Monday, April 5, 2010

Debt and Deflation

I checked some figures relating to general indebtedness in the US and the numbers are quite startling. Household net worth were the dollars under discussion and in reviewing bursting bubbles of times past one notes that what seemed at the time to be a disaster was a mere blip compared to recent housing downturns. In the year 2000 household net worth in the US amounted to 42.5 trillion dollars. The cot com bust knocked off 1.6 trillion of that. Which sounds bad enough, God knows. Then check out the increase in household net worth during the housing boom years.

In the five years leading up to 2007 net worth increased by almost sixty percent from 40 trillion to 63 trillion dollars. Those were the happy days when we were told our homes were the equivalent of ATMs and were available for exploitation by way of home equity loans. Even those of us who declined the offer of easy credit still found ourselves in a world of apparent wealth. I never did understand how all those second mortgages would get paid off and I was scared away from increasing the debt carried by my house. But, even so, I never imagined a general, world wide collapse as a result of those ruinous debt policies. The encouragement to overburden oneself with debt was never a good thing. Unless were in charge of countrywide and raking in the bonuses...

The reckoning came in 2008 when it seems household net worth lost eleven trillion dollars in that disastrous sudden downturn. That was when everyone stopped spending money and banks stopped lending money even as they collected free taxpayer bail out cash. Finally Americans started saving what they could and setting aside money that previously was spent like water. The odd thing is that we are told that 70% of the US economy is generated by consumer spending. Yet, instead of helping consumers out with twelve trillion dollars of leveraged money, the Federal government throws it at the big banks who promptly declare a profit, reject any attempt at regulatory oversight and continue the fatal credit default swap policies that got us here.

If one listens to the gloomy section of the economic commentators there is half as much wealth destruction to come- another five trillion dollars of reduced home values. The stock market we are told is grossly over valued and likely to drop by as much as thirty percent even as commercial real estate loans made before the crash start to come due and will find themselves unable to re-finance. All of these negative prospects are reinforced by the generally gloomy view of a population that now seems to be busy not spending money. We are, most of us, declining to make large purchases which means that foreign countries that traditionally supply our every need find their factories stalled because they have no consumers to supply with "durable goods."

Add to all this the concern that countries who usually buy our debt are now slowing down those purchases and we find a future that looks much more bleak than the mainstream press would have us believe. If interest rates have to rise to persuade China and Japan to buy dollar debt there will be additional pressure on our economy. Yet the argument goes that the Federal Reserve cannot physically print enough money to revitalize our economy. The actual supply of cash seems likely to shrink, meaning there will be fewer dollars available to buy products. Which is the classic conundrum of the 20th century Great Depression, when cash money simply was not to be found.

At the time of the Great Cash handout to the banks Too Big To Fail, I wondered out loud why our leaders didn't simply use the twelve trillion to pay off first mortgages on all primary residential loans. Had they done that a handful of huge banks would have gone bust and served them right for creating this mess, while the US economy, consumer driven, would have sparked back to life, perhaps wiser and more cautious. Instead we are serfs and pay the price for the gambling by our economic leaders. I am inclined toward the position that deflation will murder our economy for years to come not least because the people in charge seem to benefit most from this terrible cycle of unemployment, mortgage destruction and general impoverishment. We seem to be along way from the days of having a government that responds to the needs of the people. I wonder what FDR would say about our current situation and the government's response?


CrisisMaven said...

This "fear of deflation" is largely nonsensical. Deflation does not keep people from spending – they always spend what's necessary. And money NOT "spent" is then saved which means it is credit to someone who invests it for capital goods etc. thus it is again being spent, only not for consumption. Money never lies completely idle to any extent whether there's inflation, deflation, stability or a solar eclipse. For deflation to seriously happen, not only the current extreme credit expansion by the central banks and states (through "quantitative easing", stimulus packages, monetising and then spending national debt etc.) but also the money that was released into the economy PRIOR to the collapse would have to be "mopped up" again. This is nowhere to be seen nor would it be technically possible (confiscation aside) so we will rather see inflation than deflation.

Jimmy Carter Econ 101 said...

CrisisMaven speaks wisely here. The money supply increases / easy credit by the Fed to the banks will come back to haunt this country in ways far more insideous than the current crash - inflation - which will lower the average persons std. of living.

The Manchurian President is either too impotent or ill informed to step into the breach and do the right thing.

Conchscooter said...

I am strictly on the fence when it comes to the deflation/inflation debate. I expect the people in charge will pull whichever string suits their purpose at a given time. It's a debate worth returning to. I don't think President Obama is ill informed but he certainly appears to be impotent.