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franciscanway - Franciscan University of Steubenville

franciscanway - Franciscan University of Steubenville

The Summer

The Summer of Our (Economic) DISCONTENT By Tom om o Sofi ofi o 18 Franciscan Fr Fra Fr Fra Fr Fra Fr Fra Fr Fra Fr Fra Fr Fra F Fra FFra Fr Fra Fr Fra Fr Fra Fr Fra Fr Fra Fr ra a nc nci nc nci nc nci nc nci nc nci nc nci n nnc n ci i iisca sc s n nW nWay WWay ay a • Autumn Aut AAutumn utt um umn um umn um umn um u mn 2008 220 20 2 08 0 Agallon gall of gas now costs more than a Big Mac. The mortgage loan mess has pushed thousands of people out of their homes, while whi home values nationwide have dropped. Massive layoffs in the auto industry and other sectors have upped unemployment rates in many man states. There’s been talk of a recession or, worse yet, an outright depression. No wond wonder so many Americans see these recent events as signs th that the economy eco is in trouble. In fact, Fran FFranciscan University’s Professor Joseph Zoric and Dr. Mi MMichael ch c ael We Welke Welker say there is no grave cause for alarm. Citing busi- ne ness s theories su such as creative destruction, adaptive expectations, and the greater gr g eater fool theory, the two economists say the recent spate of ba bbad d economic ec e onomic nnews is the normal business cycle at work, albeit in dr dram dramatic am a at a ic boom and bust fashion. We Welk Welker, l er, who specializes in international fi nance, and Zoric, who dire directs re rects Fr FFranciscan’s ancisc MBA Program, discussed these issues and more for Fr Fran Franciscan anciscan Way W readers. FW: Let’s start with your assessment of the American economy. Some economists say that recent events signal a permanent decline in the American economy. ZORIC: This isn’t the start of a forever-changed economy. The economy changes all the time. Think about how we lived 100 years ago and how we live today. The shift from making buggies to cars put thousands of people out of work, temporarily. Land values, prices of commodities constantly rise and fall. This doesn’t mean it’s not an upheaval for those affected, but it is the normal business cycle at work. WELKER: One glance at the Wall Street Journal and you’ll see that the economy is constantly changing. On the very same page next to a headline, “Wal-Mart Posts Flat Earnings,” I saw an article, “Amazon.com Posts 41 Percent Net Increase in Profi ts.” We call this creative destruction. It means that one new business cycle comes in due to technological innovations and destroys the other, yet the new is better than the old. FW: How does this theory play out with the oil crisis? WELKER: We could fi ll your entire magazine explaining the causes for oil price increases. Countries like China and India are using more oil. You have an industry that is clunky and slow to deliver crude oil to market. There is an environmental movement that has bootstrapped the oil producers from tapping into oil in the Western Hemisphere, and many other factors. What’s important to know is that we are seeing a demand shock. There’s plenty of supply but the demand has risen faster than supply and the result is a run up in price. What this creates is a ballooning of all sorts of inventions to deal with high prices. For starters, Detroit has to change. ZORIC: The number-one selling car last year was the Honda Civic. For the fi rst time last year Toyota had a higher share of the U.S. market because they were poised for the market to shift to small cars. During this same time Detroit was offering SUVs and trucks. I just read about a solar-based sports car under development that goes from 0 to 60 in four seconds and gets 100 mpg.

WELKER: If you’ve got crude running at over $100 a barrel, entrepreneurs start to think, “Aha, let’s develop something new.” For example, the U.S. Army has shifted to using about 50-percent ethanol, 50-percent synthetic crude oil. Now, to get synthetic crude at a reasonable price you’re going to have to invest $6 billion to get this factory to the scale that will enable it to pump crude out at about $70 a barrel to make a profi t. FW: So Americans might actually benefi t from the oil crisis? ZORIC: In most cases technological advancement results in prices that fall long term, because of the substitutes that will be created. The price of computers has dropped 90 percent in the last 10 years. Even the price of a new car has dropped 3 percent in the past 10 years. So in this situation we may see insurance premiums start to fall because smaller cars are less expensive to repair. And lifestyle shifts, like people moving closer to work, people walking and riding bicycles. WELKER: Why, our health might actually improve as a result of this. FW: On to the home mortgage crisis. Who gets most of the blame: The homeowners? Unscrupulous mortgage lenders who took advantage of naïve homebuyers? A lack of government oversight? Investment fi rms that took on too many risky home loans? WELKER: The best way I can highlight it for Franciscan Way readers is with something called the greater fool theory. When I buy a house and it’s worth $1 million, someone will look at me and say, “You’re a fool. Why did you buy it?” Because I’m following the greater fool theory. I think there’s some “greater fool” out there who is going to buy it for more than $1 million. That’s the nature of speculation with these homebuyers. They fi gured out that the way to buy an immensely expensive house was to get into an adjustable rate mortgage (ARM). However, you should get into the ARM when you think mortgage rates are going to fall, not when mortgage rates are going to rise. Because when the adjustable period ends you are locked in at a fi xed rate. Well, millions of people took bets that the price of their home was going to continue to go up, which didn’t happen, and they ended up with high monthly payments. By taking those bets and losing their houses, it’s just like gambling. ZORIC: It’s what we call adaptive expectations. You think because something has happened in the past it will continue to happen in the future. And that’s not a rational expectation. People in California started thinking that housing prices would always rise. And now Congress passes legislation that is causing people who made these bad bets not to lose. In doing so, Congress has undermined the market process and has thus postponed the bottoming out of the crisis. Professor Joe Zoric and Dr. Michael Welker give their take on today’s economy. ECONOMICS “The sure bet is that we are going to come out of this economic slowdown.” FW: You seem to be pointing to an element of personal responsibility here. ZORIC: People’s expectations are too great. They think they should own a bigger house. They think they should have more things. This has always been a problem, but it’s particularly a problem today when credit is so readily available. It’s very tempting to take out your credit card and spend money you don’t have. WELKER: This fl ies in the face of traditional notions of stewardship and the Protestant work ethic with its strong emphasis on saving, working hard, innovation that fuels growth and job creation, and eventually the expansion of income. FW: Will either of you hazard a guess as to the future of the economy? WELKER: The sure bet is that we are going to come out of this economic slowdown. ZORIC: The worst thing would be for the government to not extend the Bush tax cuts. And a good way to help the economy would be to cut the corporate income tax by 10 points or so, which would put us on par with the rest of world. But overall the U.S. economy is too resilient for any political body to destroy it in four years. Entrepreneurs will continue to fuel our economy. We’ll come out of this downturn and the market will rise again. And I’ll be able to retire. � Seth Harbaugh Franciscan Way • Autumn 2008 19

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