January 7, 2008 (With 2011 notes)
As the 2007 shopping days of Christmas fade behind us, a look forward seems in order.
About 70% of our GDP is based on consumer (household) purchasing. (Still true…) As a country we buy more than we sell, in total dollar value, so while we export some of what we make, we buy back a larger amount, sending dollars outside of our country’s internal economy at a faster rate than we get them from the rest of the world. (The trade deficit has reduced somewhat, but still about 10% of GDP). That’s one source of a rising supply of dollars in the currency markets. Our dollar’s value has fallen against foreign currencies recently, because other countries don’t want as many dollars now as they used to. (As other currencies like the Euro have faltered, ours has gotten better again. Like being an ugly boy at a dance who is joined by many other uglier boys.) Foreigners are coming here to get things that used to cost them a lot more in American bucks. Recent figures put the discount at 30% or higher. That has improved our balance of trade, but it’s a long way from evening things up. We’re still buying more than we sell, in dollar value.
Why don’t those other countries want our dollars as much, and why do they want to spend the ones they do have? Because they see that the fundamental value of the dollar, which is essentially the guarantee of the U.S. government, is diminishing. We have artificially suppressed our interest rates (the reduced Fed rate and our legislators’ desire to bail out the large banks’ investment portfolios with a sub-prime adjustment freeze). This reflects a lower risk-reward factor than the dollar deserves considering our mounting debt and the ongoing pressure of inflation due to increases in many fundamental elements of the CPI. If the interest rates don’t reflect the market’s view of the risk, then the adjustment has to come out of the “principle”, i.e., the dollar itself. And it doesn’t help that our government is pushing a lot of money into the supply to ward off lack of capital in the financial markets. This simply puts more dollars into the supply-demand equation at the same time the number of buyers is shrinking. (Interest rates are at historical lows still. Overall inflation hasn’t hit yet, because unemployment stays high and therefore our consumer-based economy can’t buy the stuff on the shelves so much. Keeps the prices low. Keeps companies from hiring because they can’t make much money on current pricing.)
The good news is that this correction in value of the dollar will help us in the long run to even out the costs of products and services around the world, keeping more of our created value within our country. (Wage rates are rising fastest in places like China and India.) The bad news is that if we don’t get our debt under control (private and government alike), either interest rates will have to go up (to attract buyers of U.S. debt and support the value of the dollar) or the dollar will go a lot farther down, making the things we currently have no choice in buying externally really, really expensive. (And so it did.) As if $90-$100 per barrel for oil isn’t expensive enough as it is. And if oil contract denomination moves away from the dollar, making it even weaker, then the price will go up more. (Not likely now, because the European Union fell into the same debt trap as we did.) And that’s just oil and gasoline. Housing, clothes and food have all risen significantly as well. (Housing has dropped, clothes has stayed even and food has indeed continued to rise.)
Because the median household typically funds its lifestyle through debt (credit cards, financed car purchases, first mortgages and equity lines of credit, etc.), that means there’s no room to give on the household budget. What’s a head of household to do? Get more debt? That’s getting much harder. Demand a raise? Maybe. And if you can’t get that, finally, cut out some of the spending. (Which did happen and since later in 2008 when the stock market went into its convulsions, consumer spending has been really tight.)
When our internal consumption engine starts to lighten up on the throttle because of these household economic realities, then we will experience the next recession. (And so we did. Some say we still are, if you don’t count the official measure but rather the measure of how tough it is to find work and pay the bills.) I know the government projections are for a “soft landing”, which means that we expect to correct our fiscal profligacy in time to increase the value of the dollar and justify our lower interest rate targets. I just don’t see that happening when our national debt stands at $ 9.1 trillion and rising, representing more than 65% of our current annual GDP. Our 2007 federal spending deficit of about $172 billion, (not counting current Social Security surpluses used to augment revenue shortfalls), represents 6 % of the government’s budget and 1.2 % of the GDP. The current administration doesn’t project a balanced budget until 2012, let alone a reduction in the total debt. The interest alone on that debt is hundreds of billions of dollars annually. (Balance budget by 2012? Wow, that was a fantasy. National debt is now about $15 trillion, or over 100% of GDP. This year’s federal budget deficit will be about $1 trillion. The current administration is really trying to put the ingredients in place, i.e., spending reductions and tax increases on higher incomes to equalize the proportion taxed.)
And what government spending could we cut? Even if we decided tomorrow to get out of Iraq and some number of the over 700 locations around the world where we station more than a million military and contractor personnel, it would take years and more money to make the change. (Slowly, we are doing this. We’ve dramatically reduced our costs and involvement in Iraq. Afghanistan is moving ahead on independent control of its territories.) Slash “entitlements”? That word implies that people are getting something for nothing, something they haven’t worked for. I don’t consider my Social Security and Medicare benefits due me as “freebies”. I’ve been paying a significant portion of my income into these funds for decades, just so I could have at least one source of money for living and health care when I might reach a point in life where I can’t earn the income I do now. Isn’t that the whole reason we as a country put those programs into place? We didn’t want another Great Depression where millions of people lived in the dirt and many thousands died for lack of ability to take care of themselves. (If Medicare payouts to service providers are reduced, the whole healthcare system will wring the expenses out of their models and healthcare costs will indeed decline in the coming years. The Medicare system is the largest single buying decision-maker in healthcare. With reduced reimbursements, healthcare as an industry will have to get more cost-effective. It’s already happening.)
I don’t see a way around a recession. (I may have been right, but just remember, I didn’t cause it!) And that may not be such a bad thing. First of all, every aspect of life on this planet is cyclical. Periods of growth followed by periods of contraction, followed by periods of growth, etc. It’s a natural process that is found in every element of our world. Secondly, a recession is the external force that will tighten our belts for us, teaching us how to conserve, save for the future and spend less than we make. A recession will also force us to scale back our attempts to be the world’s police force, because we won’t be able to afford it. We’ll need to focus our resources more narrowly, and hopefully more wisely than we have been. (There are signs that the benefits of the Great Recession I spoke about here really have come to fruition. Thankfully! A crisis is a terrible thing to waste.)