Japan 1990 – Unites States of America 2006

By Daan Joubert

The past as a window on the future

Part 5 of 5

The United States of America: A day of reckoning?

"An increase in the quantity of money or fiduciary media is an indispensable condition of the emergence of a boom. The recurrence of boom periods, followed by periods of depression, is the unavoidable outcome of repeated attempts to lower the gross market rate of interest by means of credit expansion. There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.

The breakdown appears as soon as the banks become frightened by the accelerated pace of the boom and begin to abstain from further credit expansion. The change in the banks' conduct does not create the crisis. It merely makes visible the havoc spread by the faults which business has committed in the boom period.

The dearth of credit which marks the crisis is caused not by contraction but by the abstention from further credit expansion. It hurts all enterprises – not only those which are doomed at any rate, but no less those whose business is sound and could flourish if appropriate credit were available. As the outstanding debts are not paid back, the banks lack the means to grant credits even to the most solid firms. The crisis becomes general and forces all branches of business and all firms to restrict their activities. But there is no means of avoiding these consequences of the preceding boom.

Prices of the factors of production – both material and human – have reached an excessive height in the boom period. They must come down before business can become profitable again. The recovery and return to "normalcy" can only begin when prices and wage rates are so low that a sufficient number of people assume that they will not drop still more."

“Dearth of Credit” by Ludwig von Mises

Do you perhaps hear the hens cackling?

Introduction

Hard words and a tough line in the above quotation: ‘. .unavoidable . .’, ‘. . no means of avoiding the final collapse . .’ and ‘. . not only those that are doomed at any rate.’

The great Ludwig von Mises saw no easy avenue out of a full blown credit binge; there is a hard price to pay for all the fun everyone had had, spending all that windfall money; the politicians being even more gleeful than shop-owners – it is easy to get re-elected when life feels good, when consumers have lots of new things they can afford and retailers sit with empty shelves and full cash registers.

We return later to the von Mises quotation; then we shall find that behind the credit binge lies a change in the fundamental nature of the US financial system and that this change makes a final collapse of the system for all practical purposes inevitable.

So far the discussion has been almost exclusively qualitative – the nature of the situation as it was in Japan long ago and how that unfolded, in comparison with developments in the US leading up to 2006 and extrapolating into the future. Qualitative and subjective –to a substantial degree, the likely consequences (‘unavoidable’, according to von Mises) of observable trends in the US economy rely on a personal viewpoint.

To the extent that the situation is accurately reflected in government and other statistics, optimists see major imbalances being gradually scaled down without an accompanying crisis, later to be followed by sustained growth into a period of new goldilocks years.

Pessimists, on the other hand, see imbalances and excesses snowballing as time passes, if only because the powers that be in charge of policy have their hands tied; at best they can do no more than continue to feed the beast with more credit, more liquidity, in order to buy time, while praying for a miracle to happen. Anything they may attempt to curb the run-away credit excess will trigger the exact recessionary healing process in the economy they have been trying so hard to prevent the past few years.

The corner into which the wise and all-knowing central banks and monetary institutions – so-called according to the widely held and euphoric view of the mid 90’s, with the US Fed and IMF in the forefront – have painted themselves into, has become so cramped the authorities employ public relations measures and false economic data to keep consumers committing themselves to greater amounts of debt needed to sustain their spending spree.

The essay paints a bleak picture for the future of the US – much more bleak than what it was for Japan after 1989, even if the brush strokes used here apply muted colours, more by inference rather than hard and stark, explicit black and white. So, a question remains; can the trends be reversed, stability and normalcy return without great upheaval; without the recession and depression that is so explicit in the opinions expressed so far? With, of course, severe consequences also for the global economy.

