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38 comments on Nate Hagens on "The Reality Report" with Jason Bradford at Noon EST
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Jason, this is a very interesting question. The first thing to mention is that the world economy grew pretty quickly in the early 80's while global crude output fell. There was a lot of substitution and some significant efficiency gains.
In terms of total energy, there is still a lot of coal, lots of natural gas, lots of nuclear going up and Three Rivers Gorge as well, so I'm not sure that energy shortages will cause a global contraction in the near term. Down the road??
The most interesting thing I have read on the credit crunch is Ben Bernanke's book on the Great Depression. Theoretically, if A defaults on a loan to B, there is no net contraction in the economy just a transfer of wealth from one party to another (especially if the loan is nonrecourse or is discharged in BK). The question is why did the defaults of the early 30's cause real effects, i.e. people out of work and standing in bread lines? Bernanke's conclusion was that it was due to the failure of the financial institutions which served valuable intermediation roles in the economy.
The obvious conclusion one draws from the book is that Bernanke is just not going to let any major US banks fail, he views any such failures as too dangerous to the economy.
And the point is an interesting one, how do consumer loans really increase consumption if one person has to not spend to provide the money that is loaned? It seems that what is coming is more spending by the oil producing countries (look at what is happening in the Gulf and Russia) and less spending by the oil importers (except on oil), together with more spending by the Chinese and less lending by them to the US.
Perhaps this is wishful thinking. A global Great Depression will be most unpleasant.
I'm looking forward to the show being on GPM as I enjoy all your broadcasts.
CLZ,
The one-on-one borrowing/lending relationship you describe exists only on Prosper.com. In the wonderful world of fractional banking, banks lend huge multiples of their capital bases. On top of that, you have off-balance sheet lending in the form of Structured Investment Vehicles (SIVs) that add another layer of leverage. The best estimates are that the major bank' and investment banks' unmarketable, off-balance sheet assets ("Level 3") at Citicorp, Goldman Sachs and the other majors is double their capital bases. The Fed has no way to inject liquidity into these off-balance sheet funds. That's why Paulson is desperately trying, so far unsuccessfully, to create his Master Liquidity Enhancement Conduit. But the ultimate problem is beyond liquidity: It's solvency. The assets backing all the short-term paper that is now frozen are NINJA mortgages, credit cards with 18% APRs and seven-year car loans. Financial historian Martin Hutchison estimates the ultimate losses on these assets in a bear market at $1 trillion, or 7% of GDP - at the very least a deeply recessionary event. I wouldn't be surprised as this unfolds to see Helicopter Ben hovering over my house and the sky raining money, but I doubt it will help.
ftr
FTR:
At the risk of sounding somewhat ridiculous, let me say , "Solvency is an accounting fiction."
You have two very nice ties. I like one of them and would like to wear it. I offer you one million dollars for the one I like, financing the transaction with a no doc loan with zero down, secured by a trust deed on the tie. This loan is bundled, sliced diced, and some of the best resulting tranches are placed in a SIV.
You take the million dollars in proceeds and realizing that your remaining tie, similar in all respects, is also now worth a million dollars, feel you can spend the million from the first transaction. You do so and benefit the economy.
Unfortunately, I experience difficulty making the payments on my million dollar tie when the teaser rate expires and my payments go from $2 per month to $6000 per month. Ouch. Plus, they are selling similar ties down the street for $50. All, in all, I decide to place the tie in the mail and sent it to the bank who is servicing my tie-purchase loan. Even Steven.
The marketplace of high-quality inexpensive ties is causing many people who also overpaid for their tie to do the same. The SIV investors get wiped out, and maybe the purchasers of the commercial paper issued by the SIVs also loose money.
But what difference does it make? Except that I now no longer own a million dollar tie, and you realize your remaining tie is only worth $50 not 1M. We feel poorer, but in reality nothing has changed except that you got to spend some of the money that formerly belonged to some poor schlubs who invested in a hedge fund that invested in an SIV. Their loss, your gain.
The real economy did not contract or expand as a result at all.
Moral of the story: a lot of people in these pages talk about how our economic system is founded on debt and that without ever expanding debt it will all collapse. I don't think that is true. The only thing that allows society to consume more is an improvement in productivity. Consumer debt is in virtually all cases nonproductive (compare: the vehicle that allows a worker to get to a factory). As a result, lending just transfers consumption in the present from one person to another at a price, and with a certain risk of default.
Of course, we Westerners have as a society taken debt financing to unsustainable levels and our lenders (China, Saudi Arabia) are about to cut us off. We will inevitably default. But what we don't consume in the future, they will.
PO is a problem, because it causes a dramatic decline in our productivity as a global economic system as what was once produced easily becomes difficult and expensive to obtain. That and we may end up nuking one another, which would result in a rather significant decline in productivity as well.
The problem occurs when people really begin to mistrust the whole system because of the kind of bizzarities you explain.
Without trust, liquidity breaks down, and without liquidity all kinds of transactions become difficult.
High transaction costs can result in low productivity as people a lot of time figuring out if the trade in goods via pieces of paper or IOUs is viable.