From Virtuous to Vicious

Honestly, is this the best that policy makers can do in Anglo-Saxon countries?

Faced with the inevitable leveling of living standards around the world due to the unstoppable force of globalization in what is now a well connected world economy, why have policy makers chosen to forestall this process by duping the masses into borrowing and spending money? Money which provides a short-lived stimulus to the local economies, but which is wholly unsustainable.

For a brief period of time, the masses may believe they have become wealthy, but inevitably, the virtuous circle of the housing boom turns into a vicious circle, with the duration and magnitude the only uncertainties.

This seems to be what is playing out in other Anglo-Saxon countries around the world - the transition from virtuous circle to vicious circle. This is most evident in the U.K. where their housing boom is roughly a year ahead of America's. In many ways the U.K. is a smaller version of the U.S. - a large trade deficit, a large budget deficit, a large increase in consumer debt in recent years, and economic growth based disproportionately on consumer spending. Here's a look at what's happening in Britain:

• 150,000 retail jobs losses puts pressure on rates
• Spending slump prompts calls to cut interest rates
• AAA Fund Manager Survey: sentiment slumps to new low
• House Price Crash U.K.

The virtuous circle of the housing boom has been enabled by easy credit and encouraged by elected officials, but as events overseas now demonstrate, the self-reinforcing effects of changing home prices work in both directions.

When home prices rise, many new jobs are created - construction workers, real estate agents, mortgage lenders, and related fields. Rising home prices and easy access to home equity then enable homeowners to spend more freely, thus stimulating other parts of the economy and reinforcing the housing boom by creating more demand for housing.

When home prices stagnate or fall, then the process works in reverse - housing related jobs are lost and consumer spending declines, causing other parts of the economy to contract, resulting in less demand for housing. This is the bad part - the vicious circle.

It seems the argument that home prices will not decline unless the broader economy falters was much more sound when the broader economy was not so dependent on housing. In many parts of the U.S., half of all new jobs created in the last few years were housing related - the underlying economy is now soundly based on the continuing rise of home prices.

The unfortunate aspect to all of this is that there have been millions and millions of unwitting accomplices - people who, without the encouragement of policy makers and without the availability of unsound lending practices by under-regulated lenders, would not have placed such risky bets on real estate.

Policy makers have failed to protect the masses from their own worst instincts - their instinctive response to follow the herd and join in on a speculative frenzy, in an attempt to get rich.

Individuals who have done what policy makers have allowed and encouraged them to do may soon learn a hard lesson, one that they will not soon forget - but it was all unnecessary.

Is that the best that policy makers can do?