Sam Zuckerman, Chronicle Staff Writer /
Sunday, April 27, 2008 /
It's a global ****ft that some are calling the Great Reckoning.
For a generation, economists warned that Americans were living too
large. With wallets crammed with credit cards and home-equity loans
available to any homeowner who could sign his or her name, consumers
went on a debt-fueled buying binge. Living rooms bulged with the
latest in snazzy electronics and garages filled with ****ny new cars
and trucks. Restaurants were fully booked, and airlines whisked happy
passengers to dream vacations around the world.
Now, that shop-till-you-drop, I-want-it-all-and-I-want-it-now era may
be coming to an end. It couldn't last because it was built on a
mountain of money borrowed from overseas.
Year after year, the United States bought more from the rest of the
world than it sold as foreign nations cranked out ****pload after
****pload of goods destined for American consumers. By 2006, the U.S.
international deficit in trade and related payments exceeded $800
billion, about 7 percent of the entire economy.
It was only thanks to the kindness of strangers that such a drain of
dollars was able to continue. Every year, overseas investors poured
hundreds of billions of dollars into U.S. stocks, bonds, real estate
and other assets, largely offsetting our taste for im****ted goods.
But the housing crash, a severe credit crunch and a dizzying fall of
the dollar are depriving the nation of the means to keep on borrowing
and spending. Foreigners have become wary of underwriting the U.S.
standard of living. The flow of outside investment is slowing.
In effect, the United States has maxed out on its national credit
card. Like it or not, that's one of the most im****tant things now
forcing a new standard of frugality on free-spending Americans.
"We're going back to the good old days of living within our means,"
said David Rosenberg, chief North American economist for securities
giant Merrill Lynch.
Because household spending represents 70 percent of all economic
activity in the United States, a prolonged consumer slump could weigh
heavily on the nation, fostering recession or weak growth for some
time to come.
A long boom
The years from the early 1980s until recently were a long boom for
American consumers, even though their incomes grew slowly if at all
during much of that period.
"There was a lot of air under this economic expansion," Rosenberg
said. "It was engineered by an unprecedented increase in (borrowing)
that involved practically every area of consumer credit."
Consumer debt reached levels never seen before and, by the end of
2007, the household savings rate fell below zero.
The United States is now in the early stages of a prolonged period of
belt tightening, a contraction not seen in decades.
Consumer purchases of items other than food and gas have fallen this
year, according to the Commerce Department. Sales of a broad range of
products - including clothing, home furni****ngs and motor vehicles -
were lower last month than they were in March 2007. The slump extends
to services too, such as air travel, restaurants, hotels and casinos.
The International Monetary Fund forecasts that in 2008 and 2009,
household consumption will decline further.
"We're seeing the birth pangs of a new economic structure," said Neal
Soss, chief economist for the securities firm Credit Suisse First
Boston. "The next year or two or three will be about the transition to
a new equilibrium. Consumption by households will grow more slowly
than their incomes, which is the exact opposite of the last 25 years
when consumption grew faster than incomes."
Time to cut back
The adjustment is painful. Few people voluntarily cut back their
standards of living. In most cases, families are doing so because
their incomes aren't keeping up with soaring prices, especially for
such necessities as food and fuel. Their homes and investments are
falling in value and can't be tapped as readily for consumer
purchases. With credit standards tightening, people can no longer
borrow easily to make up the shortfall.
"Standards of consumption have to fall," said Stanford University
economist Ronald McKinnon. "The burden really falls on households."
The changes in middle-class family budgets are likely to be
significant but not necessarily devastating, economists say.
"This is not the end of the world. It's not Armageddon," Rosenberg
said. "It doesn't mean we're going to have to live in a cave or a hut
or an RV. The areas of retrenchment are in things we can do without,
such as cutting out that extra vacation."
The current period marks the finale of the post-World War II era when
the United States stood unchallenged atop the world's economic pyramid
and the dollar reigned as the one truly global currency, many
observers say. Now the nation must deal on more equal terms with a
rising China and India, a united Europe and a powerful bloc of Asian
manufacturing nations. Even Latin America, the long-time
underperformer in the global economy, is flexing its muscles.
"The world has become multipolar," said UC Berkeley international
economics expert Barry Eichengreen. "Our dominance will decline."
In places such as Asia, where Uncle Sam long wagged his finger at
nations that mismanaged their economies, "there is a peculiar sense of
satisfaction that the United States has received its comeuppance,"
Eichengreen said.
The catalyst for this transformation has been the traumatic collapse
of the nation's housing market. The abrupt U-turn in home prices in
the United States beginning a little more than a year ago set off a
chain of events that dramatically altered the nation's position in the
world economy, creating a set of cir***stances that made a consumer
retreat inevitable.
Reasons for downtrend
The strands of this story are complex. Several im****tant trends are
interacting to change the global balance of economic power and bring
U.S. consumers down to earth. Put the pieces together, and you have a
recipe for consumer cutbacks in the United States.
