In a Wall Street Journal editorial today, Mortimer Zuckerman does a good job analyzing US economic performance–past, present and future:
Importantly, the bubble of exuberant consumerism that powered the U.S. economy for the last 10 years of the 20th century and for most of the first years of the 21st century has burst. In reaction to economic hard times, American consumers are planning for the worst rather than hoping for the best, and they continue to pay down household debt instead of spending cash.
Who could blame people for holding back when we see roughly 50 million Americans on one or more taxpayer-supported programs, be it food stamps or unemployment benefits? This downturn may not have the 1930s feel of despair, but in large part that is because, as the economist David Rosenberg of the wealth-management firm Gluskin Sheff put it, “The modern day soup line is a check in the mail.”
An unprecedented number of Americans are borrowing against their 401(k)s, canceling their life insurance policies, and forgoing physicals. And that isn’t all. The American consumer today is fearful of the impact of higher food prices, higher gasoline prices, higher insurance costs, higher everything. The inflation of food and fuel alone has absorbed the December tax cuts agreed to by Congress and the administration.
No arguing with any of those points here. But why? Why are all these things happening? What has happened to America? In a word, debt:
Why are all the vital signs discouraging? Quite simply, it is because households are still carrying far too much debt on their balance sheets. Relative to income, debt today is approximately twice as high for families as it was in the 1980s. Total borrowing in relation to disposable, personal after-tax income leaped to approximately 136% in the first quarter of 2008 from 60% in the early 1980s before it began to recede. It has now declined to 117% of income compared to the pre- bubble norm of 70%. To return to that level, debt would have to be reduced by another $6 trillion.
But this still doesn’t get at the heart of the matter. Why all this debt? For two reasons: First, because we could. Due to two decades of Fed Reserve monetary hijinks fighting a losing battle against deflation, and to massive trade deficits that had to be financed, there was an ever-increasing amount of money to be lent. Second, because the international arbitrage of wage costs meant American wages had to decline or stagnate relative to its trading partners.
Consumer price levels naturally wish to decline over time, particularly in the face of technological advancements that make production more efficient. The Greenspan Federal Reserve would have nothing of it. For the Federal Reserve, “stable prices” means inflation of about 1-2% a year, and anything below that gets them terrified of that economic bugaboo, deflation. So Greenspan inflated every time he even smelled a price decline, but particularly from 2001-2004, decreasing Fed Funds rates to 1% and holding them there for over a year. This created piles and piles of money that could be lent, and was, to make up for the stagnating incomes of the American worker.
Trade deficits were, paradoxically, another source of money to be lent at home. At least two of our main trading partners–China and Japan–run mercantilist trade policies, i.e., the strategy of believing that export is good, but import is bad. Thus they run massive trade surpluses, which means their currencies should appreciate relative to the trading partners with whom they run surpluses (i.e., the US). But they don’t want their currencies to appreciate, because doing so would balance out the trade disequilibrium which they consider to be profitable, so they recycle the dollars they receive back into the US, in the form of, not least, investments in residential real estate, not least Fannie and Freddie MBS’s, yielding even more money to lend to heavily-indebted US consumers. This sort of cycle is why, even in the face of the massive earthquake last Friday, the Japanese Yen is trading at an all-time high. The Yen was held artificially low by this repatriation of dollars, but the Yen will now be brought home to pay for recovery. A lot of dollars will be buying a lot of Yen, so the Yen is appreciating.
International wage arbitrage operates to bring down US wages even as US workers are being sold all the rope (debt) they need in order to hang themselves. China and Mexico are two of our biggest trading partners. China’s per capita income is a little over $5,000 per year. Mexico’s is roughly $13,000. The US’s is about $45,000. The laws of economics require wage rates across trading partners to move towards equilibrium, meaning Chinese and Mexican wages should be moving up and the US’s wages should be moving down or stagnating, on a real, purchasing-power-parity basis. If the US trades with China and Mexico long enough, the cost of either a McMansion or a Big Mac in all three countries should roughly equalize in terms of the amount of labor expended to procure it.
Zuckerman’s piece is worth the time to read, though he doesn’t explain two factors that will likely have some large effects on the US economy going forward–the Japanese earthquake and political unrest in Arabia. Perhaps he refrains from explication because it is impossible to know what their effects might be, as it is impossible to even know what things will look like once the smoke clears and the dust settles. The Chinese must have cursed us. We are living in interesting times.