Use It or Lose It: Understanding the Global Financial Crisisby Keith Rankin, 22 September 2009
I have, in recent weeks, written a draft essay – Use It or Lose It – which uses a simple global model of creditor and debtor behaviour to explain not only the present global financial and economic crisis, but also the repeating nature of such crises.
I present a brief synopsis of my argument here, and invite constructive comment, both to this missive and to Use It or Lose It.
The basic idea is that a significant proportion of the world's households are habitual savers (which, in essence, means perpetual lenders), and an equally significant proportion of the world's households are chronic debtors (which means borrowers). To be a saver means a person sells more than s/he buys. To be a habitual saver, saving – selling more than buying – represents a long-term strategy. For salary earners, earnings are the market value of the services they sell to their employers. Thus many salaried professionals may be much like the proverbial Belgian dentist, pursuing a strategy of saving for its own sake, habitually selling more than they buy.
In a stable global economy, people who are savers for a while later become net spenders. At any point in time, a balanced economy is made up of four types of household: debtor-spenders, debtor-savers (ie persons reducing their indebtedness), creditor-savers, and creditor-spenders. For global economic stability, every household should pass through stages of both saving and spending. It means that as some people's debts rise, other people's debts fall, allowing systemic (ie collective) indebtedness to never exceed some threshold of danger. While saving can be a good thing, it should never become a habit, because the flip side of accumulated saving is accumulated debt.
Habitual savers and habitual borrowers are "joined at the hip". Each needs the other, much as a coin needs two sides. Their combined activities – in raising the debt-GDP ratio over time to critically dangerous levels – spell danger for the global financial system and the global economy.
My analysis places the burden of systemic blame for financial crises on habitual savers. Part of the reason for habitual saving is that income distribution has become so skewed, and wages so low relative to GDP per capita, that chronic economic decline can only be averted by rich habitual savers lending to the income challenged in circumstances where the loans are increasingly unlikely be repaid. Further, as repayment can only take the form of non spending by habitual spenders, then it also can only take the form of spending by habitual non spenders. (Note that "spenders" here means people who buy more than they sell; "non spenders" are people who sell more than they buy.) Thus, habitual savers resist attempts by spenders to repay their debts, because habitual savers are too busy saving. Habitual savers, to maintain their habit, must continue to lend, collectively, to those who are already in debt.
It is easy to understand this if we give habitual savers names – eg Japan, China – and also give habitual debtors names – eg New Zealand, United States. But this means we miss the entirety of the problem. Many households in New Zealand and the United States are habitual savers with huge accumulations of financial assets, and many households in China and Japan are in debt. Yes, indebted households (eg many New Zealand households) should save more (ie by becoming debtor savers), but this can only take place if the creditor households of the world (including New Zealand's creditor households) become creditor-spenders.
This is the rebalancing that is required to cure financial crises in an orderly manner, the use it option, but it will not happen. Households of habitual savers interpret the crisis as a call to extend rather than to cease their savings habit. This is exacerbated by governments such as that of New Zealand giving the message that all New Zealand households should save more; when in reality only indebted households should be selling more than they are buying.
In the absence of voluntary rebalancing, where habitual savers change their spots and start to sell less than they buy, then crisis rebalancing must take place. Crisis rebalancing means that the ratio of global financial assets (the stock of savings) to output (gross world product) must fall involuntarily.
Crisis rebalancing takes place either through inflation or large scale debtor default. The global crisis of 2007-2009 has been of the later type, and already the ratio of global financial assets to gross world product has probably come down sufficiently for us to conclude that this crisis is over.
For the next few years, habitual savers will rebuild their paper fortunes, and habitual debtors will borrow from them in order to buy the goods and services that the habitual savers offer for sale. Next time we may experience (and misinterpret) an inflationary rather than a debtor default rebalancing. Or we may experience both together.
Anti-inflation policies of raising interest rates only perpetuate and exacerbate creditor-debtor imbalances through: higher rates of compound interest; through banks' heightened preference for lending secured by real estate and shares vis-à-vis unsecured lending to entrepreneurs; through less rebalancing inflation (if indeed such policies do actually lower inflation); and through exchange rate shifts that favour expanded production by creditor countries and reduced production of traded goods and services by debtor countries.
The Great Depression of the 1930s remains by far our most spectacular case of global debtor default rebalancing. The present crisis, perhaps more on the scale of the 1907-09 crisis than on the 1930s' scale, has achieved nothing like the level of rebalancing that took place in the 1930s. Hence the next crisis will come quite soon, especially if massive income inequality is allowed to persist.
The global economy was largely cured of financial crises between the 1930s and the 1970s. The principal reason for this was the implementation of policies that allowed a reduction of income inequality. So long as incomes are relatively equal, it takes much longer for habitual savers (ie lenders) and habitual borrowers to raise the global debt-output ratio to crisis critical levels. Under conditions of relative equality, the rich and other committed savers do not have to lend to the relatively poor on a mass scale in order to enable the sales through which the collective rich accumulate the vast and unrealisable stocks of the financial assets (which are basically loans and inflated real estate) that we confuse for wealth.
The boom bust financial cycle is simply a feature of global capitalism in a world in which significant numbers of capitalists and salaried professionals prefer to lend much of their profits and salaries to the relatively poor, rather than to appropriately remunerate their workers and sub contractors, and rather than pay sufficient taxes that would facilitate a more equal (and stable) distribution of income.