Credit Crunch 2010

Over the past several decades, one of the primary engines of U.S. economic prosperity has been a constantly expanding debt spiral.  As long as the U.S. government, state governments, businesses and American consumers could all continue to borrow increasingly large amounts of money, the economy was going to continue to grow and “the greatest party on earth” could continue.  But many of us knew that if anything ever came along and significantly interrupted that debt spiral, it could cause a credit crunch even more severe than we saw at the beginning of the Great Depression back in the 1930s.  You see, back in the “roaring 20s”, American businesses and consumers had leveraged themselves like never before.  Debt soared to record levels and when the credit spigot was suddenly turned off the whole thing came crashing down and it took an entire decade and a world war to recover.  Well, today things are frighteningly similar.  Over the past 30 years we have piled up unprecedented mountains of debt.  In fact, today our entire economic system is based on debt.  So what would a credit crunch do to an economy based on debt?  Well, it would absolutely devastate it of course.  So are we facing a credit crunch in 2010?  Yes.  Consumer credit in the United States has already contracted during 15 of the past 16 months, and there is every indication that things are about to get even worse.

The truth is that once a deflationary cycle starts, it tends to feed on itself.  People quit spending money, banks quit making loans and everyone starts hoarding cash.

And right now there is a lot of fear out there.  According to one major indicator, consumer sentiment declined in early July to its lowest in 11 months.

U.S. consumers are starting to pay down debt and are holding on to their money.  Others can’t spend more money because they are out of work or are completely tapped out.

But without more spending, the U.S. economy won’t get revved up again.  And if the U.S. economy does not get going soon, there are going to be more foreclosures, more bankruptcies and even more jobs lost.

In a recent article for The Telegraph, Ambrose Evans-Pritchard set out some of the statistics that show that the U.S. economy is in really, really bad shape right now….

The US workforce has shrunk by a 1m over the past two months as discouraged jobless give up the hunt. Retail sales have fallen for the past two months. New homes sales crashed to 300,000 in May after tax credits ran out, the lowest since records began in 1963. Mortgage applications have fallen by 42pc to 13-year low since April. Paul Dales at Capital Economics said the “shadow inventory” of unsold properties has risen to 7.8m. “The double dip in housing has begun,” he said.

It seems like almost everyone is using the words “double dip” these days.

It is almost as if it was already a foregone conclusion.

But the truth is that this would have just been one long economic decline if the U.S. government (and many of the other governments around the globe) had not pumped so much “stimulus” into their economies over the past several years.

Now that governments around the world are pulling back and are beginning to implement austerity measures, the “sugar rush” of the stimulus money is wearing off and the original economic decline is resuming.

All that the trillions in “stimulus” did was to give the world economy a temporary boost and get us into a whole lot more debt.

In his recent article entitled “The U.S. Is On The Edge Of A Growing Deflationary Sinkhole”, Lorimer Wilson did a really good job of detailing how all of this debt has gotten us into a complete and total mess….

Capitalism cannot function unless its constantly compounding debt is serviced and/or paid down. Today, the U.S., the world’s largest debtor, can no longer pay what it owes except by rolling its debt forward and borrowing more [in] what the late economist Hyman Minsky called ponzi-financing, financing common in the final stages of mature capital systems.

The amount of outstanding U.S. debt, according to Martin D. Weiss, www.moneyandmarkets.com, has now reached levels that can never be paid off. The United States government and its agencies have, by far,
– the largest pile-up of interest-bearing debts ($15.6 trillion),
– the largest accumulation of unsecured obligations (over $60 trillion),
– the largest yearly deficit ($1.6 trillion), and
– the greatest indebtedness to the rest of the world ($4.8 trillion).

The truth is that the United States is in the early stages of a truly historic financial implosion.

Earlier this year, all of the focus was on the European sovereign debt crisis, but now all eyes are turning back to the U.S. once again.  David Bloom, currency chief at HSBC, recently remarked that world financial markets are extremely concerned about the state of the U.S. economy right now….

“We’re in a world of rotating sovereign crises. The market seems to become obsessed with one idea at a time, then violently swings towards another. People thought the euro would break-up. Now we’re moving into a new phase because we’re hearing alarm bells of a US double dip.”

