Some good work has been done on this subject by a few of my preferred sources, Kevin Depew at Minyanville.com and Mike Shedlock of Global Economic Analysis. Let's take a look:
These are heady times we are living in. Collectively, our national intoxication runs deep and fierce. From moment to moment no one really knows whether to laugh, cry, or do both at the same time, and so the air on the street is juiced with a mildly psychotic hum. I enjoy it, but not everyone is built to handle this kind of environment. This is, after all, the Age of Self Evidence. Don't even think about attempting to verify the facts behind that assertion. It's as right as rain and as true as a tree stump. It is... self evident.
For example, consider the assertion - made almost daily by politicians and monetary policy figures - that all we need to do to end this economic crisis is “kick start” lending and that credit is the “lifeblood of the economy.” These baseless assertions infect news article after news article and are repeated by the vast majority of economists and market pundits over and over again as “self-evident” truths. The Age of Self Evidence.
The reality, however, as noted on Minyanville recently in the article, “Deflation Redux,” is that these assertions are non-sequiturs. “Credit is the lifeblood of the economy.” This sounds reasonable, which is why it’s so easy to value it as self evident.
But think about it for a moment. Lending is actually a function of productivity, and productivity is a function of price. Lending to create productive assets is done by savers who want a decent return. They stopped lending a long time ago, long before this “debt crisis” erupted, because the return for risk wasn’t there.
In place of these lenders, however, there was the Federal Reserve, which has the unique ability to make credit available (i.e. print money) whenever they like, and essentially out of thin air. Fed credit availability, unlike the lending normally made available by savers, is not backed by savings. And so this credit made available by the Fed went to create assets such as houses, strip malls and office buildings that aren't productive. The net result of this has been a massive debt buildup that is now being liquidated, or deflated. When will this debt deflation end? When savers, once again, see a reasonable return for the risk. Unfortunately, this requires prices to come down - a lot.
Depew hits the nail on the head with this analysis. "Credit" is not what creates wealth. Production creates wealth. Credit is a claim on future profits from production. That is what this crisis is all about. We have realized, essentially, that there is not nearly enough production to justify the amount of credit in the economy. For a decade, the most useful way of generating wealth we could think of was to devise new ways in which to create credit based upon a declining amount of production. It had to end sometime.
Mike Shedlock sheds some light on the same topic:
Like Kevin, I had to laugh the first I heard “Credit is the Lifeblood of the Economy”. After it was repeated 20 times then espoused by Congress, the Treasury, and the Fed, and indeed even President Obama, it became more scary than funny.
This is why:
The flip side of credit is debt. Is debt the lifeblood of the economy?
Surely not! It’s not that debt is bad in and of itself. Debt is fine as long as it is going to productive uses or as long as the lending is backed up by savings somewhere. No one can argue that savings should not be lent.
However, the problem is that credit has been extended without savings backing it up to those who had no possible means of paying it back, with leverage, and with “no money down”.
Were it not for fractional reserve lending, this could never have occurred.
Clearly debt is not the lifeblood of the economy. By extension, credit is not the lifeblood of the economy either. Rather it is savings that is the lifeblood of the economy, because without adequate savings, extending credit is nothing but a pyramid scheme that eventually implodes, which is of course what happened.
Amazingly, the “solution” in Congress is to encourage more reckless lending even though there is no savings to lend. This Ponzi financing scheme can’t possibly work, which by definition means it won’t.
These should not be groundbreaking developments. It should be "self-evident" that borrowing ourselves out of this mess is not going to work. Yet this fallacy that we need to "unfreeze the credit markets" is such an entrenched belief among our policy makers that all I can do is shake my head. Or write. Take these examples:
Timothy Geithner, Feb 25th, 2009 in a radio interview with NPR:
...we issued a very powerful statement by the secretary of the Treasury, the chairman of the Fed, the chairman of the FDIC on Monday, and the president has said this consistently. And it's really important for people to understand, which is again, to get the credit necessary for recovery to be firmly established, we need to make sure that we strengthen the system and that these institutions have the ability to provide this critical function. I mean, credit is the lifeblood of the economy. Economies don't work without it, and the necessary path to recovery is to make sure that there is enough confidence in these institutions and they have the resources to play that critical role.
Geithner essentially says that without more debt, the economy cannot work. This is patently absurd.
Think the idiocy is concentrated on the US? Think again. Canadian Prime Minister Stephen Harper suggested the same in a press conference today announcing more billions in "stimulus." A few excerpts:
And let me be clear to you as my fellow citizens:
We will not turn the corner on this global recession until the American financial sector is
Our stimulus plan will help us to sustain economic activity and make transitions but it
cannot fix the problem of the global financial system.
Harper proves here that he has no idea where economic activity is rooted. Building a factory has nothing to do with the American financial sector.
Finally, the Economic Action Plan contains a large number of important measures to
improve the availability of credit in the Canadian economy.
In spite of the strength of Canadian banks, the availability and cost of credit here is being
affected by the international financial crisis.
I will not go into the details.
Seriously though. What possible good will making credit more available do if there are no economic means with which to use it?
We need to start making things again. Having credit to do so does not help make the production of goods economic. What is required are lower overhead levels in conducting business. If widgets are being made in China at X price and Y quality, then there are two ways in which to return that production here: Improve the quality and/or lower the price. But there is no way to compete with the Chinese if we need to pay 5x too much for land to put the factory on, 5x too much for building the factory, and way too much on labour. All of the governments actions thus far serve to prop up the costs of business overhead, thereby making it impossible to make a product for a reasonable price. Even if the quality is far superior, the consumer will elect the cheaper product if the price differential is too great.
Asset prices need to be liquidated, and wages need to adjust to the new economic reality.
Having increased credit availability will not help to achieve either of these things.
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