[Futurework] Winners and Suckers

[Ed Weick]

One has to wonder how much substance there now is to the US economy.  As Paul Krugman suggests in the following op-ed piece, it seems addicted to bubbles, the high-tech bubble of the past decade and now the housing bubble.  But are the two sets of bubbles really comparable?  I would suggest that they aren't.  The high tech bubble ran its course during an era of reasonable fiscal responsibility.  As in the current housing bubble there were winners and suckers (losers), but one never quite got the feeling then that the US economy was going to hell in a handbasket.    Since Bush took over, one can't really feel that level of confidence.  The value of the US dollar has continued to decline on international markets.  With mounting fiscal deficits (now about 4.2% of GDP) and trade deficits (about 5.5% of GDP) and the prospect that America has little to export except "freedom and democracy" backed by huge military expenditures, there is little reason to feel confident about American currency.  Some of the things that keep it from sliding even more rapidly than it is are downright suspect.  The Chinese are buying up large quantities of dollars in order to maintain the fixed relationship between the Yuan and the dollar.  And many of the dollars that the Chinese buy are being used to purchase American securities and thus help finance the US trade and fiscal deficits.  One wonders what would happen if the Chinese pulled the plug and let the dollar slide.  Probably nothing beneficial to the Americans or Chinese.  If the Yuan rose in value, making the textiles and gadgets Americans now buy from China less affordable, Wal-Mart etc. might just shift to other places that can make those things, like Southeast Asia or India.  America doesn't make textiles or gadgets anymore.  It doesn't make a lot of other things either.   But back to Krugman and the housing bubble.  He notes: Many home purchases are speculative; the National Association of Realtors estimates that 23 percent of the homes sold last year were bought for investment, not to live in. According to Business Week, 31 percent of new mortgages are interest only, a sign that people are stretching to their financial limits. In other words, much of the bubble is a game being played by people who can win as long as housing prices keep going up, but could lose and lose rather terribly if housing prices fell.  Why might they fall?   Chinese, Japanese and other foreign investors are currently keeping the US economy propped up by buying dollar denominated American securities.  What if they lost confidence in the US dollar?  To maintain the value of the dollar and keep attracting foreign lenders, the US fed would have to raise interest rates.  Because the housing bubble is based on very low interest rates, mortgagees, whether interest only or interest plus principle payment, would be in a difficult spot.  Housing prices would fall. Many borrowers would be greatly overextended at least partly because they have no savings of their own and are heavily in debt quite apart from housing (the majority of U.S. credit card holders are said to carry annual debit balances of $9,000 plus - but why save if interest rates are so low?). I did not intend to make the foregoing sound as though the US economy is in a state of imminent collapse, but for the time being at least it is caught somewhere between a rock and a hard place.  The result could be a recession, and perhaps a major one.  And, if that were to happen, much of the world could go into recession with it.  Canada greatly depends on exports to the US.  As mentioned, so does China.  However, some interests would gain.  If rising US interest rates stabilized or appreciated the dollar, holders of dollar reserves and dollar denominated assets would gain.  US citizens might be persuaded to save some of their income and eliminate some of their deficits instead of being so dependent on, and at the mercy of, foreigners.  In other words, it could all lead to a better and more sensible world, with people more able to accept freedom and democracy without having guns pointed at them. Ed        May 27, 2005 Running Out of Bubbles By PAUL KRUGMAN Remember the stock market bubble? With everything that's happened since 2000, it feels like ancient history. But a few pessimists, notably Stephen Roach of Morgan Stanley, argue that we have not yet paid the price for our past excesses. I've never fully accepted that view. But looking at the housing market, I'm starting to reconsider. In July 2001, Paul McCulley, an economist at Pimco, the giant bond fund, predicted that the Federal Reserve would simply replace one bubble with another. "There is room," he wrote, "for the Fed to create a bubble in housing prices, if necessary, to sustain American hedonism. And I think the Fed has the will to do so, even though political correctness would demand that Mr. Greenspan deny any such thing." As Mr. McCulley predicted, interest rate cuts led to soaring home prices, which led in turn not just to a construction boom but to high consumer spending, because homeowners used mortgage refinancing to go deeper into debt. All of this created jobs to make up for those lost when the stock bubble burst. Now the question is what can replace the housing bubble. Nobody thought the economy could rely forever on home buying and refinancing. But the hope was that by the time the housing boom petered out, it would no longer be needed. But although the housing boom has lasted longer than anyone could have imagined, the economy would still be in big trouble if it came to an end. That is, if the hectic pace of home construction were to cool, and consumers were to stop borrowing against their houses, the economy would slow down sharply. If housing prices actually started falling, we'd be looking at a very nasty scene, in which both construction and consumer spending would plunge, pushing the economy right back into recession. That's why it's so ominous to see signs that America's housing market, like the stock market at the end of the last decade, is approaching the final, feverish stages of a speculative bubble. Some analysts still insist that housing prices aren't out of line. But someone will always come up with reasons why seemingly absurd asset prices make sense. Remember "Dow 36,000"? Robert Shiller, who argued against such rationalizations and correctly called the stock bubble in his book "Irrational Exuberance," has added an ominous analysis of the housing market to the new edition, and says the housing bubble "may be the biggest bubble in U.S. history" In parts of the country there's a speculative fever among people who shouldn't be speculators that seems all too familiar from past bubbles - the shoeshine boys with stock tips in the 1920's, the beer-and-pizza joints showing CNBC, not ESPN, on their TV sets in the 1990's. Even Alan Greenspan now admits that we have "characteristics of bubbles" in the housing market, but only "in certain areas." And it's true that the craziest scenes are concentrated in a few regions, like coastal Florida and California. But these aren't tiny regions; they're big and wealthy, so that the national housing market as a whole looks pretty bubbly. Many home purchases are speculative; the National Association of Realtors estimates that 23 percent of the homes sold last year were bought for investment, not to live in. According to Business Week, 31 percent of new mortgages are interest only, a sign that people are stretching to their financial limits. The important point to remember is that the bursting of the stock market bubble hurt lots of people - not just those who bought stocks near their peak. By the summer of 2003, private-sector employment was three million below its 2001 peak. And the job losses would have been much worse if the stock bubble hadn't been quickly replaced with a housing bubble. So what happens if the housing bubble bursts? It will be the same thing all over again, unless the Fed can find something to take its place. And it's hard to imagine what that might be. After all, the Fed's ability to manage the economy mainly comes from its ability to create booms and busts in the housing market. If housing enters a post-bubble slump, what's left? Mr. Roach believes that the Fed's apparent success after 2001 was an illusion, that it simply piled up trouble for the future. I hope he's wrong. But the Fed does seem to be running out of bubbles. E-mail: [EMAIL PROTECTED]

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