10/26/11 Madrid, Spain – Last time we looked, yesterday, stocks were falling. We’re on a plane bound for Madrid this morning. So, we’re just going to forget the markets and move directly to the economy that supports them.
Both The International Herald Tribune and The Financial Times signal that the American economy has hit a bad patch. Both refer to consumer confidence as a cause of the problem. Consumers aren’t willing to borrow or spend…say the papers…because they lack confidence.
What they really lack, of course, is money. They don’t have enough money to continue spending at the bubble era rate…and they have little hope of getting any.
“Gloom holds back the US economy,” says the FT.
The Conference Board does an index of consumer sentiment. It’s at its lowest point in 40 years.
And no wonder. More Americans are unemployed now than there were 40 years ago, or any time in between. And never have house prices fallen so much. The Case-Shiller index puts house prices nearly 4% lower than they were 12 months ago. If all of America’s housing stock has a value of around $20 trillion…this represents a loss of about $800 billion over the last year.
“It was all on paper anyway,” you might say. But that was the paper that the baby boomers had hoped to use to finance their retirements. Seventy million of them are supposed to retire over the next 15 years. Few have actually saved enough money. Some looked to the stock market for the money they needed. Others counted on selling their houses.
Now, they’re in a jamb. Stocks and houses have gone nowhere in the last 10 years. These years should have been the “peak retirement savings” years for the boomers…when their earnings were peaking out and the beaches of sunny Florida beckoned to them like Lorelei on the banks of the Rhine.
But they blew it. They took their peak earnings…invested in stocks or real estate…or simply spent the money. Now, what have they got?
They’ve got to do a lot of saving!
The trouble with saving money is that it is incompatible with a debt-soaked economy. If your earnings are increasing you can pay back your loans with your extra money. It doesn’t take anything away from the economy. But if your earnings aren’t increasing, you have to reach into your pocket and take out money that was earmarked for other things. This has the inconvenient consequence of reducing consumer spending…which sends the economy into a funk.
Even the mainstream press is beginning to understand how this works. Here’s a piece from Atlanta Home:
How Debt Deleveraging Killed the Economy
By Harris Collingwood
October 11, 2011
When US consumers, businesses, and government all pay down debt at the same time, the inevitable outcome is lower growth, higher unemployment, and lower standards of living.
Millions of Americans are taking similar steps. Some 8 million US consumers stopped using bank-issued credit cards in 2010, according to the credit-reporting agency TransUnion. The average credit-card balance has fallen 10 percent this year from 2010, to $6,472; US consumer debt has dropped for 12 consecutive quarters, from a peak of $14 trillion in early 2008 to $13.3 trillion last spring, mainly because of mortgages repudiated or abandoned. People are cutting visits to the hairdresser, buying used cars without financing, and living on surplus cheese as they trudge toward the promised land of a debt-free existence.
Ponder what economists call the paradox of deleveraging. This occurs when economic actors on all sides — consumers, business, government — all retire their debts at once. Unless their incomes are rising, they can pay off debt only by cutting what they spend. This, in turn, reduces the demand for goods and services, which drives prices down, further trimming businesses’ revenue and thus their ability to pay employees, who in consequence spend less. The cycle continues, until incomes fall so low that there’s no longer cash available to reduce the debt. And as incomes and business profits decline, so do government tax receipts, resulting in fewer police officers, more unfilled potholes, and greater pressure on pensioners.
A deleveraging nation, economists say, risks higher unemployment and years of subpar economic growth and could trigger a deflationary spiral in which consumers forgo spending, anticipating lower prices in the future. “When economies are deleveraging,” Atlanta Federal Reserve Bank President Dennis Lockhart said in a recent speech, “they cannot grow as rapidly as they might otherwise.”
Such is the bind in which the United States finds itself, three years after the world financial system nearly collapsed amid the collective realization that governments, businesses, and households had all borrowed far more than they could possibly repay — far more, in fact, than there was collateral to secure it.
The federal government led the way. Its debt swelled from $907 billion in 1980 to $14.7 trillion in September 2011. The rise wasn’t slow or steady. Powered by tax cuts plus two wars and a Medicare prescription-drug benefit, all financed by borrowing, the debt rocketed during George W. Bush’s administration, from $5.7 trillion in 2001 to $10.7 trillion. Under President Obama, the federal debt has soared by another two-fifths, mainly because of the debt-financed public spending that was meant to stabilize the economy after the 2008 meltdown.
