Paul Krugman: Coming Down to Earth

Is this the beginning of the big slowdown? Paul Krugman reviews the stresses the economy is under and concludes there is cause for concern:

Coming Down to Earth, by Paul Krugman, Commentary, NY Times: ...We shouldn't read too much into a couple of days' movements in stock prices. But it seems that investors are suddenly feeling uneasy about the state of the economy. ... the puzzle is why they haven't been uneasy all along. The rise in stock prices that began last fall was essentially based on the belief that the U.S. economy can defy gravity — that both individuals and the nation as a whole can spend more than their income ... more or less indefinitely.

To be fair, for a while the data seemed to confirm that belief. In 2005, the trade deficit passed $700 billion, yet the dollar actually rose against the euro and the yen. Housing prices soared, yet houses kept selling. The price of gasoline neared $3 a gallon, yet consumers kept buying ... even though they had to borrow to keep spending...

Over the last few weeks, however, gravity seems to have started reasserting itself. The dollar began falling about a month ago. ... there's a definite sense that foreign governments, in particular, are becoming less willing to keep the dollar strong by buying lots of U.S. debt. The housing market seems to be weakening rapidly. ... Finally, there are preliminary indications that consumers, hard-pressed by high gasoline prices, may be reaching their limit. ...

I can't resist pointing out that the Bush administration's response to the squeeze on working families has been, you guessed it, to accuse the news media of biased reporting.

On May 10 the White House issued a press release titled "Setting the Record Straight: The New York Times Continues to Ignore America's Economic Progress." The release attacked The Times for asserting that paychecks weren't keeping up with fixed costs like medical care and gasoline. The White House declared, "But average hourly earnings have risen 3.8 percent over the past 12 months, their largest increase in nearly five years."

On Wednesday John Snow repeated that boast before a House committee. However, Representative Barney Frank was ready. He asked whether the number was adjusted for inflation; after flailing about, Mr. Snow admitted, sheepishly, that it wasn't. In fact, nearly all of the wage increase was negated by higher prices.

Meanwhile, the return of economic gravity poses a definite threat to U.S. economic growth. After all, growth over the past three years was driven mainly by a housing boom and rapid growth in consumer spending. ... As I summarized it awhile back, we became a nation in which people make a living by selling one another houses, and they pay for the houses with money borrowed from China.

Now that game seems to be coming to an end. We're going to have to find other ways to make a living — in particular, we're going to have to start selling goods and services, not just I.O.U.'s, to the rest of the world, and/or replace imports with domestic production. And adjusting to that new way of making a living will take time.

Will we have that time? Ben Bernanke, the chairman of the Federal Reserve, contends that what's happening in the housing market is "a very orderly and moderate kind of cooling." Maybe he's right. But if he isn't, the stock market drop of the last two days will be remembered as the start of a serious economic slowdown.

Previous (5/15) column: Paul Krugman: D is for Debacle
Next (5/22) column: Paul Krugman: Talk-Show Joe

Comments

[reason]

So Krugman(n) is shrill about the economy. I'm fascinated/scared because he is hardly alone. Some people are seriously forecasting 1929 Take 2. What is his record like at prognostication? The doomsayers, curiously span a pretty wide politically spectrum. I was fascinated to see people plugging Lyndon LaRouche in the Fußgängezone in Bad Homburg (near Frankfurt/Main) this weekend. They obviously think their time has come (wierd ideas spread far).

If I wasn't part of the world, I would find this all simply fascinating instead of a bit scary as well). Maybe a new economic theoritically synthesis will emerge from the ashes - combining some insights of the Austrian School (regarding asset prices and asset price cycles) together with Keynesian and Monetarist insights. I hope some serious reforms of the international payments will also be undertaken. It is really the neo-classical school that has the most to lose from a meltdown (theoretically speaking that is) so they must really be a bit nervous.

