Credit is Money, till it isn’t

We don’t have a housing bubble. For that matter, we didn’t go through a stock tech bubble’s collapse around 2000.

What we have is a credit bubble. A bubble in financial instruments that are, at heart, a promise to pay you Wednesday for a hamburger today. The bubble comes in large part because the hamburger in hand is used as justification for a loan. Which is in turn used as a loan to someone who wants to buy a hamburger. Oh – and the anticipated interest in all these — the promises of profits — are used (like the hamburger above) to justify MORE loans.

Now in the long run, a complexity like this – or any bubble – comes crashing down for the simplest of reasons — a critical number of people quit believing they’re going to get theirs if they wait, and get what they can now. And those left can’t sustain enough belief (and dollars begetting dollars) to make up the difference. In short, the needle’s point is disillusionment.

I’ll digress briefly to point out that something is usually necessary to sharpen the needle. Usually, it’s something about the hamburger. There are always people “cashing out”, but what tends to sharpen the needle is when some people trying to cash out don’t get all the hamburger they thought they were supposed to get, and it gets noticed. OR to put it in more realistic imagery – the core product can’t be purchased, or profits are unable to pay the anticipated dividiend, or the ships that were carrying the spices sunk, or… you get the idea, I think. So much for the digression, back to the credit bubble.

Now here’s the fun part. If we were all rational, some disillusionment wouldn’t matter. We’d accept the occasional shortfall as something that happens, and continue onward. But then if we were rational we wouldn’t push median house prices to levels that less than 10% of the residents could afford, either. But we’re not rational, we’re manic-depressive. Bipolar. Whatever you call it, we have massive mood swings from optimist to pessimist. And when we swing pessimistic, it’s a doozy.

Everyone shifts their credit “just a bit” to cope. They quit loaning as much. They (perhaps) call in the loans a bit earlier. They ask a bit more interest on what is getting loaned. And suddenly there just isn’t as much credit out there — or in broadest terms, the “money supply” has decreased. (See Deflation-A in the definitions post). This becomes self-reinforcing. Less money means people have to spend what they have more wisely. Which means things don’t sell as much. Which results in a variety of things – higher inventories, reduced production, reduced paychecks and jobs, and eventually reduced prices. In short, a recession.

And recessions can be diverted. Though some economists tell us that eventually the piper must be paid, there are two methods we use today. First, there’s the ‘add more money’ method. Someone does something to make people trust that the trigger is no longer a problem. I’ll point – to counter the skeptics – to the 1930s HOLC (Home Owner’s Loan Corporation) as an example of how this could be done.  The other method is the “shiny object” method, where a new pool for the credit games can be deployed.  In either case, the bubble quits shrinking.  Faith is restored, and enthusiasm regains the upper hand.

I do not know if there will be a successful application of the addition or shiny object methods, but I do know we’ve crossed the bulge and are seeing the bubble’s deflation.  I admit it took longer than I expected.  I think – leading reports seem to indicate – that the actual deflation is going to be swifter than I thought as well, which will make catching it much harder.

Yes, Virginia, we’re going to see a recession. The only questions in my mind are how severe and how long.

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