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August 2, 2002
The economic recovery stumbled to a standstill in July, and mortgage rates are well under 6.50% this morning, headed down toward the lows set during the worst of the stock market plunge three weeks ago.
The ISM index collapsed from 56.2 in June to 50.2 in July ("50" is a flat economy), and the weakest component was the most worrisome, an abrupt drop in new orders. The GDP grew at a slim 1.1% pace in the 2nd quarter (half the forecast figure), and this morning's news that payrolls increased by an insignificant 6,000 jobs in July pretty much finished off the optimists.
Was July a one-time fade, weakness reinforced by the stock market crashlet, or a true change in trend? The futures market says the latter, this morning estimating a 75% chance of a rate cut by the Fed.
Chart watchers are having the time of their lives comparing the similarities among Japan's stock market 1985-present, the American 1929-1931 market, and our current predicament.
Fight off the gloom. We're in a soggy recovery, the GDP may wander into negative territory a time or two ahead, and strong economic growth may be a couple of years away, but this is not Japan and not 1930.
Our dissimilarity to Japan's decade-long and unresolved trouble is clear. Japan cannot bear to close down failed businesses: they lumber along, propped by halfway bailouts, and make it impossible for competitors to succeed. Imagine if the S&L industry were still operating today, bankrupt, holding a million or two foreclosed and empty properties, and sucking tens of billions of dollars in new bailout money each year.
Japan has another unique problem: a demographic disaster. Its citizens are the oldest in the world, and it has the lowest birth rate: following the current trend, the population of Japan will shrink by 20% in the next 50 years.
The Great-Crash-as-cause-of-Great-Depression is one of America's most durable myths. However, the damage done to the economy by the '29-'31 Crash was possible only by linkage to the banking system, and that linkage was regulated away in the '30s. In '29, there were no margin requirements, and 100% borrowing of stock purchase was commonplace (as was compound leverage: "holding companies" borrowed to buy whole portfolios of stock, and sold stock in themselves to investors who borrowed 100% of their purchase).
When the market crashed, margin loan defaults impaired the banks, and wiped out depositors (pre-deposit insurance). Well into the '30s, individual banks issued their own paper currency which, when the issuing bank failed, made useful mattress stuffing. Banks were finished off (some 17,000 of them) by a cascade of defaulted mortgages in the pre-FHA days of short-term mortgages. In those days, if the value of your house had fallen, the bank would not renew your loan even if your payments were on time.
The stock market is vulnerable to further losses measured in Dow thousands, at least until America's businesses figure out how to make money again. And until then, a soggy economy (not Japan, not 1930) means that the bias in mortgage rates is down.
The chances for five-something in the fall are growing, though I wish they weren't.
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