Tag: lending

I’ve been thinking a lot about what’s going on in the US economy. Every time I hear someone talking about how to fix it, I feel that they have it horribly wrong. They just aren’t looking at the facts. They aren’t asking themselves where these facts point. This includes my robotic peers and my calcified professors. Everyone one wants to speculate with their platonic definitions and abstract calculations and no one wants to look at the facts, the actors, to data, the trends, and it’s really disconcerting.

That being said, I’ve just read several journal articles on this topic and one struck me most poignantly, titled Income Inequality and Current Account Imbalances by Kumhof Et Al of the IMF. Not only did their hunches and conclusions resonate with me beautifully, they happened to address the exact questions I’ve been wrestling with in my own journals and writing. It was a relief.

In sum, I believe the that the major source of our problems revolves around global account imbalances. More specifically, the global account imbalances and the low world real interest rates were the primary source that fueled financial instability leading up to the 2007 financial crisis. I believe that the perception of foreign investors that the US was a haven for ‘safe-asset’ investments, compounded by low interest rates post 2001, fueled financial recklessness leading to the financial crisis and our current recession. Before I explain…

Let’s establish the facts– basic facts– and ask ourselves some more questions regarding how these facts came to be (we can get into details later):

• Rising Income Inequality
• Top 5% earnings have risen steeply
• Bottom 95% earnings stagnated
• High Unemployment: recently between 8-9% (Severe demographic variability)
• Wealthy own majority of capital assets, liquid or illiquid
• 80% of US population owns 7% of wealth
• Wage Stagnation: Real wages have not risen in 30 plus years
• Consumer Price Index has risen during the same period
• US Savings rate: Historical Lows; downward trend since early 1980’s
• Current consumer savings rate 3.75%
• Massive Consumer debt Increases
• 33% revolving credit (credit cards)
• 67% loans (mortgage, car, student, etc)
• Massive Private Lending Increase
• From 1998-2008 private credit from other financial institutions, i.e. credit cards, loans, etc., rose from 37% to 150% of GDP
• From 1998-2008 private credit from deposit money banks rose marginally from 55% to 65% of GDP
• Rising Global Account Imbalance
• Rise in Foreign Investment in US
• US Current Account deficit 3.3% as of Dec. 2011
• US is the worlds reserve currency: Safe bet for investing
• US has most developed financial markets
• High liquidity assets: investing is attractive
• Debt yields good returns: Debt markets are lucrative and considered “safe assets” (more the case in the past; not so much as of recent)
• Expansionary Monetary Policy: Federal Interest Rates 0% (Open Market Operations, Quantitative Easing, etc)
• Buy bonds from banks, Increase bank reserves supply
• Increases money supply
• Increase inflation
• Increases consumer prices (CPI)
• Lowers interest rates
• Increase lending/ borrowing
• Scarcity value: Increased scarcity (decrease supply) drives up prices
• Bargaining power: the concept related to the relative abilities of parties in a situation to exert influence over each other
• Wage bargaining: caused wage stagnation
• Thorstein Veblen describes the manifestation of this sociological phenomenon in his book The Theory of the Leisure Class

These are some basic facts regarding the current state of things. Let’s cite some facts relating to economics, finance, human behavior, and the like:

• Compounding Interest: Returns are exponentially proportional to investment; the more money you have to invest, the greater the return
• Investment requires surplus capital, and surplus capital requires saving
• ‘Wealthiest’ possess vast majority of all surplus (investment) capital and therefore investment power
• Investment power is concentrated to a very small fraction of the population
• When investment capital begins to concentrate in one investment area, that investment’s value will begin increasing as the price is bid up (scarcity value), fueling reflexive expectations, which causes speculation, drawing in more (and smaller) investors  and more reflexivity, leading to an eventual bubble and collapse when the largest investors begin pulling their money and running.

Consider the following: High domestic account deficits indicate high income inequality.
Why?

• The poor and middle class do not have access to international capital markets, they rely on borrowing from the wealthy
• When Aggregate Output increases and lower class receives smaller share, i.e. decreased income/ wages because lack of bargaining power, they are forced to borrow from wealthy.
• Due to this borrowing, the lower class’ drop in consumption is less than their drop in real income, while upper class consumption and assets increase along with aggregate output
• Domestic demand continues to rise, which fuels current account deficit, as wealthy increase their domestic lending and supplement their lending with foreign savings
• Income inequality is exacerbated.
• Domestic Political Interventions increase in an effort to alleviate those suffering from stagnant real wage
• Typically symptomatic treatment through Cheap Borrowing/ Financial Liberalization
• Short-term success in preventing drop in consumption from lower class.
• Long-term increases in domestic debt levels, higher debt services, and therefore lower consumption.

The authors of  Income Inequality and Current Account Imbalances look at how income inequality is exacerbated by domestic lending of the rich. As rising aggregate output/GDP is coupled with rising income inequality and stagnating wages, poor/ middle class consumption is less than their drop in income due to domestic lending of the rich. (Prices go up, they get more credit/ debt, buy more, fuels domestic demand, aggregate output increases, current account deficit widens).

The typical short-term political fix is to target policies that allow for cheaper borrowing/ financial liberation (Hence the fed is keeping rates at 0% to increase borrowing). But long-term financial liberation only leads to higher domestic debt levels, higher debt services, and lower worker consumption: it generates increases in workers’ consumption, yet slows down capital accumulation as investors prefer financial over real assets (less value-added investing, more speculative investing, i.e. financial securities, real estate, etc, eventually leads to economic stagflation…. current situation?).

The article continues by discussing historical economic trends and the global repercussions if new policies are not sought to address these systemic issues. They project that the issue of domestic indebtedness will spread globally as the income inequality gap widens and financial liberation continues.

