In his recent column, The Economy of Fear, John Cassidy makes an excellent case that the U.S. is headed for an awful economic outcome. He compares the current economic situation with others caused by credit crunches over the past 150 years and does not like what he sees.
Unlike some past recessions, which were rooted in inflation problems, this one has been triggered by credit and real estate—both of which have a lot to do with how people perceive their financial well-being and, in response, how they adjust their spending. (View a tally of recent recessions and their causes.) For what is probably the first time since the 1930s, home prices are falling sharply. Nationwide, housing prices have slipped about 10 percent in the past year, and the decline is accelerating, according to the S&P Case-Shiller home-price index. As prices drop, more and more homeowners discover that they owe more than their property is worth, at which point they experience the temptation to hand the keys back to the bank or mortgage company. Jan Hatzius, an economist at Goldman Sachs, estimates that by the end of 2009 up to 15 million households could be in a position of negative equity. If Hatzius is right, the glut in houses for sale will only get larger, and prices will fall a lot further. Just how low they could go is anybody's guess, but a reading of data compiled by Yale economist Robert Shiller, which show the evolution of inflation-adjusted home values since 1890, suggests an overall drop of 30 or even 40 percent.
The situation is certainly serious, but in this analyst’s opinion not as grave as Cassidy portends. Like most
First, the world economy is in far better shape than the
Chinaand India, the Philippines, and Eastern European countries are reaping the benefits of the opening of global markets in manufacturing and services Malaysia
- As those economies build much-needed infrastructure and develop professional classes with strong consumer demands, they are driving up commodities prices and purchasing industrial and transportation equipment
- Oil-rich countries are reaping the windfall profits born of the tremendous uncertainty in global supply brought about by the
Second, the deflation in
Third, Bernanke is taking a targeted approach (see Getting it Right on the U.S. Economy), directly absorbing risk in financial markets while reducing interest rates and constraints on lending. Opening up the supply of money by reducing federal lending rates and shifting some risk from financial institutions will only be inflationary if matched by corresponding increases in demand. In the near term the more likely scenario is that all institutions will adjust through a rocky first and second quarter, financial and housing stocks will bottom out and increased export activity will start to be felt. Lenders are already finding creative ways of absorbing some of the cost of over-financed properties, as they attempt to avoid becoming
In the near term, government policy should be directed, as it has been, toward averting panic in the financial markets. (This is a far cry from a bailout—investors in lending institutions are in for a very rough time.) Moreover, the
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