Reaganomics is in Intensive Care

Two days of testimony by FED Chairman Bernanke brought unusually clear indications that the US economy is bad and that the risks of serious degradation are very high. While the Administration, President Bush and his mignons, continue to indicate that the “Underlying Economy is strong” the FED chairman talks about the dislocations in the market are serious. The Administration indicates that if you eliminate the losses of the Financial and Housing Sectors corporate earnings are at all time highs. While this is an exaggeration, it is true that other sectors are holding up fairly well. The problem is that our economy is Financial and Housing. We call it the Service economy. I call it the smoke and mirrors economy.

The most important comments by the FED chairman concerns the imminent failure of smaller banks with exposure the mortgage industry. The FED chairman also indicated that the number of failures would be inferior to the Savings and Loan failures of the late 80s. Further questions by the committee brought an unusual clarity to the discussion. Inflation is a problem however the FED believes the slowing economy will place downward pressure on demand. Oil and other commodities will most likely stabilize thus reducing inflationary pressures from raw materials.

To a direct question about alternative solutions the chairman indicated that should inflation remain strong there is little the FED can do without destroying the economy. In other words, if we are unable to stimulate the economy quickly and inflation continues because of the deterioration of the dollar’s value, the resulting environment could be disastrous.

Notwithstanding these clear indications our political leaders refuse to look at the “why” we find ourselves at this point. They somehow believe that fixing the housing market will make everything better. The economists promoting Free Trade and Open Borders continue to say that labor costs are the most important part of costs of goods produced. They lump labor costs along with advertising and transportation indicating that raw materials are only 18% of costs of goods.

While our structural problems are numerous the highest cost responsible for inflation is energy. Labor costs have been driven so low that they no longer count in the top 5 costs associated with the production and sale of goods. Obviously a business oriented government will support this breakdown because a reasonable person would find the immediate solution in producing goods locally and strengthening the dollar. How could big business compete with this geographically distributed model? How could a CEO siphon a $150 million dollar salary when locally produced goods could do without his infrastructure? Where would the lobbies get money from to pay off the politicians? How would the politicians survive without free vacations and free travel?

The road is still long. Without a doubt there will be more layoffs. There will be more foreclosures and bankruptcies. There will be more people who have to choose between heating and eating. If left to our politicians things will go from bad to worse. They will hold hearings and create stimulus programs that make the problems ever greater. They will try to find someone to blame. If we want to avoid or attenuate the inevitable we, the people, must force our politicians to think about the good of America and not the good of their pocket books.

Note: For my Australian readers I have had the opportunity to speak with a group of individuals heavily involved in the economy there. From their comments I believe you can substitute America for Australia and have a home grown article.