Depression Economics Explained, Part 2: The Credit Crunch
People are desperate for an explanation of the economy that actually makes sense. They're not getting it from the experts. My talks with "Norm" are a composite of recent conversations I've had with friends and family about what's going on with the economy. The first installment dealt with "speculative bubbles." Here we turn to the "credit crunch."
Norm: There are a few things I don't understand about this "credit crunch." I heard on the news that cities can't borrow the money they need to fix roads and build schools. The next day I heard a story that corporations are canceling projects because they can't borrow money anymore.
Zack: So what don't you understand?
Norm: This is what confuses me: We are the same people we were a month ago, when we were fixing those roads and starting those projects. How does all that change because of some numbers on some screens in some banks?
Zack: Norm, that's an incredible question. I wish some financial journalists would ask it.
Norm: So you have an answer for me?
Zack: I bet you already have the answer. Are you a different person than you were a month ago?
Norm: I'm not, but my bank thinks I am. They rejected me for a home equity loan to build a second bathroom on the first floor of our house.
Zack: You're getting at something really important about our economy. It's obvious, it's right in front of our faces -- but our (mis)understanding of the economy causes us to look right past it.
In our economy we have given control over decisions -- those roads, those projects and even your bathroom -- to banks and investors who extend or withhold credit. So while a city is physically capable of repairing it's roads, it can't mobilize the people and materials to do it without the banks' go-ahead. In the Soviet Union, the government's central planners chose what resources can be mobilized. In our system, we've essentially tasked the banks with that role.
Norm: So you're saying it's our fault: that if we just saved and lived within our means, that the city would be able to fix the roads and I'd be able to build my bathroom.
Zack: Well, before we get to the alternative, let's just make sure we're on the same page about how the current system works. Think about how the banks make the decision to lend or not...
Norm: They look at your income and debt and try to figure out whether you'll be able to pay them back.
Zack: Well, that's what they're supposed to do, but they didn't do it over the past decade, did they? They lent trillions to speculators whose business they didn't even understand. And they lent trillions to home buyers who had nowhere near the incomes needed to pay back the loans. (See Part 1: Speculative Bubbles.)
Norm: Yeah, for a while, they were giving everyone money for everything, no matter how stupid. And now they're doing the exact opposite and not giving anyone money for anything. I have a stable job, and my house is nearly paid off, but they won't lend me $20,000 to add on to my house.
Zack: Right. Because we rely on credit, and because banks and other lenders control credit, they have become the "central planners" of our economy. And it turns out that they're really bad planners.
Norm: Well, they're not "central" planners -- because there are thousands of different players in the market.
Zack: You're right, but they sure do seem to run in a pack, don't they? So the result is sort of the same. But you raise an important point: it's in the nature of packs that they sometimes act erratically.
Norm: And that's why the government now steps in as the central planner.
Zack: But the government didn't step in as a planner. That's what's fascinating. The government is just extending cash and credit to the lenders. They're feeding and sustaining the pack, hoping that it will turn around and run the other way. But there's no guarantee they will.
Norm: But if banks get an infusion of capital from governments, why wouldn't they start lending again?
Zack: Because, if they think the economy is going down the tubes, they want their money in cash just like you do. The banks are acting rationally by not lending. We covered in our last discussion. So the government can give them all the money they want, but it's still up to the banks whether they go back to acting crazy and lending money for everything and anything. They are still in charge of whether or not to mobilize our resources for fixing roads, or building your bathroom.
Norm: So you're saying we're helpless.
Zack: No, there's an alternative.
Norm: You mean saving and living within our means? Then towns and businesses could pay for their roads and projects -- and I could pay for my own new bathroom. You're saying that if we just saved, then we'd have control over our economic lives.
Zack: Well, it's not that simple actually. There are so many other things that could get in your way, even if you were the model of perfect frugality:
- Inflation could rise and wipe out your savings.
- The economy could contract and you could lose your job.
