Can Anything Bring Down the Monthly Payment Consumer?
Part VII (final) - January 15, 2007
Featured Economist: Dr. Richard Curtin
, director of the Surveys of Consumers at the University of Michigan
Editor: iTulip reporter Jane Burns' piece on Burnsian economics leads us into her interviews with nine leading US economists on the question: Can anything stop the Monthly Payment Consumer?
First, a definition from the iTulip Glossary.
monthly payment consumer : n. (iTulip 2006) a new kind of consumer last seen in the late 1920s when installment credit was invented to allow the middle class to afford new products which resulted from the wave of government financed WWI military technology working its way into consumer products, such as radio and refrigeration. Sustained low interest rates starting in the mid 1990s, and accelerating in the early 2000s as a result of post stock bubble collapse Fed reflation policy, created the Monthly Payment Consumer. This consumer's behavior accounts for the cost of purchases not in terms of the total price but as a monthly payment in portion of monthly income. After several years of “No Money Down!” and “Zero Interest for Six Months!” financing, not to mention interest-only and negative amortization mortgages, consumers changed their behavior, stopped saving, and became used to the idea that credit is almost free and in nearly infinite supply. The monthly cost of a home that went for $1 million in 2005 purchased with a $3.3% ARM carried the same monthly cost as a $500,000 home in 1995 purchased with a 6.6% fixed rate mortgage. The two homes are equally affordable, but the two prices apply to the same house with the 100% increase in price separated by only five to ten years' time and representing no equivalent 100% increase in value (utility). The price inflation was the result of low interest rates provided by the Fed. Capital gains income earned by speculators who made money flipping houses during the period of rapid price inflation–tax free up to $500,000 for a married couple every two years!–contributed significantly to consumption during the period.The Monthly Payment Consumer, through his and her grim determination to eek the last ounce of material enjoyment from the last dollar he or she may so easily earn or borrow as he or she can today, famously accounts for 70% of US GDP. Jane's no help, though, as she explains at the outset. The Burnsian consumer gets more joy and gratification from not buying each and every dispensable product she doesn't purchase than the folkloric consumer of economists' models gets from, in the words of George Carlin, "spending money he doesn't have on crap he doesn't need." The question is how many consumers go Burnsian on us next year. Economists interviewed are Peter Morici, University of Maryland business school professor and former chief economist of the U.S. International Trade Commission under the Clinton administration; Kevin Hassett, director of economic policy studies at the American Enterprise Institute; Lakshman Achuthan, managing director of the Economic Cycle Research Institute and a governor of the Levy Economics Institute at Bard College; James O’Sullivan, a UBS economist; Ken Goldstein, an economist with the Conference Board; Dean Baker, co-director of the Center for Economic and Policy Research; Russ Roberts, a professor of economics at George Mason University; Ron Blackwell, chief economist of the AFL-CIO; and Dr. Richard Curtin, director of the Surveys of Consumers at the University of Michigan.
Below is Jane's opening column. Every day for the next nine days, we'll publish a new economist interview below.
Does the US face recession in 2007? It will with too many consumers like me
by Jane Burns - January 9, 2007
A boyfriend once accused me of “hoarding” money because I wouldn’t shell out $500 to fix the raggedy headliner—the interior roof lining—of my classic Volvo. I explained to him the headliner didn’t bother me; the body was cherry, waxed by me every six months, and keeping up the car mechanically was expensive enough. But I couldn’t get through to him. The sight of the headliner so enraged him one day he actually ripped out a hand-rest to express his feelings. The poor dear, whose desk was covered with creditors’ demands, could not comprehend Burnsian Economics—the theory that the pleasure of saving the price of non-necessitous goods or services surpasses the pleasure of consuming them. Eventually I did replace the headliner but only when it got so undone that stuffed-in newspaper couldn’t stop rain from dripping on my head. I replaced the boyfriend, too.
