Credit crisis and the deflating of the 60 year post war bubble

[financeguy]

"Credit Crisis II" by Christopher Laird, FSU Editorial 08/25/2008

Where are we now in the credit crisis, and why isn’t the massive Fed and ECB weekly lending working to loosen interbank lending? Why is the credit crisis not really improving? Where is this going next? We describe what may happen next as Credit Crisis II in this article.

Now that the credit crisis that started in 2007 is a year old, there has been a debate about whether the financial system will recover, or will the Western/world financial system end up like the Japanese financial system after the stock and real estate crashes in the 1990’s. In that case, the Japanese banks more or less carried their tremendous losses for ten years, and Japan entered a mild but painful decade of deflation. To this day, Japan is battling some of the deflationary forces from that time.

The question now becomes, will the Western financial system recover some normalcy, or are things merely going to get worse and the world end up with a financial malaise lasting ten years like Japan’s?

Bankrupt en masse

In effect, this means the Western banks, etc are bankrupt en masse. The only thing propping up the entire Western financial system, and its respective stock markets has been massive ‘temporary’ lending, on an ongoing basis, by the Fed and ECB. Both central banks are beginning to balk at this situation. Even as they are starting to have second thoughts, the Western financial institutions continue to borrow more money than ever on a weekly basis. Why aren’t things loosening up?

Can’t stop or else

And, if the ECB or the Fed stops the emergency infusions, or even admit who the borrowers are, another round of collapsing banks/bank runs ensues as investors flee and pull their money out. In other words, the central banks have no choice but to continue the weekly $30-50 billion or so of infusions each for the Fed and the ECB, or else face a cascade of bank runs around the world.
…And each week the Fed and the ECB are effectively taking on another $30 or $50 billion of the bad assets from the various and sundry financial institutions scattered across the EU and the US. So, week after grueling week, the Fed and the ECB keep adding another $50 to $100 billion of bad assets to their balance sheets, as ‘collateral’ and making ‘temporary’ loans they keep having to roll over and extend the repayment on. Ie, the junk stuff is becoming a permanent resident on the central bank’s balance sheets. If either the Fed or the ECB stop the weekly infusions, quite possibly the entire Western financial system stops dead. And we get a massive world stock crash.

The question now becomes, what happens when these two central banks finally decide they have to let go? You are not going to tell me they are going to keep infusing a combined $50 to $100 billion worth of financial bailouts each week forever? This massive temporary lending certainly has to end at some point.

And even with all this new money every week, the credit system is barely functional anyway right now. And this half dead world credit system is dragging economies downward, as there is less and less and less credit. This is a paltry return for all the bailouts and massive temporary lending.

[melon]

Although I do not think that communism is the answer...

The capitalism is capable of tremendous growth because the capitalist can, and has an incentive to, reinvest profits in new technologies and capital equipment. Marx considered the capitalist class to be the most revolutionary in history, because it constantly improved the means of production. But Marx argued that capitalism was prone to periodic crises. He suggested that over time, capitalists would invest more and more in new technologies, and less and less in labor. Since Marx believed that surplus value appropriated from labor is the source of profits, he concluded that the rate of profit would fall even as the economy grew. When the rate of profit falls below a certain point, the result would be a recession or depression in which certain sectors of the economy would collapse. Marx thought that during such a crisis the price of labor would also fall, and eventually make possible the investment in new technologies and the growth of new sectors of the economy.

Marx believed that this cycle of growth, collapse, and growth would be punctuated by increasingly severe crises. Moreover, he believed that the long-term consequence of this process was necessarily the enrichment and empowerment of the capitalist class and the impoverishment of the proletariat. He believed that were the proletariat to seize the means of production, they would encourage social relations that would benefit everyone equally, and a system of production less vulnerable to periodic crises. In general, Marx thought that peaceful negotiation of this problem was impracticable, and that a massive well-organized violent revolution would be required, because the ruling class would not give up power without struggle.

Now let me state that, although Marxist philosophers obviously stated every critique of capitalism with the presumption that communism was the solution, is it possible that Marxist critiques of capitalism are correct, even if they do not, as history has shown, offer any viable alternatives?

I am increasingly concerned by the fact that wages, for the bulk of Americans, are stagnant or falling, and, as such, "growth" has been almost entirely dependent on endless credit. You can blame business, in part, for not paying people, but you can also blame economics and government for defining "inflation" considerably around higher wages--in other words, giving incentive to not pay people, because it is "bad."

