Recession: Expect More Flakiness

When everyone has money and is busy, they don't have time to sweat the small stuff. That cuts both ways. On one hand, they are more likely to overlook details that may matter to someone else. It's not important to them, therefore it just doesn't seem very important, period. On the other hand, if someone does catch them on something they overlooked, they are more inclined to just pay the money or do whatever seems necessary to take care of it in the easiest possible way. It's different when people have less money and more time. They are more likely to notice the details that weren't handled quite right, because now those little amounts of money seem more important. They have the time to fool with the details, and the time to hassle those who aren't paying attention. In this sense, it can be more difficult to get away with small crimes and offenses in hard times. A countervailing factor is that small offenses are likely to be more common in hard times. When everyone has money, it's pretty much assumed that everyone will pay their bills on time, that broken stuff will be fixed properly, and that generally things will work as they should. But when people don't have money, or are afraid of losing what they've got, they are likely to be more flaky. They will want to be adjusting or backing out of deals and looking for squirrely ways to save a buck. Poor countries are not known for their crisp, efficient handling of problems. As more people find it necessary or helpful to scrounge for the occasional extra little bit, it seems likely that corruption and complication will be increasingly likely, in situations where one would not previously have expected such behaviors. It is ironic, because this theory implies that the countries that most desperately need efficiency are least able to achieve it. If this prediction of one aspect of future life in America should prove accurate, it will reflect an unfortunate and ironic fact. There was a long period of time, a half-century or more, in which the U.S. had a unique opportunity to shape the terms of trade around the world. There was sufficient power to make a tremendous impact upon the processing of routine transactions in developing nations -- transactions that sometimes meant everything to the powerless. Rather than stand for corporate power and the accumulation of wealth by a few, the international image of the U.S. could now be that of a power that believed in its touted principles -- of equality, for example, and of the rule of law over all citizens. The current business climate in places like China could have been influenced favorably. Now, instead, the U.S. economy is increasingly at risk of coming to resemble that of a developing nation. Having failed to make the world a better place in this regard, we may find ourselves forced to live in the world we have helped to create.

Recession: Acceleration at the Top

On the subject of recession, envision two models of shifting views. In the first model, belief that a recession may occur grows linearly. Last week, 40% of economists (or whoever) believed that we would have a recession. This week, it's 50%. Next week, it will be 60%. That, I think, is an unlikely model. The alternative, I suggest, is a logarithmic or accelerating model. The acceleration occurs because recession means fear and pain. One might expect a similar acceleration in predictions about any undesirable but increasingly probable development. In this acceleration model, people initially resist believing in the negative outcome. The positive was good for them, and they want it to continue. So instead of ratcheting up by 10% per week, as perhaps it should, the opinions of economists (or whoever) initially increase by only 5%. Last week, 40% of economists publicly admitted that we were approaching a recession; this week, 45% of economists did so (even though the facts were such as to support that finding by a full 50%). It is like a rollercoaster. You do not just go directly into a 45-degree drop. First, once everyone is on the train, you roll out of the station. You screw around for a while -- up, down, up, down. Nothing major. Finally, you come to the big drop-off. But it does not happen all at once. There is a gradually steepening curve. You know what comes next. It is really scary, and there is no way on Earth to stop it. But you are not yet prepared to embrace it; and for a few seconds, the rollercoaster does not actually force you to embrace it. You are going down -- soon, but not for another fraction of a second. There is still time to hope, and to fear. That's Part I. Next, you do go over the cliff. You are indeed plunging downwards at a 45-degree angle. But it feels like 75 degrees. You're moving like a bat out of hell. You feel like you are going straight down. So now the economists are fully focused. We are into a recession: it will be a bad one, we don't know when it will end, etc. Now, instead of an increase from 50% of economists this week to a tally of 60% next week, the pace picks up. Now everybody is a believer. You go from 50% in one week to 75% in the next week. This is what panics are all about. People sell when they actually might not need to sell. The bottom might come soon. Or it might not; we really have no idea. The point here is simply that opinions change at an accelerating pace, not a linear one.

