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Global View: A U.S. slump?
By IAN CAMPBELL
UPI Chief Economics Correspondent
From the Business & Economics Desk
Published 4/15/2002 11:40 AM
Many Americans feel they live in the best country in the world. But, asked to explain why, few are likely to say "because of the depth of our financial markets." Yet America's free-spending lifestyle owes much to them. Perhaps, after the 1990s' boom, too much so. Therein lies this correspondent's concern: the reason why the U.S. economy, far from recovering strongly, may remain in the doldrums for some years to come.
Before explaining why, let us go back to those deep financial markets. What do we mean?
Coming to live in Boston in 1998, two things struck your correspondent about buying homes in the United States. The first was that, unlike in Britain, a buyer could fix his mortgage rate for the length of the mortgage term. In Britain such fixes are normally available for only a year or two; above that , the interest rate tends to become punitively high. The second thing was that at almost any point in the term of the loan most U.S. mortgages may be refinanced at the prevailing interest rate.
The U.S. home-buyer is unlikely to be aware of it but by comparison with most other countries he has everything in his favor. Part of the reason for that is the existence in the United States of a deep, ultra-competitive market for mortgage-based securities. Lenders transfer much of the risk of the mortgages they sell to investors in the mortgage market. The mortgages are "securitized." This is U.S.-style capitalism, and it works.
Property ownership in the United States is high and the fluid market for homes is one of the factors that helps to make the U.S. economy so big and dynamic, for house purchases lead to much other spending: on carpets, furniture, air conditioning, landscaping: the list is as insatiable as the appetite of the U.S. home-owner.
And the property-market funds broader consumption than this. For it is possible too to take out loans based on the value of homes. These home equity loans can fund other purchases: of a new car, a vacation, a yacht, a college education -- or even a second home. Americans own assets and convert them into a source of cash and therefore of consumption. That is part of living in the society with the most advanced financial markets in the world.
In recent years that ability to turn assets into consumer spending has gone up--because the assets themselves have risen in value. U.S. stocks boomed in the second half of the 1990s. U.S. house prices have still not ended their boom. Wonder why U.S. consumer spending held up so well in the slowdown of 2000 and 2001? As argued previously in this Global View column, the answer may not be so difficult to find.
U.S. consumers continue to be the beneficiaries of a huge wealth effect. We looked at the household wealth numbers most recently in the Global View of March 4, "America's consuming passion," which can be found on upi.com. But how much do these increases in stock market and housing wealth affect consumption? A new essay by the International Monetary Fund, entitled "Is wealth increasingly driving consumption", and included in its World Economic Outlook (available at imf.org) which will be published in the coming week, examines the relationship.
What the IMF finds is that the impact of asset price gains on consumption is growing. It is particularly high in what it calls "market-based" economies, such as the United States, Canada and the United Kingdom, and less in what it terms "bank-based economies" such as Japan and continental European economies. In the "market-based" economies, households hold a greater share of their wealth in financial assets (mainly equities). "The distribution and ownership of equities and property tends to be wider in market-based economies," the IMF writes. And the ability to borrow is also higher in these economies.
The study finds that in a market-based economy such as the United States a one dollar increase in stock wealth would lead to a 4.5 percent boost in consumption, while in a bank-based economy the rise in consumption is of only one percent.
The impact from rising house prices, however, is still greater than that from rising stock prices. Focusing on the 1984-2000 period in the United States the study finds that for every dollar increase in house prices, consumption increased by 7 percent.
The IMF makes a number of conclusions from its study. Asset prices, it says, "have become more important over time as a determinant of consumer spending" in both market based and bank based economies. In addition asset prices have become "more important in the transmission of domestic and global business cycles." Finally, asset price developments "will become an increasingly important input in the assessment of demand conditions, and therefore policy decisions."
Asset prices, we know, have been in the mind of the world's most important policy-maker, Federal Reserve Chairman Alan Greenspan, at least since December 1996 when he made his famous comment about "irrational exuberance" in U.S. stocks. More recently Greenspan's comments show that he has been more concerned that stocks might fall further, causing a negative wealth effect in the United States. His slashing of the short-term interest rate to just 1.75 percent in 2001 might be seen as a means of averting just such a stock market crash. It had two other effects. It prolonged the positive business cycle, by allowing high consumption and the housing boom to persist.
The danger we must consider is that if the positive period of the business cycle can be extended through monetary policy is there also a risk that the negative period will be extended as well?
If it is true that the house price boom is unlikely to go further -- and even some industry insiders expect that -- and that stocks are still unlikely to regain their buoyancy of some years ago, then the drag on consumption could be pronounced and prolonged.
To put it more graphically, if consumption has been turbo-charged for years by rising stock and house prices, what is going to happen if house prices join stocks and actually fall?
What would seem likely in those circumstances is that consumers save more and spend less until the relationship between their spending and their wealth is again one they are comfortable with.
Wall Street does not appear to be considering this possibility that U.S. consumer spending might fall, leading to another leg down in the U.S. economy. But only when it happens will the U.S. trade deficit -- a sign of excess consumption -- correct. So let your correspondent make it plain: he finds the consensus forecast understandable but unrealistic. He expects the U.S. economy (and house prices and stock prices) to struggle for some years to come.
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Global View is a weekly column in which our economics correspondent reflects on issues of importance for the global economy. Comments to ianscampbell@yahoo.com.
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