[nth]

marko,

I disagree with one of your key scenarios.
US currency will be sold off by foreign banks- governments.

This has nothing to do with US prestige or whatever currency traders are doing. Foreign governments will print more money to buy more US cash when US recession hits. You got to understand that except for EU- most other countries economy are based on export to US. They cannot afford their currency to strengthen. They will intervene and see their own currencies devalue against the Euro. Sooner or later, Euro will intervene and the world's currency will stabilize as everyone will print more money to save the USD.

If you look at currency valuations historically, all countries except the US have aggressively managed their currencies. So a run against USD will get all the countries to support it. When that happens, the run against USD will be negated.

Point to note is that under my above scenario will cause major inflation, but we are supposed to be in a world recession, so the cycle will up tick. The people running against the USD will have a lot of foreign currencies to buy stuff and if they do, then economy recovers.

Okay, all this is unrelated to PO. How will PO change this? I haven't read anyone explain it correctly. They don't talk about government mitigations, which will happen b/c it always have. To predict the future, you have to analyze how the actors will respond to the environment. PO forecasters are not- many claim there is nothing the gov't can do, which is plainly a cop out.

[jaakkeli]

$this->bbcode_second_pass_quote('nth', 'T')his has nothing to do with US prestige or whatever currency traders are doing.

[nth]

$this->bbcode_second_pass_quote('jaakkeli', '
')It <i>does</i> have something to do with US prestige. Remember, the post-WWII dollar-centered currency regime - Bretton Woods - began to unravel partly because the US and it's allies were drifting apart. It wasn't the only reason, but it was certainly a big factor. (You can see the evidence of political ties and economics meshing together in the way the thing collapsed - the French were the first to dump the dollar, the Brits the last...)

[maverickdoc]

$this->bbcode_second_pass_quote('', '[')b]U.S. Economy: Sentiment Falls, Import Prices Rise
March 18 (Bloomberg) -- U.S. consumers unexpectedly grew less confident this month and import prices rose in February as oil surged and drove up the cost of gasoline.

The University of Michigan's preliminary confidence index dropped to 92.9, the third straight decline and the lowest since November, from 94.1 in February, today's report showed. Import prices rose 0.8 percent last month, including the biggest gain in foreign petroleum costs since October, the Labor Department said in Washington.

``The consumer is worried about rising gasoline prices,'' said Elisabeth Denison, a U.S. economist at Dresdner Kleinwort Wasserstein in New York, who predicted the university's index would fall to 93.

The higher prices reinforce expectations the Federal Reserve will raise its benchmark overnight bank lending rate next week, the seventh straight increase since June to head off faster inflation. The Fed is predicted to raise the rate a quarter-point to 2.75 percent, based on the median forecast of 101 economists in a Bloomberg News survey.

...

Higher Prices

Imported petroleum prices rose 3.9 percent in February, today's report showed. Compared with the same month last year, the cost of petroleum was up almost 30 percent. Excluding oil, the index rose 0.2 percent after a 0.3 percent rise.

Rising fuel prices can make consumers less confident in the economy, raising concern about whether they will in turn curtail spending habits.

The university's sentiment index was forecast to rise to 94.9 was forecast for the month, according to the median estimate in a Bloomberg survey. The index has averaged a reading of 88.1 since 1978, when it was first issued monthly. The preliminary index is based on a phone survey of about 300 households. The final report, due April 1, will reflect about 500 responses.

The consumer expectations index, based on optimism about the next one to five years, fell to 83.6, the lowest since May, from 84.4. The index of current conditions, which reflects Americans' perceptions of their financial situation and whether it's a good time to make big purchases, fell to 107.3 from 109.2.

Oil Costs

Crude-oil prices have risen for a sixth straight week and reached as high as $57 a barrel in New York futures trading today. The price rose about 30 percent so far this year.

The average U.S. price for regular-grade gasoline rose to a record $2.055 a gallon on March 16, according to AAA, the largest U.S. travel organization. The latest average is up from $1.898 a month ago and $1.721 a year ago, Heathrow, Florida-based AAA said on its Web site.

``Whether the increase in energy costs will start to negatively impact the consumer sector this spring remains to be seen,'' said Michelle Girard, an economist at RBS Greenwich Capital in Greenwich, Connecticut. ``So far, the spending pace has held up well in the face of higher gasoline prices, perhaps buoyed by stronger employment and income trends.''

