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    Default The Fog of Economic Folly

    The Fog of Economic Folly
    Beware Today's Economic McNamaras


    On TV a few nights ago, I watched the movie Fog of War, Eleven Lessons from the Life of Robert S. McNamara. That was the 3rd time I'd watched it.

    I'm trying to come to terms with McNamara's self-aggrandizing mea culpa, in which in his old age he puts himself at the center of many major historical events. The reason I bring this movie up is not to bash McNamara, whom I met once by accident at an airport in DC. He was in a wheelchair and not looking well. I want to point to one scene in the movie that offers a lesson for our economic leadership today.

    At one point in the movie, McNamara tells interviewer Errol Morris that he "... now realizes the Vietnam conflict was considered by the North Vietnamese to be a civil war and that they were fighting for the independence of their country from colonialism."

    I bet 90% of those who watched that scene reacted as I did. "How could he not have known that at the time? Nearly everyone else did."

    In August 2002, I was attending an event in Boston put on by an investment bank. I sat next to a man who was a Federal Reserve bank president during the 1990s bubble era. At one point I asked him, "Why did the Fed finally decide to raise rates in 1999?" He replied, "We took a look at the telecommunications industry and said 'Holy cow! Look at what they've done with our money!'"

    Who could have known?

    For years before that, iTulip.com among other sites had been sounding the alarm on the technology stock market bubble. iTulip.com specifically warned that when the tech stock market bubble popped, the collapse was going to take my industry -- high tech -- down with it. Here we are six years later and the industry is still broken. As evidence, when was the last time a Boston based high tech company went public?

    Many of you knew at the time that this was going to happen. The data were readily available but the Fed did nothing. The bubble grew larger and larger and finally collapsed. The technology industry around which the bubble formed hasn't recovered.

    Makes you wonder what you know now that the Fed doesn't know.

    You know that the Fed has since 2002 allowed a housing bubble to grow in many regions of the U.S. to outrageous proportions. You know you have friends and neighbors who live in huge houses filled with expensive goods and drive expensive cars and will tell you, as the smiling man on the rider lawnmower in the famous television ad says, "How do I do it? I'm in debt up to my eyeballs. Somebody help me."

    We all know how it's going to turn out. The same as the Vietnam War and the tech stock market bubble. It's going to be a disaster.

    The bearish sites passed the point of accepting that outcome as fact years ago and have focused their energy on trying to figure out whether the disaster will be characterized by deflation or inflation. Ka-Poom Theory says inflation is the most likely outcome as the dollar will lose much of its value in the process. But it's just a theory, and like any responsible inventors of a theoretical model, we're constantly hammering it into finer detail in the face of fresh evidence.

    If so many can foresee disastrous outcomes of follies like the Vietnam War and the Technology Bubble coming, why can't the folks in charge see the same thing?

    The Vietnam War and tech stock bubble lessons are parallel. Insulated by power and reinforced by bureaucracy and self-fulfilling careerist orthodoxy, men and women at the top of the system can make horrific policy misjudgments that seem incomprehensible to the man or woman on the street. Once in place, these policies take on a life of their own, become institutionalized, mostly by the career limiting consequences of either pointing out someone else's error or admitting one's own. On and on they go. When the inevitable happens, the McNamaras of the economy finally see what everyone else saw all along. What was for years mundane daily experience for most enters the consciousness of leaders as a sudden revelation of fact.

    You can often see a disaster like the tech stock bubble coming at you from miles away, like a slow motion economic tsunami rolling inexorably toward you.

    Reports of excessive debt levels by households and the U.S. government itself have been in the press for years, just as the anti-war movement and later the press detailed the folly of U.S. involvement in Vietnam's civil war. The fact these policy mistakes can go on for years or even decades is what makes them so insidious. As each year passes, most of us succumb to the natural human tendency to adapt to the increasingly perverse circumstances around us. We become immune to the constant torrent of warnings.

    At some point, usually toward the end of the cycle at the peak of cognitive dissonance between what we feel is wrong and what we can intellectualize, we may even be tempted to join the risk takers, thinking that if the ice has been holding up for this long, why not a bit longer? Or maybe it isn't so thin. Or maybe it isn't ice at all, it's concrete. If you question the ability of otherwise perfectly sane humans to internalize data that contradicts common sense and adapt to bad government policy, political or economic, I point to Nazi Germany as an extreme example of how a population can go along with their leaders even where their leaders are completely insane.

    Stock market bubble collapses in the U.S. 1930s and in Japan in the early 1990s got all of the press. But it was the secondary collapse of credit bubbles -- the underlying foundation of stock market bubbles -- that caused the real economic carnage. In the U.S. in the 1930s, the credit bubble collapse was nearly simultaneous with the collapse of the stock market bubble, while sixty years later in Japan their credit bubble did not collapse until a few years after their stock bubble collapsed. More than fifteen years later, they are still struggling with the result.

    I'm in a restaurant in London in 2002 meeting with a investment bank analyst. We're talking about the credit bubble. "Oh, my god." He said, rolling his eyes. "I'm not looking forward to what happens when that ends." I have to remind myself of these conversations, and many others, because otherwise I'm just as susceptible as anyone to become complacent.

    Lessons of the Vietnam War and the 1990s tech stock bubble, prelude to the collapse of the global credit bubble:

    Lesson #1: Do not listen to vague assurances from the current cast of economic McNamaras. You know more than they do. Listen to your good common sense.
    Lesson #2: There is nothing new under the sun. Don't believe that anyone has built a better mouse trap. They have not.
    Lesson #3: You are not helpless. There are things you can do. We talk about them here and offer links to many other sites that can help give you guidance.

    Sincerely,

    Eric Janszen

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    Last edited by FRED; 07-03-06 at 08:39 AM.

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