A different perspective comes from author Guy de Maupassant who long ago commented the prospect of growing old is most unappealing, but that the alternative is completely unacceptable. Very similar sentiments, I believe, today concern the powers that be in US. Continuing along the current path, for households and the government, piling on more debt on top of an already top heavy credit system to keep it from collapse is unappealing; most unappealing. However, the alternative – to end the debt spree and to begin working down the outstanding debt – will trigger very serious consequences for the GDP, for US business, for the home property market, for the dollar and US interest rates, for jobs and for investors – both the local variety local and, horror upon horror, also for the foreigners. This is – as du Maupassant will understand so well – politically completely unacceptable.

Political suicide, no less.

Therefore, the powers that be – through the PPT with a disturbingly open ended mandate to ‘maintain investor confidence’ (Executive order 12631), and whatever other avenues can be exploited – will do their utmost to keep the markets and economy on even keel. So far they have achieved this with enviable success. However, the edges are now starting to unravel; the move higher in the price of silver and gold – threatening instability in the key precious metals market with its massive short positions and a psychological impact on perceptions of dollar health – shows that control is not total. At least not when there is a limited amount of a commodity that enjoys world wide demand.

This is a rear guard battle to ‘maintain investor confidence’; the objective is not victory; that is out of reach. The aim is an honourable peace, otherwise known as a soft landing.

The question is whether this can be achieved.

Von Mises, as per the quote above, says “No!”

Readers can decide for themselves from what they have read so far and what follows.

Trends

The primary point of departure for this essay is that in a sane and rational world nobody can keep on making debt at a faster rate than the increase in his income. This applies to an individual, a household and a country. Even if the starting point is one with very low debt relative to income and even if income doubles every year; making debt at a faster rate than the growth in income, even if just marginally so, at some point in time runs into a solid wall of reality where one of two things happen: nobody is willing to grant further debt or alternatively, no one is willing to take on more debt, since it is no longer possible to service the debt and repay capital.

Then the world as it is known ends and a new and terrible dispensation rings in.

Even if interest rates fall to zero in order to prevent this from happening, there will come a time when the borrowed capital cannot be repaid in anything approaching an acceptable time frame and no sane and rational lender – or a sane and rational borrower – will think of adding to the mountain of debt.

Of course, if either one or the other, lenders or borrowers – both? – become irrational, the catastrophe can be postponed; but only for some limited time. The even more horrible consequences one could expect should this really happen and the situation be allowed to become even more out of kilter, do not bear thinking about; yet it is a real possibility.

The original intention when starting on Part 5 was to follow the introduction with a series of charts and various statistics to show how dire the situation has become and how much the overall to the economy risk increases as long as the ruling trends continue – in effect they are being sustained by intervention of the likes of the PPT and by misinformation in official statistics and speeches by prominent figures.

This intention changed when, during the writing and pondering on what von Mises had written, it became clear that there had been a structural change in the way the financial system operates. Many people, notably Doug Noland, has written extensively on changes that had taken place. However, an analogy from engineering highlights the degree of risk in a most direct manner. This is discussed later.

We therefore examine only one chart, that of the ratio between household or consumer credit and personal disposable income [The source for the economic data is the St. Louis Federal Reserve.] A small number of minor blips in the data for the disposable income were adjusted to the average value of preceding and following months in order to present a smooth chart.

Text Box:

The credit consists of the total of consumer credit, individual loans from banks and real estate loans from all commercial banks. While this might not be the exact figure for all credit extended to households, our interest is in the trend, not so much the actual ratio.

Following WWII there was a clear increase in the amount of credit taken on by American households – the chart shows the end of that phase, from 1959 to 1965. For the next 20 years the ratio oscillated in a narrow range between 0.35 and 0.4 as people adjusted the amount of credit they were willing to tolerate. From 1985 the ratio increased sharply – for reasons not known to the author – and not even the 1987 Panic showed much effect.

The ratio went through a temporary decline during the recession of the early 1990’s. The data show that this was a period during which the amount of credit remained quite stable while the disposable income continued its consistent climb. This change in trend raises an interesting question: was the lack of growth in credit a result of a recession that started for other reasons, or did the recession result because US households for whatever reason decided at that time not to take on more debt, so that consumer spending was reduced?

