Hi ZZ, I hope you came out of Frances with nothing more than a major cleanup project. Though I didn't stay in my own digs, we got real lucky down here on Lake Tarpon. Got back Monday in time to see our next door neighbor lose most of his roof. Give us a 'sign' when you get a chance.
International Perspective, by Marshall Auerback September 7, 2004
Everything (Un)Hinges On The US Consumer September 7, 2004
As we come to the end of the Labour Day festivities, it seems appropriate to refocus attention on the source of much of that labour – namely, the US consumer. Arguably the engine of so much of the world’s economic growth over the past 3 years, the US consumer now appears truly tapped out. The problem, from the perspective of driving global economic growth, is that there is no obvious candidate to replace him. The fiscal lever appears well and truly pushed to its limits; foreign lenders (notably Asia’s official sector) are now dealing with the consequences of their own domestic credit bubbles, and monetary policy (now in tightening mode in many countries) can hardly offer a further external offset should the US consumer scale back. American corporations are saving more, but seem hardly inclined to go on a renewed capital expenditure binge. At the risk of sounding like one of Arnold Schwarzenegger’s “economic girlie men”, the status quo hardly seems like a comforting place to be right now.
According to the Terminator’s interesting formulation at the Republican Convention in New York last week, anyone who believes the American economy is suffering from grave problems is a sissy. With the new category of "economic girlie men," everyone who has a problem with the debt, unemployment, or the future of Social Security has now become an effeminate male. So do the size of the economy’s level of debt and its rate of growth compel not just girlie men but serious analysts as well to rethink some basic assumptions underlying their models of the American and world economy? Let’s look at the numbers.
First the good news: In contrast to US households, US companies are sitting on large stockpiles of cash they have accumulated from rebounding profits rather than spending it, according to Moody’s, the credit rating agency. In fact, for all of the talk of US financial profligacy, American companies have taken hoarding to a new level. Moody’s calculates that the ratio of liquid financial assets to debt on US balance sheets hit a 35-year high in recent quarters. The amount of liquid assets held by non-financial US corporations has almost doubled over the past seven years to $1,165bn at the end of the first quarter, according to Federal Reserve data. This figure was positive between 1998-2002 - reflecting more spending than cash flow - but turned negative in 2003 and the first quarter of 2004.
So how does this square with the now common perception of a debt-addled US economy? Let’s go back to simple first principles.
For every borrower there must be a lender. When any economic agent spends more than they earn over any given period of time, they are deficit spending. Liabilities must therefore be issued by deficit spending units to plug the spending/income gap – they have a financing gap which requires issuing financial claims.
For these liabilities to be voluntarily placed, there must be other economic units that are net saving, or spending less than they are earning. The economy can be split into three sectors: private domestic (households and firms), public (combined state, local and federal government), and foreign.
The net saving or financial balance of these three sectors must sum to zero: this is simply an extension of the fundamental principle for every borrower there must be a lender. It follows, therefore, that if the financial balance of government moves massively from surplus to deficit, which it has, there must be offsetting financial balances, of which US corporations’ cash hoards are but one manifestation. And the financial balance of the rest of the world vis a vis the U.S. has also moved in the direction of a greater surplus with America.
This framework is nothing new. It has long been associated with the work of Wynne Godley, whose analysis of sectoral financial balances and their impact on debt, as well as that of the financial theorist Hy Minsky. Godley in particular predicted that the move toward massive fiscal deficit by the Bush administration would arrest private debt growth and stabilize an unstable economy. Godley was only partially correct: Although the fiscal surpluses of the Clinton years have in fact moved rapidly into deficit under President Bush, (thereby helping to arrest the deflationary impact of the US corporate sectors build-up toward savings surplus), this did not arrest the explosive growth of US household debt.
The net savings of the US personal sector has fallen unrelentingly since 1992, reaching a historically unprecedented minus 6 per cent of disposable income by 2001 – a record low from which there has yet been no recovery. The fall in net saving was accompanied by a steady rise in net lending, culminating in a rate of personal indebtedness which reached a record of 140 per cent of disposable income by the first quarter of 2004. At the same time, the Fed’s broad measures of households’ financial obligations to service debt has been hovering around 18.5 per cent of income – a record amount notwithstanding historically low prevailing interest rates. This more than offsets any savings done by the US corporate sector.
How do we explain the perpetuation of this trend? One cause is clearly the steady rise in foreign creditors. China, Japan, and emerging Asia remain prodigious financiers of US consumption, despite the weak returns they get from low US interest rates.
But this does not provide the whole picture. Indeed, even Godley’s financial balances sectoral approach understates the reality of what is occurring in the American economy, where private households also appear to be borrowing at a greatly increased rate from one another, as well as from overseas. This makes intuitive sense. When mortgage credit and debt explode, some households are borrowing much more through financial intermediaries and securitized markets that in turn fund themselves largely from domestic household savings sources. The young newlywed couple borrows more against their house from an S&L in Plano, Texas whilst their retired parents are in theory adding to their deposit balances.