One Factor Auguring a Depression

It seems fairly clear, by now, that Ben Bernanke is very concerned -- almost preoccupied -- with the performance of the stock market. Since last August, his interest rate cuts have repeatedly proceeded for the purpose of saving the market, and despite warnings of potential inflation. The dollar is now at an all-time low against gold and is also very low and headed further downward against key currencies, including not only the euro but also the Chinese yuan, which is moving at a gradual but increasing pace toward becoming a freely traded currency. The low value of the dollar means that dollar-denominated investments perform poorly for international investors. As has been often noted, a foreign investor who entered the U.S. stock market five or six years ago, at the start of its recent and remarkable rise, would have *lost* money because of the contemporaneous decline in the dollar's value. Actual and potential foreign investors are not ignorant of this. They have funded the deficits of the Bush years, buying U.S. government securities because they have believed in the safety and profitability of investments in America. During the past year, however, such investors have become more audibly concerned about the sense of such investments. Steps are being taken -- gradual steps, but significant ones -- toward diversifying away from the U.S. economy. U.S. consumer purchases and government expenditures are founded, alike, on cheap credit. If money becomes less available and/or more expensive, consumers will borrow and spend less, and the government will be less able to afford to hire people, build and buy things, and otherwise stimulate the economy. Money will become less available if foreign investors supply less of it. Rationally, they should be doing so; and over time, by present trends, they will do so. It is not yet clear whether we are now in the opening phase of a massive readjustment to a more realistic world, one in which money is supplied to us based upon our present productivity and competitiveness, as distinct from faith in our future promise. But there is a good chance that that day has arrived. We face unprecedented competition on both counts, as rising economies (especially in Asia) offer seemingly endless supplies of people willing to work hard and live cheap. The market is confident that Bernanke's Federal Reserve Bank will again cut rates, two weeks from now, perhaps by as much as a half-point. (Some are betting on an even greater cut.) Foreign investors are undeniably paying attention. The standard wisdom continues to be that Asia cannot fully decouple its prospects from America's -- that, in other words, if the U.S. sneezes, Asia will catch a cold. But foreign investors cannot be expected to continue to invest where they will realize a negative rate of return. There remain an unacceptably high number of unknowns and negatives in today's stock market. Stocks may not be overvalued in historical terms. But there is a good chance that they are overvalued within a context of troubled times. It is not obviously a good time to cast a vote of confidence in the S&P 500 -- a vote that, essentially, things will return to where they were a year ago. That sort of renaissance seems unlikely in the near term. In short, the market and Fed policy seem to be based upon a worldview that says we have been coping with some difficulties, but that they will ultimately resolve themselves and good times will return. This is bull market thinking: it is the mentality in which everything finally turns out OK. Yesterday's market rout suggested that doubts are now emerging in the bull market mindset. Descriptions of that rout included the key word "panic." Panic is a bear market concept. It is the recognition that companies whose stock you own can go bankrupt, that you can lose your shirt, that the elevator to the penthouse also goes all the way to the basement. The stock market has been extraordinarily resilient despite repeated and growing pressures on multiple fronts. Some unknown portion of that resilience derives from the inexperience of a generation that has known largely good times. Even the recession of 2001 was mild, in contrast to the successively greater hardships known by previous generations, as one goes back in time to 1991, 1980, and, of course, 1933. If the American century were not over, one might expect a continuation of that pattern of successively milder national economic hardships. But this generation, unprecedentedly fortunate in its exposure to hardship, may yet encounter the novel thought that what goes up can go down. Panic remains possible for today's investor. People can reinterpret recent bad news through the bear's eyes. In that event, that grey expanse above us, presently perceived as a set of storm clouds over the economy's forward march, may instead come to be seen as the surface of the ocean, far, far above one's head. In such an event, thoughts go to survival, and standard valuations become rapidly recalculated. The U.S. government, including the Fed, does not presently understand the nation's capital markets, nor does it have the power to fix them. Nobody understands them fully; nobody has that power. Bernanke's consensus leadership style is, moreover, the wrong style for uncertain times. He is a brilliant man -- he is as competent as they come -- but the impression is growing that the Fed does not have the power and wisdom that investors were previously willing to credit to Greenspan's Fed. The impression grows that the Fed is becoming desperate, and that its desperation arises from its impotence. The Fed is behind the curve, and my hunch is that it will not (and could not) get ahead. What it can and apparently will do -- much to the lifelong regret of Bernanke, student of the Great Depression -- will be to alienate the foreign investors whose deposits in our economy have made the bull market possible. It does seem that there will be a wrenching readjustment, and that bear market thinking will come to seem more realistic.

