Leverage Begets Leverage, and Vice-versa

There are two groups of nations in the world.  There are those with bad banking systems and too much financial leverage, and there are those with too much industrial/commodity capacity.  These two groups, which comprise most of the world economy, are symbiotic.  The nations that developed their industrial/commodity capacity did not want to import goods from their clients; they were forcing savings on their nations.

So they accepted assets, mainly bonds, of the nations that bought from them.  This stimulated the borrowing economies as interest rates fell, and there was a speculative boom.  Financial companies expanded, making loans they should not make.  Investors pushed up the prices of energy, basic materials, industrial and financial stocks.

It was a thing of beauty.  It was a house of cards.  We can view it as a buildup of operating leverage in one group of exporting nations, and a buildup of financial leverage in the importing nations.

Now, on the other side of the bubble, we have collapsing financial leverage among the importers, leading to a fall in demand for the exporters.  Thus the crisis is global.

For an analogy, think of the tech bubble.  Some companies financed other companies that bought their gear.  They continued to do so, booking sales, while not receiving any real cash.  Then when the companies buying the gear could not pay, both buyers and sellers suffered, and stock values plummeted.

These lists are stylized, but reflect my view of the world:

Importers

  • United States
  • United Kingdom
  • Eurozone

Exporters

  • China
  • India
  • OPEC
  • Brazil
  • Russia
  • Canada
  • Australia
  • Japan
  • Other Asian Tigers

Really, it would be better to break the world down by industry, but there is enough correlation within nations that this characterization works, with a little hand-waving.

This is what makes this depression so tough.  The importers have to eliminate bad debts, while the exporters have to eliminate excess productive capacity.  As with Japan in the late 80s, they overinvested in things that the world would not need in the 90s.  So it is now, and every policy choice is painful.  Making the situation worse is that the crisis is global, but it is the payoff for the exporter nations behaving as neo-mercanilists.  Remember, the mercanilists, the exporters, were the ones that lost originally.