And so you see the real vulnerability over our modern economy. If the credit stops and people can no longer continue to afford additional loans to make up for their poor wages, coupled with the wide perception that a "healthy economy" is predicated on consistent "growth" (rather than holding relatively steady) and government inflation policy that discourages higher labor wages, can this circus be maintained ad infinitum? I'll be bold here, and say that it can't. I proffered the idea early on here in FYM that we were potentially veering toward Japanese-style deflation because of these very conditions. Whether it actually happens now or another generation or two from now is up for history to decide, but I do not believe that our current application of capitalism is sustainable.

I highly think we should reconsider our heavy reliance on credit to make our world go round, and actually consider the revolutionary idea of paying people reasonable wages again. I state this with the knowledge that 30 years ago, it was possible to buy a car with cash and go to a private university for an entire year by merely working a run-of-the-mill summer job; and 50 years ago or so, it was also possible to buy a house with saved cash, as well. Apparently, much of the world existed perfectly fine without credit once upon a time, but now too many institutions feel flat out entitled to profit no matter how little money we actually have these days, and so we have our current mess. One of these days, we'll actually have to get our heads out of the sand and address this unsustainable situation.

[financeguy]

Originally Posted by melon

I am increasingly concerned by the fact that wages, for the bulk of Americans, are stagnant or falling, and, as such, "growth" has been almost entirely dependent on endless credit. You can blame business, in part, for not paying people, but you can also blame economics and government for defining "inflation" considerably around higher wages--in other words, giving incentive to not pay people, because it is "bad."

And so you see the real vulnerability over our modern economy. If the credit stops and people can no longer continue to afford additional loans to make up for their poor wages, coupled with the wide perception that a "healthy economy" is predicated on consistent "growth" (rather than holding relatively steady) and government inflation policy that discourages higher labor wages, can this circus be maintained ad infinitum? I'll be bold here, and say that it can't. I proffered the idea early on here in FYM that we were potentially veering toward Japanese-style deflation because of these very conditions. Whether it actually happens now or another generation or two from now is up for history to decide, but I do not believe that our current application of capitalism is sustainable.

I highly think we should reconsider our heavy reliance on credit to make our world go round, and actually consider the revolutionary idea of paying people reasonable wages again. I state this with the knowledge that 30 years ago, it was possible to buy a car with cash and go to a private university for an entire year by merely working a run-of-the-mill summer job; and 50 years ago or so, it was also possible to buy a house with saved cash, as well. Apparently, much of the world existed perfectly fine without credit once upon a time, but now too many institutions feel flat out entitled to profit no matter how little money we actually have these days, and so we have our current mess. One of these days, we'll actually have to get our heads out of the sand and address this unsustainable situation.

Synchronicity! Not three or four days ago I posted the following on another forum, regarding a thread discussing an article in similar vein:-

I have seen posts by well-educated, middle class, and financially responsible (yes, some still exist!) Americans in their late 20's or early 30's on other forums complain, with some justification, that the things their parents took for granted in the '50's and '60's (buying a house and a car without getting financially over-extended) are nigh impossible for them.

As the author of the piece correctly points out, this has been happening over a period of several decades (remember the 'Generation X' book of the early '90s, where the characters have essentially opted out of the middle class dream by going to live in the desert because they can't afford the kind of lifestyle their parents took for granted?).

Is it that the lax credit standards fed into a kind of vicious circle whereby the cost of housing was driven up, thus leading banks to make the credit standards ever more lax?

And someone else said this:-

Undoubtedly lax credit is a cause, but I was pondering how much of this is caused by the emergence of "dual income households" over the past few decades.

Back in the old days a sensible multiple of house price to average salary would be 3-4 times.
Presumably we are now talking a multiple of 5-6 when dual incomes are taken into account?

It is arguable whether the dual income phenomenon has really caused much of an improvement in the real standard of living.

(... and no, I'm not looking for an ideological debate on whether married women should work or not )

Here is a link to the article:- http://www.prudentbear.com/index.php...y?art_id=10098

[financeguy]

Originally Posted by melon

. I proffered the idea early on here in FYM that we were potentially veering toward Japanese-style deflation because of these very conditions.

I assess that as somewhere between highly possible and relatively likely, at this point.

[financeguy]

Originally Posted by melon

Apparently, much of the world existed perfectly fine without credit once upon a time,.

But hold on. You dismissed Ron Paul's policy of returning to the gold standard as unworkable. Have you changed your view on this?

[melon]

I have seen posts by well-educated, middle class, and financially responsible (yes, some still exist!) Americans in their late 20's or early 30's on other forums complain, with some justification, that the things their parents took for granted in the '50's and '60's (buying a house and a car without getting financially over-extended) are nigh impossible for them.

I should also point out that I do blame our politicians, in part, for this too. I do believe that the right place of government, in theory, is to provide leadership and direction. In the case of our current energy crisis, that means setting the tone, nationally, that it is a top priority, or, quite possibly even, setting a standard, although that can be dangerous if the standard being set is more about politically-convenient populism (ethanol) than an actual solution (hydrogen).

