Beyond the subprime crisis

In my post about US debt to China, we found out that each and everyone of us in America owes the Chinese about $6,000. This is partly due to the fact we import more goods from China than we export to them, and because the Chinese government invests heavily in our currency. The two are actually interrelated, we give them money for goods, and then they turn around and loan it to us.

The result is that we seem to be $6,000 richer per person, but we aren’t, because it’s just debt. In that post about China I warned that our trade deficit with China couldn’t grow forever, and now the Times’ Paul Krugman warns that worldwide debt — owed primarily to Asia — now presents a gigantic obstacle to economic recovery:

For a while, the inrush of capital [From Asia] created the illusion of wealth in these countries, just as it did for American homeowners: asset prices were rising, currencies were strong, and everything looked fine. But bubbles always burst sooner or later, and yesterday’s miracle economies have become today’s basket cases, nations whose assets have evaporated but whose debts remain all too real. And these debts are an especially heavy burden because most of the loans were denominated in other countries’ currencies.

Nor is the damage confined to the original borrowers. In America, the housing bubble mainly took place along the coasts, but when the bubble burst, demand for manufactured goods, especially cars, collapsed — and that has taken a terrible toll on the industrial heartland. Similarly, Europe’s bubbles were mainly around the continent’s periphery, yet industrial production in Germany — which never had a financial bubble but is Europe’s manufacturing core — is falling rapidly, thanks to a plunge in exports.

Krugman says the seeds of this crisis were planted in the mid 1990s when the emerging Asian economies had a financial crisis of their own. They responded by saving tons of money in the form of foreign assets, in effect becoming capital investors for the rest of the world. The trouble now is that American and European consumers are reacting in a similar way. We’ve all rediscovered the virtue of savings, which only perpetuates the downward economic spiral. Consumers spend less, businesses have to make cuts as sales drop and people are laid off, wash, rinse, repeat.

Unfortunately, no one seems to have an answer for how we get out of this mess.