I recall a moment after climbing Kilimanjaro. Three days after the conquest of the snowy peak, we were at a local airport. The sizable parking lot was entirely filled with white Toyotas – mostly vans or 4WDs. When I pointed out this extraordinary market saturation, my friend, from Charlottesville, VA replied dismissively – “better to be a small operator in a large market than a large player in a small market”. We disagreed because our assumptions of what that ‘small market’ was differed. For him, it was Tanzania. For me, it was the non-American “rest of the world”. And in the rest of the world, American cars, and indeed, American products are hard to come by these days.
Last Friday, the market capitalization of General Motors fell below $6bn. Meanwhile, Toyota’s market cap is $147bn, thank you very much.
It has been a year since the then oddly dubbed “subprime” crisis broke out. And just as the dotcom bubble at the beginning of the century spread fast beyond the dotcoms’ arithmetical share of 6% of total market capitalization, the “subprime” credit – originally only 14% of total securitized mortgage debt – has proved contagious enough to drag the entire US credit system (and beyond) down the bottomless pit.
For the readers living in net-creditor economies, this last paragraph could elicit little more than a shrug. Credit? Unless you launch your own business, why would that matter, you may ask?
In the US, your credit record counts more than your criminal record or your blood type. If you ever immigrate here, by default you end up with a presumptively “negative” credit record, because you have none to start with. In other words, you are presumed guilty until proven trustworthy. It won’t matter that you have stored your wealth in a Swiss bank or in a loco London gold account. You won’t be able to get a credit card, or lease a car. That is particulary painful if you originate from a wealthy country, say, Australia or Norway. On the other hand, should you arrive from a poor, immigrant-sending country, your own local ghetto will already have a support network, with enough Salvadorian, Pakistani or Filipino bank clerks in your community to facilitate access to credit lines. In larger Chinatowns or Little Indias, banks with familiar names from your home country will do it for you. And somehow, in an economy in which “credit history” is a defining feature of your probity, righteousness and trustworthiness, you will muddle through. It does help a marginal immigrant with no initial income, as it helps a low income, US-born family. Unfortunately, the system also creates a set of expectations that affect economic behavior of people who, in light of their actual income, should not be able to live beyond their means. And yet, access to credit will, with time, make the American Dream possible…
Now this whole system, based on consumption generated from credit, rather than saved income is on its last legs. Not long ago, my American friends were laughing at some European statistics which indicated a falling housing stock in Germany. Such a “contraction” was beyond comprehension for Americans whose entire banking system was anchored in perpetual expansion of the housing market. A veritable ipse-dixitism has ruled here for years: “home ownership is good for you just because we say so”. It certainly is true for those who can afford it. But preaching the gospel of universal home ownership to the entire population created an unsustainable paradigm of anticipatory and eventually dysfunctional economic behavior. This unsustainability was revealed in aggregate data – for several years, growth in consumer demand outpaced growth in incomes. Ever larger houses, ever further away from workplaces, attracted oversize cars to humongous parking lots surrounding monumental shopping centers: Home Depots, Costcos and Wal-Marts. America grew, enriching export-oriented economies in Asia and elsewhere and helping boost their central bank reserves to $5.4 trillion. But this growth was financed with debt and asset sales, not with productive income generation. Spend today, worry tomorrow.
For years, the American consumer purchased and digested so much that the current account deficit required at some point over $3bn in capital inflows into the country per day. Astonishingly, the economy that had stopped producing anything of value for its trade partners shifted gears up, through exploding domestic consumption that reached an unprecedented 72% of GDP. But this consumption was never predicated on income saving. Indeed, the creditor economies’ addiction to saving first and spending later was ridiculed in the official dogma. The fast growing economies of USA and its loyal disciples (Ireland, UK, Spain) based its expansion on unprecedented level of asset-based “saving”. In the case of the US economy, one should rather point to dis-saving, as net equity extraction from real estate reached 9% of disposable income. Not surprisingly, the level of debt has now soared to unheard-of levels – 350% as a percentage of GDP! This is debt recycled in all exotic, opaque, convoluted ways. No wonder, the infectious ripple hit the alphabet soup of products (ABS, MBS), monoline insurers and fraudulent vehicles (SIVs) saddled with the most toxic of credit products.
