We are broke. We may have a couple more months of sustained living if the Fed keeps injecting liquidity into the system, but to all intents and purposes, America is broke.
For the past 50 years we have been sustaining low unemployment rates (albeit not as low as the official figures show), based on a formula devised by John Maynard Keynes nearly a century ago. The formula says that if you increase public consumption, you reduce the amount of money that companies need to invest in production. In a way, you buy your way out of unemployment.
The formula seems to have worked pretty well for America’s economy for the past 50 years. However, during the past 10 years we have not been able to keep ourselves out of unemployment by spending, but, instead, we started borrowing to keep up with the pace of our spending. As we borrowed money to buy the goods that allowed “entrepreneurs” (the quaint word used by Keynes) to give us a job, our real economic capacity shrank at the pace of our increased debt. This goes beyond the simple fact that we have less Disposable Personal Income to keep us employed (by means of increasing consume expenses) but the reality is that we are fast approaching the eleventh hour.
I am told that houses that should have been under foreclosure month ago are not being claimed by the banks. The reality is that the most banks do not want, and can’t hold any more real estate in their books. The solution they found is not to foreclose on the properties. They have the liability of the unpaid loan, and they are making the big write-offs we are learning about daily in the news, but if they took into their books all the houses whose loans defaulted, they would not be liquid enough to remain in business.
This makes a lot of sense, because the savings rate of the American public is close to zero, or perhaps even negative (we need to wait for the new numbers) and the goods they own are worth less than the money the owe for them. Do you see the problem here?
If you know something about economics you can skip the next paragraph.
Normally, when you take out a loan, the lender requests some kind of collateral for that loan. For instance, you take out a loan to buy a car, and if you don’t pay, the repo guys knock at your door and take the car, same with furniture and with real estate. The risk of the lender is that the goods he sold to you are going to be worth less than when he sold them to you, and thus the interest rate he would charge you will be aligned with the amount of risk of you not repaying the loan. That way, when he repossesses the goods he sold to you with a loan, the amount you paid in interest will compensate and provide some gain for the lost value of the goods. However, what happens when he lent you money for you to buy a Lexus, and all of the sudden your Lexus became a Kia? You can’t sell the Kia to exit the loan, and he can’t sell the Kia to recoup the money you did not pay. Not only are you broke, but he is also broke because he can’t pay to the Lexus manufacturer, and thus all the way back to you.
As the current debt of Americans surpasses the value of the goods they hold, the American economy is living on borrowed time. It is indeed puzzling that the American economy does not stop to a sudden halt.
In fact, the only difference between today and 1930-1941 is the elasticity of current money. In 1930, you had to have gold in order to print money and to create Keynesian inflation; nowadays, you don’t need anything, and it is possible to create liquidity for as long as somebody is willing to lend you money.
The kindness of strangers
So far, we are seeing that some foreign powers are willing to lend us money. The oil-exporting countries are financing our current economy, albeit requesting a higher return for their borrowed goods, thus the price of oil keeps rising. You may think that rising oil prices are good for oil exporting countries, but the truth is that there is a limit to how much they can squeeze out of us before we are unable to buy anymore. If we can’t afford buying their goods, it is not good for them, so they have a vested interest in trying to actually lower the price of oil.
The problem is that they have not been able to do this yet . We may expect new measures by the OPEC in terms of increased production to try and avoid squeezing the global economy out of business, and that may give us a respite.
China and Japan also have vested interests in keeping our interest rates low so we can keep buying their goods and keep their economies running. However, as we borrow more, the Dollars we paid them for their goods lose value, and their prices increase.
A quick look at the 2007 CIA fact book will give you a clear idea of how America is indebted to China, and the oil exporting countries. The following chart shows the current account balance of all the countries in the world, where China has the biggest surplus and the US the biggest deficit. I will copy here those countries that are relevant to this article, and I am not even going to mention the irony that Iraq has a surplus, while the US is conducting the war on borrowed money.
|1||China||$ 363,300,000,000 2007 est.|
|2||Japan||$ 195,900,000,000 2007 est.|
|4||Saudi Arabia||$ 88,890,000,000 2007 est.|
|5||Russia||$ 74,000,000,000 2007 est.|
|9||Kuwait||$ 51,490,000,000 2007 est.|
|10||Singapore||$ 41,390,000,000 2007 est.|
|11||United Arab Emirates||$ 36,110,000,000 2007 est.|
|12||Algeria||$ 31,500,000,000 2007 est.|
|14||Canada||$ 28,460,000,000 2007 est.|
|18||Iran||$ 19,000,000,000 2007 est.|
|19||Venezuela||$ 17,020,000,000 2007 est.|
|20||Nigeria||$ 14,610,000,000 2007 est.|
|21||Angola||$ 13,640,000,000 2007 est.|
|31||Iraq||$ 7,802,000,000 2007 est.|
|32||Qatar||$ 7,733,000,000 2007 est.|
|33||Azerbaijan||$ 7,535,000,000 2007 est.|
|164||United States||$ -747,100,000,000 2007 est.|
America the Broke is the biggest debtor in the world, carrying more than 1/4 of the total world debt, a debt that it has no means to pay.
At this point, if we increase the amount of money available for consumption, we are able to buy less goods, and if we don’t we are not able to buy at all. As I see it today, there is very little that we can do to get out this crisis, and most of it is not in our hands.
As you see, we are depending on the kindness of strangers and America’s economic power looks a lot like the faded glory of Blanche DuBois.
Franklin @ April 15, 2008