Monday, August 29, 2005

As Expected, Krugman Made His Rant......

This will be my second "official economic rant" in a row.....and to be honest, I haven't really went public with any of my views until last Friday.

Again, I agree with Krugman's economic analysis for the United States on the 2006 outlook, and where he pointed out the consequences of a housing slowdown (i.e. the burst of the housing bubble) in the United States. (I can't really remember, in recent times, that I found any flaws with Krugman's Economic rants - he is just one smart fellow economist.....or maybe I'm just not "up to the par" yet to see those flaws.........)

However, I don't think it is necessary to "bash" Mr. Greenspan on his record. The man is going to retire in a few months, and Mr. Greenspan did an exceptional job as the Chairman of the Federal Reserve for all these years.

Krugman should focus on how to deal with the potential recession rather than pointing fingers.

The American government has to first deal with the twin deficit - control its spending, and possibly need to reverse the 2001 tax cuts, (i.e. tax hikes for the highest income earners and maybe giving a tax cut to lower income earners.) In addition, the Central Bank may as well should try to slowly devalue the Greenbags to stimulate export. However, doing so may have to decrease interest rates.

Decreasing interest rate may not be something that the Feds want to do at this moment. Of course, it also depends on the elasticity of money demand to the interest rate (i.e. how sensitive the money market is to the adjustment of interest rate.) In fact, the Feds should increase interest rate to moderately cool off the over-heated housing market. Such a move will ease some of the pain when the real estate bubble bursts. Also, with the new oil crisis looming, there could be a need to increase interest rate to fight potential inflation, which leaves the Feds with only one option - to devalue the Greenbag via open market operations.

The last resort for the Americans is to "copy" what they did between 1985-1987 (the Plaza-Louvre Accord), where they "strong-armed" G5 countries to devalue the Greenbags. If this is what the Americans are planning to do, they will have to deal with more countries this time around, not to mention that those key players at this round of talks will have to include China. Personally, I cannot see China give-in too much to those U.S. demands on this issue. The Americans have been calling the Chinese to appreciate the Renminbi (aka Yuen) vs. the U.S. Dollar for the past few years, but nothing too significant has happened so far.

As I mentioned last week, there are very few options that the U.S. government can choose at this moment to deal with this potential recession. These measures will cause some pain in the short run, but those are necessary steps to go through to avoid a large scale recession.

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August 29, 2005

Greenspan and the Bubble
By PAUL KRUGMAN

Most of what Alan Greenspan said at last week's conference in his honor made very good sense. But his words of wisdom come too late. He's like a man who suggests leaving the barn door ajar, and then - after the horse is gone - delivers a lecture on the importance of keeping your animals properly locked up.

Regular readers know that I have never forgiven the Federal Reserve chairman for his role in creating today's budget deficit. In 2001 Mr. Greenspan, a stern fiscal taskmaster during the Clinton years, gave decisive support to the Bush administration's irresponsible tax cuts, urging Congress to reduce the federal government's revenue so that it wouldn't pay off its debt too quickly.

Since then, federal debt has soared. But as far as I can tell, Mr. Greenspan has never admitted that he gave Congress bad advice. He has, however, gone back to lecturing us about the evils of deficits.

Now, it seems, he's playing a similar game with regard to the housing bubble.

At the conference, Mr. Greenspan didn't say in plain English that house prices are way out of line. But he never says things in plain English.

What he did say, after emphasizing the recent economic importance of rising house prices, was that "this vast increase in the market value of asset claims is in part the indirect result of investors accepting lower compensation for risk. Such an increase in market value is too often viewed by market participants as structural and permanent." And he warned that "history has not dealt kindly with the aftermath of protracted periods of low-risk premiums." I believe that translates as "Beware the bursting bubble."

But as recently as last October Mr. Greenspan dismissed talk of a housing bubble: "While local economies may experience significant speculative price imbalances, a national severe price distortion seems most unlikely."

Wait, it gets worse. These days Mr. Greenspan expresses concern about the financial risks created by "the prevalence of interest-only loans and the introduction of more-exotic forms of adjustable-rate mortgages." But last year he encouraged families to take on those very risks, touting the advantages of adjustable-rate mortgages and declaring that "American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage."

If Mr. Greenspan had said two years ago what he's saying now, people might have borrowed less and bought more wisely. But he didn't, and now it's too late. There are signs that the housing market either has peaked already or soon will. And it will be up to Mr. Greenspan's successor to manage the bubble's aftermath.

How bad will that aftermath be? The U.S. economy is currently suffering from twin imbalances. On one side, domestic spending is swollen by the housing bubble, which has led both to a huge surge in construction and to high consumer spending, as people extract equity from their homes. On the other side, we have a huge trade deficit, which we cover by selling bonds to foreigners. As I like to say, these days Americans make a living by selling each other houses, paid for with money borrowed from China.

One way or another, the economy will eventually eliminate both imbalances. But if the process doesn't go smoothly - if, in particular, the housing bubble bursts before the trade deficit shrinks - we're going to have an economic slowdown, and possibly a recession. In fact, a growing number of economists are using the "R" word for 2006.

And here's where Mr. Greenspan is still saying foolish things. In his closing remarks he suggested that "an end to the housing boom could induce a significant rise in the personal saving rate, a decline in imports and a corresponding improvement in the current account deficit." Translation, I think: the end of the housing bubble will automatically cure the trade deficit, too.

Sorry, but no. A housing slowdown will lead to the loss of many jobs in construction and service industries but won't have much direct effect on the trade deficit. So those jobs won't be replaced by new jobs elsewhere until and unless something else, like a plunge in the value of the dollar, makes U.S. goods more competitive on world markets, leading to higher exports and lower imports.

So there's a rough ride ahead for the U.S. economy. And it's partly Mr. Greenspan's fault.

E-mail: krugman@nytimes.com

Copyright 2005 The New York Times Company. All rights reserved.

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