Some might argue that, if households borrow from other households, the resultant growth in aggregate debt may not matter, as all the credits and debits “cancel out”. We would argue just the opposite. The explosion in “intrasectoral” debt may reveal an even greater financial fragility. Debt difficulties and defaults occur only when the financial structures of borrowing units are greatly strained. Therefore, it is not just the ratio of aggregate debt to aggregate income that determines the propensity to debt default: the distribution of overall debt matters as well. If the debt burden on the household sector is uniform, even though the aggregate debt to income ratio may be high, the debt of all households may be manageable. But if it is highly skewed, then some households will surely be burdened with unmanageable debts. This becomes the weak link in the daisy chain of credit. When intra-sectoral debt explodes, as it did in the first half of this year, there must be a serious skewing of the indebtedness of the household sector. The balance sheet of a retired couple with their rising bank deposit balances must be getting better while their son and daughter-in-law move deeper and deeper into debt.
It is worthwhile considering this fragile position of many American households in light of last Friday’s August employment report. The 144,000 increase in jobs certainly marks an improvement on the feeble 73,000 jobs created in July. But the figure still falls short of the 150,000 new jobs most economists estimate are required to keep pace with population growth. More ominous, from the perspective of personal household balance sheets, average earnings have thus far failed to keep pace with rising inflation. In the year to August earnings rose by 2.3 per cent, whilst the heavily doctored headline inflation figures (which clearly do not reflect the rising impact of higher energy prices, amongst other things) rose by 3 per cent in the year to July.
Faced with these circumstances in the past, US households would behaved much like US corporations have done in this cycle; they would have moved to repay debt and would be encouraged to do so by responsible monetary authorities. Sadly, many took the advice of Dallas Fed president McTeer, who openly encouraged U.S. households to purchase (yet) another SUV (often with borrowed money) as the solution to the 2001 recession. Presumably, the new governor of California would also applaud this virile display of economic behaviour, which not only restored US growth, but has become an increasingly important engine driving the global economy to this day. Now comes the “morning after” impact.
Many apologists for the US economy claim the indebtedness is America's good fortune--a sign of strength that other nations are so eager to finance US consumption. This is pure nonsense: China and Japan are willing to do this because they calculate that sustaining their own industrial output and employment is worth more than seeking stronger financial returns elsewhere.
Even those who see problems in the tendency to “overconsume” – that is, living beyond their means – assume that "market forces" will eventually correct the situation. Once the global economy regains robust growth, it is said, other nations will buy more US exports. Or, once the dollar has depreciated in value sufficiently, Americans will buy fewer imports.
Well, the US dollar has depreciated by some 13 per cent on a trade weighted basis this year, and the external account has deteriorated further. The US economy, in essence, is being kept afloat by enormous foreign lending so that consumers can keep buying more imports, thus increasing the bloated trade deficits. On the other hand, were US consumers in aggregate to scale back their lifestyles, reduce personal indebtedness and concomitantly restore their savings balances in the absence of some additional countervailing stimulus would be required from abroad to offset the diminution of US domestic demand. The non-US world has become enormously dependent on America’s growing deficit (and, by extension, the continued profligacy of US households) as an engine for growth.
In theory, the rest of the non-US world, particularly the saving bloc of Asia, could be persuaded to encourage greater domestic consumption, as an offset to American consumers’ collectively tightening their belts. This would have been easier to achieve a few years ago, but the persistent accommodation of US overconsumption from abroad has left many of the foreign creditor nations coping with their own domestic credit bubbles, which many are now seeking to confront. China, in particular, is moving to curb excessive real estate speculation and rein in capital expenditure. The country had 139,400 building projects under construction in the first seven months, with total investment rising 38 percent to 11.2 trillion yuan ($1.35 trillion), according to a recent government report cited by the official Xinhua news agency. In response, the country’s central bank Governor Zhou Xiaochuan said banks should keep up lending curbs because the economy needs to slow more and inflation hasn't abated.
Similarly, in Thailand, credit-card debt surged by more than a half last year, prompting Bank of Thailand to limit borrowings to five times a cardholder's monthly salary. Krung Thai Bank, Thailand's second-biggest lender by assets, unnerved investors last month by disclosing that it had classified, under instructions from the central bank, an additional 46 billion baht ($1.1 billion) of debt on its books as loans that would probably not be repaid. So little should be expected in the way of additional Asian monetary stimulus.
What about Europe? European financial and monetary authorities could argue with some justification that there has already been a substantial appreciation of the euro against the dollar, so that they too, have done their bit to encourage less US-centric growth. It is also worth noting that the current political context gives one little hope that Euroland would do anything further to accommodate the Bush administration.
Which brings us back to the US consumer. If the US were unexpectedly to become a nation of savers again the global system would lose its best customer. In the short term, this is not in anybody’s interests because of the resultant economic turmoil unleashed by it. It’s certainly the last thing George Bush or Karl Rove want to see right now. American consumers have propped up global trade with their open-ended purchases and with Asia in tightening mode, it appears the status quo will remain operative, at least until there is a financial/political accident that occurs. Political imperatives in Europe also point in a similar direction.
To therefore expect “market forces” to correct this situation in a benign way seems foolhardy in the extreme. A financial accident is out there, waiting to happen, even if it’s only us “economic girlie men” who dare to point this out.
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