I have been spending a lot of time reading economic commentary for 2008 and 2009. I think the most sobering analysis has been coming from Nouriel Roubini of RGE Monitor. While a lot of economic analysis seems to form the consensus that things will slow down in 2008 and pick up in 2009, Roubini talks about the possibility of financial meltdown and the inability of the Fed to stop it. I think that Roubini and Jim Grant were amongst the minority of market watchers that were pessimistic about the financial system a few years back.
My observations on the matter are not as pessimistic. There are major stability issues of the financial markets right now. While everyone is focused on the subprime mortgages, I think what is not seen right now are the substantial increase in delinquencies and defaults of auto loans and credit card debt. All of this is the sign of reckless debt financed consumption by the American consumer. Even without the defaults, the typical consumer is over-leveraged, and more and more are in negative equity situations, thanks to falling home prices. I believe the next two years will be a period of paying off debt. The stimulus package passed by Congress will not stimulate anything; for the bulk of people, it will be used to pay off debts from consumer spending that stimulated the economy a few years ago. This definitely implies that with the consumer fixated on paying off debt versus other spending, that the economy will soften.
What will amplify this slowdown is the precipitous fall of the value of the U.S. Dollar, which is also driving inflation. The Federal Reserve has little choice right now but to provide liquidity to the banking system at the cost of inflation and further declines of the dollar. Consumers will now face a lower standard of living after years of living beyond their means. The federal government has not helped the problem with their profligate spending and deficits. If the Democrats take over the White House in 2008, and embark on a program of tax increases, this will only exacerbate the situation.