From 1995 to 2000 the ratio remained almost constant, despite a sustained increase in total credit. These were the Goldilocks years when household income jumped in tandem with the performance of equity investments. Then, beginning in 2000 as the ebb tide in the markets took its toll, incomes were affected and taking on additional credit was used to maintain the newly accustomed life styles. Interest rates fell and homes were used as ATM’s to supply cash to spend; durable goods were easy to purchase on what the British call the ‘never-never’ and this, combined with special prices on motor vehicles and many other goods, became the kind of temptation that almost nobody could resist.

In this way the economy received a transfusion and the good life rolled on.

The effect of this still current phase on the debt to income ratio is visible on the chart.

One could wonder how much longer that steeply rising trend can continue unabated, in particular if interest rates and the yields of longer dated notes and bonds should increase further, both of which will take their toll on over-extended consumers and home owners. However, the timing of the anticipated event when the trend reverses is secondary to the fact that this is a trend that can not be sustained indefinitely. In fact, the longer it lasts before people decline to take on more debt and perhaps even begin to repay their debt, the worse the outcome will be.

If this unsustainable trend in household debt by itself is not sufficient to convince readers that something has to give and that when the trend changes it would trigger a major re-alignment of the US economy, then no other statistical analysis of the US credit market and examination of other potentially adverse trends affecting the USA will do so.

Readers who have their doubts whether the thesis of a coming credit based collapse in the US can hold water, are advised to search out other reading in this regard. Top of the list is probably the Doug Noland’s weekly Credit Bubble Bulletin at Prudent Bear. If the trends in credit generation of all kinds that he writes about is not enough to scare one silly, then nothing will.

There are many writers who have and continue to comment on the precarious state of the US economy with its major deficits, on mounting Federal debt, on corporations that carry heavy obligations towards their pension funds – and which will be in a worse position if Wall Street should tumble. Readers should visit the following websites where they can read commentary on elements of the US economy and the risk factors that exist.

www.prudentbear.com

www.fromthewilderness.com

www.freebuck.com

www.goldenjackass.com

http://www.morganstanley.com/GEFdata/digests/latest-digest.html

www.financialsense.com

www.dailyreckoning.com

and many others.

Below follows a partial list of the kind of factors ion which to focus attention; factors that could provide the trigger that sets off the whole shooting match.

The ring of dominoes

There have been a number of references to toppling dominoes essay in this as well in the writings of other authors on the subject of the US economy. The dominoes referred to would typically include at least some of the following as well as others not on the list. These factors play their part in the mounting inter-connectedness of the US economy and thereby increases its fragility and vulnerability.

An increasing imbalance between household income and debt, as illustrated above
Government efforts to report lower than real CPI to reduce demand on funds for various entitlement programs and Social Security; ‘cooking’ the CPI figure also has a positive effect on the budget deficit (as per Clinton’s ‘budget surplus’!) and provides a boost for the reported GDP. However, as so often happens, unintended consequences creep in. A lower CPI means reduced consumer spending by people relying on government support as prices escalate much faster than their income (if Social Security kept pace with the CPI as originally calculated, the emolument would be 70% higher – economist John Williams (Shadow Government Statistics) in an interview by Kate Welling.( www.weedon.com). No wonder many aged are said to be reduced to eating pet food; they no longer can afford any better.
The escalating budget deficit – setting new and unenviable records even without off-balance sheet items that themselves are assuming dangerous proportions, with no sign that the trend will reverse in the near future. With US Federal debt having an average turn-over duration of less than 3 years (6 years in 2001), the Treasury is now very vulnerable to increasing interest rates; no wonder the 30 year Bond is making a come-back despite all the hooh-hah when it was announced it would no longer be issued
The reliance of the US on overseas funding of its deficit on the current account. If a country in effect has to run the biggest military budget in its history in order to maintain its position of power despite being visibly and uncomfortably vulnerable to countries that either were or could easily again be counted as its enemies, it is a very sad state of affairs
With consumer spending aspiring to be 70% of the US economy, the health of the property market and the ability of homes to continue to serve as ATM’s have to be very high on policy makers’ priority list. News that in February sales of new homes fell by more than 10% has to make more than a tiny ripple through their planning processes; it would not surprise to hear measures are to be implemented to keep the property market on even keel – perhaps better stated as ‘to maintain confidence among the property investor community’ – to the extent this objective can be achieved by manipulation of facts or decree
Many corporations are doing all they can to reduce the risk of their obligations to their pension funds. With Wall Street near its all-time high the problem persists. Should equities take a dive, it could happen that the Black Hole in one or more of the pension funds exceed by far the market capitalisation of a corporation. How to deal with that issue when it arises could be very interesting to observe; employees and retirees on one hand, share-holders on the other, will form two antagonistic camps with very diverging demands based on self-interest. The courts may well have to deal with a whole gamut af new situations
Vulnerability – life, material, financial and psychological – to more events where nature shows its power in a most disruptive manner

