To examine this idea, we have to look at the direct cause of the financial crisis. The roots of the financial crisis lay in the subprime mortgage crisis. Although economist James Hamilton alleges that the crisis was worsened by high oil prices after the crisis began, the direct cause lays in an epidemic of foreclosures.
However, although economists agree with each other that the mortage crisis caused the economic downturn, there is no consensus about what caused the subprime mortgage crisis. To examine the subprime mortgage crisis, we have to return to 2007. In 2007, a sudden spike began in the number of properties with foreclosure activity:
To understand why people Foreclosed on their homes, we have to examine the people who Foreclosed on their homes. The right wing alleges that the spike in foreclosures was caused by political correctness mandating that poor minorities would be given mortgages as well, because it was seen as unfair that only white people could afford to buy homes.Although it is true that minorities are overrepresented amongst those who are given subprime mortgages, they are not overrepresented amongst those who default on their mortgage. Hence minorities are not "lousy borrowers", though this does not refute the suggestion that the poor should have never been giving subprime mortgages to begin with.
However, even if we assume that the crisis was caused by the increase in subprime mortgages, this still does not explains why the spike in defaults happened in 2007. The problem lies in the spike in default, as subprime mortgage lending does not have to lead to problems for Mortgage brokers if mortgage brokers can accurately predict the default rate. Mortgage brokers were faced with an increase in defaults beyond what they expected. This increase in defaults in turn, was caused by an increase in costs beyond what the borrowers expected.
One thing that subprime mortgage lenders have in common is a low income. A few things those of us with low income have in common is the fact that basic life neccesities such as food and fuel make up a larger part of our expenses than luxury products. For those with an income between 10.000 and 15.000 dollar, food expenses make up about 37% of total expenses. For those with an income above 70.000, food expenses make up just about 8% of total expenses.
When the rich are faced with growing prices or fear becoming unable to pay their mortgage, they can skip a vacation, sell a car or take some other measure to reduce their costs. If most of your costs consist of interest payments, transportation and food it becomes difficult to cut down on anything. Although Europeans with poor income might be capable of switching over to public transport, for many poor Americans this is not an option. And unfortunately, these basic necessities are most vulnerable to price fluctuations.
For Americans below the poverty line, a rise in gas prices from 2 to 4 dollar means a further 4.3% of income is spent on commuting to work. For Americans above the poverty line, the increase would swallow up just 1.1% of their income. The implication is clear an increase in food and fuel prices is a significant problem to poor Americans, the ones enchained to sub-prime mortgages.
As can be seen in the following graph, food and fuel prices both spiked during 2007:
The answer thus becomes clear. Poor Americans became unable to pay their mortgages, because they became unable toafford their basic necessities. Economists and pundits tend to overlook this explanation, because most of them have lived their entire lives in wealth, unaware of the impact that the rise in costs for basic necessities has on the working class.
As shown in the graph above, rises in food prices correlate closely with rises in fuel prices. Another suggestion has been that an increase in land used for biofuels caused the food crisis. Although this is partly true, it does not explain why land is used for biofuels to begin with. The answer to this question is, because biofuel becomes economically valid, because of rising oil prices!
The answer for a sudden increase in defaults amongst the poor can always be found by examining whether their expenses have increased, or their income has declines. In our case, the answer is a sudden increase in expenses. This increase in expenses due to rising prices for basic goods leads to a constant decrease in consumption of luxury goods, as people simply become unable to afford them. Therefore, businesses become unable to function, employment declines, hence causing expenses to continue declining. This chain reaction was set in motion by the rise in oil prices.
The rise in oil prices in turn has been set in motion by our lack of oil and the increased effort required to find oil. Oil that can still be found takes more effort to find, as it is miles deep beneath the earth, in the ocean, or in other remote and difficult to access places. Oil that is found is of lesser quality, hence taking more effort (and thus money) to refine.
Similarly, other resources such as potassium are becoming more expensive, as our civilization has used up all the easily accessible sources. Optimists might argue that this means our problem is of temporary nature, because innovations can be sought that will end our problem as wel always. For example, when we ran out of guano, we began using Potassium rock, and because our equipment had improved, prices did not rise a lot.
The problem however, is that never before, has our civilization entered a time period in which every resource is becoming more expensive to gather. As an example, there is the problem that fresh water is becoming scare. An optimist might argue that we can take salt water from the ocean and desalinize it at a slightly higher price. However, what the optimist forgets is that desalinizing water requires energy. Although this may now be affordable, in the future, energy prices will be higher as we will be unable to use oil.
Similarly, solar panels used for the desalinization plant will be more expensive, as solar panels require Gallium to be produced. Global Gallium extraction peaked in 2000. Our historic solution to problems has been innovation. In most cases, innovation meant moving on from one resource to another. As an example, since mercury production peaked in 1960, we have stopped using Mercury. It's very difficult to buy thermometers that contain mercury these days.
However, our current problem is different, as there simply are no more resources to switch over to. Switching from one resource to another increases demand for the second resource, which 50 years ago would have been no problem, but today is, because the resource we step over to is also being depleted. As an example, an increase in nuclear energy would increase demand for Uranium, which would imply a faster decline in Uranium reserves.
Hence we can conclude that the economic crisis is not a temporary recession, as most economic analysts believe, but an end to our way of life.
