comments on Baker reports
Source Jim Devine
Date 02/01/10/02:27

To understand what's happening in the U.S., look at Dean Baker's ECONOMIC
REPORTING REVIEW [Jan. 7, 2002]: summarizing "Recession, Then a Boom? Maybe
Not This Time" by David Leonhardt (New York Times, December 30, 2001), Dean
writes:> This article examines the reasons why a recovery from the current
recession is likely to be weaker than previous recoveries. Specifically, the
fact that car purchases and home sales remained strong through the downturn,
as opposed to falling off sharply as they had in prior recessions, is likely
to dampen the strength of the upturn. <

In reference to my dialogue with Fred Moseley yesterday: it's true, as Fred
notes, that personal consumption hasn't fallen much (or at all) during the
current recession. Nor have purchases of family homes. But, as Dean's
summary of Leonhardt's article suggests, this implies that one of the usual
sources of economic recovery is unlikely to play a big role in the near

This is especially true since consumer indebtedness is still pretty high
(and rising). According to the Fed's Flow of Funds accounts
(, household
[and nonprofit organization] debt as percentage of disposable personal
income rose into 2001:

In 1996: the debt/income ratio = 0.961
in 1997: .976
in 1998: .995
in 1999: 1.046
in 2000/Q3: 1.041 (average for 2000: 1.035)
in 2001/Q3: 1.049 (average for 2001, so far: 1.044)

The growth of this ratio slowed in the last part of the period shown (even
falling from 1999 to 2000/Q3). This fits with the notion that households are
reaching their credit limits, their ability to carry debt. However, the
continued rise into 2001 suggests that people are beginning to engage in
what Bob Pollin has called "necessitous borrowing," i.e., are borrowing
because they have to in the face of stagnating incomes and rising
unemployment. If so, the U.S. economy has trouble ahead, since necessitous
borrowing involves what we professional economists call "bad karma."

Of course, what really counts for many is the ratio of net worth to incomes.
As the Fed calculates it, this ratio looks better:

in 1996: 523.4
in 1997: 561.3
in 1998: 581.0
in 1999: 632.3
in 2000/Q3: 600.3 (avg. for 2000: 601.6)
in 2001/Q3: 510.8 (avg. for 2001, so far: 536)

It looks pretty good for awhile, but it's been falling because of the
shrinkage in the stock-market bubble.

I believe that this ratio would have fallen even more steeply except for the
effects of the Fed's 11 rate cuts last year. Instead of working through the
textbook channel (rate cuts encourage real investment) so far, the Fed's
anti-contractionary policy has worked by boosting the value of bonds (and
thus stocks) and of housing,[*] keeping them from falling further than they
actually did, so that the ratios in the second table didn't fall as much as
they could.

Let's continue with what Dean says:

Another New York > Times article [December 29, 2001] includes, without
comment, a graph showing a very ominous trend in recent data. The graph
shows that the median price of a new single family home fell to $155,400 in
November, nearly 14 percent below the peak value reached earlier this year,
and close to 8 percent below its average of the prior two years. Rising home
prices have been one of the factors driving consumption in the last few
years, as Alan Greenspan and others have frequently noted. If housing prices
are now following the stock market downward, then this
could be a significant drag on consumption spending in the coming year.
Also, since consumers have borrowed heavily against their homes, pushing the
mortgage to value ratio near historic highs, many homeowners may soon find
themselves with negative equity in their homes (the mortgage exceeds the
value of the house), if this drop in housing prices continues. <

The flow-of-funds numbers show that owners' equity as a percentage of
household real estate has actually risen since 1999 (and is above the 1996,
1997, and 1998 ratios). (The ratio fell from 1997 to 1999.) As Greenspan and
others have noted, this has buoyed personal consumption spending. But if
house prices are falling, as indicated by the quote above, that's a real bad
sign for this ratio.

Further, it's likely that (1) house prices could fall steeply, because both
demand and supply are inelastic, producing results in the national level of
the sort that hit California a few years ago; (2) other asset prices,
including stock prices, could fall steeply, given historically high
price/earnings ratios; and (3) merely low interest rates aren't enough to
buoy asset prices, so that further interest rate cuts are needed, which
becomes more difficult as rates approach zero. (The low interest rates may
spur a rapid fall in the value of the dollar, redistributing demand from
other countries to the U.S., but I'll ignore that.)

The possible story initially sounds a lot like a textbook Keynesian one (or
perhaps like Fred's). Stage 1 is what the U.S. has been in, in which private
domestic fixed investment in plant and equipment falls. In Stage 2, which I
think we're entering, the multiplier effect kicks in, driving down
consumption and depressing real GDP and employment further.

Getting beyond the textbook flow-oriented story, the pre-recession (stage 0)
boom of consumption was financed by rises in private-sector debt. For
workers, this rise was needed because of the relative stagnation of wages
(except, temporarily, at the end of the 1990s) that I discussed yesterday --
but it led to soaring debt/income ratios. For capitalists, etc., it was
encouraged by rising stock prices -- and again led to soaring debt ratios.
In stage 1, so far, asset-price deflation has been largely avoided (with the
effects of stock price falls cancelled out by housing price rises). But in
stage 2, it's quite possible that asset-price deflation could kick in,
hammering balance sheets. This might encourage waves of personal
bankruptcies (not to mention further corporate ones) and Fisherian

Japan, anyone?

[*] It's interesting that this asset-based stimulation of the economy has
involved helping asset owners, as with the whole Greenspan-Clinton era. Of
course, working-class renters didn't benefit from higher housing prices.

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