Sinking Prices; Sinking Ships

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Imagine the face of Lt. George Morris. On March 8, 1862, his ship, the USS Cumberland, found itself a victim of what the economist Joseph Schumpeter called ‘creative destruction.’ The creativity came in the form of a revolutionary new technology, iron-clad ships. The destruction came in the form of cannonballs, which were smashing the poor Cumberland to bits. The Cumberland fired its cannons too. But its volleys merely ricocheted off its adversary, the CSS Virginia, like pebbles off a turtle’s back.

Our subject today is not naval warfare. Nor is it history or metallurgy. Instead, it is a worry fit only for an economist. No sensible man would waste a minute on it. It is the problem of ‘too much.’

The normal ups and downs of a healthy economy frighten capitalists terribly. As soon as their businesses get into trouble they howl for subsidies. When their investments go down, they whine for bailouts and central planning. It is not brains they lack; it is courage. They are not dumb, in other words; they are wimps.

But their philosophers and policymakers are the most pusillanimous of all. Their desperate reaction to the mini-recession of ’01 led to the bubble of ’05-’07. In a panic, they turned the fiscal balance of the US government upside down, from surplus to deficit; the country added $2 trillion to its national debt in the following 48 months. Meanwhile, interest rates dropped below the rate of consumer price inflation – where they’ve been ever since. Then, when their bubble popped in ’07- ’09, they showed no interest in discovering what was really going on or why. Instead, blinded by fear, they rushed in like a waiter dousing the flames on a bananas foster.

And now we sit in front of a soggy mess. Having learned nothing, our leading economists are all for action. In his advice to the Fed, for example, Paul Krugman urges a variety of experiments. “Nobody knows how well any one of these actions would work,” he admits. But the Fed should be “doing all it can…” Why? His English counterpart, Martin Wolf, answers. Because “…advanced countries remain highly short of demand…a threat to the survival of the Eurozone and even the open world economy.”

This terror du jour is the most remarkable yet. Wolf and Krugman believe there is an imbalance between the supply and demand. No kidding. They fear capitalism is not up to its most basic and simplest challenge.

Krugman: “The fact remains that our current problem is, in effect, a problem of excess worldwide savings, looking for someplace to go.” With five people looking for every US job, there is also presumably an excess of labor. Even the normally level-headed Nouriel Roubini says we have a “world of excess supply.”

Can you believe it? Their knees give way, fretting that markets no longer match up buyers and sellers. They might as well worry that maggots won’t find dead meat. Karl Marx warned about the same thing. Driven by the profit motive, entrepreneurs will always overdo it, he said. Then comes a correction, as overcapacity is eliminated. The correction will cause people to lose jobs, he continued. The unemployed workers will have to stop shopping, causing a depression. Oh ye of little faith! There’s always a buyer for every seller – at some price. For thousands of years, supplies have always come together with demand.

What is the cure for ‘excess’ capacity? Falling prices. Everybody who is not a swindler or a fool knows it. The real problem, from the activists’ point of view, is not excess or shortage. It is fear. They are afraid of the prices it will take to clear the market. Shares may have to lose half their value. Property could be knocked down by another 20%. Banks and nations may go broke.

Falling prices are painful. But it could be worse. Capacity could be reduced in another way. Iron ships were pioneered by the French in 1859. Their first effort was named La Gloire. The British quickly made their own ship, Warrior, a year later. But it was in America, at the mouth of the Chesapeake Bay, that the world first saw what iron hulls and steam engines had wrought. The iron-clad CSS Virginia shot up the USS Cumberland, and the USS Congress. It retired for the night, having destroyed an entire industry too – timber-based shipbuilding. The next day, the confederate ship came back to finish off the USS Minnesota, which had run aground the previous day. In its path was an even newer and more modern ship, the USS Monitor, with only two big guns and a revolving turret. The two of them blasted away at each other for three hours. Neither could land a decisive blow.

In 48 hours, shipbuilding capacity was destroyed twice. Until then, there were shipyards all over the world that could turn out state-of the art vessels. But on March 10, 1862, there was hardly a single one. First, the heavy iron-clad Virginia had made wooden warships obsolete. And then, the technologically more advanced Monitor brought forth a whole new era. It was not enough to cover a ship in iron. The ship had to be radically redesigned and constructed using new skills and new materials. Suddenly, the iron mongers were working night and day…and the great oaks could relax.

Bill Bonner
for The Daily Reckoning Australia

Bill Bonner

Bill Bonner

Best-selling investment author Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter companies. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail The Daily Reckoning.
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Comments

  1. Does anyone have an explanation for the recent trend to inverse movement in 4 pillar hybrids versus regular stock price when the latter enters a downturn? Why is debt doing better than equity (I didn’t think hybrids were secured against collateral when I looked at them)? There must be a traders explanation …

    http://hfgapps.hubb.com/asxtools/Charts.aspx?asxCode=cba&compare=compare_code&indicies=XJO&compareCode=cbapa&chartType=3&pma1=0&pma2=0&volumeInd=2&vma=0&TimeFrame=D12

    Reply
  2. BB: “Shares may have to lose half their value. (US) Property could be knocked down by another 20%. Banks and nations may go broke.”

