Heather Stewart / The Observer & Dean Baker / t r u t h o u t – 2006-12-11 00:21:35
Plunging Dollar Will Set World Markets Reeling
Heather Stewart, economics correspondent / The Observer
LONDON (December 3, 2006) — The slowdown in the US economy, which has sent the dollar into freefall over the past fortnight, will have devastating knock-on effects in markets around the world, analysts warn.
As the US slows, and consumers in the world’s biggest economy feel the buying power of the dollar in their pocket declining, global growth will be hit hard, economists say. The greenback took yet another turn for the worse on Friday, after a survey of the US manufacturing sector showed output declining for the first time in more than three years.
Wall Street is now betting that Federal Reserve chairman Ben Bernanke will slash interest rates to stave off a recession. The dollar ended the week at $1.98 against the pound, and $1.32 to the euro, but analysts say there is further weakness to come. ‘I think the dollar’s going to hell in a handbag,’ said David Bloom, currency strategist at HSBC. ‘
Some analysts have argued that a more balanced global economy, with strong growth in Asia and Europe, means the impact of a US slowdown will be limited; but Stephen Roach, chief economist at Morgan Stanley, believes China – and in turn the rest of Asia – will follow.
‘America is China’s largest export market, accounting for 21 per cent of its total exports over the past five years,’ he said, adding that economies such as Japan, Korea and Taiwan, which export directly to the US but also sell components to China that are assembled before being sent on to the US, will be hit.
Eurozone finance ministers have expressed alarm at the strength of the euro against the dollar, fearing that their exporters will suffer; but the European Central Bank is expected to push up interest rates by another quarter-point on Thursday, as it frets about inflation.
Despite increasing signs of weakening demand in the world’s biggest economy, ECB chairman Jean-Claude Trichet has insisted the 12-member single currency zone can shrug off a US slowdown.
The ECB’s in a complete state of denial,’ said Paul Mortimer-Lee, global head of market economics at BNP Paribas. ‘Quite a lot depends on how Trichet plays it at the ECB press conference next week. They’re hankering after raising rates again next year.’
Wall Street will also be watching Bernanke for signals of a change. The Fed has left rates on hold at 5.25 per cent since the summer, after increasing them 17 times over the previous two years as the US economy recovered from the post-dotcom downturn.
Bernanke sought to reassure the currency markets last week by stressing that the Fed is still concerned about inflation, but his words failed to stem the sell-off. ‘It’s as though the markets are saying, “you central bankers are worrying about inflation, we’re worrying about the reality of life”,’ said Bloom.
Mortimer-Lee said the Fed would wait for definitive evidence before making a move. ‘At the end of the tightening cycle, you know you’ve got an inflation problem, and it’s only when the evidence is overwhelming that you move.’ However, he believes that evidence will come soon: with investment in construction already falling as the housing boom turns to bust, BNP Paribas is predicting that a million jobs will be lost in the building industry alone over the coming 18 months.
Equity markets are already wobbling as investors weigh the cost of a US slowdown. Graham Turner of GFC Economics said a shake-out would raise questions about this year’s merger frenzy.
‘We have had an absolute monster year in terms of leveraged transactions,’ he said. ‘A lot of them looked quite dubious in terms of their economic value. Once the market starts to retreat, all the suspect things that went on come out of the woodwork.’
© Guardian News and Media Limited 2006
The Housing Crash Recession of 2007
Dean Baker / t r u t h o u t
(December 3, 2006) — As we approach the end of 2006, the economy’s prospects for next year appear more gloomy with each new piece of economic data. And, just like President Bush in his assessment of the situation in Iraq, the economic forecasters are gradually revising their forecasts downward, as it no longer appears credible to present the rosy pictures that they had been trying to sell.
The trouble began early in the year, when the housing boom that was supposed to continue forever turned into a housing bust. The rate of house price appreciation didn’t just slow, as most economists predicted, nor did prices simply flatten in accordance with their revised predictions. House prices began to fall.
