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RESTRUCTURING AMERICA'S SUBURBAN DREAM
by Michael Hampton
January 7, 2008
The comfortable fantasies that have sustained the American Dream for several decades, are fading fast. 2007 was the year when we took a peek behind the curtain, and saw what financial machinations are sustaining the world's largest economy. American consumer spending represents 25-30% of global GNP, but the money that Americans are spending is not all their own, nor is much of the energy we are using. Keeping the oil and the money flowing relies on spin, financial manipulation, and statistical adjustments which are now being exposed as fiction. If the dollar loses its purchasing power, how will US energy consumers go on importing the oil they need to maintain an extravagant lifestyle?
A House of Cards?
We learned something important in 2007. Mortgage loans were being repackaged and sold at high ratings. This practice had helped to sustain the final years of a massive US housing bull market. But when the subprime crisis hit, shocked investors learned that these securities were they were not worth what they thought they were. In some instances they were worthless. Now these securities are no longer in demand, the money is no longer flowing so easily into mortgage loans, and the US finds itself in a deep housing crisis.
This story is only at its beginning. The US economy is reliant on "the kindness of strangers." But those accommodating foreign strangers can lose confidence in dollar-denominated investment opportunities, and their "kindness" can be quickly withdrawn. Even if they can be persuaded to go on providing capital, they will do so on less generous terms. It is now very likely, they will be providing less money in the future. The US will find that it has to rely more upon its own capital, and that may mean that certain excesses, and fantasy lifestyles such as are found in the American suburbs will need to be curtailed or cutback.
We are beginning to see the impact of credit tightening on US consumer spending, and that may put the US into recession. But don't expect the Fed to provide a quick fix. There are other serious vulnerabilities likely to hit the confidence of dollar investors in the next year or two. With China holding almost $1 Trillion of US dollar assets, Japan about half that amount, and Middle Eastern oil exports holding gigantic dollar assets too, their confidence cannot be taken for granted. They are already beginning to lose their appetite, and may dump dollars if they hear more bad news from the US.
Other fictions that I expect will be exposed are:
+ US inflation is low : - The true rate of inflation could be more than 2 to 3 times the widely-reported "core" rate, which is near 2%. Imbedded in the core rate, are items like "owner equivalent rents", which represent almost 40%, and hardly moves, while energy and food costs (which everyone pays) are not included. These vital items are now soaring ahead at rates of increase we havent seen the 1970's. Higher inflation, will also impact on real growth calculations. If more realistic adjustments to nominal growth are made, we would find that the US economy is not growing at all, and is already in recession.
+ The US banking system is solvent : - Once American banks have finished writing down their tier three assets to more realistic market-related values, and they have recognised all their losses from their credit derivatives business, much of their capital may be wiped out. It will not be cheap and easy to replace the lost capital, as many banks are now finding. They have turned to sovereign wealth funds, who are providing convertible preferreds at high interest rates, like 9-11%. When capital is as expensive is that, and it is supporting assets earning half that rate of return, then the banks are passing away more than their profits just to stay alive.
+ US government finances are sound : - Too many future liabilities have not been funded, and are being improperly accounted for, and some would say the government's position has been mis-represented. As Comptroller General, David Walker and others have pointed out, if someone were put all the liabilities onto a "balance sheet", the US government would be seen to be insolvent. It looks virtually impossible for the US to meet its future obligations, without massive inflation or huge tax rises. Meantime, Presidential candidates are speaking about introducing expensive health care initiatives, while others are saying it is essential to maintain the Bush tax cuts. If the government keeps borrowing and printing money to meet its obligations, rather than raising taxes, there will be no alternative to colossal inflation.