[maverickdoc]

I am expecting oil to hit $65 by May which will mean regular unleaded oil will be $2.80 for the summer driving season. The Housing bubble will also to bust between May and August. Oil will hit $75 by August (3.00+ for regular) and by September we will be in a major recession. All this assuming there is no geo-political event that is a big if.

[EnviroEngr]

Come to think of it, you're right. Aren't we due for another big spanking from the "T" word(s)?

Can't keep the Herd conditioned if you don't scare 'em up real good on a random schedule.

[maverickdoc]

Maybe I am too optimistic


Today

I saw $2.85 for regular self serve in NYC today

[jaakkeli]

$this->bbcode_second_pass_quote('nth', '')$this->bbcode_second_pass_quote('jaakkeli', '
')It <i>does</i> have something to do with US prestige. Remember, the post-WWII dollar-centered currency regime - Bretton Woods - began to unravel partly because the US and it's allies were drifting apart. It wasn't the only reason, but it was certainly a big factor. (You can see the evidence of political ties and economics meshing together in the way the thing collapsed - the French were the first to dump the dollar, the Brits the last...)

[marko]

Wow! You guys have written a lot about this. I mostly agree with jaakkeli but am not going to address your arguments quote by quote. Let me instead paint the scenario that I see as most likely.

The current account deficit is not the only financial problem facing the US. The US also has a large government budget deficit, an extremely low rate of savings, a real estate bubble, and a very high rate of consumer debt. Because wages have not risen in real terms, growth in consumer spending has come, essentially, from borrowing, often borrowing from the inflated value of real estate.

Now, eventually, we will have a recession. The business cycle guarantees it. I think that it is likely to be triggered by oil prices, particularly if they rise much above $70 a barrel, as I believe they will do by next year if not later this year. However, it could be triggered by a rise in interest rates or even just a halt in the rise of real estate prices (which would deprive consumers of new equity against which to borrow). Real estate prices have to stop rising because in many parts of the country they are way beyond what first-time buyers can handle.

When we have a recession, layoffs will occur and consumer spending will drop. Some people will fail to meet mortgage and credit card payments and will default on mortgages. Because so many buyers in the recent boom maxed themselves out on mortgage payments, I believe that any recession will bring a high rate of default and foreclosure. The flood of distressed sales to the market will bring a sharp drop in real estate prices. The rate of credit failure will lead to a rise in consumer interest rates and a tightening of credit.

Rising interest rates will lead to another massive wave of defaults, this one from the millions who took out adjustable-rate mortgages because the only way that they could afford the mortgage was at a 3% interest rate. Ultimately, I think that this will lead to a wave of bank failures and the implosion of the financial and retail sectors, which are now the basis of the US economy, since we hardly produce anything any more.

The collapse of the financial and retail sectors will lead to the collapse of most other sectors and a general depression. When this happens, the government budget deficit will go through the roof, because revenues will drop sharply, while domestic expenditures (poverty relief) and debt service costs (higher interest rates) will rise sharply.

Now, how will this affect the rest of the world and the dollar? First off, the collapse of the American economy and of the massive "mortgage-backed security" market will send foreign private investors running for the exits. That will push the dollar down regardless of the actions of the central banks.

Meanwhile, US economic depression will sharply cut US imports and the current account deficit. That might sound like good news, but it is not. It means that the Asian economies, which are dependent on exports to the US, will collapse as well. Furthermore, they won't be getting dollars that they can lend back to the US. Finally, they will need to spend what dollar reserves they have left to support their own economies. You might argue that the best way to support their own economies would be to support the US economy, but in the scenario that I have painted, the US private economy and consumer demand are toast, and any dollars they lend to the US will go to debt service, poverty relief, and probably war, and won't return any benefit to the Asian economies. When they stop seeing a benefit, they will stop giving us their money.

The panic selloff of dollar assets by Asian central banks hoping to rescue some value while they still can will send the dollar through the floor. The US will no longer be able to import much.

