Food in the Cupboard

I hope you’re spending less than you’re making, so that you have some money left over.

In normal times, you could add to your financial strength by putting money in the bank or the stock market. That still might work, but I wouldn’t rely on it entirely.

One of my banks recently notified me that it was cutting my money market interest rate to 0.15 percent. That means if I keep $8,000 in my account for a month, they will pay me, you guessed it, one dollar in interest. If I were a multimillionaire reckless enough to keep $2 million in the bank, they would pay me a whopping $250 at the end of the month. Even a multimillionaire could go hungry trying to live off the interest on their money.

It’s not like the bank really wants my money, is it? But it’s not really the bank’s fault. Interest rates generally follow the interest rates set by the Federal Reserve Bank, which just decided 2 percent was too high for one of their reference interest rates, and cut it to 1.5 percent. Savings rates traditionally run about 2 percent less than the Fed’s rates, so the bank can pay its expenses — but that would be negative one half percent. So the bank is actually doing me a favor by paying me a little over a seventh of a percent in interest.

My money is safe in the bank — safe from burglars, that is. But how safe is it really? Not very — because of inflation, bank failures, a near-broke FDIC, and a near-broke U.S. Treasury. More about that another day.

And the stock market — Wall Street seems to be in the process of shutting down and moving out as fast as it can go, so right now, the less said about stocks, the better.

You’ll probably still want to keep some of your money in the bank, and put some of it in the stock market after it hits bottom, but it is more important now to keep a little money at home, and to start buying things you are sure to need in the near future.

I don’t want you to rush out and stock up on three months’ worth of supplies this morning, because if everyone did that all at once, the supermarkets would be stripped bare and there would be a nationwide panic. But if you have the money, gradually start accumulating a few month’s worth of supplies. Get an extra bottle of mouthwash, a box of laundry detergent, some toilet paper. The next time, bring home some extra canned vegetables, pasta, flour, beans, and rice.

When you store food for a period of time, remember that you have to protect it from rodents and insects. This means keeping it in solid containers. Don’t accumulate more than you really have room for. Don’t stock up at all if you are getting ready to move.

In normal times, stocking up like this is something I would never recommend. But I am not sure these are normal times.

Stocking up serves two purposes. First, it guards against the calamity that would hit if you lost your paycheck, savings, and credit accounts simultaneously. In normal times, there would no reason to worry about that happening. Over the next two years, it absolutely will happen to a few unlucky people, and if things go badly, to more than a few people.

Second, stocking up is a hedge against inflation. In inflationary times, buying things a little sooner is like buying them at a discount. When prices are likely to go up month after month, and unlikely to go down, you pay less if you buy this month than if you wait till next month.

And these are inflationary times. The Wall Street bailout plan and the subsequent initiatives that have come out of Washington are almost all inflationary by nature. Other countries that have undertaken similar deficit spending binges have seen inflation rates of 80 percent or 500 percent. The U.S. economy is stronger than those countries were. Still, we could see inflation of 20 to 50 percent a year, more than anyone has ever experienced in the United States. Even if inflation is “only” 8 percent a year, that still makes buying things in advance, if you do it right, better than money in the bank.

It is a rare economic time when food in the cupboard is a surer investment than money in the bank. In my opinion, you should still have some money in the bank. But it is just as important to make sure you have food in the cupboard.

Angry and Economically Vulnerable

For two hours over the weekend, the top video on YouTube was “The McCain-Palin Mob,” a rough-cut sequence of interviews with voters outside a political rally. These voters were angry about what they had heard — stories about a suspicious candidate who had materialized seemingly out of nowhere within the past year to take over their country by winning a national election. They were so angry they couldn’t think straight. More than a million people have watched this video on YouTube, and I believe many are watching to laugh at the inane things people can think when they are angry enough.

The anger the voters show in the video is not a reaction to anything anyone did to harm or threaten them, and it is not a random accident either. It is the result of a political campaign. This is something that has happened before. From time to time, candidates think they can manipulate voters by telling them stories that make them frightened and angry. But there is a serious flaw with this as a political strategy.