+ American pensions are adequate : - Many Americans have inadequate pensions. They are relying on future extractions of equity from their homes, to get them through retirement years. But demographic changes mean that many retiring baby boomers will find little demand for their large and expensive homes in the years to come. If home prices slide back to the real prices of 2000-2001, as some hitherto accurate forecasters have predicted, many Americans will find they have difficulties in their retirement years. Meantime, if we see high inflation, it will greatly erode the value of traditional pension assets,
+ The American suburban way of life is sustainable : - Most of the US suburbs were originally built when oil was cheap, and the US was the world's largest producer of oil. Now the US remains the largest user of oil, but imports over half its requirement. High US oil consumption reflects the widespread suburban lifestyle. 25% of the world's oil is consumed by America, yet the country has only 4% of the world's population. Other countries, like China and India, are becoming richer, and competing with America for scarce oil, so oil prices are bound to go higher, and probably far higher when priced in a sliding dollar. As the largest users per capita, North America consumers (including Canada), are highly vulnerable to a rise in oil prices. A peak in oil production may be apparent within a few years, putting ever more upwards pressure on the oil price. Global competition will eventually force prices to levels which make America's "wasteful" suburban life style unsustainable. And it is not only the cost of transport fuel that will hit suburban dwellers. Individual homes are expensive to operate, with high costs of heating and air conditioning. With more residential space per capita than other countries, and lacking the efficiencies of multi-family apartments, suburbanites will find themselves hit hard if electricity, gas, and heating oil prices rise.
The sad thing is that the crisis point is coming from many of these issues, all at the same time. That will make them doubly difficult to address with traditional remedies (ie. a moderate recession, with moderate cuts in oil consumption, while simply buying time until more oil production comes onstream.) The old muddle-through strategy will not make oil more abundant. The most worrying thing is that intense global competition for scarce oil is about to hit at a time when the US dollar is beginning to rapidly lose its purchasing power.
Americans are not prepared for the coming crunch, and the leading politicians are focussed on other issues. Most politicians are content to leave the main fictions unchallenged. They know that negative campaiging rarely succeeds. Few have the courage to make the call to sacrifice and change of lifestyle that is needed. So we may find ourselves sleep-walking when the crisis hits. Ultimately, a big shock may be the only thing that will get the average voter worried enough to demand that their leaders start to address the root problem : America's traditional yearning for the a suburban way of life, which has left the country with a mammoth and unsustainable appetite for oil.
Author and cultural commentator, James Howard Kunstler, has called The American suburbs "the greatest misallocation of resources in the history of the world". This grandiose claim struck some as a massive exaggeration when he first made it several years ago. But since then we have seen oil prices zoom up to $100, and US real estate prices have gone into serious decline. Assuming these ominous trends continue, Kunstler's pronouncement will be seen to be correct, and we may be headed towards "the Long Emergency" that he has warned us about. America's investment in the suburbs, will need to be restructured or written off, in order that we can find a new and more sustainable future for our children and grandchildren.
Too Much Complacency?
The coming crisis is fundamentally an American problem, and Americans will need to solve it for themselves, because the rest of the world is losing patience. Without foreigners willingness to sustain an obsolete lifestyle, by allowing America to over-borrow and over-consume, the decades-old American dream will simply collapse under its own weight. The gravity of financial reality and fact of limited resources will be finally driven home to Americans through the market. Oil prices could easily surge to $200 per barrel, $250, or higher - whatever is needed to deliver the necessary shock and coerce people into changing their living and commuting patterns. The props that hold up the fantasy were barely adequate in 2007, and they are getting more wobbly as we move into 2008, and oil threatens to make a sustained breakout about $100.
The American dream, for many is a home in the suburbs, with commuting to work, to school, and to social activities by car. It grew up after the invention of the automobile. Unlike Europe, most of America lacked a developed railway system. So the invention of the car, spurred the growth of the suburbs. The few streetcar routes that existed, were torn out and replaced by highways. Only a fewer older cities, mainly on the East coast, had exploded in size before the invention of the car. A handful of big cities had already provided themselves with an effective mass transport system, which did not rely on automobiles. The rest of the cities and suburbs are an oilman's dream. The vast majority of the inhabitants get around by private car. While poorer folk take buses, and only a tiny minority use the rare rail connections. The result? Per capita consumption of oil is more than double in America, compared to what it is in the UK and continental Europe. Only Canada, with its sparse population, and wide open spaces, exceeds America in per capita oil use. An important difference is that Canada has the oil it needs to meet its domestic requirements. The US must turn to foreigners, many of whom are actively hostile to its politics, and unsympathetic towards the ill-disciplined "energy hog" which keeps asking for ever-more oil. Might it not make sense for oil exporting nations to conserve some of that scarce oil for its own future generations?