-- The U.S. housing bubble - especially the shaky subprime mortgage
market - was inflated not only by U.S. lenders, but by foreign ones
too. As mortgages were repackaged in the form of exotic securities,
banks and investment funds in Europe and elsewhere snapped them up.
When the market crumbled, those investors were left with hundreds of
billions of dollars in losses.
Not surprisingly, many foreign investors lost their taste for U.S.
securities. When the Federal Reserve pushed down interest rates in
response to the housing crisis, overseas investors had another reason
to yank their money and put it to work in markets where returns were
higher. In the second half of 2007, foreign investment flows into the
United States fell to about $623 billion, about half what they were in
the first six months of the year, according to the U.S. Commerce
Department.
-- As foreign investors lost interest in U.S. markets, the dollar
tumbled. Since the beginning of 2007, the greenback has fallen 17
percent against the euro, the currency of 15 European nations, and 13
percent against the Japanese yen. That's made im****ted goods and
services more expensive, putting such products as French wines and
Japanese autos out of reach for some consumers.
-- The fall in the dollar coincided with a big run-up in the prices of
oil, foodstuffs such as wheat and corn, and other commodities. That
raised the cost of such necessities as gas and food, leaving less
available for discretionary items such as restaurant meals and new
cars.
-- Lenders in the United States responded to housing losses by
imposing more stringent credit standards, tightening qualifications
for home loans, car loans, student loans and credit cards. The volume
of home mortgages and equity loans dropped and was only partly offset
by increases in credit card debt.
-- The downturn in the U.S. economy took big bites out of the value of
consumers' two most im****tant assets: their homes and their stock
****tfolios. That left fewer resources that could be drawn on to buy
goods and services. It also robbed people of confidence in the
security of their nest eggs, leaving them more reluctant to spend.
-- Rising unemployment, slow wage growth and higher inflation squeezed
family budgets, forcing many households to cut back.
Meanwhile, even as consumers retreat, U.S. ex****ters are having a
field day with the weak dollar, stepping up overseas sales of products
ranging from soybeans to technology equipment.
Add it all up, and you get a downturn in retail spending, a drop in
nonenergy im****ts, and a notable improvement in the U.S. trade balance
with the rest of the world. In the second half of 2007, the current
account deficit - the broadest measure of trade and other
international payments - was $350 billion, down 13 percent from the
second half of 2006.
Im****tant medicine
As difficult as the adjustment may be, experts say the change is
im****tant medicine. To take one example, we're moving into a period
when loan standards are more realistic. Home buyers now have to put
money down and pay interest appropriate for their level of
creditworthiness.
"We should not look at today's raising of credit standards as being
bad," said Catherine Mann, professor of international economics and
finance at Brandeis International Business School in Massachusetts.
"We're returning to a more realistic credit paradigm after a period of
excess. What people are comparing it to is something that was
outlandishly unrealistic."
As for the nation, being humbled isn't the same as being bankrupted.
The United States can still thrive in a world in which the dollar is
no longer king and where economic power is centered in Shanghai and
London as much as in New York.
"I see no reason that we can't continue to enjoy productivity gains
and double the standard of living in the next 30 or 40 years," said
John Shoven, director of the Stanford Institute for Economic Policy
Research. "I still sense that there's lots of excitement for things
like solving our clean technology problem. I don't see a country
that's down on its luck and out of ideas."
Dollar falls, prices rise, credit eva****ates as foreign investors cut
off funds to U.S.
How do the weak dollar and the declining fortunes of the United States
in the global economic arena add to the pressure on consumers? The
answer isn't obvious, but it's an im****tant part of the squeeze on
household finances. For years, the United States im****ted far more
goods from overseas than the nation sold abroad, creating a trade
deficit that topped $800 billion annually. The only reason the United
States could afford to buy all that foreign stuff was that overseas
investors put hundreds of billions of dollars into the U.S. economy by
buying our stocks, bonds and real estate. Now, spooked by the housing
crisis, foreigners have cut by about half the money they invest in the
United States. That's had a dramatic effect on consumers. First, it's
pushed the dollar down. The lower dollar is one of the key reasons
prices of food, gas and other products have shot up. For example, oil
ex****ting countries are getting paid with less-valuable dollars, so
they raise the price of crude to offset the greenback's fall. U.S.
motorists in turn get walloped at the gas pump. The same holds for a
wide range of other im****ted products. Second, the reluctance of
foreigners to invest in the United States is one of the reasons credit
is scarce and loans are harder to get in this country. If U.S. banks
can't sell mortgages to investors in Europe and Asia, they are less
willing to lend, intensifying the credit crunch.
Ins and outs
Squeezed by food and energy prices, tight credit, stagnant incomes and
falling home and stock values, many consumers are throttling back.
Here's what's in and what's out in the new economic order.
IN OUT
Saving Borrowing
Cooking at home Eating out
Fixing the old car New car
Staying at home Foreign vacations
20 percent down No down payment
Debit cards Credit cards
Working past 65 Early retirement
Library Bookstore
Tap water Bottled water
BART Bay Bridge
Patching Remodeling
Public park Theme park
Eyegl***** Lasik surgery
Poker night Weekend in Vegas
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