Consumption accounts for over 70% of American spending. Thus even if households do not go back to 1950s saving rates, their balance-sheet repairs will still weigh heavily on demand in the economy as a whole. An increase of five percentage points of saving would leave the economy with a $545 billion gap to fill.

America’s housebuilding industry has left another hole. Residential investment in the second quarter of 2009 was 56% below its peak. The industry will not, and should not, return to its pre-crisis size, when it accounted for 6.1% of GDP. But if homebuilding recovers about half of the ground it has lost since then, it will be about $216 billion below its peak.

Crudely put, therefore, American spending is about $760 billion short of the amount required to return the economy to full employment. Martin Feldstein of Harvard University, who makes a similar calculation, calls this shortfall a “black hole”. If no other source of spending takes over to fill the gap, then sales will stagnate, employment will fail to recover and household incomes will falter.

So, although savings is a good thing, it’s a bad thing when spending has accounted for 70% of the nation’s GDP in recent years. It’s going to take years for us to get back to where we were if we do it in a healthy manner.

I’m working on a follow-up post about consumer spending and the GDP. Stay tuned…

…Despite a welcome return to growth, the world economy is far from returning to “normal” activity. Unemployment is still rising and much manufacturing capacity remains idle. Many of the sources of today’s growth are temporary and precarious. The rebuilding of inventories will not boost firms’ output for long. Across the globe spending is being driven by government largesse, not animal spirits. Massive fiscal and monetary stimulus is cushioning the damage to households’ and banks’ balance-sheets, but the underlying problems remain. In America and other former bubble economies, household debts are worryingly high, and banks need to bolster their capital. That suggests consumer spending will be lower and the cost of capital higher than before the crunch. The world economy may see a few quarters of respectable growth, but it will not bounce back to where it would have been had the crisis never happened.

They go on to talk about a “new normal,” in which they expect the world economy to take one of two paths:

• one where it returns roughly to its pre-crisis rate of growth, without regaining the ground lost.

or…

• one where growth stays at a permanently lower rate, with investment, employement and productivity growth all feebler than before.

In order to avoid the second scenario, The Economist suggests that the U.S. consumers must cut back on spending because we are so much in debt and countries that have been savers must start spending.

How likely is that going to happen?

You can read the rest of the article here, along with a Special Report on the World Economy.

Banking 2: A bank’s income statement 11:59

Banking 3: Fractional Reserve Banking 11:48

Banking 4: Multiplier effect and the money supply 11:07

Banking 5: Introduction to Bank Notes 8:49

Banking 6: Bank Notes and Checks 11:02

Banking 7: Giving out loans without giving out … 8:29

Banking 8: Reserve Ratios 10:49

Banking 9: More on Reserve Ratios (Bad sound) 8:52

Banking 10: Introduction to leverage (bad sound) 9:21

Banking 11: A reserve bank 11:28

Banking 12: Treasuries (government debt) 11:18

Banking 13: Open Market Operations 12:28

Banking 14: Fed Funds Rate 11:42

Banking 15: More on the Fed Funds Rate 12:16

Banking 16: Why target rates vs. money supply 11:40

Banking 17: What happened to the gold? 10:12

Banking 18: Big Picture Discussion 14:08

The Discount Rate 13:22

Repurchase Agreements (Repo transactions) 11:24

ECONOMIC policymakers across the rich world face two delicate balancing acts over the new few years. The first, involving monetary policy, is being widely discussed and carefully planned by teams of technocrats. Central bankers must keep their balance-sheets big and interest rates low for long enough to prevent deflation setting in, but they also have to be prepared to change things quickly to prevent inflation taking off. The second balancing act, involving fiscal policy, depends on politicians rather than specialists—and has, so far, been shamefully ill-planned.

A couple of paragraphs later we get the meat (emphasis mine)…

To be fair to the politicians, this fiscal balancing act is far harder than the central bankers’ task, for two reasons. First, politicians must not only get the timing of fiscal tightening right, but must also decide on the best ways to cut spending and increase taxes, and the right mix between the two. These decisions involve more goals, more tools and more politics than stabilising prices. Second, politicians lack the credibility that central bankers have built up after two decades of low inflation. The first of these differences is inevitable: decisions about the size of government and its priorities are profoundly political and politicians must answer to voters for their choices. But politicians could go a long way towards building credibility for their fiscal decisions by copying more of the tricks of modern monetary policy.

If we leave the stimulus money out there too long, it will lead to inflation (too many dollars chasing too few goods). If we pull it out too soon, we could go back into decline (not enough dollars to spur growth).

