Economics doesn’t have to be boring
By Eric Kulisch
One reason the real estate and financial markets got into major trouble in 2008 was because there was a global savings glut. People just had more money than they knew what to do with.
‘People have a tendency to do foolish things when they have access to too much money all at one time,’ said Anirban Basu, chairman and chief executive officer of Sage Policy Group, pointing to MC Hammer, Michael Jackson and Mike Tyson as poster children of profligacy.
Basu is a fresh face in the economic forecasting arena, a lively and entertaining speaker who stands in marked contrast to the typical button-down economists who deliver understated assessments of growth prospects.
He spoke in late May at an event hosted by the Port of Baltimore to highlight the regional impact of its improved Seagirt container terminal, and demonstrated a strong knowledge of the freight industry.
People having so much money at their disposal created ‘perverse incentives’ and led significant investors, banks and other institutions to make horrible decisions about how to deploy their resources, the Baltimore-based economist said.
One of the entities that made bad bets was Cerebus Capital Management, one of the world’s largest private equity firms.
Cerebus, you may recall acquired 51 percent of GMAC (the former lending arm of General Motors that finances homes and autos) for $7.4 billion in 2006 and an 80 percent stake in Chrysler in 2007 for another $7.4 billion. GMAC had a huge debt burden and non-performing loans that nearly sank the company before it received billions of dollars from the government’s Troubled Asset Relief Program. Chrysler went bankrupt and was bailed out by the federal government, which forced Cerebus to forfeit its equity and ownership as a condition of the rescue.
After taking the companies private, Cerebus quickly reduced its risk by selling more than half of its equity to some of its own investors, as well as banks, hedge funds and other asset managers, according to the Financial Times in June 2008.
That’s typically what private equity firms do. They only put up a small amount of money themselves while acting as a sponsor for other investors.
Cerebus officials, Basu recalled, thought they could turn the company around to make the investment pay off.
Basu said that was ‘disingenuous because if Daimler, an actual car company which had bought Chrysler in 1998 for $36 billion and promptly realized that was mistake, what made a global private equity firm think they could turn around Chrysler?’
Those types of decisions led to the credit crunch and the near collapse of the financial markets, Basu noted.
Here are some other amusing sidelights from Basu’s rundown of the global economic landscape:
‘ ‘Chindians’ — That’s the term coined by Basu for Chinese and Indians, whose economies last year each grew more than 10 percent. The one country that didn’t grow at all last year was Spain (gross domestic product declined 0.1 percent).
‘But they won the World Cup, so they could care less,’ said Basu, who is of Indian descent.
‘ The price of crude oil on July 20 climbed above $98 per barrel on the New York Mercantile Exchange. That the high price of oil continues to be the top concern of the U.S. consumer ‘tells me that when we Americans put our minds to it we can make almost no progress whatsoever.’
Basu was referring to the fact that high oil prices put the country into a recession during the 1973 Arab oil embargo, and that the government has done little to reduce U.S. dependence on foreign oil and develop alternative sources of energy.
‘ The U.S. economy is not monolithic. Productivity varies by industry sector and geography. Two states growing faster than the rest are North Dakota and Alaska, both of which have oil.
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North Dakota is the beneficiary of recent development of oil and gas locked in shale rock formations. Oil companies are mustering to extract the oil and gas from large fields in northwestern North Dakota, northeastern Montana and parts of Canada. Others are following the oil companies there to provide support functions, such as constructing pipelines, maintaining equipment and delivering supplies, not to mention businesses arriving to cater to the needs of new residents working in the fields. In fact, the fastest growth is now occurring in states with intensive natural resource production, namely food and energy.
Basu noted that North Dakota and Alaska, as of March, had surpassed their pre-recession highs in terms of output. North Dakota, in particular, is ‘minting millionaires’ who are leasing their land to energy firms.
Alaska was the last state in the union to succumb to the recession.
States that are prospering during a time of uncertainty are those that produce staples people need regardless of the economy’s condition versus things people want.
To illustrate his point, he asked how many members of the audience or their wives had purchased fine jewelry in Montana. When he asked the same question to an audience in Iowa City, Iowa, he said, a woman raised her hand.
‘To which I said, ‘Madame, I had asked about fine jewelry, not what you’re wearing this evening.’
‘Montana does not exist to provide us with the finer things in life. There is no Rodeo Drive in Montana,’ Basu said.
The recovery, however tenuous, has taken hold in about three-quarters of the states, according to Moody’s Analytics. Several are still struggling to move the economic needle forward.
The two states still experiencing a recession are Nevada and Mississippi. Nevada has the highest unemployment rate in the nation.
Basu said that nationally about 27 percent of mortgage holders are underwater on their homes, meaning they owe more than the homes are worth. In Nevada, that figure is 82 percent!
It will take years for the Nevada real estate market to recover. ‘And as they will tell you, they’re just one good roll of the dice away from getting it all back,’ Basu quipped.
North Dakota, by contrast, has the lowest unemployment rate in the nation. ‘The problem with North Dakota is not unemployment. It’s that nobody wants to live there,’ he said.
‘ Some worry that U.S. population trends could work against America’s ability to retain its status as the world’s second-largest economy. U.S. population growth is projected to slow from greater than 1 percent to about 0.65 percent. By 2020, more than 30 percent of the U.S. population will be above 55 and by 2030 one-third of the population will be in that age bracket. That means there will be fewer people able to produce goods and services, build the infrastructure and run the government.
Economists like Walter Kemmsies, who analyzes markets for freight transportation and maritime engineering firm Moffat & Nichol (and contributes commentaries to American Shipper), say the shifting population will require further outsourcing of manufacturing and less restrictive immigration policies to replenish the workforce.
Basu believes that America’s demographics relative to most of the developed world are quite good. Although the U.S. population is getting older, there are a lot of young people living here too, he said.
Last year the children of the baby-boomer generation represented the largest class of college freshmen in the nation’s history, he pointed out. These are the kids born from 1980 to 1999.
The United States has a big labor advantage over Europe and Japan because similar generations in those parts of the world are much smaller, Basu said. China’s dominant labor position will be undermined by its policy of one child per family, which will make China the first society to grow old before it grows prosperous, he said.
India, however, has no birth control policy and has the largest emerging labor force in the world to support economic expansion, according to Basu.
‘Indians are the ones who gave us the Kama Sutra. And apparently there is a big game of twister out there’ because the city of Bengali has a huge population between the ages of 5 and 25, Basu said.
‘The issue for the Indians is do they have enough jobs for that workforce, particularly for the young men.’
The demographic data suggests that the United States will outperform the developed world in the future and the Indians, in particular, will outperform the developing world, Basu said.
‘ Is there a new economic tiger on the horizon like China? Basu says there will never be another country with the phenomenal double-digit annual growth rates of China that turned that country into an economic superpower within three decades because there are no centrally planned nations left of any significance. Most countries have adopted capitalism and some form of liberal democracy, which are better systems but rely on consensus-building and the private sector rather government commands to dictate policies and resources for development.
‘You cannot put limits on the marketplace of ideas and continue to grow prosperity forever,’ Basu said of China’s long-term prospects.
Brazil, meanwhile, is widely recognized as a country with huge potential because of its natural resources, diverse economy and innovative capacity. The South American nation’s GDP grew 7.5 percent last year, is projected to grow 4.5 percent in 2011 (versus 2.6 to 2.8 percent in the United States) and 4.1 percent next year.
Brazil’s surging productivity flies in the face of nation’s proclivity to party, Basu suggested.
‘These people never seem to work by the way. So how they can produce so much output is a (question). And they’ve done this fully clothed.’ – Eric Kulisch