Comment on the Economy

This is a general-purpose commentary on the economy. I have not edited it for precise focus on a single topic. Indeed, my purpose in writing it is to bring this blog more up to date on several themes that seem to be emerging in recent articles on the state of the American and global economies.

That said, it seems to me that those several themes are related, and to some extent I have sketched out what I see as that relationship. My decision, in writing this piece, was to use the available time to present several ideas in imperfect form; it was not to present one idea in highly coherent fashion. It is, in short, consistent with this blog’s effort to offer ideas for further thought and development.

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When times change, assumptions get tested. Sometimes the tested assumptions are small ones – that e.g., tomorrow will be sunny, or that I will not catch cold and spend the day in bed. Sometimes the assumptions are larger – that the President won’t be assassinated, or that electricity will reliably come through my outlet to this computer.

We have been assuming that real estate prices would always go up. They are still going up, in some locations. But they are going down in others, sometimes dramatically so. This seems especially likely to occur, not only in markets that got overheated, but also in places where the people doing most of the buying were able to get mortgages only because mortgages were available to virtually anyone.

The rules are now changing. That sort of mortgage is increasingly a thing of the past. So there will be some units – quite a few, I gather – that were built for people on the economic margin, who now will not be buying them. Those people will instead be renting, and as a result will not be taking out home equity loans (as they may well have done, had housing prices continued to rise) with which to purchase things. So that part of business as usual is changing; and the portion of our economy’s planning and investing that depended on it will be hurt.

Of course, as those people become unable to afford their mortgages, their units – again, quite a few, as I understand, amounting to (if I remember correctly) as many as 20% of all mortgages in the United States – will be foreclosed upon. That will not happen if their lenders or the government or somebody gets on top of the problem and figures out some way to keep them in their houses. Which is what should happen, since foreclosed and vacant units are at serious risk of being looted for their wiring and plumbing, and/or may become refuges for drug dealers.

None of these things is good for a neighborhood’s property values. But at present, it seems that foreclosures and vacancies continue to be the dominant theme, among those who cannot keep up with the terms of their mortgages. Apparently quite a few mortgage terms will be reset within the next three to six months, so this should be a highly informative time period on the question of what will be happening to the financial health of banks, neighborhoods, and homeowners.

The tightening of credit, and the slowing growth in paper wealth of homeowners, will combine to reduce the ability and/or the inclination of other homeowners to take out home equity loans that they can then spend. We can no longer assume that the American consumer will continue to drive the world economy. In practical terms, this means that people may not be willing or able to buy whatever they need, whenever they need it.

Already, of course, we cannot buy whatever we want; that is a privilege for the wealthy. We cannot even buy what we need, if need is defined as including health care or a home. Even before the subprime mortgage crisis, few people could afford to own their homes outright. Invariably, they took out mortgages that gave the bank the final say over whether they could remain there if they suddenly became unable to make their monthly payments. But now, as we see, not even the 30-year mortgage is available to a substantial number of would-be homeowners.

