The big country

Posted by – December 11, 2007

I have received feedback that my entry about the state of finance in the US was a bit inaccessible. I thought at the time that there’s a lot there to write about but that nobody would want to read it – but what the hell. It’s my blog, right? Don’t like it, go to Russia.

1) US financial sector profits as a percentage of total corporate profits in 1947: about 10%. In 2007: about 50%.

The financial sector is supposed to provide two things: distribution of opportunity and distribution of risk. Where there’s an opportunity for financial activity, capital is needed to exploit it. Banks distribute the opportunity to a number of people who have money to lend for the venture (ie. people who make deposits). Interest and dividends earned represent the fruit of this distributed opportunity. And because economic activity (and life) always involves risks of catastrophic failure, it’s sensible to have insurance companies to distribute the risk among risk-takers.

So the statistic I quoted says that these activities, essentially peripheral to creating actual value, generated 10% of all profit sixty years ago in America. To me that actually sounds like rather a lot. But due to the fractional reserve system and other clever tricks (I’ll write about that some other time), modern banking is essentially a money-making machine. So people who own the banks get a cut from lubricating the wheels of the economy, ok. But over 60 years their slice of the profit pie has quintupled. To me this represents an increasing artificiality that happens to any developed economy; properties become super-valued and huge numbers of people get rich by moving property around. The financial sector “leech” has become very much larger.

2) Debt intensity of US GDP growth in 1965-1975: under 2. In 2006: over 4.

This certainly could have used more explaining. What is debt intensity of GDP growth? It’s the ratio of increased debt to increased economic activity per year. This takes into account both public and private debt without reference to holders of the debt, so it’s a pretty rough number. Essentially, it answers the question “How many dollars does the US economy need to borrow to produce one dollar of value?” It is normal for this number to be over one (creating more debt than value), but it’s less normal that this number has more than doubled in 40 years.

Why has it doubled? Well, as economies become increasingly developed their markets become increasingly competitive and easy opportunities get exhausted, so new economic activity becomes more and more capital intensive. That explains a part of it. But an arguably larger and certainly more worrying part of it is that Americans as private citizens have been living beyond their means for a while now (this becomes really noticeable around 1984-1985, the time of my birth), the government has been living far beyond its means since Bush took over and everyone’s been caught up in an property bubble for the last five years or so. What is the property bubble? It’s what Alan Greenspan said would keep the economy going when the dotcom bubble was bursting. Keep interest rates low, encourage people to remortgage, buy or build new houses and spend spend spend. A ludicrous number of people decided that borrowing money to buy houses and watch their value go up was a reasonable way to make a living.

What does this mean? I think it means that a big chunk of the growth the US economy has experienced over the last five years is a fiction. I think the US is in for a shock when private consumption finally drops off (the cheap money party is over for the lower classes) and everyone’s stuck with falling property prices and mountains of debt. I think this ties in with the finance sector, that ever-growing leech at America’s neck. A lot of people have become fabulously rich by slicing, dicing and re-packaging bogus loans and a lot of people are going to feel the pain.

3) After-tax corporate profits as a percentage of GDP (in the US) just before GWB took office: about 5%. Now: about 10%.

This was the political commentary part. Quite simply I think it’s a good index of the way the Bush administration’s response to all this has been to ramp up the plundering. In an economy where genuine productivity becomes harder and harder to achieve and financial perils abound, the government squeezes the patient to pump blood into the leech. That, and spends about 5e12 dollars (and counting) dollars on warfare in Iraq. The great American public is being had, and we’re all going to be sorry.

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