January 21, 2009

Another Real Estate Crisis Is About To Hit

By Paul Craig Roberts

For a picture of the US real estate crisis, imagine New Orleans wrecked by Hurricane Katrina, and before the waters even begin to recede, a second Katrina hits.

The 1,120,000 lost US retail jobs in 2008 are a signal that the second stage of the real estate bust is about to hit the economy. This time it will be commercial real estate—shopping malls, strip malls, warehouses, and office buildings. As businesses close and rents decline, the ability to service the mortgages on the over-built commercial real estate disappears.

The over-building was helped along by the irresponsibly low interest rates, but the main impetus came from the slide of the US saving rate to zero and the rise in household indebtedness. The shrinkage of savings and the increase in debt raised consumer spending to 72% of GDP. The proliferation of malls and the warehouses that service them reflect the rise in consumer spending as a share of GDP.

Like the federal government, consumers spent more than they earned and borrowed to cover the difference. Obviously, this could not go on forever, and consumer debt has reached its limit.

Shopping malls are losing anchor stores, and large chains are closing stores and even going out of business altogether. Developers who borrowed to finance commercial ventures are in trouble as are the holders of the mortgages, derivatives and other financial junk associated with the loans.

The main source of the economic crisis is the infantile belief of US policymakers that an economy could be based on debt expansion. As offshoring moved jobs, incomes, and GDP out of the country, debt expanded to take the place of the missing income. When the offshored goods and services were brought back to be sold to Americans, the trade deficit rose, adding another level of financing for an economy that consumes more than it produces.

The growth of debt has outpaced the growth of real output. Yet, the solution offered by Obama’s economic team is to expand debt further. This is not surprising as Obama’s economic team consists of the very people who brought on the debt crisis. Now they are going to make it worse.


The unexamined question is: Who is going to finance the next wave of debt?


The US budget deficit for fiscal year 2009 already appears to be on a path to $2 trillion, and that is before Obama’s stimulus program. What we are looking at is a $3 trillion budget deficit if Obama’s program is enacted in time to impact the economy this year.


Foreign countries can finance a $500 billion US budget deficit out of their trade surpluses with the US. But foreigners do not have the funds to finance a US budget deficit in the trillions of dollars, and they would not finance such a deficit even if they had the funds. Foreigners are over-weighted in dollar holdings and prefer to lighten their holding than to add to them. America’s economic prospects are dim as are the dollar’s prospects as reserve currency. An annual budget deficit in the trillions of dollars makes the dollar’s prospects appear even dimmer.

The federal government’s likely solution to the debt problem will be to monetize the debt, that is, the government will finance its deficit by printing money. Debt will be inflated away. But for those Americans without jobs or whose incomes do not rise with inflation, life will be cruel.

Life is already cruel for Americans living on retirement savings. Not only has the stock market bust reduced their wealth by half, but also their remaining assets are producing no income. Interest rates are so low that debt instruments produce no income, and there are scant capital gains in the stock market. Retirees are living by consuming their capital.

[b]America’s economic policy of low interest rates and debt expansion bodes ill for everyone living off their savings. Their future prospects are even worse as high inflation will destroy the value of their savings, especially if held in cash or debt instruments, including “safeâ€