Fuel Shortage. For
the financial markets, last week had a ugly feel to it, both on Wall
Street and globally. It wasn't a crash, certainly, but also more than
just a garden-variety correction. It felt like the preliminary
stages of a sea change in sentiment -- the kind that either accompanies
the popping of a bubble, or causes it, depending on your economic point
of view.
The Dow dropped 420 fast points in the final three days of the week,
interrupted by nothing that could be called a significant countertrend
rally. This despite positive earnings surprises from both GE and
Citigroup.
When the market ignores good news from those two, it's essentially a
storm flag for the entire economy, since between them you have a pretty
good proxy for GDP -- particularly now that passing electrons with
dollar signs attached to them has become such a big part of the U.S.
economy. While first quarter earnings may yet be OK, the market is
looking further ahead -- and seeing a sharp slowdown in both sales and
profits.
It's interesting that the triggers for this sudden gloom have nothing directly
to do with the market's most widely shared recent fears -- not higher
interest rates (bond yields plummeted along with stock prices), not the
dollar (which has rallied lately) and not even another spike in oil
prices (which have drifted back down towards $50 a barrel.)
So the conventional bearish nightmare scenario -- in which runaway
growth and a soaring trade deficit trigger a dollar collapse, sending
bond yields to the moon and leaving the Fed in a hopeless no-win
position -- doesn't seem to apply. Or does it? We'll return to that
question later.
An Oily Explanation
On the other hand, the financial journalism theory de jour -- that
the U.S. economic locomotive is being run off the tracks by the
cumulative impact of high oil prices -- also leaves something to be
desired, even if it was enough to send the free world's financial
leaders (read: the political hacks of the wealthy oil-consuming
nations) into a frenzy of false promises to "do something" about those out-of-control free markets.
Higher gas prices no doubt are taking a toll on U.S. consumers -- as
I'm reminded every time I fill up, even though, unlike every third U.S.
motorist, I don't drive an SUV the size of Alaska. But I think
something more fundamental is going on here. What we're seeing, I
suspect, is the inevitable fading of the various artificial stimuli
that powered the U.S. economy out of its painful 2001-2002 brush with
deflation.
Without those fiscal and monetary booster rockets, it's not clear
whether the traditional motors of capitalist expansion -- private fixed
investment and the income it creates -- will be enough to keep the boom
going, much less produce the kind of growth required to force the
benefits down to the bottom 90% of the population.
Higher gas prices -- even as high as they are now -- probably
wouldn't endanger the expansion if it didn't have such a weak engine to
begin with. And one of its most serious weaknesses is its dependence on
debt-financed consumption to keep the wheels turning.
Consuming Desires
As others, such as Morgan Stanley's Stephen Roach, have repeatedly
noted, this expansion has seen personal consumption soar to an
unprecedented share of total GDP:
However, the same general trend has been in place in the U.S.
economy for almost four decades now -- with particularly strong upward
shifts in the mid-to-late '60s, the early '80s and, of course, from the
end of the '90s to date. What is, or was, so special about those
particular periods?
As turns out, they share several common economic denominators:
massive fiscal stimulus; easy -- or easing -- monetary policy; and (the
handmaiden of the first two) massive asset bubbles, either in the
financial markets, in hard assets such as commodities and real estate,
or both.
This is as you would expect: riotous living and asset bubbles have
gone hand in hand since the first tulip bulb was sold to the first
Dutch speculator. But what's striking about the current U.S.
consumption mania is the extreme willingness of consumers to go deeper
into debt to finance it.
By way of comparison: - During the first big
consumption boom shown in the chart above -- that is, from the end of
1966 through 1972 -- consumption increased 30% (in real terms) while
total household debt rose just 23%.
- During the
Reagan binge (end of 1981 through 1986) consumption rose 26% while
household debt increased 41% (but this, mind you, was after a very deep
recession, and also hard on the heels of the inflationary '70s, which
sharply eroded consumer debt burdens.)
