A periodic blog dedicated to providing commentary and encouraging debate on topics in Economics and Finance.

About Me

Age: 26 Occupation: Private Equity

Friday, May 11, 2007

"The Worst is Over".... Yeah Right

Check out the rather humorous Wall Street Journal Article below my diatribe...

It looks like many of these economists went to the same school as David Lereah. We have gone from "The economy is strong... The housing issue is contained as consumers continue to spend" to the "the worst has passed" in only one quarter. Economic cycles take much longer than that. I suggest they start paying attention to Nouriel Roubini. Of course, it's too late and the train wreck has begun.

I think the debt-laden consumer is starting to feel like the guy in the picture running from a tsunami. Unfortunately, since he's the average guy, he doesn't have the "high ground" of savings to run to.

Here are my reasons why it's going to get worse before it gets better:

1. False Expansion: The recent economic expansion was not precipitated by a growth in productivity or incomes. Instead, the economy was dragged out of a slump by spending through a massive increase in consumer debt. That debt has to be repaid, and the average consumer's income hasn't grown by an amount necessary to compensate for this. Takeaway: The consumer now has to restrain spending in order to pay for past consumption. We simply traded in future consumption to pay for current consumption, with interest.

2. Misallocation of Capital: Why hasn't the consumer's income grown enough? That one's easy. We borrowed massive amounts to pay for a capital good, housing, which has no payoff in productivity. In Econ 101 - Higher Productivity = Higher REAL incomes (meaning income growth greater than inflation... so you are REALLY earning more). A lot of that money should have been spent on infrastructure and technology that would have helped us become more productive and thus earn more. Typically, borrowing is not a good investment if the cost (interest) exceeds the benefit of using those proceeds. Takeaway: Our incomes haven't grown because we flushed away trillions of dollars on assets that don't help boost our incomes. We now have to pay that money back with interest.

3. Negative Savings Rate: Notwithstanding the fact that we are borrowing a lot more, we are borrowing to consume more than we earn. That hasn't happened since the two years before the great depression. Too many of us are relying on paper gains and asset bubbles to support ourselves. Unfortunately, asset bubbles don't make the economy as a whole richer (only producing more goods and services per person does). Low savings rates mean that the average person has much less of an ability to withstand an economic downturn... especially if he has high monthly debt payments to worry about. When the asset bubble deflates, and we haven't saved, we are no better off than when we started.

Negative savings rates are bad for long-term economic growth as well. Using savings instead of debt to pay for investment that improves our lives means that we get all the benefits without having to pay interest. Productivity rises, we earn more, and we get to keep it all. Takeaway: We have severely hindered our long-term ability to earn more by failing to save.

4. The Big One - Consumer Running Out of Credit: Following up on the negative savings rate, a consumer can live above his means as long as there is someone to supply the credit (See: U.S. Government). Consumer debt is already at record highs, and many consumers have little room left to borrow. Mortgage equity withdrawals accounted for a significant portion of economic growth recently (their use has perhaps increased tenfold over the year 2000). Our economic growth has become dependent on consumers continuing to spend at the rate they have been (i.e. spending more than they earn)... which can't be sustained.

The consumer will have to cut back on consumption, soon (he is already beginning... check the retail sales data). When that reality takes hold, the economy will dip into recession... consumers will default on their loans in record numbers (commensurate with the record amounts of debt) and we will be faced with a significant financial crisis. Takeaway: We're screwed.

Nope, the worst is yet to come....

Economy Is Clawing Back, but Not Much

Economists See Signs of a Rebound in Growth,
But 2007 Is Still on Track as Weakest in Years
May 10, 2007

The worst of the economic slowdown has passed, private economists said in the latest WSJ.com forecasting survey. But they don't see any reason to expect a significant acceleration.

By a more than 5-to-1 margin, the economists said they believe the first quarter's 1.3% growth -- the weakest in four years -- marked the low point in the slowdown that gripped the economy much of last year. However, they expect growth to stay below 3% into early 2008, leaving 2007 on track to have the slowest economic growth since 2002.

[Full Results]
See and download forecasts for growth, inflation, interest rates and more. Plus, items on the dollar, the alternative minimum tax and the outlook for a new high in Nasdaq stocks. Survey conducted May 4-8.
Washington Wire: Economists See No AMT Overhaul

The economists don't see any new engines for growth this year. They expect continued weakness in consumer spending, for instance, which accounts for 70% of the economy.

