<nettime> Costs of Bursting Bubbles

[Brian Holmes <brian.holmes@wanadoo.fr>]

Mark Stahlman sent me a link to this NY Times article, with insight 
into how the statistical American consumer will contribute to the 
general downswing...
With huge operations like Merril Lynch and Citicorp on their knees, 
practically all the economists are now saying the same thing. 
Finally! But what about political economy? Who's talking about the 
consequences on international relations? Anybody with some ideas? - BH

***

September 22, 2002

The Costs of Bursting Bubbles

By Stephen S. Roach

A year after terrorism dealt a seemingly lethal blow to America, talk 
of resilience and economic recovery is in the air. The nation's 
inflation-adjusted gross domestic product has risen for four 
consecutive quarters following a mild downturn in the first nine 
months of 2001. While the estimated 3.2 percent growth rate over the 
past year is subdued when compared with the more vigorous rebounds of 
the past, the hope is that it's a down payment on bigger and better 
things to come.

But while Sept. 11 was a defining event for America, it was not a 
defining event for the economy or the financial markets. That role 
belongs to the stock market bubble of the late 1990's that finally 
popped in March 2000. There was far more to the excesses of the 
1990's, however, than an asset bubble. The bubble expanded high 
enough, and for long enough, to have infected the behavior of 
consumers and businesses alike.

The equity bubble helped to create other bubbles -- most notably in 
the housing market and in consumer spending. Their continued 
existence poses a serious threat to lasting expansion -- and yet, 
puncturing them raises the grave risk of deflation. This suggests the 
economy will prove as challenging to America's political leadership 
as any other issue in the year ahead.

There is good reason to believe that both the property and consumer 
bubbles will burst in the not-so-distant future. If they do, there is 
a realistic possibility that the United States, like Japan in the 
1990's, will suffer a series of recessionary relapses over the next 
several years. Yet denial remains deep, just as it was when the 
Nasdaq composite index was lurching toward 5,000. Few want to believe 
that this economic expansion may be built on such a shaky foundation.

The evidence in support of a housing bubble is compelling. The 27 
percent increase in inflation-adjusted American house prices since 
1997 represents the sharpest five-year increase since 1945. This 
surge is about three times the increase in real housing rents over 
this period. (The divergence of home prices and rents, which usually 
move in tandem, is one measure of the speculative element of the 
housing market.) As their property values rise, hard-pressed 
consumers have been quick to extract purchasing power from their 
homes, taking advantage of low interest rates to refinance their 
property and use the savings to buy cars, furniture, appliances and 
other luxury goods. Thus the ever-expanding property bubble has 
become central to the culture of excess that is now driving the 
United States economy.

The consumer-spending bubble will undoubtedly be the last to pop. 
Short of savings and long on debt, an aging American population must 
begin to come to grips with the looming realities of retirement. Yet 
it must now do so in an era of defined contribution pension plans 
whose performance has been battered by a devastating bear market in 
equities. We all know that Americans are addicted to shopping. Yet we 
also know that, if they want to retire with any kind of financial 
security, they must increase their savings and rein in their spending.

What might cause the consumer-spending bubble to burst? It's hard to 
say, although several realistic possibilities come to mind -- a spike 
in oil prices, a surge of white-collar layoffs or a collapse of the 
property bubble. Any one of those developments could send a wake-up 
call to the American consumer, thereby denying the United States and 
the broader global economy its main source of support.

But it gets worse. The saga of the post-bubble United States economy 
doesn't stop with the bursting of the housing and consumer bubbles. 
Since these events are likely to occur when inflation is already 
running at a very low rate, they could push the United States into a 
period of outright deflation -- a decline in the nation's overall 
level of prices for goods and services.

This is a rare and worrisome condition for most economies. The impact 
of deflation would be most acute for wage earners and debtors. To 
stay profitable, companies would have to cut jobs or wages, 
eventually inhibiting consumer purchasing power. And the fixed 
obligations of indebtedness would have to be paid back in deflated 
dollars, squeezing overextended borrowers all the more.

America is already on the brink of deflation. Our broadest price 
gauge, the G.D.P. price index, recorded just a 1 percent annualized 
increase in the second quarter of 2002. That's the lowest inflation 
rate in 48 years. Prices of goods and structures -- covering nearly 
half the economy -- are already contracting at an annual rate of 0.6 
percent. Only in services, where price statistics are notoriously 
unreliable, are prices still rising.

The hows and whys of America's deflationary perils will long be 
debated. Two sources seem most likely. First, the bubble-induced boom 
of business capital spending led to an overhang of new information 
technologies and other forms of capital equipment in the late 1990's. 
The result was excess supply, a textbook recipe for lower prices.

Also at work are the unmistakable effects of globalization. The 
modern-day American economy now has a record exposure to global 
competition. In the second quarter of 2002, America imported a third 
as many goods as it produced, well in excess of the 20 percent ratio 
prevailing at the onset of the last recovery in the early 1990's. 
Significantly, more and more of these goods are coming from highly 
competitive Asian producers who have much lower cost structures than 
their American counterparts.

Moreover, with the exception of Korea, every major Asian economy is 
now in the throes of its own deflation. Consequently, courtesy of 
ever-expanding trade relations with Asia, America is now buying more 
and more from countries like China and Japan that are already in 
deflation. The growing share of these increasingly cheap foreign 
goods helps drive down prices of products made at home, thereby 
deepening deflationary pressures.

History tells us that when major asset bubbles burst, deflation is 
often the result. That was true of the United States in the 1930's 
and Japan in the 1990's. Most are quick to claim that America is not 
Japan -- that its more flexible, dynamic economy stands in sharp 
contrast to Japan's economic inertia. But the United States is 
already a lot closer to the deflationary edge than most concede -- 
and it could go further.

Deflationary risks can never be taken lightly in a post-bubble 
economy. Yet that's precisely what American investors and policy 
makers now seem to be doing. If the housing and consumer bubbles pop, 
then the risk of outright deflation will only increase. It's time to 
stop pretending this can't happen in the United States.


http://query.nytimes.com/search/article-printpage.html?res=9400E5DA1F30F931A1575AC0A9649C8B63

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