At the center of it all were entities enjoying implicit government backing – Freddie Mac and Fannie Mae. As it has now been made evident, both cooked their books for years, waving goodbye to their executives with parting bonuses worth several multiples of tens of millions of dollars. Quite why the executives of a notorious Houston-based energy company were once persecuted is, in this light, unclear. Until you realize how internally corrupt the financial system and their Washington backers really are.
But there is a darker side to Freddie and Fannie shenanigans and the ultimate government bailout announced two weeks ago. Out of nearly $1 trillion of Freddie and Fannie debt held overseas, almost $400 billion remains in the hands of China, which recently opted to purchase more of these “agency” products, rather than US Treasuries. Mr Putin and his Petrorussia hold another $100 billion. This very fact, unsavory as it is, may have precipitated the decision to shift the pain over to the US taxpayer. The US taxpayer not only carries the burden of ultimately saving the corrupt financial system, but is also expected to salvage poor investment strategies of nations that can hardly be labeled Washington’s allies and whose resurging neo-imperialism threatens the sovereignty and prosperity of neighboring countries – Georgia, Ukraine, Taiwan or India’s Arunanchal Pradesh.
Now Fannie and Freddie will be able to borrow from “Feddie”, the central bank. The Treasury will have the authority to purchase equity in these two “companies”. In the process, the risk has been transferred, yet again, from the shareholders to taxpayers, in the form of socialism for the wealthy. All this to keep the lending system going, in a false hope that the rescued skeletons of their former glory will now relax their credit standards and push the overextended American borrower back on the spending binge.
A decade ago, a Korean friend of mine complained about Bretton Woods institutions’ mantra repeated ad nauseam in crisis-stricken Seoul: “liberalize, liberalize, liberalize”. In the midst of a liquidity crisis, unfettered free market dogmatism was supposed to avert the economic plunge in Korea, Indonesia or Thailand. But Washington failed to walk the walk. Yes, we knew it from the way the US administration always protected its airline, banking or farming sectors against foreign competition. But the current apex of hypocrisy will make it all the more difficult to resume any of intellectual stewardship over the global economic affairs, not to mention moral authority.
Optimists hope that the legendary flexibility of the American taxpayer, consumer, investor and citizen will bring the country back from the brink. Probably, but this time it may take a while. The tax receipts are falling, consumer is running out of the handout doled out earlier this year, the investor is bruised after the relentless selling pressure in the property markets and securities (especially the earnings-poor, but still dominant financial sector) and the citizen raises doubts about the very efficiency of the system. The tax rebate offered to American consumers earlier this year simply prolonged the agony of buying on credit. Perversely, the politicians expected the overextended consumer to do just that – spend that money, rather than brace for more difficult times ahead and do the unthinkable – begin to save!
The US consumer is simply too indebted to meaningfully pull the economy as s/he repairs the frayed balance sheet. Those who counted on a quick turnaround in US current deficit have been disappointed. It is not enough to flash a weak dollar to save the trade account, even though the recent collapse in imports has been helpful. A tour around this marvelous country will quickly convince you that there isn’t much left of a manufacturing base here, and what America does have in surplus and for which it could command a premium on the world’s markets – coal, grains, natural gas – cannot be easily boosted for export due to lack of adequate infrastructure. It is, therefore, not surprising that the external deficit has been stubbornly sticky at 5% of GDP. Things could even get worse; the weak dollar may not offer a refuge for much longer because the currencies of most of America’s trade partners are now too strong and should weaken correspondingly.
Out of the population of the United States, some 90m people live on less than $40k a year. Half of them do not have health insurance. These people need income support, not a mirage of their own “home”. Many of them have nothing to even start saving from. But income distribution is a taboo among the so-called “conservatives”. They contest the above figures with another one – average pre-tax earned income (some $49k), which has risen 11% over the last seven and half years (except that hourly wage growth has been slowing down since 2006). But it is income per capita – which includes pensioners and children – that has not moved this year. Meanwhile, energy and food prices have jumped. Indeed, Sara Lee, Kellogg and other producers of packaged food are only now starting to pass on significant price pressures to the consumer. There is more to come.
