The inconvenient truth about American consumption

“The western world has embarked on a speculative journey for which all the historical precedents are ominous.” —Peter Warburton
Although many are now having to acknowledge the worldwide impact of the sub-prime crisis, some are still singing optimistic tones that demand from China and India can buoy the world economy and keep growth humming along without solvent US consumers. But an inconvenient truth screams back at this hopeful sentiment.
Over the past year, American consumers spent close to $9.5 trillion, compared with the meagerly $1 trillion spent by Chinese consumers and the downright paltry $650 billion spent by Indians. Indisputably, US consumers have been the superstars of world consumption. They have gorged on more stuff than one could ever imagine and in doing so have accounted for a record 72% of US Gross Domestic Product. But their earnings growth has not kept pace with their habits. Consumption has been paid for by soaring debt levered off of raging asset bubbles and and enabled by insane “innovative” credit derivative products now estimated outstanding at some $50 trillion. Over the past 5 years some $1.1 trillion of equity has been extracted from American homes, which represents almost half of the increase in total consumer spending over the same time period. Household debt at the end of Q2 2007 stood at over $10 trillion versus $4 trillion in 1999, an increase of more than 136% in 8 years!
Now as the horses have long left the barn, yesterday the US Federal Reserve proposed new rules for sub-prime mortgages, including a ban on low- documentation loans and limits on penalties for borrowers who prepay their debts.
And the brilliant underwriters of this disastrous economic history the broker/dealer/bankers, are all now admitting that their miraculous funny money was not actually real currency but ethereal counterfeit that must now be written down as the trash that it always was. In an acknowledgment of the most-difficult period in Bear Stearns Cos.' 84-year history, Chief Executive Officer James Cayne and other senior executives are expected to forgo bonuses for this year, people familiar with their plans say.
The expectation comes as Bear prepares to announce tomorrow its first quarterly loss ever, an outcome certain to curb pay for the firm's 15,500 employees. This is a turnabout for Bear, which over the years has used its generous, merit-driven compensation system to recruit job candidates it calls PSDs: those who are poor, smart, and have a deep desire to be rich.
Apparently when you are poor, smart and have a deep desire to be rich you will jump zealously for all manner of destructive behaviours. Poverty is after all the main reason the Chinese and other developing nations say they must produce mass goods for sale at all cost to the environment and individual human dignity. They are trying to become us in the western world, how can we ask them to do any less? Such is the tangled web we have woven in our insatiable desire for material, apparent wealth above all else.
How will this clear itself? We need a broad economic contraction that corrects for the reckless excesses of this period, and sees bubble prices written down across the world. Consumption must slow for a time, as we work to pay down debt. We will also likely need waves of bankruptcy or forgiveness where companies, individuals and some countries default on outstanding debt. In this way we can hope to start over, begin afresh, and design wiser policies ahead.