Third Eye on the Third World

Date September 29, 2008

Author: John Mangun

BUSINESS MIRROR

“Outside The Box”

From this column last Thursday: “By mid-2008, the Western financial system was in deep trouble. The incredible corporate failures you have read about are because these companies do not have enough cash to fund their operations or to pay back their clients’ investments and deposits. These firms are holding their share of the hundreds of billions of dollars of non-performing loans, near worthless loans, backed by near-worthless collateral (houses) that have lost a large portion of value, and worse, cannot be sold for cash”.

In the 1928 American Presidential campaign, Republican Party candidate Herbert Hoover ran with this slogan: “A chicken in every pot and a car in every garage”. The thought behind that message was that a Hoover presidency would provide the framework that would lead to individual citizens creating their share of national prosperity, and therefore, having that chicken and car.

Unfortunately, the American public and their politicians took that campaign promise literally, that government could provide people with chickens and cars. Eighty years later, we see the fruits of their actions in the “Financial Crisis”.

In the 20^th century, the political/economic/social philosophy was created that the government had the ability to give wealth to its citizens. Individuals no longer had to rely solely on their own efforts but could come to the government for at least a portion of their prosperity. It is a childish belief not unlike my five-year old son asking me to buy him a new toy. However, I have the wealth creation ability to do that; government cannot create wealth. It takes a portion of its citizens’ wealth through taxation.

In order to provide the “chickens”, government attempted to earn an income on its own by owning and operating businesses. The best example is post-war Great Britain where virtually all major industries, coal, transportation, power generation, petroleum, airlines, were government owned. The principle was that if government could generate legitimate income, then it would have the money to buy the chickens and cars. That policy failed miserably.

The only alternative to get the money was for government to borrow the funds. And this has created a 50 year philosophy that, if government could do it, then every person could borrow their way to personal prosperity.

Wealth as a result of personal productivity and innovation has been replaced by wealth through creative financing. America and Western Europe has conditioned two generations that a person can have everything they want and never have to pay for it as long as they can meet the monthly amortization.

Now because of this major global financial predicament, the West has learned that you cannot borrow your way to economic growth and prosperity. What will the future bring?

The US government will provide a financial infrastructure to rescue their financial and banking system. The formula they will use is very similar to the Philippine response to the Asian crisis in 1997; the “Special Purpose Vehicle Act Of 2002”, where the government will take over much of the non-performing loans of US banks.

The US economy will experience a slowdown but that is actually minor point. The probability is that the US economic system may be dramatically changed and that is a greater issue. When the Philippines was hit by a credit crunch in 1997-2000, the economy was sustainable because our economy is not dependant on borrowed money. Not so the US and Europe. Those economies cannot move without borrowing. And that is where the fundamental changes will come. President Bush described the situation on Monday as a “system failure”. He is right. The system of wealth through borrowing failed.

The economic bubbles of the 20th century have been caused by excessive borrowing that inflated assets to unrealistic price levels followed by a collapse of the value of those assets. This current bubble is simply the largest and most pervasive. The Great Depression would have been contained were it not for the long drought that nearly destroyed the US farming regions. This crisis is purely financial.

Over the next three years, major global economies (especially China) will slow significantly. American and European consumerism will fall like a rock, as they will actually have to pay for what they buy. Corporate expansion will come to a near halt for the same reason. More US jobs will disappear.

However, the net result will be a stronger and sounder Western economic base and that is good for everyone.

The global debt party is over and now we have to live through the morning-after hangover. Nevertheless, with the severity of this debt hangover, we will see fundamental changes in the way the West does business as happened in Asia after 1997.

This crisis had to happen not only because it is a result of the debt excesses but also because it was the only way to get the West off the drug of false wealth created by borrowed money.

Asia and the Philippines should and many will use the next few years to strengthen even more, its economic base. The West has been sucking out the world’s capital these last years to keep the bubble growing. Real global economic prosperity was sacrificed for the illusion of false wealth. That has now changed. The next decade will see global growth and prosperity such as the West experienced in the early 20^th century prior to World War I with productivity and innovation creating sustainable wealth.

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