Boom2Bust.com

Make no mistake; extremely difficult times lie ahead. Our nation’s character will be tested like never before. Whether it will rise to the occasion or be found wanting remains to be seen. While we can all hope for the best, the pragmatist in me suggests that we had better prepare for the worst. -Peter Schiff

The Great Depression,
where the stock market declined more than 90%
and real estate lost 73% of its value.

The material found on Boom2Bust.com is based on research conducted by the editor, Christopher E. Hill, who predicts that a U.S. financial crash is imminent. Mr. Hill, an independent financial research analyst based in Chicago, believes that the United States is in the middle of a financial “minefield”— with no safe way out. Bubbles, which exist whenever an asset’s perceived or psychological value exceeds its real economic value, can be found in the U.S. Dollar, Stock Market, and Real Estate. Some even argue we are experiencing the first worldwide bubble in history that covers ALL asset classes. Jeremy Grantham, chairman of Boston firm Grantham Mayo Van Otterloo and the man Vice President Dick Cheney and 2004 presidential candidate John Kerry have trusted with their money, wrote in a letter to shareholders last year:

From Indian antiquities to modern Chinese art, from land in Panama to Mayfair; from forestry, infrastructure and the junkiest bonds to mundane blue chips; it’s bubble time!

Eventually, all bubbles burst and perceived values retreat back to their true economic values, causing financial chaos along the way. In addition to asset bubbles, astronomical levels of Consumer and Government Debt also threaten the U.S. economy. Mr. Hill believes that all of these dangers are interdependent. Therefore, as with a minefield, a single detonation (in other words, the realization of one of the dangers) may set off a chain-reaction and bring about a financial crash in the United States the likes of which recent generations have never seen. In fact, the editor suspects that the ongoing housing downturn may very well be the catalyst for the coming financial storm.

Dollar Bubble

In the last few years, the central bank of Japan has bought almost $1 trillion of U.S. currency, with the Chinese not too far behind at $800 billion. Why would a foreign government buy so much of our money? Because everyone loves the United States and the greenback, right? Wrong! Japan and China continue to buy U.S. dollars to keep its value high so that we will continue buying their exports. Anytime a nation’s currency (or any asset, for that matter) is bought up in large numbers in order to maintain its value, this is evidence of a bubble.

Stock Market Bubble

The value of U.S. blue chip stocks grew nearly ten-fold from 1983 to 2000, while real earnings (adjusted for inflation) increased only three-fold during the same period. By contrast, in the previous 54 years (1928 to 1982), the stock market, as measured by the Dow Jones Industrial Average, grew a much more reasonable three-fold during a time of significant economic growth.

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Dow Jones Industrial Average, 1900-Present
Courtesy of StockCharts.com

Real Estate Bubble

In the 20th century, U.S. home prices consistently rose about 1% a year (when adjusted for inflation) in response to rising incomes and growing population. More recently, however, the average U.S. home price defied gravity and shot up (average annual growth rate of 11.2% in 3Q 2005) while real wage growth was essentially flat and population growth slowing.

Source: New York Times/Robert J. Shiller, “Irrational Exuberance”

Real Wage Growth, 1983-2004
Source: Centrists.org

According to Jennifer Cheeseman Day of the U.S. Census Bureau, Population Division:

The U.S. population growth rate is slowing… the rate of population growth, referred to as the average annual percent change, is projected to decrease during the next six decades by about 50 percent… From 2030 to 2050, the United States would grow more slowly than ever before in its history.

If the most fundamental drivers of real estate prices, increasing income and growing population, are simply not present, then there should have been no real solid economic basis for skyrocketing real estate prices. When real wages doubled from 1950 to 1970, rising home prices made sense. During the recent U.S. housing boom, that economic logic was simply not there. Still, Americans borrowed like mad to buy pricier and pricier homes. The fervor could not be sustained, however, and the boom has turned into a bust with growing mortgage delinquencies, foreclosure filings, inventory glut, and inevitably lower home prices:

Source: McClatchy Newspapers

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Properties with Foreclosure Filings/NAR Existing Home Inventory, January 2005-April 2008
Source: RealtyTrac

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S&P/Case-Shiller Home Price Indices, January 2000-January 2008
Source: The Mess That Greenspan Made

How bad could it get? Well, I don’t believe that history repeats. However, I do agree with Mark Twain, who suggested that it often rhymes:

Sources: New York Times and Patrick.net

Before you dismiss this last chart, keep in mind that back on December 26, 2006, BusinessWeek did an analysis of housing booms and busts, and found:

Housing booms are short and exciting. Housing busts, on the other hand, are long and painful. So don’t put much faith in those oft-heard assertions that the worst is already over. Prices are likely to fall further in many markets in 2007. In some others, prices may rise, but at less than the rate of inflation. A BusinessWeek analysis of the past three decades shows that if history repeats itself, it’s likely to take 15 years or more for many parts of the country to get back to their inflation-adjusted peaks.

Consumer Debt

Collectively, American consumers went from owning a mere $19 billion in loans (excluding home mortgages) in 1950 to a staggering $2.59 trillion of debt as of June 2008. Look around you. It appears buying on credit has become a way of life in America. This is a far cry from generations past, where saving money for a future purchase was the norm. Savers are seen as losers and instant gratification permeates throughout American society. Even if we cut up all our credit cards and continue to make our minimum payments, it would take American consumers many decades to pay all that debt off.  We’re broke, which doesn’t bode well for an economy that is kept afloat by consumer spending.

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U.S. Household Debt: 1966-2006
Source: Global Policy Forum

Government Debt

In 1980, the U.S. government had a deficit of only about $50 billion. In 1982, the deficit had tripled to $150 billion based on the decision to stimulate the floundering U.S. economy through deficit spending. Alas, deficit spending became so seductive that each year the government borrowed more and more (especially from foreign investors) until our total government debt (the sum of all our deficit spending, over many years) went from less than $1 trillion in 1980 to a whopping $9.57 trillion as of mid-August 2008. It’s important to note that few people realize the U.S. government’s annual budget deficit is actually much higher than reported amounts. The government borrows the “extra money” from your Social Security Trust Fund, thus reducing the amount of deficit that the government normally reports. Of course, they intend to pay back the borrowed Social Security funds in the future. Don’t hold your breath, Generation X, Y, and beyond!

U.S. National Debt, 1980-2007
Source: McClatchy Newspapers

Financial Storm?

In conclusion, from 1982 to 2007, Americans experienced almost 25 years of uninterrupted economic growth fueled by easy credit. Inevitably, blowback appeared. Asset bubbles emerged. Main Street starting living beyond its means. And every time the economy started to flounder, the government rushed in to provide more stimulus. Economic cycles weren’t allowed to operate, and the excesses grew. And now, at a time when the American government and consumer is broke, the chaos caused by the housing bust is spilling over into other areas of the U.S. economy.

Is that thunder I hear in the distance?

Photo by Tech. Sgt. Cherie A. Thurlby, USAF