Tuesday, October 07, 2008

Comment: How deep is the economic crisis?

During a congressional hearing yesterday, the CEO of Lehman Brothers said he was surprised that the mortgage problems led to the current crisis on Wall Street.

Obviously, this guy did not become the executive officer of one of America's oldest financial firms without understanding the system, but he claims to have been caught off-guard by the credit crunch. So, it's worth noting that nobody may know quite what's going to happen until after it happens and long hard analysis takes place.

We do know that there will be mortgage resets on those risky housing loans until 2012. In fact, there will be quite a few more at-risk mortgages scheduled for resets over the next four years as compared to the subprime loans that led to the current meltdown. The future problems will be more with adjustable rate mortgages.

However, behind the mortgage problem there is still the fundamental problem of US debt. All told, the total governmental, business and consumer debt of the United States adds to about $34 trillion or four times GDP.

The most important part of this debt is that owned by foreigners, the external debt.

External Debt Worldwide

World $ 51,780,000,000,000 2004 est.
United States $ 12,250,000,000,000 30 June 2007
United Kingdom $ 10,450,000,000,000 30 June 2007
Germany $ 4,489,000,000,000 30 June 2007
France $ 4,396,000,000,000 30 June 2007
Netherlands $ 2,277,000,000,000 30 June 2007
Ireland $ 1,841,000,000,000 30 June 2007
Japan $ 1,492,000,000,000 30 June 2007
Switzerland $ 1,340,000,000,000 30 June 2007
Belgium $ 1,313,000,000,000 30 June 2007
Source: CIA World Factbook

From the chart above, it can be seen that the US is easily the world's largest external debtor. This means that every year a significant amount of US assets goes to other countries.

Internally, pratically everything in the economy is built up on a structure of debt. We saw the same thing with the dotcom economy, which was allowed to fail when George W. Bush came into office. There is an imaginary economy based on debt-based growth. People were basically borrowing money using previously-borrowed money as a type of collateral, or as evidence of growth or stability. While the dotcom system was allowed to meltdown, the government is desperately trying to save the broader Wall Street system.

America's debt problems arose with the idea that easy credit was good, the easier the better. Everyone borrowed with the federal government leading as an example. Savings rates tumbled also due to the impact of consumerism.

In order to feed the consumer frenzy, oil had to be imported and manufacturing jobs had to be exported, where labor costs are cheaper. Because America has failed to educate large segments of its population, professionals and skilled labor had to be imported as well. And foreign capital was needed to finance much of the "growth."

Many people are looking for the end to the current crisis in the bottoming out of the stock market, but over the long run there may be several bottoming outs. A lot depends on when the credit markets actually can't keep up with the demand on a regular basis. You can call it peak credit after a similar term for the coming peak in oil production. There will be no choice at that point but to let everything reset after a massive liquidation of debt.

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