Do We Really Need More Credit?

Eric Dash and Vikas Bajaj write in the New York Times under a headline: "In 2009, Economy Will Depend on Unlocking Credit."

How long this situation lasts will determine the immediate course of the nation’s economic life. Will the recession, already a year old, drag on through 2009 — or even longer? Will the stock market revive soon or shrivel further? What of the beleaguered housing market?

The answers to those questions will depend on the availability of credit in all its forms — home mortgages, personal and business loans and bonds sold by corporations, states and municipalities. For now, many banks are hoarding money rather than lending it. Their holdings of cash have nearly tripled to just over $1 trillion in the last three months, according to Federal Reserve data.

This is complete rubbish. There is clearly too much debt in existence. The current economic trouble is greatly magnified by the fact that each piece of actual money is lent about ten times in a ridiculous daisy chain of debt. This creates a situation pretty much analogous to a line of cars driving at a high speed on a highway with too little space in-between. Everything seems to run very smoothly until any small obstacle results in a massive pile-up.

What is now needed is some controlled creation of actual money. The problem is that the money that is created by a central bank is traditionally given to banks, which have absolutely no use for it at the moment. This is not a liquidity crisis, like the authors try to claim above. Liquidity is about trust, but insolvency is a fact. It is fully natural for the banks to keep their lending down, because of the shortage of solvent debtors.

Instead of force-feeding cash to banks, we need to have a source of money to the actual (nonfinancial) economy. Because paying back debts with existing deposits is deflationary—the deposits used for debt payment just cease to exist—money from outside the banking system will be needed for reducing the economy-wide debt load.

At the moment, people collectively owe much more money to financial institutions that they have in deposits. This is a debt trap that can not be escaped without an influx of money from outside of the financial system.

There should be a period of government spending with newly created money directly into the economy, accompanied by rising reserve requirements to prevent the banks from multiplying that cash into new debts. We should be aiming at returning reserve requirements to healthy levels around 25–50%, where each piece of actual cash could only be lent out once or twice.

The real (nonfinancial) economy would use the seignority of newly created money to escape from the clutches of the overgrown monster that the banking system has become. Paying existing debts with new money would create permanent deposits, instead of the "temporary" deposits that are borrowed into existence.

The inflationary effects of monetary printing would not necessarily be very high, if the printing is kept below the rate of credit destruction. That would not be a very difficult thing at the moment. Of course, some people that have been accumulating savings in anticipation of deflation would not get those expected gains, but the alternative of complete collapse would be even worse. Besides, those savings—even if they are stuffed into mattresses—are ultimately made of funny money like everything else.

So my point of view in short: In the long run, economy will depend on demolishing debt.