Our Economic Crisis is Debt - Part 1

It is amazing to listen to the politicians and the media talk about the economic crisis in which we now find ourselves. It would seem that the past years of economic boom were a myth and that the past administration was busy robbing the common man blind. They must think we are idiots - and by the response of many Americans, we may be!

Let's look a little more closely at the facts. Over the past thirty years, the American economy and the world economy has experienced a major shift in its dependence on debt/credit. In 1989 World credit levels were approximately equal to the world GDP output. By 2009, this ratio has gone from 1 to 1 to 3.7 debt to 1 GDP, world wide. Let's think about the implications of this shift from cash transaction to debt transactions.

When my grandparents went shopping, they paid cash. If they did not have the money, they waited until they saved it. There were some stores that would allow them to place items on lay-a-way, but there was always the discipline of waiting until an item was paid for before enjoying its ownership. There came a special sort of pride in achieving the purchase of expensive goods. Demand for goods and services was tied to what was being bought and kept a fairly steady pace.

During the time of my parents' prime, there was a move to extend credit to businesses. Personal loans were primarily focused on home mortgages, automobiles, and revolving accounts in stores. Now, people were able to leverage a small fraction of their take home pay to buy high value items and take possesion before the item was actually paid for. The cost of this priviledge was the interest payment to the institution extending credit. As far as mortgages went, these loans were being made against assets that were generally appreciating in value. Along with this appreciation, the purchaser was required to have a significant down payment which provided a hedge against any loss in value of the property.

What businesses found was that the demand for goods and services seemed to be stimulated by the access to credit. By extending more credit, it appeared that more demand could be created, fueling economic growth. So, our economy entered the age of explosive expansion of credit. My generation is now accustomed to receiving multiple applications for credit on an almost weekly basis. No money down and term sales are being used to sell almost anything. I can remember the announcement when Sears made more money off interest payments than profit from the sale of goods!

Let's reason together for a moment ... what is the nature of the demand generated by credit. I would suggest that credit does not create more demand, it just moves scheduled demand to occur sooner. By using credit to buy goods and services, consumers simply consumer sooner. This creates an artificial sense of increased demand when it is really a timing issue. This shift in timing causes businesses, perceiving increasing demand, to expand business accordingly.

What happens when the limit of credit is reached? Demand is curtailed precipitously, as we have just seen. The bottom falls out ... unless the government steps in and forces a continued use of "credit" by deficit spending which the taxpayers children and grandchildren will be expected to pay back.