A bucket of economic cold water for America • 28 July 2007 • The SnowBlog
A bucket of economic cold water for America
Just to lay out my prognosticating credentials, if you've really been paying attention, you might remember me saying that after the middle of July, the rain was going to stop. Well, that's not what happened. Instead Britain has had the most rain ever. Ever. That's the approximate calibre of my predictive skills. On the other hand, I've been boring people for a while on the subject of the U.S. economy. Just like the UK's, following a stock market shock at the beginning of the century, people seemed to want somewhere else to put their money. (Or in the case of the U.S. someone else's money. More on that in a minute.) On both sides of the Atlantic, real estate seemed like the answer. In the U.S. though, there was a good reason for the property market to take off. While vigorously waving the flag, U.S. industry has stealthily been transferring its manufacturing capacity overseas for some years now. A good proportion of Walmart's Made in America merchandise is made in China. A torrent of dollars flow into Chinese banks as massive convoys of container ships head in the opposite direction.
If the world worked the way the U.S. Treasury would like, one could keep printing dollars in order to pay for Chinese goods and everyone would be happy, but of course the world doesn't work that way. The dollar gets weaker against the renminbi (what a name!) and gradually Chinese goods aren't so cheap any more. But China is using its role as America's new industrial heartland to pay for its transition to affluent modern superpower and they don't want to jeopardise that - even if it means doing something apparently foolish. Instead of finding the best possible investment for all those incoming dollars, China puts them to a much less productive use: it invests them in the U.S. China buys T-Bills - effectively giving the U.S. government gigantic low-interest loans - as well as investing on the U.S stock market, helping prop it up despite the loss of its manufacturing heart.
Dollars flow back into America and the result is that Chinese goods remain cheap and therefore desirable to Americans (which is what the Chinese want) and America is given truly vast amounts of credit at very low interest rates (which means it doesn't have to pay for anything). And what has America done with this credit? Well I'll steer clear of saying much about the government because this is not supposed to be a political post, but suffice to say it's been possible to start a war and cut taxes at the same time, by simply putting all military adventures on American's credit card. Private citizens, on the other hand, have borrowed money over the long term and spent it in the short term - or they've invested it in property. And it's not just cheap credit that has made property look good, it's also cheap fuel.
Trying to do this sum in my head is making my eyes cross, but by my reckoning, U.S. petrol prices are about 33p per litre at the moment. It's considered a scandal. But compared to the U.K. price of 97p it's practically free. And fuel prices are important because of a third component of the US property boom: land. Unlike the UK, America actually has lots of places it could build new houses. Many of these green field sites include views over amber waves of grain and/or purple mountains' majesty*. And if China will pay the mortgage and the petrol is cheap enough, building a house in some picturesque spot is a very attainable American dream for a lot of people - attainable, but not necessarily sustainable.
As gas prices go up (and they do tend to if you start a war in the Middle East) out of town property gets less desirable. As US credit lines expand and expand, the dollar inevitably looks more precarious and that jeopardises future borrowing. One point in America's favour is that the dollar is the hard currency and a lot of the world's debt is denominated in dollars. That gives the U.S a special form of protection that other nations don't enjoy. The bills it has to pay abroad are often in dollar amounts, which means the dollar can weaken all it wants and the payments don't get any bigger. The flip side of that protection is that the pain is felt by the people on the opposite side of the deal: the investors. The weaker the dollar gets, the poorer an investment those old U.S. Treasury bills become. They cost strong dollars to buy, but they're paying out in weak dollars now. If the time ever comes when China and Saudi and the other big lenders decide to cut their losses and switch to Euro-denominated investments then America's protection becomes its downfall. In other words, the pre-eminence of the dollar staves off the collapse for longer, but when it happens it's that much deeper.
Throw in one more factor and I have to say the U.S. economy is not looking good in my opinion. America has been famous for a while for buying on credit (even worse than the U.K.), but it's gone further than before, with more credit than before, at a time when it has less chance of paying its bills then before. So there are plenty of people out there with mortgages they can't pay off on houses that won't be worth much if a) interest rates rise and b) gas prices rise. And let's face it, both of those things are likely to happen.
Let me remind you again that I have no track record at all in predictions. None. But I think massive investors like China and Saudi will move away from U.S. investments. Which means the U.S. won't have money available for loans so interest rates will rise. The property boom has already started to slump, but rising interest rates and high gas prices will cause a property crash. That will hit the middle class in America very hard, ruining small businesses and pushing middle managers into bankruptcy. The U.S. working class is already feeling the pinch: no healthcare, no manufacturing jobs, real wages down. Personally, I think the result will be a major crash and a depression.
The only upside I can see is a political one, so look away now if you don't want my lefty political views rankling your ire. I think this crash will also mean the end of the Republican party in its current incarnation. It is, to use a phrase much beloved of political commentators, a perfect storm: a record-breakingly unpopular administration turns Clinton's economic golden era into a full-blown crash while destroying American goodwill right around the world. The endless dirty laundry of this administration will receive a proper airing just as the economy tanks and just as Americans go to the polls next year. I think the hard right in the U.S. have had it. Unfortunately it's everyone else who'll have to pay the price.
One final note for anyone who's read this far and is tempted to be depressed: I tried to teach myself economics a while back, having never studied it in a classroom. I then took an A-Level in it and got an 'Unclassified'. That's the lowest possible mark you can get. It is entirely possible that none of the foregoing is accurate. Let's hope, eh.