- So far
in our latest national shopping frenzy (end of '99 through 2004)
consumption has risen slightly more than 18% while household debt has
jumped 44%.
It's also interesting to note that over those same three periods, the consumption share of total GDP growth has also risen -- particularly in the current one.
In other words, the U.S. economy has become dependent on ever high
rates of debt accumulation to sustain the levels of consumption growth
to which we (or at least, some of us) have grown accustomed -- but is
getting progressively less economic bang for the buck, so to speak:
Home Sweet Spot Home
One obvious explanation for this trend is that credit has become
ever so much easier for American consumers to get -- and abuse, which
is why the credit industry spent the past six years lobbying Congress
to bring back debt peonage. And nowhere has the industry been more
inventive, or successful, than in its ability to persuade American
homeowners their houses are actually giant credit cards made of brick,
wood and plaster.
Which means the mainline pumping the Fed's monetary smack to the
pleasure centers of American economy hasn't been the stock market --
which after all hasn't gone anywhere for over five years now -- but the
housing market, which hasn't gone anywhere but straight up:
It seems reasonable to assume -- as Roach does -- that the main fuel
source for the current expansion has been the Great Refi Gravy Bowl,
the memory of which no doubt will cause a generation of mortgage
bankers go misty eyed long after thay have retired and moved to Florida.
By cashing out their winnings from the housing bubble, U.S.
consumers have been able to keep their consumption budgets growing well
in excess of incomes, pushing the personal savings rate to ever lower
lows, but also pulling the U.S economy -- and, by extension, the global
economy -- out of a rut (with a little help from the U.S. Defense
Department and the Medicare budget.)
In fact the relationship between the two trends -- growing economic
reliance on consumption and the mortgage refinancing bonzanza -- is
extremely close, at least on graph paper:
You will notice, however, that the great wave of refi activity
triggered by the steep 2002-2003 decline in interest rates has run its
course. The chart above only takes us through the first three quarters
of 2004, but more recent data also show the refi market slipping back
into dormancy, which is what you'd expect given that rates have been
rising -- at least until recently.
At the same time, the federal budget deficit -- that other main
artery for pumping easy money through the economic bloodstream -- is no
longer deepening:
Mind you, it's still huge -- particularly compared to the pool of
domestic savings available to finance it. But in terms of economic
stimulus, what matters most about the deficit is the rate at which it
is shrinking or growing, not the absolute level. And while the
President who never met a tax-cut or a spending bill he didn't like and our Chamber of People's Deputies are both doing their very best to pump the red ink, even they haven't been able to offset completely the rise in federal revenues produced by the expansionn.
General Glut Rides Again
Combine all this with the spike in oil and other commodity prices --
which has also been aggravated by easy money -- and it's not too
surprising that U.S. growth is slowing, perhaps sharply. Nor it there
any immediate reason (such as absurdly rich equity valuations) to
expect a boom in private investment to take up the slack.
Whether an economic slowdown is good or bad news depends on your
point of view -- and your expectations. For the Fed, which is worried
about an inflationary surge or a dollar crisis (or both) slower growth
is good news, at least up to a point. However, for the stock market,
which had been counting on unrealistically high earnings growth to
justify last year's 4th quarter rally, it's just as clearly bad news.
What makes a U.S. slowdown potentially bad news for everybody
is its impact on the global economy. And this is where we return to the
huge financial imbalances that have been the basis for so many bearish
forecasts (including mine) for such a long time now.
But the nightmare scenario I laid out earlier -- in which a current
account blowoff leads to a dollar collapse, causing what the econ wonks
like to call a "systemic crisis" -- doesn't fit well in a world in
which demand is hard to come by and stagnation, not inflation, is the
spectre haunting the landscape.
In an inflationary environment, America's foreign creditors would
soon have cause to regret their steadfast defense of the dollar -- and
plenty of opportunities to redirect their surplus savings elsewhere.
