Tuesday, December 16, 2008

Basic Economics for Tricky Times

(From the December 11, 2008 Grand Haven Tribune)

Like many of you, I’ve been thinking a lot about the economy lately. As I pondered our current financial fate, the thought occurred to me that I had similar musings on the matter previously. In fact, four years ago, in January of 2004, I wrote a column about the economy that seems eerie to re-read today.

Back then, I suggested we look at how our economic obsession affects us. But then I meant an obsession with consumption and growth. I feared that too many people were getting carried away by financial measures of happiness and that the eventual end of that behavior and thinking would be anything but happy.

I may have been right.

Today we are obsessed with the economy for the opposite reason—its rapid collapse. Our conversations are dominated by words like bailout and bankruptcy, foreclosure and liquidity.

As I said then: companies want to grow in sales volume and expand to new markets. Consumers want to get bigger homes, newer cars and clothing styles, the latest gadgets. And to a degree, as Adam Smith, author of the famed economic tome “Wealth of Nations,” would say, this is a positive cycle of exchange, a necessary economic engine. But maybe, I wondered four years ago, that engine could be geared down a notch.

Now, the engine hasn’t been geared down by us. It has blown a gasket because of our relentless pushing on the accelerator. Banks extended too much credit. Too many citizens bought bigger houses than they could realistically afford, or “bought” cars with no money down, never thinking that eventually they would be asked for actual money.

Four years ago, there were others thinking that maybe we were putting ourselves in danger with too much economic excess. I mentioned a CEO who pondered in a Business Week article: “What if people already have everything they want to buy?” An Associated Press report in 2004 on annual economic forecasts projected that the federal budget deficit will reach a record $500 billion in 2004. Sounds like a bargain today. Dick Grasso, former chairman of the New York Stock Exchange, was ousted because his $188 million compensation was deemed excessive. He was the first executive to lose his job for being paid too much.

Too bad that trend didn’t stick. Fast forward to this week in 2008 and I read that the president of Merrill Lynch had to be talked down from his insistence on a $10 million bonus. The amount is nearly equal to the losses the firm suffered under his watch. He thought he did a good job preventing further losses and orchestrated the sale of the firm to Bank of America. How far have we come when people want bonuses for not failing worse?

In the past, I suggested that maybe not everyone needs an SUV, unless you have to haul lots of stuff or pull a heavy trailer. Since 2004 we have seen gas prices slingshot above $4 and back down again. We are seeing auto company executives go hat in hand to Washington, like reckless children asking for an allowance increase.

It’s ironic that “sustainability” is one of the more popular business trends these days. It’s the idea that businesses should be managed for long-term viability, factoring in economic as well as environmental and social equity factors. But we’ve learned that the economic attitudes of the past were not sustainable.

So, I humbly submit some principles that should guide our thinking so that we are hopefully in better economic shape in four and 40 years from now.

One, think long-term. Businesses are in bankruptcy or begging for bailouts because easy credit, mortgages, and payment plans were not sustainable. They managed the books on a quarterly basis to please stockholders and boards who wanted to see an increase every quarter for quick portfolio gains instead of making prudent decisions that would position companies to endure long term. Consumers fell into this trap too. Too many people wanted to “drive new every two” or get mortgage deals that delayed, but inflated, interest payments. Ask yourself what is the total you will pay for something, not what the monthly payment is.

Two, distinguish between wants and needs. Many children have been cautioned with this warning. Too many adults need a time out on this one. Think. Do you need a Hummer or will a simple sedan get you where you need to go (and probably more cheaply)? Do you really need a house three times the size as the one you grew up in? Do you really need that gadget, those clothes? Or do you want them, because the economic engine is racing, and you’re excited, and—like a child says—all your friends have those things?

Three, consider that if you don’t have the money now, you can’t afford it. Resurrect the idea of a budget and live by it. Live within your means, not within your dreams. Use credit cards for the convenience of not carrying cash, and pay the balance every month. If you can’t handle that, get rid of your credit cards.

This isn’t tricky economics. And if it sounds simplistic to you, it is. But too many businesses and individuals in our culture took their eyes off the ball. We were diverted like kittens with a flashlight on the wall.

It’s a basic concept that the economy depends on the production and consumption of products. But it is also a fundamental truth that controlling one’s finances may lead to the possession of fewer things, but not less happiness and security.