from the hip

In my previous post about the American recession I wrote about the structural causes of the current crisis. I stated that the housing market fell because it finally burnt itself out, after having been too hot for too long due to low interest rates in the US.

The fall in the housing market, which is likely to last for quite a while – I think well into 2009 – has another disturbing effect. It reduces the value of property in America. Thus, the wealth effect – everybody getting “richer” because the value of their houses and apartments have increased, and spending some of that newfound wealth on consumption – is reversed. Now there is a negative wealth effect.

A negative wealth effect means that this time increased spending will not be fuelling the economy and lifting it out of recession.

The effects of the reversal of the wealth effect are now slowly becoming visible in the US. Automakers are adjusting their sales expectations down:

Dismal Year Is Forecast for Car Sales

writes New York Times. And it doesn’t stop there:

Slump Moves From Wall St. to Main St.

In Seattle, sales at a long-established hardware store, Pacific Supply, are suddenly dipping. In Oklahoma City, couples planning their weddings are demonstrating uncustomary thrift, forgoing Dungeness crab and special linens. And in many cities, the registers at department stores like Nordstrom on the higher end and J. C. Penney in the middle are ringing less often.

… Many economists forecast that overall consumer spending will slip 1 percent for the first three months of the year.

“That’s a wow,” said Robert Barbera, chief economist for the trading and research firm ITG. “Outright declines for real consumer purchases are unusual.”

What is shaping up as the second recession of the 2000s is the product of declines in home values, which play a far bigger role in most Americans’ personal finances than the stock market. Households have borrowed against the increased value of their property to buy cars, send their children to college and add home theater systems.

What all the stories of declining demand point back to, is of course the wealth effect. And in months to come, it will increasingly be reinforced by imported inflation, making the crunch on the dollar increasingly felt by the consumers as well.

Indeed – all the charts for the US look bad for the moment: Jobless claims up, consumer sentiment down, housing starts down, retail sales down, industrial production down, dollar down. Meanwhile, the stock market will continue to be turbulent.

To me, it seems a rough ride is ahead!

More to come.