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ANALYSIS

A New Economic Order

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By Neil Irwin
Washington Post Staff Writer
Friday, March 14, 2008

Retail sales plummeting. The dollar at a new low against other world currencies. A 60 percent jump in U.S. home foreclosures. A major investment fund going kaput.

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This is what a reordering of the world economy looks like in real time.

Don't think of yesterday's economic news as discrete events. They are small pieces of a much bigger reversal in a series of imbalances that made Americans feel richer than they were and created unsustainable distortions in the world economy that are now righting themselves.

Americans are consuming less, and their houses and other assets are becoming less valuable. Painful as they may be, in the long run, both trends must happen to restore sustainable growth. But in the short run, they are wrenching changes that are probably causing a recession.

The weaker U.S. economy, combined with low interest rates due to Federal Reserve rate cuts, has made traders around the world less inclined to buy dollars. Thus, the value of a dollar fell below 100 yen yesterday for the first time since 1995, and slumped to a new low against the euro. Unpleasant as that is for people planning European vacations, it should help cushion the blow to the economy by making U.S. exporters more competitive.

On the way up, a worldwide boom of cheap credit fueled consumer spending, kept the U.S. economy strong and artificially boosted the prices of real estate and other assets. Now the reverse is happening. Lenders made too much money available, taking on too much risk for too-low interest rates. The pullback is reflected in yesterday's other big business news, the default of Carlyle Capital, a fund operated by District-based private-equity giant Carlyle Group.

The Carlyle fund had increased its returns by borrowing money from banks to buy securities backed by mortgages. When the value of those securities fell and lenders demanded more collateral, lenders took control of the fund and began dumping its assets into a market that was already swimming in such securities.

Simultaneously, the lessening availability of credit is causing consumers to spend less. That causes lenders to be more cautious, making the credit problems more severe. It is what leaders of the Federal Reserve call an "adverse feedback loop."

There was clear evidence yesterday that Americans are spending less. The Commerce Department reported that retail sales fell 0.6 percent in February, a sign that consumers are bringing their spending more in line with what they can afford after a decade of spending beyond their means. Auto dealers and restaurants took the biggest hits, as people delayed purchases of new cars and saved money by eating in.

This pullback by consumers and reduction in credit availability are behind the increase in home foreclosures that RealtyTrac announced yesterday. The 60 percent jump reflects the fact that U.S. assets are becoming less valuable, making consumers poorer. With home prices down 8.9 percent in the past year (according to the Case-Schiller index), the dollar lower and stock prices down, we aren't as rich as we thought we were.

"The distress we are seeing in the credit markets, the pullback in consumer spending, the retreat in the dollar -- these are really all part of the same story," said David A. Rosenberg, chief economist at Merrill Lynch. "We had a dramatic overextension of credit and consumption growth for a long time."

In economics textbooks, such a rejiggering of economic forces happens in a nice straight line. In practice, it happens haltingly, with world markets on edge, day after day. Days like yesterday, full of jangled nerves and creeping panic.


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