Few countries in the world publish a detailed and complete analysis of money flows within their economy.
This is what makes the USA central bank's document
Flow of Funds Accounts of the United States special.
This document is studied by economists and economic analysts worldwide to trend the world's largest economy's debt, money flows, and balance sheet. The latest 125 page document was released on 11Mar2010 covering the economy through the end of the fourth quarter of 2009.
The detail in this document is so significant that no single analyst can review it in its entirety, let alone understand the implications of the data movements. My areas of interest are the financial health of business and people.
People are 2/3rds of the American economy. This is why I concentrate on the financial elements of the people to understand the future direction of the American economy.
Understanding the changing financial situation of the people should tell you the direction of the economy. My analysis in this article came from page 104 of this Flow of Funds document.
What stood out in this document was the slight drop of $20 billion dollars in the fixed (tangible) assets of the American people. It is easy to understand that people who feel they are becoming more wealthy will spend more money. On the other hand, people who believe they are getting poorer will tend to spend less money.
This drop in asset value since 2006 is significant. The average American does not own a business, or have more than a few thousand dollars in a bank account. The vast majority of the net worth of the average American is their home.
Beginning in mid-2006, the value of houses in America began to decline. Today the home values are at 2004 levels. But what is not understood well by analysts outside the USA, is that the American people's equity in their home (the value of the home less the amount of money borrowed to buy the home) has declined even more dramatically.
The average American is worth less than half of what he was worth in 2006. They feel poor.
In the graph above, the rise in equity in 2009 was not caused by rising home prices, but was caused by the banks foreclosing on many houses which were worth less than what was borrowed from the banks (negative net worth).
As many as 1 million negative valued homes were foreclosed (taken away from the owners) in 2009. Before this crisis is over, it is estimated at least 5 million more homes will be taken away.
You might have read in other sources that the worth of Americans is increasing. This is also true. But this not the net worth of the average American – it is the net worth of the investors in the stock markets who accounted for the increase. The big investors are the 10 per cent of the population which own 70 per cent of the stock.
Unfortunately, the home values have begun to fall again in 2010 after rising slightly in the second half of 2009. My estimate is that home values will fall an additional 5 per cent to 10 per cent in 2010. This will make the average American poorer.
Many economists are forecasting a strengthening economy as 2010 continues. I disagree.
With 90 per cent of the Americans already poorer, and my forecast is that they will continue to grow poorer this year – how many new cars will these poorer Americans buy? How many new homes will they want? How many will want new appliances?
The recovery in America is uneven with the rich getting richer and the poor poorer. The recession America was initially caused by home value declines – but once the decline started the recession became debt driven. A debt driven recession occurs when the value of assets fall – and there is a high level of borrowing.
For America, the last time this event occurred was in 1929. It triggered a depression which lasted 10 years. Japan has suffered since 1990 with a debt type recession triggered by declining asset values.
But this is not 1929. It is different this time as the USA central bank (the Federal Reserve) has flooded the economy with liquidity to suppress a dramatic economic collapse. But there is no way to re-inflate home prices except by triggering a round of inflation.
And there is little mechanism to wipe out the large debt without inflation. Inflation lets the debt be paid back with money that is worth less.
Inflation normally makes the value of assets increase as the value of the currency is worth less. But this process would take years to occur. If and when inflation is triggered, the initial effect is a rise in the prices of food and materials. History has taught us that wage increase follow the beginning of the inflation cycle by a year.
So while inflation is accelerating, the average American will feel even poorer. Inflation will not let the American economy expand. In fact, it should have the opposite effect initially.
As the average American will be poorer at the end of 2010 then he is today, there is a good chance the American economy will not expand in 2010 – and the global economy will not expand either.
Email the writer:
s.hansen@alrroya.com
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