"All of expected growth is addition by subtraction of drags," said Bruce Kasman of J.P. Morgan Chase & Co. "Drags from housing and inventories of manufacturing are fading," he said. Business spending may pick up a bit from its recent lull, said Allen Sinai, of Decision Economics.

On the whole, the 60 economists predict gross domestic product, the broadest measure of economic output, will grow at a 2.2% annual rate this quarter. Over the second half, they expect growth of about 2.6%, which is a slight reduction from what they had forecast in a survey conducted last month. They don't expect growth to reach 3% until the second quarter of 2008.

Mickey Levy of Bank of America said he expects home construction to provide a slight boost to the economy by late in the year, after dragging down growth the past six quarters. But economists don't expect a big housing rebound. They predict home prices will fall more than 1% this year, as measured by an index calculated by the government's Office of Federal Housing Enterprise Oversight.

Inflation risks continue to loom, a concern that was reinforced yesterday by the Federal Reserve, when it voted to leave interest rates unchanged and cited inflation as its primary policy concern. Amid the inflation threat, the Fed is reluctant to cut rates, something that could boost the economy. And with energy prices high, particularly for gasoline, consumer spending is crimped.

The Wall Street Journal surveys a group of 60 economists throughout the year. Broad surveys on more than 10 major economic indicators are conducted semiannually, at midyear and at year-end. Between each semiannual survey, four monthly updates are conducted for the most closely watched forecasts. This is the monthly survey for May. For prior installments of the semiannual and monthly surveys, see: WSJ.com/Economists.

Economists, on average, increased their estimates for consumer price growth from the previous survey, seeing 2.4% growth this month and 2.8% in November. When asked in April, the economists had forecast 2.1% and 2.7%, respectively, for the periods.

When asked which presents the bigger risk of triggering a spillover of inflation pressures in the overall economy, 67% of respondents chose energy prices, while 33% said food prices. While some economists said that the spillover risks remain small, Mr. Sinai expressed concerns about their affect on wages.

Last year, inflation appeared to shrug off a spike in energy prices, but Mr. Sinai said that was earlier in the inflation process. "When workers bargain, they don't bargain on core [consumer prices, which exclude food and energy]," he said. "Does anyone really think gas prices are going to go down much?"

Of course, the biggest risk to growth remains the unknown. "The economy is more levered here. Something is going to give, either on the upside or the downside," Mr. Kasman said. "I'll be surprised if we just chug along."

Among other findings of the survey:

More than three-quarters of economists said that a widening income gap in the U.S. -- where a growing share of income is going to the top 1% of households -- is a worrisome development. But the majority said the government shouldn't seek to restrain it.

When asked if the Fed is currently behind the curve, just right or too tight in light of its goal of price stability, 75% said it is just right. Just a few economists see the Fed changing rates at its June meeting, but 35 expect a change by the end of the year: 26 see a cut and nine forecast an increase.

While the Dow Jones Industrial Average continues to set records, economists don't see the Nasdaq Composite breaking its high -- which is nearly twice its current level and was set in 2000 -- any time soon. Nine out of 10 said they don't expect a Nasdaq record until 2010 or later.

Almost three-quarters of the economists expect the dollar to fall further this year, and, on average, they expect a 3.42% decline.

Write to Phil Izzo at philip.izzo@wsj.com


McDude said...


you need to update the Q1 numbers they readjusted down to .7 or .8% growth..After the fed met of course.

eternitus said...

Thanks, Mcdude.... I do agree that the revision will probably be lower (as does Roubini).

What's posted in my blog is a copy of a WSJ article...

Anonymous said...

You make several really good points. Like most things that we dread, we think that if we ignore it, it'll just go away. Not this time!

Ron Jon 27 said...

Holy Cow!

I never thought of that! "Investing" in housing does nothing for our economy. We should spend more on roads, broadband, education, etc.

__k said...

We should spend more on roads, broadband, education, etc.
And better livestock feed.

I definitely agree. The economy is not only getting worse, but the rate of its decline is accelerating. I also think the fact that tax laws discourage saving exacerbates the matter. (Maybe only savings interest earnings above the inflation rate should be taxed.)

dxm113 said...

Does investing in housing do nothing for our economy?

While I agree that our money is typically better invested in other forms mentioned here already, is it not necessary to invest in some sort of housing??

I'm definitely not saying that housing is a good investment... I think it's a bad investment. But don't we need a place to shelter us? (As Ben Stein said recently "...no one I know can live inside a stock...")

