As has been discussed over the past months, the economic imbalances around the world have grown beyond normal measures for some years now. Trade imbalances, government debt, consumer spending have all been beyond expectations in the US and other mature economies. With the tremors of collapse touching many since the cracks in US housing started to show in July have focused the attention of analysts who are increasingly focused on the scale of the mountain of credit that has accumulated over the past 5 – 10 years. Last month’s commentary characterised the pyramid-scheme type of credit accumulation that has been allowed by financial derivatives: dicing and splicing of financial assets to create derivatives more and more removed from the reality of the underlying instruments. Analysts have increasingly focused on the dysfunction that occurred in the sub-prime lending niche as rating agencies, investment banks, asset managers, lenders, mortgage brokers and other fiduciaries became caught up in the game of singing the same tune: “doesn’t the emperor have lovely new clothes”. And this deluded song had been taken up by all of us from regulators to consumers.
Historically one could expect that the multiple of credit to cash (which together underlie money for the economy) might be of the order of 10:1. But this has grown, perhaps by a factor of 10, as credit builds upon credit to build an economy based on leverage. We have bought a wonderful life, but have not recognised the mortgage secured on our future.
The challenge is to deflate this balloon of credit in an orderly manner. And this is made difficult by the need to change human behaviour, to change our expectations. It will be impossible for developed economies to continue the illusion because the natural resource constraints are bringing the reality of debt from “the future” to today. There is no doubt that the currently used measures of economic growth, focussed on GDP, can only show a flat or negative trajectory while the global financial system deleverages. This requires that regulators, governments and business must either adjust to alternative methods of economic measurement, which are increasingly advocated, or suffer the pain of depression era economies.
It is not certain how long the illusion will remain. We all want to retain it, especially since our cultures and measures of progress are slaves to the notion that more consumption is desired, ad infinitum. But I do not expect it to hold for long because the imbalances have reached the ends of the earth. Our economic systems have become contained by our natural world, both by physical resource interconnectedness and virtual communications. We must learn to live together or the pain of adjustment will be gruesome.
The best advice for taking a step in the right direction is to not be afraid of letting go of the illusion. Enlightened individuals and leaders have already started to do so. Make an effort to recognise that you have enough and focus your energy on building relationships with family and friends, not business.