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A US Recession Now Inevitable?

  1. Jan 23, 2008 #1


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    Soros appears to be predicting doom and gloom though whilst pessimistic about the US he is more optimistic than many other commentators who are predicting a global recession.

    Although he sees the $US maintaining it's reserve currency status how realistic is this given it has fallen by 55% against the Euro since GWB came to power in 2001 and given that the dollars share of currency reserves fell to a record low of 63.8% at the end of September, down from 65% three months earlier. Meanwhile the Euro's share rose to 26.4 percent from 25.5 percent.

    China are trying to protect the value of their 1.4 trillion $US treasury holdings by using the funds as collateral for Euro denominated purchases in effect liquidating their $US in favour of Euro denominated assets.

    So is America in recession or if not is recession inevitable and if so how deep will it be and how long is it likely to last? Will the changeover of the presidency give a boost to the economy and the dollar?
    Last edited: Jan 23, 2008
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  3. Jan 23, 2008 #2


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    You don't know you're in a recession until you get all the numbers, and often things are improving again by the time you get them. The stock market is unequivocally in bear mode, and there's every indication that consumer spending (2/3rds of the economy) has been sucking for the last two or three quarters. Credit has become increasingly difficult to obtain as people increasingly default on their debt obligations. Investors and home buyers and credit card users are already acting as if we're in a deep recession, so it's almost irrelevant whether or not the economic data due in July will agree.

    The majority of today's economic problems began when banks began to develop mortgage-backed securities like CDOs, all predicated on the idea that housing prices never fall. In fact, for the last six decades, housing prices have been very reliable, and the idea made very good sense. Unfortunately, the cost of housing (in inflation-adjusted dollars) has grown about five times as fast in the last ten years as any other period in American history, including the times of prosperity after the Great Depression. Throughout the last decade, people have increasingly viewed housing as a get-rich-quick scheme, with disastrous results for those who bought last. The rampant proliferation of "house flippers" and real estate speculators getting rich off one another is an indication of just how unsustainable housing price appreciation has become. For the last ten years, home prices have had almost no connection to reality, and those involved in the housing market had no idea how deeply their excesses were tied to rest of the world's economy.

    Cracks in the housing market spread to the financial markets via CDOs and SIVs. Cracks in the financial markets spread to consumers via their retirement accounts and the new-found difficulty in obtaining financing. Cracks in consumer spending bring down the entire economy by reducing the efficiency of all businesses and decreasing labor demand. Rising unemployment is followed by rising demand on social programs, which causes the government to spend more money. The government doesn't actually have the money, having blown it all on an unpopular war, and has to borrow it from other countries. Thus, the full effect of what will be known in history books as the Y2K housing bubble is that a significant portion of US wealth ends up moving into the hands of foreign investors. The weak dollar and crippled banks make it easy for our assets and businesses and even homes to be sold wholesale to whomever has enough cash. Yes, when Abu Dhabi buys part of Citigroup, they buy part of your mortgage, and they now own part of your home, and part of your local grocery store, and part of your retirement fund.

    The disparity in wealth distribution between "have" and "have not" nations has been untenable for decades. This is, in my opinion, an inevitable collapse of a differential in wealth that never should have existed in the first place. Yes, it's a recession. Yes, it's an economic collapse. Yes, it's a chance for other nations to share in our spoils. Will we recover? Of course. By mid- to late-2008, all of the balance sheets will be clean, the banks will stop hemmorhaging, the CDOs will be dismantled, home prices will shrink back to sensibility, and the stock market will begin another bull run. We have a long way to fall yet, but the incredible speed of this correction indicates hope that recovery will be prompt. I don't forsee another Great Depression, but I do forsee another year or eighteen months of falling home prices and tightened household budgets.

    - Warren
  4. Jan 23, 2008 #3


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    The defnition of "recession" is negative economic growth. Except inso far as the statistics for today aren't out today, we're probably not in one yet. Odds are decent for the next few months to bring one, though.

    [that was a response to Art]
  5. Jan 23, 2008 #4
    That's the consequence of running up large budget deficits. The average American knows absolutely 0 on basic macroeconomic principles. You could use the Ricardian Equivalence argument to try to point out the fact that tax cuts don't really do anything for stimulating the economy. Large budget deficits increase inflation, decrease the value of a currency, and also contribute to larger trade deficits....these are all problems that we are seeing right now. Much of the huge deficits over the past 8 years have to do with the ludicrous amount of spending Bush and the Con Congress did. I forget off the top of my head how many times, but during the Con controlled Congress several emergency sessions had to be held over Bush's first term in order to raise the maximum federal debt allowed by law. The Con controlled Congress basically gave Bush an unlimited amount of blank checks and now we are reaping what we have sown.
  6. Jan 23, 2008 #5

    Which court determined this?

