Special Report: 2.12.2009

Posted by TED Magazine on Thursday, February 12, 2009

What's Happening To You

By Joe Salimando

No one (except me) will say we’re in a Depression. So be it! Let’s look at things from an historical perspective.

In the 19th century, Great Britain was the world’s economic leader. The British Pound was as good as gold. The United States was not No. 1. At one point, we were roughly the equal of Argentina!

Then World War I happened. Europe took it on the chin; Britain didn’t fare so well. When they were done kicking the crap out of each other, one heck of a lot of gold began crossing the Atlantic Ocean, going WEST.

After the Depression began, the U.S. government (1934) outlawed citizen purchase and ownership of gold. Yes, this seems drastic, but it really happened. People bought gold out of fear. Using dollars to buy gold reduces the “velocity” of money. The government had to stop it.

World War II came along. In 1944, the world’s economic system was reorganized. The U.S. dollar became king of all currencies; 35 dollars were declared equivalent to one ounce of gold.

Many believed the Depression would resume when the war ended. But they hadn’t considered major changes: (a) the currency thing, referenced above, and (b) the fact that the war had destroyed the factories of the major industrial nations (and killed/maimed their workers, too).

As a result, from 1946 to the late 1960s, the United States, alone, thrived. Baby Boomers were born and raised in this environment; it’s the period to which everyone harkens (men had good jobs, moms stayed home). It is impossible to return to this era!

Unfortunately, the United States in the 1960s pursued a “guns and butter” policy. We spent a lot of money on the Vietnam War, and even more on social programs. We spent ourselves into annual deficits.

That hasn’t stopped!

While U.S. citizens could not present seven $5 bills and get one ounce of gold from their government, other nations were able to do so. One of them (France) saw the growing debt and insisted on turning its dollars into gold.

Beggaring the French

In 1971, Richard Nixon (who inherited the war, DeGaulle’s golden desire, and increasing national debt) “closed the gold window.” That meant:

a. The French could not convert dollar holdings into gold. C’est la vie!

b. Without the gold commitment, U.S. government spending would have no realistic consequence. We could print dollars at will, unless the rest of the world balked.

c. But the U.S. dollar remained the global default currency. The rest of the industrial world could either go back to the gold standard or put its “faith” in the dollar. It chose paper.

d. With these developments, the United States was able to print money to pay its debt, a privilege the world’s economic system extended to no other country.

Result: The economic developments of 1971-1987. Debt expanded, with no consequence. Inflation went bananas. Oil prices went up and up and up (assisted by the sudden realization by the Arab oil producers that U.S. oil output had finally peaked!).

Between 1979 and 1987, one man tried to fix the problem, Paul Volcker. His solution was imposing pain on the rest of us. As head of the Fed, he raised interest rates, with the goal of choking off inflation.

It worked.

But Volcker took on negatives. A guy who raises interest rates won’t be popular (he was hung in effigy). He was a Democrat, and when his term expired, the President who could re-appoint him (or appoint someone else) was a Republican. And Volcker was plain spoken; people in Washington, D.C. don’t like to hear the truth.

The No-Standard Standard

Before moving on to the past 22 years, let’s focus on the gold standard: It worked. But it limited economic expansion. The problem with what Nixon did was NOT that he went off the gold standard, but that nothing replaced it.

And so: The only economic standard in existence was what the Fed elected to do (as Volcker went on to prove in short order).

Without a standard, the Fed was (de facto) delegated authority to manage economic growth. How? However it felt like it!

What was the alternative? Rules. Here’s a possibility: Grow the money supply by the nominal growth rate desired (say, 3%) plus the annual increase in population (say, 1.25%) plus inflation (say, 2.5%). Keep things from being too tight; keep things from getting too loose.

That didn’t happen.

Instead, money supply and interest rates are set by the “feel” of the person who serves as Fed chairman. This person’s “feel” is the difference between “over” expansion and too little economic growth!

We went from a standard to “seat of the pants” management. Don’t blame Bush, Clinton, Bush, Reagan, Carter, Johnson, Nixon, DeGaulle, and the banks.

