This storm has been brewing since the last big recession that ended in 1982. At many points in the last 25 years it looked like the storm might come ashore, but instead it stayed out at sea, intensifying. Now it is a full blown category five storm, coming dangerously close to our economy, whose protective levies are already creaking. And at this point, we’ve only felt the outer squalls. Things could get very bad, very quickly.
First: how we got here. The problems started with how we got out of the last recession. The sudden drop of oil prices from nearly $40 a barrel to ultimately under $15 provided the impetus to get out of the recession, and in fact all of the western world started doing well by 1983. In the US, however, a move towards privatization and supposedly freer markets helped spur a new consumerism, and new public and private debt. We’d been paying back the high WWII debt, which was over 100% of GDP, to the point that by 1981 it was 30% of GDP. During an economic boom, the pay down should have intensified. Instead we cut taxes, refused to cut spending, and by the end of the decade debt was up to 60% of GDP. The result was an economy that appeared to be extremely vibrant — low oil prices, a growing economy plus stimulus from tax cuts and government spending put the economy into overdrive, and created the impression things were going very well.
The result was a short recession in 1991-92, as attempts to curtail the spending increases and deal with the structural problems caused by the binge of the 80s led to a sharp but surprisingly short downturn. People expected a far worse recession, and were pleasantly surprised when the economy quickly turned back around. Low oil prices fueled this rebound, as did the expansion of global trade thanks to globalization. This in turn fueled a stock market bubble that reached insane proportions by early 2000. The 90s thus became what I labeled last week the “decade of illusions.” People thought getting rich was easy, the free market was an unqualified success, and oil would remain cheap — by the late nineties it was, when adjusted for inflation, as cheap as any time in history. By the end of the decade the dollar was strong, and it looked like we’d balanced our budgets.
Then in 2000 the stock market crashed, with the tech heavy Nasdaq hit hardest. It fell from 5048 on March 10, 2000 to less than 2000 later that year. On September 10, 2001, the day before the terror attacks, it was down to 1695. The tech crash hit the DOW less hard, it fell from a high of 11,722 in early 2000 to 9600 just before the terror attacks. 9-11 caused stocks to drop further, but they rebounded from that low; the real damage, however had already been done. The bubble burst, and today (June 15) the Nasdaq is at about 2230, and the Dow hovering near the 11,000 mark.
That, plus 9-11, was feared to bring about a major recession, especially as oil prices finally started to rise. However, a new bubble, the property bubble, took over and not only did Americans buy property at inflated prices, often with mortgages they couldn’t afford (figuring they’d refinance when the value goes up), but took out home equity loans up to or beyond the value of their homes, figuring home values would only continue to go up. The result: skyrocketing consumer spending. American saving rates went into negative territory, as home liquidity reached all time lows and debt all time highs. This set up for another bubble bursting, this time in a way that has created a colossal credit crisis (witness the news this week about Freddie mac and Fannie mae), and there is nothing left to prop up consumer spending.
So now the storm comes ashore. High consumer spending helped our market ignite China and India’s growth. American consumption, however, has created a current accounts deficit that is unsustainable, and hinted long ago that the dollar was over valued and American consumption could not continue. China and India have diversified markets and continue to grow (though our problems will likely slow them down a bit). This has helped spark a huge increase in demand for oil in those countries. A dirty little secret of our post war prosperity is that while markets and free trade are credited with the boom the “West” has experienced, nothing as dramatic as the growth in wealth over the last 60 years would have been possible if not for insanely cheap energy, thanks to oil. But oil production is no longer increasing and may soon decrease, even as demand continues to increase. That risks future shortages and might make today’s $145 a barrel for oil seem cheap. We can’t continue our ‘oil denial.’
On top of an energy crisis, a credit crisis, a society with no savings due to hyperconsumerism and a succession of bubbles, the dollar is rapidly losing value. Relative to the Euro it’s now worth half of what it was just eight years ago. This, along with high energy and food prices, will create inflation — already we are seeing the highest levels of inflation in 27 years. However, it also will increase unemployment and bring back the dreaded stagflation. The only good news in this is that a declining dollar will bring jobs back to the US — but for most consumers it also means everything will be more expensive. The collapse of the housing bubble also will have a ripple effect through the economy, as housing affects construction work, electricians, plumbers, home furnishers, and spreads through the economy. We’ve only started to feel the impact.
Moreover, demographics are changing as the population ages. As baby boomers retire (and they just started retiring) they will cease putting money into 401 K and other retirement plans, and instead pull out. That will have a negative effect on the stock market, but government spending will have to increase dramatically to deal with expensive health care and social security for a larger number of elderly and fewer younger workers. Add to that environmental problems. Already global warming has created a year long wild fire season in California, and has led to weather that is increasingly unpredictable, as this years floods have shown. Globally the impact could be devastating. The benefits of globalization praised in the 1990s, already under pressure due to increasing transportation costs, could give way to fears of terrorism and migration as impoverished folk will do anything for a chance at a decent life.
Put all this together, and we have the makings for an economic catastrophe rivaling or even surpassing that of the great depression. Moreover, the bubbles and deficits of the last 27 years have created a hyperconsumer society, as noted in my consumerism and fascism post. This has fostered a mentality of individual entitlement and disconnection from community. One ray of good news is how quick, even briefly, New Yorkers responded to 9-11 with a strong sense of community. Perhaps that will be something this will force us to regain. Worst case scenarios involving oil shortages and prices that go over $1000 a barrel would see something akin to a civilizational breakdown, at least for awhile.
I don’t think the full impact of this confluence of economic events has been comprehended by most people, including governmental and business leaders. No one knows for sure what the future will bring; I hope I look back at this post and think ‘gee, I was horribly pessimistic that day.’ And, of course, storms pass and there is a ‘morning after.’ The contradictions of our era — American consumption alongside third world starvation, hypermaterialism alongside a sense of modern emptiness and dissatisfaction with life, ultra-convenience alongside waste and environmental degradation — cannot last. This storm could wash them away.