- The U.S. dollar could crash and then all the materials for your bathroom would cost a lot more.
Norm: So your point is that we can never have control over our economic lives and that we have to roll with the punches.
Zack: I didn't say that. My point here is to show that, without even thinking about it, our whole society has taken this radical approach to managing our labor and resources: we rely on banks and other private investors to do it. And this isn't something from the last couple of decades -- this is how most of the world has managed its economic activity for the past few hundred years.
Norm: It seemed to work for a while, didn't it? And are you saying we should go back to feudalism when kings managed our resources? Or you think Stalinist central planning is a better model?
Zack: Of course those aren't better models. But I disagree that the current model has ever worked well or that it's the best possible model.
A lot of upper-middle class people and rich people were happy with the last couple of decades because they got wealthier. I'm all for people living better. But most people in America saw their real incomes fall or stagnate during that period. They also worked a lot harder and had less time for their families.
On top of that, our "planners" spent resources unsustainably. In other words, they trashed the environment which is another way of saying they made a huge mess that we and our children are going to have to work really hard cleaning up. And they invested in industry and infrastructure that now has to be totally dismantled and rebuilt if we're going to stop creating these messes.
Norm: Yeah, I understand all that. But what's the alternative?
Zack: I think we're going to have to get through a few more of the concepts underlying depression economics before we start thinking through an alternative. Until next time...
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It will be a permanent change in the economy of he USA. This is because the impact of transfering our factories to China has been hidden by the easy money spend policies of the last 8 years. Now the consequences of dismantling our industrial infrastructure will be seen full force. The Chinese will not want to buy more bad debt treasury bills and the house of cards will fall to dust.
We have been sold out
This 92 year old remembers how the Great Depression was caused. She wrote a book on it.
http://online.wsj.com/article/SB122428279231046053.html
Before Bush every American could have donated $35.00 and we could have paid the Federal Reserve off and told them to go away.
Now the Federal Reserve owns the USA because of the National Debt.
Another alternative would be the creation by the next government, and that is Barack Obama's Government,of a Federal Bank that will take over on the demand for this kind of sound making sense type of loaning at a low interest,no more than 5%,for those folks with good credit.
A Federal Bank that will be linked to its own money which will finance the fixing of the whole country.
In broad terms, many very bad practices led to the housing and market collapses of the Great Depression. FDR's administration carefully and systematically instituted safegaurds to prevent another housing and stock market bubble. Fast forward 50 years. Mostly Republican administrations systematically dismantled the safegaurds that FDR had put in place, in the name of "the free market." In reality they were opening the door to quick and easy profits in another housing and market bubble, like the one of the 1920s.
Many of us criticised the neo-cons for not learning the lessons of history as they applied to Vietnam. For us, comparisons between Iraq and Vietnam are numerous and obvious.
But there are many lessons from history which the neo-cons have chosen to ignore, and we are now seeing the results of their not learning the lessons of the Crash of 1929. The suggestion that any Republicans will fix the problems they caused by ignoring history and by destroying the very safegaurds that could have prevented the recent economic bubbles, is worse than laughable, it is tragic.
There are still a few good politicians who call themselves Republicans, but they are so few in number that they are statistically insignifigant.
The writer here, like many others, presumes the banks aren't lending because they are simply more risk-averse.
The failure of big banks and the Fed's reporting of contracting money supply suggests that perhaps the banks simply don't have the necessary reserves to do much lending. There's a global "run on the bank" going on, part of a "deflationary death spiral":
http://stevemdfp.blogspot.com/
And this is the heart of the crisis.
well, i know the answer...but i don't want to spoil your book....even if you come to a different conclusion.
i do enjoy reading www.mises.org
Really interesting first chapter.
It lays out the nature of our economic system as one where all real power lies in the hands of private bankers, who make economic policy decisions IN THEIR OWN BEST INTEREST.
Which is why we have a financial bailout of the bankers rather than the economy.