The list could go on an on. It is important to observe that a significant problem in any one of the above areas – or in one of those that are not mentioned here – is more than likely to negatively affect other factors on the list. When they topple as well, affecting others in turn, then far from facing a manageable situation, the full economy slips into a tail spin.

It is left to the reader’s imagination as to which particular event will be the real trigger. If the consequences of whatever begins the final melt down are not clear, spend a little time reading and thinking of the implications of sections of part 4 of this essay again.

Engineering and the nature of feedback

We now come to the promised insight that should provide a clincher for anyone who still hopes for a soft landing. While nothing in the economy is impossible to exclude, there is grave doubt whether a soft landing can be engineered – or a catastrophe averted without force majeure appearing like mushrooms all over the economic landscape.

Engineers know that systems do not operate in isolation. All systems have an effect on the environment and what happens in the environment in turn affects the system. It is a closed cycle that means the system, through its operation, also affects itself. The feedback effect via the environment or even through the operation of the system itself – if that is in the design – can be of a positive or negative nature.

Negative is almost always good; positive is almost always bad.

Negative feedback counters a trend that the system my have away from stability, towards some condition of excess; positive feedback accelerates such a trend. The principles of positive and negative feedback can be easily and simply illustrated by examining what happens when someone takes a shower.

At first, when the person steps into the shower, one assumes that the temperature of the water had been adjusted to the desired level. Over time, the temperature can change for a variety of reasons, which are not important. The reaction to a change in temperature in principle can be positive or negative.

The normal reaction, typical of negative feedback, is to use the taps to counter the trend; if, say, there is a fall in the temperature of the water, one would open up the hot water tap a little further, or close the cold water tap some – or a combination of the two – until the desired temperature has been restored. Similarly, if the water becomes warmer, the cold water tap can be opened further or the hot tap closed a little, or a combination of the two.

Doing so, with due regard for the lag between changing a tap and the effect at the shower head, achieves the stability that is the domain of negative feedback.

Now imagine that the person in the shower is an avid adherent of positive feedback. Let the initial temperature again be adjusted to a desired level. Now, when the temperature of the water deviates from that ideal, the reaction is different. If the water begins to feel too warm, the hot water tap is opened further and/or the cold water tap is closed – or both – positive feedback in action.

This action raises the temperature even further, which elicits another reaction, similar to before. Again the hot water flow is increased or the cold water tap is closed even more, or both actions undertaken. It is not too difficult to imagine the end result – if the person in the shower persists beyond reason with the positive feedback – a badly scalded exterior, perhaps even requiring hospitalization if the thermostat in the water heater has been set high enough so that the water is near boiling.

Engineers rely on negative feedback to prevent machines and systems from being trapped in runaway conditions where their destruction is assured. Even economists know about negative feedback in the economy – expressed as the law of marginal returns. This law is an elegant way of saying that trends in the economy become self-limiting as conditions tend towards saturation. It is the operation of this law that to a substantial degree provides the negative feedback so necessary to maintain an economy as a whole within desirable limits of stability.

Exactly as happens in engineering and under the shower.

