How do imploding property values in innercity Cleveland slums bring down the world economy?
Cleveland may loom large on the balance sheets of financial institutions and equities worldwide (see pages 7-9), through the wonders of leverage and securitization. But global GDP is a whole other ball game. Is Cleveland, and all the other depressed property markets in the US, really big enough to deep-six a $60 trillion world economy?
And how do falling property values in Cleveland create a recession in Japan, and the Euroland economies, before they even create a recession in the US economy. And if Cleveland and its ilk are really the epicenter of all the world economies’ ills, why is the rest of the world buying greenbacks?
Perhaps there is something else going on, and Cleveland, and its slumping property values and soaring foreclosure rates, is just a big head fake. What else has happened that could possibly cause a world recession? Here’s a clue. Four of the last five global recessions were caused by huge spikes in oil prices.
And the world economy is coming off the mother of all spikes. Over the past expansion, real oil prices rose over 500%, twice the climb in real oil prices that produced the two biggest recessions in the post-war era: the 1974 recession and the double-dip recession in 1980 and 1982. If oil shocks half the size of the recent one caused the worst recessions in the last fifty years, they’re a pretty obvious explanation for the recessions in oil-dependent Japan and Euroland earlier in the year. And even back in Cleveland, few could doubt the link between $4/gallon gasoline last Memorial Day weekend and what’s happening in Detroit today. And from where the US economy currently stands, vehicle sales have a much bigger downside than housing starts.
Oil shocks create global recessions by transferring billions of dollars of income from economies where consumers spend every cent they have, and then some, to economies that sport the highest savings rates in the world (see pages 4-6).
While those petro-dollars may get recycled back to Wall Street by sovereign wealth fund investments, they don’t all get recycled back into world demand. The leakage, as income is transferred to countries with savings rates as high as 50%, is what makes this income transfer far from demand neutral.
The good news is that if triple-digit oil prices were the real culprit, then surely $65/barrel oil paves the path to recovery. Two dollar and fifty cent per gallon gasoline gives consumers back a lot more purchasing power than Washington’s last stimulus package. Of course the bad news is, where do you think oil prices will be once the economy recovers?