Almost half of American live in the suburbs, where their daily routine requires driving. This makes them reliant on cheap energy, and particularly dependent on moderate gasoline prices. America's oil addiction is a necessity of its living-and-transport infrastructure, and it has been maintained by a belief that inexpensive oil is a birthright. Cheap gasoline is so fundamental to the American economy that no politicians have been willing to risk votes by proposing higher gasoline taxes to discourage over-use, as most European countries have done years ago.
Decision Gridlock and Bad Decisions?
The idea that we can simply replace an oil-fueled car with a new one, fueled by an alternative fuel, and need to do nothing about changing our transportation infrastructure is misguided, and even dangerous. Such thinking stops us from taking needed actions while there is still time, and encourages poor decision making. A good example of a bad decision, are the extensive tax incentives which have created an industry around ethanol. These policies ignore the reality that, as Richard Branson has put it, "Sugar-based ethanol is seven times more effective than corn-based ethanol, so every acre of land can create seven times the volume of fuel."
Added demand has forced up the price of US-grown corn, and other derivative food products, while doing little to reduce our dependence of foreign oil imports. Ethanol is lower grade fuel than gasoline, and requires much energy in its production, so there is little net energy gain from its production. The inadequacy of this "solution" becomes more apparent when we consider the energy and fertilizer required on a farm to produce corn, the raw material for ethanol. Higher oil prices will force up farming costs, and so corn and ethanol prices too.
Unfortunately, China and India have shown some willingness to follow the US pattern, with a growing proportion of their citizens living in the suburbs. In a time of peak oil, the world can simply not afford two or more large countries, with a transport infrastructure like America's. The longer we persist without seeing this, the more capital that will be committed to an outmoded transport infrastructure, and a wasteful way of living.
It will not be easy to turn back. Americans have invested far too much in their suburban dream, to make an easy u-turn. However, we have moved beyond the horrors of Greenspan's Money Machine (see my article, "The Lessons of Grandparents", FinancialSense.com October 3, 2005), which helped to recycle US dollars spent on Chinese products, back to America, when the Chinese bought dollar-denominated bonds.
This financial recycling operation helped to keep dollar mortgage rates artificially low for years, and thereby encouraged Americans to buy too much of everything, while piling up increasing debts against their homes. Many refinanced their homes, and purchased excessive amounts of foreign and Chinese goods. And they bought properties that they did not need, using houses as "chips" in a wild gamble that real estate prices were headed forever higher. Now, with the tightening of credit, and a fall in property prices, there has been a change in sentiment, and new construction has stalled. This will slow new properties being added to the already-huge surplus (4.27 million unsold homes in November 2007) that's enough to satisfy 10 month's worth of demand. But the problem of too many homes, and too few buyers will not go away quickly. Prices will have to fall until those homes are affordable to buyers, without the help of funny finance. And the location of the homes in relation to cheaper forms of transport, and become a factor long before the bottom is hit.
An Unhappy Legacy?
The years of excess have left the US with an unhappy legacy:
- Huge malinvestment in suburban property,
- A massive build-up of mortgage debts, and
- An unpredictable pool of dollar reserves held by sovereign foreign governments, like China, Japan, and various Middle Eastern countries.
Those dollar instruments represent a liability that needs servicing, and also a threat. If they are discarded quickly, it could trigger a crash in the dollar. The subprime crisis has precipitated a rethink in the desirability of holding big dollar reserves. Foreign governments are now diversifying away from dollar bonds, preferring to use their dollars to purchase strategic equities, such as private equity firms (like Blackstone), commodity producers, and the preferred shares of investment banks. Some of the dollars getting recycled into other hands in this way, are then invested outside equity markets, and find their way into gold, oil, and food - forcing higher the prices of those commodities.
Implications:
+ American mortgage finance may be starved for capital for many years to come. Costs of borrowing will be higher, and terms will be less favorable.
+ US house prices will continue to fall, until prices reach a level where they are affordable to the masses, on more normal financing terms- not the zero percent down, low start-up rates we saw in 2004-6. That could mean a fall of 30-40 percent, or more, compared with peak prices.
+ Higher oil prices mean that transport costs will take an increasing share of American budgets, leaving less for housing related expenses. This is will mean forced downsizing for many. People will move closer to their places of employment, giving up long and expensive drives to work.
