2/14/06 “Mommy, Where Do McMansions Come From?” 1887 words

"Capital gains, of course, cannot supply any of the saving required to finance gross domestic investment." Alan Greenspan, speech at Jackson Hole, Wyoming, August 26, 2005

“Mommy, my school teacher says Americans work longer than Europeans, but don’t save as much as Asians. But if we don’t save, then how can we buy all this stuff?”

“That’s a good question, Emily. Your school teacher is right, those Europeans really do need to stop slacking off and buckle down, like us, and the Asians have to learn how to loosen up a bit and enjoy themselves a little more, uh, again, like us!

Besides, Daddy heard from the smart man on the radio on the way to work that the very smart people on Wall Street say don’t believe that stuff about Americans not saving, the government people are just not counting it right, they're ignoring the value of our nice home. We've told you honey they can’t do anything right in Washington anyway.

Why, since we moved into this nice house just five years ago, its value has more than doubled, and your daddy and I have saved almost half of that for your college education. How can they not count as savings such a good thing as that, it makes no sense, right?

Your daddy has worked very hard for all that we have, he's earned every penny of it, you know that. So don’t worry, Emily, everything will be fine, and you can keep going to nice private schools just as long as you want.”

"But Mommy, even if we're okay, what about all those poor people in the world, don't they need savings from houses to buy stuff, too."

"That's a good question, Emily, but your mommy doesn't have time to think about it right now. I have to drive you to soccer practice. So please don't worry about it dear, they'll be fine, I'm sure. The good people in Washington will take care of it, they seem to spend all our tax dollars on foreign aid anyway."

"But Mommy, you just said that the people in Washington..."

"Never mind, Emily, we're late. I'll ask Daddy to talk with you about all this later when he comes back from work. He learns so much from that smart radio man. I just wish he didn't have to drive so far everyday."

"Mommy, my friend from public school says the rich just get richer, and the poor just get poorer. What does that mean? Are we getting richer because we own a home?"

"Not now, Emily, we really have to get going. That's just another one of those silly stories from some of those people in Washinton. They're so confusing. They're all just paper shufflers anyway, not like your daddy, who sells home mortgages so other people can buy nice houses too. Let's go."

"I thought you said he sold stocks?"

"That was before, you have to change with the times, Emily, never forget that's what makes America so great! Not like those lazy Europeans your teacher was telling you about."

Unfortunately for the hypothetical radio talk show host, Wall Street, and more importantly Emily and her mom, no less a “free market” deity than Greenspan has actually supplied the intellectual connection between their home equity ATMs and the massive global misallocation of capital, only no one has bothered to tell them, it seems.

In a speech given at the annual Jackson Hole, Wyoming confab last August 26, Greenspan made a critical point, not surprisingly relegated to a mere footnote, which virtually no economic commentators or politicians with oversight of the Fed ever mention, at least in the U.S.:

“The rising prices of stocks, bonds and, more recently, of homes, have engendered a large increase in the market value of claims which, when converted to cash, are a source of purchasing power. Financial intermediaries, of course, routinely convert capital gains in stocks, bonds, and homes into cash for businesses and households to facilitate purchase transactions.6 ” “6. Capital gains do not add to GDP…Capital gains, of course, cannot supply any of the saving required to finance gross domestic investment.” [Emphasis added.]

Please think about the bold-faced sentences for just a minute and let it sink in. Perhaps do a little “thought experiment” and focus on real production of goods and services, to try to finally cut through one’s “money illusions.” How does massively marking up the prices of already existing homes actually shift any real production from consumption into new investments to produce new real wealth?

It can’t, as Greenspan clearly footnoted. So, who are you going to believe, some hypothetical radio guy, Wall Street, which decimated your 401(k) in that equity bubble, or THE Alan Greenspan?

But if you believe Greenspan, then where do those real savings for real investment actually come from? As taught in econ 101, with very little savings of its own, U.S. so-called “paper wealth creation” is in fact necessarily based upon real savings from real income from real production in the rest of the world.

This is reflected in the fact that the U.S. is singularly running a huge current account deficit with the rest of the world of more than 6% of U.S. GDP, nearly 2% of world GDP, sucking in about 70-80% of the world’s so-called “savings glut” (Bernanke’s term, which we will deal with some other time, suffice to say for now that the world doesn't have too much savings, it has too little non-speculative financial intermediation).

