SPEAKING
FREELY US consumer in a
hurricane By Axel Merk
Speaking Freely is an Asia Times
Online feature that allows guest writers to have
their say. Please click hereif you are interested in
contributing.
How well equipped is
the US economy to weather shocks such as the
catastrophic Hurricane Katrina? How does the
economic stimulus of rebuilding the area weigh
against the effects the high cost of energy has on
the consumer? Why is the dollar down and gold up
since the catastrophe hit? We can find answers by
looking at the big picture.
For starters,
we should wind back to the days before Katrina
devastated Louisiana. Before significant parts of
the US energy supply, as well as an important
transit route (the Mississippi) for food and raw
materials, were taken offline. Before the
hurricane, commodity prices ranging from oil and
gas, from steel to copper,
from coffee to grain were
near or at historic highs. These high prices are a
reflection of elevated global demand; part of this
high demand is due to a US economy that has
enjoyed and continues to enjoy accommodating
monetary and fiscal policies (low interest rates
and low taxes). Asia's drive to sell cheap
consumer goods to the US and Asia's growing
internal consumption have also contributed to high
commodity prices.
To understand how
shock-resistant the US economy is, let us look at
what its most important and vulnerable part is. A
key driver behind economic growth in recent years
has been consumer spending, which these days
comprises about 70% of gross domestic product
(GDP). Declining interest rates and lower taxes
have contributed to consumer spending growing
faster than overall GDP for more than a decade.
When the technology bubble burst in 2000, consumer
spending never declined. At the same time, the
savings rate has been declining in the US. While
Chinese consumers save more than 30% of their
income, the US savings rate recently turned
negative, to an unsustainable -0.6%, for the first
time since records began in 1959. Negative savings
rates are possible if consumers spend by selling
assets, dipping into savings or borrowing against
future income. The savings rate is also lowered by
homeowners who refinance and take more money out
of their home; in recent years, many consumers
have treated their homes like ATMs.
The
rise in housing prices has far exceeded the rise
in income in recent years. Current housing prices
are not sustainable and we are clearly in a
housing bubble induced by an extended period of
very low interest rates; talking to real estate
agents around the country in some of the hottest
areas gives the impression that we have passed the
peak in the housing market. In summary, the US
consumer is the key to understanding what will
happen to the US economy; and the US consumer now
not only has record amounts of debt, but the
drivers that have allowed this debt to accumulate
have shifted into reverse: interest rates are
rising and housing prices are at risk of
declining.
Another important factor
influencing consumer spending is real income. If
incomes were to rise, the effects of higher
interest rates could be mitigated. Real incomes
have a very difficult time rising in an
environment where US corporations are squeezed by
both high commodity prices on the production side
and low consumer prices because of a flood of
cheap imports from Asia. In such an environment,
US corporations attempt to keep up their profit
margins by accelerating their outsourcing. In a
best-case scenario, income growth will lag GDP
growth.
Taken together, US consumer
spending is most vulnerable; the question is when,
not whether consumer spending will falter. Unlike
the government, consumers cannot print money to
pay off their debt. As housing prices decline and
incomes don't rise, consumers will have to spend
less and will liquidate other assets (such as
their stock portfolio) to service their debt.
The massive US trade and current account
deficits are another threat to the economy. Every
day, foreigners need to purchase almost $2 billion
worth of US dollars just to keep the dollar from
declining. If the US economy slows, foreigners may
be less inclined to invest their assets in the US
economy. The aforementioned squeeze on US
corporations through high commodity and low
consumer goods prices above has resulted in an
erosion of the manufacturing base. To illustrate
this point, Germany just surpassed the US as the
world's largest exporter. Even a declining dollar
will not bring that manufacturing base back
anytime soon. A declining dollar would, however,
further increase inflationary pressures. Unless
policies are instituted that foster savings and
investment, the pressures on the dollar may remain
firmly in place for years to come.
Higher
fuel prices at the gas pump already have an impact
on weaker consumers. This winter, heating costs
will be substantially higher. In the building
frenzy over the past couple of years, lots of
larger homes were built requiring higher
maintenance costs. Note that all of this was in
place BEFORE the hurricane hit the Gulf Coast. You
may start to understand why lawmakers have already
approved over $60 billion in aid to help the
region recover. This is an unprecedented amount -
a reflection of the even greater stimulus needed
to keep an economy going that is dependent on a
consumer living on borrowed money.
