The Credit Crunch Continues

The Daily Reckoning Wednesday, December 9, 2009 The global circus of fractional-reserve banking and "empty money," Greece: even the ratings agencies won't buy it! Commercial and industrial borrowers left out in the cold and more... --- The Agora Financial Reserve Closing Soon --- We'll Pay You $5,909 to Cancel Your Agora Financial Subscription Right Now We know it sounds preposterous, but it's true. Not only that... If you act now* you'll receive every one of our elite publications... And that's in addition to the nearly $6 grand we just mentioned. Just give us 10 short minutes out of your day, and we'll explain everything. *The doors to the Agora Financial Reserve are only open a few short weeks out of the year. We suggest you take advantage while you can. --------------------------------------------------------------- Joel Bowman, reporting from the Hong Kong airport lounge... Not much time for reckoning today, dear reader. Bill is traversing the globe somewhere and your managing editor is about to board a plane. Still... Dollar in, risky Mediterranean debt out. At least, that's what the markets were indicating earlier today. Indexes from The Thames to The Nile and back again were in the red last we checked. The euro was down too. That the Greeks are in trouble is hardly breaking news, of course... Heck, even those geniuses at the ratings agencies had time to figure it out! Fitch, one of the agencies NOT responsible for forecasting the biggest economic tsunami since (at least) the Great Depression, just downgraded Greece's sovereign rating from a single-A-minus to BBB+. So NOW investors run for the hills? The only thing really surprising about all this brouhaha is that investors should find it at all surprising in the first place. Did they think Dubai was going to be a one off occurrence? That the same immutable laws of nature would not also apply to other overleveraged, undercapitalized economies? Not likely! If the agencies are crying wolf, dear reader, your lamb dinner is likely already minced meat. Fitch worries that Greece's government debt burden may reach 130% of GDP before stabilizing and that it has a poor record of debt management. Now why pick on the Greeks, we wonder? If imprudence and debt additions are the indictments, why not hall the United Kingdom in for questioning? And what about those hot-to-trot Baltic economies? And what about those American consumers? Household liabilities for the average American family now happen to weigh in at a familiar 130% of total disposable income. It doesn't take a ratings agency to figure out that consuming more than one produces must eventually end in tears...either for the spender or the lender...or both! It's little wonder then that American banks are tightening their belts so much. Consumer lending fell 1.7% during October, representing the ninth consecutive monthly decline and a 4% drop since its July 2008 peak. Curiously, consumer economies don't tend to fare too well when consumers start (or are forced to) economize. And it's not only the American Gap-goers who find themselves in a tight credit squeeze either. Eric Fry has some details below... --- Mayer's Special Situations Resource Report --- Urgent Retirement Recovery Alert: Closed to New Investors for the Last 6 Years - Now Open Again... The "Chaffee Royalty Program" That Turned Every $1 Into $50 In 2002, the same royalty "paycheck program" that paid out $50 for every $1 invested... decided to shut the door to new "members." In 2008, that door is open again...and it just got easier than ever to "make money while you sleep"... But there's no telling when it could close again... So you'd better collect your own "Chaffee Royalties" right NOW! --------------------------------------------------------------- Eric Fry, tossing in a few data points from Laguna Beach, reports... "The great American consumer deleveraging continues," our colleagues at The 5-Minute Forecast observed yesterday. "The Fed announced that consumer credit shrank for a record ninth month in a row in October." Consumer credit, as we all know, drives a big chunk of consumer spending, which drives a big chunk of the American economy. Ergo, no credit; no economy. But consumers are not the only borrowers between the Atlantic and the Pacific who contribute to economic activity. Commercial and industrial (C&I) borrowers also play a large role. The dots are pretty easy to connect here: When C&I lending is growing, businesses are expanding. And that means rising profitability and employment. When C&I lending is falling, however, businesses are contracting. This is the unfortunate condition that now prevails. The combined total of C&I and consumer loans outstanding contracted by nearly $300 billion during the first nine months of this year. And this dismal trend shows absolutely no sign of reversing itself, as our guest contributor, Douglas French, explains in the column below... --- A Special Report from Capital & Crisis Research --- Introducing the Single Best Way to Make Sure You'll Never Run Out of Money... The Endless "PAYCHECK PORTFOLIO" In three simple steps, unleash a steady flow of work-free income...starting with up to 48 automatic "paychecks" deposited directly into your account. Act now or risk missing the next "payday"...