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Is the western world reaching to the end of it's wealth?

I'm seeing currently a big deficit in western world economies. As I see it, western worlds are slowly beginning to decay in terms of standard of living as well as unemployment generally. I believe that personally, it's China that's becoming the essential problem. Yes, it might be due to the working conditions, but it's not something we can directly control. One even might argue for the sake of China, that their wealth is growing to a point where their middle-class is becoming bigger and their education might bring them even help with humanitarian problems.

The fact is, China is currently making products for fairly cheap price that everybody buys because of their price and in some cases, because there's no other option. For example, I don't know a TV brand that isn't manufactured in China. Whereas people, who are getting poorer in Western World, can't necessarily even buy an alternative option to Chinese products. Back in the days, "Made in China" meant "Cheap & Low-grade", nowadays it's more a "Clone". Like their cloned cars for example, which have structural problems that can mean death in a crash. On the other hand, if you really want a BMW X5-esque car, why would you care for a crash that's unlikely because you're getting a BMW X5 and confidence!

I feel that we're facing a problem here that China is getting their wealth out of western production & consumers. Basically, China is doing what's actually best for China and largely, this might help their humanitarian issues, while bringing couple others on the table though. But this wealth is strictly out of our pockets - production is either outsourced to China or it doesn't pay that much. Also, if country has social security employed, it's also taxing itself heavily and getting a larger debt figure, which is why it can't afford the growth of China.

So, what happens next? Monopolies or will Western World become the new Africa? How to solve the problem, if it even is a problem?

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  • Aug 1 2013: Dear Ted,

    Here is my take: wealth is resources measured in terms of money. If you have money, you have wealth. However, this does not explain why deficits occur.

    Banking creates additional money by taking deposits of money and lending out 90% or more of that money to others, which is then spent. The depositor thinks they have $1 million in the bank and the borrower borrows and spends $900,000, which means someone else in the economy thinks they have $900,000. The banking system just created $900,000 out of thin air.

    For several decades, everything was fine and the banking system created more and more money. Most of the new money was "credit" money and a lot of it was used to purchase property and shares, which increased the value of these assets greatly.

    One day the system hit its natural limits and no new credit could be created by the banking system. There was a sudden shortage of money, which led to huge falls in asset prices. People panicked because they had high debts and low asset values, which caused them to stop spending and the economy fell into recession.

    Governments and central banks know this, so they drop interest rates to reduce the burden of debt and governments step in to spend money to move the economy out of recession. This is why deficits occur.

    Several such cycles have taken place since WW2. Each time the credit economy collapsed, governments and central banks intervened to help the economy recover. For example, after the tech bubble collapse of 2000, low interest rates helped push up house prices which then caused the 2007 financial crisis.

    Now we are in the third cycle of recovery and a new asset bubble is being created to fix the last one but everytime an asset bubble collapses, the country ends up with more debt and it gets harder to recover.

    China has less debts because it is a young economy and it is still growing its asset bubble. Right now it is creating a lot of paper wealth but could be near its natural limits.
    • Aug 3 2013: That's a nice take. Ultimately, it leads to question - where's the limit of debt and what happens once we reach it? Or does debt simply move the economy from socialistic economy towards capitalistic economy? And overall, what are the effects?
      • Aug 3 2013: The limits of debt are dependent on the ability of a country to service its debts. The IMF thinks it is somewhere around 120% of GDP. Other economists measure a country's debt servicing ratio and how quickly debt has built up.

        My best guess is that the US has quite a bit of room to go but will need to change laws to reduce healthcare costs and pension obligations. In the meantime congress may prevent the US from borrowing excessively, which is probably a good thing because incurring more debts over the long term is ultimately unsustainable.

        China is interesting because they are attempting to transition from a high GDP growth-high debt growth economy to a lower GDP growth-lower debt growth economy. Of major concern is their ability to service existing debts during this transition process. Their economy appears to be heavily skewed towards manufacturing and construction activities, which must shrink as a percentage of GDP in a low GDP growth environment because there are already too many workers in these industries. People worry whether a smooth transition is possible in a low debt growth environment because existing industries will suffer losses.

        The economy tends to be very capitalistic during the debt growth phase and socialistic during the asset price deflation phase. Over several debt inflation and deflation cycles, it appears that the wealth gap between the rich and poor is worsened each time. Those holding assets behave in a very capitalistic manner once they have been bailed out but during the bailout itself they are highly dependent on government and central bank backstops.

        Overall, I would say that social inequities are worsened by each credit cycle and the eventual outcome is likely to be a change in policy triggering a financial system reset. In other words, a Great Depression will happen eventually once the wealth gap has gotten too big. This has happened to many great civilisations in history.

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