The credit crisis – I need to vent…

Once again, unbridled greed has precipitated an economic crisis. At least in my memory, first was the savings and loan melt down followed by the dot com bomb, and now this one. All of them had something to do with a few people who were getting incredibly rich for being in the right place (pre-IPO option allocation anyone?) followed by everyman getting the shaft.

The top dogs at large companies make big bucks. But it’s always a little jolting to see just how big those bucks are relative to the paycheck of everyman. In 2006, the average CEO of a company with at least $1 billion in annual revenue made $10,982,000, or 262 times what the average worker made, according to an analysis by the Economic Policy Institute (EPI). And while companies are melting down – laying off workers while the stock price heads towards zero, retention bonuses and termination payments are still huge.

While the top dogs are making their millions, most American workers have not shared in the growth and prosperity they have been helping to create. One measure of the success of an economic growth period is how much of that growth finds its way into workers’ paychecks. In a period of sharply rising inequality, many workers’ wages have been stagnant for a number of years, after adjusting for inflation, particularly those at the middle and lower end of the pay scale. For example, while productivity is up nearly 20% since 2000, the real median hourly wage is up 3% overall and 1% for men, with none of this growth occurring over the three-and-a-half years since 2003. At the top of the wage scale—at the 95th percentile—real wages are up 9% and at the top .1%, the rate is even higher. One reason for this is that CEO compensation is chosen by their peers in a system that gives CEOs and their hand-picked boards of directors, rather than the market, control over top incomes.

But let’s get back to the crisis. What happened? Everyman became convinced that they were entitled to the same good life that the top earners had even if they couldn’t afford it. Cheap oil and goods flowing from outside of the United States along with even cheaper money allowed everyman to buy anything and everything that they had to have, even if they didn’t have the money to pay for it. Rampant borrowing and consumerism gave the impression that all was well with the world and our standard of living was increasing. But if you read the previous paragraph, you will note that workers’ wages were stagnant. Workers were giving themselves raises through the magic of cheap credit. The increase in prosperity was an illusion funded by credit cards and houses that acted like ATMs.

In the USA, 71% of our GDP is due to consumer spending, while another 21% comes from financial services. In China, over 40% of their GDP is from manufacturing. That’s right, China’s GDP comes from making things, while the US’ GDP comes from moving money around in circles and buying things. I am at a loss to explain how a country can prosper if it is based on pushing around money and shopping.

According to CAPTAIN CAPITALISM, consumer debt was 98% of GDP in 2007. In other words, we are no longer a capitalist country, but a debtist country. For years we have been borrowing back the same money that we are spending as the countries supplying the goods to feed our appetites invested their profits in US assets. 

So it seems to me that we need to get back to basics and stop a) buying a lot of stuff we probably don’t need (who really needs $300 jeans that come pre-damaged?), b) start making things to sell rather than making money by pushing other people’s money around, and c) pay off what we already owe.

I am so lucky to be married to a Chinese woman. She converted me from an instant-gratification credit card junkie to someone who won’t make a purchase if I can’t pay for it – even a new car. She is still working on the savings part of the program. I have some savings, but I still like shopping.

But for the rest of our nation of shoppers, we have a conundrum. Stop spending and pay off debt and the US economy tanks even further. But maybe we need some strong medicine to reboot ourselves for the future. What do you think?

Ron LaPedis, MBCP, MBCI, CISSP-ISSAP, ISSMP
Principal
Seacliff Partners International, LLC

1 Comment to “The credit crisis – I need to vent…”

  • MM says:

    I agree with you that this country is running on a growth model that is way too leveraged. No other country in the world relies their economic growth on spending money and moving around money as much as America does.

    You also brought up a very interesting thought when you compare US to China. True that we need to build a more sustainable growth. One possible way to do that is by actually making things, like what China is doing.

    However, I think China’s economy is at a different stage from the US. As China starts to open up to the world, China’s economy is rapidly expanding. Like most countries who are facing this \first-phase-of-growth-bubble\, they are fueling their economic growth through increased manufacturing / production activity.

    The US however, has a different economy model. Like other developed countries, the US economy has shifted from manufacturing to focus more on the services business. I think this is really what triggered the US leveraged economy model. For example, there are fewer and fewer American manufcature workers– we see more Americans working in services business, i.e. more Americans who work as Wall Street bankers who package and repackage MBS, vs Americans working at a Ford factory making cars. And these guys end up wrecking the economy with their fancy financial services products.

    With that said though, as developing countries evolve to adopt more services-oriented economy, I hope they will learn from the America example and not copy the American model. At the same time, America needs to start building a stronger foundation to sustain growth. Being innovative is key. But, we need to be careful not to build unsustainable innovation. I think it’s great to have innovative financial products – that is paired up with healthy regulation, or promote the creation of innovative products in a new business that helps make this world a better place like green cars.

    Bottom line: We need to run on a sustained model – and I think that what we’re going through now is actually a necessary evil, a learning process that will hopefully lead us to emerge stronger and better both as an economy and as a country.

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