Munich Personal RePEc Archive

The world's dream, economic growth revisited

De Koning, Kees (2013): The world's dream, economic growth revisited.

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Financial sector companies are different from those in the real sector. In the real sector the price for consumer goods and services is a price reflecting all costs which have been made to produce the output. Profits reflect the difference between the sales price and the costs base. The “guiding hand principle” helps entrepreneurs to make rational decisions. In the financial sector the managers do not produce anything else than “considered opinions”. The money entrusted to them belongs to the individual households. The prices quoted by the financial sector managers are based on guesses about future cash flows over the funds entrusted to them. There is no clear costs concept in financial sector companies as only future events will determine the true costs picture. The key difference between the two sectors is that real sector companies work with historical costs and the financial sector with future costs. The difference between the two sectors is immense as no one can really predict what the future holds in economic terms.

In the U.S., where the combined balance sheet of individual households has been collected for many years, the statistics show that the financial assets net of liabilities on home mortgages and consumer durable goods are now 81% of total individual household assets. The remainder 19% is constituted by non-financial assets. This 81% was practically four times the annual personal income level of U.S. households in 2012. The net financial assets were also 3.5 times U.S.GDP in 2012. This figure alone shows the dominance of the financial sector over the real sector.

However the picture for jobs and incomes is totally different. Nearly all jobs and incomes out of jobs are derived from the real sector. In 2011 the U.S. financial sector employed 5.8 million out of the 141 million employed persons or 4.1% of the total number of people employed in the States in that year. About 4% of the workforce manages financial assets which are 3.5 times GDP values, while 96% of the labour force works in the real sector.

Job levels and disposable incomes are central to economic prosperity and they are the drivers of demand levels. The experience over the last 10 years has shown that the collective (mis)management of financial assets, especially on the home mortgages front, has been the principal cause of the downturn in jobs and incomes.

The collective mistakes made by the U.S. financial sector in risk taking can be exemplified by the fact that, over the period 2004-2012, 21.4 million households out of the 53 million households in the U.S. who had a mortgage were affected by foreclosure proceedings and 5.4 million of them lost their homes. In all respects the individual households were the losers: on the jobs and incomes front; on the asset prices front as well as on the government debt front

In this paper questions will be raised why no volume control measures were put in place to control the excessive growth in home mortgage volumes as compared to income growth of individual households. Questions will also be raised about quantitative easing policies which main aim was to lower the costs (price) of borrowings, rather than repair the income loss to individual households -a volume loss-. Evidence collected from the individual household statistics over the last 5 years show that individual households wanted and needed to repair their own balance sheets first, before entering into more borrowings, irrespective of the price.

This paper aims to set out how the U.S. financial sector became the key player in causing the U.S. economy and with it most of the world economy to stumble and what can be done to shorten the adjustment period if a financial debacle affecting individual households has taken place.

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