From buying Cristal to being cheap

October 5, 2009
By: Tim Heston

It's 2005. A group of investment bankers visit a dimly lit New York club. One banker in his 20s makes more than a million a year packaging mortgages and sending them on to the big Wall Street firms. Two waiters arrive carrying four champagne bottles each with tiny sparklers. Everyone turns to look. Those bankers just ordered four bottles of Cristal at $1,000 a pop.

It's 2009. Tom Tseng, general manager of Chinese bicycle-maker Tandem Industries, tells a newspaper reporter that "China's ability to consume has reached a fairly high level & [while] in the U.S. people now only want to buy cheap things."

The first story came from "This American Life," a radio show that recently aired a retrospective on the financial crisis. The second story came from a recent Wall Street Journal article. Together they describe the massive adjustment the global economy has undergone. American consumers aren't the economic engines they were. China manufactured things, exported like crazy, and saved. Now, the Chinese government is flush with money, and its aggressive stimulus plan is propping up Chinese consumption, so much so that companies like Tandem Industries are finally focusing on their home market.

When the global economy starts to emerge from the doldrums (as many think it already has), I hope U.S. manufacturers will be doing business in a much more stable world, and participating in globalization how it should be.

"This American Life," usually a quirky show about life's little moments, took a stab at the financial crisis and, for me (a noneconomist), painted the clearest picture showing why the whole mess happened in the first place.

One of the root causes was the world's money supply (technically, fixed-income securities), which doubled from $36 trillion in 2000 to $70 trillion in 2006, thanks in part to globalization. A greater percentage of the world's population was producing more for global consumption (mostly America's). Developing countries with big natural resource reserves (Middle East) and cheap labor (Asia) benefited the most. Unfortunately, all this money went to relatively few people. Cheap labor means most people aren't paid very much, right? These workers used their relatively meager paychecks to make their lives just a little better—a significant leap, but they certainly weren't out ordering bottles of Cristal. So much of the $70 trillion went to government wealth funds and the rich.

They bought only so much; the rest of it, they needed to invest. Usually, U.S. Treasurys would be the first safe-haven on the list. But the Fed kept rates abnormally low. They did this to promote economic growth, but the unintended consequence was that U.S. Treasurys, with such low yields, weren't an attractive place to funnel the world's investment demand. Those few holding the world's vast money supply were hungry for something that had low risk and a higher return. Enter the mortgage-backed security.

So this is where those club-going, Cristal-drinking bankers step into the picture. The world's investors were hungry, so bankers fed them with even more mortgage-backed securities. To do this, they needed more mortgages. Once everyone who could pay for a house had one, they set their eyes on the subprime market, which gave people houses even if they couldn't afford it. They figured that if they packaged these bad mortgages with hundreds of other good ones, they would spread risk. Even if all the bad mortgages foreclosed, things would be OK because the banks would just own a lot of homes that were increasing in value. And homes would always increase in value ... right?

We all know the story from there. I like this explanation because it doesn't point fingers at the finance sector, or the people who bought homes who shouldn't have. It goes back to the issue of the money supply, globalization, and unintended consequences.

For the record, I'm all for globalization and free trade. I just worry about the personal freedoms of the people we're trading with. One moral problem with a global economy is that while the laws of supply and demand may be universal, political systems and power structures aren't. A poor worker across the ocean may assemble a plasma TV for a U.S. consumer who has had all the benefits of (relatively) free capital markets and even some disposable income.

In my opinion, that injustice was at least one factor that ultimately snowballed into the financial crisis. More people in this world should have the luxury of consumption beyond basic necessity, and manufacturers the world over would see the benefits. When I hear news of Chinese consumerism on the rise, I think it's a step in the right direction.

Tim Heston

Tim Heston

Senior Editor
FMA Communications Inc.
2135 Point Blvd
Elgin, IL 60123
Phone: 815-381-1314