ARE WE ON THE VERGE OF A CREDIT COLLAPSE?
When Janet Yellen recently decided to not raise interest rates from 0% to 1/4%, it brought about much debate about why this decision was made.
Wall Street wanted the raise so it would send a vote of confidence that the economy was improving and asset prices could be bid up further.
While this may have temporarily had that effect, higher rates would encourage more flight to U.S. Bonds etc. and possibly raise the value of the dollar further. With the dollar at all time highs against other currencies. U.S. manufactures and exporters are at an extreme disadvantage now, One example is Caterpillar, sales are falling and layoffs are increasing.
A little history, the idea of Keynesian economics is that when an economy slows , lower interest rates, encourage borrowing, and it will stimulate an economy, While if inflation increases, raise rates, to slow economic expansion.
While this is somewhat oversimplified, it has been the basic tool of the Federal Reserve since WW2.
Couple this with what used to be part of basic economics, something called ,The Business Cycle, It was a cycle usually lasting from 7 to 10 years where the economy expanded, debts increased, then prices increased, sometimes some shortages started to appear, interest rates were raised, the economy slowed, risky or speculative investments failed, bad debts liquidated, followed by a resetting and then the next expansion.
Kept some discipline and fear over debt in everyone's mind.
Again an oversimplification but the basic idea.
Our Money has had no backing by assets since 1964, and our last Balanced Federal Budget was 1969. This has allowed Federal spending and indebtedness to go unchecked.
In the 1970s we had several recessions caused by oil shortages, caused by oil embargoes from the middle East. They were relatively short in duration but under President Carter and Arthur Burns the Federal Reserve over compensated and inflation soared to double digits.
Toward the end of his term Carter replaced Burns with Paul Volker, Reagan was elected in 1980, interest rates were raised to 17%, In 1981 we entered a severe recession, with a recovery taking hold in 1983. followed by over 17 years of lowering interest rates and economic expansion. Interest rates finally settled to around 5 or 6 %. The period was an expansion with stable inflation and steady growth.
While there was a slight downturn in the early 90's, and the nasdaq collapse in 2000, which was basically caused by over purchasing of computers for Y2K. and the inevitable decline of that market when demand collapsed.
It retrospect it became the policy of the Federal reserve under Greenspan and Bernanke to immediately lower rates and stimulate spending and debt whenever there was attempt by the market to correct and wash out malinvestment and bad debts.
By refusing to allow the normal business cycle to run its course, Debts began to build in all sectors of the economy, Federal, State, Corporate, Mortgages and personal debt.
Then came 9/11/2001 . The government flooded the economy with easy credit. And the quickest and easiest way was to subsidize mortgages through Fanny Mae. Force banks through laws such as the Community Reinvestment act to make unsound loans.
I recall in 2004 or 2005, the banks were paying 5 to 6 % on a 1 year CD and you could get a 30 year mortgage with no down payment, for 5%. Anyone who cared knew that something was wrong..
Since sound minded Local Banks were not enthusiastic about holding these loans , they were sold to Fanny-Mae, other Govt. Agencies and Wall street, who bundled these mortgages into investment packages. Real-estate Mutual funds etc., some paid handsome dividends.
We know that banks and wall Street were encouraged to do this by the Community Investment Law. but I also wonder if they were not also assured that they would be protected if things went wrong.
Real-Estate boomed, priced increased on existing homes by 50%, in very short time. Houses sprung up like mushrooms in the fall. Everyone was either buying, flipping or investing in real-estate.
The economy also boomed in anything to do with housing, furnishings etc.
Commodity prices soared, copper went from &1.00 lb. to $4.00 plywood from $6.00 a sheet to $12 to $15.00. I recall these prices because I was building a house before this went crazy and was aware of the increases.
Finally oil hit $150.00 barrel, gas to $4.00 a gallon. and people who had over purchased houses began to be squeezed by the higher prices and could no longer manage their debts.
The first to implode was the so called sub-prime loans, these were loans that should most likely never have been made.
It set off a cascade, as Real-Estate prices declined , more people went underwater, and a viscous Credit Collapse was started.
It all came to head when exits from money markets and the stock market reached a point were in a few days it would have been irreversible. Government stepped in and insured all funds up to $200,000. and helped to halt the carnage.
I remember watching Bernanke explain, that the answer was to stimulate the economy with easy credit till asset prices recovered.
Rather than let controlled and systematic bankruptcies to eliminate the bad debts and investments, the decision was made to keep increasing debt, rather than endure the pain.
Interest rates were lowered to 0. and here we are today.
Now 8 years later we are still at 0%.
We have seen QE1,QE2,QE3, and now there is talk of QE 4 . although it has not really accomplished anything but run up the stock market, the bond market and the debt of every country in the world.
Quantitative easing is nothing more that the Federal Reserve making a book entry from the Fed to the Treasury Department for Trillions of Dollars of Debt, or buying Treasury bonds. Of course the Federal Reserve creates these Trillions with a stroke of a pen. Common sense tells me that this is just crazy stuff.
The other thing talked about by some , Citi Bank President, Swiss treasury officials and many other economists, is an attempt to go to negative interest rates. Where bank deposits would be taxed in a slow economy and sales taxed in an overheated economy. This would necessitate the elimination of cash to stop people from withdrawing their money to avoid the tax.
Citi-bank would love if they could get 2% on every transaction and Government could view every transaction.
I guess we would all need a smart phone and a card reader, even to go to yard sales or bake sales.
I do believe and hope there will be overwhelming resistance to this.
It seems that every country in the world is in a slow down and heading to a recession., Commodity prices are declining, creating job losses in natural resources and in equipment sales.
Real-Estate has recovered , but is still not to pre-crises levels even with 3.5% mortgages.
Government Debt has exploded , China has debt of 300% of GDP, Japan $200 % of GDP, USA, 110% of GDP, all higher than Greece's debt levels.
There has been a race to the bottom in most countries to lower the value of their currencies to increase exports, and yet there sales are declining.
Retail sales in most of the USA have been flat or down.
The world is saddled with excess debt.
It will start with defaults in emerging markets, followed by bankruptcies expanding around the world.
With interest rates at unheard of low levels, stimulation by lowering interest rates, and increasing debt will not be the answer.
It looks more and more that the market will rule, and the real answer is to allow the laws of finance and money to do its work of eliminating excessive debts and bad investments. This will now be very painful and prolonged, but it is probably inevitable.
We will need Governments and Politicians to be honest and clear , and if they are credible they can gain the trust and cooperation of the nation and we can overcome this.
If they promise quick fixes and more bail-outs, and intervention. it could be decades of decline and unrest worldwide.
I
