Effect of Global Economic Slowdown on Milwaukee Company

My local newspaper, the Milwaukee Journal Sentinel, published an article this week about the global economic impacts on the Milwaukee based mining company, Joy Global.  The short-term outlook for the company appears to be rather measly due to globally weak mined comodity prices, slowing Chinese industrial economic activity, and lower U.S. natural gas prices.  Equally important, the  slower pace of the U.S. economic growth and its fiscal cliff,  European debt, and slow growth in China are also adversely impacting the growth prospects of the company.  As a result, mining companies will likely decline capital spending from 5% to %10 by cutting capacity and closing some factories in order to prepare for the looming challenge of a difficult business market.  A company like Joy Global has a lot at stake when it comes to the global mining, as nearly 100% of its invested capital and and operating profits are in mining, whereas a company like Caterpillar Inc. has less at stake with only half of its capital invested in mining.  However, this problem is only cyclical, and Joy Global has a rather positive outlook on the long-term prospects.  As the article notes, even though the Chinese economy has slowed recently, China is still is one the world's largest users of coal, and produces nearly half of the world's steel.  Back in September,  The Wall Street Journal posted an article about the news of the Chinese government passing a $156 billion infrastructure bill as a means for boosting their industrial economic activity.  With a huge increase in steel production comes an increased demand for iron ore, which is mined by the heavy machinery manufactued by Joy Global.  The Journal Sentinel article also mentions that more developing nations are demanding mined commodities.  With that in mind, Joy Global has globally expanded their-service centers and increased manufacturing in emerging markets.  The effects of these promising global changes have made their effect locally.  P&H Mining Equipment, a Milwaukee based subsidiary of Joy Global employs more than 800 people and is looking to hire even more employees for skilled-labor positions as they increase production of their mining shovels and drilling rigs. If, however, the global economy prospects do not play out as predicted, Joy Global is well-prepared to cut costs by outsourcing these manufacturing jobs to countries with lower labor costs such as China, South Africa, and Poland.

You can read the Milwaukee Journal Sentinel article here:

http://www.jsonline.com/business/economic-slowdown-felt-at-caterpillar-joy-global-787pun0-180936761.html

Leftovers

For all of you still salivating at the thought of your Thanksgiving feast this past Thursday, I found this graph on the Economist today which depicts the increase in inflation since 2008 in terms of turkey prices:

Anyone else worried about the rising "pecuniary cost" of Thanksgiving dinner?

Credit and Blame

I recently read a Wall Street Journal article from 2007 for my Econ 211 class that offers an interesting scope into the years leading up to the Great Panic of 2008.  The article describes how rating firms like Standard and Poor’s, Moody’s Investors Service, and Fitch Ratings catalyzed the subprime mortgage crisis of the early 2000s. During this boom in sub-prime mortgages, as we learned in class a few weeks ago, borrowers with weak credit were able to take a “piggyback” loan or a secondary loan to help pay for the down payment of the mortgage.  Underwriters then assembled these extremely risky loans into securities which were sliced into “tranches,” with the riskiest of tranches having the highest level of return.  As we know, during this time, the Fed  was keeping interest rates low; so many investors were in search for these high-risk/high-return securities.  When housing prices finally fell, and the sub-prime mortgage bubble burst, many were left wondering how the tranches containing the extremely risky sub-prime mortgage bonds received such good ratings.  The reason lies within the role of the rating firms in the sub-prime market.  Rating firms receive fees about twice as high when they rate securities containing a pool of home loans.  If underwriters didn’t receive a good enough rating for their tranches of securities, they would take their business to a rating company that would give them a better rating.  They called it "best execution" or "maximizing value," but in reality they were shopping around for a good deal on a fabricated rating.  As a result, some of riskiest tranches were given triple-A ratings, and because many hedge funds and money managers relied on these ratings, they bought securities in large quantities.  Enter a sudden and unexpected rise in housing prices, and you know the drill.  

After reading this article, I am a bit more reluctant to point the blame at the Alan Greenspan and the Fed for the monetary policy they enacted during this time.  Their policy was merely a groundwork that would provide for honest economic growth, but unfortunately would be taken advantage of by a culture of greed on Wall Street.  Shady backdoor deals between underwriters and executives at ratings firms are just one of the many components that caused the Great Panic of 2008.  If we experience a promising economic environment again in the future, hopefully the volatile actors of Wall Street won't be overcome by a voracity for personal profit, and realize the risk involved in the decisions they make.