    I don't see the Chinese dumping US assests, and the Euro is a hot ticket; they are the new band in town everyone wants to see and be a part. To say the Euro has risen by x amount since Bush's presidency is a bit of...politics, not economics. The Euro was introduced when? 2000.
  7. Jan 23, 2008 #6


    Congress itself writes laws.


    "Congress Sets New Federal Debt Limit: $9 Trillion"

    It is taught in the fundamentals in macroecon at every university that huge budget deficits will have a negative impact on the value of a currency.

    Huge budget deficits retard future economic growth by hindering present investment.

    I don't want to be all doom and gloom though, not all deficit is bad. However, when deficit is owned by foreigners, which more and more of it is, then it is time to start worrying.
    Last edited: Jan 23, 2008
  8. Jan 23, 2008 #7
    Well, the legislature is not the one lending money, so there must be a contract or court decision limiting the legislature's ablity to indebt itself. They are not lending themselves the money, that is for sure.
  9. Jan 24, 2008 #8


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    1999 as a paper trading currency and 2002 as 'real' money.

    One thing that is slightly confusing me.
    The US cut interest rates and this raised the dollar - I thought the idea was that you cut interest rates, people didn't want to put their money in your savings accounts and so demand for your currency falls and it's value drops?
  10. Jan 24, 2008 #9
    Congress sets the limits on how much it is allowed to spend. Courts deal with issues of the law, they don't write them.

    The people of the United States and foreigners lend the government money through the form of buying bonds, t-bills, etc.

    However, the FED can buy the bonds as well. This is exactly how the FED controls the supply of money.

    In fact a large chunk of the deficit is money that the government owes to itself. Case in point-- you know that so called social security surplus that is supposed to exist? Well it doesn't really exist as cash, Congress already took that money and spent it. The surplus only exists as special non marketable bonds. That's right the social security "surplus" is nothing more than more debt that the government owes to itself in the form of bonds.
  11. Jan 24, 2008 #10
    I thought you said the legislature set the limit on debt, not spending. So I will assume in this case that the foreigners, the people of the United States and the Fed set the limit on how much debt the national government may aquire. We seem to be getting at the opinion of the people of the United States with regard to how much debt the US should rack up, what in this case are the opinions of the foreigners and the Fed?

    The Fed controls the supply of money because it is the Fed's; they may print money or buy and sell bonds in order to control interest rates.

    Social Security is an entitlement, this is different than any other normal government spending. Social Security spending is not included in what economists call 'government expenditures' and is marked at a set limit to be spent no matter the situation, so I do not entirely understand Social Security surplus if it is mandatory spending which does not count as part of the debt.

    I do believe you are correct stating recessions involve periods of debt. Markers for recessions use inflation, debt, currency rates and other real and nominal variable rates in a given period of time in close proximity to the present and compared to periods of economic boom and bust.
  12. Jan 24, 2008 #11


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    Two possible explanations:

    1. Currency traders had expected a bigger cut.

    2. If the dollars drawn out of savings accounts were diverted to alternative dollar denominated instruments (for instance, U.S. stocks and bonds and their derivatives) then the net effect would be zero. But this does not take into account the secular effect in the stock markets. If the demand for U.S. stocks increases faster than the demand for U.S. savings accounts decreases, then the net effect is positive.
    Last edited: Jan 24, 2008
  13. Jan 24, 2008 #12

    Congress BOTH sets the limit on how much federal debt is allowed and also must approve of the federal spending budget every year (the President proposes the budget and must sign it).

    Honestly US debt controlled by its own citizens really isn't so bad. Debt will just be paid back to the US's own citizens. However, when debt is owed by foreigners (which more and more of it is), then you have to start to worry. This represents a loss of income from the country when debt is paid outside of the country.

    Social Security surplus is exactly what is sounds like--more taxes were taken in for SS than were used to pay SS benefits. However, all of that excess lucre was already spent by Congress and was replaced with special nonmarketable government securities. I only used this as an example of how a some of the US debt is actually just debt owed to itself.
  14. Jan 24, 2008 #13
    Foreign debt builds foreign bonds between nations. An obligation is made by both parties to live up to the terms of contract, this gives a common grounds by which outside business between the countries may be conducted. Debt is also a finance term, and the US is financing its spending, not indebting itself.

