Friday, 15 May 2009

Was consumer credit too cheap or incorrectly priced?

There is a thought provoking article entitled Consumption Junction: 2 Thoughts on the Declining Savings Rate which addresses the very topical matter of consequences to the robustness of recovery given the increasing propensity of US consumers to save rather than consume 100% (102%) of their income in the current economic environment. The article is refreshing in that it goes beyond a lot of the usual cliches that are trotted out by many commentators when considering the "materialism" of US culture.

The author considers how the cost of "things" has actually been far less relevant to the current crisis being faced by middle-class Americans than the cost of "quality of life" issues such as the neighborhood that one inhabits in order to to qualify for good schooling for one's children and the cost of health care, both of which in historical terms have risen far more dramatically in comparison to (say) the cost of dishwashers, PC's and food.

For many middle class Americans (and residents of other G7 economies) the real trap has been the need to maintain the income required to support their aspirations for these "quality of life" issues and the fact that they allowed their savings rate to decline to zero based upon a mis-perception of their susceptibility to loss of income from unemployment or their false sense of security and the asset side of their personal balance sheets from unrealistic assumptions about the value of their real estate.

The availability of "cheap" credit, with very relaxed standards of qualification, enabled many to stretch their lifestyles to afford what they considered the norms required for the education of their children and adequate health care. The "trap" that was laid for a culture of aspiration - the over-use of easy credit to pay for these aspirational "goods" - was the engine that enabled the financial services industry to expand as rapidly as it did during the last 20 years so that the sector became equal to about 40% of total national income in the US (and similar levels in the UK).

The author of the article draws attention to the fact that the over-use of easy credit has led to a situation where the US with only 4% of the world's population is consuming about 25% of the world's resources and this has been largely motivated - in my opinion - by the dynamics of the aspirational mindset which was facilitated by easy credit.
When the author says that we should be
....concerned about how wasteful we are with our gasoline consumption and meat production (neither priced anywhere near their externality cost)."
it is hard to disagree that the true economic cost has been massively under-estimated because of the failure of traditional costing analysis to incorporate the external costs to the planet Earth from reliance on fossil fuels etc.

But the essential point that I would maintain is that the principal reason why the US, and many other economies, are now faced with such a grim financial position is that the "external" costs of credit were also massively under-estimated.

The trillions of dollars which have been required from the public sector balance sheet to under-write the integrity of the banking/credit system are just part of these external costs. The not so readily quantifiable costs of human misery, bankruptcies and loss of homes, break-up of families and childhood suffering are far more substantial.

As a culture of aspiration we deluded ourselves into thinking that credit was cheap. Especially in the arithmetic that underpinned mortgage related securitization we got it colossally wrong.

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