Time to Rebalance
America’s economy is set to shift away from consumption and debt and towards exports and saving. It will be its biggest transformation in decades.

By Greg Ip, The Economist, 3/31/2010, http://www.economist.com/specialreports/displayStory.cfm?story_id=15793036

Steve Hilton remembers months of despair after the collapse of Lehman Brothers in 2008. Customers rushed to the sales offices of Meritage Homes, the property firm Mr Hilton runs, not to buy houses but to cancel contracts they had already signed. “I thought for a moment the world was coming to an end,” he recalls.

In the following months Mr Hilton stepped up efforts to save his company. He gave up options to buy thousands of lots that the firm had snapped up across Arizona, Florida, Nevada and California during the boom, taking massive losses. He eventually laid off three-quarters of its 2,300 employees. He also had its houses completely redesigned to cut construction cost almost in half: simpler roofs, standardised window sizes, fewer options. Gone were the 12-foot ceilings, sweeping staircases and granite countertops everyone wanted when money was free. Meritage is now catering to the only customers able to get credit: first-time buyers with federally guaranteed loans. It is clawing its way back to health as a leaner, humbler company.

The same could be said for America. Virtually every industry has shed jobs in the past two years, but those that cater mostly to consumers have suffered most. Employment in residential construction and carmaking is down by almost a third, in retailing and banking by 8%. As the economy recovers, some of those jobs will come back, but many of them will not, because this was no ordinary recession. The bubbly asset prices, ever easier credit and cheap oil that fuelled America’s age of consumerism are not about to return.

Instead, America’s economy will undergo one of its biggest transformations in decades. This macroeconomic shift from debt and consumption to saving and exports will bring microeconomic changes too: different lifestyles, and different jobs in different places. This special report will describe that transformation, and explain why it will be tricky.

The crisis and then the recession put an abrupt end to the old economic model. Despite a small rebound recently, house prices have fallen by 29% and share prices by a similar amount since their peak. Households’ wealth has shrunk by $12 trillion, or 18%, since 2007. As a share of disposable income it is back to its level in 1995. And if consumers feel less rich, they are less inclined to spend. Banks are also less willing to lend: they have tightened loan standards, with a push from regulators who now wish they had taken a dimmer view of exotic mortgages and lax lending during the boom.

Consumer debt rose from an average of less than 80% of disposable income 20 years ago to 129% in 2007. If other crises of the past half-century are any guide, America’s consumers will spend the next six or seven years reducing their debt to more manageable levels, reckons the McKinsey Global Institute. This is already changing the composition of economic activity. Consumer spending and housing rose from 70% of GDP in 1991 to 76% in 2005 (see chart 1). By last year it had fallen back to 73%, still high by international standards.

The effect on the economy of deflated assets, tighter credit and costlier energy are already apparent. Fewer people are buying homes, and the ones they buy tend to be smaller and less opulent. In 2008 the median size of a new home shrank for the first time in 13 years. The number of credit cards in circulation has declined by almost a fifth. American Express is pulling back from credit cards and is now telling customers how to use their charge cards (which are paid off in full every month) to control their spending.

Normally, deep recessions are followed by strong recoveries as pent-up demand reasserts itself. In the recent recession GDP shrank by 3.8%, the worst drop since the second world war. In the recovery the economy might therefore be expected to grow by 6-8% and unemployment to fall steadily, as happened after two earlier recessions of comparable depth, in 1973-75 and 1981-82.

No bounce-back

But this particular recession was triggered by a financial crisis that damaged the financial system’s ability to channel savings to productive investment and left consumers and businesses struggling with surplus buildings, equipment and debt accumulated in the boom. Recovery after that kind of crisis is often slow and weak, and indeed some nine months into the upturn GDP has probably grown at an annual rate of less than 4%. Unemployment is well up throughout the country (see map), though it declined slightly in February.

So if America is to avoid the stagnation that afflicted Japan after its bubbles burst, where is the demand going to come from? In the short term the federal government has stepped up its borrowing—to 10% of GDP this year—to counteract the drop in private consumption and investment. Over the next few years this stimulus will be withdrawn. Barack Obama wants the deficit to come down to around 3% of GDP by the middle of this decade, though it is not clear how that will be achieved. Indeed, if the rest of the economy remains moribund, the government may be reluctant to withdraw the stimulus for fear of pushing the economy back into recession.

Tighter credit and lower consumer borrowing are not the only drivers of economic restructuring. A less noticed but significant push comes from higher energy prices. A strengthening dollar and ample supply kept oil cheap for most of the 1990s, feeding America’s addiction to imports. That began to change a few years before the crisis as the dollar fell and emerging markets’ growing appetite put pressure on global production capacity.

