Yes...but!

November 3 2008

Home > Columns >Yes...But! Year 8-52

The next US president couldn’t have picked a worse time to be elected. Whether he will be able to implement the “Change we Need” is an open question. Of course he knows the score. Every body knows that when people have no money they have three choices: borrow, steal or do without. As far as borrowing is concerned: banks sit on their money as chickens on their eggs, hoping that something will hatch, which means that people are on their own, tapped out, forced to do without or rob a bank.

All this is bad news for the world in general and for the US in particular, because America consumes a full quarter of global production, while its economy depends for 70 percent on people buying stuff. Now that the high US dollar makes its exports too expensive, its well-being depends even more on national consumption.

The past decade has been one of total illusion. The American people were able to spend because they used their rising home equity to finance such things as new cars, vacations, second homes, college education, having a good time, all in the mistaken notion that house prices always go up. $800 billion, or 6% of its total GDP, was extracted to artificially extend the American dream.

This unreal situation has now deteriorated into a nightmare and the residential cash-cow has become a cadaver.

The banks which so blatantly made these billion dollar bloopers possible were bailed out with trillions of dollars - like giving robbers a large reward for stealing – while the victimized home-owners suffer mental and monetary trauma.

There is more at stake here than people losing their homes. Just as everywhere else, America is ageing, and even those who had saved money are now caught in the stock market bubble: bubble bubble, trouble trouble. With less or no money at all, people are forced to save more or postpone retirement: the gold in ‘the golden years’ has turned to lead and dread.

What applies to personal pensions it also true for company ones. I once was on a pension board of a large institution, where future pay-outs were based on an unrealistic return of 10% per annum. With stock prices collapsing, corporations will be forced to dip into their cash reserves to make up shortfalls in their contributions. Many of these – Chrysler, General Motors, Ford come to mind - simply don’t have the extra funds. They just might go broke, stopping the benefits to hundreds of thousands of pensioners.

In the last few years America’s savings rate dropped to negative 2% of GDP. Even a low savings rate of 4% would curtail consumption quite drastically. Over the past decade Americans have spent big on houses, furniture and fittings, electronic gadgets and autos, all major ticket items. No more: today we witness the great unravelling. Last week Whirlpool announced that it would let 5,000 people go. It is joined by firms in every field especially real estate, construction, retail, finance and automobile: millions of good paying jobs are evaporating rapidly.

Just as the Great Depression had a lasting impact on that generation’s psyche, a long drawn out downturn will also severely sap the confidence of consumers for some time to come, especially since real estate values are still dropping, with another 10-15% to go. Not surprisingly last week the US mood switched to negative: the lowest confidence factor in 40 years.

All this is setting the stage for the next boomerang problem: lower house prices and lower sales mean lower tax revenues, means lay-offs in the state and local governments, means increasing need for social programs for the poor. Will they get help?

Hedge funds are also on the chopping block. They had placed their bets on CDS – Credit Default Swaps – which have grown from next to nothing in 2000 to topping $60 trillion in 2007. Now, in state of collapse, they are forced to liquidate. As major defaults in the credit card business become reality, as auto finance and commercial property sectors further weaken, the capital base of US, the entire foundation of its financial institutions, may prove to be built on quick sand.

So Mr. Elect President: welcome to the Brave New World of phantom financing. Throw in a bit of Climate Change and the inescapable depletion of oil supplies and you’ll require divine attributes to navigate through this turmoil.