Until recently, consumers borrowed almost as avidly. As lenders crafted credit products for borrowers of every need, consumer debt exploded after 1980. The largest increases came from 2000 to ’07, when total household borrowing more than doubled — to $13.8 trillion, mostly for mortgage debt — while consumer prices rose by only one-fifth. Consumers, some economists say, were trying to compensate for stagnant incomes, which gained by only a tenth on average (adjusted for inflation) from 1973 to 2010. Business joined in, especially in housing-related industries, borrowing half again as much in 2007 as in 2000. Small businesses availed themselves of cheap money.
But now, the feds pump furiously, still raising debt levels in the public sector, but the tide goes out for almost everyone else. It sweeps millions of households out to sea with it. They are now drowning in debt, ‘underwater,’ with little hope of ever getting back to the surface. The best they can do is to let go the burden of mortgages, student loans, credit cards…all the debt that is dragging them down.
Then what? Then, they have to cut back…and save real money for retirement.
And you already know what this does to the economy.
“Well, Mr. Smarty Pants,” said our better half, “What’s your solution?”
“I don’t have a solution. I only have a resolution.”
“What’s that?”
“Let the markets sort it out. Let the chips fall where they may. Give bankruptcy a chance.”
“But it was the markets that got us into this mess. It was the markets that got people into so much debt. It was the markets that made them think houses would go up forever. It was the markets that rewarded Wall Street for its financial engineering.”
“Well…yes…it was the markets reacting to a lot of bad cues and misinformation supplied by the feds.”
“Maybe…but if the markets could make such huge mistakes…how do you know they won’t make more of them?”
“Hey, the markets never know what anything is worth. They always make mistakes. But they are always finding out what things are worth. And when they realize they’ve been suckered into a bad position, they correct. They’re always correcting their mistakes. And that’s why we have a Great Correction on our hands today.”
“But how do you know the correction will be any better than the mistake?”
“You’re asking tough questions. I thought we were on a vacation.”
“You’re the one who is always talking about these things…”
“Of course, we never know anything for sure. That’s why we have markets. They don’t know anything either. But they’re always discovering. It’s sloppy. It’s painful. But that’s just the way it works.
“And what’s the alternative? The Soviets tried to eliminate markets. They got smart people together and let them decide how capital was to be allocated, who got what…and at what price. It was the greatest economic experiment ever conducted. And they stuck to it. Over a 70-year period. If people objected, they sent them to Siberia. Some tried to get out of it by jumping over the Berlin Wall; many were shot by the guards. We really should erect some monument to the Soviets for such steadfast zeal and earnest commitment to economic experimentation. Maybe they should get a Nobel Prize. They certainly have done much more than Keynes or Krugman to help us understand how markets work. Sensible people would have dropped the experiment after a few months. But the Soviets kept going.
“And now we know. Seven decades after it began, Russia was poorer than when it began.
“But that’s the problem with a command economy. It corrects too, but only very reluctantly. Usually after a revolution.
“And that’s what we see right now. The private sector — a market economy — is correcting the errors made in the bubble years. It is correcting its debt. It is de-leveraging. But the public sector? Government is a command economy. Decisions are made by bureaucrats, lobbyists and glad-handers. Capital is allocated according to political considerations; they are not guided by the invisible hand of the market. So they don’t correct. They just keep making the same mistake — running up debt — until a correction is forced upon them.”
Regards,
Bill Bonner
for The Daily Reckoning
Bill Bonner
Since founding Agora Inc. in 1979, Bill Bonner has found success and garnered camaraderie in numerous communities and industries. A man of many talents, his entrepreneurial savvy, unique writings, philanthropic undertakings, and preservationist activities have all been recognized and awarded by some of America's most respected authorities. Along with Addison Wiggin, his friend and colleague, Bill has written two New York Times best-selling books, Financial Reckoning Day and Empire of Debt. Both works have been critically acclaimed internationally. With political journalist Lila Rajiva, he wrote his third New York Times best-selling book, Mobs, Messiahs and Markets, which offers concrete advice on how to avoid the public spectacle of modern finance. Since 1999, Bill has been a daily contributor and the driving force behind The Daily Reckoning. Dice Have No Memory: Big Bets & Bad Economics from Paris to the Pampas, the newest book from Bill Bonner, is the definitive compendium of Bill’s daily reckonings from more than a decade: 1999-2010.
