This article, excerpted here, grew out of an ongoing email correspondence on banking and economics between me and it's author, Kelly Cowan. Kelly is an artist, investor and observer of the economy and capital markets. Although she left the professional investment world behind long ago, she is a close watcher of economic and market trends. She maintains close contacts with a number of individuals in the investment world. The full article can be found at Planet Waves--Eric Francis, editor
FROM THE TEMPLE OF DEBT a prayer rings out. It is the busiest time of year for the Cathedral of Commerce. 'Tis the season of Debt.
A critical issue facing this nation is our debt problem. Excessive levels of both private and government debt exist today. There are two ways to deal with debt: service the debt or default on the debt. With default can come deliberate debt reductions or bankruptcy. Current debt levels are unsustainable and there is no way to service all this debt. The debt cannot and will not be repaid. The wealth just isn't there. We are living in an era of negative equity.
All this debt was accumulated for consumption and speculation on asset prices. It was not used to expand production. This increased debt burden did nothing to add to productive capacity. So where did the money go? The debt was secured by asset values that were never really there (no, your two bedroom house that hadn't been remodeled since the 50's was never worth $1 million; it was an arbitrary number created in speculative ecstasy).
The choir of lenders sang borrow, borrow, borrow. The money borrowed against these assets was used to purchase stuff, and useless stuff at that. Much of that stuff came from China; we shipped dollars to China and China shipped stuff to us. US consumers consumed more than they produced, using borrowed money (much of it from China) to pay the difference. Chinese consumers produced more than they consumed and saved the difference. America borrows China's savings.
The solution is to unwind the debt and allow the necessary hits, however painful. Pain management will require a lot of emotional resources. The adjustment period is underway. The dynamic is in play and we need to decide how this will occur. Instead, we are pushing the problems down the road and expecting a miracle.
UPDATED: (included from the full article at Planet Waves) Have you heard the "good suit" story?
The cost of a good suit in 1920 was about an ounce of gold, or around $20. Today, the value of an ounce of gold is $1,125, more than enough to buy a good suit. In 1920 the purchasing power that allowed an American consumer to purchase a good suit, in today’s dollars, would be $216.18. Hardly enough to purchase a good suit. the real price difference between a suit then and a suit now is inflation. This is a link to calculate inflation and purchasing power. Feel free to play with it.
We can see from the suit story that the suit costs more in today's dollars. That $20 in 1920 would put $216.18 in your hands today. While your great-grandfather could purchase a good suit for $20, today with the $216.18 you would not be able to purchase a good suit. Up and down the line, businesses take more of a profit. The price increase certainly isn't due to the cost of production. Labor cots are not higher-adjusted for inflation.
Technology and overseas production (often at slave wages) have decreased the costs of manufacturing. Inflation hides these manufacturing cost decreases. Today, a smaller proportion of the population can afford suits; suits have become a luxury. But the profit on each suit is higher for a long string of business owners, from the industrial fabric weaver in Italy to your local department store (which is probably not owned locally, and as part of a chain has much greater economy of scale than if it were owned locally).
We think of inflation like air -- that it is a necessary part of life: but it is not. Yet it’s not just inflation. Those on the purchasing end are hurt both by the value of the dollar going down, and by manufacturers taking higher profit.Meanwhile, as wages and incomes fell and inflation and prices increased, credit was pushed to fill the gap. Consumers didn't notice, as they could still purchase their car.
Just this past week, President Obama, in a speech outlining his new stimulus proposal, said that the nation must continue to "spend our way out of this recession." We all remember President Bush in the days following 9/11 encouraging Americans to go shopping. This is the gospel preached by our leaders: shop and spend. Jim Rogers, a noted global investor and an expatriate American, recently commented, "The idea you can solve a problem of too much debt and too much consumption with more consumption and more debt defies belief. I cannot believe that grown-ups would stand there and say that."
Here some numbers to think about:
Household consumption in the US is 70-72% of the economy. In Europe it is 55-65% and in China it is 35% of its economy. America is the orthodox branch of the debt religion. We have practiced faithfully. Individuals and businesses have started to delever. A closer look at the numbers, however, might point to something different: a transfer of leverage rather than a deleveraging.
Households have reduced borrowing by $351.3 billion, businesses have reduced borrowing by $238.9 billion and the financial sector has reduced borrowing by $1,532.6 billion in the past year. Over the same time the federal government has increased borrowing by $1,484.9 billion and the state governments have increased borrowing by $115.9 billion (these figures are from the Federal Reserve, Flow of Funds Accounts, for the third quarter 2009).
The debt crisis is a collective story. It is our story. We are all involved. Each of us has a part in the story. Our roles are based on the individual choices we have made. The altar of debt seems to have been quite seductive. The 19th century Danish philosopher and theologian, Kierkegaard, once depicted seduction as a sacred and religious practice, but he also wrote that the seduction requires the permission of the seducee. All of us are accountable for the debt world we have created.
So what is the debt story? What do we tell ourselves? What do we tell each other? What story should we tell? We need to have one narrative based on the record of events. This takes emotional honesty. Building a story requires time and reflection. It demands awareness and decisions.
To do this we need to begin to "call to account" those who were the key architects of the debt world. We need a public forum to hold them answerable for their decisions. But it can't stop with the CEOs, members of Congress or the regulators. The discussion must include everyone who has taken on debt. This has been a collaborative series of events and we are all stakeholders, even if we feel that our stake is diminishing.
The process would eventually create a healthy boundary and allow for a way forward. We certainly need a boundary as we are currently on the slippery slope of moral hazard. Neither path is easy, but the path of moral hazard never gets any easier. In fact, it often gets worse. Both paths have economic and emotional prices to pay, but the path of moral hazard has spiritual consequences. The path forward will eventually have spiritual rewards.