Sunday, December 9, 2012

The nature of credit (I)

The nature of credit is such that people who save money (by not spending more than what they make) make it available to people who need it for starting or running a business and to people who are impatient and want to own 'stuff' beyond their means.

It is pretty simple: you have extra money and deposit it at a bank. You trust the bank to use your money wisely. If the bank grants loans to people/companies that pay it back on time, plus interest, then all is dandy and good. If banks cannot get their money back from borrowers -and this is persistent- then we have a problem.

When banks and individuals collude on asset perception and think simultaneously that the assets' values they endorse are 'stable' at unrealistic levels then everybody suffers the consequences. All banks lose money at the same time and this cannot be sustained over long periods of time.

When you bring the government and the central bank into this equation then entire nations and even the world economy suffer. The central banks interject in the value of credit equations by totally arbitrarily asserting that the magnitude of risk components in credit is almost zero. How can risks decrease when asset prices decline? Yet central banks want us to believe that the cost of credit should actually be very low as the risks are very low and/or returns should be very constant (i.e. low). Really?

The stock market and individuals' earnings disagree. Wages are expected to grow as companies are expected to make profits at some historical rates greater than 3-8%.  So, how can the Fed rationalize holding the interest rates at 0.25%/year? It makes no sense, as the ratio of bad performing credit to performing is about 10%.

Under these conflicting conditions, credit cannot be cheap when uncertainty on taxation is at historical levels. The consequence is that the economy remains paralyzed. Business, individuals, and asset traders are not sure about who is right in this economy. The central bank cannot be right as they have a poor record. Private banks and financial institutions have had a poor record too. The government has had a very poor record as well.

Individuals cannot all be wrong in insular cases but they can be wrong in groups.

Credit should be expensive and tax rates should be high and neither is true. How can this be conducive to real economic growth? We are in a check-mate situation, with the government and central bankers holding most of the high value cards. Individuals and business need to chip away at getting out of the current state on their own. The government and the banking system cannot be trusted and the value of credit has been usurped. I will get back to this topic, no doubt.

No comments:

Post a Comment