“New car sales fall as buyers shun debt,” says a Wall Street Journal headline.
Just what we expected…but so long coming we had begun to wonder.
Americans represent nearly 20% of the world’s consumption. And the US economy, too, is more dependent on consumption spending than any economy ever has been. If American consumers don’t spend more, the whole shebang falls apart.
We are witness to something that doesn’t happen very often – like the eruption of a volcano…or the collapse of a bridge – the first stage of a credit contraction. So far, the effects have made the headlines, but it has not yet affected most people. So far…only at the top and the bottom of the credit structure are people getting pinched, squeezed and punished.
At the bottom, of course, are the ordinary homeowners.
“I’ve got a tiny little house on the edge of London,” explained a colleague yesterday. “I’ve got to sell it, because I put a contract in on another place. But it’s been on the market for three months now, and only four people have even looked at it. I’m getting very nervous…
“The problem is that it is a starter home. And the banks don’t want to lend to people who are buying starting homes. They’re the worst credit risks, because they don’t earn much money and don’t have much in assets. Naturally; they’re just starting out. But this is completely different from a couple of years ago, when the banks would lend to anyone…”
The people at the bottom are beginning to feel anxious. Many have never, ever seen a time when house prices were not rising and mortgage credit was not readily available. Many loaded up with debt when the going was good. Now that the going ain’t so good, they regret it.
Yesterday, we looked at the bull market in gold. We wondered how and why it might come to an end. If the credit contraction were to worsen, we concluded, the price of gold – in dollars – might go down.
When credit expands, more money enters the system…and prices rise. But then, there comes a time when the debts must be paid. Then, people have to take money out of the system; they have to cut back on their expenses in order to put aside the money to pay back the loans. The credit contraction phase is typically a phase of falling prices; as more and more currency is withdrawn in order to pay debts (and, incidentally, build up savings), less and less currency is available to buy things.
But wouldn’t the financial authorities simply emit more paper money?
Ah, yes, they would try. But that is what we learned from Japan. Once a credit contraction begins, it is very difficult to reverse. The Japanese tried monetary policy – with a central bank lending rate of “effectively zero”. And they tried fiscal policy – with the largest government deficits in the developed world. Still, prices fell.
Ben Bernanke has spent years studying the Japanese example. If we ever got in that sort of jamb, he says, he’d drop money from helicopters in order to break the contraction cycle.
We’re a long way from there. So far, we seem to be only at the beginning of a credit contraction. The average person doesn’t even feel it. When the squeeze begins, only the outer edges feel it first – the top and bottom of the credit structure.
But will it eventually involve everyone…and will the Bernanke Fed need to drop money from helicopters in order to get the economy moving again? Maybe… but then we’d really see the price of gold soar!
Markets and Money