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Professors Differ on Economic Outlook
by Nathan Heath
Grainger Caudle, Ted Berzinski, and six months of the Dow Jones Index
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So, What Got Us Here?: A Brief Explanation of The Housing Meltdown
There are various ways to make your money grow. One way is through real estate investment. The concept basically works like this: You buy a house, let the price of the house appreciate in value over a period of time, and then resell it at the new, higher price and reap the benefits. If you do this with borrowed money, you have a real money machine.
As more people tried this, more jumped on the train, prices rose faster, and the train sped up.
To finance the purchase of a new home, most buyers borrow money in the form of a mortgage. Lenders, such as banks and mortgage companies, analyze your credit, income, etc., and if you meet their criteria you receive the loan.
As the lenders began to make more money on loans, stock investors responded by allocating more money into lending companies, like banks. Some banks, in the pursuit of profit, rolled the dice and gave loans to people who had no realistic way of paying them back.
This worked as long as the housing market continued to gain value. If buyers were unable to make payments on their loans, they could simply resell the house and address the debt with the profit made on that sale.
Last summer, however, housing prices began to fall. And now, people who couldn't pay could no longer bail themselves out of debt by selling their home. Lenders could not collect. Investors, many of whom had bought houses as well as bank securities, saw their money turn to dust. Housing prices fell faster. The train picked up speed in reverse.
Obviously, those invested directly in the housing market suffered when the bubble popped, but why has it had such an impact on everyone else? The answer is that at one point the housing pie looked so delicious that everybody wanted a piece of it. When housing was booming it was a very lucrative market to have a share of, and big firms, along with others, began to dump investments into the market with the expectation of reaping appreciated returns.
This was essentially achieved by buying loans from banks, who then had more cash to lend to investors through mortgages. Although housing is just one sector of our economy it attracted so much attention that a lot of people, firms and organizations had their hands in it. When it crashed everybody's fingers got burned -- and in more severe instances reduced to ashes. - Nathan Heath
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It's a good idea to be prepared for a storm. Whether it be a blizzard, a hurricane or in this case of a more abstract nature: an economic storm. Two ways to prepare are to invest in food supplies, which are jumping in price, and to get out of debt.
That's what Assistant Professor of Business Ted Berzinski has been telling his personal finance class, and why some of you may have spotted him at Ingles stocking up.
"Buying long-term storage food like canned goods before the expected double-digit price increase gives you a better return than a savings account," Berzinski says. "And it also provides a great cushion if there's a natural disaster...FEMA (Federal Emergency Management Agency) recommends a minimum of three days of food storage in case of a disaster, and so I'm taking moderate measures to be prepared."
Berzinski forecasts a good chance for economic problems: double-digit inflation, bank failures, huge layoffs resulting from the contraction of our economy, food shortages, record home foreclosures and bankruptcies, ultimately driving some major political and social transformations that could change the state of our country dramatically.
Professor of Economics Grainger Caudle, however, while certainly not opposed to preparedness, is less concerned about the current state of our economy, and isn't even convinced that we are facing a definite recession. Caudle believes that the nature of our economy will pull us out before the situation becomes too drastic.
Berzinski believes that this recession is going to be different from other recessions because it has been a long time coming. "The way we've handled economic stresses in the past has been to just throw money at the problem." This prevented our economy from making necessary adjustments and shaking out bad investments.
"Our economy has become like a house of cards, with good investments built on bad investments," says Berzinski. "The bad investments are now starting to fail, starting in the housing market, and they are beginning to take good investments down with them." Although in the past stimulating the economy with money has worked, Berzinski claims that this time the U.S. Government has pumped hundreds of billions of dollars into the system, and so far it has not made a difference.
Caudle, on the other hand, has a lot more faith in our economic resilience. "We are the largest, most dynamic economy in the world." The U.S. economy is so multifaceted and innovative that when one area slumps, we can often rely on a completely unrelated sector to rally and pick up the slack, he says. While we may tip into a recession, Caudle feels that it is very unlikely that it will be any more devastating than usual.
He also points out that the stock market is not always a great indicator of our economic vitality. "We are less industry-based than in the past, and so a large part of our economy is left unrepresented by the stock market." On top of that, due to the nature of current investors, such as day traders (traders who buy and sell stocks in the same day, sometimes within minutes) the stock market swings up and down in a volatile manner. Caudle claims that the economy is actually far more stable than the stock market might imply.
Even though the stock market is currently declining, Caudle recommends leaving your investments where they are, and if possible even diversifying a bit (spreading your investments across more than one industry) while prices are down.
"The stock market fluctuates from day to day, month to month, and year to year. However the over all, long-term trend would be growth." Therefore if you leave your investments where they are, their value may decline from time to time, but ultimately they should gain value, he says.
Berzinski disagrees. He believes that the value of the dollar will continue to plummet and that ultimately investments based on the value of the U.S. dollar alone will see great declines in value.
He would advocate re-allocating your portfolio (holdings in stocks, bonds and mutual funds) into more commodity-based investments. Things like corn, steel, wheat and sugar are tangible and have concrete value to back them up. No matter how much the dollar falls, there will still be a demand for sugar somewhere.
Berzinski emphasizes working hard to try and eliminate debt. "It won't be long before the sinking value of the dollar starts to show up on the shelves at Wal-Mart." Foreign exporters are going to start charging America higher prices to compensate for the decreasing dollar. Pair that with the increasing job losses that come packaged with the kind of crash Berzinski is predicting, and you can expect money to be scarce.
Berzinski warns that if you don't pay your loans off now, you may find yourself unable to do so in the sharp downturn ahead. The downside to that advice is that avoiding debt can be bad for the economy; in fact part of the issue we're facing now is people tightening their wallets and spending less. This places consumers in a bit of a Catch-22 scenario.
In addition to all this, food shortages loom on the horizon, Berzinski says. Record drought in Australia and higher demand from China and India has brought food reserve levels to all-time lows and pushed up food prices. The U.S. Government's energy policy has caused more corn to be used for making ethanol, bringing about shortages in corn for food and higher corn prices.
Once "The Breadbasket to the World," Berzinski claims that the United States is floundering in regard to domestic agriculture. This means that as our economy turns and the dollar loses value, we will not be able to rely as heavily on domestic agriculture to bail us out of a food crisis. Berzinski asserts that if the economy were to crash, food shortages seem inevitable. It would be advisable to take at least moderate measures towards preparation, and for a brief guide on how to do so you can visit the website of the Federal Emergency Management Agency (FEMA)
Economics can often be a very subjective matter. Due to the complexity and abstract nature of the discipline, there is rarely a clear right or wrong path to take on any one particular issue. There's a proverbial saying about economics that goes something like this: Economics is the only field in which two people can be awarded a Nobel Prize for saying exactly the opposite thing. While it may not be that catchy, it does a lot to illustrate the weirdness of economics and, believe it or not, it has actually happened.
Grainger Caudle and Ted Berzinski are simply two (albeit well educated) perspectives on the subject. Only the hundreds of millions of people whose individual perspectives define the U.S. economy will ultimately affirm or deny the wisdom of either.
Reader Comment:
Lee Long, 3/11/2008, 2:33 p.m.
Interesting approaches to the pending "economic storm." Liked that phrase. I'd try to do a combination of the two approaches because a balanced approach to life's challenges often brings good results.
Gill Bosonetto, staff, 3/12/2008, 5:05 p.m.
Great topic, Nathan, and I like how you made a potential nightmarish subject a balanced and enjoyable, easily understood, read!
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