An example of positive feedback in an economy

An example of what positive feedback can do to an economy is found in Japan in the run-up to the market collapse in 1990. In ‘A Japanese Tale’ it is recounted how, for reasons that seemed eminently logical at the time, the Japanese government instituted measures that created a climate in which a massive and eventually unstable property bubble was the unintended consequence.

The first measure was an accounting change during the post WWII years of rapid growth to allow frequent revaluation of land. This was to enable fledgling Japanese companies in a world hungry for consumer goods to boost their balance sheets, which in turn enabled them to borrow more working capital in order to fuel their own growth relative to foreign competitors.

The second was an emergency step to prevent a sell-off of over-priced property carrying large and suddenly expensive mortgages during the oil crisis induced inflationary period of the mid-70’s. Instituting an 80% capital gains tax if the proceeds of a property sale were not ‘invested’ within a year in a more expensive property, was like the after-burner on a fighter jet; this ignited positive feedback and resulted in a property binge with no global precedent. Natural inhibiting forces in the Japanese property market were switched off; normal negative feedback was disabled, so that positive feedback came into its own. No wonder that by 1990 the land value of Greater Tokyo was 20% more than the value of the whole of the US – all 50 states of it.

When, in the extreme, natural forces eventually snapped the effect of positive effect – as must eventually always happen – the collapse of the Japanese property market was an unmitigated disaster for the banks. It was only by exploitation of various loopholes in the regulatory system that they managed to survive – as briefly described earlier in the essay.

It will be very interesting to see what happens in the US when property prices finally fall to where many home mortgages are under water. It would be quite surprising if US home owners do not follow the Japanese example and stop paying their installments.

Japan has shown that positive feedback can be equally as destructive in an economy as in any mechanical system or engine.

Negative and positive feedback in the credit cycle

We now return to the subject touched upon in the opening quotation by von Mises.

A major credit binge, inevitably accompanied by all manner of excesses and imbalances, always ends in a period of economic healing, in the form of recession or even depression. According to von Mises, the end of the credit induced boom comes about in one of two ways: either the banks become so concerned about the massive issuance of debt they had engaged in that they reduce or even stop their lending, or borrowers become debt weary and abstain from obtaining further loans; perhaps even begin to repay existing loans.

Logic and self-knowledge inform us that should the banks live up to their reputation for being prudent and conservative, they will curtail the amount of lending before the credit boom assumes real crisis proportions. Therefore, when banks act prudently, an incipient credit boom is nipped in the bud with little or no indication that the economy was on the way to become over-heated. In this respect, timely action by a central bank to maintain stable growth through the use of interest rates – reducing rates when the economy cools off; increasing rates when it gets too exuberant – plays an important, even essential, role in maintaining the economy on an even and healthy keel.

In a credit economy, banks that lend prudently, with an eye on risk, and a central bank that employs monetary policy with good effect, provide the absolutely essential negative feedback required to sustain stability in an economy.

Read the above paragraph again and ponder its significance.

If one had to rely on the consumer in pursuit of all the things the heart desires to set the limit to the credit boom, the economy is bound to pass beyond the point of safe return. By the time the consumer realises that he has moved into unsafe credit territory, it is too late. This proclivity to employ an excess of credit is exacerbated if the consumer can purchase goods where installments begin much later after the purchase date. The retailer can smile with satisfaction at the way sales are going, but consumers find when installments come due that they can no longer keep financial head above water.

Then, new credit is sought with which to service existing debt, over and above spending to maintain a desirable life style. When that becomes the rule and not the exception, the economy enters a realm of complete excess and instability that demands the more severe healing process of a depression to achieve eventual full recovery; a mere recession is no longer adequate medicine.

At the time when von Mises penned his thoughts on the dearth of credit, the banks had a strong incentive to be prudent. When a bank made a loan, it assumed all the risk for the money that is lent. If a loan defaulted, the bank suffered a loss. There was thus a good and compelling reason for the bank to investigate the credit worthiness and integrity of a person applying for a loan. When in doubt, rather than assume too great a risk, the bank would decline to make the loan. Also, there was a limit to how much credit a bank could extend and it was only common sense to make the limited capability to lend available to borrowers of good repute.