First of all, as others have commented recently, there is little evidence that anger gets people to vote. On the contrary, anger is a technique used, mostly by incumbents, to keep people from voting. It is a vote suppression technique. When voters are angry, they show their anger mainly by staying home on election day. As a candidate, if you tell people things to make them angry, the people who are most likely to not vote are the people who are paying the most attention to you. You are suppressing the vote of your own supporters. That is hardly a way to win a popular election.

But that is not the flaw I am referring to. There is a worse problem with anger as a political tool, especially right now. Angry people are economically vulnerable. With their diminished ability to separate fact from fantasy, it is very hard for them to adjust to changing economic circumstances. They have trouble making the changes that get the economy going again in a recession. If many people in any particular area are angry, the recession could hit harder and last longer there. And so a politician who uses a strategy of anger risks impoverishing her own supporters.

This fits with the distinction between energy and direction that I wrote about yesterday. The purpose of anger is to raise your energy — specifically to give yourself a boost of energy for a few minutes of physical combat. As I wrote yesterday, extra energy can compound the problems of a recession, which is caused in the first place by too much energy and the lack of a strong enough direction.

When you put together lots of people who have lots of angry energy and no coherent direction, what you have is a mob. That is what the video shows. If you watch it, it will remind you how hard it is for a mob to solve even the simplest problem. This is a time when we need to be empowering people to solve economic problems. Anger is not the right emotion to make that happen.

Energy and Direction

When you reduce it to the most primal terms, economic success is based on two forces: energy and direction. Things go best when these are in balance.

There are times when you know exactly what to do, and you just want to go ahead and do it. This is when you hope you have enough energy to match your direction.

I remember a time seven years ago when I was writing urgently needed software fixes and preparing one of my books to go to press. Both projects perfectly fit my talents, they paid well, and they were needed quickly, so could I get myself through the 14-hour days? That was a case of having more direction than energy. It worked out well enough, but it wasn’t balanced; I wouldn’t have been able to keep it up for more than a few weeks.

The other extreme happens when disappointment strikes. You fail the test and don’t get the job after all. Your business keeps losing money and all you can do is shut it down. And you don’t know what to do next. But in the bigger picture, disappointment is not a bad thing. It is what stops you when you are putting your energy in the wrong direction.

When you are figuring out where to turn next, what you don’t need is more energy, at least not the same kind of energy you pour into your work when you know exactly what to do. What you need is direction — the other primal force that goes into economic activity.

It is important to be aware of the distinction between energy and direction whenever there is an economic problem. If there is an imbalance in one of these two economic forces, you usually cannot solve the problem by adjusting the other one. If you do not know your direction, it does not help to add energy or to go faster. If you cannot get yourself going, even though you know what to do, the only solution is to add energy; it will not help to further refine your direction until the energy is there.

The same is true of the economy as a whole. A recession is often described as a “sluggish” economy, but it is not really a shortage of energy. Rather, it is a deficiency of direction, a natural result when competing businesses put too much energy into staying ahead of each other when they are all going in the wrong direction. A recession is not solved by adding more energy, but by adding direction. This means that efforts to “stimulate” the economy will not resolve the recession, but will actually make things worse. Unless, that is, they are focused narrowly on the direction we need to go. The economic stimulus package of May and June did not end the recession, because it did not provide any direction. It served only to make the coming crash more spectacular when it happened.

Other non-directional proposals such as investment tax credits or a reduction in taxes on investments would do similar harm. But a massive investment in energy independence for the country — that is the kind of thing that could pull us out of the recession, because energy independence is a direction we need to go in right now.

Trying to rescue the national economy by pumping it up is rather like giving a man cocaine because he just lost his job — the buzz is dangerous and doesn’t do anything to solve the problem. A recession is a time for us collectively to find our new direction. And if we do it well enough, there might not be another recession for a long time.

A 1 Percent Change

Gasoline prices are falling here in Pennsylvania. At this rate, they might be below $3 a gallon by next weekend. People are happy about this, and one of my friends told me, “It’s a good time to take a road trip.”

But no one I know is taking a road trip beyond the traditional weekend at Grandma’s house.

If you went to the mall in King of Prussia yesterday, you would think boom times never left. You would have to really like crowds to approach Starbucks or the Apple Store.

But retailers, including Starbucks, say that sales totals continue to be disappointing, perhaps even a little lower than last year. And go into one of the high-end department stores, or a few miles down the road at Target or Circuit City, and the place is so quiet you might feel like you should ask whether the store is open.

