The Real Cause: Current Account Deficit

Recently there has been a lot of finger pointing going around about who is to blame for the crisis. A lot of people point to the Wall Street banks, but this is ridiculous in so many ways. Suffice it to say they are the victims of this crisis just as much. Many in politics and the media cast blame on derivatives, but MBS and CDOs aren’t derivatives, and aside from AIG and the monolines no other firms have really gotten into trouble with CDSs.

Some say it was the bond rating agencies or the predatory lenders. While both - no doubt - are guilty of gross abuses, they are more a symptom than the actual problem. Then there are the people who claim it was Greenspan, and in a sense they are right. As far as individual people go, the blame resides more with Greenspan than anyone else, but ultimately the blame falls upon the American consumer and American society. While many in the mainstream media continue to state that our current financial straits are simply an extension of the subprime crisis, to say this is a subprime crisis misses the point. This is a debt crisis caused by an unsustainable amount of debt in the economy. Underlying this problem, however, is a massive $800 billion annual current account deficit.                                                                                   

Since the beginning of the 1980s, Americans have been consuming more than they have produced, resulting in a current account deficit. To fund this deficit, the American economy has been reliant on investment, both public and private. As a result, household debt levels have soared, the federal deficit has skyrocketed and banks have become overleveraged. The United States' GDP stood around $13.8 trillion in 2007, while our current account deficit was $800 billion. This means that we took out debt to finance roughly 5.8% of all our purchases. That year, the US national deficit ran at $162 billion. The remainder of the deficit was financed through the private sector. Quite naturally, a nation cannot just take out debt to the tune of 5.8% of GDP ad infinitum and not expect a crash to occur.

Source: Cleveland Fed

The US economy has been due for a correction for a long time. However, Greenspan’s monetary policies merely delayed the inevitable. Throughout Greenspan’s reign whenever the economy threatened to meet its fate, Greenspan merely lowered the rates and flooded the economy with debt. Cheap financing allowed consumers to continue spending money they didn’t have, until the amount of debt in the economy grew to an unsustainable level.

Additionally, a whole generation of bankers, now finding themselves in senior positions, grew up under Alan Greenspan and his lax monetary policy. Throughout their whole careers, they had known nothing aside from easy credit. Over the course of 20 years, this abnormal economic behavior began to be taken for granted. As a result, many of these bankers simply leveraged their firms to ridiculous and dangerous levels in pursuit of profit.

Reading the mainstream media’s accounts of the causes and nature of the current crisis has become an exercise of annoyance over the past few weeks. Right now, we are in the midst of an economic emergency of a massive scale that was clearly years in the making. There have been housing and financial crises in American since the Great Depression, but this crisis is an order of magnitude larger. Rather than searching for a convenient scapegoat to blame, why don’t we look in the mirror and face the truth: we have consumed too much for too long and now we are paying the price for it.

Disclosure: none

Comments

[Steven Hansen:]

surely the current account deficit adds to this crisis, but this is a tsunami which is too massively large to have been induced by the current account deficit.

more likely precipitator of this crisis was the commodity (spelled 'o i l') prices which caused the consumer distress which cascaded into the already bubbled and under stress housing and credit markets.

you cannot blame the consumer when they have a choice of products to purchase and they purchase the one with the best value. you can blame the country (spelled 'china') who refused to properly allow their currency to float to its natural value, and is now standing around pretending they are victims of american greed.

2008 Oct 28 06:13 AM

[Paul Fekula:]

Our trade inbalance with China, while large, is about $250 billion in 2007. We still imported another $550 billion more than we exported. Even if the Chinese were willing to allow their currency float to more realistic levels, we would still have a large trade deficit regardless.

I am contending that the amount of debt that we needed to pump into the economy over the past 28 or so years to keep it growing us ultimately the problem. America is plain and simply over-leveraged. How did it get there? Current accound deficit.

2008 Oct 28 07:08 AM

[Moon Kil Woong:]

Nice to point out fundamental problems. In order to cover up the effects of debt more and more leverage (debt) was allowed to build up. Banks that leveraged themselves 5x started leveraging themselves 20x with the help of brokerages who increased their leverage from 20x to 45x withthe help of insurance like policies with no collateral and no regulation. This allowed the party to go on and on. Now it's time to pay the piper except the ones we have to pay is China, Taiwan, Japan, Korea, etc. who aren't feeling too swell about demand dropping off a cliff now that America is broke.

