2010-03-01

U.S. Government Epic Fail

Why the US economy could suffer another contraction
The US economy is now in a situation that is unique in its monetary history: a massive and totally unprecedented expansion in its monetary base followed by a contraction in bank deposits. I must admit that in my humble opinion only an utterly incompetent Democratic administration could pull off a stunt like this. Defenders will immediately blame the banks, arguing that they are not lending. But they are not lending because firms are not demanding loans. While Democrats shed crocodile tears about people who claim they are forced wear their dead relatives dentures they are nevertheless are unable to find scores of businesses unjustly denied bank funding. The truth is that banks will always lend if they are assured of a return. In fact, if there is a boom it appears they will even lend when no return is assured.

That Commercial and industrial loans are currently dropping at an annual rate of about 16 to 17 per suggests to some in the commentariat that the money supply needs to be loosened up further if a depression is to be avoided. It has yet to occur to them that the drop might have something to do with firms paying off debt and shelving plans for expansion rather than the banks refusing to lend. Firms operate on a little thing called a profit margin. When this margin disappears so do jobs, investments and the demand for loans.

Now expectations play a crucial role in making investment decisions. However, expectations are also partly shaped by uncertainty. Therefore the greater the degree of uncertainty of success regarding a business decision the higher will be the return that potential investors demand. Sometimes the uncertainty is so great no amount of promises will separate investors from their money.
What the U.S. economy requires is massive reductions in the structural fixed costs imposed by government. From Bush through Obama, the policy has been to add long term fixed costs via new spending and deficits. Obama has accelerated the process, or is at least trying to.

The American public has a massive debt hangover. What they want is a bacon & eggs with some coffee. Bush & Obama responded by cooking up big vats of moonshine. There's a 180 degree policy mismatch and the result will be another downturn in the economy.

For more detail on the decline in loan growth, see this post: GDP AND LOAN GROWTH
The 6.51% year-to-year contraction in LOANS over the course of 2009 was unprecedented in the post-war period; the 1.49% year-to-date contraction in TOTLL projects to a remarkable and equally unprecedented 13.26% contraction for 2010. Unless the Federal government can continue to substitute public debt for private debt on a one-for-one basis as it did through the third quarter of 2009, this promises to be a very good test of Austrian economic theory and the hypothesized link between debt contraction and economic contraction.
Note that fewer U.S. dollars means each existing U.S. dollar is worth more...

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