Wednesday, March 18, 2009

The Three Kings

On Monday we discussed the game of three card monte. So what are the three cards acting as culprits in this mess? Let's examine:

The King of Spades - Natural Excess of the Cyclical Economy

In every recession, there always seems to be some sector/product of excess, that creates a bubble, or a run up or oversupply of/in that particular sector/product. When demand can't catch up, the recession hits, as there is no longer a need for that sector/product. To briefly explain why oversupply can cause or lead to a recession, we need to understand relationships in the economy. When oversupply occurs of a major economically impacting product, and demand is far behind supply, supply temporarily stops because there is no need for it. This causes roughly a 3% decline in GDP (gross domestic product). Every time there is a 3% decline in GDP, it roughly translates into $2 million lost jobs.

Naturally, over time, the excess is burned off, because production stops, the population continues to grow, and eventually, demand catches up to a healthier balance with supply. When the tech bubble burst, tech startups stopped, datacenters stopped being produced and were converted into alternative uses, and eventually, we recovered. The housing bubble (which was the main culprit for this recession) is, and will be no different. Construction of single family homes has dwindled, but over time the population will continue to grow, demand will catch up with supply, pricing will stabilize, and we will recover.

The King of Diamonds (aka the King of the Middle East) - Gas Prices

This is probably the card that fools everybody. For months, all anybody wanted to talk about as the culprit for all this mess was the housing bubble. While it certainly was a major culprit, as we analyzed above, it certainly was not the only one. From mid 2006 to the fourth quarter of 2007, the price of a barrel of oil rose $100 per barrel. This was a $100 RISE in oil prices, after the price of a barrel of oil had only previously topped $100 per barrel for four months in the history of commodities trading. Suffice it to say this was unprecedented. The massively booming rise of the populations, and economies, of India and China were a significant cause of demand for oil, which helped push the price up, up more, and up higher still.

Yet, nobody talked about that as a cause of potential recession. No matter how you slice it, every one of us paying more at the pump led to one of two things. Either we spent less as consumers, or we saved/invested less of our money. Both of these have a negative impact on the economy. In fact, this phenomenon alone also caused about a 3% decline in GDP, or another $2 million jobs lost. The good news here is that since then, as the global economy crashed, oil prices have gone DOWN by about $100 per barrel, which should help lead us out of a recession over time. That is of course, if it weren't for card number three...

The King of Hearts - Emergency Tracheotomies

In the notoriously awful film Anaconda, featuring J. Lo and Ice Cube, Eric Stoltz gets a nasty bug lodged in his throat while swimming in the dangerous Amazon River. Jon Voight, who plays a shifty snake hunter (and also has one of the worst accents of any actor trying to portray an indigenous foreign national ever) sees he can no longer breathe. So Voight's character, trying to help, stabs a pen in his trachea, below the blockage, and puts a plastic stint in it, creating another passageway for oxygen to reach his lungs, thus saving his life. We are led to believe Voight's character has done this before, and is somewhat of an expert at Amazon first aid.

Well this is precisely what Secretaries of the Treasury Paulson and Geither have done to the asphyxiating US economy (in the form of ridiculously expensive and often unnecessary bailouts), only they don't have the medical training, and are more likely to kill the patient (the economy) than save its life.

On Friday, we will examine the impact of these bailouts, and what they really mean. Stay tuned.

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