Currently CDS contracts total 55 trillion. That's why no one will loan to anyone until this gets sorted. The SEC allowed everyone to suspend market to market allowing everyone to hide the liability. If the current account deficit is consumers debt driven binge than CDS and CDOs are the bank and brokerages version of it. The problem is, with the US net assets at $72 trillion dollars before September (about $8 trillion less now) who can afford to cover their exorbinances. No one. BTW gov+consumer+corporate US debt = a whopping total of $61 trillion.

Now we see the light or darnkness depending on how we look at it.

2008 Oct 28 08:16 AM

[cheapybob:]

You are on the mark. And we are completely DEPENDENT on the rest of the world to LEND us back the money we pay for goods, and if they get scared to LEND it back to us, the music stops....

Just imagine what happens when they realize those dollars are just like confetti.

2008 Oct 28 09:25 AM

[The Small T...:]

You are absolutely right.

Current policy makers are desperately trying to apply Greenspan's recipe, but is no longer working. They are winning weeks, months at most, but the unavoidable is going to happen.

Our fate is knocking insistently the door, but they prefer the next administration opens it.

2008 Oct 28 09:30 AM

[derryl:]

Paul,
Nice to see some clarity amidst the unrealistic flailing around looking for a way to restore the unsustainable level of consumption financed by ever increasing foreign debt. The truth that cannot be told--which you tell--is that Americans consumed more than they produced for a long time, and now they will have to produce and export more than they consume for an equally long time, to get out of debt. Unless America immediately finds some way to become massively more productive in some kinds of exportable goods or technologies and produce its way out of debt, this means a serious and quite lengthy decline in consumer standard of living.

The Hand is probably right that high oil prices triggered the collapse of the credit card economy. People on the financial edge with mortgage and credit card payments were pushed over it by the increased price of filling up their car to go to work. But as you explain, it is the credit card economy itself that created the vulnerability by insanely overleveraging practically all economic behavior.

Artificially cheap credit--Greenspan's contribution--misalloc... resources every bit as much as does malinformed government interventions. America put way too big a share of its economic activity into building and furnishing unaffordable houses for each other, and way too big a share of its financial activity into inflating stock prices way beyond what P/E would justify. Now, as domestic and foreign debt is paid down, all these prices are deflating back down to levels that people can actually afford based on their incomes, not their inflated asset values and credit scores. These misallocations made America economically and financially lopsided and now it's returning to balance.

People "felt" wealthy as prices of their houses and stocks kept rising. This motivated more debt-financed consumption. But all those prices were artificially inflated by cheap credit that inflated the money supply faster than the economy could produce and rationally allocate real wealth to spend all the money on. The real wealth is there--all those unaffordably large and luxurious houses have been built--but the "wrong" stuff was built if you base "rightness" on real people being able to really afford to command that much of their economy's output.

In reality, if America could actually support the amount of house construction that was done, 2 or 3 times as many houses should have been built, each one of them 1/2 or 1/3 as large and luxurious. This would have used the same amount of economic resources but the house prices would have been shared by 2-3 times as many buyers and this would have been "affordable" housing. $1000/mo mortgages for 3 million buyers of modest housing rather than $3000/month mortgages for 1 million buyers of an inflated version of the American Dream.

As debt is paid down and the money supply contracts, prices will come back down to earth and resources will begin again to be allocated to productive uses that Americans can actually afford to pay for with their incomes, savings and responsible use of credit. The transition back to reality almost certainly involves a deflationary "depression" as old luxury-fueled jobs are lost and new affordable-goods-fuele... jobs and export-driven industries are created and expanded.

US dependence on foreign oil is a huge vulnerability that can be ameliorated by accelerating the development of electric cars that are powered by America's abundant supply of coal, maybe supplemented by wind, solar, biofuels, tidal power and other emerging energy technologies. Clean coal technology, which converts coal into a liquid that burns as clean as natural gas, is commercially viable and ready for industrial scale use for electricity generation. Clean coal electricity is price competitive and won't need subsidies.

"Global warming" is a fraud. Recent years have seen global cooling. Global temperature varies directly with solar output, as should be obvious to anyone who knows that solar output varies. If you turn up the solar fire it gets hotter on Earth; turn it down it gets cooler. Duh. That's the real reason Earth's temperature varies. CO2 levels have no correlation at all with temperature changes.