A one paragraph look back at my previous article to set the table. I asserted that U.S. policies which distort the so-called “free market” to deliberately produce record real estate speculation, which is especially rampant in a number of blue-state regions, has the unintended, at least I hope it’s unintended, effect of also impacting the funding of educational opportunities, making them much more unequal. Since admitting this would create “cognitive dissonance” in their core value/belief system of equal opportunity, blue-state liberals, to avoid feeling guilty, support well-meaning programs inadequate to get at the core issues.

Here’s another example of this same problem, but first a very strong disclaimer. I don’t think blue-state liberals are responsible for this or any of the world’s other problems. Nor do I think blue-state liberals are any worse than red-state conservatives. Most Americans, blue-state or red-state, are hard-working, decent, well-meaning people. The main villain running through my blog is the global speculative financial system and its “power of myth” regarding so-called "free markets."

Obviously unlike their children’s education, blue-state liberals aren’t pre-occupied with global economics, but if they were, again they simply couldn’t psychologically make the connection between how their home equity ATM’s massively distort the global allocation of capital, and their views of themselves as good liberals favoring such things as increased foreign aid and humanitarian disaster relief, less military intervention abroad, and perhaps even more just global economic development.

E.g., it’s very difficult for blue-state liberals to come to grips with the fact that real estate is actually the most heavily government promoted and protected sector of the U.S. economy (in all the ways laid out in a previous article), far more than those perennial liberal whipping boys, agriculture and military.

Blue-state liberal home owners in areas of rampant real estate speculation, such as California, and the metropolitan areas of New York, Boston, and Washington D.C. might gladly support ending government subsidies for wealthy agribusiness, especially in some sparsely populated “red states,” in the Doha round of WTO talks, in order to help global economic development.

Yet these blue-state liberals would rise up like medieval peasants if you threatened their real estate tax breaks and very low mortgage interest rates.

Rather than face up to the disturbing reality that the rest of the world, including poor still developing countries such as China, are helping to finance U.S. consumption of McMansions and everything that goes in them, well-off blue-state “conscience consumers” seem to prefer to spend a few extra dollars on “fair trade” coffee and t-shirts in a well-meaning but rather futile effort to help low-wage foreign labor that is starving for capital for economic development (and most importantly, for their own viable domestic economic/financial corporations and other institutional framework that can productively use their savings).

Suffice it to say for now we find it a little hard to believe that any blue-state liberal not on a Wall Street or big media payroll, which of course are key blue state industries, takes seriously the argument that it’s a hard, even selfless endeavor for America to “shop til it drops” (which may in fact eventually happen from excess debt) in order to support the global economy, but someone has to do it (perhaps as Keynesian demand creation).

Again, it is not that the econ 101 distinction between paper speculative capital gains, on the one hand, and real economic production and real savings = real productive investment, on the other, is intellectually difficult to understand, but rather psychologically and politically hard to grapple with, due to self interest.

It is just psychologically difficult to come to grips with the fact that the often hundreds of thousands dollars in capital gains on homes is essentially “unearned,” ultimately simply due to sheer speculation in the global financial system.

At this point, the vast majority of Americans seem simply unaware of the difference between real economic wealth creation from creating new goods and services from investing real savings from real income from real production, versus “paper wealth creation” from capitalized speculative financial gains.

To almost all Americans today, after years of watching how people have become very wealthy through speculative capital gains and through intense “positive reinforcement” conditioning by distorted market incentives, these two different economic concepts, real wealth creation and speculative financial gains, have melded into one and the same thing. (A good example of this are the large, enthusiastic audiences that turn out for real estate "wealth creation" seminars.)

There are other twists to the story we won’t go into here, e.g. American corporations, not consumers or government, are in fact saving a lot, it’s just that they don’t seem to know what to do with all that cash piling up, except spend it, often wastefully, on paper deals that have strongly come back in favor the past two years, much to Wall Street’s delight, such as leveraged m&a and lbo’s, stock buybacks, etc.

We will perhaps try to assess in other articles this extremely lopsided global economic arrangement, which many mainstream economists seem to believe is neither economically sustainable nor morally defensible in the long run (so far, they've been wrong for years about the economically sustainable part), and also the political implications of Americans not understanding these simple economic facts of life about real savings and speculative capital gains.

Clearly busy, stressed ordinary working Americans are not responsible for that lack of knowledge, it is mainly the fault of the oligopolistic corporate media and the Republocrats. Unless and until the media changes (I doubt that the Republocrats ever will), this country is not going to significantly understand how to change.

Which is why, having finished our two-part look at blue-state liberals, next up may be “The New, New Thing” of this decade, Silicon Valley’s torrid love affair with Hollywood and Madison Avenue, media and advertising.