US Addiction to Debt

[fuji]

In 2007 the financial sector of the US economy took in 40% of the corporate profits and employed 5% of the US work force. Those profits were predicated on debt: After the end of the doctom bubble financial sector growth switched from being based on rising asset prices, to being based on cheap credit. The growth of the 1980's and 90's was continued after 2001 by leveraging up--returns and risks rise when you invest on margin.

So 40% of American corporate profits since 2001 have been predicated on debt.

Aside from that, most consumer spending over that time was driven by debt as well. Much of the increase in demand arose from people feeling wealthier: House prices rose, and they remortgaged and spent the difference. But house prices were rising because credit was cheap: The rise in demand for homes came from the ease with which more and more people could borrow more and more money.

Plainly that bubble has burst, but the Federal Reserve has stepped in with the same old answer: Cut interest rates, making it cheaper and easier for people to go further and further into debt.

The public sector isn't faring any better. The last eight years have seen a massive expansion of public sector debt. Some of this was to fund the Iraq war, but a considerable amount was also to subsidize American industry--farms in particular, but not only farms--so that much of the economy outside of finance is also predicated on Federal debt.

I've posted on this topic a few times but really this is pretty serious:

When are Americans going to start living within their means? That switch will be painful (and not only for the US) but inevitably it will be even more painful later. The longer the pain is postponed, the worse it will be.

 

[fuji]

Put this another way: At some level the US continues prosperity primarily by selling off its assets. In other words, the great gains of the past are now being sold off. Since past gains were large, there is a lot to sell, and this can continue on for quite some time.

It cannot continue forever.

 

[S.C. Joe]

So are the Canadians that much better ?

Mexicans, yeah, they can't get any credit

 

[fuji]

So are the Canadians that much better ?

Mexicans, yeah, they can't get any credit

Canada produces more than it consumes.

 

[bjsk90]

So are the Canadians that much better ?

Mexicans, yeah, they can't get any credit

At the personal level, I believe that the rate of savings is higher amongst Canadians than with Americans. But I don't have any figures handy for that.

At the federal governmental level, it's a night and day difference. Canada has maintained a budget surplus since around 1997, and never looked back. The government is no longer just paying the interest on its debt (i.e. treading water), it is actually paying down the debt. I think recently (i.e. in the last few years) the national debt went down to below 50% of GDP.

Local and Provincial/State government levels are a little more all-over-the-board, so it's pretty comparable to the USA in that case.

 

[S.C. Joe]

I meant personal, the USA HAD a budget surplus until Bushie and his tax cuts and "war on terror" took over.

 

[frasier]

Canada produces more than it consumes.

Not a very difficult task with 10% of the population..and a huge amount of natural resources...

 

[S.C. Joe]

Well who would want to live where its winter 8 months of the year

 

[onthebottom]

That's a grotesquely simplistic analysis. For example, aprox 40% of Bank income is payments related - it has nothing to do with debt. In fact an in-depth analysis of bank balance sheets would show they make most of their spread based income on deposits.

In 2005 the Economist reported that banking (this would include financial markets) comprised 25% of US corporate profits.

You'll want to be careful here, I know a fair bit about this.

OTB

 

[fuji]

That's a grotesquely simplistic analysis. For example, aprox 40% of Bank income is payments related - it has nothing to do with debt.

Well two things. First, if those payments are credit card payments I'd question whether it really has nothing to do with debt. Second, even granting that, the 40% was financial sector as a whole, and I'd gather that conventional banks represented only a very small part of that.

In 2005 the Economist reported that banking (this would include financial markets) comprised 25% of US corporate profits.

The figure I quoted comes from this week's Economist and relates to 2007 in the article What went wrong?.

This process has turned investment banks into debt machines that trade heavily on their own accounts. Goldman Sachs is using about $40 billion of equity as the foundation for $1.1 trillion of assets. At Merrill Lynch, the most leveraged, $1 trillion of assets is teetering on around $30 billion of equity. In rising markets, gearing like that creates stellar returns on equity. When markets are in peril, a small fall in asset values can wipe shareholders out.

