What will happen when credit stops? - The Daily Reckoning
The Daily Reckoning by Bill Bonner
On This Day - 20 May 2014
What will happen when credit stops? A  A  A

Baltimore, Maryland

Not much action in stocks...or gold...yesterday. So, let's go back and see what we've figured out recently. For one thing: the middle class can no longer afford a middle class lifestyle.

We've also confronted the awkward truth: America is more of an oligarchy than a democracy. In a university study, it was found that the government often snubs the will of the democratic majority in order to serve the desires of the dirty dealing special interest groups.

And we learned a new word - 'poligarchs' - for the teeming masses who enable it.

Richard Duncan came to visit yesterday. You may recall; he's the economist who has developed a theory about how excess liquidity affects asset markets:

"Milton Friedman said it was the supply of money that mattered. But he based that view on his analysis of the Great Depression. He was right. But real money was replaced by credit money, 40 years ago. Now, it's not the money supply that matters. It's the supply of credit."

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And here, we simplify Duncan's conclusion:

    As long as credit is increasing at a healthy rate, markets and GDP go up. When they don't increase, expect recession and bear markets.
Credit expansion began when Ike Eisenhower was still on the golf course. It has been expanding ever since, with more than 50 times as much today as back then. And today, finance and industry - not to mention asset prices - depend on it as if it were cable TV and cheap beer. Cut it off, and the whole economy goes into a gloomy funk. Duncan:

"The Fed knows that credit must expand, or we have a depression. And today, debt levels are so high that a depression would be catastrophic. The disaster would be worldwide, not just in the US. And people would die. Because a depression in the US would mean tens of millions...maybe hundreds of millions... of people in China and Southeast Asia would lose their jobs. Businesses would go broke. Governments would go broke. People living at the margin - with no savings - would soon be desperate. I don't think our civilization would survive.

"That's why the Fed will not allow a real credit contraction."

For the moment, the sun still shines and credit is still expanding. Asset prices are still going up. But all that is set to change.

"In the third quarter, excess liquidity will fall sharply. We should see much more volatility in asset prices. My guess is that before the end of the year we'll see a very disturbing drop in the stock market. The Fed will pause...interrupting its 'tapering' program. Then, depending on how markets react, it will probably hint at another QE program for 2015. That should send markets back up."

Mr. Duncan sees the situation much as we do. Up to a point. He sees the dependence on ever-expanding debt. He sees the catastrophe that comes when debt expansion stops. He expects, as we do, that the Fed will respond with more QE. All right so far. But he lacks our deep cynicism and insensitivity. He sees the tunnel, but he thinks he sees a flicker of light at the end of it.

"Governments can still borrow...and still expand credit. One way or another, they are going to try to keep the credit expansion going. So, instead of throwing money away, they might as well invest in things that might expand future output - new technology, new infrastructure, and new industries."

Ahh...but that ignores the oligarchs, poligarchs and the nature of government itself. Government's primary concern is not to protect its citizens or their economy. Instead, it aims to transfer more power, status, and wealth to the elite who control it (the oligarchs). And to do that, it must keep the masses (the poligarchs) sedated. Charles Hugh Smith explains it:
    The State has two core mandates: enforce quasi-monopolies and cartels for private capital, and satisfy enough of the citizenry's demands for more benefits to maintain social stability.

    If the State fails to maintain monopolistic cartels, profit margins plummet and capital is unable to maintain its spending on investment and labor. Simply put, the economy tanks as profits, investment and growth all stagnate.

    If the State fails to satisfy enough of the citizenry's demands, it risks social instability.
The feds will be the borrowers of last resort. But the money won't be invested in a brighter future. It will be pilfered and squandered.

And then what? Tune in tomorrow...

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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