Rebecca Moves from Sunnybrook Farm to the New York Times!

Below, New York Times economics writer David Leonhart gives us the upside of down. My comments are in brackets.

The New York Times / November 14, 2007

Economic Scene Good News: Housing's Down, Market's Off, Oil's Up
By DAVID LEONHARDT

Until yesterday's rally on Wall Street, the news on the business pages has sounded pretty grim lately. Stocks are still down 6 percent from their peak this year, and oil is near a record high. The dollar, incredibly, is worth only 96 Canadian cents. And house prices will be falling for a long time to come.

So in an effort to cheer everyone up before Thanksgiving, this column is going to focus today on some good news. Here it is:

Stocks are still down 6 percent from their peak, and oil is near a record high. The dollar, incredibly, is worth only 96 Canadian cents. And house prices will be falling for a long time to come.

Seriously.

[I truly admire this willingness to be contrarian! There's no reason to accept any
version conventional wisdom at face value. -- JD]

As long as the financial system doesn't have a major meltdown, none of these developments will turn out to be as bad as you think. Some of them are downright welcome.

[This "as long as the financial system doesn't have a major meltdown..." is quite a clause! (a veritable Santa Clause!) Can we rely on the Fed to prevent such a meltdown? do they have the power to do or will they have to mobilize the big banks to save the day? (can the big banks afford to do so?) will the taxpayers foot the bill, as with the bail-out of the Savings & Loan industry? or is the financial mess smaller and milder than most think? there are no answers in this article.]

Too often, we think about the economy without nuance. We treat it as a local sports team that is either winning or losing, up or down. We're always supposed to be rooting for stocks and homes to become more valuable and for oil and overseas vacations to become more affordable.

But that's not quite right. There are real downsides to an economy full of expensive assets and inexpensive resources. There are also a lot of people who are better off because of the recent turmoil. You may well be one of them.

The best place to start is the stock market, because it's the most counterintuitive. The notion that anybody but a sophisticated Wall Street short-seller should be hoping that stocks fall sounds, frankly, bizarre. But it's true: a huge chunk of the population -- including most people under the age of 50 -- has benefited from this year's market drop.

My favorite explanation of this idea is still a column that Peter Coy of Business Week wrote in 1999, during the dot-com mania. He said he was thinking of forming a club called Stockholders Who Wish the Stock Market Would Stop Going Up So Fast. It would be meant for people who were at least two decades from retirement and who weren't active investors. They instead owned 401(k)'s and individual retirement accounts.

They were, in other words, typical. Only 21 percent of families owned stocks outright in 2004, the most recent year for which the Federal Reserve has released data. Almost 50 percent of families owned a retirement account, by contrast. The typical retirement account (median value of $35,200) was also a lot bigger than the typical stock holding ($15,000).

These long-term, buy-and-hold investors, as Mr. Coy pointed out, are actually hurt by a market that rises too quickly. When stocks get so expensive, returns over the next few decades are usually mediocre. And only a small chunk of a typical person's investments will have been made before the run-up.

It would be much better -- tens or even hundreds of thousands of dollars better -- if the market rose more steadily and the bulk of the 401(k) contributions could then rise along with it. Buy low and sell high, right?

[Alas, a lot of people don't get this. I still remember friends asking me for advice when they were leaping into the stock market in the late 1990s. My advice that they "stay out until prices fall" wasn't acceptable.]

A true crash would take care of this problem. But the market's big fall from 2000 through 2002 doesn't fit the definition, because it didn't come close to erasing the effects of the bubble. Stocks are still more expensive today, relative to corporate earnings over the previous decade, than at any time besides the late 1920s and the dot-com boom.

So unless you're about to retire or sell stock for some other reason, you shouldn't get too upset about the market's fall. As long as you are planning on more buying than selling over the next decade or two, a market correction is your friend.

[The problem with this is that a "true crash" creates other problems. Suddenly the ability to use stocks as collateral for loans is severely undermined. If you are already heavily indebted, perhaps if you borrowed to put money into stocks, falling asset values represent a serious problem. It can drive you into bankruptcy.

Further, the wealth effect of a true stock market crash depresses consumer spending, especially that of stock-owners (mostly, the rich). Corporations have a harder time raising funds to finance real (fixed) investment by selling new stock. Expectations of future profitability are hurt. All of these spell recession, all else constant. This usually hurts corporate dividends and returns, and the stock market.]

It's also likely to improve the nation's long-term economic prospects. The bull market of 1990s, combined with the housing boom, fooled many people into thinking they didn't need to save money. They evidently figured that their existing assets would continue to soar in value and could serve as their nest egg. Last year, Americans saved only 0.4 percent of their disposable income, down from 7 percent in 1990.

This decline in personal savings has set the stage for all kinds of problems. The biggest may be that less savings, by definition, equals a smaller pool of capital available for overall investment. Less investment -- be it in medical technology or software -- will mean slower economic growth and lower standards of living down the road.

[This is illusion. As Keynes pointed out, it's not saving that drives investment. Increased saving, all else equal, encourages a _fall_ in total spending on GDP, i.e., recession. A recession -- or even a slow-down in the economy -- can, via the famous accelerator effect, _stop_ private fixed investment (the real stuff, not the financial investment in the stock market).