People will continue to be able to buy a great number of things they need, along with some they want, as long as they have jobs that pay a decent wage. As the U.S. dollar declines precipitously (and appears likely to continue to do so), there should be a lot of hiring in export-oriented businesses. American goods will become more affordable for people in the rest of the world, so to some extent we will reduce or hopefully even reverse our present enormous trade deficit. It is not clear how much this will occur, however: as long as China continues to peg its currency to the dollar, its exports will continue to be cheaper than ours, for buyers elsewhere in the world.

Moreover, wages paid to those who have jobs may not be sufficient to let them keep buying what they want and need. The decline of the dollar means that things from elsewhere (other than China, at present) continue to become more expensive. That includes oil, a major component in the things that the world makes and in how the world makes them. There is concern that inflation may begin to rise again. I would say it will rise dramatically, over time, as the world’s cautious financial players gradually steer their ponderous institutions toward a new scheme in which the dollar is not the reigning currency. So you may still be making $1,000 a month, or $10,000; but the rising cost of oil and other inputs may mean that other things in your life will follow health care and housing into the realm of unaffordability.

There is hope, among global-scale financiers, that people in other countries (e.g., China and India) will step up and take the place of the American consumer, to buy all sorts of things and keep the world’s people working and making a living. No doubt that will happen, at least for those who are better-off in those places. Consumers in developing nations face limitations, however, that consumers in America did not face during their own heyday. Our sort of consumption may not be able to occur in those places within the foreseeable future.

There are many such limitations. For one, commodities (e.g., gold, copper, oil, iron) are scarcer and more expensive now. It is not clear that those countries will be able to afford, as we could, to run iron (or even plastic) pipes and copper (or even aluminum) power lines as we have done. They are also nowhere near having enough clean water. The acceleration of global warming makes it unlikely that the average Chinese or Indian town will ever enjoy the green lawns and running water now found in almost every American town. If anything, the pace of dirty industrialization in China makes it more likely that that nation will become known, around the world, as a center for cancers, birth defects, respiratory diseases, and toxic foods -- as China lurches, once again, to a collectivist and self-destructive extreme in pursuit of an ideal. Developing countries generally will also tend to suffer increased rates of infectious disease as global warming facilitates the growth and spread of harmful bacteria.

There are other potential shocks whose impact can barely be guessed at present. Terrorism – especially, but not only, Islamic terrorism – has become international, and as such has found unprecedented access to funding and materiél. Criminal gangs now have sufficient wealth and firepower, not only in Latin America but also in some places within the United States, to stand and fight it out with the police. In these and other ways, people with grievances are better equipped, now, to inflict serious damage upon the smooth machinery of government and finance. Equally important, through the Internet they have acquired means of unification and mutual support. In many regards, their movements are intrinsically (even if not expressly) opposed to much of the foundation upon which business as usual rests.

The hope seems to be, not that developing nations will become knock-offs of the United States, but rather just that a growing middle class within those nations will come to have spending power comparable to that which has been wielded by the middle class in the U.S. – that, collectively, there will continue to be growth in the numbers of millions, around the world, who will have spare money to spend on gizmos and modest luxuries. This could happen. But in China, at least, the prospects for such growth will be hampered if, as seems likely, the overpriced Chinese stock market crashes, wiping out the savings of millions of would-be members of the middle class.

Generally, a middle class does not grow in a vacuum. To the extent permitted by law and culture, or mandated by necessity, the rich will feed off of it, and the needs of the poor – the multitudinous poor, in China and India – will drain it. Of course, China and India are booming. But they are starting from an extremely low level. As they move closer toward developing a genuine middle class, they will also see – they are presently seeing – that the benefits are not equitably distributed among the many. Over the long term, nations of haves and have-nots tend, not toward dynamic long-term growth and increased consumption, but rather toward the relative economic stagnation and political instability for which many Latin America countries have typically been notorious.