We Burnsians are a tough bunch. I once reported on lower- and middle-wage earners who’d practiced Burnsian Economics to such extremes that by their senior years they had saved and invested hundreds of thousands, even millions, which they left to charity. (None had children, making it easier to save.) One woman was so tight she wouldn’t buy curtains for her house—she let vines cover her windows instead. A man chose his fast food joint for its nickel-per-hamburger price advantage. They were nuts. I could identify.
As a grade-schooler in the mid-1960s, I discovered Burnsian Economics when I lusted for white go-go boots like the dancers wore on TV’s "Hullabaloo" and "Shindig." At a discount store I picked out a pair. But when I accumulated enough quarters and dimes for the purchase, I found the thrill of the full-up coin jar preferable. I was a natural Burnsian, no surprise given my family. In Germany, my mother’s father, Vati, an Iron Cross-decorated World War I veteran with a textile business, had put away enough marks so that by the time Hitler prohibited Jews from working, his family could live on their savings for two years in Frankfurt and still have the price of passage out when places on a boat finally became available in October 1938, a month before no one could leave. Vati lived with us the last 10 years of his life. When my mother went shopping, we’d go smoke outside on the patio where I’d roll my own and he’d light up the least expensive cigar, a cigarillo, he could find. “If money can fix it,” he would philosophize, “it’s not a problem.”
At heart about freedom, Burnsian Economics troubles some people. A magazine once had me interview “Edward,” whose broker averred this client made $100,000 annually on his own in the stock market. Finding local corporations whose leaders he could meet and question, Edward bought large blocks of low-priced shares—he called them “shabby dolls” he “fixed up”—and sold when they rose. Edward never shorted a stock, because that was “unpatriotic.” He also had a full-time job as a county probation department manager and his own antique store he ran on weekends. Edward had classic Burnsian traits: While he got a kick out of making money and enjoyed things it bought, especially stuff he could buy for his daughter, what he liked most about money was freedom—to kiss off the day job, for example. He told me how at one point he had sold his house and moved into a one-room apartment near a barrio because it was all he needed at the time. But when I put this colorful fact in my copy, editors in New York figured there was something wrong: What reversal of fortune, they asked, had forced Edward to move into a "hovel"?
They would have been surprised to learn Burnsians perch in the highest aeries of business. One evening some years ago, after discovering stores had stopped carrying darning wool, which I needed to mend my fine wool and cashmere sweaters, I called the main switchboard at Coats & Clark, a major sewing goods manufacturer. After a few rings, a distinguished and cheery-sounding gentleman answered. At that hour it was either the janitor or the CEO. It was the CEO. Sales for darning wool had been so paltry—nobody mended anymore, they threw things away and bought new ones, he explained—sadly his company couldn’t make it anymore. It was a shame, he said, because at places like church bazaars one could find such wonderful old sweaters—of much higher quality than anything currently made—that needed only a little mending. I could imagine him in a three-piece suit and wingtips, picking through a pile of them.
I thought about fellow Burnsians this week as I asked economists what they thought might possibly slow the seemingly unstoppable Monthly Payment Consumer’s spending, which now is an astounding 70 percent of the nation’s Gross Domestic Product. Peter Morici, a University of Maryland business school professor and former chief economist of the International Trade Commission under the Clinton administration, kindly taught me this equation: GDP (Gross Domestic Product) = “C” (consumption) + “I” (business investment including home purchases) + “G” (government spending) + (“X” [exports] – “M” [imports]). After 9/11, President George Bush urged our “continued participation and confidence in the American economy” and told us to “fly and enjoy America’s great destination spots.” Thanks to tax cuts for top earners and low interest rates enabling the housing bubble—we eventually spent the nation out of recession, defined as two consecutive quarters of declining GDP.
But today, with the housing bubble deflating, if “C” declines sharply with it, especially in tandem with “I,” Washington can’t tap those recession-fighters again. A Democratic Congress isn’t likely to approve war economy tax cuts except modest ones for the struggling middle-class and big interest rate cuts would spook foreign investors. So, although many households could not live on their savings for two months, much less two years, it’s a good thing for the GDP right now that Burnsian Economics has so few believers, and even fewer practitioners. And just a little non-necessitous spending by Burnsians won’t kill us—I’ve examined the headliner on my new used Volvo and I may not wait for the rain.