Nationwide, house prices are now down between 1 percent and 2 percent from their levels at the same point in 2005. (The decline is between 4 percent and 5 percent, if we adjust for inflation.) The price declines in some of the most over-valued areas, like Washington, DC, and parts of Florida and California, have been considerably sharper.
In fact, the price declines are even larger than is shown in the data, because sellers now routinely make payments that are not captured in the contracted price, such as picking up some of the buyer’s closing costs or making repairs to the house before the sale. Such practices were unheard of a year ago.
When the downturn in the housing market could no longer be denied, the economic forecasters assured us that the rest of the economy would remain strong. They noted the strength in non-residential construction, strong investment in equipment and software, and of course the resilience of consumers.
This picture is not panning out well either. The non-residential sector experienced a short boom earlier in the year. This should not have been a surprise. The housing boom pulled resources (workers and construction materials) away from the non-residential sector. In some of the areas with the most over-heated housing markets, it wasn’t possible to get the workers needed to build stores, offices or other non-residential structures. This meant that when demand in the residential sector eased, resources could switch to meet the pent-up demand in the non-residential sector.
But, it was predictable that this boom would be short-lived. The residential sector is twice as large as the non-residential sector. And there just is not that much pent-up demand. There was serious overbuilding in the office and retail sectors in the late-90s boom, and the continued decline in manufacturing means demand for factory construction is limited. According to the most recent data, construction in the non-residential sector was already falling off by the end of the third quarter.
The boom in equipment and software investment also seems to have disappeared. The latest numbers in this sector have been negative also, suggesting that investment will be at best a very small positive in the economy in the next year.
This leaves us with our resilient consumer. The economic forecasters assure us that strong job growth, coupled with healthy wage growth and falling gas prices, will give consumers the money they need to keep spending.
Well this story does not look very good either. Job growth has actually been slowing over the course of the year, with the private sector adding less than 100,000 jobs on average for the last two months. Falling gas prices are a positive, but since no one had expected gas prices to soar to $3 a gallon, the fact that prices have fallen back to last year’s levels does not give consumers that much of a boost. Finally, we are looking at modest real wage growth (at 1 percent annually), but this is not extraordinary and not enough to provide a very large boost to demand.
The more important part of the story for consumers is that they are losing the ability to borrow against their homes. Last year, consumers pulled more than $800 billion in equity out of their homes. Many people bought their homes with little or no money down, and then borrowed against their equity as quickly as their house price rose. Now that house prices have turned down, they have no further equity against which to borrow. This means that these consumers have no choice but to curtail their consumption.
The evidence for this falloff is spreading by the day. Projections of weak holiday sales and slumping car sales top the list. Throw in the reports of rapidly rising rates of mortgage delinquencies and defaults and you get a clear picture of rapidly growing distress.
Of course, with all sources of demand showing weakness, job growth will slump further, and we’ll get our classic downward spiral: declining employment, falling income, falling consumption, and then further job loss. The story is not pretty, but unfortunately there is no way to prevent it. This downturn will be especially painful because it is associated with a crash of the housing bubble. This means both that many people will lose their life’s savings and also that the recession is likely to be longer lasting than most.
The picture would not have been so dire if economists had been better able to do their job. Unfortunately, economic forecasters seem more interested in happy talk than economic analysis. Not one of the “Blue-Chip 50” forecasters saw the 2001 recession coming. The record seems no better this time around.
Unfortunately, no one ever holds the forecasters accountable. Even though they all missed the last recession, and just about all of them will have missed this recession, the same group will probably still be around to miss the next recession. Some workers, like dishwashers and custodians, teachers and truck drivers, have to meet performance standards. Economic forecasters apparently just have to show up to collect their paychecks.
Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of The Conservative Nanny State: How the Wealthy Use the Government to Stay Rich and Get Richer (www.conservativenannystate.org). He also has a blog, “Beat the Press,” where he discusses the media’s coverage of economic issues. You can find it at the American Prospect’s web site.
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