Sunday, February 26, 2006

out of my depth in economic waters, yet again

We all know that the assets of American homeowners have grown substantially as housing prices have escalated over the past few years. Now a report from the Federal Reserve -- Recent Changes in U.S. Family Finances (pdf) -- shows that their increased assets haven't generated much increase in net worth: put simplistically, these folks haven't held on to their gains.

As this little chart shows, the Fed's survey of consumer finances shows a tiny increase in net worth during the most recent period compared with substantial ones in the prior two.

You can see the impact of homeowners' failure to hold on to their gains in the Fed's comparison of debt held the third quarter of 2001 and the same period in 2004: it shows a 26 percent increase inflation-adjusted aggregate household debt. That's a huge increase.

Unfortunately, as the report points out, there are limits on how much many Americans are able to enjoy the benefits of increasing house prices. This is because wages declined 6.2 percent during the same period and, as the report says, "wages represent the largest share of family income."

It can't be a surprise that, as the first of these tables shows, Americans' mortgage debt has been growing and growing (in this case shown as a proportion of all debt). What seems more significant to me is the increase in debt as a percentage of total assets as shown in the second table.

Nor can it surprise that a larger number of Americans than previously have put themselves dangerously in debt. The report measures this by caclulating the proportion of debtors with payments exceeding 40 percent of their income. (It's now 12.2 percent of American families).

Nor, again, is there a surprise in the finding that the proportion of debtors who were sixty or more days late with their payments increased 1.9 percentage points over the previous period.

These numbers show a huge amount of risk. Does this mean that Americans have a huge amount of confidence that things will work out in the long run? Or does it mean they don't know the meaning of restraint? Or, maybe some of each plus a feeling among many that they don't have much choice but to borrow against the future.

All this brings to mind the situation in which families find themselves within the world's fastest growing economy.

Their situation in that place -- China -- is pretty much the opposite of Americans'. According to a recent IMF report, "by some measures, Chinese households have in recent years saved almost a third of their disposable income." The report says "one would expect a lower saving rate in an economy that still has a relatively low per capita income and, more importantly, good prospects for continued high income growth" and it gives the following reasons for this high figure: (1) Savings for retirement. China lacks an adequate pension system and is experiencing sharply rising costs of health care. (2) An aging population. The Chinese birth rate is low (because of the country's one-child policy, instituted in the 1970s). (3) Savings for education. (4) Lack of investment opportunities. (5) Absence of ready credit (no credit cards) so people have to save in order to purchase big-ticket items like houses and cars.

What does this list of five reasons say about the situation in America? (1) Not worried about retirement, despite unhealthy Social Security and Medicare projections; (2) Aging all the same, and, as in China, as consequence of a low birth rate (though for different reasons); (3) Having publically-funded schooling through 12th-grade and a system of higher education (including tax breaks, low-interest loans, and the like) which does not do much to encourage saving); (4) Enjoying about as many avenues for investing as anyone could want, but, of course, have been investing primarily in their own houses (a tax-advantaged investment since mortgage interest and points are deductable); (5) Blessed (?) with an over-abundance of ready credit.

The IMF, and I think most economists, say that the Chinese need to consume more and Americans to save more. It sounds so easy. But it's not. The Chinese government has an enormous problem restructuring the economy, reforming the banking structure, and disciplining the Party (particularly corrupt local functionaries). The US goverment has no less a challenge. How does an elected (and pretty much representative) government effect policies that restrain rapacious consumption -- bring expectations down to a more realistic level (for retirement for example), and protect people against bad things happening?

And how does the global economy wean itself from its current extreme level of dependence on American consumers to keep it afloat?

If I only knew ...


Here's a citation for the IMF report:
Rebalancing Economic Growth in China
A Commentary
by Steven Dunaway, Deputy Director, Asia and Pacific Department
and Eswar Prasad, Division Chief, Research Department
International Monetary Fund
January 11, 2006


And an addendum: It's interesting that English entrepreneurs did not have access to loans or investment capital during the early stages of the industrial revolution. Instead, they took little out of their business for themselves and used their profits to expand their operations, purchase equipment, and the like; when they obtained money from others, the most likely sources were family and friends. The Chinese are acting in this way at least to some extent.

On the other hand, American entrepreneurs have been and continue to be heavily dependent on investment capital. Since so many Americans are spending rather than investing, much of this new investment now comes from foreigners.

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