The Crisis of Credit

Linking slowdowns and recessions with excessively high debt cycles

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In this post, we’ll be looking at why a Financial Crisis or a bubble is always bigger than the previous one, and what actually leads to it, and why it happens despite so many learned economists being there.

Normally, Credit Crises lead to an economic recession or a depression. First, let’s see what would normally happen in a slowdown or a recession…

1) Firstly, people would lose their jobs, several people, and industries would be shut down as the toll of production cuts deepens.

2) As one industry fails, it would take down its related and dependent industries with it. For instance, when the Infra industry falls, it takes down Cement industries; when auto sector falls, it takes down Metals industry with it.

3) As large global economies start to fail, they start to reduce their imports (These contribute to over 34 percentage of our country’s income… just for instance imagine if all the 20% of people dependent on the Export of services sector lose their jobs.)

“Hol’ up, wait a minute…”

The basic law of economics is that, “My expense is your income”, and that someone’s loss is someone’s gain. So, if all countries are losing, who is gaining?

We’ll come to that shortly.

When countries and people rake up too much of debt, more than they can afford to pay back, hoping that growth would pick up, with which they can pay back it all… they create an artificial growth. Everyone gets money, everyone spends more, but, this isn’t what they earned. This money is what they’ve borrowed. So, it has to be paid back with interest.

When money is pumped into economies, they reduce the value of the currency itself, and this leads to spiralling asset prices, and investors running behind the assets like dogs would go behind steaks. These speculators drive up the market frenzy that would cause the large recessions and slowdowns. Coming back to the question, who gains during a recession?

“THE CURRENCY.”

The currency that had been losing value since the start of the lending craze, now, would slowly start gaining value, and start going up in intrinsic value. Which would mean, there is lack of demand for the currency. Something that is happening in India right now.

The economy is like Nature, it has built in measures to correct itself, unless you mess it up too much. Unfortunately, excessive lending has always been a problem with governments which want to achieve their goals of Economic Growth, and in our country, just like all others, the period after 2008 saw excessive lending boosts. It was meant to soften the impact of the fall the economy was supposed to have, in the crisis. The concept was that, since the crisis left so many people out of business, to spur growth, the government would reduce interest rates, and hold them for a good period of time, and alternate between low interest rates, and structural reform of industries to improve growth.

Alan Greenspan, former US Fed Chairman started this concept of Soft-landing and he was a very highly celebrated Economist. He soft landed the US Economy, and saved it and the world from further damage in the wake of the 2000 Dotcom bust. (A time when everyone was going crazy on internet companies, and were investing all their moneys in them, driving up valuations to crazy levels. It was an Asset Bubble like the one in Japan, but in Internet Companies.)

But, just as all economists were celebrating Greenspan for being the Messiah of Modern Economics, every economy was already on the Bridge that was unfinished and a gap in the middle (Like the one in the movie Speed)

The problem with a soft landing or for that matter, any measure that is going to dampen the fall, is that, as a response to a crisis that happened because of too much easily available credit, we are feeding the economy with more credit.

There is only going to be a delay in the crisis, and when it hits, it’d be harder than the previous one.

It all comes down to the crisis of credit. Credit runs economies, but, too much of it ruins them.

The greater issue at hand is that not only are several organisations running purely on debt financing, but, global growth figures have been obscured by debt, and the real growth figures are no where close to what is shown to us.

Debt is invariably accounted as income in several economies, and income numbers are boosted up. If it were not for the debt, growth would come to a standstill. From being in the age of Industrial Revolution, where production expanded rapidly, we have now come to be dependent on debt for everything.

To give statistics, just the top 10 countries of the world, on a net basis (Borrowings - Settlements) borrow over $100k, and that’s every second. A day has 86,400 of those seconds, a year has more than 31.5 million seconds. That comes to Three trillion, one hundred and fifty billion raked up in debt, per year, and this is just the top 10 economies.

The real figure for all countries put together is closer to 6 times that number. which is near $ 20 trillion of new debts taken every year! . That is the GDP of USA. (Not the actual GDP, it’s the bloated value due to the debts)

We are accruing interest of 4.5 million dollars every minute, and there is no way we can pay off the interest, we would borrow more to repay the interest, which would push up borrowing and interest subsequently.

When individuals like you and me, or companies borrow, we borrow from the Banks. But, when governments borrow, they borrow from the Future. Believing a greater future with greater growth exists, and that could be used to repay the debts that we’ve accumulated.

Now, globally, we have surpassed every limit, every boundary and have been raking up borrowing like stacks of paper in a bundle. Global debt is at over 80 thousand USD per citizen, at the time of writing this article. But, why express it per head? After all you and I didn’t borrow right?

Our governments borrowed it, and they borrowed from each other. For instance, China holds over $1.15 Trillion of US debt.

To better understand how this works, lets see how Currency is Made:

Currency can’t be printed out of thin air. The value of a Dollar is the work done to earn it. When governments need currency to be infused, they issue bonds to the Central bank, and the central bank lends the government Currency notes.

So, every rupee note is a loan. As long as a citizen of the country works, and produces output to earn the rupee, the value is intact, and the loan is good. But, when the government does too much of this, and also borrows from foreign governments, the debt climbs steadily, and is no longer under control.

At present, Government Debt is a market, where all people want to get a slice of the action. Institutional investors, speculative traders, other governments, banks, pension funds, investment corporations, insurance companies… all put their moneys into the Debt Market. (Note : Their money isn’t actually theirs. Their money is what they would have to give their lenders, “the insured”, depositors, investors.) Governments all around, lend each other money and borrow money too, through bonds. Governments lend themselves money they don’t have at hand, hoping they get it, and the borrowers borrow money they can’t repay, and hope that the loan gets renewed at maturity forever. Is every country doomed in this crisis? Well.. no. There are about 15 countries with less debt, and probably the biggest one of them is the Socialist motherland Russia. It notably has extremely low levels of Debt, with total debt (Of everything!) over just $500 Billion. For a country 6 times the size of India, it has just half of India’s debt.

In India, the situation gets worse…

People holding the Indian government’s debt (meaning who have lent the government) are mainly Commercial Banks, Insurance Companies, Mutual Funds, Investment Corporations. Note that all these leadings are our money. What we earned with our hard work, was trusted with Corporations which went to our Government.

Debt across all governments represent dreams and savings of all the billions and billions of people across the Globe, it represents our work, our effort, and the means for us to live a decent life in case things go awry. It is meant to be our last resort, and available to us when we need it the most.

But, it is in a system that is designed to fail big time.

What do you do then ?

Go for real assets, Housing, Land, Gold, Silver. Yes, agreed that it’ll have problems on its own, and there are cycles in these too, and prices fluctuate. But, this is the best solution until the economies all around the globe cool down, and realise that taking in debt to cover old debt isn’t a sustainable solution.

If there was a Credit Score for the World, it’d be Default - D