In Vanity Fair, Niall Ferguson has a long article tracing the history of our current financial crisis. None of it will surprise you if you have been following things for a while, but it’s a good overview of the roots of the crisis if you haven’t (though the bit about goldbugs being “vindicated” in their crusade against fiat money seems a bit crackpot to me). All the bases are touched: the Chinese savings glut, Fannie and Freddie, financial derivatives gone wild, S&L deregulation, delusional quant models, etc., etc. His main conceit is that thanks to unprecedented leverage and a kind of blind faith, operations in the financial world (Planet Finance) had come to dwarf the goings-on in the actual world. As investors recognized there was no ground beneath their feet, that Planet began to self-destruct.
Interestingly, Ferguson connects the rise of leverage to stagnating wages.
By the 1980s, in any case, more and more people had grasped how to protect their wealth from inflation: by investing it in assets they expected to appreciate in line with, or ahead of, the cost of living. These assets could take multiple forms, from modern art to vintage wine, but the most popular proved to be stocks and real estate. Once it became clear that this formula worked, the Age of Leverage could begin. For it clearly made sense to borrow to the hilt to maximize your holdings of stocks and real estate if these promised to generate higher rates of return than the interest payments on your borrowings. Between 1990 and 2004, most American households did not see an appreciable improvement in their incomes. Adjusted for inflation, the median household income rose by about 6 percent. But people could raise their living standards by borrowing and investing in stocks and housing.
Throughout the bubble, right-leaning economists tended to argue that wage stagnation didn’t matter for this very reason: people were garnering tax-advantaged gains in assets and shrewdly borrowing against them, so wages were an outdated way of measuring how well-off people were. Better to judge that by their consumption, because as we all know, spending is a proxy for feeling good, and more stuff equals more joy. And consumers were not flagging at all in their spending through the bubble period, and they new better than any fancy economic analyst what they could comfortably afford.
It’s a much different picture now, with retail sales “collapsing” according to this NYT headline, and the credit supply all but dried up for many would-be borrowers. The NYT article offers this choice anecdote about glum shoppers:
Two stylishly dressed friends spending time in Midtown Manhattan on Thursday said they used to enjoy shopping. “I want to impulse-buy again,” said a wistful Louise Van Veenendaal, an actress. But these days, economic anxiety is prompting the women to steer clear of stores. They refuse even to look at sales circulars.
“I’m much poorer than I’ve ever been,” said her friend, Kate Pistone, also an actress, who makes ends meet by working at a restaurant. Sales there have been declining. “I made $5 last night,” she said.
Analysts who spend time prowling the nation’s stores to track trends say that consumers are simply shell-shocked by all the grim financial news.
“You walk the mall and consumers look like zombies,” said Mr. Morris of Wachovia, after visiting a mall last week. “They’re there in person, but not in spirit.”
I have mixed emotions reading such accounts. I want to find something hopeful in people steering clear of shopping, but if the choice is forced by anxiety, than no progress is being made. The idea is for not shopping to make people less and not more like zombies. If we are less preoccupied with acquiring and collecting stuff, the thinking goes, we’ll have more energy to devote to actually doing things. (The presumption is that shopping is not quite a real activity but a substitute — we buy a skiing magazine and imagine going skiing rather than just heading to the mountains.) But such anecdotes as the one in the NYT article remind us that we as a nation are going to experience shopping withdrawal, which most likely will only enhance the allure of the now-rarefied pleasures of impulse buying. We may have forgotten to some scary extent how to enjoy things outside of the structure of a retail exchange. Shopping has become the stage for our pleasurable experiences, making a purchase the trigger for joy. We won’t unlearn that immediately simply because it has become economically expedient.
As the wistful waitress-actresses demonstrate, without more money coming in via wages, we have to scale back spending and lose access to the surest pleasures we know. And worse, fewer and fewer Americans are drawing wages at all. This keeps consumer confidence spiraling downward, making it impossible for them to lead a economic recovery.
Paper gains can’t supplant wages in sustaining economic growth. In assessing the degree to which the current crisis echoes the Great Depression, historian James Livingston points out that when the share of productivity gains that go to wages falls, consumers can’t be counted on to sustain economic expansion:
At the very moment that higher private-sector wages and thus increased consumer expenditures became the only available means to enforce the new pattern of economic growth, income shares shifted decisively away from wages, toward profits. At the very moment that net investment became unnecessary to enforce increased productivity and output, income shares shifted decisively away from wages, toward profits.
And those profits had nowhere to go but into inflating bubbles.
Ferguson connects the reliance on investments rather than wages to the essential problem with the ownership society:
Once upon a time, people saved a portion of their earnings for the proverbial rainy day, stowing the cash in a mattress or a bank safe. The Age of Leverage, as we have seen, brought a growing reliance on borrowing to buy assets in the expectation of their future appreciation in value. For a majority of families, this meant a leveraged investment in a house. That strategy had one very obvious flaw. It represented a one-way, totally unhedged bet on a single asset.
Hence, as housing prices fall, people panic. Housing is better thought of as something you consume, not as an investment, and certainly not your only form of savings. During the housing boom, it was trendy to argue that America’s negative savings rate wasn’t a problem because it was off-set by swelling asset prices. What we are confronting now shows exactly what was wrong with that thinking.