Tyler Cowen Argues That This Is A Crisis Of Sectoral Shifts

Tyler Cowen at Marginal Revolution has a post up today which in my opinion is brilliant. He advances the argument that the concept of leverage extends far beyond the notion of debt. Here is a snippet from his post:

You also may have heard that the Phoenix Suns have been trying to unload All-Star players Amare Stoudemire and Shaquille O’Neal.  They are not hoping to get equal talent in return but rather they need to lower their payroll.  (Why pay $75 million a year for a fringe playoff club?)  And the New Orleans Hornets, former contenders, traded center Tyson Chandler simply to unload his salary.

I think of the Suns or Hornets as similar to a highly leveraged institution.  I don’t know the debt level of their corporate structure but that is not the point.  The Suns have been spending lots in recent years toward the goal of ever-rising prices for season tickets and corporate boxes.  Does that strategy sound familiar?  If the future price hikes don’t come on the main asset, they can’t afford their obligations and so they will try to shed illiquid and hard-to-value assets into an unwilling market.  Sound familiar?  (As an aside, I wonder if barter is one way to jump start trading in illiquid financial assets.)

You may as I did have to read this short post in its entirety for Mr. Cowen’s concept to sink in. He is arguing that many parts of the economy (worldwide, not just in the U.S.) have leveraged themselves based on expectations of certain events playing out. To the extent that does not occur and in fact will not ever occur, then a sea change in strategy has to occur. He concludes by offering the opinion that we may find out just how deeply real leverage is in the economy and why, “…this is fundamentally a crisis of sectoral shifts.”

If you accept his logic, which I do, then you begin to see not only the dimensions of the problem but also the necessity of attacking it in a measured manner. For instance, the recently passed fiscal stimulus plan admits nowhere that the consumer may have changed his preferences regarding consumption. The plan assumes that to repair the economy it is necessary to nudge the consumer towards spending at previous levels. No allowance is given for a shift in this sector of the economy towards a different set of values and, therefore, the likely success of the program is diminished.

I don’t mean to pick on the fiscal stimulus plan particularly, it’s just one of the best examples currently around. The larger issue is that is that the discovery of inherent leverage within particular sectors is going to cause unexpected adjustments that will impact other sectors. In many respects, they are like tectonic plates in that a shift in one is going to have an impact on unknowable size on those it rubs against. In such a situation, the best the government might be able to do is provide lubrication for the plates to insure that the adjustment process doesn’t result in a cataclysmic result. The plates will realign themselves for sure and no amount of force can be brought to bear that will alter that process.

This may not be an easy process.

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