In any event, domestic saving is not needed to finance real investment. Funds can -- and have been -- coming from outside the country. This is where many people get upset: an inflow of funds is the same thing as a trade deficit (or, more accurately, a current-account deficit), where the country is spending more on foreign goods and services than it sells exports.

But there is nothing wrong with that kind of deficit if the funds go to pay for productive investment. The US did very well during most of the 19th century
despite trade deficits, since it used the borrowed funds to build up industry
and rise toward the top of the pack.

The problem is that nowadays these imported funds (capital inflows) go to pay
for wasteful activities, such as tax cuts for the rich and the war in Iraq. They are mostly going to current consumption and unproductive purposes rather than to fixed investment (broadly defined, to included education and the like).

In sum, it's fixed investment that deserves our attention, not saving.]

Fortunately, the savings rate has begun to climb, especially since the housing market turned. So far this year, Americans have saved 0.8 percent of their income, and the number should continue to rise. As Joe Davis, an economist at the Vanguard Group, the investment company, said, "This will be a slow-moving and ongoing process, but I think a welcome one."

[Yes, if we want a recession. Now, it _is_ true that rising (net) exports due to the falling dollar can help avoid a recession. But that falling dollar imposes a loss of real living standards on all of us who import or rely on others to import -- i.e., all people in the US. It also encourages inflation, for example in oil prices (in US dollar terms).

It is also true that a rising government deficit can avoid recession. But, as
mentioned, currently that's going mostly as rewards to Bush's rich supporters
or down the sink holes of Iraq and Afghanistan. That hardly helps the economic
health of the Average American!]

The other ostensible pieces of bad news have their own silver linings. As the cost of gas has soared to $3 a gallon [and significantly higher in places like California, where I live -- JD], from an inflation-adjusted low of about $1.20 in 1999, Americans have finally started buying more efficient cars and trucks. For the first time since the mid-1980s, the fuel economy of new vehicles has increased for two straight years, the Environment Protection Agency recently reported. This will slow global warming and make life a little less comfortable for oil-rich autocrats (though not nearly as much as a carbon tax would).

[Yes, but the rising oil price also creates an inflationary impulse that prevents the Fed from using monetary policy to moderate recession and/or solve the big financial mess that Wall Street faces. Not that the Fed is normally all-powerful, able to "fine tune" the economy and avoid recessions, inflation, and the like. But the inflationary shock makes its tasks even harder.]

The fall of the dollar, meanwhile, may be precisely what the world economy needs right now, as James Paulsen of Wells Capital Management points out. It provides a lift to the sagging American economy, by allowing companies in the United States to export more, while encouraging consumers to spend less on imports and save more.

[See above.]

It's not even clear that falling house prices are such a bad thing. They don't really matter for families who aren't planning to move. They don't even matter much for families moving to a similar house in a similar market. The house they are buying will have gotten cheaper, too.

Families hoping to buy their first house, on the other hand, clearly benefit. (Easy for me to say, though. As my boss pointed out when he heard about this column, I'm a renter and still decades from retirement.)

There is no question that people have gotten hurt this year. Many families have struggled to pay their bills. Others have had to delay retirement, and thousands have lost their homes to foreclosure. In an ideal world, the imbalances in the economy would never have become so extreme.

[Note that the housing crunch, like a "true" stock market crash, encourages recession by dampening consumer spending -- and also by hurting fixed investment in the housing industry (and related, like Home Depot).]

But once they did, what, really, was the alternative to the recent turmoil? An ever-higher stock market, ever-cheaper oil or an ever more insane mortgage market wouldn't have solved the problems of the American economy. It would have made them worse.

Copyright 2007 The New York Times Company

[This shows a total lack of perspective. Since the end of the Keynesian age (in the 1970s) we've seen a return to the business cycle pattern that prevailed in the 1920s and before. There are speculative booms in GDP like that of the late 1990s, followed by speculative crashes as in 2001 (moderated by the Fed). The boom creates the conditions that create the crash, which then creates the next speculative boom. Just as then, the self-generating cycle is changed by the US involvement in wars (World War I back then, the Gulf War I and II now), which stimulate the economy.

The only complication is that nowadays (unlike under the gold standard) the Fed moderates (or tries to moderate) the fluctuations. Sometimes, it seems, it creates the basis for new speculative booms, as with the currently-ended housing bubble.

Using perfect 19th century logic, Leonhardt is arguing that because of the speculative boom, we need the speculative crash. But what about changing the policy regime? The government could increase the role of the automatic stabilizers as it did starting in the 1930s, while increasing the amount of investment in (needed!) infrastructure, basic research & development, education, and public health. It could actually make an effort to clean up the aftermath of Katrina. That would get us back to the 1950s & 1960s. Of course there would be problems, but that's another topic.

Another problem with the pre-1950s cycle -- and with Leonhardt's logic -- is that the economy can spin off its normal up-and-down path. This is what happened back in 1929-33. I don't think Leonhardt wants to contemplate this possibility.]

[by Jim Devine]