I do not see why Europe would intervene here. It would be throwing its money away. Europe does not depend on exports to the US. Its economy will be hurt by the loss of the US market, but unlike Asia it has a strong internal market and will be insulated from the depression that will sweep Asia and the United States. The UK may be an exception here. It has an economy, much like the US, built on debt, and it is much more dependent on the US market than other parts of Europe. But countries like Germany, France, Italy, and Finland should get by with merely a severe recession.

Meanwhile, the demand for credit by the US government will send interest rates soaring to the point where the government will not be able to service its debt. At that point, it must either repudiate the debt (which it might do when the Asians begin selling) or else print money until the debt is trivial.

Either way, the dollar's days as the world's reserve currency and the role of the US as world's consumer will be over.

[DantesPeak]

Some good comments above, and I do not want to diminish them by a point by point rebuttal.

AS far as why oil hasn't had a great apparent impact on the economy yet,
I offer two points plus one additional comment that I think is not immediately visible.

1. If you follow how General Motors has done lately, then you will realize that PO already has had an impact on some parts of the economy. GM projects it may lose $2 to $3 billion in the first part of the year before a hoped for recovery later in the year.

2. The effect of rising energy price is cumulative and gradual. Remember last year the mass media publicized the comments of the Maestro, Alan Greenspan, who said oil prices had peaked. If businesses and individuals thought higher prices were temporary, they would not adjust spending habits and prices. Only as the cumulative cost of higher energy prices sets in do businesses raise prices and consumers notice they have less to spend.

3. The most invisible reason of all is that foreigners, particularly foreign central banks, have facilitated higher energy prices and higher oil import volumes by buying dollars at an accelerating rate. The buying by FCBs has consequences too - mainly the inflationary expansion of those countries money supply to buy those dollars. Like the availability of oil that lead to its consumption, the availability of FCBs to buy dollars indirectly helps US consumers pay for the oil they buy. In reality, the link is not direct - the FCBs actually accumulate debt of the US government which frees up US savings to fund mortgages and domestic spending.


Ultimately I believe the final solution for the dollar is not continuous depreciation but a reduction of imports. Exactly how this can be accomplished is the part that no one likes to predict or discuss. This is where PO may insert itself. So far, energy imports are available as long as we are willing to pay a higher price for them. After PO, the markets may no function in the way we are used to them - oil might not be available even if the money to buy it is. PO itself may then bring on recession - or even worse economic times.

[nth]

$this->bbcode_second_pass_quote('jaakkeli', '
')No, not necessarily. Maintaining undervalued currencies has detrimental effects, not just the benefit of getting export-led growth, and being forced to provide financing for US deficits is clearly not something you'd want to get into. It's a complicated cost/benefit analysis and politics <i>will</i> be a factor in it. For example, the Japanese have a reason to keep propping up the US even when it has become economically non-beneficial, as they have an important alliance with the US, while the Chinese have no such reason. The Chinese will drop the dollar the second they think it's doing them more harm than good, as they have no reason whatsoever to keep the US afloat when they no longer benefit from it.

[nth]

$this->bbcode_second_pass_quote('marko', '
')The current account deficit is not the only financial problem facing the US. The US also has a large government budget deficit, an extremely low rate of savings, a real estate bubble, and a very high rate of consumer debt. Because wages have not risen in real terms, growth in consumer spending has come, essentially, from borrowing, often borrowing from the inflated value of real estate.

[pogoliamo]

GM is in a pretty miserable situation, with credit rating downgraded to
BBB, or almost a "junk".
I'll be currious to see that the usofa govt is going to do about it...
Too big to fail, but too expensive to subsidize. Will it default???

http://www.economist.com/agenda/displayStory.cfm?story_id=3782915

http://justin.cerastes.org/archives/000141.html

[nth]

$this->bbcode_second_pass_quote('pogoliamo', 'G')M is in a pretty miserable situation, with credit rating downgraded to
BBB, or almost a "junk".
I'll be currious to see that the usofa govt is going to do about it...
Too big to fail, but too expensive to subsidize. Will it default???

http://www.economist.com/agenda/displayStory.cfm?story_id=3782915

http://justin.cerastes.org/archives/000141.html

[marko]

Here are some responses to nth's questions.
You are right that most of the problems I mention have existed before in some form. However, they have not been anywhere near as large in relation to GDP. Most of these problems are at unprecedented levels, and they are occurring together in an unprecedented way, creating the perfect financial storm.