Meltzer Lecture: "Socialism is Dead, but Social Welfare Lives On"

I appreciate Simone's comment regarding German taxpayers paying for other countries failed welfare systems because it was one of many topics covered tonight in Professor Allan Meltzer's lecture "Socialism is Dead, but Social Welfare Lives On."  Meltzer, a professor from Carnegie Mellon's Tepper School of Business, founder of the Shadow Open Market Committee, and author of A History of the Federal Reserve, a book considered to be one of the most comprehensive histories of the central bank, is an expert on monetary policy and the Federal Reserve. 

Before his lecture, I was fortunate enough to attend a Q&A session with Meltzer where I received a copy of his most recent book, Why Capitalism?  The context of the Q&A, which focused mainly on the Federal Reserve and monetary policy leading up to the 2008 Great Panic, could not have come at a more opportune time as it supplemented what I had learned from David Wessel's In Fed We Trust.  Meltzer would agree with Wessel that Alan Greenspan kept interest rates too low for too long, as he was afraid of deflation.  But quoting Immanuel Kant, "out of timber so crooked as that from which man is made, nothing entirely straight can be carved," Meltzer emphasizes that no human is perfect, and admits that the problems of capitalism stem from human weakness, but human weaknesses are not specific to capitalism.  Meltzer shifts the blame towards government housing policy.  Around 2005, the Housing and Urban Development Agency encouraged the use of "piggyback" mortgages, or mortgages with no initial down payment. Paired with immense political pressure to put people into houses even though they couldn't afford the mortgage, government-sponsored financing agencies like Fannie Mae and Freddie Mac began to buy these subprime loans, thus fueling the housing bubble which inevitably burst in 2008.  Meltzer believes that social welfare systems attempting to redistribute wealth in capitalist market economies ultimately fail, and Fannie Mae and Freddie Mac are one of many examples.  Meltzer would later delve into the other examples of inefficient welfare programs, such as the Weatherization Assistance Program.

During his lecture in Stackhouse, Meltzer focused primarily on the dysfunctions of social welfare programs and how they must be ameliorated in the face of this global economic crisis.  He started off by saying that European countries boasting extensive welfare programs have not surpassed the more market-oriented United States, and are the main cause to the EU crisis.  Greece for example has experienced a longer, deeper, and wider crises than the Great Depression due to a society structured around a costly welfare system.  Like I posted in our first writing assignment, the struggle for these EU countries lies within the dichotomy between stimulus spending and austerity.  Meltzer simplified the concept to "wanting more consumption now vs. receiving more from long run growth."  Essentially, the fiscal burden is so deep, that it cannot be paid for in taxes; rather, more can be paid for by cutting spending in the short run and balancing the budget, which will ultimately allow for lower tax rates in the future.  Meltzer believes that Greece must face the hard reality that it is hard to find a solution that fits everyone's needs, and a cut in living standards is inevitable.  As made apparent by Simone in her blog-post today, Germans do not want to pay for the economic woes of a failed welfare state like Greece.  As Meltzer put it, "German's who retire at the age of 65 do not want to want their hard earned money going to Grecian's who retired ten years prior at the age of 55." 

At the end of his lecture, Meltzer focused on the home-front.  He prefaced his conclusion by proclaiming that no agency should have the power the Fed has given itself.  In the near 100 years since its birth, the Fed has never made clear its "lender of last resort" policy.  That is why, Meltzer argues, that we have nearly $1.8 trillion worth of excess reserves today.  To prevent this from happening in the future, Meltzer believes that the Fed should follow a set-in-stone "lender of last resort" standard.  He supported this claim by referencing that the two periods of the most economic growth in the U.S., the Fed was bound by some sort of rule.  From 1923-1928, it was the gold standard; and from 1985-2003 it was the Taylor Rule.  Looking forward, Meltzer believes we need to separate ourselves from becoming a social welfare state with more regulations, because the social welfare state is prisoner to interest groups, and regulations are set up by lawyers and bureaucrats who know how to circumvent them.  It is an unsustainable path, and there will be no way to end the probable inflation due to the $1.8 trillion worth of excess reserves without a temporary rise in unemployment.  Therefore, Meltzer concluded, "capitalism works best in a stable environment that permits people to achieve their plans.  To achieve the growth and freedom that only capitalism provides, countries must adopt rules that force policymakers to plan for the medium term and prevent inflation."