* *Two "paychecks" per day on at least eight of the days listed. --------------------------------------------------------------- The Daily Reckoning PRESENTS: Nice segue, Mr. Fry. We'll stick with that. Enjoy today's column... The Credit Crunch Continues By Douglas French The credit crunch continues, with businesses large and small finding that their bankers remain exceedingly stingy in the wake of the 2008 financial debacle. "We need to see banks making more loans to their business customers," Federal Deposit Insurance Corporation (FDIC) Chairwoman, Sheila Bair, told reporters recently after the FDIC released figures showing that the amount of loans outstanding in the nation's banks fell $210.4 billion in the third quarter of 2009. That is the largest quarterly decline since the FDIC began tracking loans in 1984. If we dig inside these data, we see that business lending has contracted at a much faster pace than consumer lending. This trend is not merely a function of contracting economic activity, it is also a function of the fact that banks have been deemphasizing business lending for many, many years. Numbers from the FDIC reflect this shift over the past decade. At the end of the third quarter of 1999, the assets of the nation's banks totaled $5.5 trillion. As of September 30 of this year, bank assets had grown to $13.2 trillion. But commercial and industrial loans outstanding barely budged, only growing from $947 billion a decade ago to $1.27 trillion by September 30 this year. Meanwhile, loans secured by real estate increased from $1.43 trillion in the fall of 1999 to $4.5 trillion this fall. And investment in securities doubled, rising from $1.03 trillion to $2.4 trillion. This secular shift away from "productive" lending to businesses toward "nonproductive" lending to consumers creates a new kind of structural weakness for the American economy. Robert Prechter makes the point in the November edition of the Elliott Wave Theorist that banks have lent sparingly to businesses for the past 35 years. Businesses report that since 1974, ease of borrowing was either worse or the same as it was the prior quarter, meaning that - at least according to business owners - loans have been increasingly hard to get the entire time. Unfortunately, from a macroeconomic perspective, lending to consumers rather businesses is a suboptimal emphasis/counterproductive exercise. Prechter writes in his book Conquer the Crash that the lending process for businesses "adds value to the economy," while consumer loans are counterproductive, adding costs but no value. The consumer may call his borrowing "productive," but it surely does not create capital, i.e., build shops or factories or manufacture tools and dies that enhance the productivity of human labor. The banking system, with its focus on consumer loans, has shifted capital from the productive part of the economy, people who have demonstrated a superior ability to invest or produce (creditors) to those who have demonstrated primarily a superior ability to consume (debtors). Total household debt peaked in 2008 at $13.8 trillion, with $10.5 trillion of that being mortgage debt. And as Sean Corrigan explained, "Houses are nonproductive assets, financed with a great deal of leverage." And while homeowners reap the services provided by homes slowly over time, houses "deliver a large dollop of uncompensated purchasing power up front to their builders or to those cashing out of the market," making housing "the ultimate engines of created credit on the upswing, and...among the more dangerous deflators on the way down." In the last decade, the US system of fractional-reserve banking has created what Frank Shostak calls "empty money," which masquerades as genuine money when in fact "nothing has been saved." This explosion of money was created through the banking system, as consumers gorged themselves on nonproductive assets like houses, autos, and big-screen TVs. These purchases gave the illusion of economic growth and good times, but in reality weakened the process of wealth formation; instead of building capital, this system wasted it. Meanwhile, businesses that create wealth-producing jobs have stagnated. The workforce was induced into working for enterprises that represent malinvestment: home and commercial construction, as well as other real- estate-related jobs, and businesses dependent on consumer consumption. Unfortunately, the federal and state governments constantly enact legislation that makes the employment of workers more costly and in turn makes business expansion riskier. So wealth-producing businesses, like metal fabrication and the like, have every incentive not to borrow money from a bank to expand their operations and not to wander into a wider thicket of onerous employment rules by hiring more workers. Instead, the entrepreneur puts energy into obtaining a low-interest mortgage and buying a big house, or dabbling in real-estate development and speculation. Besides, up until this current meltdown the entrepreneur could obtain a real-estate loan much more easily than a business loan. Those in Washington are doing all they can to promote the continued destruction of capital and wealth. Policies like "cash for clunkers"; tax credits for home buyers; the bailing out of the big banks, Fannie, Freddie, and the auto companies; and keeping interest rates near zero only serve to promote speculation and consumer consumption. Instead, Washington should be lowering taxes and the costs of hiring employees, especially in industries that produce capital and wealth. Regards, Douglas French, for The Daily Reckoning Joel's Note: Douglas French is president of the Mises Institute and author of Early Speculative Bubbles & Increases in the Money Supply. He received his masters degree in economics from the University of Nevada, Las Vegas, under Murray Rothbard with Professor Hans-Hermann Hoppe serving on his thesis committee. We're happy to have been able to bring you Mr. French's insights and suggest (at least) a few hours trolling the net for his back catalogue. The Mises.org website is a good place to start if you're interested in Austrian economic theory, as is our own Richebächer Letter, edited by Rob Partenteau. We trust you'll find both of immense value to your continuing investment education. And we'll have to leave it there for today. Your editor's flight has been called and he's still half an airport away from the gate. Ugh... If you wish to comment on anything in today's issue, drop us a line at the address below. Until tomorrow... Cheers, Joel Bowman Managing Editor of The Daily Reckoning joel@dailyreckoning.com   The Daily Reckoning - Special Reports: The US Trade Deficit: Fort Sumter...And The U.S. Trade Deficit US Recession: By far the Weakest Recovery "THE GREAT AMERICAN RECOVERY RP-OFF" Brace yourself for what's about to go down as the BIGGEST FINANCIAL SWINDLE in world history.