Cracks in the Credit Cement
Money and confidence do not necessarily go hand-in-hand...
I ARGUED recently that disruptions caused by an artificial excess of credit will squeeze margins and lead inevitably to the demand for yet more credit, writes Sean Corrigan for the Cobden Centre.
Taking this particular tiger by the tail may well defer the day of reckoning, but only at a steep cost. The business first becomes unprofitable, then barely cash generative and, at last, a mere Ponzi scheme reliant on infatuated bankers and intoxicated shareholders for its continued existence, but ever more susceptible to any shock to its credulous sponsors' confidence as its balance sheet deteriorates in lockstep with its chances of achieving any more than a specious, bubble-supported, stock-jobbing sort of return on invested capital.
Indeed, it is in this pathology that we might seek the explanation for a very curious observation; namely, that certain key measures of business confidence, such as the US NAPM or the German IfO (themselves usually responsive to changes in business revenue), tend to wax and wane in opposition of the ratio of a 'broad money' measure – such as M3 or total banking assets – to a narrower, more proper M1-type gauge.
One has to think about this for a moment to see how perplexing it appears on the surface. Here we have the blessed 'multiplier' in full operation, with several Dollars of credit being added for each unit of new money created and yet industry is becoming more, not less, uncertain of its prospects as they are.
From a mainstream perspective this makes no sense at all, but, to an Austrian the answer may be that the oversupply of credit has served to hyper-extend the chain of production in the manner outlined above. The fundamentally alien, unintegrated nature of much of that incremental activity means its cash flow is at best scanty, at worst negative. We might say that the 'length' of the Hayekian triangle or cone we use to envisage the productive structure has become disproportionate to its volume (broadly the total revenue flow rate of the economy), given that the height of end-spending has not only not become reduced to compensate (as saving takes place), but is actually now pushing higher.
Only the cement of credit can shore up this unstable edifice, but with the mortar increasingly lacking the monetary fixative necessary to maintain its integrity (through generating sufficient means to make interest payments, meet amortization schedules and the like), this, too, will soon give way and – barring the implementation of an ill-advised, official policy of forced petrification – which seeks to immure the living so that the zombies may be spared the tomb – the ensuing crash will usher in the grim austerity of the Bust to succeed the giddy abandon of the Boom.
Up to that last roll of the dice, as Hayek himself phrased it, we will be suffering from the foredoomed tail-chasing of 'an investment that raises to the demand for (finance) capital', though some will see this fateful scramble as a sign of a potentially remunerative chance to fulfill the falterers' importunate demand for funds. Sadly, those who hold that 'as long as the music is playing, you've got to get up and dance' tend to find this is no Jazz Age Charleston, but rather a deadly tarantella.
In a passage we have frequently quoted for its insight, the great Richard Cantillon expressed it thus, according to the usages of his own time:
In 1720 the capital of public stock and of Bubbles which were snares and enterprises of private companies at London, rose to the value of £800 millions, yet the purchases and sales of such pestilential stocks were carried on without difficulty through the quantity of notes of all kinds which were issued, while the same paper money was accepted in payment of interest. But as soon as the idea of great fortunes induced many individuals to increase their expenses, to buy carriages, foreign linen and silk, cash was needed for all that, I mean for the expenditure of the interest, and this broke up all the systems.
This example shews that the paper and credit of public and private Banks may cause surprising results in everything which does not concern ordinary expenditure for drink and food, clothing, and other family requirements, but that in the regular course of the circulation the help of Banks and credit of this kind is much smaller and less solid than is generally supposed. Silver alone is the true sinews of circulation.
Substitute properly-defined 'money' for 'silver' and think TMT, sub-prime, and Chinese reflation instead of the South Sea Bubble, and you have it in a nutshell.
Once the mood shifts, of course, there arises a general desire to pay down existing debts and an anxiety not to incur more, a restorative tendency which strikes terror into the heart of all the capering tribe of macromancers – befuddled to a man, as they are, by their economics of collective paradox, their reverse quantum mechanics of counter-intuitive large-scale phenomena.
For, by their will-o-the-wisp lights, if no-one stands ready to reinforce failure by outspending his means, the moment his neighbor rediscovers the compelling logic of good husbandry, this disavowal of a dreary cortège of serial ruination implies that a total and coincident ruin must instead be the sorry result.
It should, however, be clear from what we have argued above that since much credit is not in any way actively monetized, and that money is what ultimately counts, the discharge of that portion of the stock of credit should have few further consequences beyond the benign ones of reducing one man's exposure to the soundness of another and hence of lessening the financial vulnerability of all – not least that of any bank which happened to intermediate between the two.
After all, where this is the case, in order to pay off his borrowing, the debtor must either have gained command over a valuable asset, contributed to the production of a good, or performed a useful service – i.e., he must have been a net economic contributor. To extinguish the charge held against him, he must make shift to offer one of these directly to his creditor, or else to sell them for money to a third party and offer that in its turn.
His obligor, who earlier was only holding an unfulfilled title to a future economic satisfaction, is thereby given the concrete means with which to enjoy the fruits of his former thrift with no further delay, whether by reinvesting the money (or goods) received in a productive undertaking, or by going out and spending what he has been rendered – or what he has thus been spared from expending elsewhere – on some good, old-fashioned, exhaustively indulgent consumption.
How can this be an ill? Is not to say so the same as to argue that if I borrow my neighbour's lawn mower, promising to cut his lawn, too, as a quid pro quo when I return it a week hence, I occasion my benefactor real harm by actually doing what I promised to do? In the same vein, if we do consider this an evil, should we insist, henceforth, that no-one ever be permitted to deliver into an expiring futures contract, but that he must roll the position eternally forward, lest he bring the market for grain, or gasoline – nay! the entire global economy – shuddering to a halt by closing out his position?
Moreover, if it is (almost) universally accepted that we all routinely partake of the bounties of voluntary exchange in order to increase our mutual satisfaction beyond what we can each hope singly to achieve, how can we argue that the mere introduction of a time delay between the two halves which make up every bargain transmogrifies the second component – but never the first, you will note! – into an act of social violence? And if it is so insisted, where are we to set the threshold for this noxious change? Five minutes after the first goods have been dispatched? Five days? Five weeks? Five months? Five years?