Such is not the case today. When Paul Volcker
complains that the United States is now absorbing 80% of all global
capital flows, or the IMF's chief economist argues that developing Asia
has stockpiled enough dollar reserves to guard against everything short
of the Apocalypse,
they're both addressing the same bleak fact, even if they don't know
it. The capitalist world (which these days, means practically the
entire world) is drowing in a general glut of excess savings -- which is simply the financial reflection of a general shortage of effective demand.
You could spend all day arguing about why this is so. You could
blame the Chinese for their growth-at-any-price development strategy --
the kind of capitalism Stalin could have learned to love. You could
blame the Europeans and the Japanese for failing to figure out how to
make their highly regulated, producer-friendly economies grow faster.
You could blame the investment banking Masters of the Universe for
their pump and dump approach to Third World development. Or you could
blame imperial America for creating a dollar-centric global financial
system that makes U.S. assets unusually attractive to risk-adverse
investors.
Or, if you're a Marxist, you could simply blame the laws of
capitalist accumulation -- thus relieving yourself of the need for any
creative thinking.
For the purposes of this post, though, the root causes of our global
dilemma don't really matter. All that matters is that they exist, and
as a result the United States has become the global consumer of last
resort, the marginal provider of aggregate demand to a world with way
too much aggregate supply on its hands.
This gives America's creditors a powerful incentive to defend the
current exchange rate regime (some call it Bretton Woods II, but that's
an insult to the economic visionaries who created Bretton Woods I.) The
central banks of China, Japan and Korea are in roughly the same
position that Cisco, Oracle and Intel were in during the late stages of
the '90s Internet boom: They, too, have a vested interest in protecting
the bubble by providing their biggest customer with lots of cheap vendor financing.
Slouching Towards Armageddon
But economic and financial systems can die with a whimper as well as
a bang. One of the most alarming facts about the current situation is
that the U.S. trade deficit continues to widen, despite dollar
depreciation, the Fed's belated interest rate hikes and the emerging signs of an economic slowdown:
To be sure, part of this reflects the lagged effect of a weaker
dollar -- the so-called "J-Curve" effect -- which tends to push up
import prices. Higher oil prices have also played a role. But, as Roach
points out, even if you back out oil imports, the trend is still towards ever larger deficits:
In fact, over the 12 months ending February 2005, the real,
or inflation-adjusted, non-petroleum trade balance widened from -$39.2
billion to -$49.4 billion (monthly rates) — accounting for virtually
all the deterioration in the overall real trade balance over the same
12-month period . . .
An ever widening trade deficit constitutes yet another drag on U.S.
economic growth, since dollars spent abroad don't trigger the kind of
follow-on spending (the so-called multiplier effect) that generates
additional income at home.
So here's where I end up: The standard bear case -- as expounded by
Roach and others -- sees a creditors' strike as the end game for the
current U.S. consumption binge. The bears generally advocate a hefty
dose of "tough love" -- higher interest rates, tighter fiscal policy --
to ward off this disaster.
I've no doubt that if left on autopilot the current system (i.e. "Bretton Woods II") would
lead to a great big debt/dollar crisis -- eventually. At some point,
the bubble would simply become too big and too absurd to protect, even
for a cartel of Asian central banks. But, given the structural and
institutional obstacles to change (both here and abroad) that point
might not be reached for years.
Long before then, however, the weight of the global savings glut
might bring the U.S. locomotive to a halt -- or even start pulling it
backwards. And the "tough love" remedies proposed by the bears, while
inevitable in the long run, could make things much worse in the short
run, by further sapping global aggregate demand.
Not a pretty thought, and definitely not the kind of problem that
can be solved with a G-7 communique -- or even by adding a few hundred
thousand barrels to OPEC's daily production. But if the U.S.economy
continues to slow, it may be a problem that can't be ignored (or
misdiagnosed) much longer. [Whiskey Bar]
9:57:19 PM 
|
