Great summary.
My answer to the question is, the banks are simply afraid of throwing good money after bad. The complete and total lack of transparency is a disincentive for banks to lend. They can’t tell if the institutions they lend to are on the verge of insolvency, so they refuse to lend to anyone who can’t prove sterling credit circumstances beyond a shadow of a doubt.
Quick question. If all the toxic paper was exposed today, wouldn’t this solve the liquidity trap? The banks would immediately begin lending to that half you mentioned that are doing real business with real money, and the other half would be left hanging out to dry as the banks would avoid them like the plague.
Not that this will ever happen... Just saying. Or, asking.
Actually, that is the key to things. Banks used to ferociously protect their loans, so literally, a loan would only be assured if the bank kept 100% collateral for the loan in cash in the bank. They really meant “You can’t have a loan unless you don’t need it.”
Otherwise, the bank loan officer would interrogate whoever wanted the loan. Proof of employment, in the right kind of job; proof of home equity; proof of vehicle ownership; etc., to several hundred percent more value than the loan itself. Loan defaults were exceedingly rare, because loans were very hard to get.
In the 1960s, easy credit was unheard of, so much so that both the US government and Hollywood tried to teach people how to improve their lives with easy credit. That is, it was used as a plot device on TV shows and in the movies. Many people were “credit averse” and refused to own a credit card.
Much of the impulse for this was that the government wanted to move away from the great cost of physically printing cash, as well as the difficulty of keeping track of cash. Were the US to return to just cash, the US Bureau of Engraving and Printing would have to have from 15 to 20 times as many facilities, from the two in Washington D.C. and Fort Worth, TX, to most of the US States.
This creates confusion when some commentator says that the government is “just going to print more money”. Because this means more virtual money, not actual paper money. Paper money and coinage are in extreme shortage right now, backing only 5% of daily US retail trades.
Right now we face a bizarre situation, in which our currency might be “split” between virtual and paper currency. There is no law that anyone must accept virtual currency for anything, but paper currency is valid for all debts, public and private, and must be accepted.
A credit crunch, that is happening right now, throws a monkey wrench into the whole system. Starting with the government, that has already promised half the annual US GDP this year, on top of twice that much in existing national debt, and the leverage economy, there is literally no more money left to loan. All possible creditors, read “China”, have been tapped out.
This means that all other debtors or bond issuers have no one to borrow money from, either. This includes the credit card companies that have to issue bonds to underwrite their cardholders transactions.
In real terms, this means that if you have good credit, and are in a good credit class of people unlikely to default, your credit limit may be reduced from $10,000 to $5,000 or less. If your credit is good, but the class of card holders like you is becoming riskier, you might have your card canceled. And if you have problems with your credit, you will be canceled, and they will demand full payment now.
Millions of Americans are reliant on credit cards for their monthly expenses, and will be instantly bankrupt if their card is canceled. So those with bank checking will likely overdraft en masse, and either banks will cancel checking, or retailers will refuse personal checks.
This leaves only debit cards and cash as ways to spend money. Most retail will have to be with debit, but cash will be king, because there is so little of it.
At the same time, with tax revenues dropping by double digits, and the US government unable to sell T-bills, or worse, if the T-bill holders cash in their T-bills and demand the principal, the US government will have no choice but to “monetize the debt”, or as it is incorrectly called, “print money”. Again, just decreeing that more virtual money exists.
Instantly, this creates hyper-inflation in virtual money, while at the same time deflation in paper currency and coins. Cash is king. Bank accounts may have tens of thousands of dollars in them, but the bank branch will have to currency to redeem that money. All they can do is issue a debit card for what they owe you.
So retailers will have signs to the effect that debit card purchases for $1 cost $10, because of hyperinflation, or if you pay cash, 10 cents, because of deflation. At the same time.
The next step is for the government to physically print, and issue, very high denomination paper currency, from $100k to $10M, to be given to the real economy corporations in exchange for some of their virtual money. This VHD paper cannot be legally transferred without the permission of the Treasury Department.
This insures that they *cannot* go bankrupt, and can be used as 100% collateral on loans from authorized lenders. However, the money cannot be taken from them without permission, and cannot be owned by individuals, only *that* authorized company.
And because international trade has stopped completely, the US will have to rebuild all the industry it outsourced, which will put us on the road to recovery.