Even if we use ALL the $700BILLION to re-capitalize banks.
If they expect a recession, or worse, they HOARD.
Which should be illegal.
But it is not.
Because the private banking system in this country is self-regulated.
Which is how we got here.
The private bankers took control of this country's economic well-being via the Federal Reserve Act of 1913.
It set up an entirely private banking cabal that has been granted what Martin Van Buren always expressed exactly as THE MONEY POWER.
That is, these private bankers have the power to create the nation's money and to decide where and how that money will create economic well-being, and for whom.
That’s why they’re rich, and we ain’t.
At the time, the democratic-farmer-labor populists were proposing a government-issue, debt-free money system in this country.
So, instead of BORROWING $700 BILLION from the taxpayers on the full faith and credit of the same taxpayers, and giving it to the banks, we the people would create money directly and pay it out for the things we need to keep the economy going.
$700BILLION is still excessive.
Looking forward to chapter 2.
best investment looks like toliet paper. just in case
For an explanation of this economy read The Shock Doctrine by Naomi Klein
Is that book breathtaking -or what.
It's like looking at our own recent history and having it played back before your eyes from an angle we absolutely know without any doubt existed- because we were all there! It's then that you realize that this shadow government that's always been so convinced they have themselves so hidden and insulated from everyone cannot hide from history and the effects that they wreak upon the world and ourselves.
It should be required reading for any government class that really wants its students to be really good Americans knowledgable to what's really going on.
I am for replacing the whole damn money system because I believe it is rotten to the core. I read somewhere that since our money is created by debt, if we were were to pay all our debt back we would be left with no money! If so, I say it is a fundamentally flawed system. I think Federal Reserve system is a fraud perpetrated on the American people. I don't think our Framers had anything like Federal Reserve in mind except perhaps Hamilton.
It won't be zero. it will be in the negative realm.
Who was it that said "If bankers ever gain control of currency the corporations and banks that grow up around them through the process of inflation and deflation will cause the American people to wake up penny-less and homeless on the continent their fathers conquered" or something to that effect.
Banks create money out of thin air that they then charge interest on, the interest is the only wealth created and it is what we pay at every link along the chain of consumerism back to the bank. Through the fractional reserve system of currency, banks never actually have all the money on hand that they say they are worth. when that fraction was taken from 10 or 12 times to 40 times in 2004, it guaranteed that it would take much less to cause a bank to not be able to pay out when ever the money was called upon, thus the credit crisis. These people have cooked the books and leveraged themselves so badly that they can not trust that if they lend money to another bank that that bank will have the adequate money on hand to pay them back, even the next day. Credit freezes because the crooks no longer trust each-other. This does not even begin to explain the completely unknown exposure of banks to the quadrillion dollar derivatives market as in AIG and Lehman.
You did not state one thing very clearly, and that is banks do not want to loan money to individuals because they fear that those individuals will lose their jobs in the future. They already know what the future job trends are going to be and they know it does not look good at all. They base their lending habits on what their analysts see coming down the road. When lenders look at you like they would look at a dead man or woman you know you got problems!
The answer to this is simple. The FEDERAL RESERVE AND LACK OF A GOLD STANDARD. Here's why. The federal reserve acting as a "central planner" has kept interest rates artificially low under political pressure to keep the economy "growing". When the fed cuts interest rates it does so by making money available for lending. This is NEW money that it creates out of thin air with a printing press. THIS IS THE ESSENCE OF INFLATION. So this new money is then monetized in other words its entered as a balance in the books of the federal reserve that they can lend against. But because of the fractional reserve system, if they create 1 billion dollars they can "lend" or create credit of 10 billion. So this "new money" diffuses into the economy and the markets become awash with low interest easy money. This fuels all kinds of malinvestment and risktaking. Since interest rates are low, savings is also discouraged. ALSO since there is all this new money, the value of the existing dollars goes down. So all those who worked hard and have savings and fixed assets LOSE. This is essentially a tax in which the wealth is transferred from the savers and poor and middle class to the bankers and investment houses.
