Credit, Crisis and Opportunity
In order to understand the crisis in the global economy – and what must be done to resolve it - it is necessary to understand the role that credit has played in bringing it about. When credit expands rapidly, it drives economic growth. With more credit, consumers spend more so business profits increase. Businesses then hire more employees, buy more raw materials and expand production. They even pay more taxes, so governments have more money to spend. All the while, asset prices inflate. However, as the Austrian economists rightly pointed out, the day always arrives when credit stops expanding; then, the depression begins.
In the US, total debt (household, corporate, financial institutions and government debt) exceeded $1 trillion for the first time in 1964. During the next 43 years, it expanded 50 times to $50 trillion. That explosion of debt was replicated to varying degrees all around the globe. In the UK, total debt rose from around 210% of GDP in 1990 to more than 500% in 2008. That debt created the world we live in. We are all much more materially prosperous than we would have been otherwise.
Credit proliferation on such a scale only became possible when money ceased to be backed by gold with the collapse of the Bretton Woods system in 1971. The gold-based monetary system in place up until then imposed a severe constraint on the amount of credit that could be created. Afterwards, not only did credit make the global economy much larger, it also changed the nature of the economic system itself. Capitalism was transformed into Creditism. The economic growth dynamic under Capitalism had been driven by investment and savings. That process was slow and difficult. The growth dynamic under Creditism has been driven by credit creation and consumption; and that has created very rapid growth.
The problem now, however, is that Creditism appears to have reached its limit to create any more economic growth because the private sector cannot bear any more debt. Since 2008, it has only been a surge in government debt that has prevented a debt-deflation death spiral.
Milton Friedman persuaded policymakers that the Fed could have prevented the Great Depression if it had stopped the money supply from contracting in the 1930s. That message now guides the overall policy response to this crisis. What is not yet clearly understood, however, is that the Credit Supply has become the new Money Supply. In the past, there was a clear distinction between Money and Credit. Money was gold and credit was the obligation to repay money. Today, what is the difference between a Dollar and a ten-year government bond? They are both credit instruments; the only difference is that one pays interest and one does not. Furthermore, after the link between money and gold was broker, credit exploded to such an extent that it left the quantity of money (however it is defined) completely irrelevant in comparison.
Today, it is not the quantity of money or the money supply that matters. It is the quantity of credit that counts now. It is not enough to prevent the quantity of money from contracting as Milton Freidman taught. If a new great depression is to be avoided, it is essential to prevent the quantity of credit from contracting. Policymakers understand that and that explains why they continue to bail out the banks, to run massive budget deficits and to finance them with paper money creation.
What policymakers and the public so far have failed to understand, however, is that this crisis and our new economic system, Creditism, create unprecedented opportunities as well as perils. The private sector can’t borrow more because it can’t afford to repay the debt it already has. The government sector can, however. The interest rate on government bonds in most developed economies has never been lower. That means our societies could launch investment programs on a massive scale. Government investment could end this crisis; not investment in patching up the roads and bridges, or even in new infrastructure, but investment in transformative 21st century technologies that could restructure our economies and generate sustainable growth, industries such as renewable energy, biotechnology, genetic engineering and nanotechnology.
If governments grasp this opportunity, then not only would this crisis be resolved, technological miracles would be achieved. If governments fail to act and allow the quantity of credit to contract as the private sector pays down its debt, the new great depression that would ensue could last for decades.