U.S. consumers have run up about $3 trillion in excess borrowing and spending over the past five to ten years--consumption that was not justified by income growth.
The result? A multitrillion dollar bailout of the global financial sector that will still leave us with sluggish growth in the years ahead.
2003 was when real wages and salaries peaked in the U.S. From that point on, most workers saw their buying power drop. That drop in real wages offered the first clue that something was wrong.
Historically, real wages have gone up in an economy with rising productivity. So either the productivity growth wasn't as strong as it looked or something else was holding down wages. In part, cost cuts for outsourcing were being reported as productivity gains because of a quirk in the economic statistics.
Yet, American lenders made a big mistake. When real wages started falling, they should have tightened their mortgage and consumer-credit lending standards and made it harder for households to borrow. Instead, they threw money at people whose real incomes were shrinking, not rising. Why did they do this?
Looking back, it has become clear that rampant borrowing and spending by U.S. households concealed fundamental weaknesses in the rest of the domestic economy. The rising debt, like a fever, was a symptom of a deeper problem.
The rule for a prudent individual is simple: Don't spend more than you make.
For a long time, the U.S. economy obeyed that rule. As far back as the 1960s, personal spending, adjusted for inflation, has basically tracked the overall growth of the economy, as measured by gross domestic product (GNP).
That pattern changed in the 1990s. As of the third quarter of 2007, the 10-year growth rate for consumption was 3.6%, vs. GNP growth for the same period of 2.9%. This difference represents an enormous gap. If consumer spending had tracked the overall economy over the past decade as it has in the past, Americans today would be spending about $600 billion less a year. The extra spending has amounted to a total of about $3 trillion since 2001. The question now is how much of that extra $3 trillion we will have to give back.
A slow-growth world has big implications for companies. For one, it's likely that the prices of commodities such as oil and copper, already well off their peaks, will continue to fall. In the past, oil had its sharpest declines in years when global growth was slowest. Similarly, industries that require long-term investment--aircraft, semiconductors and cars--may find themselves squeezed by slower long-term growth.
Several things need to happen to get the economy off the slow-growth track. First, the private sector in the U.S. must concentrate on generating more productivity gains at home. In addition, U.S. companies need to focus on creating more innovative goods and services that can be produced in this country and shipped abroad. Finally, when the U.S. government undertakes fiscal stimulus measures, the money should be directed toward funding infrastructure, education and innovation rather than consume spending.
In the end, we may look back at fixing the banks as an easy task compared with changing the direction of national economies as we climb out of this long recessionary period.
Sources: BusinessWeek, October 27, 2008 and Conquer the Crash by Robert R. Prechter Jr.
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Non-self-liquidating credit is a loan that is not tied to production and tends to stay in the system. When financial institutions lend for consumer purchases such as expensive cars, boats or homes, or for speculations such as the purchase of stock certificates, no production effort is tied to the loan. Interest payments on such loans stress some other source of income. Such lending is almost always counter-productive; it adds costs to the economy, not value. The result is the subtle deterioration in the quality of spending choices due to the shift of buying power from people who have demonstrated a superior ability to invest or produce (creditors) to those who have demonstrated primarily as superior ability to consume (debtors). Near the end of a major expansion, few creditors expect default, which is why they lend freely to weak borrowers. Deflation involves a substantial amount of involuntary debt liquidation because almost no one expects deflation before it starts.