The difference between boom times and depression are so stark in national economic terms that you would think they are the result of drastic changes in behavior, but they aren’t. It only takes small changes in the way people perceive their financial options and make decisions to make major changes in the economy.

In recent years, the U.S. economy has wavered mostly between 1 percent and 2 percent growth rates. At 1 percent growth, the economy is faltering, unemployment is rising, it’s hard to get a raise, businesses postpone major investments — that’s a painful state for the economy to be in. At 2 percent growth, the economy is basically working. More people are finding jobs, and workers can expect to get a pay raise that keeps up with inflation. Businesses can modernize and invest for the future. And if we could get to 3 percent growth, that would be a boom time, when businesses would try to accelerate their plans and would be offering raises so their best workers wouldn’t leave.

That gives you an idea how much a 1 percent change affects the economy as a whole. And a 1 percent change in the whole economy could, in theory, occur just from every single person making a 1 percent change in their economic behavior.

But some of your economic behavior can change by 10 percent or more before you even notice you are doing anything different. When I heard, “It’s a good time to take a road trip,” that’s when it occurred to me: no one has been taking road trips. That used to be a regular part of life, but sometime around June, it seemed like everyone stopped doing it. Obviously, we were discouraged by the high cost of driving, but I’m not sure it was a conscious decision on anyone’s part. It’s more like life is busy and everyone just forgot.

I know a few people who are political organizers, and in the middle of everything else they are doing this fall, they never got around to buying any new fall clothes. They were busy doing other things, and perhaps the mild September weather didn’t remind them that it was the fall clothing season. To them, it’s a minor omission that goes almost unnoticed. Skipping a season also means that their clothing purchases for the year will be about 25 percent less than usual.

If enough people are just forgetting to spend money in this kind of way, it’s enough to drag down the economic aggregates.

Or, think of it this way. If you are feeling just the slightest bit cautious, you might go to the mall 5 percent less often, go into 5 percent fewer stores while you are there, and spend 5 percent less on average in each store. You may not be able to tell that you are doing anything different. After all, you are still doing all the things you expect to do. Yet you are spending 14 percent less.

It is the same in business. Feeling just a hint of budget pressure, managers may go ahead and interview for all their open positions, yet end up hiring only half as many people, leaving some positions vacant. “Those weren’t the ideal candidates we were hoping for,” they may say, yet it is really the possibility of budget trouble that makes them hesitate.

This is the kind of thing we’re seeing across the economy now. In a growing economy, the hesitation in some areas would be balanced out by enthusiasm in other areas. The areas that are suddenly growing now — natural food, electric cars, insulation, alternative energy, espionage, hurricane recovery, political advertising, and so on — are not nearly large enough to carry the economy as banking, construction, real estate, personal services, health care, restaurants, fuel-burning cars, consumer products, movies, and other areas falter. The growth we are looking for will come soon enough, as more business adjust to provide the things that people are willing to buy now.

Derivative Anxiety

President Bush poked his head outside yesterday just long enough to read a prepared statement about how bad the economy is. Using phrases such as “losing their homes,” “abusive practices,” and “freezing up,” he so firmly emphasized how fraught with peril the current economic circumstances are that I am not sure more than a few people heard the rest of what he said.

Bush hinted that Washington had done, or started on, essentially all that it could do, and that there was little more he could do at this point but wait to see whether these actions have any effect.

And he suggested that ordinary citizens and Wall Street traders were partly to blame by buying into the sense of crisis that he himself had created in Washington to try to get the Paulson slush fund through Congress two weeks ago. Anxiety, he said, can feed anxiety, and that doesn’t solve any problems.

Bush might as well have said, “I have nothing to be anxious about but anxiety itself.” He was very clearly anxious, and rightly so, as the anxious actions of most of the people in the country are currently making his policy initiatives look downright foolish.

But where does anxiety come from? Anxiety is a kind of fear, but with a focus on dangers that are mostly unknown. There is a lack of clarity in the financial system that makes the current crisis seem to move in frightening fits and starts. If we knew what was really going on, we would not be nearly so anxious.

