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Is Debt the Lifeblood of the Economy?
Mish's Global Economic Trend Analysis ^ | 09 Mar 2009 | Mike "Mish" Shedlock

Posted on 03/10/2009 1:56:38 PM PDT by BGHater

Everywhere you turn there is news that the Fed, the Treasury, or Congress is attempting to "get credit flowing again".

Kevin Depew was discussing this situation in Five Things: Credit is the Lifeblood of the Economy?

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.

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 reality, however, as noted on Minyanville recently in the article, “Deflation Redux,” is that these assertions are non-sequiturs.
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.

Now let’s turn our attention to various proposals to solve the problem by rewriting the books on “Mark To Market” accounting.

Such proposals make for good sound bites. However, they miss the boat entirely. Had banks not lent with leverage and instead put those loans on the books in a hold to maturity portfolio (they could have done that), then the banks would not be in trouble.

The reason banks purposely put those assets into a mark to market portfolio is that allowed them to increase leverage (the number of loans with nothing backing them up). With leverage comes increased profit potential and increased risk. Banks were speculating pure and simple.

Without that excessive leverage banks would have had losses but they would still have been solvent, and we would not be in this mess. It was the excessive leverage that destroyed Bear Stearns, Lehman, Citigroup, AIG, Bank of America, Merrill Lynch, etc., not mark to market rules, evil short sellers, or hedge fund bets via Credit Default Swaps.

Suspending mark to market accounting does nothing to reduce the leverage so suspending mark to market accounting cannot fix the underlying problem. Instead, such games may further enhance the already huge mistrust in the system.

To fix the problem, one must go to the root cause. That root cause is fractional reserve lending that allowed banks, brokerages, and insurance companies to lever up to insane levels. Sadly, not a single peep has come from the Fed, the Treasury, or the Administration about addressing the real problem. Instead we hear complete nonsense on how to "get credit flowing again".


TOPICS: Business/Economy; Government
KEYWORDS: credit; debt; economy; mish

1 posted on 03/10/2009 1:56:38 PM PDT by BGHater
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To: BGHater

Debt is the lifeblood of the economy. Been true for several hundred years.

Will be for another several hundred years (clue: Stocks are a form of debt....oooooooooooh).


2 posted on 03/10/2009 1:59:49 PM PDT by texmexis best (uency)
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To: BGHater

Creation is the life blood of the economy. And investment and profit are the pumps that drive it.


3 posted on 03/10/2009 2:05:35 PM PDT by marron
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To: BGHater
oooohhhhh!

Someone else who reads MISH.

Follow the link at his site and read the comments. Lots of back and forth, some libs, but most of the time not too bad. The economic info and speculating has helped me understand alot of what is going on in our economy.

4 posted on 03/10/2009 2:06:35 PM PDT by TruthConquers (Delendae sunt publici scholae)
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To: BGHater
No, debt is not the lifeblood of economy.

Consumption is the lifeblood of the economy.
The flip side is supply.

Once you consume more than you have the ability to pay at the time you consume, THEN you have debt.

Debt is not the lifeblood of economy, debt is the leech of economy.
I little won't hurt you but get too many (too much) and it can kill you.

5 posted on 03/10/2009 2:12:25 PM PDT by Just another Joe (Warning: FReeping can be addictive and helpful to your mental health)
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To: Just another Joe
A little won't hurt you but get too many (too much) and it can kill you
6 posted on 03/10/2009 2:13:28 PM PDT by Just another Joe (Warning: FReeping can be addictive and helpful to your mental health)
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To: texmexis best
Debt is the lifeblood of the economy. Been true for several hundred years.

These guys disagree but they are soooo passe!

"Necessity is the plea for every infringement of human freedom. It is argument of tyrants. It is the creed of slaves." William Pitt in the House of Commons November 18, 1783

"All the perplexities, confusion and distress in America arise not from defects in their Constitution or Confederation, nor from want of honor or virtue, so much as downright ignorance of the nature of coin, credit and circulation." John Adams

"I believe that banking institutions are more dangerous to our liberties than standing armies. Already they have raised up a moneyed aristocracy that has set the government at defiance. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs." Thomas Jefferson

"If the American people ever allow private banks to control the issue of currency, first by inflation, then by deflation, the banks and corporations that will grow up around them will deprive the people of all property until their children wake up homeless on the continent their fathers conquered." Thomas Jefferson

"We must not let our rulers load us with perpetual debt. We must make our selection between economy and liberty or profusion and servitude. If we run into such debts as that we must be taxed in our meat in our drink, in our necessities and comforts, in our labors and in our amusements, for our callings and our creeds...our people.. must come to labor sixteen hours in the twenty-four, give earnings of fifteen of these to the government for their debts and daily expenses; and the sixteenth being insufficient to afford us bread, we must live.. We have not time to think, no means of calling the mis-managers to account, but be glad to obtain subsistence by hiring ourselves to rivet their chains on the necks of our fellow suffers. Our landholders, too...retaining indeed the title and stewardship of estates called theirs, but held really in trust for the treasury, must...be contented with penury, obscurity and exile.. private fortunes are destroyed by public as well as by private extravagance.

This is the tendency of all human governments. A departure from principle becomes a precedent for a second; that second for a third; and so on, till the bulk of society is reduced to mere automatons of misery, to have no sensibilities left but for sinning and suffering... And the fore horse of this frightful team is public debt. Taxation follows that, and in it's train wretchedness and oppression." Thomas Jefferson

7 posted on 03/10/2009 2:24:49 PM PDT by DJ MacWoW (Make yourselves sheep and the wolves will eat you. Ben Franklin)
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To: texmexis best
clue: Stocks are a form of debt....oooooooooooh

No, they're not. Stocks are equity. Debt and equity can serve similar functions, but they're not the same thing.

