David_N
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A very interesting read that makes a whole lot of sense.
Credit Growth Drives Economic Growth, Until it Doesn’t - The Daily Reckoning
Credit Growth Drives Economic Growth, Until it Doesn’t - The Daily Reckoning
^ The last sentence is the most important thing people need to understand.The single most important thing to understand about economics in the age of paper money is that credit growth drives economic growth.
Before the breakdown of the Bretton Woods international monetary system in 1971, there was a difference between money and credit. There no longer is.
Paper dollars and US treasury bonds denominated in paper dollars are just different types of government IOUs. When gold was money, the increase in the Money Supply (M1 and M2) had an extraordinary impact on the economy. Today, what matters is the increase in the total supply of credit.
At the end of 2010, $52.6 trillion of credit was outstanding in the United States. In 1971, the ratio of total credit to GDP was 150%. Now it is 354%. In other words, credit has been growing much more rapidly than the economy for the past four decades.
It is easy to understand how rapid credit growth facilitates economic growth. When credit is expanding, consumers can borrow and spend more and businesses can borrow and invest more. Increasing consumption and investment creates jobs and expands income and profits. Moreover, the expansion of credit tends to cause the price of assets such as stocks and property to increase, thereby boosting the net worth of the public.
Rising asset prices give the owners of assets more wealth (i.e. collateral) against which they can borrow still more. This cycle of expanding credit leading to increased spending, investment, job creation and wealth, followed by still more borrowing produces a happy upward spiral of prosperity….so long as it continues. Eventually, however, every credit-induced economic boom comes to an end when one or more important sector of the economy becomes incapable of repaying the interest on its debt.
This was written in 2011, but it's still incredibly relevant.In recent decades, the financial sector has expanded its debt much more rapidly than the non-financial sector, and therefore has played the more important role in creating economic growth. In 1971, the debt of the financial sector was equivalent to 12% of GDP. It hit 100% of GDP in 2005, peaked at 121% of GDP (or roughly $17 trillion) in 2008 and is now 96% of GDP. The sharp reduction in the sector’s debt after the crisis began in 2008 was made possible by the first round of Quantitative Easing, during which the Fed printed $1.7 trillion and used it primarily to buy assets from the financial sector, thereby allowing the financial sector to reduce its leverage.
Between 1971 and 2009, household sector debt increase from 43% of GDP to 98% of GDP (or to $13.9 trillion). Borrowing and spending by US households drove the US economy; and, as imports into the US exploded and the US trade deficit blew out to a previously unimaginable level, it also drove the global economy. Like every credit bubble, this one was fun while it lasted.
Over the last two years, the debt of the financial sector has contracted by $2.9 trillion (to $14.2 trillion) and the debt of the household sector has contracted by $443 billion (to $13.4 trillion). Offsetting that has been a $3 trillion increase in the debt of the federal government (to $9.4 trillion). Overall, total credit in the US increased by 0.4% or $203 billion (to $52.6 trillion). Like credit, economic growth in the United States has been essentially flat, increasingly by only 0.1% or by $19 billion between 2008 and 2010.
The $3 trillion increase in US government debt prevented a global depression over the last two years, but what sector of the economy will take on additional debt and drive the economy over the years immediately ahead?
Will it be the household sector? The corporate sector? State and local government? Will Fannie and Freddie or the ABS issuers come back from the dead? No, no, no and no.
The only sector of the US economy that can finance significant amounts of new debt is the federal government. Economic growth in the United States (and therefore, to a very significant extent, the world) will be determined by how much more the US government borrows and spends. Those who wish to slash government spending should bear that in mind.