In this way, risk acted as negative feedback; it mitigated against a runaway credit boom – and yet, even with this negative feedback, over-exuberance and optimism in the economy still on occasion resulted in such a destructive credit induced boom.

Today things have changed substantially; banks and the many new issuers of credit no longer themselves carry all the risk of bad loans; the factor that used to enforce prudence. Introduction of the Asset Backed Security (ABS) enables the lending institution to pass the risk on to someone else, namely to the investor who purchases the ABS and the entity that insures the instrument against default on the cash flow inherent in the instrument – the interest due and the repayment of the capital.

In engineering terms, this means there is no longer any negative feedback to control the extent of the lending by banks and other institutions and thus to keep the volume and the quality of debt within safe limits.

In fact, and horrifyingly so, the opposite is true; the more credit a lending institution can extend the more profit it makes.

In other words, instead of enjoying the safety of a self-limiting force, positive feedback rules. Rather than inducing prudence, there is an incentive to market credit aggressively to all comers; to extend as much credit as the market can absorb, using any and all loop holes and marketing gimmicks. With no risk element to compel lenders to keep matters within safe limits, the growth in debt is destined to be off into the blue yonder.

Much like the Japanese property market in the 70’s and 80’s.

[I leave it to readers to consider, if they were to be in charge of a bank, with the objective of maximum profit, what their policy would be in respect of staff spending valuable time checking the credit-worthiness of borrowers, or refusing the loan if it would seem that the borrower may not be able to perform as expected. From that speculation, extrapolate on the integrity of the ABS’s they have sold. Assuming what they find is true of a majority of lending institutions, they can then wonder about the capacity for survival of the small number of credit insurers, if claims proliferate when the economy runs into a headwind.]

Because of risk, investor peace of mind has to be secured either by a guarantee from the seller – not very likely, except in rare cases, such as by Fannie Mae and Freddie Mac – or by means of insurance from one of the credit insurers. The ABS practice thereby assumes a cloak of respectability and apparent safety – which may well be valid for normal times, but becomes a meaningless farce when a major discontinuity in the credit market should happen and nearly all holders of ABS ‘investments’ run to the credit insurer for relief; all of them at the same time.

Every engineer knows that running a plant with the safety valve screwed down to obtain more performance carries great risk. In the past the banks played the role of safety valve in the credit system; when risk to their profitability became too great, they become more careful and prudent in their lending practice and the credit market begins to cool down. It is a self-correcting mechanism that may have come into play numerous times in the past to smother an incipient bubble before it has taken on a life of its own; even before people were aware of an incipient problem.

It functioned like a safety valve.

Today, ABS – in a broader sense, what Doug Noland at PrudentBear.com generally refer to as ‘structured finance’ – is in full swing. The apparent safety of the ‘new age financial system’, backed by credit insurers and all manner of derivatives, provides peace of mind to every one involved in the chain of recycling liquidity; apparently with full agreement from the regulatory system.

It is a case of, “Nothing can go wrong . . . go wrong . . . go wrong . . . wrong . . . ”

The safety valve in the financial credit system has been screwed down. It would seem this time there is not going to be any entity, lender or credit issuer or investor – or regulator? – who is likely to get sufficiently concerned about risk and the precarious state of affairs to let off some of the super-heated steam and bring pressure in the system down to a more prudent level.

The US credit engine is in positive feedback induced run-away mode. There is really no way to release the steam and so it must end in disaster.

If any reader wants a graphic illustration of what this really means, fill a pressure cooker to a third of water, put it on a hot plate on the stove and screw down the little thingamijig on the lid so that no steam can escape when the pressure inside approaches the danger level. If you really do so, make very sure nobody else is in the kitchen while the cooker heats up. Also make sure all insurance is fully paid up. The end result is going to be both loud and destructive.

