Saying Goodbye to the Borrow and Spend Economy

Let’s get this straight.

Household credit is shrinking…

Profits are shrinking…

Employment is shrinking…

Housing values are shrinking…

The wage base is shrinking…

But the recession is over!

Whoa…how is that possible?

This weekend’s news brought no surprises. For example, the housing picture is still depressing – unless you’re a buyer.

There’s “no bottom in sight” to Florida condo prices, says Barron’s. And Reuters warns that option ARM mortgages “are about to explode.” At least, that’s what the attorney general of the sovereign state of Iowa says. The option gives the homeowner the right to pay only the interest (or in some cases less than the interest) for the first few years. They’re sometimes called IO mortgages (interest only). And now these mortgages, written at the height of the bubble, are beginning to reset to more normal terms. According to Reuters, 128,000 people in Arizona alone will face reset IO mortgages next year.

How much more will these people have to pay? Between 5 and 10 times what they’re paying now. Almost all these homeowners are underwater. They bought at the bubbliest period. How many of them can afford a 400% increase in their mortgage payments? How many of them will be willing to pay?

Not many. That’s why a new wave of foreclosures is coming. And that’s why house prices are likely to keep going down; the supply is going to increase, while the demand (willing and able buyers) will probably stay steady.

Meanwhile, the California jobless rate has risen above 12%.

But let’s go back to the first item – shrinking consumer credit. This is the key thing. The expansion of the US economy – broadly speaking – from 1945 to 2007 depended on consumers’ willingness to go further into debt. Wages rose during the first half of that period – supporting consumption. But as the great boom continued, more and more of it was based on credit, not on wages. At the end, it was almost all credit expansion. Consumers weren’t earning more money…nevertheless, they kept spending more and more money. How did they do it? By borrowing.

Without this borrowing the economy would not have grown.

And now what’s happening? Well, consumers aren’t borrowing anymore. Consumer credit is going the other way, shrinking rather than growing.

The feds are trying to counteract this major trend. This year, they’re borrowing $1.7 trillion. Consumers won’t borrow; no problem, the feds will borrow for them!

So far, the feds have put at risk about $13 trillion in order to counteract the downturn. This is about equal to the amount that Americans had lost in the crash. But while the crash wiped out $13 trillion in housing and stock market wealth, the feds have no obvious way to put the money back. Banks were easy to reflate. Bankers and federales are tight with each other; they’re happy to share out the taxpayers’ money. But getting money to the consumer is a different matter. The banks don’t lend and the consumers don’t borrow.

Of the $13 trillion the feds have put at risk…very little has actually made its way to the consumer economy. Result: no new boom in consumer spending…no new boom in hiring…no new boom in production or profits.

Pity the poor investors who are counting on a bull market. Profits aren’t increasing. So the increase in stock prices is based on an increase in the multiple. As stocks rise, investors pay more for each dollar of earnings. Unless there is a big boom coming, this will turn out to be a mistake.

The Dow rose 36 points on Friday. Gold ended the day at $1008. And the dollar keeps sinking; on Friday, American visitors to Europe found that it cost $.147 per euro.

“Things have changed so much,” said a colleague yesterday. “We’ve been telling readers that they could live so much more cheaply overseas. But now, about the cheapest place in the world to live is the US…”

We spent Sunday with the publisher of International Living magazine.

“Prices have fallen so much in Florida that you really get more for your money there than practically anywhere else,” she continued.

“I think Florida may be cheaper than Buenos Aires,” added son Will, who’s been living in Argentina for the last three years.

Housing is cheap in the United States. In Texas and Arkansas, housing is probably the best bargain on the planet. Food prices are going up; still food in the US is much cheaper than it is in Europe. And cars? We have a friend in Paris who goes back to the US to buy his Mercedes. Even with the cost of shipping the car back to France…and the cost of refitting the car to European standards…he still saves about $10,000.

“I was just in Paris,” Will continued. “You pay $10 for a cup of coffee and a croissant. In Florida, I can get the ‘Breakfast Special’ for $5.95…and it has everything. Pancakes. Bacon… Everything.”

“But what is amazing,” continued our International Living colleague, “is that interest in moving overseas is going up. It’s not about money. Apparently, a lot of Americans are just fed up…or afraid. They want to get out. They see taxes going up or they see the society going down the tubes. I don’t know. But many say they just don’t like the way things are going.

“One thing I hear is that they think American society has become meaner…ruder…less civil. You can’t have a polite discussion of politics anymore. People get really upset and nasty. I mean, someone yelled out and called Obama a liar in the middle of a joint session of Congress. And a substantial part of the US population regards the guy – the guy who called him a liar – as a hero. They think Obama is a traitor…

“I think this is really a result of the financial downturn. People feel betrayed. Let down. They think something is very wrong. That the nation is in decline. So they look for someone to blame. And they tend to blame each other. Conservatives blame liberals. Liberals blame conservatives. They blame the bankers. They blame the capitalists. They blame the government.

“I guess that’s what happens when you get a major correction or a big financial crisis.”

We recalled what happened in Germany in the ’20s and ’30s:

“Germany was probably the most civilized country in the world – before WWI. Artists, philosophers, scientists, mathematicians, musicians… Germany had the best in the world. The war shook the public’s faith in its leaders. But then, according to people who lived through the period, the financial crises of the ’20s and ’30s were worse. Hyperinflation…depression…strikes…a decade of financial chaos and disruptions led to a breakdown in social order. By the early thirties, groups of communists and fascists were battling in the streets. People seemed to leave the center and move to extreme positions. Soon, the Nazis had the upper hand and Hitler was voted into the government.”

Until tomorrow,

Bill Bonner

The Daily Reckoning