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The PIC - Connections
As long as the flow of money around the circle kept going, everything went alone well. The American population was not growing out of control and a manageable level of growth was maintained. The problem was that the economic wealth generated by the 300 million Americans needed to support the 300 million and billions of foreign people who have an increasing dependence on that economic wealth.
In conjunction with the global slowdown of economic activity that laid off about 2 million American workers in 2007-2008, there has been the layoff of 20 million Chinese workers who depended on exports to world markets, primarily the USA. Those Chinese, along with millions more Indians, Japanese, and SE Asians were living of the borrowed wealth of Americans. These areas built their economies as exporters to America. With China alone the US had a trade deficit in the hundreds of billions of dollars per year.
During the peak oil prices of $140 per barrel the US was sending $700 billion annually out of the country to OPEC countries and the others that are our energy suppliers. While we were feeding our addictions to oil and consumer electronics, they were becoming addicted to our dollars. Their workers were able to make formerly unimaginable incomes and enter the consumer marketplace. Their governments were able to fund their activities and progress on the transferred wealth from America.
One of the uses that the trade surpluses (surplus from their POV, deficits from ours) were put to was lent it to Americans so they could continue to buy the exports. This foreign wealth (formerly domestic wealth) fueled the US ability to borrow larger and larger principles to maintain the US buying habits. We did not have to increase taxes so much when foreign sources would buy our bonds and ultimately our mortgage debt making payment of the interest the only necessary expense.
US buying habits benefited the exporting nations and allowed them to industrialize their formerly agricultural economies. Similarly the OPEC nations built urban populations where only desert formerly existed. When the mortgage crises tipped the balance and the economic slowdown ensued, the massive export engines of China, Japan and SE Asia began to fail in collateral fashion. When the price of oil dropped from over $140 per barrel to under $40 per barrel, a lot of economic development in the supply nations ceased. Nations that were becoming rich on world oil demand, were converted into debtors who are trying to pay off their debts.
These debts were incurred to foster and facilitate the development of their economies. They are now faced with defaulting on those loans because the US is no longer buying as much of their exports at such high prices.
They, too, entered the game of borrowing against future earnings with the expectation that the game would forever stay in play. They assumed that price inflation would continue unabated indefinitely. Indeed, there are economic experts who proclaim that deflation was a natural impossibility. It could be created by fiscal policy, but it would not just happen. All parts of the world engaged in the giant pyramid marketing scheme that the Principle of Imminent Collapse knows must fail.
The lending and borrowing that took place in the US and around the world pumped up employment for people who otherwise would never have a regular job. People who formerly lived in villages and hamlets could move to where factories painted wooden toys with lead-based paint. They could assemble cell-phones and personal entertainment media file players. Every sort of truly non-essential device was manufactured and sold to an eager public who could not afford all that they buy. While the game was in play, they too benefited.
But all games have a time limit. It is just that we don't always know when the final whistle will be blown or by whom.
The game is Pyramid Builder. It goes like this. Capital is made available for the most worthy of projects by the most qualified of borrowers. It could be to buy inventory to resell. It could be operating funds to send boats out to sea to haul in a catch of Cod or Tuna. It may be to buy land and build a strip mall or business park. It may be for a home mortgage. Whatever the purpose is, it is most worthy. Only a few people and businesses qualify.
The lender sees the benefits of lending the money and generating a rate of return as income. More borrowers are needed. Additional idle capital and the funds from existing loans form the basis of the second tier of principle that is lend to the second tier of borrowers. These borrowers are highly qualified, have solid collateral and a high reliability of being able to repay the principle and interest. More idle capital is funneled into the lending machine along with the earnings from the first and second tier borrowers. A third tier is created.
A fourth tier comes about. And a fifth. Each time the new tier is created in must be bigger than the last because more and more idle capital is being attracted into the mill in order to generate the easy money that comes from the charging of interest on outstanding balances. Each time a new tier is created it is less worthy and less qualified because if they were better, they would have been at an upper tier. This is not to say that new highly qualified and worthy projects and borrowers do not arise and replace someone in a higher and smaller tier.
In order to facilitate everyone who wishes to put their capital to work in lending to someone, the demand for credit must be aggressively marketed. The real method for a credit card provider to make the billions of dollars that they do is to finally get the card holder to spend more than he can pay by the end of the month. In this way they begin to earn income at very high rates of 9.99% to 24.99% annually.
Mortgage borrowers buy a house and finance the purchase price less any down payments. After five years, most home owners owe more to their mortgage holder than they paid for the house or condo. This occurs because of the refinancing and folding in unpaid consumer credit balances and cash out to buy that boat, add that bathroom, shingle that roof, and a whole host of other possibilities.
Each tier of borrowers is bigger in numbers, less capable of repaying, and closer to the tripping point where they will fall significantly behind on the cause of some otherwise insignificant factor. Factors such as the tripling of the price of gasoline cause both a direct impact on the household budget as well as an indirect one in the price of food, clothing and other regularly purchased items.
Mathematically, the pyramid is an unsustainable financial structure. Even with a power of 2 exponent, the growth of the participating population quickly overtakes the available participants. The numbers grow thusly, 1-2-4-8-16-32-64-128-256-512-1024-2048-4096. So if we are talking about 1,000,000 first tier participants, the 13th tier constitutes over 4 billion people and the 9th tier is just over half a billion. Such growth schemes rarely survive the first few tiers. In the instance of mortgage issuance, packaging and reselling the numbers fail very early on. Therefore, the collapse of banks and credit markets in 2008 was both knowable in advance and unavoidable without positive action to stop it.
Although few people like the current circumstances of the global economy, there are a lot of net positive outcomes to be had. In my book, It's All Tuna!, I posit that the economy doesn't care about how and for what money is spent, it only cares that the money is moving. Therefore the first actions of the US Congress was to act to provide liquidity in the credit markets so that people and businesses have the funds to move.
The economy being a non-conscious entity has no concern for how many people lose jobs, can't feed their families, get evicted from their homes, can't obtain health care and avoid disease. It has no concern for the cessation of farming and fishing that feeds tens of millions of people. It doesn't care that a hundred million retirement accounts lose half their value. While the music continued to play and the world circled the line of chairs, we all laughed and had a merry old time.
America may well be the epicenter of the quake that shook the world to its knees but it was only so effective because everyone was feeding on the wealth creating ability of the US economy and its ability to sustain a $1 trillion net trade deficit each year. Too bad it was partially funded with loans and investments by the very entities that were generating a trade surplus on our activity.
We must keep in mind that for every dollar that is lost in the mortgage meltdown and the concomitant stock market slump, someone else received that dollar or it was a make-a-believe dollar in the first place.
Soon-to-retire homeowners were happy to sell their house at an inflated price to a willing buyer who was backed by a willing lender. Those homeowners made their money by buying, holding then selling their residence. It did not matter to them that the buyer might not be able to fulfill his obligations to the willing lender. The purchase price of the houses are no longer touchable by the lenders who have gotten burned by defaults. Mr. and Mrs. American Retiree are in Florida living in a snowbird community with the proceeds of their house sale. There is the dark side of such house selling where the appraisers, the brokers and other conspire to inflate sales prices of specific dwellings and thereby artificially inflate the selling prices of neighboring houses. A few well placed frauds will enable a lot more legitimate sales prices because of the "neighbor effect" on home prices. Apparent wealth has been created by such manipulation of selling prices.