This is exactly the situation in the US economy. Nobody is concerned because all is now working so smoothly; the credit cycle ensures maintenance of high liquidity and risk, as we have been expertly informed, is being diversified away into the derivatives market. There is no new dark cloud on the horizon, the economy booms along and Americans live in the best of all possible worlds.

Yet somewhere in the financial system there is a cooker building up steam and reaching towards the danger point. All appears normal and under control, until the BANG comes, as it must; then the event is a big and ugly surprise to one and all.

Is there a solution?

When (not ‘If’) the situation described by von Mises sneaks up on the US economy, the cause will almost certainly not be because banks have become reluctant to make new loans – positive feedback will see to that. When the banks are not prudent, von Mises writes that the credit boom ends for one of two reasons:

“The alternative is only whether the crisis should come sooner as a result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”

Either consumers and household voluntarily decide they cannot afford additional debt or the currency system goes into free fall; or melt down, if that term is preferred.

Von Mises is the complete pessimist on credit fueled booms and views a recession or – in more extreme cases – a depression as the inevitable end result..

At http://www.polyconomics.com/searchbase/fles12.html Jude Wanniski discusses von Mises’ view on the dearth of credit and the contraction and/or deflation that results. He comments on the role of the Federal Reserve as follows:

“If the Fed attempts to stop a contraction by monetizing debt, it only will succeed in causing an inflation. On the other hand, if the Fed is faced with a deflation caused by a surplus in the demand for "new" money, it can of course arrest that deflation by supplying the new money, with no increase in inflation.”

The question is whether there will be any takers for the ‘new’ money if this meant adding to existing debt obligations. In terms of the von Mises alternatives, if households – and therefore by implication also corporations, facing a decline in demand – were brought to the point where they have little choice except to avoid making new debt (even to reduce their obligations) the Federal Reserve may find that their attempt to increase liquidity is very much like pushing on a string.

This reminds of Bernanke’s solution to the deflation problem – calling on the helicopters – which action in terms of the von Mises recipe will change the trigger of the crisis from “ . . as a result of voluntary abandonment of further credit expansion . .“ to “ . . a final and total catastrophe of the currency system involved.”

It is difficult, seeing the commitment of the powers that be to maintain the status quo, to think that the positive feedback mechanism in the debt cycle can be reversed. Rather, the inducements for banks and other credit-granting institutions to market credit increasingly aggressively will remain irresistible, in part since they well know that any decline in the use of ever more debt to keep the credit cycle going will be catastrophic.

In this effort it would appear that they will continue to be aided by a compliant Federal Reserve; in which case one can expect a more accommodative interest cycle as soon as the economy shows signs that it is stalling, with a concomitant threat of deflation.

Conclusion

The essay is of broad scope, touching on matters such as culture and tradition that are not often brought into a review of the economy. Yet it would seem these factors have played a part in how Japan has dealt with its own market collapse in 1990; and will again play a part when the US have to contend with the unfortunate results of the credit binge that has been a key part of that economy for at least a decade.

Make no mistake; the Japanese went through tough times after 1990. Sit back and think, dear reader, what it would do to your own standard of living if you were putting up to 30% of your income into the savings account, month after month. The motor car – not SUV – in the driveway would not be the latest model; the TV would not be a digital flat screen; the furniture would not be new and shiny; the house would not be as luxurious as the one you probably now live in. Vacations would not be spent in exotic locations, with the cost added to the credit account. And much more.

This is not meant as an idle exercise; if you, dear reader, happen to be a typical American or have friends who classify as average US citizens, loaded with debt, this could be your future. When markets collapse and the crunch comes, this comparatively bleak existence may well be the life style circumstances prescribe for you, while debt is worked off in a climate of increasing job losses and when it is difficult, if not impossible, to obtain credit.

On that personal note, thank for reading this far. It most certainly could not have been an enjoyable experience – not with all the doom and gloom.

But, as the saying goes, the chickens do come home to roost.

daanj@telkomsa.net