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Dr. Richard Curtin, director of the Surveys of Consumers at the University of Michigan.
Bio: Richard T. Curtin has been the Director of the Surveys of Consumers at the Survey Research Center, The University of Michigan, since 1976. The results from the surveys are widely used by businesses and financial institutions, by federal agencies responsible for monetary and fiscal policies, as well as by academic researchers. This represents a significant, independent confirmation of the usefulness of the surveys for understanding and forecasting changes in the national economy.
Through frequent presentations and published articles, Dr. Curtin has reported on his research in behavioral economics, including consumer saving and spending behavior, household income and wealth, reactions to changing economic opportunities, and public policy preferences. Dr. Curtin received his Ph.D. in economics from the University of Michigan in 1975.
Editor's Comment: Of all of the economists interviewed for this series, Dr. Curtain has the most specialized experience and expertise in the area of consumer behavior. Nearly every professional economist who makes projections on future consumer behavior uses the UMich consumer survey data that Dr. Curtain's team has pulled together under his direction since 1976. We encourage you after reading his comments here on iTulip to look at his presentation given at Georgia State University on August 24, 2005 "The Consumer Driven Economy: Will Demand Sputter or Shift into Overdrive?" referenced in the dscussion section, below. The presentation includes two charts in particular shown in the discussion section below that, in our opinion, suggest answers to a great mystery of the post technology stock bubble economy since 2001: consumer behavior with respect to housing and energy prices is not the same in the past. He accurately predicted in 2005 that consumer demand was due to remain strong in 2006, due to a number of factors shown in the presentation. Looking forward from today, Dr. Curtain explains that consumers are likely to cut back somewhat due to the decline in housing, especially lower income brackets, but that unless an event occurs to cause consumers to change their currently positive employment and income expectations, consumption is likely to moderate rather than decline sharply.
Dr. Richard Curtain:
Now that housing prices have at least reduced their rate of growth in value and some prices have actually declined in certain areas, consumers are concerned given the role home refinancing has played in their spending. That’s why they’re insisting on discounts when they spend. In November when we asked about conditions for buying household goods and vehicles, we recorded more references to discounts than ever in the history of those questions, which came into the survey in 1948 and 1949. Because of gas prices in recent years, it’s the lower-earners who find themselves now with empty savings accounts and a high level of debt on their credit cards. The upper income groups also faced high gas prices, but they could afford it more easily. That’s why Wal-Mart is struggling and some of the big luxury store brands are not.
I don’t think consumer spending will succumb to concerns about housing prices, but that also depends on price collapses remaining localized in certain areas such as Miami, Phoenix and Las Vegas where prices were going up quite a bit. In our survey we ask consumers about conditions for buying and selling a home, and why they hold those attitudes. In October, November and December of 2006, people talked more about declining home prices than they have in 20 years. When you listen to their interests carefully, they’re ready to admit it’s a better time to buy now, but they’re not quite sure where the fall in prices will stop, and they don’t want to have remorse if they buy and prices continue to decline. That keeps them as reluctant home buyers.
Besides a drop in home prices, the other event that could generate consumer pessimism would be a significant increase in unemployment. People do see the connection between housing prices and the job market. That’s very visible to them when they drive down the road and see construction crews. Construction in cold climates slows down quite a bit in the winter, so cutbacks in construction jobs will become more apparent in the spring.
Regarding the strength of the dollar, we do get some consumers who’ve just come from abroad or are arranging a trip to Europe and they talk about how the dollar doesn’t buy as much. But the number of people in the population who have those experiences is rather small. Other people have talked about the value of the dollar changing in a different way, for instance noting that an employer is doing much better because their goods are more attractively priced overseas, or mentioning that the prices on some imported goods are growing. But they don’t express worry about the possibility of interest rates rising in connection with a falling dollar. In other countries, where 30 or 40 percent of the Gross Domestic Product is dependent on exports, you find consumers much more informed about currencies and global economic matters, which are often reported in their presses. U.S. consumers are going to become more internationally minded moving forward.
