Big_John
08-03-2006, 22:07
ok, so i know exactly nothing about economics. i mean literally nothing.
but i have a friend that works in finance, and he's been saying gloom n' doom stuff about our situation. anyway, i wanted to get some of you guys' thoughts on what he told me. is any of this accurate?
edit: this is quoted from an online conversation, but some edits were made, and expletives were asterisked:
Me: yo, why do you think the economy is going to tank soon?
Friend: In a nutshell, the 'Housing Bubble'. Real estate market about to stagnate for a decade or worse drop. 1 trillion dollars worth of adjustable rate mortgages will reset in 2007. reset = go up 2-3%. Net savings rate for average person in US is now like -2%. Basically the US consumer is tapped the **** out and there's a storm coming.
The World Economy is basically predicated on a model wherein Asia produces and US consumes. Which is totally fine and makes perfect sense, but the problem is that over the past 5 years or so in order to keep the party going Asia has had to lend money to the US.
Me: so, americans won't be able to consume as much.. what does that mean to the economy as a whole?
Friend: That means the whole ****ing world economy is going to have to make up for a US consummer shortfall. Asia has excess production capacity now. They are addicted to our consumption and we are addicted to their credit.
Ok so that's item #1
Item #2 is that the dollar is ****ed.
M: can you elaborate?
F: Ok so one tenet of economics is that when interest rates are lower people borrow more. In 2001 the US dropped its interest rates to like 2.5% to soften the mini recession. It was very aggressive monetary policy. It flooded the world market with dollars. Currency markets function by supply and demand just like everything else.
Anyway everybody refinanced their mortgages, which was a good idea for them. But many people simply took out a second mortgage or just straight up bought another house. Unfortunately, these low rates coincided with the heyday of ARMs (Adjustable Rate Mortgages). These are relatively new instruments that exploded in popularity 4 years ago. ARMs allow little Timmy to achieve more leverage, so instead of only being able to afford a $200k house, Timmy can now afford a $350k house.
Compounding this is that banks typically ask for 10% down on a house. Well they started asking for 0 down in like 2001. So the american consumer borrowed to its eyeballs and spent this on home equity. ARMs gave a lower starting interest rate than regular mortgages
Devils in the details and all that---The US Fed has been raising interest rates for like 22 months straight. So you've got falling home prices and rising interest rates (ie. monthly mortgage payments)
M: why are home prices falling?
F: Good question.
M: :)
F: Home prices are falling now because interest rates are rising. Higher interest rate means fewer people can afford to buy houses. Housing prices are driven by interest rates. Nobody---well almost nobody---pays cash for a house. They buy it with a loan, a mortgage.
Anyway, due to the 'Wealth Effect', and the extra money people sucked out of their home equity, the US consumer started consuming. The party keeps going because the US consumer now has this line of credit. The US consumer goes out to Walmart and starts buying. Everything in Walmart is made in Asia, period.
When Walmart needs to put stuff on its shelves it goes to Asian producers and says, "I'll give you x dollars for that". So they make the exchange and what does the Asian producer do with his dollars? He takes them to the ****ing bank and exchanges them for Yuan or w/e.
So all the Asian banks have dollars coming out their ears. They don't want to see the dollar's value fall so they go to the US and buy US federal bonds, driving interest rates in US up. And so the wheel goes around.
M: ok, so how long has it been like this? since the 80s or so?
F: Well it's gotten much worse inr ecent years but yeah prolly started back in the 80's.
Anyway, one of these day the Asian banks say, "This is ****ed up, I have too much exposure to the dollar I'm going to start diversifying into other currencies".
M: diversifying into other currencies = selling dollars for rupees and whatnot?
F: Yes, exactly. Or for the most solid currency of all, precious metals.
So, when the Asian central banks start dumping their dollars then the value of the dollar will fall. When the dollar falls the US consumer won't be able to consume as much foreign goods. Which is good for US manufacturing but little else.
M: this will be contemporary with the resetting of the ARMs rates?
F: More or less, goes the theory, but who knows?
Ok the third and final problem is the US Government budget deficit. US Government has been spending like mad for the last 5 years, putting further downward pressure on the dollar.
M: spending on what?
F: Well, 300 billion dollars on the Iraq war for one.
