Excursion: The economic crisis in the USA

I thought for months about whether this blog is the right place to write about the economic crisis. Any relation to defense and freedom affairs would be more than a stretch. A first, incomplete attempt was made with earlier this month.
I can't hold it back any more. ;)

We've seen the mortgage debt crisis, the (prevented) insolvency of banks and a crash of intra-institutional trust on the financial market. The financial markets failed completely to allocate the resources efficiently, a major blow for economic theory and an even greater blow for the banks.
This failure wasn't prevented (but instead promoted) by active policy and would in itself have done a lot of damage.
That are only the most visible symptoms - not the real crisis, though.

The real crisis is a general mismatch of consumption/investment and income. The U.S. was simply living far beyond its means, enabled by cheap credit due to its leading currency, large economy and a lot of trust/goodwill.

This mismatch happened on the private level (mortgage, credit card and other debts = ultra-low savings rate), on the government level (record budget deficits by GWB, for example) and on the national, macro-economic level (long-time & huge trade balance deficit).

The real economy wasn't able to produce nearly as much goods as were consumed and invested - that is visible in the huge trade balance deficit which equaled 5% of the GNP.
The savings rate was also much too low for too long. Some claim that savings rate statistics are a bit misleading because of technicalities, but the savings rate was reported to be negative and certainly was close to zero for some years. For comparison: The German savings rate is around 10% of the GNP.

Such a situation was not sustainable, but the bubble kept growing for decades. It became a mantra that economic growth was to be attained by increased consumption instead of a focus on increased savings or investment - the foreigners did the saving for the Americans.
That, obviously, is about to end. Such an arrangement can only work for some time, not endlessly - and it breaks down once the trust in proper payback breaks down.
That is what the mortgage crisis really did to the U.S.; it ruined the trust.

Maybe the U.S. will be able to keep a net capital import for several years, but not on the old scale. It is necessary to either reduce consumption or increase industrial production or both.
More service economy won't help much. A rapid expansion of the industry is unlikely - it would likely take a decade to cover the trade balance deficit with it. That would have been a good idea before the crisis, now it's too late. Consumption needs to drop. Rapidly.

Consumption needs to drop in favor of savings - insecure consumers is sometimes a good thing (in macro-economy). It needs to drop to reduce import demand, too. Meanwhile, the industry will likely (actually, does) reduce production, and this means even less consumption is affordable.
10-20% less consumption for 'Joe Sixpack' in 5-10 years is realistic in my opinion. realistic and economically healthy. The next U.S.President has chosen a terrible time for a presidency.

Some countries might experience similar crisis symptoms in the medium term because of similar root problems liek trade balance deficit (Spain, UK, Italy), but others (Germany, South Korea, Japan) might even prosper because of an end of the capital drain. The PRC might go just about everywhere from extreme prosperity to an economic crash.

The U.S. economic policy needs to have these goals:

1) short term: To cure the financial markets. They don't need to be organized and work as before, though. Instead, they need to do their job.

2) medium term: To revive the industrial sector. A share of only about 20% of the GNP is obviously insufficient to meet the expectations for wealth. Globalization may be a good thing, but the past policies were obviously no good idea. NAFTA needs to be revisited, for example.

3) long term: Reduce vulnerability by a reduction of dependence. That's not about full self-reliance at all, but about reduction of systemic risks by diversification and substitution.

4) attitude: Welcome in the real world, where normal rules apply because you cannot excuse your actions by claiming you're "exceptional" when you're in fact just large and about to strike out with your actions. "Normal" causalities need to be accepted, and replace ideology and wishful thinking.