They include a graph showing the trend up from 25% in 2005 to 40% in 2007, and compare it to growth in the underlying economy, making the point that recent growth has been fueled by debt.

 

[fuji]

Not a very difficult task with 10% of the population..and a huge amount of natural resources...

It's a feat also managed by China, Belgium, Germany, the Netherlands, the Czeck Republic, Denmark, Norway, Russia, Sweden, Switzerland, Singapore, Japan, Thailand, Argentina, Austria, and Venezuela, to give you only a few examples. There are many more.

Consuming no more than you produce simply takes discipline. It means nothing more than balancing your budgets (personal and government both).

 

[alphauniform]

That's a grotesquely simplistic analysis. For example, aprox 40% of Bank income is payments related - it has nothing to do with debt. In fact an in-depth analysis of bank balance sheets would show they make most of their spread based income on deposits.

In 2005 the Economist reported that banking (this would include financial markets) comprised 25% of US corporate profits.

You'll want to be careful here, I know a fair bit about this.

OTB

I'd be seriously interested on your take on what "money", debt and banking actually is, OTB.
Isn't "debt" actually what our monetary system is predicated on????

 

[onthebottom]

I'd be seriously interested on your take on what "money", debt and banking actually is, OTB.
Isn't "debt" actually what our monetary system is predicated on????

Debt is the lubricant of our economy, you can't build factories, office buildings, buy equipment ...... without it.

What fuji is alluding to is the high degree of leverage that financial services firms enjoy (which is why even bankers can make money in banking). They carry very little real capital as a percentage of the assets they make money off of.

OTB

 

[onthebottom]

Well two things. First, if those payments are credit card payments I'd question whether it really has nothing to do with debt. Second, even granting that, the 40% was financial sector as a whole, and I'd gather that conventional banks represented only a very small part of that.

Those are all kinds of payments, debit card, credit card, ACH, SWIFT.... the debt part of the return (spread) isn't part of that 40%. Banks enjoy a near monopoly on the payments system that provides them great return.

OTB

 

[onthebottom]

from the Economist article:

The banks' course was made possible by cheap money, facilitated in turn by low consumer-price inflation. In more regulated times, credit controls or the gold standard restricted the creation of credit. But recently central banks have in effect conspired with the banks' urge to earn fees and use leverage. The resulting glut of liquidity and financial firms' thirst for yield led eventually to the ill-starred boom in American subprime mortgages.

The metaphor I used with HSBC last week was that banks chaise high returns into bad neighborhoods and get mugged, this happens every 10-15 years.... they didn't dispute it.

OTB

 

[Don]

So are the Canadians that much better ?

Considering that in 2007 the most popular mortgage in Canada is zero down + 40 yr AM, I'd say we aren't that much better.

 

[fuji]

Canadians are net savers (though the rate is historically very low) while Americans are net spenders. The personal savings rate is positive in Canada, and negative in the United States.

 

[assoholic]

..the US is addicted to a lifestyle it can no longer afford.
But is unwilling to admit it. Attempting instead to seize the Middle East.

 

[assoholic]

..those at the Top of the Pyramid ,
only care about staying at the top of the pyramid.
Their allegiance, is only to themselves.
The rest of us are collateral damage
and DQ look at household debt, as a society most are
living way beyond their means.
The Real Estate stall, let alone crash will
have a huge effect on the economy.
What did OBL say, it would be the economy stupid,
the US would spend it's way to defeat.
What he has predicted has come true.

 

[fuji]

The US isn't addicted to debt. The GOP is.

It goes beyond politics. American businesses (the iBankers that kept the party going by leveraging up) and American consumers (who mortgaged their homes to keep the party going) are equally guilty. The GOP can only be held to account for their share of the Federal debt, but America as a WHOLE, private and public sector both, business and consumer, has an addiction to debt.