|May 19, 2006/New York TIMES
Coming Down to Earth
By PAUL KRUGMAN
Um, wasn't the stock market supposed to bounce back after Wednesday's big drop?
We shouldn't read too much into a couple of days' movements in stock
prices. But it seems that investors are suddenly feeling uneasy about
the state of the economy. They should be; the puzzle is why they
haven't been uneasy all along.
The rise in stock prices that began last fall was essentially based on
the belief that the U.S. economy can defy gravity — that both
individuals and the nation as a whole can spend more than their
income, not on a temporary basis, but more or less indefinitely.
To be fair, for a while the data seemed to confirm that belief. In
2005, the trade deficit passed $700 billion, yet the dollar actually
rose against the euro and the yen. Housing prices soared, yet houses
kept selling. The price of gasoline neared $3 a gallon, yet consumers
kept buying both gas and other items, even though they had to borrow
to keep spending (the personal savings rate went negative for the
first time since the 1930's).
Over the last few weeks, however, gravity seems to have started
The dollar began falling about a month ago. So far it's down less than
10 percent against the euro and the yen, but there's a definite sense
that foreign governments, in particular, are becoming less willing to
keep the dollar strong by buying lots of U.S. debt.
The housing market seems to be weakening rapidly. As late as last
October, the National Association of Home Builders/Wells Fargo housing
market index, a measure of builders' confidence, was still close to
the high point it reached last summer. But on Monday the association
announced that the index had fallen to its lowest level since 1995.
Finally, there are preliminary indications that consumers,
hard-pressed by high gasoline prices, may be reaching their limit.
The National Retail Federation, reporting on a new survey, warns that
"while consumers have seemed resilient in the face of higher energy
costs, a tipping point may soon be in sight."
I can't resist pointing out that the Bush administration's response to
the squeeze on working families has been, you guessed it, to accuse
the news media of biased reporting.
On May 10 the White House issued a press release titled "Setting the
Record Straight: The New York Times Continues to Ignore America's
Economic Progress." The release attacked The Times for asserting that
paychecks weren't keeping up with fixed costs like medical care and
gasoline. The White House declared, "But average hourly earnings have
risen 3.8 percent over the past 12 months, their largest increase in
nearly five years."
On Wednesday Treasury Secretary John Snow repeated that boast before a
House committee. However, Representative Barney Frank was ready. He
asked whether the number was adjusted for inflation; after flailing
about, Mr. Snow admitted, sheepishly, that it wasn't. In fact, nearly
all of the wage increase was negated by higher prices.
Meanwhile, the return of economic gravity poses a definite threat to
U.S. economic growth. After all, growth over the past three years was
driven mainly by a housing boom and rapid growth in consumer spending.
People were able to buy houses, even though housing prices rose much
faster than incomes, because foreign purchases of U.S. debt kept
interest rates low. People were able to keep spending, even though
wages didn't keep up with inflation, because mortgage refinancing let
them turn the rising value of their houses into ready cash.
As I summarized it awhile back, we became a nation in which people
make a living by selling one another houses, and they pay for the
houses with money borrowed from China.
Now that game seems to be coming to an end. We're going to have to
find other ways to make a living — in particular, we're going to have
to start selling goods and services, not just I.O.U.'s, to the rest of
the world, and/or replace imports with domestic production. And
adjusting to that new way of making a living will take time.
Will we have that time? Ben Bernanke, the chairman of the Federal
Reserve, contends that what's happening in the housing market is "a
very orderly and moderate kind of cooling." Maybe he's right. But if
he isn't, the stock market drop of the last two days will be
remembered as the start of a serious economic slowdown.