When the credit runs out

Not much action in stocks or gold yesterday. So, let’s go back and see what we’ve figured out recently. For one thing: the middle class can no longer afford a middle class lifestyle.

We’ve also confronted the awkward truth: America is more of an oligarchy than a democracy. In a university study, it was found that the government often snubs the will of the democratic majority in order to serve the desires of the dirty dealing special interest groups.

And we learned a new word – ‘poligarchs’ – for the teeming masses who enable it.

Richard Duncan came to visit yesterday. You may recall he’s the economist who has developed a theory about how excess liquidity affects asset markets: “Milton Friedman said it was the supply of money that mattered. But he based that view on his analysis of the Great Depression. He was right. But real money was replaced by credit money, 40 years ago. Now, it’s not the money supply that matters. It’s the supply of credit.”

And here, we simplify Duncan’s conclusion: as long as credit is increasing at a healthy rate, markets and GDP go up. When they don’t increase, expect recession and bear markets.

Credit expansion began when Ike Eisenhower was still on the golf course. It has been expanding ever since, with more than 50 times as much today as back then. And today, finance and industry – not to mention asset prices – depend on it as if it were cable TV and cheap beer. Cut it off, and the whole economy goes into a gloomy funk.

Duncan: “The Fed knows that credit must expand, or we have a depression. And today, debt levels are so high that a depression would be catastrophic. The disaster would be worldwide, not just in the US. And people would die. Because a depression in the US would mean tens of millions… maybe hundreds of millions… of people in China and Southeast Asia would lose their jobs. Businesses would go broke. Governments would go broke. People living at the margin – with no savings – would soon be desperate. I don’t think our civilisation would survive.

“That’s why the Fed will not allow a real credit contraction.”


Bill Bonner on markets, economics & the madness of crowds

To sign-up to Bill's free daily email just enter your email address below

Because these emails are completely free, we do have to fund them with advertising. Occasionally we will send you promotional emails, however we will never give, sell or rent your email address to any other companies.For more information, please see our Privacy policy.


For the moment, the sun still shines and credit is still expanding. Asset prices are still going up. But all that is set to change.

“In the third quarter, excess liquidity will fall sharply. We should see much more volatility in asset prices. My guess is that before the end of the year we’ll see a very disturbing drop in the stock market. The Fed will pause… interrupting its ‘tapering’ programme. Then, depending on how markets react, it will probably hint at another QE programme for 2015. That should send markets back up.”

Mr Duncan sees the situation much as we do. Up to a point. He sees the dependence on ever-expanding debt. He sees the catastrophe that comes when debt expansion stops. He expects, as we do, that the Fed will respond with more QE. All right so far. But he lacks our deep cynicism and insensitivity. He sees the tunnel, but he thinks he sees a flicker of light at the end of it.

“Governments can still borrow… and still expand credit. One way or another, they are going to try to keep the credit expansion going. So, instead of throwing money away, they might as well invest in things that might expand future output – new technology, new infrastructure, and new industries.”

Ahh… but that ignores the oligarchs, poligarchs and the nature of government itself. Government’s primary concern is not to protect its citizens or their economy. Instead, it aims to transfer more power, status, and wealth to the elite who control it (the oligarchs).

And to do that, it must keep the masses (the poligarchs) sedated. Charles Hugh Smith explains it: “The State has two core mandates: enforce quasi-monopolies and cartels for private capital, and satisfy enough of the citizenry’s demands for more benefits to maintain social stability.

“If the State fails to maintain monopolistic cartels, profit margins plummet and capital is unable to maintain its spending on investment and labour. Simply put, the economy tanks as profits, investment and growth all stagnate.

“If the State fails to satisfy enough of the citizenry’s demands, it risks social instability.”

The feds will be the borrowers of last resort. But the money won’t be invested in a brighter future. It will be pilfered and squandered.

And then what?

• Don't miss Bill's next Daily Reckoning. To receive the next article straight into your inbox as soon as he's written it, enter your email address below.

Because these emails are completely free, we do have to fund them with advertising. Occasionally we will send you promotional emails, however we will never give, sell or rent your email address to any other companies.For more information, please see our Privacy policy.

• Stay up to date with MoneyWeek: Follow us on TwitterFacebook and Google+

4 Responses

  1. 20/05/2014, Nick C wrote

    You need to expand on the difference between ‘real’ & ‘credit’ money….. and where moral hazard & risk fit in. (hint:- no-one goes broke or suffers loss by using ‘thin air’ credit.
    It’s all about the parasite managing the anxiety levels of it’s host. Reducing the purchasing power of ‘money’ keeps the punters anxious for rising prices, therefore they spend, pay tax & interest……. for now, anyway.

  2. 20/05/2014, Ellen12 wrote

    The concept of ‘adding value’ to supply an end product or service that people want to pay for has become secondary to buying an asset, sitting on it, and waiting for its value to rise. Our whole approach is about taking from someone else rather than creating a win-win environment of free market economics. Nick, I would say the difference between real money and credit money is indebtedness. But, yes, with factional reserve banking your ‘real’ money is somebody else’s debt.

    • 21/05/2014, Nick C wrote

      Yes Ellen so there are two types of indebtedness.
      1.Real Debt. You have created wealth, stored that wealth, and lend it to me….. I am morally obliged to repay, else I have effectively stolen from you.
      2.Thin air debt. No one creates the wealth. The money is fraudulently procured. There is therefore not the moral obligation for me (or anyone) to repay…. but future generations will be FORCED to pay….pay for something they did not request. THIS HAS NOTHING TO DO WITH CAPITALISM.
      As I have repeated many times in recent years…. if we’re lucky, our children will be forced to pick up the tab…. if we’re unlucky….we will.

  3. 27/05/2014, Stefan Langeveld wrote

    Nick, thin air debt is fraudulently procured, but there is a moral and legal obligation for the borrower to repay and for the lender to liquidate the debt. If not -fully-repaid, it is a loss to the lender, otherwise the lender is literally printing money i.e. counterfeiting, which is still illegal. So the bad loan risk is the same for debt type 1 and 2.
    But A) the creation of thin air debt is easier, more profitable, almost without restraint (a bank must have some capital). At the unfolding levels it can cripple banks (or the State who ‘saves’ them) and ruin the economy;
    B) it is wrong to leave this privilege in the hands of banks (or any group). Either no one or all may have it.

Comment on this article

MoneyWeek magazine

Latest issue:

Magazine cover
Hard cash

What's next for gold and silver?

The UK's best-selling financial magazine. Take a FREE trial today.
Claim 4 FREE Issues
Shale gas 'fracking' promises to transform Britain's energy market. Find out what it is, what it means, and how to invest.

More from MoneyWeek

FREE REPORT:
What you should really do with your money (2014 Edition)


How to buy and sell penny shares

A beginner's guide to investing in gold

How to invest in British fracking