What would happen if the sea anchor on the “hidden half of the economy” was cut free?
A few months after Gail and I were married in 1973, she invited me to hear Buckminster Fuller speak at Johns Hopkins. Fuller, the renowned 20th century inventor and author of dozens of books, including Nine Chains to the Moon and Operating Manual for Spaceship Earth, was a hero of mine and of many engineering students of the time. I was excited to hear him in person. (With no web or YouTube back then, live presentations held more importance!)
The speech was outside on the lawn in front of one of the many majestic buildings on the Hopkins campus. After thanking the crowd seated on the grass and the Hopkins faculty for inviting him to speak, Fuller asked the question, “How much does the building behind me weigh?”
What a strange question. We usually talk about how many floors a building has, or how many square feet it may occupy. A mechanical engineer may ask about cubic feet of space for heating and cooling. But, weight of a building?
Fuller explained that the weight of a building is a rough approximation of its cost to construct and the energy consumed in the construction. The more material that went into a building, the more it cost and the more it weighs. A brick building will cost more to construct, use more energy in its construction, and weigh more than a metal shell building (an aircraft hangar, for example), even though they may have the same footprint and volume.
As the creator of the mathematics that describe a geodesic dome, Fuller had thought a great deal about the construction of shapes, their volumes, etc. This idea of thinking about indirect ways of measuring things has never left me, and years later led me to ask the question, “How big is the U.S. economy?”
The standard answer to this question is usually the statistic for Gross Domestic Product (GDP). National economies are measured in GDP. The GDP of the U.S. was reported by the U.S. Bureau of Economic Affairs as $18.6 trillion as of the end of 2016, or about 25% of the world GDP of about $76 trillion. (The next closest nations are China, Japan, and Germany, which added together have about the same as the U.S.)
GDP measures consumption of goods and services and is the standard measure of the size of an economy. It is a highly studied statistic and the basis for a significant body of public policy and private decisions. But, GDP, at least in the U.S., is less than half (42%) of the story. Another federal agency, the U.S. Census Bureau, reported that as of December 2012, Total Receipts of U.S. companies was about $40.5 trillion ($44 trillion as of December 2016, adjusted by change in real GDP), more than twice the figure for GDP. This other $25 trillion is largely hidden, and is not deeply studied, as is GDP. It is not the center of public policy discussions. It is the “hidden half of the economy”.
Which number is right, GDP or Total Receipts? Actually, both. GDP measures end-user consumption, while Total Receipts measures total sales along the supply chain. Consider, the mine sells ore to the smelter, which sells to the foundry, which sells to the fabricator, which sells to the automobile factory, which sells to the dealer, which sells to the consumer. Only the final sale to the consumer is counted in GDP, while each sale along the supply chain is counted among Total Receipts in the Census report.
Which is more important – GDP or Total Receipts? Perhaps GDP is more important for measuring the overall size, growth, and vitality of the economy. But, focusing only on GDP and ignoring the hidden half masks a very important aspect of the economy – “Who carries the credit for these sales?”
This aspect of GDP versus Total Receipts is significant because “who carries the credit” is an important determinate of how fast the economy can grow. In understanding why this is important, one needs to look at the components of GDP and the role that credit plays in its growth.
About 70% of GDP ($13 trillion) is consumption by individual households (“consumers” – frequently called “B2C sales”). About half of consumer purchases are made on credit, with roughly 40% of this on credit cards, and the remaining credit in other forms, such as automobile loans and home mortgages.
More than 98% of this “consumer credit” is carried on the balance sheets of financial institutions and the capital markets. This figure has grown from about 50% in the past 70 years, primarily due to the additional credit available to consumers through the credit card system, which allows an instant, point-of-sale transfer to a financial institution of the sale on credit. The economic impact of this innovation is that the purchasing power of a consumer is no longer limited to cash on hand and the credit offered by a few retailers, but to the amount of credit financial institutions are willing to advance through the credit card system.
The 30% of GDP (about $6 trillion) attributed to business and government end-use consumption plus the other $25 trillion or so of Total Receipts not in GDP (the ‘hidden half’) total about $31 trillion of sales by businesses to other businesses (B2B) and to governments (B2G). These are collectively referred to as B2B sales. Almost all of these sales are made on credit carried by the business selling the goods or services. This is called “trade credit” by the Federal Reserve Board.
So, while roughly $6 trillion of B2C sales is carried (funded on the balance sheets) by financial institutions and the capital markets, more than $30 trillion of trade sales (B2B) is carried on the balance sheets of the B2B suppliers, the businesses selling to other businesses and government customers. This issue is further exacerbated by the fact that about one-third of B2B sales are made by small businesses (about $11 trillion), which have a very limited ability to transfer their trade credit burden or funding to others.
The U.S. economy has grown dramatically during the last 70 years – since the end of World War II. Real per capita income has increased more than four times. A significant factor in this growth was the transfer of consumer credit from the balance sheets of retailers to the balance sheets of financial institutions through the credit card system. Today, with more than 98% of consumer credit already carried by financial institutions and the capital market, we need a new economic accelerator.
Imagine what would happen if trade credit (about $31 trillion supporting about 70% of Total Receipts) were to be moved from the balance sheets of businesses to that of financial institutions and the capital markets. Would the economy show the same surge in growth that was facilitated by the transfer of consumer credit for the past several decades?
A ‘sea anchor’ is basically a cone-shaped bucket that is dragged behind a boat to slow its progress through the water. It does not hold the boat in a fixed positon, but rather permits some forward progress, albeit slowly. Trade credit on the balance sheet of businesses is like a sea anchor that, if cut free, would enable the transfer of trade credit to financial institutions and the capital markets, thereby accelerating the U.S. economy.
If this transfer were to happen, the growth of businesses would no longer be limited to their balance sheets, but by the balance sheets of financial institutions and the capital markets.
How this transfer might be accomplished and who is attempting to do it is the subject of future articles.
The Impact of Outsourcing Credit to Financial Institutions and the Capital Market
Originally, Sally had $100 of in-store credit with the local department store. Today she has $10,000 in credit via credit cards that can be used at the local department store, the grocery store, the auto repair shop, or virtually any retailer in the US. As a result, while Sally continues to use credit to purchase her clothes, the department store no longer has to carry the credit. Because Sally pays with a credit card, the store gets paid immediately and can afford to purchase more inventory. Sally now gets more credit and now can use that credit card in multiple locations. So, she is able to purchase more, the stores are able to purchase more and hire more people, etc. The multiplier effect rolls through the economy.