2008-01-11

A Nightmare on Main Street

The US Economic slowdown is hitting people hard - especially those who have been fiscally irresponsible:
In Lancaster County, S.C., laid-off textile worker Johnny Brown, 57, has parked his beloved Ford truck outside his double-wide. He's been driving it for 25 years; he rebuilt the V-8 engine himself. But it runs only on premium gas and he can't afford that, so when he has to drive, he uses his wife's sedan.

In Atlanta, Bernadette Smith, 31, has watched her credit-card debt climb to nearly $40,000. That's more than her annual take-home pay, though she works 13 hours a day at two jobs. Once obsessed with the latest style of designer jeans, Smith now shops for clothes only at Wal-Mart, or maybe Target. She has come to consider a dinner at Ruby Tuesday a splurge.

The faltering economy costs Leslie Garza, 18, nearly an hour of sleep each morning; her mom won't spend the gas money to drive her to downtown Los Angeles for her job scooping ice cream. So she sets the alarm early and takes the bus. Garza recently canceled her cellphone service to stretch her $450-a-week paycheck.
That second one scares me - a $40,000 credit card debt, more than 100% of her annual salary.

Of course, many "experts" argue that irresponsible people can be found everywhere. However we need to remember that irresponsible people can often borrow money from lenders quite easily. So what is it with all the lenders? Aren't they lending responsibly?

Well, to put it mildly, yes.

But only "yes" in a way. They lent the money out to people like Bernadette Smith because economic conditions were helpful. Interest rates were low and house prices were rising - whenever capital growth occurs there can also occur an increase in lending. In other words, the entire marketplace supported the sort of activity that allowed Bernadette Smith to borrow more than her annual income on the credit card.

I have argued elsewhere that central banks should have much stricter inflation targeting than they do. I have been pursuing some radically different economic policies for some time now, and the examples I have mentioned above have resulted from an entirely preventable phenomenon - an inflationary asset price bubble. To me, arguing that lenders should be more strict in who they lend to and how they do it misses the point. The fact is that the marketplace already has a way of doing this - interest rates.

If interest rates in the US (and elsewhere) since 2001 had been higher than they were, I would argue that the current recession would never have happened. Of course, growth during that period would have been lower than what it was, but the ironing out of peaks and troughs is what monetary policy is attempting to do.

It is my argument that central banks should aim for an inflation target of absolute zero. It's what I call "Absolute Price Stability" (APS). Although prices of individual goods and services will go up and down according to supply and demand, the aim of APS is to have the Consumer Price Index (CPI) sit at zero, and be at zero continually.

It was inflation and low interest rates that have caused the Subprime meltdown and the recession that will inevitably hit (if it hasn't done so already). Ben Bernanke has been trying very hard to point out that he will create enough money for the recession to be fixed, but the tools that he is using - loose monetary policy - is what has caused the problem in the first place.

Giving a drug addict his drugs so that he can be free of their dangers makes no sense. At some point there needs to be cold-turkey to fix things up. Hopefully this recession will be deep and broad enough to allow the US economy to "catch its breath" and travel at a more sustainable speed.

2 comments:

Ron Lankshear said...

Banks - responsible? No way should they have allowed a $40,000 USD too debt. Here they continually offer low interest if you transfer your debt. A seller accosted me in a Mall re doing that and I said "I pay off my card on due date" off she went.

The 57 yo is in trouble - no job

The 18 yo just had a break through - she is actually getting exercise and has got rid of her cell - a real drain on money for the young.
They get coerced into downloading ring tones etc

BLBeamer said...

It was inflation and low interest rates that have caused the Subprime meltdown

I believe I'm just confirming your comments here, but the meltdown is nothing more than the market reverting back to equilibirum. Over the past few years, the US housing market became riddled with bogus lenders funneling mortgage money to bogus owners with bogus collateral to buy houses with bogus prices. Attempting to prop up this phony baloney is a pointless exercise. Liquidate now, the sooner the better! What the housing market needs in order to get back to normal is a strong dose of reality - and I therefore heartily approve of the meltdown. It will remove the inept, greedy and predatory lenders, agents and brokers from the housing market.

It will also cause some pain to people who are living in houses they can't afford and have no business living in. But in the long run, that is better for them and the market. They won't be homeless, they'll just be less that home.