Monday, July 19, 2010

Krugman vs. Galbraith: my deficit is bigger than yours

Oh, wow.  The NYT discovers that we have too much debt, even as James Galbraith and Paul Krugman engage in a bitter bout of “my deficit is bigger than yours.”  What the plutocracy-controlled mainstream hasn’t yet acknowledged and what Main Street has already figured out is that bailouts and stimulus go to the rich, not to them, or as I like to put it, the income distribution in the United States is like a car engine running on one cylinder—no matter how much Stimulus pours in, most of it goes to the already-rich.  And heaven forbid we raise marginal tax rates.

The Europeans, who still have a social contract (and I’m talking about wage differentials in companies, not just government policy), even if burqua-strained, will kill the US in the dealing with the problem of excessive debt. 

And from a consumer point of view, with near-zero interest rates and a stock market that looks like a falling knife more and more, the best rate of return one can get is paying off debt.

The US seems to need sado-masochistic crisis with real blood in the streets before it deals with its historical preference for opportunistic greed as the primary element of its social contract.  Large damage is done to human capital by this means.

July 12, 2010

Paralyzed by Debt


Last month, my wife and I refinanced our mortgage. Though the rate was lower and we could have afforded more debt, we paid down a chunk of the balance. Don’t ask me why — it just felt better to owe less money. Time was, such thrift would have been hailed as patriotic. Now it threatens the economic recovery. Less borrowing means less to spend.

Suppose everybody did this? Well, it turns out, everybody has. Eschewing trips to the mall, Americans are paying off credit-card balances and home-equity lines. Despite low rates, mortgage demand has plummeted.

Some people have no choice but to pare their debts (indeed, some are being foreclosed on). For others, call it morning-after sobriety or late-blooming prudence. Losing income tends to bring on a case of the nerves, and half of American workers have suffered a job loss or a cut in hours or wages over the past 30 months. And, need we add, people’s stock portfolios are not what they were.

The economic term is “deleveraging”; it means that, as opposed to the normal state of affairs, in which, each quarter, people borrow more money and banks issue more loans, credit in the economy is shrinking. Remarkably, this deleveraging has been going on for nearly two years. Ordinary Americans are behaving just as the banks they love to excoriate — having, formerly, assumed too much risk, they are going into hibernation. If credit, in the words of the writer James Grant, is money of the mind, people have become psychologically indisposed to minting it.

Such restraint, even if sensible individually, does not augur well for the gross domestic product. Total household credit has contracted for seven straight quarters. Mortgage debt is down $462 billion from the peak, which it reached in November 2008. Bank-card borrowings, which peaked two months later, are off $126 billion. Auto loans have fallen $122 billion; home-equity lines, $77 billion.

To peruse such figures is to get a whole new sense of America’s economic crisis. The bank failures and bailouts of the fall of ’08 called to mind a great and terrible battle. The drone of falling credit numbers since then suggests a ponderous army in drawn-out retreat. As Stephanie Pomboy, publisher of the newsletter Macro­Mavens, has pointed out, government transfers like stimulus spending and tax credits masked the effects of diminishing credit for a while. That is to say, even if people were unwilling to borrow, they were happy to spend money they got from the government. Now that government supports are being pulled away, the effects of deleveraging are in plain view. Home and car sales are plummeting again. Job growth has shrunk to a sliver. Personal bankruptcies are soaring. Deflation, a dangerous state of economic dead air, when prices fall from lack of demand, is a distinct possibility.

Credit and inflation are really two sides of the same coin. When credit expands, people have more money to pay for goods, and prices go up. The Federal Reserve Board has kept short-term interest rates at nearly zero, effectively jamming the credit-creation pedal through the floor. But it hasn’t persuaded people to take out their wallets or their credit cards, stoking fears of a Japan-like deflation. Core inflation (which measures price increases of everything but energy and food) has fallen to its lowest level in 44 years. As people pay back loans rather than take out new ones, they exert a drag on business. As Pomboy writes, “The U.S. economy is in the grips of a powerful but silent undertow.”

Some of the deleveraging is being forced by banks. Underwriting standards have toughened, making it harder for people to get loans. (This is a good thing, by the way. The reason we got into trouble is that banks were too easy.)

Indeed, the underlying cause of deleveraging is that Americans got too leveraged. This excess was decades in the making. In the aftermath of World War II, the average family earned far more, each year, than the total of its borrowings. But beginning in the 1970s or so, the culture relaxed. Credit cards and mortgage options proliferated. By 2001, household debt reached a par with annual after-tax household income. (The average family owed what it earned.) By the peak of the bubble, in 2008, borrowings had surged to 36 percent more than income.

Which raises the issue: how much of that debt will have to be repaid before people return to their customary, and stimulative, profligacy? Thus far, we have undone only a portion of the excess. Household debt now stands at 26 percent more than income — still very high by historical standards. “There is no magical level where it should be,” says David Resler, an economist with ­Nomura Securities. “There is no clear equilibrium.”

Absent a massive federal stimulus (and maybe even with one), the economy is not likely to show much life until deleveraging ends. The conventional view is that we are almost there. That assumes that the average American will resume borrowing and spending before the prior excesses are fully washed out. To return to the status quo of before the housing boom — say, back to debt to income ratios prevailing in 2000 — it would take five more years of deleveraging at the current rate. Deleveraging cycles are rare, notes David Rosenberg, an economist with the Toronto firm Gluskin Sheff, but five to seven years is typically what they take. The Conference Board, which asks consumers every month whether they anticipate buying a home, a car or an appliance within the next six months, reported plummeting numbers in June. Consumers used to get their kicks from new Sub-Zero refrigerators; now they chip away at their balances. The turn is yet to come.

Roger Lowenstein, an outside director of the Sequoia Fund, is a contributing writer and author of “The End of Wall Street.”

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