Last fall, when it became apparent that most of the giant U. S. financial companies had no "there" anywhere and the stock market was crashing, one of my daughters asked how this came to pass. I answered simply, "The rats got into the grain."
The "hollowing out" of America probably began with Nixon engaging China. As China's leaders saw the growth in South Korea and Japan stemming from their roles as suppliers of increasingly value-added products to the U. S. and its allies, they shifted their mindset and joined the team.
The original "good" rationale for outsourcing, as it picked up steam in the 1980s, was as follows.
Let us say that a company wholly owned by Americans has a product (widget) that it sells for $100. Labor costs are $50. If labor costs can be lowered to $10 by moving production to Asia, net of other costs let us say that an additional $40 of profit is realized by the (American) owners of the company. Some of that goes to society in taxes, and let us assume that the bulk of the rest is spent in the U. S. If the worker who loses the job to the Asian worker finds another job for the equivalent of $35, the total income to America has been enhanced by a net of $25 per widget-- the $40 extra the owner gains, minus the $15 loss of income the American worker loses.
Of course, if the displaced worker could find a job at the same income, so much the better.
As this trend picked up speed, the jobs that were the least able to be exported expanded. These included retail and construction. Medical treatment of course has to be generally local, and that expanded as well. (In the 1990s, building out the Internet and enhancing computer technology were included, but that was an era in time that may prove transient, because no geographic specificity is associated with high-tech skills.)
Not to forget finance, centered in New York and, almost the same thing in concept, London.
Thus, there were powerful pressures to over-expand the industries of building homes and retail outlets. Big Finance got bigger and more and more creative to keep what we may call thisrecent American "business model" going and growing.
One hundred years ago, the U. S. had an export-driven business model, accumulating both gold and immigrants who flocked here to prosper. In fact, it was not all that long ago that there were no limits on the number of immigrants the country would accept. Fifty years ago, the U. S. had an export-driven business model, picking up ownership stakes in foreign companies or establishing dominant business shares in foreign countries with the trade surplus.
All of a sudden, the U. S.'s business model was exporting future claims on American wealth to foreigners, but as pointed out above, this was a sensible business model so long as productive jobs could be had by the American workers who lost their jobs to foreigners who would do the same job for a lot less money. Now that the displaced workers have nothing to do, this business strategy does not work, so we are now into government-financed make-work programs.
What has happened is that America went to far in its business strategy. It overexpanded production of homes and retail space. It also spends a vast amount on medical care, much of it useful from an individual health perspective; however, treating cancer or blocked arteries in an 80-year old retiree does not pay for the import of a shirt from China or a banana from Central America.
America financed the over-production of domestic jobs that could not be outsourced via the mechanism of over-aggressive credit creation. One clever way that this was done, and that kept New York as the center of the world's financial industry, was the invention of ever-more complex financial products. Let us think CDOs squared and even cubed. Thus, employment in finance mushroomed as well.
Unfortunately, these new complex financial products were defective and have largely been recalled. They were like a car that blows up while sitting in the driveway.
The manufacturers of these products, let us call them Big Finance, gorged themselves producing, selling and indeed consuming those products. They were like a moonshiner who was himself an alcoholic. The more, the better.
It would be nice to think that we simply have the national equivalent of a Sunday morning hangover. The headache goes away, and you can go back to work Monday. If the hangover-sufferer were a stock and his stock price dropped that Sunday when his neighbors saw how horrible he looked, but he was not an alcoholic, then a smart bargain hunter would buy neighbor's temporarily depressed stock, the neighbor would show up for work week after week and earn a living, and the bargain hunter would likely have made a good choice. If, on the other hand, the hungover neighbor was really a deteriorating alcoholic, then buying his stock would be a mistake.
Big Finance is showing the symptoms of alcoholism. It will not even admit it has a drinking problem. It is puffing itself up. It is in denial of what happened to Fannie/Freddie/AIG/WaMu/Wachovia and innumerable lesser real estate and finance companies.
Over a year ago, I was talking at a party with the man who was about the 50% owner of a large, publicly traded homebuilder. The stock was down from a high of, say, 40 to about 3. He casually told me that they were likely headed for bankruptcy. I asked him why he and his colleagues in the industry had not cut back production given the obvious mania in the industry, and why he had not sold his company when the stock was high. His answer to the first question was the alcoholic's answer: they were homebuilders. If financing was available, they built. Period. Addicted. As far as the second question, he said that none of his competitors would buy them. Addicts know each other.
Tragically, what has happened in the past 9 months is that Big Finance has, rather than going into rehab, has gotten bigger. Now that so much of corporate, municipal and especially individual America has lost a great deal of borrowing power, the biggest and most credit-worthy borrower of them all has stepped up to the plate: the patron of all this, the U. S. Government itself, in whose service all this borrowing really was done. Thus, the use of Fannie/Freddie to keep the mortgages flowing and the expanded use of FHA; the unbelievable deficits in the name of "stimulus"; the massive expansion of the IMF.
Piling more and more credit upon a collapsing mountain of credit is the alcoholic's "hair of the dog" tactic. The only real beneficiaries of this maneuver are those who package and sell the credit, meaning Big Finance once again. Things are so crazy that much of the U. K.'s current deficit is being financed by explicit printing of money by the Bank of England (sic transit gloria mundi), and of course the same thing is happening here to a proportionally lesser extent. Because Big Finance also makes money from transferring ownership of all sorts of securities from one absentee owner to another (such as a share of a "C" corporation "listed" on an exchange, or the Euro vs. the dollar to a non-commercial enterprise), you can be sure that it will make sure that there will be lots of excitement, lots of trends to follow and go with until they do not work, etc., the only certainty being the profits that accrue to the middlemen handling the transactional work.
The word "credit" derives from the Latin term credere: to believe.
Until an alcoholic confesses his condition, nothing he says can be believed. Thus, suddenly, in the teeth of a Great economic Banana, with loans going bad at a rapid pace, suddenly the accountants at FASB have found a way to pump up "earnings" at BofA, which we are glad to learn has the computing power to report this accounting benefit timely for Q1. And we have HankTimothy PaulGeith TARPing and PPIPing all over the place with no coherent explanation for the obvious question: if the banks are really soundly capitalized, why do they need more than the entire cost of the Iraq and Afghan Wars in benefits in less than one year's time? And if they are not properly capitalized, does not the law REQUIRE that they be shut down?
The United States, in league with Big Finance, has promised tens of trillions of dollars in future payments to its citizens for medical and other care, and is promising more and more dollars in future payments to foreigners. The foreigners will not take payment in bypass surgeries for our population. They will take payment in bypass surgeries for their own people, though, but first they want two or even three meals a day, good roads, etc. Increasingly they will ignore our military dominance just as they are seeing through our alleged economic dominance. We will still have our amber waves of grain, but that does not justify Dow 8000 or any particular profitability of publicly-owned companies.
The G20 meeting in London confirms the obvious: there are too many dollars promising too many goodies to too many creditors. Until America as a unified whole becomes a credible borrower again (or even a net creditor), its currency will shrink in importance in the world, and the countries that adopted the flip side of America's business model and became creditors by producing goods for U. S. consumers will gradually sell to each other and will consume more and more of their own production.
There is nothing apocalyptic yet about what is going on in America, but there is simply not as much left of the harvest from years of production and consumption in this country as was thought, and there is too much of the alcoholic's denial with regard to the Debt Addiction; thus one of those who saw this coming, Nouriel Roubini, is essentially all in cash except for his equity in his own business and his academic position.
In other words, the financial markets are especially unfriendly and unpredictable at this time.
Copyright (C) Long Lake LLC 2009
