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.
David,
This is a great post and a great analogy. It is, of course, a little simplified (much of the financing–at least of risk assets, of course, is held on the “importers” side of your diagram, resulting in significant pain of its own. Additionally, there was a build up of excess capacity (much of it service-based) on the “importers” side. But those examples notwithstanding, your analogy provokes some deep thought. For instance, the exporters, while financing their industrial capacity, a al, Cisco in the tech bubble, substantially only did that through purchases of treasuries and other sovereign-linked debt. As you noted, the way forward for the Cisco’s involved significant writedowns of those receivables. Although, there have been certain foreign currency effects to date and losses on the small amount of risk assets those exporters took back (think losses on equity investments made by SWF’s), overall their writedowns have not been nearly enough to move the situation forward. And with China, for example, back to its peg and now chafing over newly identified risk in its receivables, one would think that we are a long way away from resolution. Thanks very much.
Dear David,
I am happy to see that a few people actually figure out that balance of trade is the entire problem in the global financial collapse. But there is a lot more than that at work! If we break things down further, we discover the only nation on earth with trade deficits with everyone is the US. The country with the biggest trade deficits has been the US.
The next item is Japan: why is it on the list of third world and commodity export nations? China was third world and is only very recently risen to second world and now, just entering first world status. Japan, on the other hand, has been first world status for a very long time!
I would like to point out, the G7 nations which includes Japan, never bothered to stop Japan’s barriers to trade and the deliberate weakening of the yen. Now, the yen has risen in value to the great fury of Japanese industrialist exporters.
Elaine Supkis, EMS News
Excellent insight and synopsis! Many of the unsustainable imbalances must now be corrected. Have you done any analysis you’re willing to share which quantifies the magnitudes of some of the necessary corrections? (I realize overshoot is also a possibility.) I see that you did not shy away from the D-word… which suggests that you’re considering a > 10% real GDP decline in key nations to be a likely occurrence.
It would seem that too much of world “trade” has been built around the exchange of “stuff” (goods) for promises (debt/credit). Both parties to many trades should have been more skeptical of both the promises and the long-term real utility value of the “stuff”.
P.S. Also eagerly waiting to hear what happens to John Davidson in the next installment!
Mr. Merkel:
I’m looking at your lists and I am under the impression that, in addition to the industrial/productive overcapacity, many of your exporters also have banking systems under stress.