What seems to be unfolding is a sort of theater, in which people in other countries succeed in developing their own gated communities for their own nouveaux riches, as if to prove that they, too, can be like America. But a story loses its impact on the second telling. China can recreate American lifestyles for some, but at the risk of enormous damage and upheaval for most. It would be interesting to construct an index linking concrete production (China is now responsible for half of all the world’s concrete) and population density to upheaval (China experiences thousands of protests each year). India can try its hand at the same game, as long as it is willing to endure nightmare gridlocks – of traffic and otherwise – as the masses reconstruct the chaos of ordinary American life within a much more densely populated setting. But this does not seem to be a tenable long-term strategy.

Like most smooth-running machines, the global financial machine is vulnerable to slight upsets. It is resilient, in the sense that there will always be people who conduct trade and facilitate business; but its enjoyment of profit rather than loss frequently depends upon small margins and minuscule adjustments. All the calculations go out the window when serious upheaval unbalances the scales; and at present, upheaval is in the offing. Terrorism, the environment, the subprime crisis, the sudden fall of the dollar – these and other sources of radical change can easily alter the calculation to such an extent that many business people will pull in their horns and wait.

What seems increasingly likely, at present, is that the United States will experience what we will call a recession, but what will actually be part of a global readjustment that brings the circumstances of American consumers more in line with the circumstances of other people around the world. That is, we continue to move toward a situation in which we will have our haves, and we will have our have-nots; and except as alleviated by political intervention (e.g., socialized medicine), the have-nots will increasingly experience the living conditions and opportunities of have-nots elsewhere. Seen in this light, the financiers’ hope could be construed as a sense that, in this country as elsewhere, some will be saved for continued participation in the middle-class lifestyle, even if many must be lost. That is not at all a newly accepted sentiment on the financiers' part, but it may be more obvious in the future.

Global finance has been very good for many people for the short term. Over the longer term, however, more is taken than is given in the bargain. People should have homes, period, without regard to who profits from the arrangement. They should not be held under the 30-year threat of a mortgage, much less of a foreclosure. People should have health care. They should retain unspoiled access to the natural environment that has been with us for all of human existence. They should have clean water, period – even if that means that some businesspeople will not be able to create factories and to give all community residents daily exposure to carcinogens (along with the jobs that may be available, until economic circumstances change, to a fraction of the community’s residents). People should live in communities, period – not in isolated collections of competing residences designed and located so as to facilitate profits for homeowners, realtors, bankers, or employers.

Those, anyway, are the sorts of sentiments that tend to matter to people – especially to the have-nots, who are acutely aware of what they lack, and who do their best to reconstruct it in other terms as circumstances permit. A growing economy can be seen as a movement in its own right, one that succeeds as long as it resonates with enough people to keep it on track, and as long as it does not so seriously offend those whom it excludes as to inspire them to sabotage it. Beyond a certain point, however – as attested by the rise of armed criminal gangs and Iraqi suicide bombers – the human search for hope will drive people to seek out their own routes, authorized or not, toward something that they can consider an achievement.

It seems, in short, that we may be entering a period in which all sorts of financial assumptions – including some that have not been so good for us – are tested by many rapid changes around the world. It is entirely possible that increasing numbers of people will become, and remain, convinced of the superiority of business as usual. In that case, the testing of financial assumptions may yield only a relatively mild continuation of adjustment to new circumstances within the next several years.

It is also possible, however, that we are just at the start of an epochal transition, out of the American century into one that will be almost unrecognizably different, where the assumptions underlying American consumerism become radically rethought and retooled. Of course, business will (and should) seek to keep up with such changes. The point here is just that economic and consumerist forces (as we know them) may not be capable of accepting and adapting to the remarkably different attitudes that people of the future may have toward economic matters. To the extent that occurs, it may well develop that politics, religion, or other sources of power come to eclipse money as the guiding source of ideals by which people live their lives and direct their energies -- in which event "recession" will be an understatement and/or a misstatement of what develops.