By Neville Bennett I am drawn irresistibly to the image of Emperor Nero playing his fiddle while Rome was burning: it is a metaphor of an ebullient Wall Street elite ignoring the massive destruction of wealth that it has inflicted on the world. Moreover, incomes are also failing and I believe consumer spending will also decline. This is important as consumer spending drives about 70% of US GDP. The reality is encapsulated in Edmund Phelps's belief that it will take 15 years for American consumers to recover. Phelps won a Nobel Prize in Economics 2006. The crisis is still reducing wealth and income. I resolved to tackle this issue when I read a report that it is expected that 50% of US mortgages household will be underwater next year. Moreover incomes fell more than anytime in the last four years in June. Unemployment is headed for 10%, a several million people will have exhausted their unemployment benefits shortly.
The ravages of the Greater Depression will be found throughout the globe. Matters might be as bad in the UK. There will be less partying now in London, Dublin, Dubai and Reykjavik than formerly. So the US's travails are everyone's travails including New Zealand's. The destruction of wealth, deflating assets, and falling incomes (deposits, dividends as well as salaries and wages) is widespread and surprisingly unacknowledged. The scary thing is that household equity in the US has declined by 94%. Wealth Gross financial wealth ( shares, bonds and deposits etc ) reached a peak of US$22 trillion in October 2007, before making the greatest fall in history to $12 tln in early March this year. The recent share-market market rally has raised wealth back to $15.4 tln, but much damage has been done, with a decline of 30% from the peak. While financial assets have decreased, household debt levels have plateaued for three years at about US$13 tln. But assets and debts are close in value, so net equity is less than US$1 tln. Net equity has declined by 94% since 2007. Households still have some liquid assets in money market accounts, but there is insufficient to raise equity markets on capital flows. Housing According to a recent Deutsche Bank report, the percentage of US homeowners who owe more than their house is worth will nearly double from the present 26% now, to 48% in 2011. Large increases will arise in prime mortgages issued by Fannie May and Freddie Mac. "Jumbo" mortgage households are especially at risk. Although there is some recent stabilization in housing values, Deutsche argues that home prices will fall again in 2011. Commercial property seems even more vulnerable. Income US household income has fallen the most in 50 years. Recoveries depend on increased spending and investment, so it is unfortunate that wages and salaries fell 4.7% in June y-o-y, the biggest fall since records began in 1960. This decrease occurred despite recent tax cuts and a Social Security bonus. Personal income, which includes rents and dividends etc fell by 1.3% in June alone. This may deteriorate further as the number of jobless rises, and a number of people who have been unemployed for 6 months will no longer receive a benefit. Moreover, income and spending will be hit in the second half of 2009 by higher fuel prices and the one-off payment to retirees. Companies have lowered pay and hours worked, and some have cut contributions to retirement funds. Poverty is increasing in a country without adequate social security. There are now more than 34 million Americans on food stamps. Company earnings The stock market boom is not earnings-driven. The mantra justifying stock rises is that earnings were "better than expected". So when companies results were better than expected, and 44% were, the market responded positively. But expectations are very low, which is appropriate as earnings are meager. Reported earning on the S&P500 are 36% lower than last year. The P/E on the S&P500 is 24. Consumers squeezed Consumption is of increasing importance to US GDP. It ranged around 62% of GDP from 1951 to 1982. It then adopted a rising trajectory to 70% in 2003. It has leveled off at 70% since then, with a 2% fall in late 2007. Several factors will squeeze consumer spending in the medium term, so strong economic growth is not expected. The first change is a stronger preference for saving. This always happens in recessions as consumers try to build a cushion against unemployment and medical costs. Perhaps the greatest change is in debt servicing (other than mortgage servicing). Consumer have large negative balances on credit cards as well as car loans. About 14% of take home pay goes in interest payments - quite a steep rise since 1995. Consumer credit has been falling for several months; not so much because consumers are cutting demand but more because lenders face too many bad debts. The ratio of consumer credit to disposable personal income is still at a record high, so companies are reducing lending limits. Tighter credit and a desire to save will reduce consumption, and thereby growth, by about 0.75% p.a. Most commentators believe that the wealth effect has worn off as houses fall in value and employment get tighter. What Next? A long era has passed where millions of people in the US (and elsewhere) relied on rising real estate and share markets, and plentiful credit, to raise their standard of living to unsustainable levels. Saving plunged and borrowing skyrocketed. The era has ended in disaster; vast numbers are paying a high proportion of their income to service debt and mortgages. Many homes have fallen precipitately in value and have been repossessed. The retirement prospects of a generation have been dimmed, even impaired. People's risk appetite has abruptly changed. But security comes at the price of low yields. Bank deposits returns are not exciting. Consumers are not in a physical or psychological state to drive another boom. There cannot be a strong recovery: a long period of very low growth, like Japan's lost decades, extends to the horizon. ____________ * Neville Bennett was a long-time Senior Lecturer in History at the University of Canterbury, where he taught since 1971. His focus is economic history and markets. He is also a columnist for the NBR where a version of this item first appeared. email@example.com www.bennetteconomics.com