Kill the fed, eliminate personal federal income tax, reduce the size and scope and power of the federal government. RETURN to a GOLD standard
There has been low inflation since the early 1980s. Plus, moderate levels of inflation is good for the economy and allow is to growth. In the 1870s and 1880s, for example, there was deflation where debt became increasingly more expensive causing many folks and businesses to become bankrupt and most folks and businesses didn't want to take out new loans which caused the economy to fall into relatively deeps recessions. If the US was still on the gold standard, we wouldn't have nearly the living standards we've achieved over the past 30 years and we would have had some fairly nasty recessions along the way. In summary, the gold standard would be terrible for the vast majority of people. The system we have now is a liberal one which has allowed the economy to growth and keep us at near maximum employment.
the low inflation was just a paper-over. M3 was "recalculated", residual trust in the currency promoted mal-investment...it was false.
and you have your history completely upside down. sorry, but i've been through 3 deep recessions in my lifetime and now i'm looking at a depression.
and i wasn't born in 1870 either.
www.mises.org
we would have had recessions on the gold standard. but quick and not as deep. it is the federal reserve and our unconstitutional monetary policy that drives what is so eloquently stated: boom, gloom, doom. that has been our cycle for 95 years, ascending more so with the breakdown of bretton-woods in 1971. and now the very crooks are proposing a larger, more centrally controlled system that will do the very same thing - only the boom, gloom, and dooms will be much larger. meaning? the transfer of wealth will be greater. do you know which way it will flow? I do.
To all,
I know a lot of Mises folks are somewhat fond of Alexander Del Mar because of his renowned works on the history of monetary systems throughout the world, and for his commonality with Mises on major points like the fallacy of the fractional reserve system of lending, as practiced under the present federal reserve(private) banking system.
But Del Mar was was clearly among those monetary historians who challenged the wisdom of the Ron Paul and von Mises penchant for a return to the gold standard, or for any requirement for a metal base for any country's money system.
Read Del Mar's presentation on ""A History of Precious Metals".
Read his ""The Science of Money"".
Read his speech titled ""The Story of the Gold Conspiracy""
Read Stephen Zarlenga's ""The Lost Science of Money Book"".
Ladies and gentlemen: The issue of the removal of the gold standard is a red herring in matters of monetary policy.
Had we a gold standard based currency, nothing would have been different, except that those holding gold would have been the primary robber barons instead of the international financial capitalists of the day.
Fractional reserve banking and debt-based money are the cause of today's financial crises.
On this, we all agree with the von Mises libertarians.
But, gold is inconsequential, and a waste of time.
Here's a question: We are supposed to be a rich country, but the government is deeply in debt, the businesses are deeply in debt, and the people are deeply in debt. I used to think the banks had all the money, but now they are going broke too.
So, if we are so rich, where the heck is all the money? How is it that nobody has any?
Businesses are not "deeply in debt." In fact, the balance sheets of American businesses -outside about a dozen of financial companies that have had write-downs - are the best they've been in many decades. This recession is all about the consumer, not about businesses. The 2001-early 2003 recessionary environment was just the opposite, where consumer balance sheet were strong and business balance sheets were weak.
www.jbs.org
www.mises.org
www.silverbearcafe.org
google: money as debt
www.campaignforliberty.com
google our constitution.
it is our money that is bankcrupt...our very fiat currency. that is why people don't have any real wealth. aka - savings. credit comes from savings, not more credit.
That's the problem with capitalism - we all wind up working for the people who have the capital.
And that seems to be the only qualification.
So if the people with the capital turn out to be idiots.....
Not only that, but they have access to ALL of our information and we don't have the same access in return - we are nothing more than financial worker ants - slaves really - to the whim of the Queen banker ants...
How do you figure that, comrad?
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