I would much rather have my rent or mortgage payment back to invest elsewhere, but I would not be able to survive the cold winters here in Chicago without shelter.

Paying too much for a place to live is bad. But doesn't housing contribute to the economy? I know that I personally will see little if any return on housing, but aren't there many jobs and industries tied to housing?

Am I missing the point here? I may very well be... feel free to correct me if I'm out in left field.

just my 2 cents

__k said...


You can rent shelter. Instead paying way too much to own housing doesn't help the economy, and definitely doesn't improve productivity. Housing can contribute to the economy. If there is unmet demand for housing, then housing to address that need would help. And it can improve productivity in indirect ways such as worker morale. But this housing bubble hasn't contributed anything positive to the economy. It has instead led to massive amounts of debt being acquired for housing, which is what (as opposed to housing itself) is being said to have no payoff in productivity.

eternitus said...

First, totally swamped at work, but I do have something good in store.

Thanks ___k, you make some good points.

Dxm... Thanks for the comments.

1. I think you are confusing a good investment with a necessity.

I'm speaking in economic terms. "Capital" invested is meant to increase productivity of the labor force, which increases GDP per person, which makes us richer. Housing does not do this.

While housing does not have much use in terms of labor force productivity, it is necessary, much like food. However, neither food nor housing will make us richer, while better technology and education ultimately will.

My point was that we spent too much on the necessity of housing, and too little on the types of investments that will make us richer in the future (the whole productivity thing).

2. "You can't live in a stock" - I think this is taken out of context far too much.

But (which I'll get back to in a bit) it only serves to reinforce my point if you think about it.

No, you can't live in a stock, but you can live in a rental and invest the $12,000 a year you will save vs. buying a house in stocks. Rental and ownership of a house provide the same thing - shelter. Renting just offers you more bang for your buck right now.

BTW... It's never "always better" to rent or buy. That determination is wholly up to the relationship between house prices and rents. If they were more closely aligned (as is the historical norm) I'd be telling you to buy. If you can get a similar house for not much more than you pay in rent right now, and you are going to stay put for a while... you should definitely buy.

Back to my point mentioned earlier... while your house doesn't increase labor productivity in economic terms, in financial terms, your house does produce a return... It's called imputed rent (the rent you don't have to pay because you own).

For me, that'd be $750 per month, or $9,000 per year. Subtract $1000 for yardwork and maintenance, $4000 for taxes, $1000 for insurance and feed in $2000 in tax savings (using very general numbers - so please, no nitpicking... not material to this argument), and my "net" imputed rent is about $5,000.

Since similar houses to my apartment go for around $200,000 in my neighborhood, my "yield" from housing would be around 2.5%.

If you have all cash, you can get a better return buying a risk-free, tax free municipal bond for around 3.8%. The $7,600 per year in interest will pay for most of my rent, leaving me with only $1,400 to pay out of pocket. I'd gladly pay that $1,400 in exchange for not having to pay a net of $4,000 in "other" expenses tied to housing.

In short, by doing this, I'm "up" $2,600 compared to owning with all the variables factored in... That's assuming I have a boatload of cash.

Now instead imagine you put the money in stocks, with a 10% annual return (as long as you have enough cash to weather any market downturns)... Cha-ching.

If you're "renting money" from the bank, they're going to charge you around 6.5%, meaning your leveraged "yield" now becomes substantially negative.

Hope I didn't put you to sleep, sorry for the rambling.

- eternitus

eternitus said...


1. I can't argue that (to use a ludicrous case)if none of us had a house, bed, running water, etc., we wouldn't be less productive... That's obvious, as is the casewith any necessity. However, as long as there are enough places for people to live, relatively comfortably, additional investment in this regard does little to help productivity.

The same is true for food. A big house or a 9,000 calorie steak won't help you crunch numbers any faster... A quantum computer... now we're talking.

dxm113 said...

Thanks (k and eternitus) for clarifying.

I agree with what you are saying. As I had said, I don't think of housing as an investment - it is a necessity.

I agree wholeheartedly that overpaying for housing takes money away from more fruitful investments.

eternitus said...

Further Clarification... In the all-cash scenario, the buyer wouldn't get the tax break (comes from mortgage interest)... So the housing costs are around $6,000 annually.

That means I'd be $4,600 better off per year buying a tax-free bond with $200,000 than I would be spending that $200,000 on a house.