Income inequality is another favorite statistics of the so-called “liberals”. And indeed, it is difficult to refute that mean incomes have grown faster than median incomes, which surely supports the thesis of rising inequality. Even if politicians are loath to call the spade a space and avoid the dreaded R-word, the losers of this game will find it more onerous to withstand the headwinds. In 2001, during the last Recession (and named by this horrifying term), Americans received a tax cut and were still able refinance their mortgages. Now the tax receipt hole is so cavernous that a significant tinkering would give vertigo to the most profligate of legislators. Meanwhile, the credit standards have skyrocketed. Forget about buying a house. Today you may find it difficult to finance a car lease – even if you enjoy permanent employment and a healthy “credit history”. As a percentage of GDP, new credit creation has fallen to the lowest in 14 years. Lowering the Fed funds rate by 3.25% (and discount rate by another 75%) did nothing to de-bottleneck the credit system. The prevailing level of private sector rates is where it was when the crisis began a year ago. No wonder that consumers’ expectation indexes are their lowest since the records began in 1944.
But this is not a country where pessimism pays back. Just ask Jimmy Carter… Prophets of false dawn are aplenty. Last May, most investment bankers ridiculed the fear of inflation and cheered on the allegedly upcoming relief from fiscal stimulus and bank recapitalization. The Dow was back at 13000 and so the headaches seemed over. Certainly, we have seen some rallies over the last year, but they were all caused by government intervention: lowering interest rates when Bear Stearns hedge funds collapsed, setting up new liquidity facilities when the BS eventually folded, and, finally, promising to buttress the failed Freddie and Fannie, effectively doubling the national debt. With each bailout, “profits are privatized and losses are socialized” to use the formulation of one well-known economist.
In an effort to rescue the banking system, the Fed has covered the banks with the manna of liquidity – mostly Treasuries. Historically, these instruments were deployed against cash or pledges embedded in other government-backed paper. Not so now. This lending is “secured” by banks’ paper of dubious quality. Something that overseas Sovereign Wealth Funds, having now suffered significant losses on their investments in US financial sector, are no longer willing to do.
Yet, for all those Anti-American leftwingers, religious fundamentalists and pet nationalists worldwide, I caution against too much Schadenfreude. The US consumer cannot be easily replaced. As I noted previously, in prime time, s/he is worth over $10 trillion dollar, versus $6.5 trillion in Eurozone and $2.5 trillion in Japan. Those whose strategy bet on “rising Chinese demand” are having a rude awakening. The developed economies still account for 70% of the world’s GDP. Even if China were to maintain its current rate of growth, it will take it a decade or more to catch up with Japan. It will be too late to save General Motors and its abominable Buick limos which somehow still sell in Chongqing.
But don’t give up hope. Having bailed out the corrupt financial institutions, the government may yet bail out General Motors and Ford. Their products may be obsolete, but GM has more pensioners to feed than the entire US Army. If Moroccan university graduates can expect the government to “guarantee their jobs”, if Pakistani investors can expect the regulators to “rescue their investment capital”, and if Parisians can expect the government to perennially protect public sector jobs, then may be Americans should also adjust their expectations to the government’s willingness to “help”. Certainly, you do not have to be a professional anthropologist to understand that Washington has already made its non-market choices.
Lesson 1: Certain assets, like housing, should only go up in price. Others, like oil or commodities, should only move down. It is therefore perfectly acceptable to support the bubble in the former and manipulate the market accordingly. But should the commodity prices, for whatever reason, rise – then call a congressional hearing session or find a scapegoat. Lesson 2: Do nothing when the oil price slumps by $25 within 10 days (surely a move of that magnitude within such a short time frame must be caused by “speculation”, n’est-ce pas?). And thus, such short-term tampering plods on, further distorting what has been left of the ‘free market system’, ostensibly in the name of ‘saving the financial sector. SEC has now banned ‘naked short selling’, but only for 19 best-connected financial stocks. The entire blogosphere is wondering: “why only these 19?”
All this may immerse you in dark, morose bleakness of pitch-black, somber, saturnine gloominess and dreary, depressing doom. But you know what? The hard-working people in this country just don’t see it this way. Just look at these pictures and you will understand why. Brazilians may, in fact, have a cidade mais maravilhosa do mundo. But Unequal Socialism of America still spans over the most wondrous chunks of this planet.
Happy Holidays!
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