house of cards, 4 br, 3 ba, 1/2 acre lot

Marty Feldstein is not an economist I particularly like – an old Reagan apparatchik – but he does have an interesting column in the Financial Times today. He poses a problem: why didn’t the oil increases spark an economic downturn?

He answers this by pointing to one unexpected benefit of Alan Greenspan’s bubble:
“The key to the economy's strength in 2004 and 2005 was that household saving declined dramatically while the price of oil rose. Household saving fell from 2.5 per cent of after-tax income in the third quarter of 2003 to a remarkable minus 1.8 per cent two years later. This 4.3 per cent shift of after-tax income was equal to a rise in consumer spending equal to 3 per cent of GDP.

In dollar terms, saving fell from a Dollars 205bn (Pounds 115bn) annual rate in the third quarter of 2003 to dissaving at a rate of Dollars 159bn two years later. This shift of Dollars 364bn in the annual rate of saving far outstripped the fall in income caused by the higher cost of oil. This fall in saving allowed households to raise consumption spending on non-oil goods and services while paying for the higher cost of imported oil.

The primary cause of this dramatic shift was the fall in interest rates and the resulting rise in mortgage refinancing. Homeowners who refinanced their mortgages took out cash and reduced their monthly payments at the same time. Much of the cash obtained by refinancing was spent on consumer durables, home improvements and the like. The lower monthly payments permitted a higher level of sustained spending on all non-durable categories.”

In spite of his randy Randian beginnings, Greenspan couldn’t have been more Keynesian in his policy over the last three years. One can argue that here, if anywhere, Keynes’ jibe that in the long term, we are all dead is justified. For really, those who point to the long term are in as much ignorance as anybody else as to the features of the long term. Who would have predicted, in 2001, that Exxon of all companies would make the greatest quarterly profit in corporate history five years down the road? The energy sector looked dead in the water back in those dear days when the afterglow of the New Economy powered by the Hi Tech Industry that was going to take everyone to Cisconian heights was the line still being pushed in the biz rags and newspaper columns.

There is a problem with turning savings into (oh glorious, English averse word) dissavings. Creditors have a bad habit of getting impatient with dissavings. Ask my landlord. The macro facts of the economy do show, pretty beautifully, how features emerge via turbulence in larger systems that are not caught in the causal net presupposed by linear thinking. That the American householder can both afford the Christmas presents and the SUV to truck them away from the mall she got them in is a piece of the jugglery of everyday life that should confound the petty prophets among us (among whom, of course, I include LI).

Feldstein points out that mortgages grew by 3 trillion dollars, to 7 percent of the GDP, from 2001 to 2004. His idea is that we are reaching a limit. And that as the limit is reached, further money for oil price increases is going to have to come from ceasing spending elsewhere. And that sounds logical.
“The powerful effect of mortgage refinancing on consumer spending was a very happy coincidence for the American economy at a time when oil prices were depressing consumers' real incomes. If oil prices were to rise again in 2006 or 2007, the adverse effect on consumers' real incomes would not be offset by increased mortgage refinancing. Mortgage refinancing has now peaked and is declining. The Federal Reserve is raising interest rates again to counter the inflationary pressures that remain from the rise in energy costs. And individuals no longer have the large amounts of household equity against which to borrow.
A rise in the oil price could happen again at any time. There is little spare capacity in global oil production and oil demand is rising rapidly in China and other Asian countries. A shock that reduced the production or shipping of oil could drive its price sharply higher. Speculative forces could compound this problem. The US was lucky after 2003 to escape the contractionary effect of an oil price rise even without an explicit change in monetary or fiscal policy. It would not be so lucky if a big oil price increase happened again now.”

The only country that benefits more from that happy coincidence than the U.S. is, perhaps, Iran. While the hawks would love nothing better than to sink their talons into the hide of that country, Bush – not the world’s brightest bulb, but a man who sucked oil from his mother’s breast, so to speak – has, we imagine, an intuition that the dogs of war would definitely knock over the jugglery of peace. And that would knock down – to continue this riot of journalistic metaphors – the whole house of cards. A house that can definitely be resold next year for more than it was bought for last year!