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Here in Ireland its even worse , unemployment is over 450,000 which equates to 29.7 mill in U S but does not include the self employed with no income
and not eligible for any benefits !
Houses have fallen over 50 pct from the top and
rate is increasing at least 12.5 pct down in the last 12 months
No wonder so many are emigrating …
Not only this delevarging is a whooping for the boomers who are about to retire and don’t have enough money but also for the generation after them that are learning a listen in saving your cash and not trusting the promises of the wall street.
In other words, it’s good chance that the US economy will continue shrinking for decades to come. I have a hard time believing majority of Chinese or other emerging countries’ citizens have enough cultural similarity, social or economical, to become true engines of consumptions around the world. Their 1% rich may own 80% of their wealth.
PS, if you have cash savings that pays 12% interest isn’t all that bad which of course opens a whole new can of warms in why take a risk and invest when my savings account is paying 12%.
ABOUT THEM GREEKS…
Maybe they could stir up a little national pride and their citizens could buy back the Greek bonds in the name of national Pride.
convince the Greeks that the nasty world has declared financial war on them and that this is war and the way they can win it is for their citizens to buy Greek bonds and keep their money in Greek banks.
National pride involves triggering ancient human emotions and instincts about fighting off enemies. Bill, please elaborate, (you are ancient or at least you know about the ancient things).
what’ya think? Surely some lusty pride can deal with a lousy $360 billion or at least make one huge dent in it.
Wrong article, Shawn.
Bill, get off that plane, get your head out of the clouds, and for gosh sake sink at least 50% of your wealth into Greek Bonds, buying them from French banks at full par value, to save those banks. You’re already bald so a 50% haircut will not impact you.
Shawn, vous manquez la moitié de votre cerveau déjà, ainsi elle ne fera aucune différence pour perdre une autre moitié.
Methinks many of the OWS crowd see the Soviet experience as an ideal.
Shawn, you used the word “Greek” at least 5 times in your post. I am disappointed you did not contact me regarding the 3rd Way Project.
The Soviets weren’t all bad. They managed to produce more classical musicians than the rest of the world combined for many decades. When the Soviet Union collapsed, and the musicians all fled for the highest bidder in the west, the world lost a huge cultural asset. Soviet art wasn’t altogether bad either, and 100 years from now some of it will be highly prized, even the works commissioned for public consumption.
And then there is the American contribution to the arts over the same 70 year period…,, Or lack there of.
If you worked hard all your life and have nothing to show for it (except a boatload of debt)the Soviet option doesn’t look so bad. Is it really a free world when we are all debt slaves? I always been a capitalist, but is it really working?
It’s nice to see that your wife holds you accountable for your tirades occasionally! I completely agree with you however.
The government espouses free market ideology when things are looking up, cut regulation here, there and everywhere “I’m a market guy”, They say. But when things go bad, the market is not allowed to learn from its mistakes, because low asset prices means the ruling class just lost money.
So, like a spoilt child given endless candy and never forced to “eat it’s greens” the market continuous a path of destruction living on sugar highs, only crashing slightly before the next rush. But we all know what happens, one day his teeth fall out, then he gets diabetes then cancer. Not even mum can prevent disease. But she’ll keep him on life support until the money runs out.
Bloomer, consider moving to Cuba. The winters are nice and warm, and they have really great baseball and cigars, too.
It would certainly be an interesting experiment in economics if all the OWS crowd and every other underwater home owner pressed the reset button on the economy by declaring bankruptcy.
I visited Yugoslavia three times during the 80′s, it was really part of the old soviet system. I liked it, a lot better than capitalism’s screw each other over system. The only reason I came back to Chicago was that I missed eating steak burritos.
Shawn, geh weg!
Ah Bill, I love you. For those who need the translation of what Bill said to Shawn, it’s basically this:
“you’re missing half of your brain already, so it will not make any difference to lose another half.”