We foresee that in 2007, consumption will expand at about 3 percent, but residential investment will probably decline by nearly 10 percent. Given the consumption drives the GDP, the overall GDP will be about 2.5 percent. We don’t foresee a recession. The resilience of consumers has been amazing and withstood some events to which they would not have responded to as strongly in years past. It is true that the baby boom generation, by far the largest group in the population, has had some time to build up equity, especially home equity. That has given them a cushion to brace themselves from the more volatile events. Today consumers are concerned about home prices but they haven’t come to the conclusion they’re going to crash. If you look at year over year changes in identical homes, price increases are still above 5 percent, good by any measure.
is chief economist of the AFL-CIO
Prior to the housing bubble, there was speculative over-investment—particularly in communication and information industries—creating a dot-com boom and inflation in equity prices. What demand there’s been since the bursting of the New Economy bubble has been from the consumer, which accounts for why the recession following it was as short and shallow as it was. I thought consumer spending would have run out of steam long ago. How much debt can people assume and how can they keep spending at this rate? Our savings rate went negative in the last couple of years. People are spending more than their household income, something we haven’t seen since the Great Depression. Families have to send all their members into the workforce and they’re spending just to maintain their standard of living. The prices of things like education and health are spiraling, and some people are really struggling to make a living.
Voluntary spending, spending on things people don’t need, isn’t a factor in an economy going into recession because America’s wealthiest families, which have the money to spend voluntarily now, have enough income to keep doing it. It’s the people who are spending money they don’t have, and who have very high debt, who are forced to cut back. Every household has discretionary spending—working people take vacation, but if their budgets are strained, they skip a year or they drive instead of flying. That can bring the economy down if enough do that, but it’s a matter of how fast and how far.
People have been able to consume more than their income justifies because their homes have appreciated. A lot of the reason for that is China, which is manipulating the yuan, keeping it high relative to the dollar by buying dollars with their export earnings. China buys a lot of U.S. paper, but it also buys mortgage-backed securities, which has the effect of causing interest rates to be lower. Consumers are spending a lot on imported goods, so our trade deficit is approaching $800 billion a year. We’re borrowing close to $3 billion a day to pay for things we consume that as a nation we no longer produce. No one believes this is sustainable.
If something happened to the value of the dollar, if the Chinese, who hold all these U.S. assets, started moving to exits, everybody else would—they’d want to be out of the dollar, and it would plunge. To stop it, the Federal Reserve Board would have to start jacking up interest rates to make holding our assets more attractive. The big hit would be in investment, particularly in construction. People would lose construction-related jobs and stop buying anything they have to borrow for, like vehicles.
Now we have sliding housing prices and residential investment is off. Spending is slowing down. Next year will reductions in housing investment and consumer spending take the wind out of an already tepid economic recovery and even produce a recession? I’m not predicting it, but I wouldn’t be at all surprised.
Russ Roberts, a professor of economics at George Mason University and author of The Invisible Heart: An Economic Romancehttp://www.assoc-amazon.com/e/ir?t=w...1&a=0262182106
. Milton Friedman called it "a page-turning love story that also teaches an impressive amount of good economics." George Will called it "delightfully didactic."
Most people treat consumer confidence as if it were the foundation of economic health. My view is that it reflects the health of the economy—it doesn’t drive it. We ask what will happen if consumers get less confident and stop spending, as if the great machine will slow to a halt if they’re not constantly pumping the pedals. I don’t think that’s a very appropriate way to look at what they do. Consumers are constantly making decisions about what to buy and how much to save and those decisions can change if incentives such as tax policy change. But I don’t worry that there’s this sudden mass psychological phenomenon where people panic or become anxious with an independent effect on the economy. Contrary to what some write and read, I think the economy is doing pretty well and consumers are content to spend what they have. There’s no mystery.
