SPEAKING
FREELY Hanging on housing and
oil By Kathy Lien
Speaking Freely
is an Asia Times Online feature that allows guest
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contributing.
So
far, it has been a great year for the dollar. The
greenback has increased 12% in value against the
euro since January, 5% against the Japanese yen
and 7% against the British pound. Higher US
interest rates, improvements in the manufacturing
sector and average monthly gains of 190,000 in
payrolls has helped the dollar charge full steam
ahead. However, since July, there have been signs
that the dollar may have hit a peak, with double
threats plaguing the greenback and even more risks
in the pipeline.
The rally in oil shows no
signs of giving way, even though we are seeing new
record highs on a near-daily basis. With oil
prices over $70 a barrel, $80 now seems to be a
more realistic destination than $40, once thought
to be oil's maximum limit. The
housing market is also
showing signs of exhaustion and if the housing
market goes, so does the US consumer. Oil and
housing hold the key to the dollar's fate in many
ways, including being able to affect the Federal
Reserve's monetary policy decisions.
$100 a barrel can cripple US
growth Since the beginning of the year,
crude oil prices have increased a whopping 60%. So
far we have seen US consumers bear $40, $50, $60
and now even $70 oil with little impact on
consumer spending. Yet it remains to be seen
whether they will be able to withstand $80 or $100
oil. The average national price for a gallon of
gasoline has increased almost 50% from a year ago.
Although the high-end SUV driving consumer has
been able to shrug off a fill-up cost of $70-$100
as nothing more than a mere annoyance (though at
this rate, probably not for much longer), the
average consumer will have a much more difficult
time dealing with a price of $3 for a gallon of
gasoline, which we have already seen in California
and New York.
Unfortunately not every part
of the country is graced with an efficient mass
transit system such as NYC - many Americans have
no alternative other than driving to work.
According to the 2000 US census, 87.9% of
Americans commute by car, van or truck. In fact, a
Wall Street Journal poll of 4,000 people conducted
on August 15 reported that 31% of respondents said
they have already cut driving activities, 21% said
they would cut driving when gas reaches $3-$4 a
gallon while another 18% said that they wouldn't
cut driving until gasoline prices hit $4-$5 a
gallon.
The rule of thumb is that every
$10 rise in oil will shave 0.4% off of GDP and
even though this is far from recessionary
standards, if you combine that with other factors
that are brewing in the background, it is apparent
that the US economy and the US dollar faces big
risks in the months ahead. Right now, US consumers
have been somewhat shielded from needing to really
deal with the high cost of oil by car-pooling or
using mass transit. However, once the weather
turns cooler, consumers will not be able to avoid
turning on their heaters.
Although not all
Americans use oil to heat their homes, natural gas
- which is the most popular source of fuel - has
prices that are also at record highs. Therefore,
even though consumer spending has yet to contract
significantly, it could toward the end of the year
if oil stays at current levels. Right now
consumers are treating the rise in oil as
temporary and have continued to spend, borrowing
more and even dipping into household wealth. Yet
with this oil shock being a demand-based problem
rather than a supply-based one, there is no
abnormal factor such as weather or geopolitical
uncertainly that can later be corrected to term
this a temporary phenomenon. With Indian and
Chinese consumption driving the demand and their
consumptions needs expected to increase even
further over the next few years, the 2-year
increase in oil prices that we have seen thus far
could be far from temporary. Nine out of the last
10 recessions have been associated with rising oil
prices and even though we don't expect a recession
again, we do expect a sharp contraction in growth,
which could spell disaster for the US dollar.
Housing bubble letting out
air? The other big risk to the US economy
is the real estate market. When you have TV shows
called "Flip this House" on A&E and its
competitor "Flip that House" on the Discovery
Network, touting how easy it is to make fast
profits in real estate, you know that the market
is in trouble. In fact this feels like the dot-com
boom deja vu all over again, with real estate now
seen as the new form of "paper" wealth. Since
2001, real estate has accounted for 70% of the
rise in net household worth. Typically the housing
market represents just 5% of the total economy,
but according to Merrill Lynch, the housing market
"accounted for an astounding 50% of the overall
growth in the US economy by the first half of this
year, and more than half of the private payroll
jobs created since fall 2001 were in housing
related sectors."
With investors flipping
real estate like short-term stock market
investments, it has really become a speculator's
market. "For Sale" signs can be found on nearly
every block in some of the states. Of course,
people have been calling for a burst of the
housing market bubble for years now and have only
been proven wrong. Yet the mania is getting more
and more dangerous with increasing evidence that
the day of reckoning may be right around the
corner.
In Phoenix, Arizona, prices have
increased 47% in the first quarter from a year
ago. The highest median price for a home in the US
has reached $72,600 in San Francisco. Inventories
are building up across the country with the number
of homes on sale in the market up 26% in northern
Virginia, 31% in Massachusetts and doubling in San
Diego from a year ago. With any product that is
losing popularity, the first sign that it is in
trouble is that it stays on the store shelves for
a longer period of time and inventory just
accumulates. The next logical step for the
storeowner is to cut prices, hoping for a
fire-sale. We are already seeing the first step
unfolding in real estate, which is inventory
build-up and properties spending a longer time on
the market. Although a substantial contraction in
prices is far more likely than a crash, any
sizeable slowdown in the market could spell
disaster for US consumer spending, the US economy
and the US dollar. In addition, it will certainly
have ripple effects on the rest of the world.
Conditions will only worsen for the US
housing market and consumer spending as the
Federal Reserve continues to raise interest rates.
Mortgage costs in general will increase, but the
hardest hit will be the people who hold adjustable
rate mortgages. The same is true for other forms
of credit that have a floating rate such as
home-equity loans, car payments and credit card
payments.
The key to the dollar is oil and
housing. Either of these factors alone could cause
a sharp contraction in US economic growth, but the
fact that both of these factors are unfolding as
major risks at the same time exacerbates the
uncertainty that the US economy faces in the
second half of the year. The primary reason the
dollar has been able to hold onto its gains is
high interest rates and the prospect of higher
interest rates to come. If consumer spending
contracts significantly because of any one of
these reasons, the Fed may be forced to halt rate
hikes sooner than they may have otherwise wanted,
which could take away the dollar's ally. If oil
prices retrace or if the housing market keeps on
booming, then these concerns could fade to the
sideline, keeping the dollar rally intact.
The curse of the first
year Interestingly, perhaps this is also
the curse of the first year that the new Fed
chairman has to face. By the time all of this
becomes a major issue, it may no longer be
Greenspan's problem. Greenspan is slated to leave
office on January 31, 2006. Since 1970, every Fed
chairman that assumed the top job has faced a
major crisis shortly after entering office.
According to Toni Straka of Prudent Investor,
"Arthur F Burns, chairman from February 1, 1970
climbed the top chair only to oversee the
beginning of the 1970s bear market, the closing of
the gold window and the first oil shock in 1973.
When he stepped down on August 6, 1979, his
successor Paul A Volcker had to fight double digit
inflation with the highest Fed funds rates seen
ever and managed so that the economic downturn
through his tightening only became an on-and-off
recession from 1979 to 1982 with GDP never
declining more than a quarter in a row."
Greenspan himself had to deal with the
stock market crash of 1987. Therefore it would
come as no surprise if either oil and housing or
both becomes the next chairman's initiation task.
Even if the next chairman is highly respected and
competent, we are sure that markets will be
skeptical about whether he or she has what it
takes to pull the economy through a slump and come
out of Greenspan's shadow.