The billions of dollars that have been spent over the past 15 years on "global warming" has produced a vast network of interest groups--"rent seekers"--who would lose all their funding if the public became aware that there is no global warming problem. So most of the "experts" whose jobs and status were created by the $billions of envirohype have a direct interest in keeping up the global warming hoax and suppressing the real scientific data which show that humans are not causing global warming and indeed the globe is no longer warming but is cooling.

So there is no reason America should not exploit its own reserves of coal (and oil and natural gas) to power its own electric cars and stop sending hundreds of billions of dollars annually to Saudi Arabia and Venezuela.

The world's transportation system is currently utterly dependent on oil. Gasoline, diesel and jet fuel are all made from oil. Without transportation our economy is dead in the water, shut down. The world may have reached "peak oil", so now is probably a good time to work on new technologies to reduce our extreme vulnerability to oil supplies. "Global warming" was the wrong reason to distrust oil. Peak oil is the real reason we need to invent the next kind of power. America has the entrepreneurial genius to make this work. Go for it!

2008 Oct 28 10:21 AM

[trikerguy:]

Paul and others,

I guess I'm just too old to hang in there with you young guys.

I remember when I bought my first house (and several later) that the real estate broker only showed me houses he had determined that I could afford. The "savings and loan" would only lend on 1 1/2 to 2 times income and I had to have 20 percent down. The appraiser gave a true valuation, no inflated value. I guess these " professionals" must have had my interests in mind not just opting to make a buck for themselves.

How times have changed! So (recently, has it changed yet?) these "professionals" had only their benefit in mind. Leveraged money flowed with the risk passed off. Ethics became an unknown concept. Ditto for the sellers of any consumer good that could be financed.

To blame the guy at the bottom of the food chain is simplistic.

2008 Oct 28 11:27 AM

[bbowen7:]

Thanks Paul. This is the last thing that the politicians want to say, because it is the last thing that the voters (us) want to hear. It is not true, however, that we need to overproduce and underconsume for an equal period to get back to square 1. We own the printing press. And that is the subject of the November 15 meeting of heads of state. Unfortunately, in the next few months we will be sending a rookie with a short stack.

2008 Oct 28 12:58 PM

[derryl:]

rightinsanfrancisco,
You're right about owning the printing presses. There will be enormous public pressure on politicians to soften the landing by any means possible, and the printing presses are the obvious temporary cushion. But if the resulting price inflation can't be phased out of the system over a realistic timeframe, we're just preparing the way for the "real" mother of all crashes.

2008 Oct 28 01:14 PM

[David Martin:]

Nice try to escape blame. You are telling us that the banking industry did not know that they were puffing income of mortgage recipients?
The bonus structure biased towards short term performance did not lead to a total disregard of the long term health of their companies?
That it is right that bankers should still be collecting huge bonuses courtesy of the taxpayer after wrecking the economy?
These guys are grifters playing a shell game, and should be in prison, after confiscation of their passports and assets.
Instead of which, of course, they are charging huge sums to 'manage' the loot that Paulson has brought home to them , in a bail out which cannot and will not work, as the housing market has much further to fall.
Nevermind, it gives more time to complete the gutting of their companies and shareholders.

2008 Oct 28 03:53 PM

[xander:]

another way of looking at the trade deficit is that the usa does not require those that sell to us to buy an equivalent amount from us. obviously some of our trading partners do not deserve to be called partners since they are practicing what amounts to a beggar thy neighbor policy towards the usa. tariffs that are adjustable to the trade balance with each exporter to the usa is one way to punish mercantilism and to reward fair traders.

2008 Oct 29 03:50 AM

[xander:]

re punishing mercantilists i would like to add that less trade even no trade is better than running 800 billion dollar a year trade deficits ; the end result of which is inevitable national bankruptcy.

2008 Oct 29 04:01 AM

[pixie817:]

You say that Greenspan delayed the inevitable, but the fact of the matter is that it was inevitable. It would have happened anyway. At least now we have the time it took to prepare and try to adjust to the current financial problem.

The mass media has been looking for a scapegoat, and they can find as many as they want to find. The only problem is that by doing so, we will never fix the problem. The problem is the quality of man’s egoism, and we need to use a solution to overcome it.

Michael Laitman has explained a method for this solution to work and it is found at www.laitman.com/2008/1.../ .

2008 Dec 17 02:05 PM