US May Have To Bid Farewell To Good Times

Source : The Business Times, September 28, 2007

The house of cards is falling amid soaring oil prices, diving home sector and credit crunch

IT will be recalled as a Golden Economic Age, the Greenspan Era, or the Goldilocks Economy - but one thing is clear: The good days of doing-away-with-the-business-cycle and spending-like-there-is-no-tomorrow are probably over as far as the US economy is concerned.

End of the Goldilocks Economy: The good days of Americans spending-like-there-is-no-tomorrow and maxing out on their credit cards on luxury items at establishments in places like the high-end Santana Row shopping area in San Jose, California, are most probably over

Indeed, it is becoming obvious that Americans will have to say 'bye, bye' to an age when consumers could take out huge mortgage loans to pay for new homes and spend the weekends shopping for the latest plasma televisions - made in China - as they maxed out on their credit cards.

The era when financial institutions could juggle new and increasingly complex ('exotic') financial products that made it possible to extend more credit to the consumers and businesses, including packages of mortgages to those who had already maxed out on all their credit cards, are well and truly over.

And the time when the government could expand its current account deficit (6.2 per cent of US GDP in 2006) on military adventures in Mesopotamia and on tax breaks for financial speculators and real estate magnates - and have all of that financed by China - has gone.

And, yes, it's also an end to the years during which the US Federal Reserve Board could print more money to ensure that the good times of low interest rates, low prices, and cheap money will continue to roll.

For much of the post-Cold War era and the ensuing years of globalisation, with the former members of the communist bloc, China and other emerging markets joining the global economy, Americans benefited from the rewards of economic liberalisation abroad and at home.

Hence, global trade liberalisation, including the creation of the World Trade Organization (WTO) and the accession of China and other new economies into it, made it possible for American consumers to spend more time in shopping malls buying very cheap Made-in-China socks and shoes, televisions and computers, and a lot of toys.

In turn, the Chinese - as well as the South Koreans and Japanese - used up the money they made exporting their cheap products to the United States to purchase US treasury bills and stakes in American companies and help the US to run its huge current account deficit and maintain its low real interest rates.

While the Chinese were saving and the Americans were spending, the de-regulation of the American economy, including its banks and other financial institutions in the 1990s, made it possible for whiz-kids in the hedge funds to come up with all the various exotic financial instruments that made it possible to provide more credit to American consumers and businesses.

US financial institutions stoked up a real estate boom that provided cheap mortgages to American buyers who could then commute from their new homes in the 'exurbs' to their work in cheap SUVs and who could fill their cars with cheap gas, thanks to the low global energy prices, made possible by Saudi Arabia and other oil-producing states that the American military helped protect.

The process of globalisation combined with the high-tech boom of the 1990s, including the above-mentioned new financial products together with the intervention by Alan Greenspan's Fed in the form of pumping money during financial crises, helped protect the American economy against potential shocks and created expectations that it was possible to moderate the business cycle for eternity.

And it all sounded like a good deal. This American Empire of Debt made life good for most Americans. It enriched the money men and women and the members of the emerging class of globe-trotting yuppies while making it possible for the members of the middle class to finance their shopping for televisions, home buying and vehicle driving.

The bursting of the high-tech bubble, the bearish mood on Wall Street and the terrorist attacks on Sept 11, 2001, created the sense that the economic chickens were coming home to roost. But the Fed's intervention in the form of rate cuts helped keep the economy going with just a mild recession.

It also lifted spirits in Wall Street as low interest rates kept the credit bubble afloat even as energy prices were going up - as a result of the booming Chinese economy and the instability in the Middle East - while the US budget and trade deficit were expanding - thanks to the military intervention in the Middle East and the growing imports from China.

It was not surprising that with falling interest rates and low inflation, Americans felt that despite recession and war, they were getting richer.

But the combination of high energy prices, a collapsing housing market and a credit crunch have finally brought down the house of cards in the form of falling home prices, collapsing mortgage firms and anxious financial markets.

Even if the recent rate cuts by Ben Bernanke's Fed helps lessen the turmoil in the markets, it is becoming clear that the mood among American consumers and businesses is changing as the economy is getting ready for a major slowdown.

There are no signs that the housing market is recovering or that borrowing costs will stop rising. And there are growing fears that the rate cuts could actually backfire, by igniting inflation pressures and by putting downward pressure on the US dollar that has already been sliding against the euro and other major currencies in the last six years.

While some investors will probably take advantage of new investment vehicles to exploit the decline in the value of the US currency, and American exporters will benefit from a weak US dollar in selling their products abroad, the falling dollar is probably the most dramatic sign of a weakening American economy.

A weak US currency would put upward pressure on prices in the United States and increase the risk of inflation. Most worrying is the possibility that foreigners, including the Chinese, will be less inclined to buy and even keep their dollar reserves which - as you recall - helped finance the American borrowing and spending, and by extension the US current deficit and allowed the good times to roll.