Some people think it’s Wile E. Coyote running off a cliff and finding there’s nothing. That’s not how the economy works. It’s healthy. Employment is very strong, and yes, there are those out there saying the middle class is disappearing and job security is low, but there’s no evidence for that and the spending numbers, the activity, suggest a much rosier picture. Spending activity reflects the picture, it doesn’t create it.
It’s a sport to read the consumer confidence numbers and figure out what the future holds. To me confidence numbers say more about the past, about what the economy has been doing. As for savings, it’s poorly measured in the United States. Our tax policy is a chaotic and ugly jumble of regulations that discourage savings; we could have better tax policy. But looking at measured savings as a picture of future prosperity is not very helpful. The proportion of 18- and 19-year-olds in college is at an all-time time high—and that’s really savings. Nobody measures the foregone consumption financing all those students that’s going to lead to more prosperity tomorrow as part of official savings. Measured savings is a very blunt tool. The accumulation of what economists call human capital is very important, and not measured.
Dean Baker, co-director of the Center for Economic and Policy Research.
Consumer spending has been driven by people borrowing against their home equity at record rates. They’ve borrowed for all kinds of things—for new cars and vacations in some cases, to make ends meet in others. As soon as they run out of cash, they borrow again as long as their house value keeps going up. That ends when prices start falling and a lot of people have no more to borrow. If we have a big increase in interest rates, it would certainly become more costly to borrow against a house. Interest rates have stayed remarkably low because of the central banks of Japan and China buying large amounts of our long-term Treasury notes. If foreign investors become fearful of inflation—which comes about because of rising material prices, oil prices, slower productivity growth and higher wages—they will want higher interests rates on those notes in order to hold them. Housing prices are the most important factor in this scenario. If they collapse and foreign investors panic about the dollar and decide it’s overvalued and start dumping it, everything’s going to fall, leading to higher inflation and presumably higher interest rates.
Consumers are the bulk of the story—70 percent of demand comes from consumer consumption. Probably a third of that consumption is variable to some extent. People could change purchases such as buying new cars and furniture. A mass change in consumption would mean a recession, and it’s very likely to happen. People are going to hit the wall in terms of how much they can borrow with the housing market going down.
Consumers tend to not think ahead but to hope for the best—they stop spending when they hit their limits. It’s bad for people if they don’t stop discretionary spending that they can’t afford, but it’s bad for the economy if they do. We have to change courses. We have a huge trade deficit. If we didn’t, we’d have more demand in our economy—people would be buying more stuff produced here, and it would create more jobs here. We’ve lost control of our interest rates and there is no easy way to get it back. The Fed can easily control short-term rates, but it has a very hard time controlling long-term rates. When other central banks want to pursue a different policy than the Fed—for example to promote low long-term interest rates, as is the case now—it is not a simple matter for the Fed to counteract it.
James O’Sullivan, a UBS economist.
We’ve had ups and downs in spending growth over the years. Certainly you’ve seen some periods with stronger growth than others. The question is how much the downturn in housing feeds on itself through a weaker labor market, which depresses consumer spending. Ultimately the main driver of what’s happening is the downturn in housing. There’s recent evidence that the rate of growth in consumer spending is slowing, but it’s not dramatic. I’d be surprised if it stopped, but it’s highly likely the trend in growth will be slower next year than it has been over the last couple of years. Over the last four quarters real consumer spending is up 2.7 percent. And that’s down from 3.8 percent growth in the previous four quarters. I suspect that slowing at least partly reflects weakening in housing because there’s less of a benefit from housing wealth effects. Certainly you’ve seen that decreased housing wealth effect reflected in the decline of auto sales. People have been tapping wealth through home equity loans, which is declining as home prices slow. Tapping housing wealth is over at this point.
