Tuesday, 18 August 2015

The further failure of phony credit creation

The mainstream view on economic growth is that it is based on credit, great gobs of it, created out of thin air by trading banks on the back of very scanty reserves and lent out under the control and at the behest of the central bank. Created credit creates growth, they say.

The Austrian view is that economic progress is based on progress in creating and accumulating capital. That created credit is counterfeit capital. That growth created by counterfeit capital is illusory, is malinvestment. That it leads to bubbles (borrowing to buy inflating assets, assets inflating further, inducing more borrowing to buy more inflating assets … rinse and repeat), to over-supply, and to long-period projects begun but not able to be completed. That its phony boom leads inexorably to a real bust.

Every 6-12 years we seem to have to undergo the test between these views again. Guess which view is being exposed in recent headlines. First:

S&P downgrades NZ banks on Auckland bubble – MACROBUSINESS
Standard & Poor’s has cut its stand-alone credit profiles on New Zealand’s big four banks, and lowered its ratings on some other local financial institutions, due to concern over rising Auckland house prices.

NZ houses being purchased, of course, very largely by large amounts of created credit. Second:

Doomsday clock for global market crash strikes one minute to midnight as central banks lose control – TELEGRAPH
When the banking crisis crippled global markets seven years ago, central bankers stepped in as lenders of last resort. Profligate private-sector loans were moved on to the public-sector balance sheet and vast money-printing [i.e., of counterfeit capital creation] gave the global economy room to “heal.”
    Time is now rapidly running out. From China to Brazil, the central banks have lost control and at the same time the global economy is grinding to a halt. It is only a matter of time before stock markets collapse under the weight of their lofty expectations and record valuations.

The Telegraph lists several sinister signposts towards a bust:

  1. China slowdown … recent Chinese economic activity having being boosted on the back of credit creation
  2. Commodity price collapse … commodity production having been boosted on the back of credit creation
  3. Resource sector credit crisis … producers borrowing on the back of credit creation losing money on prices created by oversupply boosted by credit creation
  4. Emerging markets begin to fall … crippled by currency devaluation on the back of collapsing commodity prices
  5. Credit markets roll over … as six years of reliance on central banks for funds has left the credit system unable to cope
  6. Interest rate shock … as the last six years of low-interest fantasy turns into a higher-interest reality
  7. Bull market third longest on record … on only two other occasions in history has the market risen for longer. One is in the lead-up to the Great Crash in 1929 and the other before the bursting of the dotcom bubble in the early 2000s …
  8. Overvalued US market … Professor Robert Shiller’s cyclically adjusted price earnings ratio for the S&P 500 stands at 27.2, some 64pc above its historic average of 16.6. On only three occasions since 1882 has it been higher – in 1929, 2000 and 2007

Can you see a connection?

Phony credit was created in large gobs in the hope of “healing” the previous bust, which was created on the back of large gobs of phony credit creation in the hope of “healing” the previous bust, which was created on the back of large gobs of phony credit creation in the hope of “healing” the previous bust ... rinse, repeat … but repent?

Over to you mainstreamers.

[Hat tip Hugh Pavletich]

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