(This is Part 4 of a continuing series. Go back to Part 3.)
This is the situation we're in—more and more credit, but with less and less effect as the economy struggles and the labor market tightens. This Alice-in-Wonderland drama is destined to end with a world-wide crash as the blowoff stage of the credit bubble begins to outrun the ability of consumers, governments and businesses to service their enormous debt.
As the bubble begins to reverse itself, the immense and self-reinforcing leveraging that helped to propel it on the upside now begins to work in reverse, creating a vast and increasing deleveraging on the downside.
As asset values fall and loans are called, "money" seems to disappear. Indeed, the common complaint in all such crises is about a "shortage of money". A liquidity squeeze sets in and the economy plummets towards depression, as happened in the 1930's and is destined to happen again, only on a larger scale (because the bubble is much larger).
Now let's step back and look at the larger principle. Artificial juicing of the economy with more and more credit is the primary effect. The secondary, long-lasting effect is a depression caused by a collapse of the over-inflated credit bubble.
If we want to grow an economy and we're looking at causes, we're going to be looking at boosting education, worker retraining and consumer and government savings.
Instead, the savings rate is now the lowest in history at 1%. The educational system is crumbling from lack of investment. Businesses are making investments overseas rather than here. Our continuing orgasm of consumption is basically being financed from abroad, from East Asia. Foreign reserves in the Asian countries have risen from 25% to 50% in the last 12 months, a frantic rate.
Basically, this is vendor financing (from Asia to the U.S.) on the largest scale ever seen. Asia is collecting lots and lots of paper and in return sending us lots of real things like cars and TVs and clothing. Meanwhile the American consumer and government go deeper and deeper into debt to keep the wheel going.
How long can this go on? It's anyone's guess, but I doubt that it can go on much longer because signs of strain are starting to appear. Bankruptcies and credit card defaults are at all-time highs and climbing. Auto inventories are huge and climbing. Wal-Mart, to me the basic indicator of consumer condition, is reporting lower sales and sounding pessimistic.
But housing is the key. Studies have shown that housing affects the economy far more than the stock market. If housing falls, the basic asset holding up the whole debt pyramid crumbles. People think that housing prices can't really fall, yet they fell 80% in the 1930's and didn't recover for 25 years.
Housing inventories are now starting to climb in Britain, Australia and parts of the U.S. Many recent mortgages have closed with little or nothing down and will quickly be underwater if interest rates rise—as they inevitably must—and housing prices begin to fall. That is when the great unravelling will begin.
To sum up, the U.S. economy has been growing for the last two decades basically through stimulations of credit rather than through growth of savings and productive investment. Consumption has been rising well beyond income for a dozen years now.
That is, we've been concentrating on the symptom—more consumption (from greater indebtedness)—rather than the cause—greater societal savings. And the end result will be the same as a body that finally descends to exhaustion from repeated doses of "energizing" stimulants.
(This is the end of Part 4. Go to Part 5.)
—jim sloman, 9.19.04 for Jan 9
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