Credit expansion is slowing down

Oct 8, 2014

Baltimore, Maryland

Dear Diary,

When we left off yesterday we were worried. What if we have seen the highs in stocks and bonds not just for the next 5 or 10 years...but for the rest of our lifetimes?

Yesterday, the Dow fell 272 points. No big deal, of course. But what if it continues? Just 6 years ago, it fell 51%. It could easily do so again - back down to, say, 8,000.

There would be nothing unusual about it. Fifty percent corrections are normal.

You know what would happen, don't you? Ever since the Crash of '87 it has been standard procedure for the Fed to react quickly. Central bankers are now our first line of defense against normalcy. But what if Janet Yellen & Co. got out the party favors...set up the booze on the counter and laid out some dishes with pretzels and olives....and nobody came? What if the market stayed down for 30 it has in Japan?

It seems almost unbelievable. Every time US stocks have gone down since WWII they've always bounced back...and hit new highs. We take it for granted that they will always go up over the long run. But why should they?

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The period - 1945 - 2007 - is beginning to look less and less like the "way things always are" to the way things were during a very special and unusual time. It was more of an outlier than an average. The world was recovering from WWII. Populations were growing. People were starting new families and new businesses.

And perhaps most important, the world was just beginning the greatest credit expansion in its history. Gold - which had kept the dollar honest for almost 2 centuries - was taken out in 1968. Thenceforth, the flimflam began. We've been over the numbers before, no point in repeating them. Besides, the point we are making is obvious. When it comes to multiplying a whole society's debt by a factor of 50...or increasing its debt/GDP ratio from 140% to 350%...we pass this way but once in a lifetime.

Credit can continue to expand...for one year...two years...10 years even. But not for 50 years. Of course, the future includes an infinite number of days. And we don't know what will happen on even a single one. But if a half a century goes by...and we wake up one fine day and discover that debt has risen to 1,000% of GDP...won't we be surprised!

Meanwhile, look what is happening to the bond market. The Fed is supposed to withdraw from bond auctions this month. There goes the biggest and best customer...his pockets full and his head empty. You'd think you'd see bond prices fall. But no! They're going up.

This curious trend has confounded analysts all over the world. If the US economy really were recovering it should mean higher yields (lower bond prices) as more and more people bid for scarcer credit. So, what's going on? Are bond buyers making a mistake? Or is the economy really weaker than the jobs report would make it appear?

    We'll go with the bond market on this one. Yields are low because there is little demand for credit. In the US, the rate of new business start ups has been going down for nearly 30 years. And now, with so much debt already...and an older, slower population, who needs to borrow? And who can expect the same growth rate as we had over the last 50 years? Bill Gross:

    Growth in the U.S. and elsewhere has been facilitated in the past 30 years by the expansion of credit and leverage. Once capitalists recognize that they can't continue to accumulate leverage at the same pace, growth slows. Demographics also are contributing to diminished economic growth. The boomers aren't booming. They are getting older and retiring.

    Most boomers need health care, but they don't need another house or a third car. The aging of our society is putting curbs on economic growth. Thirdly, technology is a boon and a wonder, but it also has eliminated jobs that aren't being replaced at the same pace. Apple [AAPL] is a wonderful company, but it doesn't hire as many people as the old General Motors [GM].

    Finally, globalization is an issue. The U.S. has been the world leader in globalization since the end of World War II. We have benefited from mercantilistic expansion, and because the dollar has been the reserve currency. Now things are turning sour elsewhere. When you fly into head winds, you fly at a different speed.

We've spent our whole lives in a credit expansion. We began life at when the cork came out of the credit jug. We've all been pulling hard on it ever since. It juiced up the economy...and the stock market. Heck, we've lived on it. We've taken TV's from China. Autos from Japan. Wine from France and Italy. 'Hey, we'll pay you later,' we said.

What if 'later' were now?

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

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