Let's start with the current account deficit, which is mainly a trade deficit. The US current account deficit is currently about 6% of GDP. This is an unprecedented percentage for the US and a percentage that has caused serious financial crises in other countries. The current account deficit is deteriorating at a rate of almost 1% of GDP per year, and the only foreseeable way to reduce this deficit is a severe recession in the US. What is also completely unprecedented is a rate of savings in the US that is near zero. This makes the US almost completely dependent on attracting savings from foreign countries, which will be hard to do if we have a recession and a falling dollar. Finally, we have a ratio of housing prices and mortgage debt to income that is unprecedented in the history of the US. This is true at the national level, but it is especially extreme when you look at this phenomenon on a regional level. In the Northeast and in California, the housing bubble and its associated debt are way beyond anything that has ever happened in the past. The collapse of that house of cards could send the regional economies of the San Francisco Bay Area, Southern California, Washington DC, Boston, and New York crashing, and along with them, many of the countries' financial institutions.

Add all of these things up, and it is clear that the next recession has the potential to spiral into something far worse than any of us has seen in our lifetimes.

In inflation-adjusted terms, recessions occurred in the 70s mainly as a result of oil prices around current levels. True, oil prices rose to around $80 a barrel in current terms during those recessions, but the recessions were started by prices no higher than the current ones. Now, I have seen the argument that our economy is now less petroleum-intensive than it was in the 1970s, though I have also seen that argument debunked. What I am wondering is why you set a threshold so high, at $84? I would expect to see a recession if oil prices are sustained much above $70.

Price is just a rationing device. Rising prices indicate that supply is insufficient to meet demand at the previous price point. So rising prices in fact indicate shortage. As prices rise, they cut into producers' profits and/or consumers' ability to purchase other goods (or service their debt). Eventually producers are likely to resort to layoffs to maintain profits. This is how rising prices can cause a recession, even if in global terms the volume of supply is rising slightly.

The historical ratio of adjustable to fixed rate mortgages is not the point. The point is that the size of these mortgages relative to income is unprecedented, such that buyers can ONLY afford those mortgages if their interest rates remain at historically low levels. This is what is new.

Yes, but that happened in a context in which domestic savings were relatively high and the US was not dependent on nearly $3 billion of foreign lending every business day. When it becomes clear how risky those loans to the US really are, private foreign investors are going to stop lending us money or require substantially higher interest rates, which will intensify a debt crisis that will tend to spiral out of control.

Yes, my scenario is predicated on a collapse of the financial and retail sectors, both of which have been propped up by unsustainable foreign lending. I thought that I made that clear in my earlier post. Sorry for any confusion

Yes, it does sound like the Great Depression, doesn't it? Except that during the 1930s, the US was a net creditor, not a net debtor, and was not dependent on a flow of foreign lending. Also, in the 1930s, the US had a current account surplus. This was because the US had a very strong manufacturing sector. These things all set a floor for the Great Depression such that unemployment never exceeded 30%. I think that we are likely to see unemployment of 50% when our economy collapses, because our economy no longer produces many things that people in other nations want, or even many of the things that US consumers need.

That said, I do think that a collapse of the dollar and of wages will set the stage for a revival of US manufacturing, probably based mainly on coal and nuclear power, but this will take years to rebuild, and these will be years of great hardship for most Americans.

True. And I sincerely hope that I am wrong about this, too. I personally do not have enough resources to weather the kind of collapse I have described without a lot of personal hardship. I hope that I am wrong, but I do not see a plausible way to avoid this, given the present constellation of factors.

The one thing that might possibly save us from this financial peril would be a US government that very proactively intervened to correct the most dangerous conditions, like the federal budget deficit (which adds nearly 6% of GDP to US demand for credit), and the dangerously low rate of savings. The government could address both problems in one fell swoop by increasing taxes, and particularly consumption taxes, which could be targeted at the top earners who gained a windfall from Bush's tax cut. There should also be a tax on financial transactions to shore up a shaky financial system.

Personally, I think that the US also needs to quit the WTO and either quit or renegotiate NAFTA, because our current trade relations, particularly with China, are doing great long-term harm to the economic base of this country.

Of course, none of these policies has a snowball's chance in hell with the current administration. So we seem to be doomed.

