Four Phases of This Economic Decline
by Alex Saitta
January 20, 2009
There have or could be four phases in this decline. I think it would be helpful to review and discuss them.
Phase 1: The Credit Crisis
The post September 11th economic recovery began in 2002. No doubt the expansion that followed was long in the tooth by 2007 when the economy entered a recession. However, the sub-prime mortgage bubble gave the recession its current angle of decent.
Housing became the asset that always went up. As a result, banks lent money to people who couldn’t afford to repay the loans and those people felt secure in borrowing money they couldn’t pay, and both felt comfortable because the underlying collateral (the home) “always went up in value”.
Housing began to decline, and the Mortgage Banking Association says 4 in 10 homes in the United States are now “upside down”, meaning their values are less than what is owed on the home. With all these bad loans on the books of banks, the write-downs followed, banks saw a capital drain and slowed their lending by raising their lending stan dards.
The first industries to suffer were those most dependent on credit, like housing and auto sales. Looking at the Pickens County Government website, in November and December 2007, a total of 359 properties changed hands. This past November and December that figure was 156 properties, down 57 percent. Nationally, the big three auto manufacturers are teetering on bankruptcy and reporting the lowest sales since 1981.
Phase 2: The Reverse Wealth Effect
In the past the typical American would receive his pay check and put a percentage of that in the bank for a rainy day. With the onset of the housing boom and stock market rally of the past 25 years, people stopped saving. The savings rate fell from about 13% of income in the early 1980’s, to nearly zero in 2007. The typical person figured, if my home is going up 10 percent a year or my stock portfolio is up 15 percent, I can spend all of my income and let my home and stock portfolio continue to do the saving for my future. The wealth effect in the stock and housing market, helped power consumer spending and U. S. economic growth the past 25 years.
The stock market is down 45 percent, and housing has fallen the past two years nationwide, so consumers are not feeling so wealthy. As a result, they are spending less and beginning to save more of their income. This has cut into consumer spending and has weakened the economy across the board. The consensus forecast of economists for GDP growth in the past quarter is -4.5 percent.
Phase 3: Dropping Incomes
Put together the those two phases, and here come the job losses. Lay-offs in the private sector began in January 2008, and have accelerated the past four months.
In Pickens County, 1 in 5 jobs is a government job and government agencies have yet to begin to layoff. Pickens now has the 9th lowest unemployment rate in the state. That is about to change, once the government layoffs begin. Lower consumer demand means lower sales and lower sales mean lower sales tax revenues to the state. Likely, the state and those who receive state funds (higher education and K-12 education) will see lay-offs. Local cities, which are funded by property taxes (which have yet to fall) will probably not lay-off much. Soon Pickens County will begin to feel the full effect of this national recession. Thus, for our county, the worst of this recession still lies ahead.
Phase 4: Drop In Government Confidence
This phase is the one to watch going forward. Will it occur or not? I doubt it will occur now, but it needs to be discussed.
The Congress and President are borrowing and spending beyond what anyone could have envisioned. The federal debt is $10.6 trillion. This does not include the $7 trillion in bailout obligations or President Obama’s $825 billion stimulus plan. All of which is borrowed or printed money.
Despite all these additional liabilities, confidence in the U.S. government’s ability to pay its debts continues. The U.S. Government has proven it is willing to back stop the economy. Thus, as long as confidence continues in the U.S. government, this will remain a recession and not turn into an economic collapse.
I suspect this recession will be like the mid-1970’s recession which had 9% unemployment. Inflation will also be much lower, so the misery index (unemployment rate plus inflation rate) will be lower.
However, if foreign lenders lose confidence in the U.S. government’s ability to pay its debt, we’ll have an economic collapse. The U.S. is dependent on foreign capital to pay its bills. If foreign lenders lose confidence in the U.S. government’s ability to pay them back, and they’ll slow their lending. Interest rates will then have to rise significantly to attract new lenders and the U.S. economy will collapse under too high interest rates, and low income which is unable to carry its staggering debt.
Conclusion:
I believe confidence in the U.S. government will continue, at least for this downturn. With all this economic stimulus, beit 0% interest rates, low oil prices, and government stimulus packages, I believe we’ll see positive economic growth in Q3 of 2009.
In the long run, though, if the U.S. government as well as state and local governments need to curb their spending, borrowing and taxing ways. If not, we are heading for an economic train wreck sometime in the next 20 years.