THE HIGH RISK ECONOMY
By James R. Cook
The tide of monetary history is moving against the United States. For almost a century government has had its way with money. That chapter is now on the last page. With their monopoly on money our government has flooded the world with dollars and poured jet fuel to credit growth until it changed the way we think about savings, prudence and spending. The current glut of consumer borrowing, financial leveraging and corporate debt are the outcome of expansionary policies encouraged by the government.
We are now building to the climax of our loose monetary policies. We are at the point where slowing down money and credit creation is too painful to endure while continuing to turbo charge credit growth promises an even worse outcome. The great Austrian economist, Ludwig von Mises wrote, “Expansion of credit does lead to a boom at first, it is true, but sooner or later this boom is bound to crash and bring about a new depression. Only apparent and temporary relief can be won by tricks of banking and currency. In the long run they must land the nation in profounder catastrophe. For the damage such methods inflict on national well-being is all the heavier, the longer people have managed to deceive themselves with the illusion of prosperity which the continuous creation of credit has conjured up.”
Mises foremost student and a great economist in his own right, Murray Rothbard, answers the question. “Why do booms historically continue for several years? The answer is that as the boom begins to peter out from an injection of credit expansion, the banks inject a further dose. In short, the only way to avert the onset of the depression is to continue inflating money and credit. For only continual doses of new money on the credit market will keep the boom going and the new stages profitable. Furthermore, only ever increasing doses can step up the boom, can lower interest rates further, and expand the production structure, for as the prices rise, more and more money will be needed to perform the same amount of work. Once the credit expansion stops, the market ratios are re-established, and the seemingly glorious new investments turn out to be malinvestments, built on a foundation of sand. It is clear that prolonging the boom by ever larger doses of credit expansion will have only one result: to make the inevitably ensuing depression longer and more grueling.”
A question remains about the degree of today’s credit excess. Is it truly one for the record books or not? Obviously, some credit is necessary for economic growth. Classical economics suggests that no more than the amount of national savings should be used for credit. At the pinnacle of recent monetary expansion, credit stood at ten times available savings. Credit growth to GDP growth was two and a half times what it was in 1929. For every dollar added to economic growth, there was five dollars of debt growth. New York Stock Exchange margin debt soared to $265 billion. Highly-leveraged derivatives exceeded $100 trillion. The economy is now $9 trillion, total debt is $27 trillion. Debt was growing over $2 trillion a year. Corporate borrowing was half a trillion with much of it used to buy back stocks and fatten employee stock options, or to speculate in stocks or to acquire or merge with other companies with an emphasis on raising stock prices. Now all of this is stagnating and turning down. Corporate profits, which were heavily influenced by financial engineering and speculation, have collapsed.
Anecdotally, we know our neighbors have mortgages close to the value of their homes or have borrowed against their equity. We know that credit cards are plentiful, widely utilized and often maxed out. We know that banks and non-bank lenders are trying to be aggressive. Credit standards are relaxed even while credit quality is deteriorating. We know that attitudes towards borrowing have changed. We know we can finance virtually anything today from cosmetic surgery to winter vacations.
This huge growth in debt did not materialize primarily through bank lending but through massive lending by non-bank financial institutions (brokerage firms GSEs, corporations). This multiplies credit and debt without adding to the money stock. Money (liquidity) is the necessary ingredient for repayments. In other words, the money supply has been grossly overleveraged through speculative excess in financial markets and a massive debt buildup by non-bank lenders. These credit distortions contribute to the possibility of a liquidity crisis, debt meltdown and crashing securities markets.
Here’s a likely scenario in this worst of all worlds: The profit decline and the slumping economy triggers a crashing stock market and a plunging dollar. The weakening currency drives up interest rates and collapses the bond market. All asset values shrivel; interest rates climb to double digits. The soaring cost of imports sends consumer inflation into orbit. A dreaded inflationary depression and market collapse destroys the accumulated wealth of the people.
Sounds far fetched? Not at all. Our economic sins are real. They defy ready solutions. Consequently, you can lose enormously on your paper assets. Your retirement and savings plans can be devastated. The government can be overwhelmed trying to cover guarantees and losses, to say nothing of trying to solve its own debt and currency problems. Already, tax receipts are plunging. What passes for economic normalcy in America today is pure folly. Once it begins to unravel in earnest and the monetary authorities lose control, then comes panic.
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