I was pleasantly surprised today when I wrote that the presidential candidate with the vastly better chances has actually understood the roots of the problem:

...He wants to launch an "Apollo project" to build a new alternative-energy economy. His rationale for doing so includes some hard truths about the current economic mess: "The engine of economic growth for the past 20 years is not going to be there for the next 20. That was consumer spending. Basically, we turbocharged this economy based on cheap credit." But the days of easy credit are over, Obama said, "because there is too much deleveraging taking place, too much debt." A new economic turbocharger is going to have to be found, ...

source, the bold emphasis was mine

We'll see whether he's able to use that insight. The next time when the Senate votes on a stimulus package is a good opportunity to observe him.
There's no better choice, though. McCain has obviously no clue about economics (and actually told the public so years ago)

This is a time for a paradigm change, not just some talking point change.
A whole nation needs to re-learn how to match income and expenditures.
This includes a 'defense' and other (para-)military budgets based on economic reality, not on fantasy land perceptions of American greatness. The Chinese, Japanese, South Koreans and Germans won't withhold their own consumption in favor of financing the U.S. military in 2015. The Saudis will probably do so, but that isn't even enough for the U.S. Coast Guard.

(I'm curious how well this economic opinion will stand the test of time.)



  1. Hello Sven,

    Remember when just after 9/11, President Bush went on national television and told the nation that what it had to to was to go out and spend? And this within a year or two of the tech bubble bursting - which, incidentally, burst the bubble of those who were claiming that they had finally discovered the key to perpetual economic growth? And the Big Three U.S. automakers were already being reduced to offer 0.0% financing and other incentives to get people to keep buying their vehicles? And all the while more and more people were losing good-paying jobs, and for good?

    It simply astonishes me (though it fails to surprise me anymore) that people in general, and decision- and opinion-makers in particular could ever watch this happen, all the while watching it slowly unravel before their eyes for a decade. Until the Big One that nobody can sweep under the rug finally hits. Really, this process has been underway in North America, and possibly Western Europe too, since at least 1973.

    Good post Sven. And I guess people should be rereading "The Emperor's New Clothes" at bed-time, and not just to their kids.



  2. I remember even better that the old recipe of pushing consumption was used as late as this year with a few hundred dollar transfer to every citizen - despite a huge budget deficit.

    One disadvantage of my explanation of the crisis is that the evidence isn't visible yet - some lags in (real) trading and in the statistics processes will keep the statistics clean of hints till early 2009.
    Special effects like falling commodity prices are complicating the picture as well.

    Europe is in a very weird and interesting situation. Much of it has the € as currency, but the € countries have extremely different economies (Spain and Germany being the greatest contrast in trade statistics).
    The € zone was made too large - some economic theories were in favor and some were contra this € zone. The terrible detail is that the economic theory that predicted possibly disastrous consequences wasn't in favor of a large € zone.
    Maybe the € is a huge disaster for countries like Spain, Italy and Greece as well.

  3. How many Liras was it for a coffee again back before they implemented EU Currency? Do you think it's a good idea to have it back?

  4. The numbers on bank notes are unimportant. Think in cents and you'll see that a simple ice costs 700 to something like 3,000 cents even with the Euro.

    The economies aren't similar enough in the Euro zone - and economic theory predicts exactly what happened; some countries would need the currency exchange rate to balance and keep themselves competitive by being as cheap as necessary to compensate for their low productivity.

    The predicted problem countries were the southern ones - Spain/Portugal/Italy/Greece are in real trouble (in 2007 statistics already).

  5. The Euro is the second attempt for the Latin Monetary Union that dissolved early in the last century with rather similar participants. Germany had to join in order to obtain unobstructed reunion and H. Kohl wasn't the brightest guy.
    The problem is that this monetary union was envisioned as a DM substitute with all the stability, but without a common bond market.

    To solve the problem we have to significantly reduce debts of the countries under pressure while giving higher earnings for the remaining debt. So the banks have some time to write off their losses without short term liquidity problems. To finance this debt reduction trick, we need Euro-bonds backed up by the strong countries to pay the negotiated interests and refinancing. We could finance these Euro-bonds with national debts and transfer them to the Euro-bond with a slightly higher interests, so the helping countries do profit from giving the countries under stress more trust than the free market.
    The problem is that this policy has not been sold to the German population as a good idea. Our politicians lack power to convince others of a course instead of adapting to the winds.