Ben Bernanke, too, says the crisis is easing.
But he went on to say that the situation is still “far from normal.”
What is far from normal, we wonder? The Dow went down 44 points yesterday, leaving stock prices about where they’ve been for the last 10 years… nothing abnormal about that.
Consumers are still spending money, too. And since they don’t really have any money to spend, they’re still borrowing. A report in yesterday’s news tells us that one in ten baby boomers has to borrow money just to pay everyday expenses.
But here’s something unusual: house prices went down in two-thirds of America’s cities, according to Bloomberg. In Cleveland, half of all subprime mortgages end in foreclosure.
Houses are America’s number one asset… and the cornerstone of most families’ financial plans. When they go down… so does the consumer economy. At least, that’s our working hypothesis. So far, houses are down about 13%. The economy is down too – but not dramatically. The latest GDP growth figure came in at 0.6%. With the population growing at 1%, that means the average person is getting poorer. So our hypothesis is working… marginally.
Nothing very exciting happened in the markets yesterday, so we will use today to spin out a broader version of contemporary economic history.
Let’s begin with another working hypothesis – give a man a license to counterfeit currency and he will stay up all night printing new bills. In effect, when the Nixon Administration cut the final link between gold and the dollar, in 1971, the feds could print all the counterfeit money they wanted. Normally, you’d expect the dollar to become worthless.
That is exactly what we expected in the ’70s. But then a few things happened that saved the dollar… and seemed to prove that our working hypothesis didn’t work anymore. Paul Volcker was brought in to protect the dollar. This he did – by driving up interest rates and bringing on the worst recession since the ’30s. But then, other things took over… the Reagan/Thatcher Revolutions… deregulation of industries… the rejection of central planning… the collapse of the Soviet Union… the Chinese renaissance… Wal-Mart… the Internet… just-in-time inventory systems… and globalization.
All of these things tended to increase productivity and lower prices. The biggest thing was probably in the labor market, where hundreds of millions of new workers came into the modern economy (who would slave away all day for less than a tenth the typical wage in America) and reduced the cost of labor and finished product.
We wondered how much ‘just-in-time’ inventory systems saved consumers. In the latest Grant’s Interest Rate Observer we find an estimate from Fred Smith, founder of Federal Express:
“In 1980, logistics costs – including the carrying costs of inventory, plus warehousing and transportation costs – were about 17% of GDP. Last year, they were about 10%.”
“Fast cycle logistics,” he says, reduced costs by nearly a trillion dollars a year.
But wait, there’s more… after Volcker cast out the devil of inflation, interest rates could come down. Thus, began a quarter century of falling interest rates and increasingly accessible credit. This eventually produced the absurd and pernicious consequences we describe here in Markets and Money. Just as teenaged kissing leads to petting… which leads to… well, you know how it works, dear reader… success leads to complacency which leads to excess. But the long bull market in bonds (bonds go up when interest rates go down) also vastly increased the supply of capital available for new industries… and caused an explosion in output capacity.
Higher output at lower cost = deflation.
And let’s not forget oil. The basic ingredient in modern economies – petroleum – fell in real terms from the mid-’70s almost all the way to the war on Iraq.
Let us look, briefly at the oil market. When the United States invaded Iraq, we were told that $10 oil was right around the corner. Then, as the war went from triumph to tribulation… the oil price rose. Still, the war’s backers believed they had done good. Higher oil prices couldn’t last, they said. The National Review said oil was a “bubble” in ’04, when it was at $50 a barrel. Then, Steve Forbes said it was a “bubble” at $70 a barrel in ’05. Now… a Goldman expert says it will go to $200 a barrel.
Success leads to excess. Sooner or later oil really will be in a bubble… and sooner or later the bubble will pop. But when? At what price? China is doubling its use of the slick liquid every seven years. In the United States, there are 480 cars per 1,000 people. In China, there are only 10. And China could be the world’s largest automaker in just a matter of months. Our advice to Americans: fill up your tanks.
In the meantime, we return to our short version of U.S. contemporary economic history:
With prices stable or actually falling, over the last 20 years, central bankers felt they could ‘stimulate’ the economy whenever it needed a little more pep. The most memorable example, of course, followed the micro-slump of 2001-2002, when the Greenspan Fed dropped rates down to 1% and held them there for over a year. But the printing presses ran hot for many, many years. Over practically the entire period, from the late ’80s to ’08, the U.S. money supply increased at an average annual rate of about 8% – or about twice as fast as GDP growth.
And now, we are in a period which many take for normal. Our financial Vesuvius has rumbled several times in the last quarter century – the crash of ’87, recession of ’93, the Asian crisis and collapse of LongTerm Capital Management in ’97 & ’98, dotcom crash, and bear market of ’00-’02, recession of ’01-’02, and finally the credit crunch of ’07-’08.
Once again, the ground is shaking beneath our feet. And once again, people are wondering if they should head for shelter. ‘Don’t worry about it,’ say the pundits. ‘It will pass… just as it always does. This is just normal… ”
If our hypothesis still works… inflation will blow its top soon.
Markets and Money