Thursday 18 September 2008

Pic of the day: I have paid off my credit cards. How about you?

Crash on Wall Street!

The wheel of time turns... or at least the smaller wheels which we economists call economic cycles. They are not even actually cycles, but rather waves; but at the dizzying speed they go up and down, people can be forgiven for thinking they are thrown for a loop.

Seven years ago I wrote about one such dizzying downturn, which followed the 9/11 attacks on America by al-Qaeda. Contrary to popular belief, it was not the attacks that brought about a beginning recession: The economy had been sliding since spring. But it briefly turned into a panic, before bouncing back.

The "bouncing back" part is the really strange part. America did not overcome its recession, it just put it aside. People were told to show their onbroken patriotic spirit by going to the mall and shopping as if nothing had happened. After a few days, they did, and they certainly did not seem to require heavy persuasion. Shop till you drop is the American way, after all!

But determination alone can only buy you so much. You also need cash, or at least credit. The vigorous slashing of interest rates in the wake of 9/11, which I thought was a good thing back then (because it would help people pay off their credit cards, as I was sure they would) instead fueled a housing bubble the like of which the world has never seen. Actually, the world has never seen ANY bubble like it, certainly not if you count the other countries that had the same type of financial bubble at the same time; but even if you only count the property geographically located in the United States, it goes beyond anything comparable. This was already underway during the Clinton years, but rather than collapsing in 2001 as expected, it was inflated to unimagined heights.

And then, as always happens eventually, someone looked down.

***

When I compare this past week to the week following 9/11 2001, I refer only to the effect on the economy. Neither the reason nor the broader emotional and political impact are comparable. But the effect on the stock exchanges is indeed curiously similar. There are probably only so many ways to panic. But there is more to it.

Rather than a terrorist attack, you could say this is the economic equivalent to a bird flu outbreak. (The economic term "contagion" is indeed frequently used these days.) Imagine you took a weekend off in the woods and came back to the news that McCain and Biden were dead, Bush was braindead (literally this time) and Palin and Obama were both hospitalized for an unknown duration. You'd start worrying too, I bet. It is approximately like that for the average reader of The Economist. The big names that used to be on the pages - both in the ads and the articles - are gone, or crippled, or unable to stand on their own. Lehman Brothers and Merrill Lynch gone, AIG in intensive care, and most of the rest barely able to move.

Lehman Brothers was established in 1850. It was already spoken of with respect in international business when my grandfather was born. Now, from the height of its greatest accomplishments only a couple years ago, it is bankrupt. Most likely the name will disappear completely, its meagre assets divided among its creditors. Merrill Lynch was one of the most quoted sources of economic analysis. "Blah blah blah, says Mr X at Merrill Lynch" was a pretty decisive argument. While not exactly the voice of God, it was kind of like quoting Al Gore on matters of the environment or the Dalai Lama on politics of nonviolence. You assumed these people knew what they were talking about.

***

I don't think the average American can save the day this time by buying things he doesn't need. This was an idiotic solution the first time around, and I told you as much. It won't even be possible now. Even here in Norway, credit has become more expensive. In America, you don't even know whether your bank will still be there next month. More importantly, neither do the banks know, which means they are very careful about who they lend to.

You could read about this all years before it happened, in the Chaos Node. But I take little pleasure in being able to crow. If someone, anyone had listen and let themselves warn, threading at least a little more carefully, then I would feel a little pleased. But by all accounts, no one cared. I can't say I am bitter about that. Who would you believe, the guy in the limousine or the guy walking home from the supermarket with his groceries? Unfortunately, about this time people are learning that limousine guy got his riches by duping people like you. But there wasn't any way to know it back then. Not unless you actually understood what was going on, rather than believing. And I failed to convey understanding. I probably still do.

So, what should we do now? First off, it is not like the world is ending. This particular kind of black hole only swallows money. (So does the Large Hadron Collider, probably, but I can't say that from experience.) The actual physical resources are still there, the people are still there, the ideas are still there. And people still have basic needs like food, clothes, coffee and online games. People will stop purchasing things like new cars, expensive furniture and non-marital jewelry - or rather, they will delay these purchases for a while. So if you are employed in that kind of job, you may want to prepare yourself for something else.

If you have saved up money for some future expense that is not biologically necessary (for instance a vacation), you may want to hold on to the cash. During a panic, cash is king. You can buy things really cheap if you put the money on the table. The other bidders, the ones with the credit cards, will largely be absent.

If you are the one with the credit card, try to pay off as much as you can. If a card company falters, this does not mean your debt is written off. On the contrary, it means your debt is not renewed. There is typically some clause about how fast you have to pay it back if the contract is terminated, and typically that is very close to "at once", perhaps a month. More likely than a default, however, is that the card company tries to save its balance sheet by adding hugely to the cost of borrowing from them. In other words, interests go way up, and various fees may show up or increase.

If you need to move and you have a house, this is not necessarily a problem, especially not in the US where mortgage is more common than personal loans. If the place you move from and the place you move to are similar, you may get less than you wished for the old house but you should pay less than you feared for the new. Make sure every detail about the financing is in writing from reliable sources. And don't leave a large gap of time between buying the new house and selling the old, because prices still have further to fall in most of the country.

On the bright side, oil and gas prices should continue to fall for a while. It is even possible that they will never again reach the peak we saw earlier this year: By the time the next boom comes around, there will be much more production capacity for alternative energy sources. Well, if people don't act completely irrationally, but as history shows, that's a big if. Unfortunately I don't have divine revelation about these things, only the voice of reason. And taking notes from that one is a rather solitary activity.