When
evaluating the net economic impact of Hurricane
Katrina, it is not sufficient to try to
consolidate the economic output lost with the
spending package approved. While terrible for the
region, the loss of tax revenue in Louisiana will
not derail the national economy; thousands that
are likely walking away from their mortgages can
also be absorbed by the financial sector. Many
creditors have provided a payment moratorium. This
"generosity" discourages people from declaring
bankruptcy in which case the creditors would go
empty-handed. Importantly, it discourages filing
bankruptcy before October 17, 2005, when much
tougher bankruptcy laws come into effect.
An important lesson from the 1970s is that
when there is a supply shock (energy shortage),
providing an economic stimulus is highly
inflationary. The reason is obvious: if you have
too little energy, attempting to boost economic
output will leave you with an even greater energy
shortage. At the same time, it would be political
suicide to suggest after the hurricane that an
economic stimulus package is out of place.
The administration has tried to preempt
the inflationary spiral that could be triggered by
an economic stimulus package with an international
call for help. Everything from crude oil to
refined gasoline to food has been offered to the
US, and the US has gladly accepted the offers.
Note that natural gas cannot be easily imported
(PG&E, California's main utility company,
announced that residential gas bills will rise by
40% in the coming weeks). The US has a reserve of
crude oil, the "Strategic Petroleum Reserve", but
does not have significant inventories of refined
products. It is already expected that refineries
will want to purchase less crude oil from the
reserves as there is plenty of supply coming.
The administration has also issued a plea
to refineries to postpone non-essential
maintenance, and to boost output. Amongst others,
refineries are requested to produce regular diesel
instead of higher grades, such as low-sulfur
diesel. This shows how concerned the
administration is about squeezing the maximum out
of US refining capacity (to which no significant
additions have been made since the 1970s). Rumors
have been spreading that the administration will
try to artificially lower the cost of energy. At
the very least, the administration will work very
hard to try to minimize the inflationary pressures
caused by the stimulus package just passed.
Eyes will be on the Federal Reserve
whether it will continue to raise interest rates
in light of the plight caused to so many by the
hurricane. Federal Reserve Chairman Greenspan has
in the past always come to the rescue of the
markets in times of crises. Oddly, Greenspan
recently complained that there was not enough of a
risk premium in the markets - a risk premium that
may have eroded because investors believe
Greenspan will rescue them. Monetary policy
continues to stimulate the economy, and a pause
would further increase inflationary pressures.
We are now adding tens of billions of
unplanned expenses to the national debt to get
through this winter. Even with all the policies
instituted, we can expect much higher heating
costs than last year. Now add to this that it is
impossible to permanently increase refining
capacity within months (it takes years to build
these complex facilities), and that foreign aid
will abate in the coming months. What we are left
with is an economy that will have received a
substantial stimulus that is working itself
through the system, on top of a very tight supply
situation before the hurricane hit.
The
only way to think of what we are about to
experience as non-inflationary is if we exclude
energy from our inflation measures. Conveniently,
there is a government statistic called "core
inflation" that excludes food and energy. It turns
out that even the core numbers have been inching
upwards. On the other hand of the spectrum, we
have an economy that is conducting a cliff-walk,
dependent on even stronger government stimuli
holding up consumer spending. The Fed may not be
able to raise rates far enough to contain
inflation. At the same time, the housing market
will switch from being a positive force on
economic growth to being a weight on the economy.
Whereas a stock market may correct in days or
weeks, the housing market is likely to be a drag
on the economy for a very long time. Given the
tremendous leverage in the housing market (home
buyers often pay down 20% of less of the purchase
price), we are in for an extended period of belt
tightening.
Good intentions have brought
us here: we wanted to keep America rolling after
9/11. Money was made easily available and taxes
were lowered. At the same time, though,
globalization has allowed Asia to contribute more
actively to the US economy. To allow for job
growth, Asia provided an environment that has
fostered an oversupply of goods; the massive flood
of goods into the United States has kept consumer
prices down. That in turn has made it more
difficult for US manufacturers. There is certainly
a new breed of US corporations that is able to
thrive in this environment, but labor intensive,
"old-economy" style companies, notably in the
automotive sector, cannot adjust fast enough to
this environment. The US economy is growing
briskly; yet, "employee discounts" have to be
awarded by the auto industry to empty inventories.
This is one of many warning signs that the US
consumer is not in good shape.
There is a
saying that if the United States sneezes, the rest
of the world catches a cold. Much of the world has
oriented itself to sell to the US consumer. The
question is where you can hide or seek to profit
from a situation where decreased consumption in
the US will be a drag on the economy; where
consumers will have to pay down their debt; where
inflationary pressures will continue to build and
be a threat to the bond market; where the dollar
is at risk because of an enormous current account
deficit and the risk of lower investments into the
US should the US economy slow; and the risk to
numerous international companies and countries
that are highly dependent on selling to the US
consumer.
