July 12, 2024

The Illusion Of Prosperity Ends

Every day brings more examples of the failed strategy of fostering economic growth through the use of easy credit.  Modern economies need credit to grow and prosper.   Applying credit growth on an exponential basis ultimately fails when borrowers become so leveraged that any hope of repaying their debts becomes impossible.

The Perils of Consumer Debt on Display in South Korea

After the Asian financial crisis hit South Korea a decade ago, the government helped the export-dependent economy recover by pumping out money and convincing people to borrow and spend more.

But this time around, the high household debt that accumulated in the past decade is depressing spending — an experience that has relevance around the world as governments seek ways to get consumers to help lift their economies.

As exports drop and South Korea’s economy slows, a high level of household debt is keeping consumers from spending more and the government — like others elsewhere — is wrestling with the question of how much to intervene.

“Everybody is too much in debt, so they cannot consume,” says Kim Kyeong-won, a senior vice president at Samsung Economic Research Institute.

Consumer debt in Korea expanded 350% over the last decade trailing average yearly economic grow of approximately 5%.

Korea is not just one example of reckless lending; it is a worldwide problem.  Ironically, the amounts of debt and leverage are so unsustainable that to cease lending to the overextended risks a collapse far worse than what we have seen to date.  We have reached the classic debt trap and the Federal Reserve acknowledges as much by extending virtually unlimited credit in every direction.

Bernanke Goes All In (Wall Street Journal)

If the current Fed believes there are limits to monetary policy, you can’t tell from yesterday’s Open Market Committee statement. The 10 members voted unanimously to take its target fed funds rate down to between 0% to 0.25%, from 1%. With Treasury bills already trading at close to zero as the world flees toward safe investments, the practical impact of this rate cut is negligible.

With the velocity of money collapsing as the recession deepens, the Fed is trying to put a floor under the economy by pledging an unlimited supply of dollars. Another goal is to fight the risk of deflation, or falling prices, as long as the economy continues to shrink. And judging from yesterday’s rally in stocks and bonds, many investors like the idea.

Now the Fed is embarking on a further monetary adventure and asking the world to believe that this time it will work. We sincerely hope it does. And if a lack of liquidity is the problem in some credit instruments, the Fed’s direct purchase of those assets should contribute to a credit thaw. It has already contributed to a decline in mortgage rates.

However, the larger economic problem today isn’t an overall lack of liquidity. It is fear and uncertainty. Banks, consumers and business are dug in their foxholes, conserving their cash until they believe the worst has passed. Meanwhile, investors around the world are deleveraging to reduce risk and cut their losses, a process that the Fed can do little about.

It would appear that whatever victory the Fed may achieve will do little to enhance the future financial stability of the consumer or the government.