In the case of this topic, though, our politicians--Democrats included--have been useless. Their only solution to this "problem," which I do not think they even seriously acknowledge, has been to blame middle/working class stagnation and poverty on "taxes," which is really just a politically convenient way to ignore the issue. Even if all income was tax free, it still does not change the fact that home prices, car prices, health care, and college education costs are flat out unaffordable under the average American's wage levels, and we are dependent on credit, more or less, for all of it. To constantly phrase this issue as a "taxation problem" is to do all of us a disservice.

[melon]

Originally Posted by financeguy

But hold on. You dismissed Ron Paul's policy of returning to the gold standard as unworkable. Have you changed your view on this?

The trouble with the gold standard, I believe, is whether it is flexible enough to deal with financial crises. Do we see the risk of an economic depression, due to insufficient credit flexibility, to be an acceptable risk? Secondly, since we are so grossly overextended, would a resumption of the gold standard force a fairly severe economic contraction?

I would be interested in your opinion on this subject.

[INDY500]

Originally Posted by melon

I am increasingly concerned by the fact that wages, for the bulk of Americans, are stagnant or falling

Not say that we don't have some economic challenges facing us but I'd like to address a few points. On wages, they are going up but it's reflected not on your pay stub, but in higher & higher healthcare benefits. That's a whole different problem of course. We could mention also that we flat out pay more taxes. Not just payroll taxes, but higher sales taxes and all kinds of "hidden taxes" that are added to the prices of items we purchase.

I highly think we should reconsider our heavy reliance on credit to make our world go round, and actually consider the revolutionary idea of paying people reasonable wages again. I state this with the knowledge that 30 years ago, it was possible to buy a car with cash and go to a private university for an entire year by merely working a run-of-the-mill summer job; and 50 years ago or so, it was also possible to buy a house with saved cash, as well.

This is very true, but 30 years ago most households "saved cash" by not getting everyone a new pair of $125 sneakers every 6 months, or not needing a TV in every room of the house, or eating out once a month instead of several times a week, or having just that one car instead of a two or more, and most importantly, using just 1 credit card which you paid off every month -- in other words, different priorities.
To be sure, it's great that we enjoy a higher standard of living than 30 or 50 years ago but the maxim that one should not live beyond their means is no less relevant today.

[melon]

Originally Posted by INDY500

Not say that we don't have some economic challenges facing us but I'd like to address a few points. On wages, they are going up but it's reflected not on your pay stub, but in higher & higher healthcare benefits. That's a whole different problem of course. We could mention also that we flat out pay more taxes. Not just payroll taxes, but higher sales taxes and all kinds of "hidden taxes" that are added to the prices of items we purchase.

We certainly do pay exponentially more in health care costs, but I have my doubts that our health care has higher "benefit." Twenty years ago, not only would you have had full coverage for you and your family, but you also didn't have to have payroll deductions to have it either. Today? Not only are the payroll deductions increasing year after year, but the coverage is worse and some companies--including my own--have active policies discouraging you from covering your family, whether it be extremely high payroll deductions or a ban on spouses who happen to have coverage at their own workplace. I cannot possibly see how health care is any more of an improvement over the last few decades than the substantially higher costs of housing, cars, and higher education.

This is very true, but 30 years ago most households "saved cash" by not getting everyone a new pair of $125 sneakers every 6 months, or not needing a TV in every room of the house, or eating out once a month instead of several times a week, or having just that one car instead of a two or more, and most importantly, using just 1 credit card which you paid off every month -- in other words, different priorities.
To be sure, it's great that we enjoy a higher standard of living than 30 or 50 years ago but the maxim that one should not live beyond their means is no less relevant today.

Let's face it, though. Nobody can do this today and have enough money to buy even a low end house in a modest neighborhood. And, most certainly, the days of having a summer job and saving the money earned to pay for an entire year of a private university is also impossible. I even doubt that you can do this even for a car. In other words, "living beyond your means" is automatically priced into each of these examples, not to even mention the bloat that we call "health care." If we banned health insurance tomorrow and forced it to be price competitive relative to what its patients could afford, the industry would collapse instantaneously.

And that kind of goes back to the prediction I made several years ago here in FYM, where I was concerned that we were veering towards Japanese-style deflation some day. If the health of our economy is determined by increasing growth and increasing value, and yet, nobody can reasonably afford to continue to pay more and the credit gets maxed out, then deflation is an inevitability. I believe the Japanese housing market, for instance, still hasn't recovered yet (or only recently, as far as I know) to the point that those who bought a house in the early 1990s still haven't seen its value recover to what they paid for it.