Supply shock

A must-read article in the NYT--one of the few I've read that actually do a good job explaining a concept from economics. Apparently, one of the main risks of GM and Chrysler failing is that it will effectively destroy the entire car manufacturing industry in the United States, including companies like Toyota and Honda, which have factories in the South. The reason is because GM and Chrysler generate a lot of the revenue for parts suppliers--the companies that make axels and sparkplugs and such--and, do to the credit crisis, these parts suppliers can't borrow money to stay in business. But if they go out of business, then all the other car companies--Ford, Toyota, Honda, etc.--will suddenly not be able to buy parts, causing their assembly lines to stop:

As a result, the hypotheticals about the domino effect of the companies’ troubles through the vast network of auto supplier firms — which employ more than twice as many workers as the carmakers — are becoming real.General Motors and Chrysler, for example, owe their suppliers a total of roughly $10 billion for parts that have been delivered. G.M. has held off paying them for weeks, and Chrysler is paying in small increments. But the cash shortages at G.M. and Chrysler are getting more severe, according to their top executives and other officials.

...

Many of their suppliers are teetering on the verge of bankruptcy themselves, and do not have the luxury of extending credit much longer.

“I don’t think that suppliers will be able to get through the month without continued payments on their receivables,” said Neil De Koker, chief executive of the Original Equipment Suppliers Association in Troy, Mich., a trade group.

When suppliers big and small start failing, the flow of parts to every automaker in the country will be disrupted because as suppliers typically sell their products to both American and foreign brands with plants in the United States.

“There’s no question it will hit Toyota, Honda and Nissan too,” said John Casesa, principal in the auto consulting firm Casesa Shapiro Group.

“Many of the small suppliers will simply liquidate because they don’t have the resources to go reorganize in Chapter 11 bankruptcy,” Mr. Casesa said. “They’ll just go away.”

It is the dire scene laid out at the first set of Congressional hearings on an auto bailout in mid-November by Ford’s chief executive, Alan R. Mulally.

“Should one of our domestic competitors declare bankruptcy, the effect on Ford’s production operations would be felt within days, if not hours,” Mr. Mulally said.

...

In years past, suppliers have often been able to assist a troubled automaker by extending payment periods to get through tough times.

But by Mr. De Koker’s estimation, hundreds of suppliers no longer have that flexibility. They cannot borrow money in a frozen credit market, and they cannot buy raw materials without first being paid for parts they already shipped.

The Big Three, along with their foreign competitors, are what most people think make up the entire auto industry. But the car manufacturers are just the top of the pyramid.

While G.M., Ford and Chrysler employ 239,000 people in the United States, the country’s 3,000 or so auto suppliers have more than 600,000 workers.

If the bailout effort fails, and GM and Chrysler go under, can't the government work out some kind of plan to extend credit to the parts suppliers, so that they can keep feeding parts to the surviving car manufacturers in the US? At least that way GM and Chrysler wouldn't take everyone down with them...

PS: Here's a quote that doesn't bode well for the Mixed Metaphor Index:

“It’s like the dog chasing the tail,” said Tom Mullen....

“Everyone is stretched like a bungee cord,” he said. “We are waiting to hit the bottom of the river and waiting to be slingshot back up, hopefully."

I count four, with some pretty serious incoherence. What kind of a river slingshots you up when you get to the bottom of it?! First we're a dog, then we're sinking in rivers...there's even a bungee cord thrown in for good measure. Insanity.

Fast, slow

You hear a lot of metaphors in talk about the economy, and one of them is talk about it in terms of speed, as if it's a vehicle of some sort chugging along--so you get an economy that is in a slowdown, or that is in danger of overheating, or that is humming along nicely. But I never really grasped in what sense an economy could be like a vehicle like this.

Maybe it's something like this: in America you have a bunch of stuff--natural resources and factories and the like--and you have a couple of hundred million people standing around doing nothing. It's also the case that most of those people would like to have more stuff for themselves (including things which they, as human beings, definitely need, like food and shelter). And so a bunch of them get to work, using their individual time and energy to take the stuff that's there and work it into other stuff, which they can then trade for stuff that they want.

So the important things to keep track of here are two different rates: the first is the rate at which people make new stuff out of the stuff that's there, and the second is the rate at which they trade that stuff for other stuff. And, of course, the two rates are related: for example, if people are very willing to trade stuff they have for other stuff, then there's going to be a lot of demand for people to step up to the plate and start making that other stuff; contrarywise, if people are very reticent in their trading for other stuff, then the makers of this other stuff will soon find themselves without a trading partner, and will once again go idle.

Now, this relation between the two rates creates the potential for a vicious circle, because if lots of individuals decide to lower the rate at which they trade their stuff for other stuff, and makers of this other stuff go idle as a result, then these makers must lower the rate at which they trade their stuff for other stuff. And everybody else is watching this chain reaction slowly build, and so--since they as makers figure they may well go idle soon--they all decide to conserve the stuff they have by lowering the rate at which they trade it for other stuff. And so the rate of trading lowers across the board, causing there to be less of a need for making stuff to be traded, causing the rate at which stuff is made to go down. And so you have this suboptimal arrangement, where far more of those hundreds of millions of people are standing idle than need be.

