The Next Revolution in our Credit-Driven Economy. Schulte Paul

virtually all important choices in human life (when to marry, buy a home, go on vacation, go to university, expand a business, go to the hospital, have children) are predicated on the availability of credit. How can economics just leave this out? For decades, the science of economics has treated financial markets as a “harmless sideshow.”9 MIT economist Olivier Blanchard said, “We thought of financial regulation as outside the macroeconomic framework.”10

The Corporate Example

      Credit creation can make or break the balance sheet of the corporate sector and, therefore, the income statement. We should call the income statement the “outcome” statement, as it is a derivative of underlying trends in credit. In this way, the price-to-earnings ratio (P/E) and earnings per share (EPS) of a stock are meaningless and tell us nothing (we will see later that they may be a contra-indicator for investment timing and cause people to lose money!). To focus on earnings and EPS without an eye on credit and the way that credit affects national liquidity and the balance sheet of a company is to miss the big picture. Furthermore, focusing on GDP data, money supply, leading economic indicators, and fiscal positions is a waste of time without proper attention to the extent to which an economy is stretched too thin when it comes to the availability of credit and the savings that funds that credit.

      People borrow from a banking system whose capacity to lend is determined by how much these same people save. People go to banks to borrow their savings. Corporations do the same thing. Borrowings are loans (assets of a bank) and savings are deposits (liabilities of a bank). The savings of people and corporations create credit, and credit creates money supply. The ratio of bank loans to deposits (or savings) is the loan/deposit ratio (LDR). This can reach a low of 0.5 ($50 of loans for $100 of deposits) or so. This is the beginning of a credit cycle that makes for glorious asset price appreciation for a considerable period of time, usually for four to six years.

      A country that has its foot on the accelerator and is allowing credit growth to far exceed savings growth is running large current account surpluses. Domestic liquidity is sloshing around at an accelerating rate. This country can gun the engine of growth with credit up to an LDR of about 1.1 or 1.2 until they encounter trouble because the growth in credit has far exceeded the growth in savings. Examples today of highly liquid banking systems are the Philippines, Thailand, Indonesia, Singapore, Hong Kong, China, and much of Africa.

      1

      Fred Feldkamp and Chris Whalen, Financial Stability: Fraud, Confidence, and the Wealth of Nations (John Wiley & Sons, 2013).

      2

      Joseph Stiglitz, “Stable Growth in an Era of Crises: Learning from Economic Theory and History,” Ekonomi-tek 2, No. 1, pp. 1–39, 2013.

      3

      One exception is the very talented Simon Ogus, chairm

1

Fred Feldkamp and Chris Whalen, Financial Stability: Fraud, Confidence, and the Wealth of Nations (John Wiley & Sons, 2013).

2

Joseph Stiglitz, “Stable Growth in an Era of Crises: Learning from Economic Theory and History,” Ekonomi-tek 2, No. 1, pp. 1–39, 2013.

3

One exception is the very talented Simon Ogus, chairman of Dismal Science Group (DSG), who has an acute appreciation for the influences of credit (especially derivatives) in economic models.

4

Seth Carpenter and Selva Demiralp, “Money, Reserves and the Transmission of Monetary Policy: Does the Money Multiplier Exist?” IMF Working Paper, 2010–41.

5

Stiglitz,“Stable Growth.”

6

John Cassidy, “After the Blowup,” The New Yorker, January 11, 2010.

7

Bill White, chief economist of the BIS from 1995 to 2008, in the documentary Money for Nothing.

8

Ahir Hites and Prakash Loungani, “‘There Will Be Growth in the Spring’: How Well Do Economists Predict Turning Points,” Vox, April 2014. This is from an article in The New York Review of Books called “Why the Experts Missed the Recession” (September 25, 2014). The article also makes the point that the famous Fed Greenbook cannot make accurate predictions even one quarter out. A key reason for this is that these economic models, astonishingly, cannot accommodate credit data.

9

Ibid.

10

Ibid.

David Shambaugh, The Communist Party (University of California Press, 2008).

Ken Rogoff and Carmen Reinhart, This Time Is Different (Princeton University Press, 2009).

9

Ibid.

10

Ibid.

David Shambaugh, The Communist Party (University of California Press, 2008).

Ken Rogoff and Carmen Reinhart, This Time Is Different (Princeton University Press, 2009).