A fourfold increase in oil prices since the 1990s has rearranged both consumer and producer incentives. Sport-utility vehicles are losing popularity, policies to boost conservation and renewable energy have become bolder, and producers have found a lot more oil below America’s soil and coastal seabed. Imports of the stuff have dropped by 10% since 2006 and are likely to come down further. When natural-gas prices followed the rise in oil earlier this decade, exploration companies used new methods to get at gas trapped in shale formations from Texas to Pennsylvania. Abundant domestic shale gas should radically reduce America’s gas imports.

America’s economic geography will change too. Cheap petrol and ample credit encouraged millions of Americans to flock to southern states and to distant suburbs (“exurbs”) in search of big houses with lots of land. Now the housing bust has tied them to homes they cannot sell. Population growth in the suburbs has slowed. For the present the rise of knowledge-intensive global industries favours centres rich in infrastructure and specialised skills. Some are traditional urban cores such as New York and some are suburban edge cities that offer jobs along with affordable houses and short commutes.

A burst of productivity could lift incomes and profits. That would enable consumers to repay some of their debt yet continue to spend. The change in the mix of growth should help: productivity in construction remains low, whereas in exports the most productive companies often do best. But the hobbled financial system will make it hard for cash-hungry start-ups to get financing, so innovation will suffer.

The outlook for business investment depends on whether it is for equipment or buildings. Spending on equipment is expected to be fairly strong, having largely avoided excess in the boom period, and indeed in the fourth quarter of 2009 it raced ahead at an annual rate of 19%. In February John Chambers, the boss of Cisco Systems, a maker of networking gear, called it “one of the most robust, positive turnarounds I’ve seen in my career”. Demand for new buildings is far lower: empty shops and offices attest to ample unused capacity. And business investment typically accounts for only 10-12% of GDP, so it will never be a full substitute for consumer spending.

The road to salvation

As consumers rebuild their savings, American firms must increasingly look abroad for sales. They have a lot of ground to make up. Competition from low-wage countries, mostly China, has increasingly taken over the markets of domestic industries such as furniture, clothing or consumer electronics. Yet shifts in the pattern of global growth and the dollar are laying the groundwork for a boom in exports. “There’s a world view that the United States is the consumer of the world and emerging markets are the producer,” says Bruce Kasman, chief economist at JPMorgan Chase. “That has changed.” He reckons that America will account for just 27% of global consumption this year against emerging markets’ 34%, roughly the reverse of their shares eight years ago.

The cheaper dollar will resuscitate some industries in commoditised markets, but the main beneficiaries of the export boom will be companies that are already formidable exporters. These companies reflect America’s strengths in high-end services and highly skilled manufacturing such as medical devices, pharmaceuticals, software and engineering, as well as creative services like film, architecture and advertising. Thanks to cheap digital technology, South Korea and India now knock out the sort of low-budget films that compete with standard American fare. But only Hollywood combines the creativity, expertise and market savvy to make something like “Avatar” which has earned $2.6 billion so far, some 70% of which came from abroad. That adds up to several jumbo jets.

Exports are a classic route to recovery after a crisis. Sweden and Finland in the early 1990s and Thailand, Malaysia and South Korea in the late 1990s bounced back from recession by moving from trade deficit to surplus or expanding their surplus. But given its size and the sickly state of most other rich countries’ economies, America will find it much harder. It has been exporting more to emerging markets than to developed ones for several years, but if other countries, particularly China, do not sufficiently boost domestic demand, “the unwinding of the global imbalances could reverse quite quickly in 2010,” says an IMF staff paper.

America’s current-account deficit, the broadest measure of its trade and payments with the rest of the world, shrank from 6% of GDP in 2006 to 3% last year (see chart 2). Could it come down to zero? It nearly did in 1991 after five years of booming exports. This time the deficit started out a lot larger and the rest of the world is weaker. Still, even stabilisation around 3% would be a blessed relief because it would slow the growth in America’s indebtedness to foreigners.

