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Credit Crunch: Light at the End of the Tunnel

May 16, 2008
When thinking about the economic slowdown now gripping the United States, one might think of the naked emperor of yore, who could not realize his condition until told by a child. By the time analysts and the White House recognize the extent of the credit crisis, its effects will probably not be noticeable. So where are we now? Several times since last August's signs of an imminent drop in growth, markets have rallied due to speculation that problems in the area of sub-prime mortgages have "bottomed out." Alas, thus far it appears to have been in vain.

On April 25th, Reuters and the University of Michigan reported in their Survey of Consumers that consumer sentiment fell ever deeper in April to settle at 62.6 from 69.5 in the preceding month. Not only is this the third straight month that consumer's outlooks have remained downbeat, but this month's ratings are the lowest in 26 years.

The last time consumers' finances were as stressed was in 1982, which was due to the "stagflationary" economy of the time. Stagflation refers to a stagnating economy with low or limited growth prospects coupled to high inflation. The recent recession came from a different set of circumstances, but consumers are feeling the pinch all the same. While inflation remains a key factor for monetary policy makers and politicians, estimates of core inflation (which excludes volatile food and energy prices) remain low for now.

This is a good thing, because it has allowed the Federal Reserve a lot of leeway regarding monetary policy. They have cut the interest rate they charge for lending to commercial banks by nearly three full percentage points since the onset of the credit crunch last summer, and are poised to cut rates 25 further basis points at their next rate-setting meeting April 30th. However, interest-rate futures contracts also predict a 20% chance that they may not cut the rate at all, signaling a possible end to further monetary stimulus.

It is unclear whether inflationary concerns or macro-economic stability is guiding the Fed's decisions because, since rate cuts began, food and energy prices have also skyrocketed.

While this doesn't normally affect core inflation to a significant degree, over a protracted period of time prices will continue to increase for everyone. In addition, the Treasury's stimulus package is set to begin arriving to millions of American consumers at the end of April, four days ahead of schedule. The Bush administration and other prominent authorities have touted the $152 billion influx as a means to increase spending, which accounts for two-thirds of the US economy.

While consumer spending should begin to pick up somewhat, surveys have shown that many people plan to spend their check one of two ways: relieving personal debt (which reached epic proportions in 2007), or adding to savings. This reflects both how necessary a lump sum of cash is to many poor Americans, and how much spending has been curbed.

Until spending picks back up, the service sector will continue to ache. Promising numbers in manufacturing orders for April also reflect strong fundamentals, even as the housing and construction industries continue to slump It may be presumptuous to assume that the US is out of the proverbial woods, but there may yet be light at the end of the tunnel.
About the Author
Ki lives in Austin and works as a real estate broker in the Austin real estate market. He provides a free search of the Austin MLS on his website along with information on mortgage interest rates.
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