Book Review: In Fed We Trust

In his 2009 book, In Fed We Trust: Ben Bernanke’s War on the Great Panic, David Wessel, an economics editor for the Wall Street Journal, encapsulates one of the most pivotal times in our country’s history and the history of the global economy.   Not only does he offer the reader a fly-on-the-wall perspective during some of the most frenzied closed-door meetings between chief economic actors like Ben Bernanke, Timothy Geithner, and Henry Paulson, he also illuminates the historical context of the Federal Reserve and its role in the U.S. economy since its inception in 1913.  Most importantly however, Wessel intently focuses on Ben Bernanke’s role as the Chairman of the Federal Reserve during the Great Panic, and how his expertise on the Great Depression of the 1930s inspires his “whatever it takes” policy to prevent it from ever happening again.

Before the Great Panic, the Federal Reserve was considered to be a “lender of last resort,” which usually entailed lending to sturdy commercial banks at times of high speculation when customers wanted to pull their money out.  But by 2008, the Federal Reserve became what Wessel labels “the pawnbroker of last resort,” lending heavily to investment banks, insurance companies, auto finance companies, etc. that all went bust.  But how could it get this bad?  Why would Ben Bernanke be forced to extend the Federal Reserve far beyond its traditional role?  Wessel partially blames Alan Greenspan, the Chairman of the Federal Reserve from 1987-2006.  During his term, interest rates were kept too low for too long.  With such low interest rates, investors took greater risks in order to receive higher returns.  Yet these risky bets were placed on the flawed assumption that the economy would be stable in the long run, and in regards to the housing market, housing prices would never fall.  That would eventually prove to be false, and the housing bubble would burst.

Of course, Bernanke was faced with some tough decisions, but being an expert on the Great Depression, Bernanke knew what not to do: stand idly by.  According to Bernanke, the Depression of the 1930s was largely the Fed’s fault, and under his watch, he would ensure that that would not be the case. He would do “whatever it takes.”  Wessel emphasizes that the Fed had to exceedingly extend its powers to curb the threat of another full-blown depression.  In March 2008, the Fed saved Bear Stearns to the tune of $30 billion, the first time the Fed ever directly gave money to a failing firm.  Yet it wouldn’t do so with Lehman Brothers.  The Fed certainly had the power and resources to bail out Lehman Brothers, but neither Ben Bernanke, nor Secretary of the Treasury Henry Paulson were content to do so due to the poor image it would portray, seeing they just used $30 billion of tax-payer money to bail out Bear Stearns.  The Fed however would continue to reach even further, bailing out A.I.G. and welcoming a Congressional stimulus package of $700 billion. 

Though Bernanke’s unheralded response to the Great Panic prevented the U.S. economy from outright catastrophe, it has certainly burgeoned undesirable attention to the Federal Reserve’s ability to act as what some call “the fourth branch of government.”  Much of the derision towards the Feds actions can be attributed to how their policies were delivered.  Geithner called this "getting the substance and the theater right."  How a policy is framed is just as important as the policy itself, and because Bernanke, Paulson, and Geithner failed to offer a clear explanation of the policies they were enacting, it left people uncertain about the power the Fed held.  Rather than critique the amount power and leverage the Fed used to prevent a repeat of the Great Depression, critics should focus their worries on the Fed’s shortcomings prior to the Great Panic.  The worst loans that created the credit bubble were subject to little or no federal regulation.  Wessel agrees that the Fed’s inability to see the Great Panic coming is worrisome, but he lauds Bernanke’s response.  He ends his book with some food for thought.  What if Ben Bernanke had not resolved to do “whatever it takes” to prevent a second Great Depression? Would we be worse off?  I myself think we would be worse off had it not been for the Fed stepping in.  What does concern me however is the amount of excess liquidity due to the bailouts.  As we’ve discussed in previous classes, high inflation spells disaster for an economy facing a recession.