Sunday, March 20, 2005

'false wealth' and where it's leading us (maybe)

Let me say upfront that what I'm writing about here is a genuine confusion of mine, not a rhetorical pretense. (Not, as you all know, that I ever indulge in the latter.) If anyone can help me understand what this is about, I welcome the instruction.

If you succeed in parsing this little essay to the end, you'll see that I've found an interesting connection between credit card debt and the defeat of Democratic candidates in the last election. It's about at least one good reason for debtors to vote Republican.

This doesn't start out to be about politics, however. I just wonder, with the huge federal deficit and plummet of value of the dollar, why hasn't the American economy collapsed? Its continuing strength is a mystification.

The newspapers say this strength is based not on manufacturing innovations but on the propensity of Americans to continually increase their indebtedness in order to buy consumer goods. Thus my Vanguard weekly email message tells me consumer debt 'skyrocketed' in January: "The Fed reported that $11.5 billion was added to total credit outstanding during the month, the largest increase since October 2004 and nearly twice the amount expected." So, maybe you could say the economy is being driven by the famous U.S. consumerism.

As we all know, lots of the consumer goods that Americans buy are produced outside the U.S. I recently started receiving press releases from the Bureau of Economic Analysis which tells me that in 2004 gap between imports and exports of consumer goods increased 25% over the previous year.

When Americans buy more from abroad than they sell, the difference is made up in the transfer of U.S. dollars to foreigners (of course) and this is, I expect, the main reason for the big decline in the value of the dollar relative to the Euro and other currencies.

Foreign holders of dollars don't just sit on them -- although some Asian central banks do have huge dollar reserves (mostly China and Japan).

Because of the (mystifying) strength of the U.S. economy, they tend to spend the dollars to buy U.S. assets such as corporate stocks and bonds. Overall, the BEA says, "net financial inflows for foreign direct investment in the United States were $115.5 billion in 2004, up from $39.9 billion in 2003;" that's an astounding increase.

So, is it reasonable to say that the economy is being sustained by foreign investment? I think it might be so.

There's an uncomfortable "what if" that's obviously worrying Alan Greenspan these days: What if foreigners start thinking that investments in the U.S. are becoming too risky; what if they begin to think that economic growth based on consumer indebtedness can't last much longer. The federal deficit, the decline in the value of the dollar, and, I imagine, other factors, are likely to drive up interest rates, The passage of the new bankruptcy legislation is likely to increase that upward pressure I would guess. Increased interest rates have to decrease consumer purchases. The house of cards could begin to fall.

As many have pointed out, since the U.S. is now so heavily dependent on purchase of assets by foreigners, any decline in their expectations regarding the strength of the U.S. economy could, by itself, bring the economy down. What helps sustain us, I think, is the understanding they have that they don't have a whole lot of choice. They are so heavily invested in the U.S. economy that they can't afford to jeopardize it. I think that's what Greenspan (and the whole Bush administration) are counting on: that foreign holders of U.S. assets will cooperate with the U.S. to prevent an economic collapse. We can all hope they will continue to cooperate and that their cooperation will be effective, right?

Having said all that, here's the connection between credit card debt and the last election. It's a comment on a post that appeared in the Crooked Timber weblog. I reproduce the comment first and then the blog item. Note the idea of 'false wealth' that the author speaks about. It seems to me to be directly related to consumerism and consumer debt.

See if you can make the same connection I did between foreign investment in the U.S. and American credit card indebtedness: 'false wealth' -> credit card indebtedness -> fragile engine of the world economy -> uncertain foreign confidence in this engine.

Doesn't this give a clue to the enormous power of ideas -- so much more influential than facts, events, or hard, cold reality? It's the idea of individual 'wealth' -- a false idea -- that seems to drive the U.S. economy. And it's foreigners' (unreliable) willingness to accept this myth that -- to a large extent -- keeps it going.


It is interesting that the rise in consumer debt isn’t often linked, as it should be, in my opinion, to the stagnation of wages. I really think that the Repubs are eventually cutting their own throats this way — the only way to maintain a system that distributes wealth mainly to the already wealthy while stalling wealth creation - in the form of real wage increases to the producers — is to create a sphere of 'false' wealth. This is the political brilliance of the American credit sector. It is no coincidence that the extension of credit (at higher interest) to the lower and lower middle class has coincided with crushing the higher wage demands of that same class. Without credit cards and the embrace by the market of the two-earner household, the lower and middle class household would never have scraped by in the eighties and nineties. But they did, and they have exploited their sense of (false) wealth to vote for the party that will guarantee them tax cuts — the Repubs. This makes a certain economic sense — in the short term, at least, any money coming in counts. And, of course, living on false wealth is living in the short term permanently.

The best strategy for the Repubs will be to cast this as a moral question — those nasty households out there ‘stealing’ from nice credit card companies. I see no reason that they won’t be successful at this — the media will go for that story, and will wink at or simply sleep through such real rip offs as the World Comm bankruptcy.

Posted by roger · March 8, 2005 04:59 PM


Here's the Crooked Timber post

March 08, 2005
The chains of debt
Posted by John Quiggin

I’ve been sitting on this great post about reforms to US bankruptcy laws and how they fit into the general pattern of risk being shifted from business to workers and to ordinary people in general. But I waited too long and Paul Krugman’s already written it. So go and read his piece, and then, if you want, you can look at the things I was going to write that Krugman hasn’t said already.

First, if you’re looking for reading on this general topic, let me recommend "When All Else Fails : Government as the Ultimate Risk Manager," (David A. Moss), which I reviewed here. Moss shows how both bankruptcy and limited liability were (correctly) viewed as significant departures from laissez-faire when they were introduced in the 19th century. Of course, there’s no hint that the sacred status of limited liability is going to be challenged any time soon.

Second, given the rising trend in bankruptcy, this is going to affect a lot of people, quite possibly most people, at some time. Currently, more people go bankrupt than get divorced every year and, although the number has declined marginally with the economic recovery, the underlying trend is clearly upward. The proposed reforms are unlikely to change this. Although the bill will make bankruptcy a less attractive option for people who are already in difficulty, this demand side effect will be more than offset by the increased willingness of credit card companies and other lenders to lend to people with precarious repayment capacity.

Finally, while Krugman is probably right in describing the target of the reformers as a system of debt peonage, my long exposure to Dickens (and more recently to Patrick O’Brien) leads me to think that the large and powerful incarceration lobby might get in on the act here - anyone for debtors’ prison?

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