[anne]

http://flagship2.vanguard.com/VGApp/hnw/FundsByName

Vanguard Fund Returns
12/31/05 to 5/18/06

S&P Index is 1.8
Large Cap Growth Index is -0.7
Large Cap Value Index is 4.3

Mid Cap Index is 3.8

Small Cap Index is 6.2
Small Cap Value Index is 6.3

Europe Index is 12.3
Pacific Index is 8.6
Emerging Markets Index is 11.9

Energy is 11.5
Health Care is 0.7
Precious Metals is 27.0
REIT Index is 6.3

High Yield Corporate Bond Fund is 1.6
Long Term Corporate Bond Fund is -5.4

[anne]

http://flagship2.vanguard.com/VGApp/hnw/FundsVIPERByName

Sector Stock Indexes
12/31/05 - 5/18/06

Energy 8.0
Financials 3.3
Health Care -3.5
Info Tech -2.7
Materials 7.2
REITs 6.4
Telecoms 9.4
Utilities -0.4

[Nj]

Is there a link (other than NY select) where I can read Krugmans column in full ?

I saw a link somewhere ..which is a blog of someone who reproduces NYT select articles for free ??

[anne]

There is no real choice in fiscal policy, but if there were I would choose leaving Iraq immediately and using the $10 billion saving each month for federal revenue sharing programs with the states for infrastructure strengthening from lowering tuitions at public universities to developing alternative energy production facility. Then, gradually end tax reductions that were aimed expressly at the wealthiest. But, we will not leave Iraq, there will be no revenue sharing, tax cuts for the wealthiest will prevail.

[anne]

Little has happened in a couple of days in the market to be all that worrying, and from my perspective investors have been readying portfolios for quite a while. I do not find this market especially speculative. Also, even the mild sell-off in stocks has been accompanied by a decline in long term interest rates that is what I would hope would happen to cushion any stock market or economic decline.

[anne]

There are a host of loony economic ideas couched in writing that is happily incomprehensible, so do not bother. There were moments when I thought to figure out what Austrians had to say, and then I thought of what really clever double-talking comedians have to say and I have never thought of Austrian ideas again :)

[dd]

If and when we come down to earth it will be an opportunity to stress test financial deregulation and innovation. The FT had an intersting article on "variance swaps" and hedge funds:
http://news.ft.com/cms/s/7edab4a6-e6d3-11da-a36e-0000779e2340.html
Derivatives and hedge funds proliferate but not to worry:
"Greenspan also said that he is a strong opponent of increased federal regulation of hedge funds, but scolded the emerging industry for sloppy book-keeping habits."
http://www.marketwatch.com

[anne]

Remember, a sell-off is a fine learning opportunity, so attend to Vanguard stock and bond prices for a while and note relative patterns. Paul Krugman has been repeatedly right on market conditions, so even if I argue I always pay attention.

[dd]

This sell-off is not significant enough to stress the system. The equities markets are not speculative; the speculation is in the derivatives markets but because those leveraged bets are private it's difficult to gauge other than from second-hand reports as in the FT article or the actual aftermath as in the Delphi/GM bond squeeze. What is curious is how derivatives are morphing into instruments that behave no differently from traditional regulated products (ie futures and options) without regulatory margin requirements.

[well]

The truth is we Americans are stretched to the breaking point. We've taken home equity loans, have tremendous credit card debt, have kids to put through college, are paying more for gas, and are watching our pensions being destroyed and our jobs outsourced to China.

We've leveraged ourselves as far as we can to try to live out the story "the market" has sold us. We're out of funds, they've bled us dry.

Most Americans are only one serious illness away from complete economic collapse, and in their hearts, in the dark of night, they know that.

How many mortgage payments can you afford to miss? How much are you paying in credit card interest every month? How much are you paying for health insurance and to heat your house? How much are you saving?

The rich have squeezed the middle class until now there is nothing left but the bad aftertaste of overindulence. We've just witnessed the biggest transfer of wealth in our nation's history.

We've been suckered. And it's our own fault for believing that "deficits don't matter" and "globalization is inevitible" and "high corporate profits mean a strong economy" (I especially love that last one).

Time to grow up, America.