The subprime crisis may well be symptomatic of a deeper economic malaise that is affecting America's middle class.
The state of the New York Stock Exchange is, to some extent, a reflection of the health of the American economy and its consumerist middle class. Is there any significance to the current market volatility or is it just part of the long-term economic cycle?
A very interesting article entitled "America's middle classes are no longer coping" appeared in the Financial Times in January. It was written by Robert Reich, a professor at the University of California at Berkeley and the United States's 22nd Secretary of Labour (from 1993 to 1997). His thesis is simple and goes a long way to providing a structural explanation of the subprime crisis, the decline in consumer spending and the economic slowdown in the US. Reich does not have a monopoly of the truth and he does not provide the definitive answer in his article, but it certainly provides food for thought.
Reich believes middle class families have exhausted the coping mechanisms they have used for decades to get by on median wages that are barely higher than they were in 1970, adjusted by inflation. He theorises that America's middle class has lived beyond its pay cheque for years and is only now beginning to feel the consequences.
Reich says the first coping mechanism was to send wives out to work; the number of working mothers with school-age children has almost doubled since 1970 to about 70 percent. When this limit was reached, mechanism two kicked in: working families had to paddle harder and work longer hours - to the point that the typical American now works two weeks more every year than he or she did 30 years ago, and 350 hours a year more than the average European and more even than the notoriously industrious Japanese.
There is clearly also a limit to how long one can work, so as the tide of economic necessity continued to rise, the middle class turned to the third coping mechanism: borrowing big time. With housing prices rising briskly throughout the 1990s and then accelerating rapidly between 2002 and 2006, middle class Americans turned their homes into piggy banks by taking out home loans to finance their lifestyles. This was exacerbated by credit cards raining down like manna. Reich claims the dollar was artificially high because foreigners continued to hold the US currency even as the nation sank deeper into debt, and the American consumer summoned inexpensive goods and services from the rest of the world.
The bursting housing bubble kyboshed this as home equity dried up fast. Reich is adamant that the era of easy money is over. This is compounded by the fact that foreigners have begun selling dollars, firmly closing the door on access to cheap foreign goods and services. Reich postulates that the anxiety gripping the middle class is not simply a product of the current economic slowdown, but the cumulative effect of a paradigm shift that began in the 1970s. He is confident that the solution does not lie in bailing out lenders or borrowers, or stimulating the economy with tax cuts and spending increases.
Reich argues that most Americans are not prospering in the high-technology global economy that has emerged over the past three decades. He believes the benefits of this economic growth have accrued to a small number of people at the very top.
He admits to not having the answer, but feels that it lies in boosting wages through a more progressive tax regime, stronger unions, better schools for the progeny of lower-income families and better access to higher education.
This is a presidential election year in the US and as yet there is no indication that any of the candidates is addressing the economic problems that are besetting the middle class in terms of Reich's thinking. If they were to, it could add an interesting dynamic to what is going to be a long and protracted campaign until November.
The stock market is often a leading indicator, and the subprime issue has certainly led to huge volatility across the globe, but there is no indication that investors have factored in a recession in the US. It will be interesting to see how things pan out over the next few months.
I am still inclined to believe that growth in the US will slow down enough to plunge the economy into recession, but I feel the Asian economies will continue to grow, providing some support to commodity and financial markets.
It is probably time for economists and market pundits to start thinking out of the box.
- David Sylvester is the chairman of the Shareholders' Association, telephone 021 686 7567.
This article was first published in Personal Finance magazine, 2nd Quarter 2008. See what's in our latest issue