Thursday, July 14, 2011

Tradesman Saves World Economy

My father tried in vain to save the global economy. It didn’t bother him when he failed – but the possibility of failure didn’t prevent him from trying.
How could a tradesman who worked in a steel mill in Hamilton save the global economy? In his view, it was relatively simple. Just keep doing what he had always done. The economic activity that created the modern global economy is the same activity that will save it. It’s ordinary working people who will correct the economic errors made by the MBAs who have leveraged the world beyond its limit. This is his reasoning:
In 1952 my father and his young wife bought a house in the east end of Hamilton: 10% down, 90% financing. He had a steady job and paid off their mortgage in 20 years. I remember their mortgage-burning ceremony. It was an important day in their lives: the day they became debt free. In the 1950s it took only one income to buy a house. He went to work and my mother stayed home with the kids. That was the formula. Those Canadians who grew up in the Great Depression of the 1930s and fought in the Great War of the 1940s formed the basis of the economic world that is falling apart today. The “family formation formula” worked in the 1950s and 1960s. Now it’s almost impossible for a young tradesman to buy a house with 90% mortgaging and support a stay-at-home-mom. The numbers just don’t add up. That’s why it’s coming undone.
My father didn’t realize that his solution to today’s global financial riddle is a variation of Austrian Economics. The founders of Austrian Economics believed that the economy is self-correcting. When things go wrong, there is no need for a big government bail-out: just let things take their natural course and eventually everything will work out. For example, the MBAs who masterminded the sub prime mortgage fiasco in the early part of this century eventually blew up the US real estate market. My father’s view was: who cares? His mortgage was paid off in 1972. If some appraiser told him his home was worth $200,000 in 2006 and $150,000 in 2011, he didn’t care. He bought it for $7,000 in 1952. Those real estate speculators and their bankers who bought and financed some house they thought was worth $200,000 – they’re the ones with the problem. Was it his responsibility to bail them out?
In my father’s view, the collapse of US house prices is a good thing. If prices fall enough, young tradesmen will eventually be able to buy a house with 10% down – and their wives will have the option of staying at home with the kids. And if this causes the mortgage bankers and realtors to miss a few payments on their Mercedes, that’s their problem too.
Today’s European PIIGS sovereign debt default problems and American debt-ceiling default problems can be handled in the same way. Let the ones who got into debt in the first place solve the problem. And let the ones who loaned them the money solve the problem. And, of course, that’s exactly what’s going on in the world today. The wisdom in my father’s neo-Austrian approach is the same wisdom that’s found in the Alcoholic’s Serenity Prayer. “God, grant me the serenity to accept the things I cannot change, the courage to change the things I can, and wisdom to know the difference.” In the world of finance, this translates into serenely and objectively observing the economic world and courageously reacting to it by getting our own economic house in order.
With this principle in mind, let’s make some serene observations about the Canadian economy now and the Canada of my father’s era, the 1950s and 1960s.
Observation #1: in the 1950s, municipal governments started adding fluoride to city drinking water. Yes, it was an additional expense for the city, but it was good for dental health. Today, the city of Toronto is considering stopping this program because it costs too much and the city is spending way more than it earns. The city of Calgary recently stopped their fluoridation program for the same reason. It’s up to individuals to buy fluoridated tooth paste if they want stronger teeth.
Observation #2: the city of Toronto is currently releasing a long list of ways to decrease spending. They are seriously over spending and are desperately trying to reduce expenses. In the mid to late 1990s, the government of Canada found itself in a similar situation. Finance Minister Paul Martin stick-handled the federal government through an austerity program in those days. The European PIIGS countries are involved in the same ‘austerity or else’ process. Our American neighbours are currently negotiating a spending reduction program. It seems there are many governments today who are in the same predicament as Canada in 1993.
Observation #3: have you noticed that municipal and provincial governments no longer cut the grass along Canada’s highways? In my father’s day, they created summer jobs for university students by cutting that grass. They believed that putting money in the hands of university students would stimulate the economy because (a) the students would spend the money, and (b) educating Canadians was good for Canada in the long run. Now it is more common for university students of get student loans and to emerge into the work force carrying a huge debt load. Governments owe less, individuals owe more.
My father’s primary approach was to live within his means and pay off his debts. And that’s what a whole series of governments seem to be trying to do today. So, it appears that the world’s big debt problem is being solved. But the second part of his approach seems much less popular: keeping his own economic house in order. Today’s investors seem reluctant to take responsibility for their own financial fate. They keep hoping the stock market will bail them out like the governments bailed out General Motors and the banks. They keep hoping they will get back the money they lost on their mutual funds. They keep hoping...
In my investment book, Beyond the Bull, I encourage people to be active investors, not passive. This is the wrong time in the cycle to buy and hold for the long term. The long term is over. It has been replaced by a series of short term ups and downs... like when my father was growing up. It’s time to replace your passive invest plan with a conservative responsible active plan – a plan that involves serenely observing the economic world and reacting to it in a pre-planned way.

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