Bursting bubbles could result in a dark economic future.
By: Hank Kalet
The standard economic analysis these days ties the faltering economy to the stock market, assuming that when the stock market rebounds everything will be OK and we’ll start seeing the kind of growth we experienced during the 1990s.
I hope they are right. But I have this queasy feeling they are missing something.
William Greider in his book "One World, Ready or Not, The Manic Logic of Global Capitalism," published in 1997, essentially predicted that the economic bubble would burst because it was built on growing capacity, income inequalities and stagnant demand. Mr. Greider was savaged at the time of the book’s publication by a host of free-marketers and publications like The Wall Street Journal for his pessimism.
Yet, lo and behold, here we are in an economy in which we’ve been hemorrhaging jobs.
So, when I come across an analysis like this from Dean Baker in In These Times I have to take notice as all of us should. Mr. Baker is the co-director of the Center for Economic and Policy Research and is the author of the Economic Reporting Review, a weekly online commentary on the economic reporting in the New York Times and Washington Post.
Mr. Baker writes that the flush times of the 1990s contained some basic warnings that the bad times might be around the corner. He calls the sinking stock market "just a healthy return to reality."
The key is that stock prices were outpacing corporate earnings by record margins.
"When the market was hitting its peaks in 2000, the ratio of stock prices to corporate earnings exceeded 30-to-1, more than twice its historic average," he said. "No plausible explanation could ever have justified this sort of valuation. In order for the stock market peaks of 2000 to have made sense, it would have been necessary for profits to grow at close to twice their historic pace.
"In short, any serious economic analyst should have been able to recognize the stock bubble of the late ’90s. The fact that those in positions of responsibility either failed to recognize the bubble or chose to ignore it was a mistake with enormous consequences."
More bubble bursting in the housing and currency markets is on its way, he says, which could have long-term consequences for our economic future.
The housing market bubble spurs borrowing, he says.
"Families see the rising value of their homes as a source of wealth that they can draw upon to meet their needs," he says. "They have been drawing on this wealth with a vengeance in the past two years, as plunging interest rates have led to an unprecedented surge in mortgage borrowing. As a result, the ratio of mortgage debt to home equity is at near-record highs."
If housing prices fall, however, homeowners can be left with debt that exceeds what they could get for their houses. Follow this scenario: You buy a ranch house in Kendall Park in May for $260,000 (that’s the going rate, according to the appraisal we just had on our house), putting down the standard 20 percent (or $52,000) and financing the $208,000 balance. Six months from now, the housing bubble bursts in central New Jersey and housing stock loses 25 percent of its value. Suddenly, you’re holding a $208,000 mortgage on a house worth $195,000.
Another issue, and perhaps more disconcerting, he writes, is that the current high levels of mortgage debt seem inconsistent with the demographic trends.
"The population is aging, and many families are getting near retirement," he writes. "With the front end of the baby boomers approaching 60, many homeowners should be near to paying off their mortgage. The demographics indicate that mortgage debt should be lower than it has been in prior decades. But on the contrary, many baby boomers are likely to hit retirement after having just lost much of the wealth in their 401(k)s due to the stock market crash and discover that their homes are worth much less than they had expected. These older baby boomers really need to be saving to ensure themselves a sufficient income in retirement, but the illusory wealth created by the housing bubble is preventing them from recognizing this fact."
As for what he calls the "dollar bubble," he says that the Clinton administration’s "strong dollar" policy had a "desirable short-term effect of restraining inflation and raising domestic living standards by making imports cheaper for people in the United States." But long-term, it helped fuel a trade deficit that has cause the United States to borrow "more than $550 billion a year from abroad (approximately 5.3 percent of GDP)."
"This borrowing is paid for by selling off U.S. assets," he writes. "If the trade deficit remains at its current level, within a decade foreigners will own the entire stock market, much of the government debt and many of our homes."
He says the dollar will have to fall at some point, which will result in higher import prices and "will contribute to a rise in the inflation rate and a deterioration in domestic living standards."
In These Times plans a follow-up story next issue offering some economic fixes.

