Tuesday, September 18, 2007

This Week's Theme: The Rot Within

The Closing of the U.S. Home ATM Dooms the Global Economy

One of the cliches which is repeated ad nauseum in the Mainstream Media is that the global economy is so red-hot that it will lift the U.S. out of recession. I wonder if they have the cart pulling the horse.

Here's the basic idea: right now the U.S. buys about $750 billion more from the rest of the world than we export (sell) in goods and services. But if the U.S. slips into recession (as if there is any doubt of that happening), then the U.S. will be "saved" by rising exports as our big trading partners (China, the E.U., Japan, Mexico and Canada) buy more American goods and services.

Nice idea, but the last time I looked, the cart was not pulling the horse. Simply put: the global economy is red-hot largely because the U.S. consumer extracted a staggering sum (conservatively $6.6 Trillion) from their ballooning home equity, and promptly spent it-- much of it on imports.

Note that the GDP figures are from the CIA Factbook, which calculates GDP on Purchasing Power Parity-PPP.

When an American homeowner buys $1,000 worth of electronics and other gew-gaws made in Asia, the money generates economic activity far in excess of the initial $1,000. The U.S. retailer and wholesaler scrape off their slice, which pays the wages for their staff, who go out and spend their wages on other goods and services; this cycle is of course repeated in Asia as well. Though the multiplier is inexact, 2.5 is a number often bandied about as semi-accurate.

That means the U.S. home ATM (home equity extracted and spent) generated a stupendous $16.5 Trillion in economic activity--a number which dwarfs even the largest GDPs. Now to be clear: that $16 Trillion wasn't all spent on non-U.S. goods, and it was spent over the past seven years of (debt-based) "prosperity," not all in one year.

Nonetheless, the sheer scale of home-equity-based spending is almost beyond grasp. Recall that the U.S, the largest economy on Earth, exports about $1 Trillion in goods and services a year. That means that the total economic value generated by the torrid equity-extraction boom is larger than 15 years of U.S. exports.

Just for comparison's sake, recall that the trade deficit with China that everyone is focused on is about $225 billion a year. That is less than 1/30 the sum extracted and spent by U.S. homeowners in seven short years.

We can quibble about exactly how much money flowed from the U.S. home equity ATM to our trading partners, but the sums are so large it doesn't really change my point: the closing of the U.S. home ATM will have a large, very negative impact on the economic activity of our trading partners, whose own "booms" have been fueled by trillions in exports to the U.S.

And where did Americans get all those trillions to spend so lavishly? The home equity ATM. Now that it's closed-- (see The Home ATM (a.k.a. Equity Extraction) Is Broken for more details)--can anyone seriously claim that will have no impact on our trading partners?

Recall, too, that the U.S. savings rate is negative (we spend more than we earn) and that wage growth has been essentially flat for those seven years. So the idea that U.S. consumers just found the $7 Trillion somewhere other than their homes--in their sofas or cookie jars?-- is beyond ludicrous.

Yes, the Chinese wage earner has money in his/her pocket--but that didn't flow from goods sold to other Chinese--it flowed from exports. Many observers note that the E.U. is now a larger market for China than the U.S., but again, the point is not that the U.S. is the only game in town, just that it is 20% of the global GDP and therefore a large market. If exports to the U.S. drop, say $250 billion, can China sell the E.U. $250 billion more in goods? No way. And since prices are set on the margins, losing a huge chunk of sales to the U.S. will negatively impact every exporting nation.

The multiplier works when spending drops, too; as the U.S. consumer stops spending so freely, then the reduction in economic activity isn't 1 for 1--it's 2.5 for 1.

Will the end of the U.S. home equity ATM have an impact on our trading partners? The answer is rather obviously a resounding yes.

Thank you, Nelson I., ($25) for your much-appreciated donation to this humble site. I am greatly honored by your encouragement and readership. All contributors are listed below in acknowledgement of my gratitude.

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