America’s imbalances were years in the making and will not be undone overnight. But the elements of a rebalanced economy are already visible a 40-minute drive to the south of Mr Hilton’s offices in Scottsdale, Arizona. Around the same time that Mr Hilton was watching sales of his homes dry up, Brian Krzanich, head of global manufacturing at Intel, was finalising plans to spend $3 billion retooling his company’s massive semiconductor factories in nearby Chandler. Mr Krzanich knew perfectly well there was a recession going on. Intel’s sales were down and 3% of the staff at the factories had been laid off. But he also knew that once global demand rebounded, Intel would have to be ready to produce a new generation of cheaper, smaller and more efficient chips. “Unless you think your business is going to shrink for an extended period, like seven years, it always pays to make that investment,” he says. In the last quarter of 2009 Intel, helped by resurgent demand for technology, enjoyed record profit margins, and Mr Krzanich was approving overtime.

Mr Hilton, for his part, runs his company on the assumption that the days of easy money and exuberant consumers are gone for ever. In his office he has a yellowed copy of the Wall Street Journal from September 18th 2008, the week when Lehman failed and American International Group was bailed out. “Worst crisis since the 30s with no end in sight”, reads one headline. “I wish I’d had that article in 2005,” says Mr Hilton. He keeps it around as an antidote any time he is “feeling all happy and slappy”.

READER COMMENTS:

uru86 wrote:

The United States is not out of the woods just yet, these emerging signs are not enough. The cause of the crisis have not been fixed yet.

The first crisis is the most obvious: the Ponzi-economy. Finance still has not seen any new regulations of note [neither has the housing market] and with the financial reform bills in the congress being relatively weak, largely being drafted by lobbyists, like the health-care reform bill, and due to even more lobbyist pressure it will diluted even further. I doubt that the excesses of Wall St. will be reined in. Indeed, bankers know, as per the 'doom cycle' that they own the place, sans major reforms in campaign financing and the revolving door between K St. and Wall St. They know that they are too big to fail and that state has no choice but to save them, so they will continue to take outrageous risks and put the losses on the public purse. Of course, the other alternative that is the nationalization of the banks, or the creation of 'public option' to create effective competition with those banks that are 'too big too fail', since they have clearly become too powerful to be regulated. Therefore, without a stable banking system, no recovery is sustainable. We know that the banks are playing the same games they were before the crisis, using deposits to gamble, via proprietary lending instead of lending to businesses, etc., adding absolutely ZERO to the economy, apart from making it more unstable. Secondly, much of their profits are coming from squeezing consumers even harder with fees, etc., which further depresses spending. Therefore, if Americans are saving more that is a good thing, but the capital is unlikely to be invested wisely.

The second crisis is the crunch on aggregate demand. The working classes in the US have seen their productivity double since the 1970s, yet their real incomes have been stagnant. Therefore, to retain demand finance capital has extended to these formerly uncredit-worthy masses, credit; thus, the addiction to credit began. This addiction to credit created the conditions to keep wages low and with the influx of cheap imports, it allowed for an increase in the material standard of living creating a economy of irresponsibility. Commensurate with this decrease in real wages and increasing debt has been the gradually declining savings rate in the US. This madness reached its apex with the NINJA loan and other forms of subprime lending and on the other hand the excess profits of finance capital. By 2006-2008 it seemed that the entire economy was based on subprime, since so many mortgages and bad credit was securitized and sold off as if they were triple-AAA rated securities. The maxim that something is only as strong as its weakest link is a true here as ever, especially with securities.

The crisis came to ahead with the rising interest rates that squeezed home-owners and the indebted population to the brink of insolvency creating the foreclosure/bankruptcy crisis. This is a result of low real wages that have not kept with the productive forces of capitalism, and since wages have not kept up the UNDERLYING strength of the assets were worthless.

Has any of this been scaled back? No, its been made worse in this crisis. Productivity has increased while wages haven't, banks are not going to be adequately regulated, health-care costs will only increase, commodity prices as well. On the external balance sheet, China will not revalue the Yuan anytime soon, and external demand is still too weak to make up for the loss of demand in the US. If we want to see a REAL change in the US economy, we need to redistribute income in such a way to prop up aggregate demand among the masses. Supply side doesn't work, we have excessive savings, we have excess capacity ,etc.

www.perspectivos.blogspot.com

simon says wrote:

This article remindes me of the scene in the movie "The Patriot" near the end of the Battle of Cowpens. At this point with the British army in retreat General Cornwallis's aide advises something like, "Sir, if we reform and attack on the right, we can still take the field" to which Cornwallis replies, "You dream, sir". Likewise, the author dreams if he thinks America is ready for real reform. [HOT: The author actually said recovery will be "slow and weak".]

