(This is Part 3 in a series. Go back to Part 2.)
When a drug addict first takes his or her drug, be it heroin or alcohol or crack cocaine or methamphetamine, there is a "high" of pleasure and power. Though no nutrition is being added to the body, it feels as if the body has found a new source of energy and pleasure.
It is the same with money and credit creation. Though no new value is actually being created, an injection of money and credit into the economy causes economic activity to surge forward with what seems like new power.
But eventually, as the addition takes hold, the addict requires larger and larger injections of the drug not to feel good, but simply to avoid feeling bad.
And so it is with money and credit. As the addiction to artificial stimulus takes hold, the economy requires larger and larger injections of liquidity just to avoid imploding.
That is what is happening now. Goosed by the largest fiscal and monetary stimulus in history, the U.S. economy still struggles to recover from its "jobless" recession. Yet the credit just keeps piling higher and higher, like the waves of water in The Sorcerer's Apprentice. Consider:
In the 1990's, household debt rose an average of $342 billion annually, itself an astonishing number. Yet in 2002 household debt rose by a blistering $735 billion. And it didn't stop there, because in 2003 household debt rose by
nearly 1 trillion dollars. Notice the acceleration?
And this phenomenon is not confined to households, of course. The federal government is now piling up debt at the rate of half a trillion dollars per year, and that is with interest rates at the lowest rate in nearly half a century.
What happens when interest rates rise, as they inevitably must in order to entice foreign investors to keep loaning the U.S. more and more money? Answer: Government deficits will explode to heights unimaginable now.
Meanwhile, states, cities and municipalities are struggling with the largest deficits and debt loads since the 1930's,
and that's while the economy is still in "recovery" mode. What happens if the economy spirals into a depression from here? Answer: Widespread municipal bankruptcies.
Or what about the financial sector itself? Banks are enjoying record profits, buoyed by a booming business in the "carry trade." That is, banks are borrowing short-term money at 1% or so and then lending it out long-term at 4%-5%. But what happens if short-term interest rates rise above 4%-5%?
During this process Bank Credit has been increasing at a phenomenal rate of about 9% a year, resulting in greatly increased leverage. Bank reserves have now declined to an all-time low of 1%, meaning that for every dollar you deposit in the bank the bank keeps one penny and loans out 99 cents—because it's so profitable!
But this creates a tremendous multiplying effect, because the 99 cents that is loaned out gets deposited in another bank, which then loans out 99% of that and so on, vastly leveraging the amount of credit in the system. But what happens if the Great Credit Bubble begins to deleverage?
And all this is not just a U.S. phenomenon. Consider that Rest-Of-World Credit Market Instruments were up 20% last year, a torrid pace. Liquidity is being flooded into the system in China, Japan, India, Russia, Britain, Germany, France, Italy, on and on...
Nothing less than a Global Credit Bubble is taking place, on a scale unparalleled in history. But a global economy predicated on consumers, governments and businesses going further and further into debt is unsustainable.
(This is the end of Part 3. Go to Part 4.)
—jim sloman, 3.27.04 for Mar 29
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