What will ’09 bring to N.H.’s economy?
The current economic crisis began to unfold in June 2007. It started as a severe illiquidity and insolvency in the financial sector, as banks fearful of counterparty default became unwilling to lend to each other. Lending spreads widened dramatically as confidence collapsed. Some banks were comprehensively unable to finance their operations and failed completely.
Funding difficulties have spilled beyond the financial sector and into the real economy. Any business dependent on credit may now be unable to pay for its industrial inputs, finance inventory or meet payroll and might therefore face insolvency. Throughout New England, bankruptcies and layoffs continue to mount with predictable impact on consumer spending and employment.
Let’s look at the local picture. In the 12 months to September 2008, New Hampshire unemployment increased from 3.4 percent to 4.1 percent despite non-agricultural employment remaining comparatively flat. Locally, the highest unemployment exists in the Manchester area, where joblessness reached 4.3 percent, well below the national and regional averages of approximately 5.7 percent.
The value of the state’s housing stock continued to slide after peaking in the second quarter of 2007. The Office of Federal Housing Enterprise Oversight house price index for the state fell 6.4 percent in the year to June 2008.
The roots of the current predicament were a housing bubble and the activities of the so-called “shadow” banking sector – the brokerages, mortgage originators and other financial intermediaries who operated outside of the conventionally regulated banking framework. Anyone could qualify for a mortgage and corporate debt was cheap.
There ensued a global economic expansion based on house price inflation, leverage and a general mispricing of risk. There also was a significant redistribution of global wealth. Significant trade imbalances developed as the emerging economies – China, Russia, India – generated balance of payments surpluses by selling manufactured goods and commodities to the United States and Europe. The mature economies responded by issuing more debt securities to finance their corresponding deficits.
Now we face the inevitable de-leverage and bust.
Normal conditions will not return to the capital markets until market participants reestablish mutual trust – the so-called “symmetry of information” – for securities and derivatives. At that point, banks will no longer be afraid to lend to one another. Confidence will reawaken the banks’ motivation to originate good loans and service them properly.
The world’s former net exporters – China, Russia and India – must run down foreign reserves and provide markets for U.S. and European goods and services. They must show that they have viable middle classes capable of supporting the overextended U.S. consumer who up until now has been the main player on world markets.
A weaker dollar will play its part in this redress. The U.S. requires a period of higher net exports to offset weak domestic demand, coupled with a reduction in the real demand for imports.
The Federal Reserve has sharply cut short-term interest rates from 5.25 percent to 0.25 percent, reducing the return on dollar-denominated financial instruments and diminishing global demand for the dollar. However, its failure to stimulate the economy illustrates the limitation of monetary policy as a foolproof driver of asset prices and aggregate demand.
Consequently the Fed has sought to broaden the scope of its monetary efforts with a “quantitative easing” – a concerted attack via open market operations on stubbornly high long-term interest rates. By buying mid- and long-term debt, it hopes to make mortgages more affordable and revive the housing market. The goal is to return the house price index to its long-term equilibrium.
It may not work. The depletion of homeowner equity in the U.S. housing stock means that many borrowers may be unable to take advantage of refinancing opportunities, no matter how attractive those opportunities may be.
Amid the present crisis, the argument in favor of fiscal stimulus remains strong. When the government spends, it exerts an expansionary effect on income and employment. In times of high unemployment and low corporate profitability, tax revenues diminish and the government resorts to debt financing. So get ready for a return to political “fiscalism” and rising federal deficits.
The downside may be a sharp increase in the supply of government debt and higher long-term interest rates. The drive to boost employment may harm the housing market and “crowd out” private sector investment. One near-certainty is that price instability is history. Arguably, it ceased to be a threat after the oil scare of the summer of 2008, when gas prices reached near $5 a gallon at the pumps. Some features of an inflationary environment — rising asset prices, low unemployment — are desirable. If so, we should now regard deflation as Public Enemy No. 1.
Vince Woodward is chief economist for People’s United Bank and its family of related institutions, which includes Ocean Bank, with offices in New Hampshire and southern Maine.