M: oh
F: Now, when the US government spends money it's good for the US economy, cuz that money goes to US Defense manufacturers and companies like Caterpillar. Further, Bush cut taxes. Which is also good for the economy, cuz it puts more money in the US consumer's pockets.
That's all fine and good but we've been spending money we don't have. So we've been running a deficit of about 400 billion per year for the last 5 years. All five are record deficits.
This trend is unsustainable. So the government has to tighten its belt. So the US consumer will see no help from the US gov if/when the **** hits.
So that's pretty much it. Those three things are bad news
M: does that last bit mean that the gov will spend less (less jobs in defense construction etc) and/or raise taxes?
F: Yes
Now, there's one alternative. And that's to deflate the dollar. But that's not Bush's decision, that's Ben Bernake, the head of the Fed. If we deflate the dollar, we effectively make some of the money we owe foreigners disappear
M: wait, deflating the dollar means making it able to buy more, right?
F: Yes---and sorry, i meant inflating the dollar (deflating the dollar's value).
Oh funny statistic: the average baby boomer has a net worth of 64 thousand dollars. Unprecedented for any generation how little they all saved for retirement. So when the boomers retire over the next decade they won't be consuming ****.
Thus getting rid of social security is political suicide for a politician. And remember, companies are straight up axing all their pension plans. Look at Ford and GM, they're ****ed.
Our parents were raised believing retirement was a 3-legged stool: 1 pension, 2 SS, 3 savings. At best they're looking at 1 leg, possibly zero
Guess what, Chinese workers don't demand pensions and they don't ****ing have labor unions, which is why they can make cars for 1/10th th price.
So I think the next 5-10 years are going to be hard. India and China have a burgeoning middle class which is awesome for the world economy. So that will help pull out of a recession. But I think we're in for hard times, yeah.
M: so, we're looking at a situation where joe consumer will have less real money in his pocket, and he'll be less likely to be employed?
F: Oh I don't know about employment, but yeah basically. Real wages have been flat for like 5 years too, cuz you're seeing upper class jobs go to India (e.g. AOL's customer support).
M: well, if people have less money, will the "service sector" have to close down some jobs?
F: Yes. Construction will be hit hardest.
(conversation turns to a discussion of video games and beer)
but i have a friend that works in finance, and he's been saying gloom n' doom stuff about our situation. anyway, i wanted to get some of you guys' thoughts on what he told me. is any of this accurate?
edit: this is quoted from an online conversation, but some edits were made, and expletives were asterisked:
Me: yo, why do you think the economy is going to tank soon?
Friend: In a nutshell, the 'Housing Bubble'. Real estate market about to stagnate for a decade or worse drop. 1 trillion dollars worth of adjustable rate mortgages will reset in 2007. reset = go up 2-3%. Net savings rate for average person in US is now like -2%. Basically the US consumer is tapped the **** out and there's a storm coming.
The World Economy is basically predicated on a model wherein Asia produces and US consumes. Which is totally fine and makes perfect sense, but the problem is that over the past 5 years or so in order to keep the party going Asia has had to lend money to the US.
Me: so, americans won't be able to consume as much.. what does that mean to the economy as a whole?
Friend: That means the whole ****ing world economy is going to have to make up for a US consummer shortfall. Asia has excess production capacity now. They are addicted to our consumption and we are addicted to their credit.
Ok so that's item #1
Item #2 is that the dollar is ****ed.
M: can you elaborate?
F: Ok so one tenet of economics is that when interest rates are lower people borrow more. In 2001 the US dropped its interest rates to like 2.5% to soften the mini recession. It was very aggressive monetary policy. It flooded the world market with dollars. Currency markets function by supply and demand just like everything else.
Anyway everybody refinanced their mortgages, which was a good idea for them. But many people simply took out a second mortgage or just straight up bought another house. Unfortunately, these low rates coincided with the heyday of ARMs (Adjustable Rate Mortgages). These are relatively new instruments that exploded in popularity 4 years ago. ARMs allow little Timmy to achieve more leverage, so instead of only being able to afford a $200k house, Timmy can now afford a $350k house.
Compounding this is that banks typically ask for 10% down on a house. Well they started asking for 0 down in like 2001. So the american consumer borrowed to its eyeballs and spent this on home equity. ARMs gave a lower starting interest rate than regular mortgages
Devils in the details and all that---The US Fed has been raising interest rates for like 22 months straight. So you've got falling home prices and rising interest rates (ie. monthly mortgage payments)
M: why are home prices falling?
