240. On credit market debt

According to our tradition, no science discussions are allowed on Sunday (a gentleman has to be able to find fun beyond the area of his expertise), except maybe video of the day.

So, I decided to revive the old topic – global financial crisis – and continue the discussion from where we stopped last time. As far as I remember, I was willing to discuss credit expansion and explain why it is one of the main reasons of the present crisis. Since I never actually did that, maybe, it is finally a good time to return to the subject, especially because crisis is getting stronger: recently, three more banks were closed in US.

Digression: By the way, can we be really arrogant and try to estimate when exactly the US banking system is going to be really seriously affected by the crisis? Banks are insured by FDIC. According to the Bloomberg article, two of the three failed banks costed FDIC about 225 mill. dollars. FDIC budget for failed banks is about 1 bill. dollars per year, therefore, we need another 3-4 iterations in order for the insurance system to start feeling the real heat. According to FDIC report, more than 170 banks in US were recently classified as having a “problem”.

But let me get back to the point – US total credit market debt.

I have an interesting plot to show – a ratio of the US total credit market debt to the US gross domestic product starting from 1928:

Note a peak during years of the Great Depression and spectacular take-off in golden Reagan’s 1980s – leading to the peak which is way higher than the one corresponding to the Great Depression.

As George Soros explains,

the problems facing the administration of President Barack Obama are even greater than those that confronted Franklin D. Roosevelt. Total credit outstanding was 160 per cent of gross domestic product in 1929 and rose to 260 per cent in 1932; we entered the crash of 2008 at 365 per cent and the ratio is bound to rise to 500 per cent. This is without taking into account the pervasive use of derivatives, which was absent in the 1930s but immensely complicates the current situation.

Indeed, the economics where every 3 dollars of debt correspond to just one dollar of GDP, where every dollar of GDP growth corresponds to 3-6 dollars of the debt growth can hardly be considered healthy, and 8 years (4 years under Obama and another 4 if he gets reelected – of course, he will) may be not enough to return more than 50 billion dollars of debt.

As I think, huge US credit market debt is the second main reason for the present global financial crisis to take off. The first one is the Fed policy regarding the total amount of US dollars in circulation, which is actually related to the US credit market debt – intrinsic value of the US dollar is supported by the debt pyramid.

Interestingly, similar situation (huge excess of credit market debt over the GDP) is realized in many other countries. The absolute champion is Japan, where CMD is 13 times larger than GDP, while, say, in UK CMD is only 4 times larger. But that is why we call the financial crisis global, don’t we?

Via schegloff, likh and sergechaly (in Russian).