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     Apr 13, 2010
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The crisis of wealth destruction
By Henry CK Liu
This is the first article in a series.

The financial crisis that broke out in the United States around the summer of 2007 and crested around the autumn of 2008 had destroyed US$34.4 trillion of wealth globally by March 2009, when the equity markets hit their lowest points.

On October 31, 2007, the total market value of publicly traded companies around the world reached a high of $63 trillion. A year and four months later, by early March 2009, the value had dropped more than half to $28.6 trillion. The lost $34.4 trillion in wealth is more than the 2008 annual gross domestic product (GDP) of the US, the European Union and Japan combined. This


wealth deficit effect would take at least a decade to replenish even if these advanced economies were to grow at mid-single digit rate after inflation and only if no double-dip materialized in the markets. At an optimistic compounded annual growth rate of 5%, it would take more than 10 years to replenish the lost wealth in the US economy.

In the US, where the crisis originated after two decades of monetary excess that encouraged serial debt bubbles, the NYSE Euronext (US) market capitalization was $16.6 trillion in June 2007, more than concurrent US GDP of $13.8 trillion. The market capitalization fell by almost half to $7.9 trillion by March 2009. US households lost almost $8 trillion of wealth in the stock market on top of the $6 trillion loss in the market value of their homes. The total wealth loss of $14 trillion by US households in 2009 was equal to the entire 2008 US GDP.

As the financial crisis broke out first in the US in July 2007, world market capitalization took some time to feel the full impact of contagion radiating from New York, which did not register fully globally until after October 2007. In 2008 alone, market capitalization in EAME (Europe, Africa, Middle East) economies lost $10 trillion and Asian shares lost around $9.6 trillion.

Bailouts, stimulus packages and jobless recovery
As a result of over $20 trillion of government bailout/stimulus commitments/spending worldwide that began in 2008, the critically impaired global equity markets began to show tenuous signs of stabilization only two years later, by the end of 2009. Yet total world market capitalization was still only $46.6 trillion by the end of January 2010, $16.4 trillion below its peak in October 2007.
The amount of wealth lost worldwide in 2009 still exceeded 2009 US GDP of $14.2 trillion by $2.2 trillion. The NYSE Euronext (US) market capitalization was $12.2 trillion in January 2010, recovering from its low at $7.9 trillion in March 2009, but still $4.4 trillion below its peak at $16.6 trillion in June 2007.

US GDP in first quarter 2009 fell 6.3% annualized rate while surging 5.7% in the fourth quarter, mostly as a result of public sector spending equaling over 60% of annual GDP. The US government bailout and stimulus package to respond to the financial crisis added up to $9.7 trillion, enough to pay off more than 90% of the nationís home mortgages, calculated at $10.5 trillion by the Federal Reserve. Yet home foreclosure rate continued to climb because only distressed financial institutions were bailed out, not distressed homeowners. Take away public sector spending, US GDP would fall by over 50%. This is the reason why no exit strategy can be expected to be implemented soon.

It took $20 trillion of public funds over a period of two-and-a-half years to lift the total world market capitalization of listed companies by $16.4 trillion. This means some $3.6 trillion, or 17.5%, had been burned up by transmission friction. Government intervention failed to produce a dollar-for-dollar break-even impact on battered markets, let alone generate any multiplier effect, which in normal times could be expected to be between nine and 11 times. In the meantime, with the exception of Chinaís, the real global economy continues to slide downward, with rising unemployment and underemployment.

The massive government injection of new money managed to stabilize world equity markets by January 2010, but only at 73.5% of its peak value in October 2007. It still left the credit markets around the world dangerously anemic and the real economy operating on intensive care and life support measures from government. This is because the bailout and stimulus money failed to land on the demand side of the economy, which has been plagued by overcapacity fueled by inadequate workers' income, masked by excessive debt, and by a drastic reversal of the wealth effect on consumer demand from the bursting of the debt bubble. The bursting of the debt bubble destroyed the wealth it buoyed, but it left the debt that fueled the bubble standing as liability in the economy.