F: Good question.
M: :)
F: Home prices are falling now because interest rates are rising. Higher interest rate means fewer people can afford to buy houses. Housing prices are driven by interest rates. Nobody---well almost nobody---pays cash for a house. They buy it with a loan, a mortgage.
Anyway, due to the 'Wealth Effect', and the extra money people sucked out of their home equity, the US consumer started consuming. The party keeps going because the US consumer now has this line of credit. The US consumer goes out to Walmart and starts buying. Everything in Walmart is made in Asia, period.
When Walmart needs to put stuff on its shelves it goes to Asian producers and says, "I'll give you x dollars for that". So they make the exchange and what does the Asian producer do with his dollars? He takes them to the ****ing bank and exchanges them for Yuan or w/e.
So all the Asian banks have dollars coming out their ears. They don't want to see the dollar's value fall so they go to the US and buy US federal bonds, driving interest rates in US up. And so the wheel goes around.
M: ok, so how long has it been like this? since the 80s or so?
F: Well it's gotten much worse inr ecent years but yeah prolly started back in the 80's.
Anyway, one of these day the Asian banks say, "This is ****ed up, I have too much exposure to the dollar I'm going to start diversifying into other currencies".
M: diversifying into other currencies = selling dollars for rupees and whatnot?
F: Yes, exactly. Or for the most solid currency of all, precious metals.
So, when the Asian central banks start dumping their dollars then the value of the dollar will fall. When the dollar falls the US consumer won't be able to consume as much foreign goods. Which is good for US manufacturing but little else.
M: this will be contemporary with the resetting of the ARMs rates?
F: More or less, goes the theory, but who knows?
Ok the third and final problem is the US Government budget deficit. US Government has been spending like mad for the last 5 years, putting further downward pressure on the dollar.
M: spending on what?
F: Well, 300 billion dollars on the Iraq war for one.
M: oh
F: Now, when the US government spends money it's good for the US economy, cuz that money goes to US Defense manufacturers and companies like Caterpillar. Further, Bush cut taxes. Which is also good for the economy, cuz it puts more money in the US consumer's pockets.
That's all fine and good but we've been spending money we don't have. So we've been running a deficit of about 400 billion per year for the last 5 years. All five are record deficits.
This trend is unsustainable. So the government has to tighten its belt. So the US consumer will see no help from the US gov if/when the **** hits.
So that's pretty much it. Those three things are bad news
M: does that last bit mean that the gov will spend less (less jobs in defense construction etc) and/or raise taxes?
F: Yes
Now, there's one alternative. And that's to deflate the dollar. But that's not Bush's decision, that's Ben Bernake, the head of the Fed. If we deflate the dollar, we effectively make some of the money we owe foreigners disappear
M: wait, deflating the dollar means making it able to buy more, right?
F: Yes---and sorry, i meant inflating the dollar (deflating the dollar's value).
Oh funny statistic: the average baby boomer has a net worth of 64 thousand dollars. Unprecedented for any generation how little they all saved for retirement. So when the boomers retire over the next decade they won't be consuming ****.
Thus getting rid of social security is political suicide for a politician. And remember, companies are straight up axing all their pension plans. Look at Ford and GM, they're ****ed.
Our parents were raised believing retirement was a 3-legged stool: 1 pension, 2 SS, 3 savings. At best they're looking at 1 leg, possibly zero
Guess what, Chinese workers don't demand pensions and they don't ****ing have labor unions, which is why they can make cars for 1/10th th price.
So I think the next 5-10 years are going to be hard. India and China have a burgeoning middle class which is awesome for the world economy. So that will help pull out of a recession. But I think we're in for hard times, yeah.
M: so, we're looking at a situation where joe consumer will have less real money in his pocket, and he'll be less likely to be employed?
F: Oh I don't know about employment, but yeah basically. Real wages have been flat for like 5 years too, cuz you're seeing upper class jobs go to India (e.g. AOL's customer support).
M: well, if people have less money, will the "service sector" have to close down some jobs?
F: Yes. Construction will be hit hardest.
(conversation turns to a discussion of video games and beer)