Greenspan’s Legacy – Apres moi, Le Meltdown (January 30, 2006)

In March, 2000, the economy began the well-publicized high tech slide.  Manufacturing and services continued to flee the country.  Technology was a transitional industry, but the best minds were disproportionately and increasingly foreign; too many of the goods and services could be and are being manufactured and provided overseas.  As one bubble burst, however, another one was being blown.  Only one remaining domestic industry existed that could also be subsidized effectively – the real estate industrial complex.  The Fed provided the steroids.  Interest rates (the Federal Funds Rate) were precipitously reduced which significantly undermined the retirement income for those retirees (born before 1935) who relied on interest income to support them during their golden years; sacrifices have to be made.

American land, American land owners, American (and Canadian) timber, American (and Hispanic) labor, American builders, American real estate agents, American appraisers, American surveyors, American bankers, and American candle stick makers all profited handsomely.  The land perforce cannot be moved offshore, the houses cannot be built overseas economically, and most of the players, with a few exceptions, cannot be outsourced.  Between 2001 and 2005, the construction trades and the financial and real estate service sectors provided seventy percent of the economic growth in America.  Yet the largest share of the real money to construct the house of cards was foreign-born.  Americans don’t own their homes today; foreigners own their homes and rent them to Americans.  The Fed should have issued stronger warnings and recommended Congressional action to supervise the spew of credit; in the face of inevitable inaction, the Fed should have corked the champagne in the summer of 2003 by bumping up the interest rates.  [See the April 25, 2005 e-ssay entitled “Our Friend the Fed.”]  As the market peaked in the summer of 2005, however, increasingly marginal economic candidates were seduced by intoxicating no-money-down/interest only/adjustable rate mortgages to enter a hyper-inflated market.  The homes were ATM’s which provided the consumer spending that drove the economy for four profligate years.  [See the February 7, 2005 e-ssay entitled “The Microeconomics of Suburban Subsistence.”]  The “wealth effect” engendered by the growing equity in homes encouraged more spending on credit.  The homes are now occupied by “renters” who are consuming a growing percentage of their income just to service the interest payments.  The savings rate predictably went down in 2005 for the first time since 1933. Something is in the cards; the house of cards will collapse by Christmas.  It could not go on forever; as many have observed, what cannot go on forever will not go on forever.  The last viable domestic industry has now run its course with devastating consequences.  And now the country is left with vast numbers of McMansions that will soon cost too much to heat.

Ben Bernanke may be Bush’s most promising appointment.  However, he will inherit a mess beyond repair or management.  There is no industry in America left to subsidize.  With consumers and the country up to their tonsils in debt, consumer spending is and will be inadequate to drive the economy.  Foreigners will quietly reduce their purchases of t-bills and demand more return for their remaining investment in dollars.  The growing demand for oil is occurring at a time when the supply may be interrupted by some unstable or unfriendly regimes.  Rising oil prices will drive up the producer and the consumer price indexes.  Not raising interest rates will allow inflation to soar.  Raising interest rates to check inflation will stall the collapsing economy.  The Fed is likely to raise interest rates to 5.0 percent to check inflation even though the economy is entering a period of “stagflation.”

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