The Auto Bailout is a dire necessity

[crimsonblue]

X-Posted at my blog:

The current bailout for GM, Chrysler, and (to a lesser extent) Ford must happen if we are to avoid a severe recession. If only one of the Big 3 fails, the American economy will be in ruins. Here's why:

The US economy has perennial budget and trade deficits. As such, foreign investment in American companies and Government Bonds is necessary to keep the gears of our economy working smoothly. Without countries like China, Japan, and the EU buying up our debt, our economy would collapse. IF one of the Big 3 fails, then the value of all cars will plummet, especially those made by a failing company. If GM went bankrupt, then dealers, mechanics, suppliers, etc would go bankrupt, and it would be economically impractical to maintain a GM car. If there is not the supply chain in place to service a car, then it is useless after 5000 miles.

The Big 3 are the most visible, enduring displays globally of American economic power. For decades, the Big 3 made steady profits and paid routine dividends. The collapse of one will cause foreign investors to flee to other, safer countries. A collapse of the American economy will cause a global depression that far surpasses the Great Depression. Compared to Europe, the US escaped the Great Depression relatively unharmed. Unemployment briefly spiked to 25% here, but the use of deficit spending to pay for Public Works Programs and the war time surge in manufacturing saved the day. Germany saw hyperinflation running so rampant that money became literally worth less than the paper it was printed on.

The US was able to pull out of the Great Depression because of the Keynesian economic theory of deficit spending. The US had little debt prior to the Depression; in fact, the US was the guarantor for many billions of dollars of loans to European countries stemming from WW1.

Also, post-WW1, the rest of the world became reliant on American produced goods, and the US had a large trade surplus. However, foreign countries (especially European ones), could not afford to send more and more gold to the US to pay for their increasing loans. As a result, foreign countries stopped buying American made goods, flooding the American market with an oversupply of goods. Thus was borne the deflationary downward spiral that destroyed the American economy.

In addition, an artificial price inflation of food commodities ended shortly after the war. During WW1, the Federal Government heavily subsidized commodities, because the US was essentially the only source of food for Europe. Farmers were encouraged to buy more acreage and invest in new machinery on the assumption that prices would remain stable. However, when the Government ended its subsidization of food commodities, the profits of farmers eroded and caused, in conjunction with the Dust Bowl, the exodus of Midwestern farmers westward.

Due to the lack of demand, the price of products and commodities fell drastically, wrecking the profits of businesses and farmers. Companies had to start laying off workers in order to make a profit, and farmers in the Midwest gave up their land, because it was cheaper to simply walk away than bring a crop to harvest.

I know you're thinking, "but if prices fell, then wouldn't consumers be more able to purchase goods?" The answer is no. Wages lagged considerably behind prices in the run up to the Depression, and widespread price deflation caused the mass layoffs experienced by most of civilized world. In order to protect American made goods, the Government further increased trade barriers, reducing the global consumer pool for American goods, further fueling the deflationary spiral.

Deflation is real. It is scary. And it is knocking at our front door. Global petrol prices have evaporated, spurred on by the irresponsible oil speculation of the past few years. Oil is hurting the global economy twice: we saw a brief hyperinflation of oil that forced businesses to radically adapt to continue increases in productivity; and, the hedge funds that invested heavily in the oil bubble are wrecked. Any stock or derivative can ever gain and lose more than 200% of its value in a single year and result in anything other than chaos.

However, ludicrous speculation is not limited to commodities. From 1998-2005, new home construction increased at a level never seen before. Spurred on by the stupidly low interest rates of the Federal Reserve-- led by Greenspan, who was terrified of the hint of the possibility of high inflation-- financial institutions over leveraged themselves, giving loans to people who should not have qualified. In order to artificially prop up profits, the financial sector created derivatives, such as the "mortgage backed security". For a time, this made banks and corporations a lot of money. That is, until loans started defaulting on a large scale. Adding to the tragic hilarity, the derivatives were packaged in such a way as to appear as the safest grade security. Fiscally responsible banks, unions, universities, and corporations bought these securities as a hedge against more traditionally volatile market forces, only to realize that the paper derivatives they bought were worthless.

Deflationary forces must be prevented at all costs. the consequences otherwise are too dire. Only strong, quick, effective government action can stop deflation. In a recession, wages do not go up and consumers will not find more money to purchase goods, so the Government must return profitability to industry to prevent its collapse.

[MichiganVote]

1. K&R