I’ve been thinking a lot about what’s going on in the US economy. Every time I hear someone talking about how to fix it, I feel that they have it horribly wrong. They just aren’t looking at the facts. They aren’t asking themselves where these facts point. This includes my robotic peers and my calcified professors. Everyone one wants to speculate with their platonic definitions and abstract calculations and no one wants to look at the facts, the actors, the data, the trends, and it’s really disconcerting.

That being said, I’ve just read several journal articles on this topic and one struck me most poignantly, titled Income Inequality and Current Account Imbalances by Kumhof Et Al of the IMF. Not only did their hunches and conclusions resonate with me beautifully, they happened to address the exact questions I’ve been wrestling with in my own journals and writing. It was a relief.

In sum, I believe the that the major source of our problems revolves around global account imbalances. More specifically, the global account imbalances and the low world real interest rates were the primary source that fueled financial instability leading up to the 2007 financial crisis. I believe that the perception of foreign investors that the US was a haven for ‘safe-asset’ investments, compounded by low interest rates post 2001, fueled financial recklessness leading to the financial crisis and our current recession. Before I explain…

Let’s establish the facts– basic facts– and ask ourselves some more questions regarding how these facts came to be (we can get into details later):

• Rising Income Inequality
• Top 5% earnings have risen steeply
• Bottom 95% earnings stagnated
• High Unemployment: recently between 8-9% (Severe demographic variability)
• Wealthy own majority of capital assets, liquid or illiquid
• 80% of US population owns 7% of wealth
• Wage Stagnation: Real wages have not risen in 30 plus years
• Consumer Price Index has risen during the same period
• US Savings rate: Historical Lows; downward trend since early 1980’s
• Current consumer savings rate 3.75%
• Massive Consumer debt Increases
• 33% revolving credit (credit cards)
• 67% loans (mortgage, car, student, etc)
• Massive Private Lending Increase
• From 1998-2008 private credit from other financial institutions, i.e. credit cards, loans, etc., rose from 37% to 150% of GDP
• From 1998-2008 private credit from deposit money banks rose marginally from 55% to 65% of GDP
• Rising Global Account Imbalance
• Rise in Foreign Investment in US
• US Current Account deficit 3.3% as of Dec. 2011
• US is the worlds reserve currency: Safe bet for investing
• US has most developed financial markets
• High liquidity assets: investing is attractive
• Debt yields good returns: Debt markets are lucrative and considered “safe assets” (more the case in the past; not so much as of recent)
• Expansionary Monetary Policy: Federal Interest Rates 0% (Open Market Operations, Quantitative Easing, etc)
• Buy bonds from banks, Increase bank reserves supply
• Increases money supply
• Increase inflation
• Increases consumer prices (CPI)
• Lowers interest rates
• Increase lending/ borrowing
• Scarcity value: Increased scarcity (decrease supply) drives up prices
• Bargaining power: the concept related to the relative abilities of parties in a situation to exert influence over each other
• Wage bargaining: caused wage stagnation
• Thorstein Veblen describes the manifestation of this sociological phenomenon in his book The Theory of the Leisure Class

These are some basic facts regarding the current state of things. Let’s cite some facts relating to economics, finance, human behavior, and the like:

• Compounding Interest: Returns are exponentially proportional to investment; the more money you have to invest, the greater the return
• Investment requires surplus capital, and surplus capital requires saving
• ‘Wealthiest’ possess vast majority of all surplus (investment) capital and therefore investment power
• Investment power is concentrated to a very small fraction of the population
• When investment capital begins to concentrate in one investment area, that investment’s value will begin increasing as the price is bid up (scarcity value), fueling reflexive expectations, which causes speculation, drawing in more (and smaller) investors  and more reflexivity, leading to an eventual bubble and collapse when the largest investors begin pulling their money and running.

Consider the following: High domestic account deficits indicate high income inequality.
Why?

• The poor and middle class do not have access to international capital markets, they rely on borrowing from the wealthy
• When Aggregate Output increases and lower class receives smaller share, i.e. decreased income/ wages because lack of bargaining power, they are forced to borrow from wealthy.
• Due to this borrowing, the lower class’ drop in consumption is less than their drop in real income, while upper class consumption and assets increase along with aggregate output
• Domestic demand continues to rise, which fuels current account deficit, as wealthy increase their domestic lending and supplement their lending with foreign savings
• Income inequality is exacerbated.
• Domestic Political Interventions increase in an effort to alleviate those suffering from stagnant real wage
• Typically symptomatic treatment through Cheap Borrowing/ Financial Liberalization
• Short-term success in preventing drop in consumption from lower class.
• Long-term increases in domestic debt levels, higher debt services, and therefore lower consumption.

The authors of  Income Inequality and Current Account Imbalances look at how income inequality is exacerbated by domestic lending of the rich. As rising aggregate output/GDP is coupled with rising income inequality and stagnating wages, poor/ middle class consumption is less than their drop in income due to domestic lending of the rich. (Prices go up, they get more credit/ debt, buy more, fuels domestic demand, aggregate output increases, current account deficit widens).

The typical short-term political fix is to target policies that allow for cheaper borrowing/ financial liberation (Hence the fed is keeping rates at 0% to increase borrowing). But long-term financial liberation only leads to higher domestic debt levels, higher debt services, and lower worker consumption: it generates increases in workers’ consumption, yet slows down capital accumulation as investors prefer financial over real assets (less value-added investing, more speculative investing, i.e. financial securities, real estate, etc, eventually leads to economic stagflation…. current situation?).

The article continues by discussing historical economic trends and the global repercussions if new policies are not sought to address these systemic issues. They project that the issue of domestic indebtedness will spread globally as the income inequality gap widens and financial liberation continues.