* That's an American's-only joke.
Rob
Just to lay out my prognosticating credentials, if you've really been paying attention, you might remember me saying that after the middle of July, the rain was going to stop. Well, that's not what happened. Instead Britain has had the most rain ever. Ever. That's the approximate calibre of my predictive skills. On the other hand, I've been boring people for a while on the subject of the U.S. economy. Just like the UK's, following a stock market shock at the beginning of the century, people seemed to want somewhere else to put their money. (Or in the case of the U.S. someone else's money. More on that in a minute.) On both sides of the Atlantic, real estate seemed like the answer. In the U.S. though, there was a good reason for the property market to take off. While vigorously waving the flag, U.S. industry has stealthily been transferring its manufacturing capacity overseas for some years now. A good proportion of Walmart's Made in America merchandise is made in China. A torrent of dollars flow into Chinese banks as massive convoys of container ships head in the opposite direction.
If the world worked the way the U.S. Treasury would like, one could keep printing dollars in order to pay for Chinese goods and everyone would be happy, but of course the world doesn't work that way. The dollar gets weaker against the renminbi (what a name!) and gradually Chinese goods aren't so cheap any more. But China is using its role as America's new industrial heartland to pay for its transition to affluent modern superpower and they don't want to jeopardise that - even if it means doing something apparently foolish. Instead of finding the best possible investment for all those incoming dollars, China puts them to a much less productive use: it invests them in the U.S. China buys T-Bills - effectively giving the U.S. government gigantic low-interest loans - as well as investing on the U.S stock market, helping prop it up despite the loss of its manufacturing heart.
Dollars flow back into America and the result is that Chinese goods remain cheap and therefore desirable to Americans (which is what the Chinese want) and America is given truly vast amounts of credit at very low interest rates (which means it doesn't have to pay for anything). And what has America done with this credit? Well I'll steer clear of saying much about the government because this is not supposed to be a political post, but suffice to say it's been possible to start a war and cut taxes at the same time, by simply putting all military adventures on American's credit card. Private citizens, on the other hand, have borrowed money over the long term and spent it in the short term - or they've invested it in property. And it's not just cheap credit that has made property look good, it's also cheap fuel.
Trying to do this sum in my head is making my eyes cross, but by my reckoning, U.S. petrol prices are about 33p per litre at the moment. It's considered a scandal. But compared to the U.K. price of 97p it's practically free. And fuel prices are important because of a third component of the US property boom: land. Unlike the UK, America actually has lots of places it could build new houses. Many of these green field sites include views over amber waves of grain and/or purple mountains' majesty*. And if China will pay the mortgage and the petrol is cheap enough, building a house in some picturesque spot is a very attainable American dream for a lot of people - attainable, but not necessarily sustainable.
As gas prices go up (and they do tend to if you start a war in the Middle East) out of town property gets less desirable. As US credit lines expand and expand, the dollar inevitably looks more precarious and that jeopardises future borrowing. One point in America's favour is that the dollar is the hard currency and a lot of the world's debt is denominated in dollars. That gives the U.S a special form of protection that other nations don't enjoy. The bills it has to pay abroad are often in dollar amounts, which means the dollar can weaken all it wants and the payments don't get any bigger. The flip side of that protection is that the pain is felt by the people on the opposite side of the deal: the investors. The weaker the dollar gets, the poorer an investment those old U.S. Treasury bills become. They cost strong dollars to buy, but they're paying out in weak dollars now. If the time ever comes when China and Saudi and the other big lenders decide to cut their losses and switch to Euro-denominated investments then America's protection becomes its downfall. In other words, the pre-eminence of the dollar staves off the collapse for longer, but when it happens it's that much deeper.
Throw in one more factor and I have to say the U.S. economy is not looking good in my opinion. America has been famous for a while for buying on credit (even worse than the U.K.), but it's gone further than before, with more credit than before, at a time when it has less chance of paying its bills then before. So there are plenty of people out there with mortgages they can't pay off on houses that won't be worth much if a) interest rates rise and b) gas prices rise. And let's face it, both of those things are likely to happen.
Let me remind you again that I have no track record at all in predictions. None. But I think massive investors like China and Saudi will move away from U.S. investments. Which means the U.S. won't have money available for loans so interest rates will rise. The property boom has already started to slump, but rising interest rates and high gas prices will cause a property crash. That will hit the middle class in America very hard, ruining small businesses and pushing middle managers into bankruptcy. The U.S. working class is already feeling the pinch: no healthcare, no manufacturing jobs, real wages down. Personally, I think the result will be a major crash and a depression.
The only upside I can see is a political one, so look away now if you don't want my lefty political views rankling your ire. I think this crash will also mean the end of the Republican party in its current incarnation. It is, to use a phrase much beloved of political commentators, a perfect storm: a record-breakingly unpopular administration turns Clinton's economic golden era into a full-blown crash while destroying American goodwill right around the world. The endless dirty laundry of this administration will receive a proper airing just as the economy tanks and just as Americans go to the polls next year. I think the hard right in the U.S. have had it. Unfortunately it's everyone else who'll have to pay the price.
One final note for anyone who's read this far and is tempted to be depressed: I tried to teach myself economics a while back, having never studied it in a classroom. I then took an A-Level in it and got an 'Unclassified'. That's the lowest possible mark you can get. It is entirely possible that none of the foregoing is accurate. Let's hope, eh.
* That's an American's-only joke.