Yes, Europe will see losses on its US subsidiaries. Some European firms may even fail as a result. Europe will see a severe recession. But as a percentage of total profits of all European firms, I don't think that US revenues come to more than single digits. Likewise trade with the US as a percentage of euro-zone GDP. Add these two up and you may have a hit to the euro-zone economy of around 10-15% of GDP. This is indeed a very severe recession, but nothing like the collapse that I see for the US and Asia.

But this isn't really my point. My point is that everyone recognizes that this situation is unsustainable. The Europeans know that they are going to have to write off the US sooner or later. I think that they will choose to cut their losses when the US economy collapses. The size of the US imbalances is so great that they would probably swamp any European attempt to "save" the US and pull the European economy into a collapse right along with the US and Asia. European central bankers and investors are prudent, unlike most in the US. I think that they will choose to cut their losses while they can and take a severe recession rather than throw good money after bad and risk a total collapse of their own economy.

I think that it will happen within the next 7 or 8 years almost for certain, and probably within the next 3 to 4 years. As I have said, I do see hardship on a global scale. And I do think that US hegemony will erode.

On the geopolitical front, by the way, I am a little more hopeful than some. I think that the extreme financial and economic weakness of the US will force it to sharply cut back on its overseas military operations. With Russia remaining weak economically and China also greatly weakened, I actually see a lessening of tensions globally. The economic decline will reduce demand for petroleum and put off the most difficult consequences of the oil peak. Geopolitically, regional powers such as Iran, India, and Brazil will have greater relative importance. Europe would probably continue to take a more independent political stand. But that could well increase stability, at least in the short run, with the regional powers acting as buffers and courting more than one larger power at a time.

[RiverRat]

I have an interesting perspective on the state of real estate in the US.

I’m involved with ‘quality assurance’ for a nationwide appraisal and title management company. My focus is strictly on real estate appraisal. I have the luxury of seeing many dozens of appraisals on a daily basis from across the county.

All I can say about the ‘paper wealth’ of this country is… WOW !!!

The wealth is mind numbing.

$700k - $800k properties are routine. $1+ mil are common. $3 mil does not even raise an eyebrow. Only at around $5 - $6 mil do we say … ‘oohh wow … look a this shack’

I’ve seen quite a few subdivisions across the country that have over 300 homes in them all worth $700k - $800k each.

It’s nothing to see $300k, $400k and $500k … 2nd mortgages !!!

Even in ‘podunk’ Minnesota, I hear appraisers saying … ‘ values are going thru the roof’

I see and hear more and more about ‘speculation’ and ‘fraud’

I could go on and on …

[marko]

$this->bbcode_second_pass_quote('RiverRat', '
')It’s nothing to see $300k, $400k and $500k … 2nd mortgages !!!

Even in ‘podunk’ Minnesota, I hear appraisers saying … ‘ values are going thru the roof’

[skiwi]

I expect cheap things I buy to last a few years. Durable to me means to last at least 10 years..like my first mac

US durable orders weak, jobless claims rise

New orders for US-made durable goods barely gained last month but sales of new home soared, mixed news that analysts said did little to alter a view of a solidly expanding US economy.

In a somewhat disappointing signal on the factory sector, the Commerce Department said orders for durable goods - pricey items meant to last three years or more - edged up 0.3 per cent in February. This was well below the 1 per cent gain expected on Wall Street.

But the department said sales of new US homes soared 9.4 per cent in February, the largest jump in more than four years.

A third report showed claims for jobless aid unexpectedly rose last week, but remained at levels suggesting a continued labor-market recovery....

...Strong aircraft orders kept overall durable goods demand aloft last month, offsetting weakness elsewhere, including a 1.2 per cent drop in vehicle orders.

Civilian aircraft orders shot up 32.1 per cent, partly reversing a big January drop, and defence aircraft orders gained 11.3 per cent. Economists had looked for a strong non-defence figure after Ryanair announced an order for planes from Boeing Co. valued at more than $4 billion.

Excluding a 1.6 per cent transportation orders gain, durable goods demand would have fallen 0.2 per cent....

[Doly]

Maybe USA isn't expecting to be around for long.

[RiverRat]

$this->bbcode_second_pass_quote('', 'M')arko ...Here in the Boston area where I live, you hear about $1 million "dumps" that need work in some neighborhoods.