What I first recognized as a late-1980s-type housing price bubble, which I then learned to be part of a financial bubble, may in fact have been the last leg of a 25-year excess consumption boom. Now, instead of a necessary (and for tomorrow’s home buyers beneficial) return to normal housing prices with some collateral damage, we may be in for something much worse. Remember the 1970s? Next year is probably going to hurt. Some time ago I said that by the time the 2008 election rolled around no one would be talking about Iraq. I also said that the Democrats would be lucky not to be in the White House, and would have been better off not having control of Congress. That was based on falling housing prices alone. That prediction I repeat, in spades. Given that I will be affected by the fiscal fallout no matter how well I have personally insulated myself from the consequences of other people’s decisions, I’m starting to get worried. Let’s look at the scenarios.
<p>
A consumer-led recession, with a 3 percent decline in spending (the most since the 1970s, is in the cards thanks to the end of home equity extraction. Actually it could be more than that, since the U.S. has been consuming up to 6 percent more than it produces for years. According to MSNBC http://www.msnbc.msn.com/id/21838083/ “the subprime crisis…marks the beginning of the end for the long consumer borrow-and-buy boom. The financial sector, wrestling with hundreds of billions in losses, can no longer treat consumers as a safe bet. Already, standards for real estate lending have been raised, including those for jumbo mortgages for high-end houses. Credit cards are still widely available, but it may only be a matter of time before issuers get tougher. What comes next could be scary—the largest pullback in consumer spending in decades, perhaps as much as $200 billion to $300 billion, or 2%-3% of personal income. Reduced access to credit will combine with falling real estate values to hit poor and rich alike.”
<p>
Bloomberg (the company, not the mayor) agrees, as it wrote here http://www.bloomberg.com/apps/news?pid=20601109&sid=aS8qyeqQhtXk&refer=home
“Affluent consumers, pinched by shrinking stock portfolios, falling property values and smaller bonuses, are behaving like their less-well-off peers: They're reining in spending. That portends a steeper slowdown than originally forecast for the U.S. economy, or even a recession, because the richest fifth of American households accounts for almost 40 percent of consumer spending, the main engine of economic growth.” The previous idea was that it didn’t matter how much worse off the average American became, because the wealthy do all the spending anyway. You may recall the early 1980s idea that tax cuts for the better off spur savings and investment, because the poor spend everything but the rich save and invest. What a quaint idea.
<p>
And since much of consumer spending is baked in — the value of occupancy of owner-occupied dwellings and health care paid for by the government and insurers — discretionary purchases outside of necessities such as food and energy will take a massive hit. That’s why the financial markets reacted so badly when Starbucks reported weak same-store sales. I heard recently that the poundage of clothing that Americans buy per person has doubled since 1991. Expect it to halve. With wages falling behind inflation, we could be facing a significant decline in the standard of living. Except for the senior citizens, who have inflation adjustment guarantees for Social Security and, for NYC public employees, pensions.
<p>
The good scenario assumes that the rest of the world, long dependent on excess consumption in the United States for employment, is now prepared to stand on its own, and while soaring import prices (including oil) and prices for goods produced here that others want (including food) will make Americans poorer, soaring exports and a slow-growing labor force will keep everyone employed at falling real wages. Indeed, export volumes have been rising, and this is keeping us out of recession for the moment. In the bad scenario, however, China will not be unscathed. According to MSNBC "today, imports of consumer goods and autos run about $740 billion a year. That's fully one-third of consumer spending on goods outside of food and energy. As a result, most of the spending cutbacks won't cost Americans their factory jobs — those factory jobs have mostly fled offshore anyway. Workshop China, in contrast, will get hurt.” And if China can no longer sell stuff to us, because we cannot afford it, it may not be able to buy stuff from us so we can pay it back.
<p>
There is a scenario worse that any of this, however. For 25 years Americans have borrowed from the rest of the world to spend more. Now they cannot possibly service their debts, and are going to default. One way to do so is individual bankruptcies, but a second way as inflation that cuts the value of the dollars the debts have to be repaid with. Now the world’s savers and lenders are realizing they have been duped, and may demand to be paid in a currency that they are more certain is going to be worth something. Just today, the Wall Street Journal reported the oil rich United Arab Emirates is thinking of de-linking their currencies from the dollar. http://online.wsj.com/article/SB119552599363898773.html?mod=hpp_us_whats_news It was the lead story in today’s paper, but is already buried under additional (mostly bad) news. And the Financial Times reported that China is alarmed over the fall in the dollar’s value. http://www.ft.com/cms/s/0/8b1c17dc-96d1-11dc-b2da-0000779fd2ac.html?nclick_check=1 Yesterday, it was reported that at an OPEC meeting Venezuela and Iran recommended demanding payment for energy in other currencies rather than dollars, and Saudi Arabia tried to hush it up because it feels sorry for the United States and is worried out currency and economy will collapse. OPEC agreed to study the issue. If oil exporters demand to be repaid in currencies other than dollars, than other nations will be able to outbid us for the shrinking supply of the stuff.
<p>
There has been talk of New York City no longer being the world’s financial capital because of regulations that make it more difficult for executives to fleece shareholders. But in fact New York City became the world’s financial capital because the Untied States was the world’s largest creditor, and will no longer be the world’s financial capital because the city is part of a nation of beggars with a depreciating currency. No foreign firm will need to come here to raise funds, because Americans won’t have them. Worst case American companies will have to go elsewhere, and promise to repay in someone else’s coin.
<p>
And it could get worse still. Hundreds of thousands of households are going to see their homes go into foreclosure because they willfully or foolishly signed onto mortgages with low initial payments and massive payments later on, often as part of cash out refinancing that allowed them to live large on the proceeds. In the future, however, homebuyers may have to repay their debts in a currency other than dollars, and face a similar payment shock through no fault of their own, if the value of the dollar falls and more dollars are required to pay the requisite amount of Euros or Yuan. A year ago I would have said this was impossible. Not today. The value of the currency, something no one cares about here but is a major political issue in other countries, could become central to the 2008 campaign.
<p>
Hope everyone enjoyed the party. I’m only surprised (quite surprised) it went on as long as it did. We’re a rich, hardworking and innovative enough country to be able to clean up the mess. But a whiny enough country not to be willing to clean it up. Expect a lot of discussion about who (else) is to blame. Going to blame the poor, racial minorities, immigrants and those living in older central cities again? How about the children and young people? After all, they are the ones who have been slipped the bill thus far. But no matter who is blamed and who is sacrificed, unless another big terrorist attack is successful "it's the economy stupid" next year and the year after.