Interesting conundrum…

The article states that these decisions should be made by an independent group and NOT by politicians. I agree. Politicians pander because they want to get re-elected. Politicians (all politicians) don’t want to make the tough decisions.

So, two out of the six indicators they follow are now on the positive side. Also, notice how the boxes are shaded from green to red. The more green you see, the closer that indicator is to turning positive. I hadn’t noticed that before.

For reference sake, here’s what the index looked like back when I first hear about it in a June 11, 2009 email:

I have a feeling it’s going to be awhile jobless claims indicator turns green.

For explanations of each of the indicators, click here.

…the rising levels of borrowing may ironically be contributing to the accelerating cost of college, say some college-finance experts. Loans can give colleges an artificial sense of a family’s ability to pay tuition. To some extent, that false sense of security gets built into the assumptions schools make when setting prices, say experts. The idea is that as prices rise, families borrow more and more, spurring prices to rise further, which in turn requires more borrowing. Barmak Nassirian, associate executive director of the American Association of Collegiate Registrars and Admissions Officers, says this phenomenon is playing a role in why tuition grows at about twice the rate of inflation. “Instead of imposing tougher choices” on college costs, he says, it’s “easier to raise prices…because this additional loan amount is made available.”

It’s like anything, the seller always wants to know how much money the buyer has available to make the purchase rather than focus on the price of the product or service. If colleges know that maximum loan amounts and the availability of loans are on the increase, they are free to raise their prices.

I would love to see colleges and universities publishing their budgets for all the world to see. Put everything out there. Every salary paid out to professors and coaches. Every expense. Every source of income. Throw it all out there so we can see WHY prices are rising so quickly. Are the laws of supply and demand driving prices? How can we know if we can’t see the numbers?

There’s a lot about this stuff that I just don’t understand but I want to learn.

Government Debt as a percentage of GDP
(Source: WSJ 7/31/2009)

Of course things could change (and they probably will) but if this graphic is true, the U.S. is on track to have government debt equal to about 110% of GDP (it looks like it was around 63% in 2007 according to the chart). Things don’t look much better for the other nations in the graphic.

The concern with a huge debtload is that interest rates will rise, which could put a damper on any sort of recovery. But, before we come to that conclusion, we should read this post first. According to the author, he only finds a slightly negative correlation between deficits and interest rates. Interesting… Of course, the deficits of the past are NOTHING like the one we face in the future. We are in uncharted waters. That’s what’s so troubling about the above graphic.

• Calculated Risk

• The Conscience of a Liberal (sounds like one of my favorites…lol)

• Economist’s View

• Grasping Reality with Both Hands

• Greg Mankiw (we used one of his text books back in college)

• Marginal Revolution (I used to read this blog years ago but quit reading for some reason)

• The Baseline Scenario

• EconomistMom

• Econbrowser

• Real Time Economics

To their list of bloggers, I would also like to add the writings of Thomas Sowell and Walter Williams.

I have to tell you, this book is interesting. I have been a fan of Dr. Sowell’s no-nonsense writing style (he’s a libertarian) for several years now, which you can read here.

Anyway, as I read through Basic Economics, I’m going to underline the parts that really stand out and highlight them here on AFM. I hope you enjoy them. NOTE: I’m reading the red edition of the book, which is an older edition than the one I linked to.

Chapter 1 – What is Economics?

Economics is the study of the use of scarce resources which have alternative uses.

What does “scarce” mean? It means that what everybody wants adds up to more than there is.

If each resource had only one use, economics would be much simpler.

PART I: PRICES AND MARKETS

Chapter 2 – The Role of Prices

Prices play a crucial role in determining how much of each resource gets used where. Yet this role is seldome understood by the public and it is often disregarded entirely by politicians.

This so true. He then goes on to mention that people usually tend to look at prices as obstacles to their getting what they want.

From the standpoint of society as a whole, the “cost” of anything is the value that it has in alternative uses.

…high prices are often blamed on “greed” and people often speak of something being sold for more that its “real” value, or of workers being paid less than they are “really” worth.

I have been guilty of this assumption many times.

To treat prices as resulting from greed implies that sellers can set prices where they wish, that prices are not determined by supply and demand.

The fact that prices fluctuate over time, and accoasionally have a sharp rise or a steep drop, misleads some people into concluding that pices are deviating from their “real” value.

Although I agree with what he is saying here, I do wonder when the price of gas spikes when oil prices rise but then don’t fall nearly as quickly when oil prices plummets.

…people tend to do more for their own benefit than the benefit of others.

I’ll continue to add my favorite thoughts and quotes from the book as I continue to read through it. If you haven’t ever read a book on economics, I would suggest you check out Basic Economics.

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