    Financing government spending is good. An inflow of capital comes into this country, is distributed and when we pay back what we owe to a foreign nation, it is with the money earned in excess of the original loan made either through inflation, interests or the production and sale of goods. The loss of income represents the interests paid on a credit card, it is not bad that a credit holder must pay interest because the only alternative is to not paying interest is to have no credit, or in this case no financial sector. This means no banks, credit unions, lenders of any sort. It would be a wonder how the economy would exist without it.
  15. Jan 24, 2008 #14

    Who said it builds bonds? Debt that is only bought up by foreign countries, only because foreign countries believe they can make money off of it. If you wanted to borrow $100,000 and someone lent you the cash and in return got an IOU with a 6% interest rate would you want that person to come back later and ask for all of that $100,000 at once WITH the interest payment on top? or would you want that person to slowly ask for their money back in several repayments? China is in position to due such a thing. They have threatened to dump US commodities to kick the legs out from under our economy. China holds over $1 trillion of our debt (which is almost the entire amount of M1 money supply). If China ever wanted to ask for all its money back, which would not be wrong at all, it would seriously effect the value of the dollar. The US is simply financing its spending through more and more debt. How do you think we currently pay off our debt when people/governments cash in their bonds and other securities? By selling more debt. If that isn't putting yourself into debt, than I don't know what is.

    You are treating the government like it is a single consumer. That's apples to oranges. You do realize from WWI all the way up to 1980 the US was always a debt creditor? It wasn't until recently that we have become a debtor nation (and we happen to be the largest debtor in the world). I would agree that if a country uses the proceeds from a foreign investor to increase its physical and human capital, then the borrowing isn't so concerning. However when you borrow from a foreign nation to simply fund spending, then you run into problems. Unfortunately if you look at all the data, the increasingly large amounts of borrowing from foreigners is NOT accompanied by any significant increases in the rates of physical investment or in human capital formation.

    The biggest problem with huge budget deficits is the fact that they end up reducing national savings which in turn means less capital and less foreign assets are accumulated. This means that future generations of Americans have the strong potential to have lower standards of living.

  16. Jan 24, 2008 #15


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    A concern I saw lately is that foreign countries are converting their $US debt into American equity assets through so called sovereign funds. The danger being that in effect the US is selling it's future income streams which would have been used to improve the American economy but will now be used to improve the economy of the new owners.

    As for a debtor nation being a better position to be in than a creditor nation - ask yourself would you rather be a bank lending money or a consumer borrowing money? Who ends up better off in the long run? Have a look at South America and Africa to see the results.

    The only time borrowing is really justified is for capital investment where the returns earned will outstrip the interest paid. America is borrowing money to augment it's current expenditure to provide an unearned higher standard of living than they could otherwise afford and this is further exacerbated as these consumer goods are being imported mainly from China and selling off their revenue streams will make repayment very painful.
  17. Jan 24, 2008 #16


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    This actually doesn't scare me - I love it. The fact that the US's economic growth continues to outstrip most of the rest of the western world even while exporting our prosperity means our economy is just that fundamentally strong. And as a humanitarian, I want our prosperity to help people in, say, China, rise out of the dark ages.
  18. Jan 25, 2008 #17
    Great Post Warren:


    Its worse/better (depending on what side of the fence you are on) than people seem to think

    I cant think of the full reasons for why what is happening, is happening, but I tend to agree that it was inevitable. The prosperity of the USA was unsustainable, just like it was for the UK and its commonwealth up until WW2.

    Perhaps it was the built in greed of the Adam Smith ideology that has come back to haunt the true capitalists, as for an amateur economist as I am (I make my money in IT) it seems that the market forces they hold so dearly are now crashing down upon them because the drive to ensure cheaper and cheaper goods, and faster and faster money has created the situation that the markets are in now.

    I hope the USA doesnt have a full blown Recession as if they do, we will all feel the pain. But the universal truth with economics is one mans loss is another mans gain
  19. Jan 25, 2008 #18
    Good, but I think you have a skewed idea on what your prosperity is built on. Just look at one of the elephants in the room, the Worlds largest Bank, CitiGroup had to write off 13,000,000,000$ due to subprime morgage write offs in your backyard, and you are calling this growth?
  20. Jan 25, 2008 #19


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    Actually the UK system = turn up at third world country, take over, use all their resources and people and go home with some decent food is probably more sustainable than the US system of either, drop $billion weapons on sand or run up huge spending deficits with them in order to buy their cheap DVD players!

    By the bizarre definitions of GDP I think that is growth. Who said that - "from the point of view of GDP the ideal person is a termianl cancer patient going through an expensive divorce"?
    Last edited: Jan 25, 2008
  21. Jan 25, 2008 #20
    Then invite them all to come 'home' with you :smile:
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