What If Credit Tightened By Even 1%?

This week I read an article about a company that offers personal loans to folks who are seriously down and out. One of their strategies involves mailing checks for $2,000 to these people’s homes and if the check is cashed it activates a loan agreement that calls for the borrower/check-casher to repay the loan with interest at the incredible rate of 32% per year. Apparently, this is not uncommon and there are many companies engaged in similar business. Of course, like many, my first reaction to this article was dismay or disgust, thinking that these poor and obviously desperate borrowers are being taken advantage of. Then, I began to think to myself what this says about the health of our financial system. I wondered to myself, if this lending were indeed curtailed, thus depriving these borrowers from access to credit, what the impact on the economy might be. I thought: Is it possible that we NEED these people to borrow and spend, lest the economy not achieve targeted growth rates, which might undermine confidence and creating a cascading negative effect?

In the end, I began to wonder how troubled our economy really is. Our government has a debt level exceeding $20 trillion and, with deficits in its budget baked in seemingly forever, that level will soar in the coming years. There are all sorts of other very troubling statistics, including that fewer than 15% of all Americans have enough saved to live more than ONE YEAR in retirement, and that public pension funds will not be able to meet their obligations to retirees, most of whom are baby-boomers set to retire and receive their promised payments in the coming years.

It would seem that to reconcile things we’ll likely experience a severe economic contraction/recession/correction/D……sion (we’re not allowed to say that word). The only alternative, and a much more benign one, is that we will experience a longer-term manipulated economic environment during which interest rates are held artificially low so as to continue to prop up the nominal value of financial assets and diminish the impact of our debts and deficits, while at the same time our currency must be debased so as to devalue our debt in real terms. This currency debasement will also serve as a sneak wealth tax that will, over time, help chip away at the extreme imbalance of wealth distribution.  I’d bet on the latter, more benign outcome occurring, and pray that our policymakers and economists at the Fed stop misreading our current economic environment and reacting by increasing rates, thus increasing the odds of the former possibility occurring.

To truly solve this mess though, regardless of which path the markets take, we will need to examine and understand what brought our society to this disaster and take the steps required to insure it is not repeated. Having studied this some, here is my take in brief. Some 60 years ago economists and politicians embraced the concept that GDP growth ought to be the main objective. Achieving this foolish goal required that people be enticed to spend more, that they be able to borrow in order to spend beyond their means, and that population growth be made to be viewed as being a sign of a community’s health. More borrowing leads to more spending, and more people borrowing and spending all lead to more GDP growth. Now, after 6 decades down this wrongheaded journey we have a society with too many in hopeless debt (including our government’s debt which we all own our share of), a population that has replaced the Protestant ethic of our founding fathers that prized modesty with an envy-driven rush to acquire and consume, and a massive population that is directly at odds with the continuously reduced opportunities for gainful employment in today’s technology economy. This unpopular reality will NOT be embraced by our intelligentsia as long as elected officials have no term limits and are thus career politicians. With a goal of being reelected, the messages of entitlement and false optimism borne from debt-fueled spending will be the ones we will continue to hear until strict and short-term limits are introduced.

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