Who Profits?

Others however profited from this situation in a real sense. In these 30 years or so, a whole industry was built around this new wealth being produced by the combination of higher productivity and lower wages, the financial industry. CEO’s and other managers saw their income rise. The Boston Globe had this to say about it in august 2008:

“The annual survey of executive compensation is out this morning, and it finds that in 2007, the average pay of an S&P 500 company CEO was 344 times the salary of an average worker. Thirty years ago, chief executives averaged only 30 to 40 times the average American paycheck. No one begrudges people getting rich. But some compensation deals are unfairly rigged.”

For the American workers another strategy was necessary. And that strategy involved borrowing the money that could not be earned in order to consume at the desired level. Nowhere in the world did people on average borrow so much money as in the United States but very much the same happened in Europe from the 1980s onward. It was established that in the Netherlands:

“…many borrowers are struggling to meet repayment obligations, des­pi­te statutory limits on interest rates. Households’ mortgage debts are more than twice their savings deposits.”[1]

That makes the Dutch situation the worst in Europe. But Dutch consumer credit is still low when compared to the United States. Fox news reported e.g. on the credit card situation already at December 31st 2004 with the following explanation by Susan C. Walker, a Senior Writer at Elliott Wave International:

“About a month ago, the New York Times examined how the use of credit has taken off dramatically in the United States since 1990. While the number of people holding charge cards grew about 75 percent— from 82 million in 1990 to 144 million in 2003— the amount they charged during that period grew by a much larger percentage: approximately 350 percent, from $338 billion to $1.5 trillion.” […]

“In fact, on the national level, the Bureau of Labor Statistics shows that aggregate U.S. personal income in 1990 was $4.9 trillion. In 2003, it was $9.2 trillion. The rate of growth? 188 percent — pretty far off from the 350 percent growth in credit card charges.”[2]

So Americans are borrowing the difference between their wages and their desired consumption and the economy is actually encouraging that, since:

“There’s an axiom known by every economist under the sun: because consumers make up two-thirds of the economy, they must keep spending to keep the economy healthy. It’s easy to see that we’ve been acting on cue for the economy, to the point that we’ve kept spending well beyond our means.”[3]

It first became obvious that something went wrong in the credit card loans.

“For years, up to 40 percent of all auto loans, all credit card purchases, even student loans, have been bundled by banks and finance companies – the same way they bundled up risky mortgages – and then sold them off as securities.” […]

“Since investors stopped buying, the market for consumer credit has collapsed by 80 percent and shocked the American credit system. Six-hundred and thirty-eight billion dollars from investors that was available last year isn’t even in the pipeline this year – and isn’t being used for new loans.”[4]

So what happens was, that the borrowing got so out of hand, that a future income was being used that in general would take a rise in wages by more than 300% to be real while in actual fact wages remained equal or might at best rise with 180%. Because of this gap between the virtual wealth (350% increase) that was the basis for prices and loans and the future real wealth (only an 150% increase), a loan could no longer become collateral for an investor in a bank. There would be no investors to lend money to banks with consumer loans as security. Credit lost its credibility. That is why banks no longer have the money, to lend money any more. That is why the price of houses must collapse: if no one can get the necessary mortgage to buy a house at its current price, its price has to drop, leaving the sellers with a huge debt. That is why industries that rely on short term loans to invest in current projects, where they have to finance production ahead of delivery and payment, can no longer get them and have to decline such projects – with the only option to make more money available by reducing their own costs. And how do they do this? By firing employees or reducing wages even more. And of course then the circle is complete: by reducing wages, more credit is needed if consumption is to remain at the same level.

1 Comment

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One response to “Who Profits?

  1. João V

    What is interesting to notice when a credit crisis hits a country, is that on one hand the banks invest millions promoting their miraculous products of consumer credit and on another hand, when people atracted by such promotions go above their heads and get in debt more than the can afford, the stablishment, along with the banks, goes on and on about how the people is irresponsible for all the borrowing they did for consuming and how their taxes should go to cover the bank’s losses.
    So that, basically, on one hand they invest in promoting easy credit and on another hand they say that people are dumb to fall for their promotion – of course they don’t say this explicitly, the politicians do, although they don’t regulate the banking system and keep allowing them to follow this course of action.

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