    OK… . That already sounds like Armageddon, without trying to create any more unwinnable wars, I mean!~ :)

    Reply
  3. In some ways, the economy is similar to an immune system. If you get the normal cold (recession) and just deal with the symptoms (unemployment), the immune system will eventually learn to deal with similar colds in the future. But if you keep taking anti-biotics (financial stimulus) each time, the immune system becomes gradully weaker and reliant on anti-biotics (give me more money)…

    Reply
  4. Nice article. We live in interesting times.

    AnnoyingOrange
    July 19, 2010
    Reply
  5. Great Article… falling prices are indeed the solution rather than the problem that Keynesian advocates seem to be so adamant about.

    The article end perhaps is a subtle suggestion that a War and technological advances are going to be the only catalyst for prices to correct, given that governments are so quick to intervene and prevent natural market forces to take place.

    I unfortunately agree… though I hope that it won’t be the case.

    Reply
  6. Comment by Biker on 19 July 2010:

    BB: “Shares may have to lose half their value. (US) Property could be knocked down by another 20%. Banks and nations may go broke.”

    OK… . That already sounds like Armageddon, without trying to create any more unwinnable wars, I mean!~ :)

    However is the most likely position the world will be in when this is over.. then the process will start again…”Armageddon”, no, just the life cycle of economies…

    Article in the Melbourne Herald Sun on median house prices saying they have gone up even more in the June Quarter to $559000.
    Yet Auction clearance rates have been falling since May, median price of those Auction results has fallen, suburbs like South Yarra have seen falls of 26.9% since the march Quarter from $1.65million to $1.2million.. there seems to me to be some manipulation in housing price figures..

    Stillgotshoeson
    July 19, 2010
    Reply
  7. “…$1.65million to $1.2million..”

    Well, there ya go…. a saving of $450K!~ ;)

    In fact as Greg reminds us, it’s not a property markeT… there are property marketS. Little has appreciated in that million-dollar segment here in WA, either. It’s just ten percent of the market (here).

    Those with $1.2 mil spare might be interested in those Melbourne figures, (as a family home) but it’s far more productive in our market to build three for the same total. Total rental returns are far better than a McMansion can achieve… and there’ll be a much larger group of buyers at sale time.

    Good to see your interest in property continues, Shoes. Loved the recent article by The Shoeless One on ‘Kidults’, by the way… . :)

    Reply
  8. Shaun: “…governments are so quick to intervene and prevent natural market forces to take place…”

    Gawd… can’t have that!~ Thermonuclear war is _much_ more preferable.

    The loonies are out in force today!~ (Hums “Got to keep the loonies off the grass” to himself, while pondering these ‘subtle suggestions’ :) )

    Reply
  9. @Biker: Perhaps you didn’t understand my comment.

    I was advocating price corrections over any “thermo-nuclear war”. If only the gov’t got out of the way, then house prices would correct to normal levels. (Making it affordable for all individuals)

    By the tone of your reply, I’m assuming you are a Keynesian advocate; if you can provide any reasonable explanation on why continuing to inflate house prices is positive then maybe I would be willing to listen. But given your child-ish response, I guess you wouldn’t have any clue.

    Maybe you didn’t even read the above article by Bill.

    Reply
  10. … or perhaps I didn’t understand your response? It is difficult to convey sarcasm on the internet…

    Reply
  11. No, I’m all for thermonuclear war to bring down the price of houses to a ‘normal level’, whatever that may be, Shaun. Hell, I’d even settle for just an atomic war, if it meant that those Eyetalians would sell me a Multistrada Tourer for half the ‘normal’ level of $30K.

    Keynesian? Don’t assume you can assign contributors economic hats from their tone, son. Just continue to ‘child-ishly’ assume that house prices must fall to the level you want. Get the government out-of-the-way and it will fall into your lap. Nuke ’em!~ ;)

    “Maybe you didn’t even read the above article by Bill.”
    Well, yes, I did. I suggest you reread your own offerings. Your logic is stunning… . You’d actually advocate _price corrections_ over an exciting nuclear war?! Hey, c’monnnnnn…. . :)

    Reply
  12. Biker Pete:
    ‘im all for thermonuclear war to bring down the price of houses to a ‘normal level’

    And pigs fly

    Reply
  13. “And pigs fly…” (?)

    Whhhaaaatttt? Not even a _thermonuclear war_ will bring house prices down to the price you want, Steve?!~ :)

    Reply
  14. @Biker haha… my apologies. Your humuor takes a little getting used to.

    Reply
  15. This is great article , falling prices is the way forward and I agree they are wimps they should stop complaining and do something about it

    Reply
  16. “It is difficult to convey sarcasm on the internet.”

    Really?? :-)

    Reply

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