstler has memorably called The Long Emergency, a dire depiction of a bleak long-term future. While clearly very urgent, I don’t see our situation as hopeless. I prefer an interpretation similar to what I’ve seen from a number of sources in recent weeks: that innovation and ingenuity are in fact amplified during difficult times, during which many of the most enduring and important enterprises are founded.
See, for instance, the recent report on entrepreneurism by the Kauffman Foundation, George Gilder’s “The Coming Creativity Boom” in the November 10 issue of Forbes, or the Dec. 15 interview with Harvard’s Clayton Christensen in the Wall Street Journal.
Necessity is the mother of invention, and desperate times call for desperate measures. They may be old cliches, but there’s a lot of truth in them nevertheless.
Recall that Microsoft was born in 1975 during the last really bleak period of U.S. economic history. In that context, it’s interesting to read the perspective of Nathan Myrvhold, formerly Microsoft’s Chief Technology Officer, who in “Inventing Our Energy Future” in the November/December issue of EnergyBiz clearly sees the opportunities for reinventing the energy economy.
It’s not just the hardware of the energy economy that needs to change, but also the software: how we as Americans think about and operate in the world of the future.I’ve written before that we need a whole new story to move us forward in the 21st century in a truly sustainable manner. I think the story’s being rewritten right before our very eyes. The rules of the game are changing, and we don’t yet see what they will become yet.
I believe we’re in the midst of a revolution. It is uncomfortable, to say the least. But that’s the nature of revolutions.
The Beatles asked if you wanted a revolution, if you wanted to change the world. If so, here’s your chance.
But be assured, this will be a participative sport – indeed a full-contact sport – and it won’t be a spectator sport.
Advance forward a few years after the Beatles into the music of Gil Scott-Heron, who noted darkly that the revolution will not be televised. No, indeed, it won’t. We are living it now. It’s reality TV turned inside-out: the fantasy is inside the boob tube, the reality is on this side of the screen.
The revolution is now. Are you game to take part?
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