My friend and Panamanian economist David Saied wrote the following article which appeared in Washington DC's prestigious Economic Policy Journal. Lets hope David comes back to Panama in the near future to work with the government and its economic troubles.
Credit must stop
If you read the newspapers, or watch the opinion of politicos, mainstream
financial and so called economic "experts", you would believe that the
current crisis will only get better when "credit eases" and begins "flowing
back again". Most politicians and high ranking government officials, from
Congress to the White House, from the Fed to the Treasury, repeat this
mainstream siren song; they claim that the problem with financial markets
and the economy is that credit has tightened and that this will prolong or
deepen the recession if government does not intervene to ensure that credit
"unfreezes". However, contrary to what mainstream economists and
politicians say, the current problem is not lack of credit but exactly the
opposite; the current problem is that all sectors of the U.S. economy have
become highly overleveraged. Therefore, the quickest way out of the current
economic malaise is to allow banks to act according to their better business
sense and stop credit to firms and households that have too much debt.
You do not need to be a banker or a financial expert to realize that in a
crisis risks are higher, thus, you either reduce credit by being more
selective or increase interest rates to compensate for the higher risk
premiums, or both. Private lenders in any economy logically want to reduce
their exposure to a financial crisis and recession risks by reducing credit.
On the other hand, they might be willing to lend more, but at a premium to
compensate for these higher risks. At this stage of the crisis lenders want
to rationally raise interest rates. Everyone knows that more businesses
will go under and more people will be laid off in the near future due to the
worsening recession; which in turn will make the level of loan defaults
rise. Therefore, how come does the government want lower rates and to
increase credit?
If you look at the figures, credit has not contracted; it has just stopped
growing at unsustainable rates (see chart and recent Robert Higgs article).
<http://mises.org/story/3288>
Bernanke (in a December speech) continues by saying "that offset has been
incomplete, as widening credit spreads and more restrictive lending
standards have contributed to tight overall financial conditions." That is,
the Fed is lowering rates and the banks are increasing their rates (thus,
spreads increase). It seems that this statement suggests that this is
something that is not right. Government officials are saying that credit
must flow again even though household debt is an all time high at over 120%
as a percentage of National Income (it never went above 65% before 1980).
But wait, banks are also applying "more restrictive lending standards" and
this, in spite of all the data and risk management, seems to not make sense
to the Fed or to the Government. Weren't loose credit standards what
started the mortgage mess in the first place?
Most Neo-Keynesians and Monetarists believe that the economy and credit
should always expand. If credit is not growing then there must be a problem
and the economy is in "danger", according to them, therefore the Federal
Government has to intervene massively. Former President Bush at the
beginning of the crisis in September said:
"banks holding these assets [toxic assets] have restricted
credit. As a result, our entire economy is in danger. So I've proposed that
the federal government reduce the risk posed by these troubled assets, and
supply urgently-needed money so banks and other financial institutions can
avoid collapse and resume lending."
As predicted by the Austrian Business Cycle, a long period of artificially
low interest rates (see graph below--the real Fed Funds Rate has been
negative 5 years of the past 8!!) will induce high debt and lower savings.
Alan Greenspan, who was at the helm at the Fed during most of this period
said in August 2005:
"History has not dealt kindly with the aftermath of
protracted periods of low risk premiums"
This negative interest rate policy has created a huge dislocation between
savings and credit (see graphs). Credit has ballooned and savings has
collapsed (see graphs).
Source: BEA, NIPA, Platinum Consulting1
This excess credit has resulted in unsustainably high levels of debt.
Household debt, which in 1957 stood at near 45%, stands at an all time high
at over 120% of National Income (see graph).
The same is true for Business debt (near 90% of National Income) and
financial sector debt (near 140% of National Income). These are the real
threats looming over the American economy. And this problem can only be
solved by curtailing credit (or raising rates) not expanding it. Contrary
to what our public officials and mainstream economists are saying, credit
must stop, so debt comes down to more sustainable levels and savings has to
flow back up again for a sustainable recovery to begin. And this cannot
happen until the government stops intervening in financial markets and lets
interest rates rise up again to normal market levels.
* The author was head of Public Policy for the Republic of Panama and
considered to be one of the economic architects of Panama's current miracle
economy; he is also the former SEC Chairman for Panama, and is currently
finishing graduate studies in economics in Boston, Massachusetts.
David Saied
Suffolk Economics Graduate Program
& Managing Partner
Platinum Global LLC
130 Bowdoin St.
Boston, MA
platinumgloballlc.com
Cel 508-510-9951
Recent Comments