8 posted on 03/10/2009 2:37:20 PM PDT by Arguendo
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To: Just another Joe
Consumption is the lifeblood of the economy.

I would argue that supply is the lifeblood of the economy. Some of what is supplied is consumed, while some of it is saved (invested). Debt (at least according to the classical view) doesn't really fit into the picture; it's an issue largely limited to finance rather than economics.

Keynes had very different views--and there is some truth to his arguments in the short term, but I think the classical view is largely true in the long term.

9 posted on 03/10/2009 2:45:22 PM PDT by Arguendo
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To: Arguendo; texmexis best
clue: Stocks are a form of debt....oooooooooooh No, they're not. Stocks are equity. Debt and equity can serve similar functions, but they're not the same thing.

"Undoubtedly there are, in connection with each of these things, cases of fraud, swindling, and other financial crimes; that is to say, the greed and selfishness of men are perpetual. They put on new phases, they adjust themselves to new forms of business, and constantly devise new methods of fraud and robbery, just as burglars devise new artifices to circumvent every new precaution of the lock-makers. The criminal law needs to be improved to meet new forms of crime, but to denounce financial devices which are useful and legitimate because use is made of them for fraud, is ridiculous and unworthy of the age in which we live. Fifty years ago good old English Tories used to denounce all joint-stock companies in the same way, and for similar reasons."-19th century, 1883, "William Graham Sumner", one of the founders of the "new science" of sociology.

I enjoy reading and referencing the writings of William Graham Sumners--so long ago, but yet so current.

10 posted on 03/10/2009 2:54:01 PM PDT by fight_truth_decay
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To: fight_truth_decay
A Sumner quote was the inspiration for the title of Amity Schlaes's book The Forgotten Man. It's an excellent book.
11 posted on 03/10/2009 2:59:23 PM PDT by Arguendo
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To: fight_truth_decay

I hope that we don’t restrict the capital markets too much as a result of this last year of blowouts. Jail the frauds and let us get on with business.


12 posted on 03/10/2009 3:02:42 PM PDT by texmexis best (uency)
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To: Arguendo
The Forgotten Man. It's an excellent book.

Yes, was reseaching the book and found Sumner is the real source of the present edition (Amity Schlaes) of the forgotten man.

13 posted on 03/10/2009 3:10:26 PM PDT by fight_truth_decay
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To: texmexis best
Jail the frauds

But how do we jail Barney Frank? The same power brokers in government that misled investors in public statements when questioned on Fannie Mae etc..they just always stick around and knew most Americans would never remember. Plus their "backsides are always covered" by another like gray- haired Democrat.

We might have more faith in Government if it accepted responsibilty and justly policed and punishing itself with dismissal--In China, they arrest and sentence you to death! (Re: Food contamination, etc)

14 posted on 03/10/2009 3:22:12 PM PDT by fight_truth_decay
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To: Arguendo
I would argue that supply is the lifeblood of the economy.

If there is no consumption there is no need for a supply.

15 posted on 03/11/2009 6:03:19 AM PDT by Just another Joe (Warning: FReeping can be addictive and helpful to your mental health)
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To: BGHater

Debt is dependent upon good faith and trust....little of which characterizes the business world in a post-christian America...


16 posted on 03/11/2009 6:04:57 AM PDT by mo
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To: Just another Joe

There’ll always be demand if there’s supply. This is one of the fundamental differences between classical and Keynesian economics, but I think it’s important to recognize we’re better off encouraging supply than demand.


17 posted on 03/11/2009 7:34:30 AM PDT by Arguendo
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To: Arguendo
There’ll always be demand if there’s supply.

Excuse me?
What type of bunk is that?

Just because there is a supply of something (whatever it is) doesn't mean there is a demand for it.

If it's something useful for some people then there may be a demand for it from some people that find it useful.
That doesn't mean that JUST because there is a supply there will be a demand.

18 posted on 03/11/2009 7:48:16 AM PDT by Just another Joe (Warning: FReeping can be addictive and helpful to your mental health)
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To: Just another Joe

It’s classical economic theory—the sort espoused by Milton Friedman.

First of all, unless the good is completely useless, there will always be demand for it at some price. Second, producers aren’t in the business of making goods for which there is no demand, so we don’t have to worry that the supply will be useless.

If we encourage production, we’ll experience economic growth. If we encourage consumption, we might be able to push a little more supply in the short term, but in the long term we’ll probably just experience less investment and more debt.


19 posted on 03/11/2009 8:32:48 AM PDT by Arguendo
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To: Arguendo
First of all, unless the good is completely useless, there will always be demand for it at some price.

This I agree with but that wasn't stated in your first reply.

Second, producers aren’t in the business of making goods for which there is no demand, so we don’t have to worry that the supply will be useless.

I will also agree that this is typically the case.

If we encourage production, we’ll experience economic growth.

I will also agree that this is the case if we stipulate that it is physical goods.

However, you can produce as much as you want but if there is no demand (consumption) all you are doing is oversupplying and it won't sell.
People also have to be able to afford what you are supplying.

Production, by itself, will not make an economy recover.

20 posted on 03/11/2009 8:39:22 AM PDT by Just another Joe (Warning: FReeping can be addictive and helpful to your mental health)
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