Consumer spending is now 70 percent of the Gross Domestic Product
(GDP). If the rate of growth of consumer spending goes from 3.75 percent, where we were a year ago, down 1.75 points or so to 2 percent, that would take more than a point off GDP growth. If consumer spending growth goes further down, to 1 percent from 3.75 percent, the odds are the economy is in recession. I don’t think that will happen, but consumer spending will go to 2 percent growth in 2007. To what extent does that weakness in consumer spending feed on itself, leading employers to cut back hiring because there’s less demand for products? That’s how momentum builds into recession. It remains to be seen how far down this momentum in reduced spending growth will carry us. There is clear evidence of slowing, but so far there’s no collapse. If in the short run consumers spend less and save and invest more, that’s negative for the economy—but over the long run it’s positive. Over the long haul you need savings—including personal savings—to finance investments, and ultimately investments are the key to productivity and real wage gains and high living standards. But in the short run, if consumers spend less and save and invest more, that’s negative for the economy. That’s the paradox.
is an economist with the Conference Board
The announcement of the death of the consumer is a bit premature. The Federal Reserve has a publication called the “Flow of Funds Account of the U.S.” It says that in 2005 and into the first quarter of 2006, you and I and every other consumer in America had a total of $12.2 trillion debt—our mortgages, credit cards, bank loans, etc., all coming to $12.2 trillion. That’s a lot of money when you consider the Gross Domestic Product is $13 trillion. It looks like we’re about to drown in red ink—except when you look at assets. That’s almost $40 trillion in IRAs, 401ks, and all the home equity. What this says is the bankers who’ve lent money to us haven’t lost their minds. They’ve lent to us because they’re convinced we have the assets even if something happens to our jobs. Our personal balance sheets are not in that bad shape.
There’s no question that a number of households, may 1 or 2 percent, maybe as many as 3 percent, are indeed in a problem situation where they could lose their homes and declare bankruptcy. But on average, most of us have a lot of debt, but it’s debt we can handle. Something else has to happen to make people decrease consumption. If people think there’s a slowing of job growth, if there’s that perception and word of mouth while prices are rising faster than wages, that’s probably the biggest influence on consumer attitudes and spending, the material out of which you get consumers who are more cautious, telling retailers that unless something is hot, it’s got to be discounted. You can lay that argument all out without any reference to debt.
We’re reporting that retailers think that if they don’t discount, they’re not going to sell. They might be putting themselves into the same bind that auto makers did last year offering steep employee discounts and then people wouldn’t buy without them. Consequently there’s been a big cutback in auto production—20 million new cars and trucks, now down to 16, 17 million. And yet retailers discounting this holiday season are flirting with the same risk. What’s motivating retailers is cautious consumers who have to be induced to buy because they’re concerned about wages and prices and the dearth of new, better paying jobs. Six months ago we got 160,000, 170,000 new jobs a month and people were complaining it was only that. Now new monthly job creation is under 125,000; it’s so low you have people sidestepping the whole question about jobs and instead pointing to the low unemployment numbers. The price story tied to the job story—this is new-new within the last couple of months.
is director of economic policy studies at the American Enterprise Institute.
A pull-back in consumer spending is not going to occur. For consumers to stop consuming, their incomes would have to plummet or go down a lot and believe that their incomes would stay down a long time. And the economy is just not that bad. They would stop spending if they thought the economy was going to be very bad, but it hasn’t been very bad in a long, long time. People feel good about keeping their jobs and, if they lose one, about getting a new one. Your own circumstances are what cause you to spend or not spend. The fact most people aren’t saving means they’re optimistic. If they were worried—thinking oh well, it could be tough next month—they’d stop spending.
is managing director of the Economic Cycle Research Institute and a governor of the Levy Economics Institute at Bard College
Our approach to the economy at the Economic Cycle Research Institute (ECRI) is from a cyclical perspective. Spending, of which consumer spending is a big part, is one of the key indicators used to define economic activity at any moment in time. While the rate of growth of consumer spending is decreasing, consumers aren’t saving more because they don’t feel like they’re going to get fired, unemployment is pretty low, a number of people are getting some raises and they are still able to borrow long-term money at low rates. Relative to last year, they don’t feel as good, but they don’t feel like they’re falling off a cliff, either. Consumers are adjusting spending subconsciously and they have it about right. They’re playing it a little more conservatively, but they don’t think the sky is falling. That’s looking at the near term, about the next three quarters. Beyond that, there could be a major recession by the end of 2007 or early 2008—there is a limit to how far ahead we can see with our leading indexes.
