The aftermath of the global housing crash and current liquidity crisis will ultimately result in a sharply contracted world economy and staggering deflation. The contraction combined with changing demographics will completely alter the US economy to cash-based as credit becomes unavailable. The driving force of the economy will be access to food, clean water and mild weather instead of access to high paying jobs. Here is what we believe is happening based on our localized view as boomers having lived 10 years in Silicon Valley, now living in Hawaii, studying investments, and reading the views of economists and others to better understand how we will be personally affected.The internet bubble reset expectations for investment gains and lowered inhibitions to risks. Speculative investment for high reward with high risk became the norm for investors and institutions replacing traditional value based investing for reasonable reward and low risk.
After the internet bubble collapsed, US companies reduced their costs by moving jobs and manufacturing overseas. Wages and salaries in the US went down and housing prices should have dropped along with them, except that the Fed ‘s aggressive lowering of interest rates to keep the economy from going into a recession resulted in easy house refinancing. Refinancing decreased monthly mortgages and provided a surge of tax free spending money (liquidity) to Americans, more than offsetting their drop in salaries.
The internet allowed borrowers to submit mortgage applications simultaneously to many lenders forcing online competition for mortgage loans rather than relying on local banks familiar with the regional area. The increased liquidity in the economy, lower interest rates, and the growing number of mortgage lenders resulted in housing becoming more affordable and available to the average American. This increased demand caused the price of housing to go up allowing lenders to feel comfortable providing more credit. The lending process was sped up by using database generated house appraisals and internet generated instant credit scores for applications. The rapid increase in real estate drew in more speculators looking for the next high return opportunity.
Additional tax free cash was available to Americans from house equity loans and used to purchase large cars, electronics, and vacations. These purchases further accelerated the profits of retailers and American companies that had moved their operations offshore. Traditionally, that much liquidity injected into an economy would have created tremendous inflation, and it largely did for the few remaining domestically created goods like automobiles, housing materials, health care and services. Manufactured goods like electronics would have normally gone up except that they were being produced overseas at a very reduced cost and generated in mass quantities.
All of these loans to Americans for their houses generated IOUs that were sold to banks and individuals all over the world. In many cases these IOUs became a financial instrument separate from what was previously known as a traditional bank mortgage. These instruments were repackaged and bought globally by banks, hedge funds, and organizations that directly or indirectly wanted to gain access to the interest they generated. As traditional inhibitions of investors toward unregulated mortgage backed securities went away well established banks, investment banks, government and public organizations managing the world’s pensions, retirement accounts, corporate assets, and individual investment portfolios heavily invested in these house equity IOUs.
As housing prices drop and the liquidity it created disappears, the economy will sharply contract. All the cash, previously available to Americans from their housing equity, is gone shrinking the economy due to American’s not having cash or credit to spend on new autos, vacations, eating out, clothes, electronics, private schools, etc. In addition to this contraction, there is a secondary contraction caused by all the real estate backed IOUs in various financial instruments worldwide becoming worthless. These IOUs are held directly and indirectly by banks, in portfolios of wealthy individuals, by pension funds around the world, by mutual funds and numerous other financial institutions and corporations that desired their high interest income. Americans are already feeling the crunch of losing their lines of credit, having their credit cards shut down, and dealing with the upset of retirement plans that were based on the sale of their real estate. But those with these IOUs indirectly in their mutual funds, money market accounts, retirements, or investment bank portfolios may not yet know that their investments or pensions are worthless. The banks, particularly in Europe and Asia, are being slow to admit to their losses and unregulated accounts and money markets often only notify of unavailable funds when the money is requested.
As Americans are forced to downsize their energy and food consumption by replacing or modifying their gas guzzling SUVs, over energy consumptive housing, and reducing their number of vacations, prices will begin to drop. As China, India and the rest of Asia run out of their huge US dollar infusion from sales of electronics, processed foods, and manufactured goods to Americans, energy and food prices will drop even further. It will take time, but eventually the severe global economic contraction will create a strongly deflationary economy in the US and worldwide.
The US economy will fundamentally change from credit and job based to value based. Instead of access to high paying jobs being the driving force of the American economy, it will be access to healthy food, clean water and mild weather. The economy will become cash based as there will be very little access to credit. Any consumer credit based businesses, like internet sales, hotels, rental cars, and eating out, will suffer. Any businesses with inflated priced goods like Starbucks, Coach and Apple that are based on status rather than value will not do well. Any credit intensive companies, like airlines, cruise lines, tech startups, and land developers will struggle to get credit. Any company heavily in debt will struggle to stay alive in a cash based economy. Companies and people with cash and with assets and expertise of real value will do best.
Hawaii will do well in the upcoming economy, though the economic contraction will initially be painful and disruptive due to an end in the Wal-Mart tourist and a drop in real estate properties that were priced far beyond their real value. Many Hawaiian’s have expertise of real value in a cash based economy such as knowledge of how to fish, how to grow fruits and vegetables, and how to set up and live with solar energy systems. Hawaii’s mild weather and access to food and water makes it more sustainable and will draw wealthy tourists from around the world, many which will stay and impact the local economy in a positive way.