This recession has not done sufficient psychological damage to most Americans to have the kind of impact it suggests may come. Americans can quickly cut spending, as they did when gas went to $4+ per gallon a few years ago leading to a 5% reduction in fuel use and the end of the SUV era. But they can just as quickly break out the cash when they're feeling good. And this will only be encouraged by politicians who are unwilling to try to force their constituents to face facts - we cannot afford everything we want unless we are willing to work more. And I only partly blame the politicians. For if they do put the plain facts out, they will likely be the next group of unemployed. Americans just don't want to accept reality.

In this, though, they are no different than any other group. Consider the Greeks and their debt, the French and their perennial high unemployment, etc. etc. Nations are like alcoholics. They will not change their behavior until they find themselves in complete crisis. And while the so called Great Recession was significant, it was not a full blown crisis. It pales in comparison to the Great Depression.

Look at the result of the Great Depression. My grandparents raised their families through it. And my parents grew up in it. The impact stayed with them all their lives. They limited borrowing to a few critical items, a house and a car. They didn't replace a car just because the new model was prettier. They drove them till they dropped and along the way did a lot of the maintenance themselves. This was true in their homes to. They learned basic handyman skills so they didn't need to hire painters and plumbers and electricians except for the most skilled work. Growing up our home was in a constant state of renovation. It took 40 years from the day my parents bought the old farm house to the day the last room was finally redone. And this was not because we were poor. We were middle class, but it was a middle class family in which the parents knew what is was like to be poor and didn't want to go through it again.

This supposed Great Recession has not had that kind of psychological impact. Yes, 10% are unemployed, but 5% were before and 90% have made it through unscathed... so far. And even for the unemployed, gov't checks have been coming for over a year. Life is tough, but not in a crisis. And without a true national crisis, the nation is not yet ready to accept the reality of its situation. Existing federal, state, and local gov't debt and unfunded liabilities (Soc. Sec., Medicare, and public worker pensions,) total over $150 trillion. That is 10+ full years of GDP. This debt and liability will have to be paid for over the next 30 to 40 years. Best case scenario, 25% of GDP will need to be redirected into these areas. And this is on top of the 40% of GDP already going to gov't. And it doesn't even take into acount private debt.

Only when we hit real crisis will Americans cry uncle and accept what needs to be done.

Government has to focus on its core responsibilities - no more arts programs, no more grants for the local steam engine museum, no more PBS and NPR, etc. These are luxuries we cannot afford if we want to make it the government's job to make sure we all have health insurance.

[HOT: As we wrote in "Texas Homebuilding and the Global Collapse," and Time Magazine described in "Who's to Blame for the Financial Crisis," the 1999 repeal of the Depression-era Glass-Steagall Act led to risky home loans as banks and builder-owned mortgage companies were allowed to sell mortgage-backed securities to Wall Street investors. With little risk of their own, lenders often overlooked construction defects, building code violations, and inflated appraisals as they participated in predatory lending. And now underwater borrowers with small down payments (no skin in the game either) can easily default. We must restore regulatory oversight of both the Finance industry AND the Homebuilding industry.]

On the issue of health, create a real reform bill that tackles the cause of health costs that are twice as much per patient as seen in other industrial countries. The supposed reform bill just passed completely ignored the cost side of the issue.

Tell people right now that if they want full Soc Sec benefits, they'll be working till they're 70 and there will be no early retirement at reduced benefits. 65 came in at a time when most people didn't live that long and I have no idea where 62 came from.

And if Soc Sec requirements will be made tougher, so should all public employee pension programs. These things are generous beyond belief compared to the private sector - you remember the private sector, they pay the bills.

Get rid of our perverse tax system which penalizes work and savings and encourages spending and debt. Replace an income tax with national sales tax so people know every time they spend a dime just how much they are paying for all their government "freebies". Stop taxing interest, most of which is just a result of inflation anyway. Encourage savings so there is plenty of capital available for homebuyers and industry.

These ideas may sound radical, but they are just common sense. The fact that they sound radical shows just how far we've moved away from economic sanity.

JustLaws wrote: [That's us.]

As we wrote in "Texas Homebuilding and the Global Collapse" (http://homeownersoftexas.org/collapse.pdf), and Time Magazine described in "Who's to Blame for the Financial Crisis" (http://homeownersoftexas.org/blame.pdf), the 1999 repeal of the Depression-era Glass-Steagall Act led to risky home loans and helped fuel the bubble as banks and builder-owned mortgage companies were allowed to sell mortgage-backed securities to Wall Street investors. With little risk of their own, lenders often overlooked construction defects, building code violations, and inflated appraisals as they participated in predatory lending. And underwater borrowers with small down payments (no skin in the game either) can easily default. We must restore regulatory oversight of both the Finance industry AND the Homebuilding industry.