Economic Forecast, 2004-2010
by Fred E. Foldvary, Senior Editor
My forecast is a severe depression at the end of this decade.
Economies experience fluctuations of different causes and duration. There are random shocks that cause national output to rise and fall irregularly. But there are also regularities that create business cycles with similar patterns.
The recession of 2001 had four causes. First, there was the technology boom of the 1990s, which got carried to unsustainable speculative heights. Second, there was a gush of money created by the Federal Reserve Fund which became channeled into higher asset prices (stocks and real estate) rather than the price of consumer goods. Third was the fraud and abuse of corporations, stock brokers, mutual fund companies, and stock exchanges, a systematic corruption of the financial markets rather than merely isolated cases. Fourth was the September 11 attacks, with its devastating losses, followed by the costly War on Terror.
While some industries such as airlines sharply declined, the economy as a whole did not suffer that much. Stock prices fell, but were still historically high. Unemployment fell, but not as much as in some previous depressions. One main reason why the economy was able to keep chugging along was the booming real estate market, which kept on rolling despite all these troubles. Another reason was that the Federal Reserve flooded the financial markets with money in order to keep short-term interest rates at historically low levels. The federal tax cuts also helped the economic recovery, stimulating labor, enterprise, and investment. The huge federal budget deficit also provides short-term stimulation of demand by borrowing money from abroad.
Now that the economy is recovering and growing, what lies ahead? To see what is coming, we need to understand the most important cycle in the economy, the real estate cycle. Historically, the United States has experienced a real estate cycle with a period of about 18 years. Real estate prices and construction have peaked before the general downturn in the economy. As the economy booms, speculators buy real estate expecting even higher prices later, until real estate becomes priced too high for current uses. Investment therefore falls, leading to a recession.
The real estate cycle is fueled by money expansion. During the depression, the bottom of the cycle, the Federal Reserve system targets low interest rates, which requires a large expansion of the money supply. This artificial stimulation is unsustainable because they make large-scale projects such as shopping centers and office buildings look profitable, but later, prices and interest rates rise due to the monetary expansion, and many projects turn out to be losers.
Excessive monetary expansion creates long-term distortions that lead to bad investments and higher prices that later choke the economy and cause it to crash. Borrowers default on loans, leading to bank failures and a financial crisis. Less investment and financial failures result in layoffs that then reduce overall demand and lead to more contraction, and down we go.
The last real-estate-related recession started in 1990. Count 18 years forward, and we get to 2008, but because of the 9/11 attacks which made the 2001 recession worse, the next recession could start a bit later, such as 2009 or 2010. The exact year of the next depression cannot be predicted, but the economy today is following the typical pattern of real estate cycles, so we are very likely to have the recession in the last years of this decade, sometime from 2008 to 2010.
As the economy expands, inflation is likely to return, and interest rates will also rise. Rising interest rates and prices, especially for real estate, will choke investment, and the recession follows. Investment drives the cycle, and real estate drives most of investment. Meanwhile, there is a colossal trade deficit, paid for by selling US assets, including treasury bonds. If foreigners slow their buying of US debt, that will jack up interest rates even higher. The US federal budget deficits, at astonishingly record levels, are unsustainable and will do long-term damage as Americans get drained of funds and resources to pay the interest to foreigners.
Towards the end of the ozos (the 2000 decade) the baby boomers will begin to retire. Those born in 1946 turn 65 in 2011. This is an inevitable demographic financial calamity, as there will be more and more folks retiring in the next decade, collecting social security and medicare, with proportionately fewer workers to finance it. The day of reckoning will be unpleasant - whether from sharply higher taxes, truncated benefits, default, or high inflation. This will become ever more visible as we come to the end of the decade, deepening the depression of 2008-2010.
The only effective remedy is politically impossible, because not one person in a hundred has any clue about the economic realities. The remedy is to tap the land rent of the country for public revenue. That would halt the speculative escalation of land prices. It would finance the baby boomer demographic transition. It would eliminate the federal budget deficit. It would prevent interest rates from rising too high, and reduce the demand for excessive monetary expansion.
Land does not get produced, and its value comes from nature and community and public works, so tapping it for government revenue does not hurt enterprise, unlike taxes on wages and sales. No constitutional changes are needed; indeed the federal government several times taxed real estate as a direct tax prior to the civil war. The US federal government paid for the War of 1812 mostly by taxing land value. They could do it again, to avert the fiscal and economic crisis.
But they wonít. The public is not demanding it. We are dancing on the Titanic. The economic ship is now full steam ahead. Few see the waterfall beyond the immediate horizon. Even most economists are clueless. You have now been warned, but most who read this will not really believe it. Most of those who believe it will do nothing about it. Thatís why the cycle will run its course, and it may be a worse economic disaster than the Great Depression of the 1930s.
-- Fred Foldvary
Copyright 2004 by Fred E. Foldvary. All rights reserved. No part of this material may be reproduced or transmitted in any form or by any means, electronic or mechanical, which includes but is not limited to facsimile transmission, photocopying, recording, rekeying, or using any information storage or retrieval system, without giving full credit to Fred Foldvary and The Progress Report.
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