So that is, I think, the way in which an economy could be said to be going "faster" or "slower". If it's faster, then that means the rate of making stuff and trading stuff is really high, and all those hundreds of millions of people are busy as bees, making stuff for the first half of the day and then trading that stuff for other stuff for the second half of the day (and on weekends, trading all day). But if the economy is "slow", then that means that the rates of making and trading stuff is low, and that--while lots of people are still busy as bees--there are also lots of people just standing around idle, not making any stuff and trying to keep their trading of stuff they have to an absolute minimum.

So that's the metaphor, I think. It is worth adding that the government, via a central banking system, can take steps to control the speed of the economy to interrupt the positive-feedback loops that occur, where increasing speed begets increasing speed and decreasing speed begets decreasing speed. If I understand it correctly, it does this in a very tricky way. Above, when I say that people exert time and effort to work stuff that's there into other stuff, which they then trade for stuff they want--well, as you have probably noticed, people tend not to directly barter, but to trade their stuff for an intermediary thing--dollar bills--which serve no other function besides being containers of value. So when there is a slowdown in the rate that people trade their stuff--their dollar bills--for other stuff, this rate can be effectively raised simply by increasing the overall number of dollar bills. The government does this by allowing banks to borrow into existence dollar bills, and charging the banks interest on those newly created bills. When the government lowers the interest rate, the banks borrow more, and thus they are able to spend more--that is, the banks are able to trade more of their stuff for other stuff, and all that extra trading propagates through the economy. If the economy is moving really fast, the government can slow it down by raising that interest rate, and thereby reducing the rate at which the banks trade their stuff (their dollar bills) for other stuff. Of course, by constantly creating dollar bills out of thin air, and thereby increasing the total number of dollar bills in existence, eventually prices start to go up, because everybody has more dollar bills in their pocket, and so everybody bids up the price of everything. This is inflation.

What's happening now--and the reason why people like Paul Krugman are saying that the federal government should run deficits of many hundreds of billions of dollars to get the economy sped up--is that we're in a so-called "liquidity trap". This just means that the usual mechanism for speeding up the economy--cutting that interest rate, thereby allowing banks to borrow into existence more dollar bills--doesn't work anymore, because that rate has already been cut to (virtually) 0%. Moreover, even when the big banks do borrow a bunch of dollar bills into existence, it doesn't help increase the rate of trading, because the banks are hoarding the dollar bills rather than using them to trade for stuff (first off, the banks are worried that the assets on their books will plummet in value, causing them to fail; second, they don't want to lend to anyone because they're afraid they won't get paid back). And so the only way now to increase the rate of trading is to have the government itself actually start doing a whole bunch of trading (i.e., trading dollar bills for things like subway systems, improved roads, etc., or just straight up giving dollar bills to people who will surely spend them, like the unemployed). This is called "stimulating the economy".

The last time there was a massive slowdown in the economy like this was the Great Depression. The thing that eventually got the economy back up to speed again was World War II, because it required the government to singlehandedly spend absurd amounts of money on war thingys. So now it looks like it's up to the government to spend and spend and spend.

It's all so strange. I remember my grandfather once told me that, during the Depression, some communities--communities with able workers and plenty of natural resources and factories and such all around--nevertheless found themselves mysteriously idle. There were no jobs and no one could borrow money. People were starving in the streets, and yet farms were throwing away truckloads of fruits and vegetables because they couldn't find buyers for them. There was a shortage of dollar bills! So: they printed their own script. And in no time economic activity started up--people started making stuff, and trading that stuff for other stuff (using their script as the intermediary). And lo, they were busy as bees once again.

A time to spend

Says Krugman:

It’s now clear that rescuing the banks is just the beginning: the nonfinancial economy is also in desperate need of help.

And to provide that help, we’re going to have to put some prejudices aside. It’s politically fashionable to rant against government spending and demand fiscal responsibility. But right now, increased government spending is just what the doctor ordered, and concerns about the budget deficit should be put on hold.

It's somewhat counterintuitive but true: federal deficit spending is good in a recession, because it gets money flowing in the economy. Moreover, since lenders have lost confidence in the private banks, they all want to lend to the federal government--even if it means lending at an interest rate of a fraction of a percent. So the government essentially has a credit card with a hyper-low interest rate of, like, 0.15% that it can use to get money flowing in the economy in various ways: by increasing unemployment benefits, by cutting taxes, and by investing in infrastructure improvements. The idea is that you keep spending until the economy recovers, at which point tax revenues also recover and you can balance the budget and pay down the debt.

When it's all said and done, you have to admit: Bill Clinton is good

Here's Bill Clinton at his best: making an impassioned yet clearly informed case for a certain set of economic policies. I've always thought that Obama could learn a thing or two from Bill Clinton with regards to rhetoric: whereas Obama's points tend to fizzle into platitudes ("this is just more of the same Washington game..."; "blah blah blah Wall Street blah blah blah Main Street"), Clinton simply made the case and let his folksy charisma do the rest.



(Hat tip: Coates)

Clinton busts out

I'd be remiss if I didn't pass along this Clinton bust-out. She definitely knows her stuff and can communicate her mastery of a subject better than any other candidate:


(Hat tip: Sullivan)