(This is Part 2 of a 2-part article. Go to Part 1.)
Eventually what happens is that the amount of debt begins to strain the ability of borrowers to service the interest and principal on the debt. At that point the system has greatly over-extended itself. In the Great Global Debt Bubble this time is approaching with consumers, business, industry and government at all levels.
The current situation is by far the largest credit bubble in history, and so the piercing of it will be equally historic—also the largest in history.
As credit defaults and asset-selling to raise cash begin to mount, strains in the credit bubble begin to show, first here, then there. But down the road such strains begin to show up everywhere—in falling stocks, bonds, real estate and contracting economies.
Just as the credit expansion on the upside feeds on itself, so also the contraction on the downside feeds on itself, though it happens more rapidly. Contraction occurs more quickly because it is based on fear, a faster and more panicky emotion than the greed which fed the upside.
As more defaults or "restructurings" of debts begin to occur, creditors become more conservative in their lending. And production decreases as businesses are increasingly unwilling or unable to borrow money to finance expansion.
Decreased production, in turn, leads to falling wages and tax revenues. Consumers, businesses, governments, etc. begin to feel pinched. And as confidence and production decrease, the credit expansion begins to unravel, only this time on the downside.
This brings a steady decrease in financial asset prices—first in stock markets and later in bonds and real estate. As asset prices decline, people put off asset purchases to wait for prices to become lower still. Businesses are affected and the whole credit expansion now unravels, again feeding on itself but this time in reverse.
Once the credit bubble goes beyond a certain point the resulting collapse becomes inevitable. The one cannot happen without the other. It is much larger than the ability of any government—or all governments—to contain it. Just as you cannot have outbreaths without inbreaths, credit bubbles cannot occur without credit collapses.
This process can look like a one-way street for awhile because the expansion phase takes so much longer to occur than the contraction phase.
Inevitably the contraction is blamed on some precipitating event such as a general strike or the failure of a mammoth firm, etc., but such precipitating events do not cause the contraction. Rather, the contraction itself—caused by the previous expansionary excess—precedes and creates the conditions for social and political upheaval.
Such cycles have been going on for a long time. They are as much a factor of life as summer and winter, or day and night. Just as markets cannot advance further without first "digesting" their advance, so the same is true of credit and economies and the tides of human affairs.
—jim sloman, 10/6/02 for Dec 2
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