From a cyclical perspective, in addition to consumer spending there are three other factors—employment, production and income—we look at to take the temperature of the economy. With that in mind, when we ask when will consumers take a spending break, I would say that is essentially when you’re having a recession—a contraction in economic activity when these four aspects move together. So, from our perspective, when I look at the question of when is the next recession, while the risk has risen over the last quarter or two, it doesn’t look like we’re stumbling down that path. For the time being we may have veered away from that path, and I say that based on leading indexes.
Looking at things like the ECRI’s weekly leading index, you’ll see that while it’s not pointing toward a robust economy, albeit at lower rates it’s still pointing toward continued growth. What is the story behind all that? You’ve got the consumer buffeted positively and negatively from different angles. The housing or stock markets can affect consumers. Most recently, finally, after a long time, housing took a downturn, and that has had a negative effect on consumer spending, and is part of the reason the economy has slowed. However, in and of itself, a downtown in housing or stocks is not enough to cause an outright recession. For that you have to have a confluence of negative events. The downturn in housing prices is partly offset by some growth in jobs, not great growth but some, some growth in income and interest rates that remain fairly low. You have the Fed raising short-term interest rates, but long-term interest rates have been falling, and consumers are affected by both types. Short-term rates affect credit card purchases but at the same time when long term rates go down you have access through the mortgage market to capital at a cheaper price, which continues to support the consumer a little bit through a home refinancing or an outright purchase opportunity. When you add all this up, housing is weak, but rates are low, there’s some job and income growth—overall it’s slower growth and consumer spending, but not a collapse. And I am not worried about an effect on consumer spending and interest rates by foreign investor shedding U.S. notes. There are only three big currencies in the world—the dollar, the euro and the yen—and if you’ve got a ton of cash to invest because of large exports to the West and petrol money, you have to put some of it in dollars.
Peter Morici is a University of Maryland business school professor and former chief economist of the U.S. International Trade Commission under the Clinton administration.
As housing prices fall, people are saving a bit more. The savings rate is still negative, but not as negative as it has been. The growth in consumption is slowing and this will lead to slower growth in 2007 than we had in 2006. Why are consumers slowing down? They had rising housing values, which caused them to feel richer and borrow. Now that they’re feeling poorer, they won’t be shoring up spending by borrowing against their homes. They won’t stop spending, but growth in spending will slow. The reality is people aren’t being dumb by spending. What they’re doing is not irrational. It’s not unreasonable that the growth of spending will slow now that their housing prices are falling a bit. A house is an asset, and asset values do fluctuate.
Looking at the Gross Domestic Product—consumption (C) plus investment (I) plus government (G) plus [exports (E) minus imports (M)]—I, of which new housing construction is a big part, is already going down, and falling home prices drag “C,” consumer spending, down a bit. I’m expecting “C” to rise more than 2 percent next year—so the economy would only moderate and overall growth slow to 2.5 percent. But if consumption increases by less than 1 percent and investment is negative, you’re going to have a recession. I put the risk of recession next year at 25 percent.
A large element driving all this is our huge trade deficit. “E” minus “M” is negative, and the only thing that can save the economy from mediocre growth or recession would be a significant improvement in that number. Achieving this would require President George Bush to do something substantive about China, which he is unlikely to do because that would displease the multi-national corporations. Bush could get behind the Schumer-Graham
legislation to put tariffs on subsidized Chinese imports if China will not realign its currency
. Either China realigns its currency to reduce its trade surplus, or the United States should take direct action to reduce the surplus. That would not be protectionist because we’re merely responding to Chinese mercantilism. Right now our Treasury Department is advocating unilateral economic disarmament with regard to China. There’s only one word that can describe Bush’s China trade policy—appeasement.
Tomorrow, please return to read the opinion of Dr. Richard Curtin, director of the Surveys of Consumers at the University of Michigan.
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