The problem is the SYSTEM.

“Seat of the pants” management had an upside in Volcker. Now, we’re living with the consequences of the downside.

Greenspan’s Mistakes

Alan Greenspan became Fed head in 1987 and ruled for a long time. What was the feeling in the seat of Al’s pants? We can judge from what he did. His answer, to every crisis, was to reduce interest rates and print money.

Forget the politics. Focus on these:

• When Nixon detached the dollar from gold, he created a situation in which the Fed could escalate (or discourage) economic growth via simple actions.
• When Volcker tightened interest rates and reduced the damage that had taken place in 1971-1979, he demonstrated the Fed’s power. The U.S. dollar remained supreme.
• There appeared to be no need to substitute something for the gold standard. What Volcker did reinforced that. He served us well, but we’re now suffering from the consequences of putting our collective faith in human infallibility.
• Greenspan was not “The Maestro,” but a very flawed human being. We shouldn’t have expected more (especially of a government official!!!); Volcker’s performance misled us!

What you would expect from Greenspan’s insane money-printing and interest-rate manipulation is INFLATION. But instead of higher food and oil prices, we got higher stock and housing prices, as well as dramatic overinvestment in telecom and questionable Internet ideas.

What has Greenspan wrought? A significant percentage of whatever growth should have happened between 1987 and (let’s say for argument’s sake) 2017…has already happened.

What This Means

OK, it’s true: I picked 2017 out of a hat; the year could well be 2012 or 2021. To get a lengthy, chart-enabled explanation of this (without Joe’s personal spin), download the 58-page PDF from the Congressional Budget Office. The CBO picked the year 2019.

What does this gloomy news mean to you? Here is a checklist of reasonable assumptions:

• Most American business executives, almost certainly including you, have learned to run their businesses over the past 22 years. Even if you are 60 years old, what you learned in business in your first 18 years of work has been overwhelmed by information, reflexes, and decisions built into you since 1987.
• It’s certain that these years were ILLUSIONS. We (maybe) squeezed 30 years of growth out of the tube and used them in a 20-year window.
• We can’t get any more toothpaste from the tube. It’s kaput!
• We can’t put toothpaste back into the tube. Ever try that?
• SO: There’s nothing left. We’ll brush our economic teeth every night for the next 10 years with something OTHER THAN toothpaste! (How does that sound?)
• The U.S. government is dead-set on returning to those illusionary years. People in Washington (the same sorts of people who thought “seat of the pants” economic management was working and Greenspan was a God!) think they can conjure up toothpaste from thin air.
• No matter what you read or hear, THIS WON’T WORK. Try it at home: Grab some thin air; see if you can conjure up some Crest.
• It’s reasonable to believe that efforts to prop up financial institutions, car companies, and more ALSO won’t work.

What does all this mean to you? You must forget what you think you’ve learned about how your business works. The economic environment in which you took on decades (perhaps) of experience and knowledge is history; the “lessons” you’ve incorporated into your management approach might just be irrelevant (or, worse, damaging).

In other words: Continuing to do what you’ve “always done” in the past two decades may well result in the death of your company.

As someone said in another context: Change has come to America. Changing how you do what you do won’t be easy. Warren Buffett thus far hasn’t been able to do it, and he might be the smartest of all.

But if the above analysis is correct (and you’ll break your pick finding a flaw in the logic), you don’t have a choice but to evolve.

	Joe Salimando of EFJ Enterprises is a consultant, web content provider, and wordsmith based in Oakton, Va. To contact him, call 703-255-1428. See also The EleBlog.
Personal Disclaimer: The appearance of the ambling pachyderm is indicative of the writer’s obsession with elephants, not his political leanings.
IMPORTANT NOTE: THIS COLUMN REFLECTS ONLY THE OPINIONS OF ITS AUTHOR AND DOES NOT REFLECT THE OPINIONS OR POLICIES OF NAED, TED MAGAZINE, OR THE ADVERTISERS ON THE TEDMAG WEB SITE.