A READER WRITES: “What is the real cause of the current Global Credit Crunch? People say that it is the result of a “loss of confidence”, but what causes the loss of confidence? People say it was due to lax mortgage lending, but what causes the lax mortgage lending? What is the REAL cause behind what is going on?”BB SAYS: Most economists are perplexed by the global credit crunch. That is because most economists are idiots, and have no idea what they are talking about. Given that this is the biggest global recession since the Great Depression, we need to ask: what caused the Great Depression? In order to answer that question we need to see what the man who did most to solve the Great Depression had to say about it. The man who did most to solve the Great Depression was the man who implemented the New Deal in the US, namely President Roosevelt’s Treasury Secretary, Marriner Stoddard Eccles. What did he think caused the Great Depression? Well, here is what he said in his autobiography:
As mass production has to be accompanied by mass consumption, mass consumption, in turn, implies a distribution of wealth -- not of existing wealth, but of wealth as it is currently produced -- to provide men with buying power equal to the amount of goods and services offered by the nation's economic machinery.
Instead of achieving that kind of distribution, a giant suction pump had by 1929-30 drawn into a few hands an increasing portion of currently produced wealth. This served them as capital accumulations. But by taking purchasing power out of the hands of mass consumers, the savers denied to themselves the kind of effective demand for their products that would justify a reinvestment of their capital accumulations in new plants. In consequence, as in a poker game where the chips were concentrated in fewer and fewer hands, the other fellows could stay in the game only by borrowing. When their credit ran out, the game stopped.
That is what happened to us in the twenties. We sustained high levels of employment in that period with the aid of an exceptional expansion of debt outside of the banking system. This debt was provided by the large growth of business savings as well as savings by individuals, particularly in the upper-income groups where taxes were relatively low. Private debt outside of the banking system increased about fifty per cent. This debt, which was at high interest rates, largely took the form of mortgage debt on housing, office, and hotel structures, consumer instalment debt, brokers' loans, and foreign debt. The stimulation to spend by debt-creation of this sort was short-lived and could not be counted on to sustain high levels of employment for long periods of time. Had there been a better distribution of the current income from the national product -- in other words, had there been less savings by business and the higher-income groups and more income in the lower groups -- we should have had far greater stability in our economy. Had the six billion dollars, for instance, that were loaned by corporations and wealthy individuals for stock-market speculation been distributed to the public as lower prices or higher wages and with less profits to the corporations and the well-to-do, it would have prevented or greatly moderated the economic collapse that began at the end of 1929.
The time came when there were no more poker chips to be loaned on credit. Debtors thereupon were forced to curtail their consumption in an effort to create a margin that could be applied to the reduction of outstanding debts. This naturally reduced the demand for goods of all kinds and brought on what seemed to be overproduction, but was in reality underconsumption when judged in terms of the real world instead of the money world. This, in turn, brought about a fall in prices and employment.
Unemployment further decreased the consumption of goods, which further increased unemployment, thus closing the circle in a continuing decline of prices. Earnings began to disappear, requiring economies of all kinds in the wages, salaries, and time of those employed. And thus again the vicious circle of deflation was closed until one third of the entire working population was unemployed, with our national income reduced by fifty per cent, and with the aggregate debt burden greater than ever before, not in dollars, but measured by current values and income that represented the ability to pay. Fixed charges, such as taxes, railroad and other utility rates, insurance and interest charges, clung close to the 1929 level and required such a portion of the national income to meet them that the amount left for consumption of goods was not sufficient to support the population.
This then, was my reading of what brought on the depression.
In America, there has been huge economic growth and nearly all of that new wealth has gone to the wealthiest 10 percent, and to higher profits for corporations. Median incomes have hardly increased at all. The non-wealthy have only been able to sustain increases in their spending by borrowing the savings of the wealthy.
http://www.epi.org/content.cfm/ib239
Look at the graph at the bottom of the above link. Between 1979 and 2005, incomes of the wealthiest 1 percent of Americans increased by 250%. Incomes of the wealthiest 20% have increased by nearly 100%. Incomes of the poorest 20% have hardly increased at all. The incomes of people in between have also not increased very much. For 25 years real wages have been in decline for the majority of the American population. Salaries have remained the same, but working hours have increased, and inequality has just soared. Something similar has happened in other countries. Remember: we are not talking about poverty here – absolute poverty (malnutrition etc.) can decline while inequality rises.
We all know that the recent asset bubbles were the result of excessive borrowing by people who do not have sufficient incomes to pay back their loans. Excessive borrowing by some is made possible by excessive saving by others. The non-wealthy have become more indebted; and now they have stopped borrowing and they have stopped spending. The non-wealthy no longer have enough wealth to continue borrowing and spending. The only solution is a radical reduction in inequality of wealth.
Inequality of wealth causes too much saving by some and too much borrowing by others. Now, the wealthy cannot spend all their money. So they save it. This means that there is money for people to borrow – remember that Total Borrowing must ultimately equal Total Saving. Other people then borrow the savings of the wealthy – but if the incomes of the borrowers are not increasing they can only sustain so much borrowing. Eventually there is no productive place for the wealthy to put their savings – and that's when asset bubbles start – that's when assets start to be overpriced – when people are looking for a place to put their savings that will bring them a return. But now there are no good investment opportunities for savings, because ordinary people do not have money to buy extra goods and services.
The period between 1950s to the early 1970s was the period of real economic growth, based on social welfare and egalitarian distribution of income – when societies actually got better and social indicators improved. In the late 1970s the social indicators began to decline and growth fell very sharply and inequality fell back to what it was in the 1920s – leading eventually to a crash similar to the one that happened at the end of the 1920s. We need to abandon the Free Market Fundamentalism and Right Wing Economic Madness of the last 30 years, and return once more to egalitarian and sustainable economic growth.
Good work.
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