But we know there is much we do not know about what is going on in the financial system. We were startled to learn this week that the financial statements of Wachovia, one of the largest banks in the country, had given us the wrong idea about that bank’s financial condition. They seemed to say that Wachovia had two or three quarters to try to turn itself around. In court papers this week we found that Wachovia was already on the brink of collapse last week.

If a company that merely seems to be stumbling is actually dying before our eyes, what other surprises are on the way? And if the President cannot keep a straight face while telling us that the economy is likely to survive, what does he know that we don’t know?

The overarching sense of uncertainty about the economy is an accurate reflection of the magnitude of things that are kept hidden. As we have learned how derivatives function in the financial system, for example, one of the things we have learned is that much of what happens at a large 21st century bank is not on its financial statements at all. A bank could have paper assets and situational obligations that amount to trillions of dollars, and we would have no way of finding out. Even the banks’ own executives cannot get this information, although some are now trying to. But the best estimates we have so far is that the average large bank is, in financial terms, a tower of derivatives that stands much, much higher than all the assets and liabilities that are reported on the balance sheet.

This is why Washington would not let AIG fail last month. Trillions, probably tens of trillions, in liabilities are not recorded on banks’ balance sheets because of the convenient fiction that they are guaranteed by AIG. It should be obvious to everyone that AIG is not in any financial condition to guarantee anything — it has managed to keep itself going only because Washington is feeding it a billion dollars a day — yet its solvency is the key to keeping the financial system standing. If AIG were found to be insolvent, accounting rules would require banks to recognize trillions of dollars in liabilities that they currently are allowed to ignore. The day that happened, we are led to believe, almost every major bank in the world would instantly be insolvent.

How large is the derivatives bubble? One economist two years ago estimated it at a little over $10 trillion in paper assets. That was an eye-popping number that at the time he hesitated to publish, but as we have learned more, it now seems naively conservative. A separate, more recent estimate is that over $100 trillion in derivatives change hands each year in the United States alone.

To put these numbers in perspective, the largest company in the world is worth less than $1 trillion. The total amount of U.S. currency in circulation is a similar size, less than $1 trillion. Given the size disparity, it should not surprise anyone if the derivatives market sneezes and the economy falls over.

It certainly seems as if derivatives are being overused, to the point of becoming an accounting fiction at times, and that they are a dangerous and destabilizing influence on the economy, but how can we know when derivatives are unregulated and almost entirely secret?

If we want people to believe the financial system can still function, the derivatives it is built on cannot remain secret. A good first step would be to require the public disclosure of all derivatives. And to make sure that there are no loopholes, it would make sense to require the public disclosure of all contracts that spell out financial arrangements between public companies, including their subsidiaries and partnerships. Is there really any public purpose served at this point by keeping these documents secret? Don’t the stockholders, at least, have a right to know?

And so that is my proposal: a law that would override the secrecy clauses in derivatives contracts and other contracts that spell out financial arrangements between public companies, and require these contracts to be disclosed or disclaimed within a relatively short period of time.

Until that is done, no one can really say whether the U.S. financial system will stand or fall. But after the secrets are out in the open, we’ll be able to say. And then, the President may be able to keep a straight face when he talks about the economy.

Or maybe we will find out that the whole system is already bankrupt. But it is better to find that out now than to delay, as Iceland did, and allow the system to keep piling up losses. Now people are asking whether the entire country of Iceland could be bankrupt. As far as I am concerned, that is all the warning we need about the potential cost of the secrecy our financial system currently employs.

Most politicians agree by now that derivatives need to be regulated. As Ralph Nader wrote last night:

Defenders of deregulation argued that sophisticated players were involved in the derivatives markets, and they could handle themselves.

It’s now apparent that not only could these sophisticated players not handle themselves, but that their reckless gambling has placed the entire world’s financial system at risk.

It seems to be then a remarkably modest proposal for derivatives to be brought under regulatory control.

Perhaps that is true, but what regulations are needed? How can we tell when the derivatives themselves are protected by a veil of secrecy? A blanket requirement to disclose derivatives would help us pinpoint abuses and show areas where legal restrictions could make the economy more stable. It would also help to avoid the financial calamity that could result from poorly conceived regulatory language. If we are at risk of having our economy toppled by derivatives, it is only prudent that we look at them and add them up. At this point, we cannot even do that, and so it is no wonder that there are people who feel anxious about the economy.