I have finally seen someone on the national TV programs that told the truth about the economic free fall we have been experiencing in our economy. Chuck Colson, the head of Prison Fellowship Ministries appeared on the Fox News Channel on the weekend of February 28th. Mr. Colson, in his interview stated that it was greed on the part of all Americans which was the root cause of our economic woes. According to Mr. Colson, this greed has been manifested in our pervasive misuse of credit for instant gratification and the overturning of the Biblical values of hard work, saving, and delayed gratification.
Let's examine the mechanics of Mr. Colson's statement. Over the past 20 to 30 years, there has been an incredible, and reckless, extension of credit to every man, woman, child ... and even pets. It is not uncommon for a family's mailbox to receive multiple applications for credit cards on a weekly basis, irregardless of the credit worthiness of the solicited individual. The over availability of credit has led to Americans purchasing goods and services before they can actually pay for the purchased items. Think about this a moment ... buying a dress on credit before you can actually pay for it does not create a "new" demand for a dress ... it actually moves a future demand into the present time. This is critical to understand. Credit does not create new demand, it simply shifts the timing of the demand.
Look at the effect this has had to our economy. Through the use of credit, artificial demand has been created in the present. Businesses see this faux demand as an increase, which causes businesses to expand, thinking this fax demand actually points to a larger demand in the future. Businesses expand, create new jobs, buy more raw materials because of a false projection of demand. Now, at some point, the limit of credit is reached. What happens when the people who are buying goods and services on credit have no more credit? The demand falls off precipitously! Shades of 4th quarter 2008. And all that planning and investment for the projected future increase in demand is in reality an over building of production. This overbuilding actually slingshots the economy into a decline. And until the debt is paid down, there can not be any significant return to normal demand patterns.
Now, I know that an intelligent one or two of you will take exception to my statement that loose credit does not create increased demand. I will probably be told that by giving credit to people who could not afford to buy something, creates a new demand for the good or service they purchase with credit. I will concede that there may be a small increase in demand from this factor, but I would point out that this increase can only occur when someone purchases a good or service on credit that they would not have purchased without the credit. Further, I will suggest that this limited increase in demand is more than offset by the loss in demand that comes from making interest payments.
Let's examine what happens here. If I make $1000 per month in take home pay. I could purchase up to $12,000 in goods and services in a year's time. Lets assume, however, that I Use $1000 of credit at the start of the year to purchase an item. An interest rate of 25% is no longer uncommon. This means that of my $12,000 take home that I could spend in a year's time is reduced by $250, making my purchasing power now $11,750. Well, in today's economy, we have many people whose credit exceeds their annual purchasing capabilities. In this example, if I have borrowed $12,000 at a 25% interest rate, my purchasing power is eroded to only $9,000. So, you can see that using credit actually reduces purchasing power which translates into decreased demand for goods and services.
Showing posts with label Government. Show all posts
Showing posts with label Government. Show all posts
Monday, March 2, 2009
Tuesday, February 10, 2009
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.
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.
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