Irrational spending

[Captain Picard's Hair]

It has been on my mind that, in some fashion, the US "shouldn't" have been so prosperous over the past decade-plus going back into the '90's boom years. This is because so much of the growth was built on insane levels of consumer spending (much higher than in Europe/Asia) - by 2005, the US average household savings rate was just about 0%. From what I've read, the thought was that growth in equities - stocks, home equity (!!!), etc, would be sufficient to cover this. Obviously, this is emphatically not true right now. Huge consumer demand drove an American economy that otherwise wasn't as hot as it appeared, so it seems. Now, it seems that Americans are being forced to live within their means again.

My family has always been more sensible wrt finances - bucking the American trend, and I've recently learned to be frugal.

Anyway, I was just curious to hear your thoughts on the matter.

[Tsukiyumi]

Ramen noodles. 'Nuff said.

No, seriously, you're right about why the economy is the way it is. A friend of mine has literally thousands of dollars in credit card debt, and used a bank loan to finance his brand new house. How he's ever going to pay all that off on $12 an hour is beyond me.

[Mikey]

Peter Schiff, of EuroPacific Capital, unfortunately had the right of it. 4 or 5 years ago, he predicted the current downturn with amazing accuracy, down to the specific causes and symptoms, and was laughed at. The problem isn't spending of itself; it's spending money that was never there.

For a time, buying power was available for the asking. "No income verification" mortgages, for crying out loud - would you give someone a mortgage without checking to see if they had the means to pay it back? But, people were willing to take on debt above their means as long as someone was willing to float it to them. Then, the housing market boomed - I bought my house for $170,000 in 2000; in 2003, it was worth $340,000. So, people began spending all the new-found wealth they got from the housing that they bought on shaky lending. Only, there's a problem with that - that wealth was never real. I didn't "make" $170,000 on my home, because I didn't (and wasn't planning to) sell it. Well, sooner or later all the buying based on phantom money had to be backed by real money, and... uh-oh. There have always been "sub-prime" loans, but they were traditionally at a high enough interest rate that on the average the ones that stayed good absorbed the ones that went bad. Now, that cushion wasn't available. (And the CMO's, etc., that were based on junk-rated loans but sold as BB-rated loans flopped, but that's another story.)

Now, people are spooked and are saving too much, and in the wrong ways. There are people my age putting their retirements into 1% T-bills! Are you kidding me? Sure, my reitrement portfolios look awful right now, but I didn't lose anything at all - because I'm not liquidating that money right now. Over any ten-year period - including across the Great Depression - equity markets have grown. Further, nothing grows money at the long-term rate that equity investments do. I have never seen an economic downturn occur with so much money still around. The problem is that while there is liquid money out there, there is no buying power, i.e, credit. It's coming back, but in ways that are so much more careful (normally a good thing) that it handcuffs the consumer.

I fear Peter Schiff is correct again in that the answer is probably to ride it out, and let the prevailing conditions force America to restructure itself to be on a production footing, rather than a remarketing/service/borrowing one. Printing more money is both a band-aid and a Pandora's box, for obvious reasons; borrowing even more from China to prop the economy is only transferring unpayable debt from the individual to the government. It will be very painful, but we must go back to making money, not just obtaining it.

[Captain Picard's Hair]

*snip

All quite true. Thanks Mikey for expanding on my point; Tsuki's point about credit card debt is a common example of spending money you don't have. I was quick to realize (no doubt owing in part to my practical-minded upbringing) that credit cards don't expand your wealth so much as allow you to leverage your wealth more effectively (i.e., flexibly). However, it seems that even for many older than I that it has been easy to fall under the illusion that there was money in the card that wasn't there. This sort of thing has been around since the invention of plastic money, so it shouldn't be terribly surprising that an explosion of home value would create the same effect on a vastly greater scale.

I fear Peter Schiff is correct again in that the answer is probably to ride it out, and let the prevailing conditions force America to restructure itself to be on a production footing, rather than a remarketing/service/borrowing one. Printing more money is both a band-aid and a Pandora's box, for obvious reasons; borrowing even more from China to prop the economy is only transferring unpayable debt from the individual to the government. It will be very painful, but we must go back to making money, not just obtaining it.

There are always bubbles happening, and they always burst eventually. An economy based on a bubble is not a sound one. Production, creating steady, sustainable growth, never bursts of it's own accord., so certainly I see the way out as through production. Creating projects to create jobs, in the process rebuilding the faltering infrastructure across the nation, creates double benefits.

[Nutso]

Peter Schiff is a brilliant man. I love him kicking CNBC's asses in debates.

These CNBC cretins had the gall to nickname this guy "Doctor Doom," and then they didn't invite him back to their station for over 6 months. Now that his predictions have proven true, they inviting him on like crazy, but usually with some other guest to debunk him. Their best retort is to say, "look at the present strengthening of the dollar" and call this a recovery. Schiff constantly has to remind them that this is a rally on the dollar and not a permanent move. I am going to order Crash Proof tomorrow.

[Graham Kennedy]

I read an article a while back that claimed a lot of this was driven by the big expansion in economies like China and India and other rapidly developing places. He claimed that the global money supply had pretty much doubled in the last five or ten years because of this, and so there was a rather desperate push to find places to invest all this new money. A lot of it went into the mortgage market, so there was big pressure on the banks to lend more and more money to people in mortgages, so that the much larger investment companies could invest in them in turn. Which is why banks loosened up a hell of a lot on their lending policies.

I have no idea how true this is, I am far from being an economist, but it sounded plausible to me.

[Mikey]

That's true, but the problem arises when the world at large spends that new money, even though the money itself is localized. As to CPH's poitn about credit cards: very true that people too often confuse buying power (credit) with wealth. This was magnified by the paper gains in the housing market that people realized during the boom, when folks who were over-leveraged acted like they had realized real gains.