Without direct intervention from the U.S. government, the U.S. financial system is headed for a world of hurt.

The truth is that the credit markets are freezing up, and without efficiently operating credit markets, the economic system we have constructed simply will not work.

The following information comes courtesy of the Consumer Metrics Institute.  If you have never visited their site, you should, because it is packed full of excellent data.  In their most recent report, they do a good job of detailing the astounding credit contraction that we have been witnessing….

During the past week there has been a flurry of Federal Reserve reports and commentary concerning the levels of credit in the current economy. The two most notable were:

► On July 8th they reported that the level of seasonally adjusted outstanding U.S. Consumer Credit (their G.19 report) decreased during May by $9.1 billion, representing an annualized rate of credit contraction of 4.5%. Although even this change is above the average for the preceding twelve months, it is much smaller than a quiet revision to the previously published April U.S. Consumer Credit figure — which is now reported to have decreased by $14.9 billion (a 7.3% annualized contraction rate).

The Federal Reserve fails to put these numbers into perspective:

1) Consumer credit has contracted during 15 of the past 16 reported months, and it is down a record total $148 billion over that time span.

2) The $14.9 billion in credit ‘lost’ during just April is the second highest monthly amount in history, second only to the $23.4 billion ‘lost’ during November, 2009.

3) And the nearly 6% cumulative reduction in consumer credit over the past 16 months is the largest (on a percentage basis) for any 16 month span since September 1944 — when FDR was still in the White House and people were buying War Bonds instead of tightly rationed consumer goods.

► On July 12th Federal Reserve Chairman Ben Bernanke noted that small businesses were not getting the loans that they need to create new jobs. The Federal Reserve’s own data reports that lending to small businesses dropped to below $670 billion in Q1 2010, down about $40 billion (5.6%) from two years ago.

The New York Times reported Mr. Bernanke wondered: “How much of this reduction has been driven by weaker demand for loans from small businesses, how much by a deterioration in the financial condition of small businesses during the economic downturn, and how much by restricted credit availability? No doubt all three factors have played a role.”

Small businesses, which account for over 60% of gross job creation, are not – for whatever reason – tapping into the credit necessary to create those jobs.

If you know anything about economics, the excerpt that you just read should be chilling you to your bones right about now.

Without loans, businesses can’t start or expand, consumers cannot buy homes or vehicles and retail spending will be in the toilet.

But, as a recent USA Today article pointed out, part of the problem is that so many Americans now have very, very low credit scores….

Figures provided by FICO show that 25.5% of consumers — nearly 43.4 million people — now have a credit score of 599 or below, marking them as poor risks for lenders. It’s unlikely they will be able to get credit cards, auto loans or mortgages under the tighter lending standards banks now use.

As I recently pointed out on The American Dream blog, historically only about 15 percent of Americans have had credit scores that low.

So can the U.S. economy fully recover if the number of Americans that are a bad credit risk has nearly doubled?

That is a very good question.

As I noted in a previous article, the truth is that the retail sector is already a huge mess, and if we don’t get the American people pulling out their credit cards soon this holiday season may not be very jolly at all….

Vacancies and lease rates at U.S. shopping centers continued to get even worse during the second quarter of 2010.  In fact, in some of the most depressed areas of the United States, many malls and shopping centers could end up looking like ghost towns by the time Christmas rolls around.

So this is the point where Barack Obama comes riding in on his white horse and rescues the U.S. economy, right?

Well, at this point Obama has joined with the other G20 leaders in pledging to get government spending under control.

So right now there are not any plans for new stimulus packages.

But as the U.S. economy starts sinking into a deflationary depression, the temptation to pump up the economy with even more government spending will become too great.

This will especially be true the closer to the election of 2012 that we get.  By the time election season rolls around, Obama will likely be much more willing to pile up even more debt for a short-term economic boost.

So yes, we are headed for a complete and total economic nightmare, but exactly how it all plays out is going to depend a lot on what Barack Obama, the Federal Reserve, other world leaders and other central banks decide to do.

For the moment, we are heading for an absolutely brutal credit crunch, and if something is not done quickly, it is going to dramatically slow down the world economy.

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