(This is Part 33 of a series. Go back to Part 32.)
The same phenomenon can happen in the financial world; indeed, it is happening right now.
A society that is simply financing productive investment out of savings need never experience bubbles and crashes, booms and busts. There will be minor fluctuations due to changes in individual sectors, but the general price level will remain stable.
The "business cycle" begins when the money supply is artificially inflated. This can happen, as in the Roman Empire, through the debasement of coinage, but in the modern world it happens through the creation of credit.
New credit can enter an economy through a number of different sources, but primarily it enters through credit-creation by banks. This includes, of course, the Central Bank of a country, which in the case of the U.S. is the Federal Reserve System.
It also includes bankers' banks such as Fannie Mae and Freddy Mac, which have injected gigantic quantities of credit into the U.S. economy lately through monetization of mortgage operations. This is, of course, on top of the Fed's own prodigious efforts towards "easy money" and, let's not forget, banks and finance companies offering credit like there's no tomorrow.
Through similar institutions and operations on a global scale, the world has embarked upon a truly historic credit bubble, the largest ever by any measure we'd like to use. And, naturally, there are subsidiary bubbles in stocks, bonds, real estate, etc.
The effects of "easy money" on an economy at first are exactly the same as the effects of "easy stimulation" from cocaine or crank at first. The economy "feels good", it's "high", it's at level 150—business is flying. This is the primary effect.
Meanwhile, underneath the surface, serious problems are building. An environment of "easy money" means that various malinvestments are occuring; projects are being funded that are fundamentally uneconomic, but that seem viable in the "easy money" environment.
As this process continues the economy becomes more and more distorted and dragged down by both malinvestments and the accumulation of debt. Thus, the economy "adapts" to the drug—just as the brain does—so that after awhile more and more of the credit drug is needed just to attempt to feel "normal" (level 100).
This is the point where the economy is wheezing and stuttering even though larger and larger amounts of credit are being injected. This is the point where we are now.
This is the secondary effect.
Eventually the credit creation must stop. The distortions become too great, the servicing of the debt becomes too onorous, consumers and businesses and even governments become leery and a bit frightened of adding on more debt. With good reason.
Once the merry-go-round stops, once the credit creation stops it's like withdrawing the cocaine—the economy goes into a recession or depression (level 50), the purpose of which is to correct the distortions of the previous inflation.
If left alone, this process tends to be intense but relatively brief and the economy is restored to a baseline (level 100) which can be sustained indefinitely so long as the society saves and invests its savings productively.
Often, however, government doesn't allow this corrective recession/depression process to function properly. At the first sign of a downturn a clamor arises on all sides for the government to "do something". And often, government obliges by arranging for even more of the credit drug to be injected into the economy.
This temporarily corrects the symptom; the downturn now aborts and an "upswing" begins again. But of course the fundamental cause of the malaise—too much credit—isn't being addressed. In fact it is becoming worse, so that now the resulting recession or depression will have to be that much deeper to correct the new distortions.
If this process of credit-creation goes on too long without being allowed a corrective depression, then the process at last accelerates into a parabolic stage where an inflation and then hyperinflation of prices occurs. This is similar to a cocaine addict going on a manic binge where hit follows hit follows hit—whee!
...followed by a complete collapse. A hyperinflation is always followed by a depression. More, hyperinflation-then-depression is much worse than a simple depression because a hyperinflation destroys the currency—the very lifeblood of the economy. Thus the ultimate collapse is
far greater.
It's actually better, then, to let recessions or depressions happen when they want to and leave them alone. Like so many "negative" things, they are corrective processes used by nature to restore a viable and sustainable level of well-being. We do well to humbly respect the deep wisdom of nature and her mysterious process.
(This is the end of Part 33. Go to Part 34.)
—jim sloman, 10.28.04 for Jun 19
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