+ A downwards spiral in the dollar, as foreign governments disgorge their excess holdings, will push dollar oil prices higher, making the US suburbs even less viable.
+ Remote suburbs will be in less demand, allowing their real estate values to slide, and probably sharply, until a restructuring of the suburbs becomes financially possible. As an extreme example, if a neighborhood is mostly in foreclosure, it will be easier and cheaper to bulldoze a part of it, and replace it with a new light rail line.
The Way Forward
I see many changes coming, as Americans face up to the need to change their suburban way of living. Here are some of the many changes which can be anticipated. Each of these may represent a partial step towards restructuring the suburban/living infrastructure of America. Many more are needed, but these may represent progress:
+ Transit Village concept: In California and other states, new types of "villages" are being built. Homes are put closer together, within walking distance of a transport hub, from which villagers can commute to work by rail. Properly designed, these new villages feel and look like old fashioned communities, with a main street, shopping, and school all within a short distance. Property values in these communities have held up better than those in remote suburbs, as they are popular with current residents, and there is much less need for expensive commuting by private car.
+ New commuter train lines on top of highways: The highways are already there, forming arteries for a new transport system. Why not build light rail or other mass transit on top of them? The roads can be taken underground and hidden as they approach the main transit hubs- the new villages.
+ Use the new transport system, as a mechanism for capital creation: In Hong Kong, where I live, the MTR Corporation is sometimes granted land around the rail links it builds as an inducement to spend the many millions of capital expenditures required to build a new rail line. This technique was also used 150 years ago with the building of trans-American railroads- they got land by putting down rail, and were in effect property companies. This is a win/win, because once the rail link is built, the land near the stations is worth more. The railway companies literally build value for themselves.
+ As the dollar falls, US exports will become more cost-competitive: And with that, imports will also be more expensive. This will help to stabilize the dollar, at some point the balance of trade will be restored. However, America will need to rebuild some of its old export-oriented industries. And Americans will need to become accustomed to a lower standard of living, both in relative and absolute terms. The change will be less visible and create less political stress, if it is delivered through erosion of the dollar's value.
+ The US will have to reorient its economy: The new way for the US economy will be away from recent borrow-and-spend, and back towards the 19th century pattern of produce-and-export. Many changes will be needed and can be suggested. For instance, shopping malls may be turned into factories in America. Ironically, this transformation may occur while the reverse happens in some Chinese cities.
America will not be the only nation facing these challenges. However, because of the tremendous oil appetite of the US, and its weak currency, the crisis will hit America especially hard. The potential for it to be the global leader in finding a new and more sustainable way forward will be particularly compelling. If American finds a new mission as a leader for positive change, towards more sustainable living, it will have a more positive role on the planet, and its global popularity will improve. Once they are woken up, I believe Americans will face the challenge, and even demand effective leadership from its politicians. But the day of reckoning, and the rude awakening still lies ahead.
The Political Debate
Few of these dramatic changes will happen until Americans are ready. At the moment the majority of American seems to be clinging to their hopes. Most are believing and acting as if there are just some temporary stresses on the US economy, and these will go away; things will eventually "go back to normal." A few politicians (Al Gore, and Ron Paul) and some business men (Matt Simmons) are warning that there is no return, and the conditions that allowed the US suburbs to bloom were unique, and are not repeatable. The US was the "last man standing" after the ravages of WWII. It had the strongest economy, and in the 1950's was an oil exporter, with its own huge resources of oil. Those old resources are being depleted rapidly, and other countries have caught up with America, and can now compete effectively for those limited global oil resources that remain. Part of me hopes that some wise politicians will learn to talk about a return to 19th century patterns, with extensive rail links and tighter village communities, as a more "normal" way of life for American children of the future.
What we need now is an army of vigorous truth tellers (Al Gore, Matt Simmons, Ron Paul, JH Kunstler, and Jim Puplava come to mind) and an uncorrupted mainstream media willing to report their views. A co-ordinated national effort will be needed to repair the damage, and build an American dream which is sustainable, and that can be passed on to our Grandchildren.
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Originally Posted by Bordeaux
)bargain with multicult and PC (we all know minorities are bad, but we'll posture like we all accept them). Now this and other compromises "are coming home to roost".
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