Friday, November 21, 2008

Will the US bailout plan work?

A few weeks ago when the US Congress approved the US$700-billion bailout plan, some people were comparing it to FINSAC, as the plan at the time was to use the funds to purchase bad assets, as well as take some equity stake in some of the failed companies. This comparison was even more highlighted with an equity stake in AIG. This newspaper had asked the question if this action was a vindication of the action taken by the Jamaican government in the 1990s and some professed that it was in fact so, and even suggested that the US consult with some Jamaicans.

I pointed out in an article around that time that I was of the view that the action plan proposed by US Treasury Secretary Paulson at the time was not going to make much difference to the economic downturn and that it was rather premature to be talking about vindication of the Jamaican 1990s actions, as the US plan had not been put in place, much less to see what the results were. My view that the plan would not have worked was that buying bad assets and equity stakes in companies would not have solved the underlying problem of real loss of wealth. Shoring up a company's capital base will not increase economic activity.

In fact, the action by the Europeans, to state publicly that they would guarantee bank deposits, had a much greater effect on stabilising the financial markets than the truckloads of money committed by the US Congress. So maybe there was actually some consulting with the Jamaican players at the time by the US government why their ship still seems to be sinking. I have not heard anyone who came out and professed vindication follow up with a story about how it has worked as yet, and am still awaiting the discussion on it so I might be educated on how to solve a financial crisis.

The fact is that Paulson seems to have learned the art of flip-flopping from not only John Kerry, but some of our local politicians also. He has now come out and said that he will not be using the "bailout" money to buy bad assets anymore, as he first proposed, as market conditions have changed. This is one of the most flawed arguments I have heard and is an indication that Paulson did not have a plan in the first place. The fact is that the fundamental problem with the US economy has not changed, and obviously what he is aiming to address are the symptoms and not the underlying problem.

So here we are again, with Paulson changing his approach to solving the crisis, and the US automakers are the next group standing in line for a bailout, which based on the economic fundamentals, will not be the last group. So the great US is turning into a socialist state, and this is going to lead to a significant slowdown in global growth if they are not careful.

I have no doubt that the US will be the last economy to crawl out of the economic downturn, and this is for the following reasons.

1. The US economy is over 75 per cent services and only 25 per cent in industry and agriculture. Other economies such as China and India are only about 60 per cent services, and the economies that are more geared towards industry and agriculture will be the first sectors to recover;

2. The US authorities dealing with the crisis don't seem to have a proper plan, and the approach to bailout companies in an attempt to stem job losses will not lead to a resolution. It will only slow down the decline, which is going to play out anyway, and cause the pain to be protracted, much like Jamaica's failure to address the fundamental problems in the 1990s caused a long spiralling downward trend for us;

3. The US does not realise that in order to deal with the economic situation they need to change their habits, and are only changing because they are being forced to do so. This will result in another looming crisis, which may be of greater significance, as it affects the real economy directly. That is the credit card bubble. A lot of persons are using their credit cards to maintain a lifestyle that is impossible to maintain because real wealth has been lost; and

4. The full unemployment hikes have not fully hit the US as yet, and is expected to reach between eight to 10 per cent by 2009, up from the current 6.5 per cent.

Would not have worked
So unlike what the proponents of the FINSAC-type solution were saying, the plan that was originally proposed by the US was never going to work effectively. Paulson himself has realised his flawed reasoning and is trying to use changing market conditions to argue away his flawed thinking. In any event, even with its similarities, the US plan did not even go as far as the FINSAC solution, as they were still trying to allow the private sector to run the companies there.
One of the challenges the US faces also is that they are in real danger of losing their position as a reserve currency. I believe that short term, into next year, the US dollar will appreciate some more against the major currencies, such as the Euro and British pound. But as the economic downturn sets in more, and the confused regulators, throw "printed" money at the crisis, it will dilute the value of the US. If they are not careful next year we could see a significant depreciation of the US dollar, as we saw before. The long-term trend is still for the depreciation of the US dollar.

Europe, the UK, China, and India will start to see a recovery before the US and their currencies will appreciate against the US dollar. The US companies will have to look to these other economies for their growth, as US consumers will be hurt badly and there will be no more growing on credit. The "Cash Plus"-type US economy cannot continue anymore.

The US is now at risk of seeing deflation, as consumer prices have dropped the most since the data was being recorded in 1947. This as a result of reduced consumer spending, not because costs are going down and competition is increasing. In addition mortgage applications have fallen off again. The writing is on the wall that the real economic slowdown in the US is just beginning, and should go well into 2009.

As demand in other economies start to turn around, especially in China and India, we should start to see a recovery in commodity prices. So as the US economy continues its slump, and other economies start to recover, we could see commodity prices starting to increase again. As I indicated last year on the radio, what we are witnessing today is the beginning of the changing of the guard to a new world economic order. The US will still continue to be the main economic force for a while but this is the start of a changing of world economics. A lot is riding on Barack Obama.

So in my view the US bailout plan has failed to do anything positive for the economy. The way it was handled has clearly shown that the US authorities have not really come to grips with what the fundamental problem is and the Treasury secretary has shown that he does not have a well-thought-out plan. I really wonder if they had sought advice from Jamaica on how to address the crisis?


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