I consider the greatest economist of the last century to be Joseph Schumpeter, whose theory of creative destruction has implicitly underpinned the dynamism of US capitalism, at least until now. Suddenly, politicians are intervening to decide which companies are too big to fail, and stifling a necessary reallocation of capital and clearing of economic deadwood. It is essential and healthy that dysfunctional and undercapitalised investment banks go bust, or that a dinosaur like GM faces Chapter 11, painful though those events would prove for many ordinary investors and employees. The system as a whole benefits from the reallocation of capital and people from sunset to sunrise industries, and the swifter the process, the more productive the economy at large. The pain suffered by California as the post Cold War peace dividend slashed defence spending in the early 1990's is a case in point, and set the scene for the subsequent tech boom later in the decade. Government certainly has a role in softening the economic blow to those regions and groups worst effected, but definitely not in picking the winners. What if the government had blocked GM when it decided to develop diesel train engines in the 1930's, in order to preserve employment in railways driven by labour intensive steam? The wartime economy would have been severely constrained as a result. The market is best left to its own devices when it comes to winnowing out the winners and losers in any given industry; taxpayers' money is utterly wasted in delaying the inevitable and distorting private capital flows. Having tossed hundreds of billions at the financial sector via the Fed, the US government is now under intense pressure to bail out Detroit, by extending no-interest loans of maybe $50bn dressed up as an alternative energy strategy (start with no interest and you end with no repayment). It all sounds suspiciously like French state dirigisme to me, not so much freedom fries as freedom finance. Not that the appalling financial mess GM, Ford and Chrysler are in should be any great surprise after decades of relentless decline and mismanagement. Who would you guess to be the single biggest category of supplier to the Big Three US automakers? Steelmakers? Component manufacturers? Actually, it's health care providers like Blue Cross, and therein lies the problem. There is a highly competitive US auto industry but it's based in Tennessee and Georgia, and owned by Japanese companies who don't have the crushing retiree pensions and healthcare burden that hobbles Detroit, and which both politicians and management have been too terrified to tackle; bankruptcy would do the job for them. The interventionist mood in Congress is near term unstoppable and to some extent inevitable given the implosion of financial capitalism as practiced by Wall Street, and both Presidential candidates have plans that call for bigger government activity in the economy in areas from healthcare to infrastructure investment.
In fact, spending has been trending steadily higher since 2001 as seen in the chart (courtesy PerotCharts.com), after a steep decline in the Clinton years, largely driven by the peace dividend. Recent events in Georgia (see Russian Roulette) and the ongoing wars in Afghanistan and Iraq mean defence spending is heading up (much of the rise is non-discretionary, relating simply to accelerating veterans healthcare and pensions costs), while economic reflation spending will soar in the context of a declining tax base and both Federal and State levels. I would expect to see the levels of over 23% of GDP last seen in the 1980's recession hit again within 3-5 years, squeezing out private consumption (which as I've said before will fall back to trend at about 65% of GDP, from a recent credit boom inflated 71%). Investors are going to get hit with an avalanche of Treasury issuance, which I suspect the traditional foreign buyers in trade surplus countries like China simply won't be willing or able to absorb; yields must head considerably higher. This is a major and inevitable trend reversal that should inform long term investment decisions for any wise investor; exposure to US consumer exposed equities and US Treasuries should be minimised.
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