Much of the new government money came from adding to the national debt, which taxpayers will have to pay back in future years. This money went to bail out distressed banks and financial institutions, which used it to profit from global "carry trade" speculation, as hot money that exploited interest rate arbitrage trades between economies. The toxic debts have remained in the global economy at face value, having only been transformed from private debts to public debts to prevent total collapse of the private sector. The debt bubble has been turned into a dense debt black hole of intense financial gravity the traps all light from appearing at the end of the recovery tunnel.

Much criticism by mainstream economists in the US has been focused on the controversial bailout of "too-big-to-fail" financial institutions that have continued to effectively resist critically needed regulatory reform by holding the seriously impaired economy hostage. Some critics have complained that government stimulus packages are too small for the task at hand. Only a few lonely voices have focused on public spending being directed at wrong targets. Yet such massive public spending has left many economies around the world with looming sovereign debt crises.

The critical issue of jobs
The US Labor Department reported that the economy gained 162,000 jobs in March 2010, compared with a revised reading of a 14,000 job loss in February. That makes March only the third month of gains since the recession began. A gain of 184,000 jobs had been forecast for March. But despite missing forecasts, the March numbers were generally not viewed as disappointing by economists, because revisions in January and February readings added a combined 62,000 additional jobs. This is viewed as good news overall for an economy that has suffered a net loss of 8.2 million jobs since the start of 2008, a month after the official start of the "Great Recession". This sentiment shows how weak expectation is among most forecasters. The unemployment rate remains stubbornly high, holding steady at 9.7%, matching mainstream economist expectations.

President Barack Obama immediately trumpeted the jobs report on April 2, asserting that the employment figures are signs that the government stimulus package implemented a year ago has reversed the loss of about 700,000 jobs a month that was taking place at that time. Ironically, this political spin underscores that even the mild improvement in jobs creation may be reversed as soon as the government's stimulus program runs out, or when the central bank exits from its massive intervention in the market.

The president made his claim at a specially selected company in Charlotte, North Carolina, that makes membranes for lithium batteries, symbolizing the dependence on new green technology for economic recovery. The company received a $50 million matching grant from the $787 billion stimulus program in 2009 to expand one facility and to open another elsewhere in the state.

Still, the president had to admit that "government can't reverse the toll of this recession overnight, and government on its own can't replace the 8 million jobs that have been lost. The true engine of job growth in this country has always been the private sector. What government can do is create the conditions ... for companies to hire again."

Obama said many Americans are still suffering from the job losses of the last two years. But he said despite the damage done to the labor market during the recession, the economy is poised to start adding the jobs people need. "What we can see here, at this plant, is that the worst of the storm is over; that brighter days are still ahead," the president said.

In response, Republican National Committee chairman Michael Steele issued a statement saying the jobs gain in March reported by the Labor Department is not a sign of economic health. "No matter what spin the White House puts on these job numbers, it is unacceptable for President Obama to declare economic success when unemployment remains at 9.7% and a large portion of the job growth came from temporary boost in government employment," he said.

The president appeared to be putting the cart before the horse on the issue of environmentalism and economic growth. In reality, the full implantation of a green economy will likely increase unemployment from job losses in the old energy-intensive economy. Environmentalism, like universal healthcare, is an expensive movement, and can be introduced economically only with a strong economy. It is foolhardy to expect environmentalism to revive a seriously impaired economy.

The jobs report contained sobering readings for the depth of labor market distress that has built up over the last two years. There are 15 million workers counted as unemployed in March 2010, down 607,000 since the record high of October 2009, but still the fifth-highest total on record. The average period of unemployment now stands at eight months, a record duration that has put many working families under severe hardship.

Almost one million more workers have become too discouraged to continue looking for work and are no longer counted in the unemployment rate, even as the number of discouraged job seekers fell by 200,000 since February 2010.

Continued 1 2 3 4 

The Complete Henry C K Liu

Lesson unlearned
(Oct 30, '09)

A lost decade ahead (Sep 14, '09)

1. US reaps bitter 'Tulip' revolution harvest

2. New depths to plunge to

3. Israel's spies jolted again

4. The line of doom

5. The Cheonan cover-up

6. US lawsuits may flood China drywalls

7. Iran miffed by US's nuclear posture

8. BOOK REVIEW: Lifting the cloak on North Korean secrecy

9. India sets sights on killer drones

10. Pakistan's divide grows ever deeper

(Apr 9-11, 2010)



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