POST OF THE DAY
Macro Economic Trends and Risks
Credit Contraction and the Economy

Related Links
Discussion Boards

By EddieLuck
August 8, 2007

Posts selected for this feature rarely stand alone. They are usually a part of an ongoing thread, and are out of context when presented here. The material should be read in that light. How are these posts selected? Click here to find out and nominate a post yourself!

At the present time it must be remembered that in a credit-based economy, the amount of credit in circulation has to expand at an ever-increasing rate for the economy to expand. This is because old credit is constantly being paid off and the interest payments to the credit providers are constantly rising.

Mr. Bernanke seems to be taking his job rather seriously in that he seems to have read the ground rules for the Fed which state that the purpose of the Fed is to regulate price inflation and employment. He and the other Fed governors understand this and are only responding to other factors such as the dollar exchange rates in so far as they are perceived to be presently influencing one or the other of their two objects: inflation and employment (I & E). They are not acting on the future effects of current trends; just on the current trends in I & E.

Therefore, the Fed is not inclined to act proactively against trends that may influence I & E in the future. That is why they did not act today. They have all absorbed a megalomaniac mindset that they can fix things as they occur. This fact is borne out by Mr Bernanke's signature work on the Great Depression of the 1930's and his ideas of how it could have been prevented. What his work does not take into account is how human fear and credit contraction feed upon themselves and create conditions which are anomalous to his baselines, much as human greed and credit expansion feed upon themselves to create the conditions of excess credit and hubris that resulted in the credit bubble that is now starting to implode.

By the next Fed meeting it will be far too late for the Fed to stop a downward spiral. Today would also have been too late IMO because I believe we have already reached, and passed, the point where credit expansion can continue expanding exponentially. Credit issuance has now slowed and is probably contracting already. Ergo, the economy is contracting. The Fed is really helpless at this point because at the very best, drastically lower rates could only have prolonged the credit bubble a little longer. The spiral has started. The Fed is too late, if you want to put it that way.

Credit penetration into all sections of the economy is already substantially greater than it was in 1929, and as my previous post explained, we do not have the cushion of money that we had then. It's basically all credit now.

I fail to see how the Fed and the banks will be able to entice this economy to keep expanding its credit consumption at this time. Remember how in Japan circa 1955 they tried Mr Bernanke's helicopter approach in the form of sending out free shopping vouchers to their citizens? It didn't work because they were a form of real money, which people save in deflations. People just saved them.

My analysis says that Mish was and is right. Our economy is contracting and will inevitably continue to do so until we are in a radically different position. I am sure that the rest of the developed world will join us on the way down.

It's been a great ride. Now we have to pay for it.

Good luck,

Ed.

 


Become a Complete Fool
Join the best community on the web! Becoming a full member of the Fool Community is easy, takes just a minute, and is very inexpensive.