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not long ago, Gary North wrote an exceptional piece about the effect of the bailout and banking crisis on credit and investment decisions.
This is majorly important to you and me, understanding what is happening now to banking and credit and the future of the US economy in a very tangible, bring-it-home-to-mama way.
Written in July, 2008.
and:
At some point, [The Fed] will run out of Treasury debt to sell to the general public in order to offset the increase of its purchase of questionable assets held by the financial system. At that point, the great inflation will begin.
This could be a year away. This could be a month away. All we know is this: when the Federal Reserve system runs out of Treasury debt to sell, its purchase of all assets will be inflationary. The banking system as a whole is protected. What is not protected is the purchasing power of the dollar.
and:
This is majorly important to you and me, understanding what is happening now to banking and credit and the future of the US economy in a very tangible, bring-it-home-to-mama way.
Written in July, 2008.
The threat to the banking system is that failed banks are a yellow flag to consumers. It warns them that the economy as a whole is at risk. Bank failures testify to the incompetence of supposed experts who manage the public’s money. When the average investor begins to lose confidence in the money managers, they may decide that discretion is the better part of valor. At some point, he will call his pension fund or stock mutual fund and tell the person at the other end of the line to sell the stocks. He will have to buy something, and what he will buy will be short-term money market instruments. He may also buy U.S. Treasury bonds. [bold added here and in what follows]
The problem with this is that long-term money, meaning long-term capital to be used in long-term projects, will become less available. The government will spend any money that the public invests in Treasury debt. Businesses will find that it is more difficult to gain access to long-term capital. This will slow the rate of economic growth in the United States. This will remove the engine of economic growth. By moving their money out of the private sector, and especially out of equities, investors will contract the overall economy.
The problem with this is that long-term money, meaning long-term capital to be used in long-term projects, will become less available. The government will spend any money that the public invests in Treasury debt. Businesses will find that it is more difficult to gain access to long-term capital. This will slow the rate of economic growth in the United States. This will remove the engine of economic growth. By moving their money out of the private sector, and especially out of equities, investors will contract the overall economy.
At some point, [The Fed] will run out of Treasury debt to sell to the general public in order to offset the increase of its purchase of questionable assets held by the financial system. At that point, the great inflation will begin.
This could be a year away. This could be a month away. All we know is this: when the Federal Reserve system runs out of Treasury debt to sell, its purchase of all assets will be inflationary. The banking system as a whole is protected. What is not protected is the purchasing power of the dollar.
When banks lose capital, they must either find new investors, or else they must reduce their loans. When they reduce their loans, they refuse to roll over existing lines of credit to American corporations. This is the major threat to the system. It is not a threat of the bankruptcy of the banks; it is the threat of the reduction of lines of credit to American corporations – corporations that are dependent on these lines of credit.
In a financial panic, American investors will move from corporate bonds and stocks and put their money in Treasury debt. This threatens the solvency, not simply of individual banks, but of individual corporations that are dependent upon lines of credit issued by specific banks. American corporations are not dependent on the banking system as a whole. They are dependent on continuing lines of credit from specific banks. They do not have time to renegotiate loans with other banks. They have to meet their payrolls. This will become increasingly difficult to do in the environment created by constant reports of individual failures of specific banks.
This is the famous and widely denied crowding-out effect. The Federal government’s debt certificates are trusted; the private capital markets are less trusted. In order for the private capital markets to continue to operate in such a hostile environment, they will have to offer greater economic returns than Treasury debt. It will become more expensive for private companies to attract long-term investment, precisely because individual banks are failing.
...
The problem is not the collapse of the banking system as a whole. The problem is the crowding out by government, especially the Federal government, of capital that would otherwise have gone into the private sector. The threat is the long-term erosion of confidence in the private capital markets.
This is not a minor threat. This is a major threat. It threatens the long-term growth of the American economy. It threatens the long-term growth of an economy which is heavily indebted to foreign investors. When foreign investors perceive that growth has stopped, they are going to cease lending money to Americans to sustain their present patterns of consumption. The dollar will fall. The price of imported goods will increase. The public will have to readjust its household budgets. When the public must readjust spending patterns, the result is recession. In a major readjustment of their budgets, the result is a deep depression. We have not seen this since the 1930s.
When we read of more bank failures, we will grow more nervous. It is not that tens of millions of depositors will go down to their banks and take out currency. A few million people may do this to a limited extent, but most people will not. This is because they do not have sufficient reserves in their bank accounts to enable them to take out $1000 in currency and not use that money to spend on household bills. So, they won’t do this. (You probably should.)
In a financial panic, American investors will move from corporate bonds and stocks and put their money in Treasury debt. This threatens the solvency, not simply of individual banks, but of individual corporations that are dependent upon lines of credit issued by specific banks. American corporations are not dependent on the banking system as a whole. They are dependent on continuing lines of credit from specific banks. They do not have time to renegotiate loans with other banks. They have to meet their payrolls. This will become increasingly difficult to do in the environment created by constant reports of individual failures of specific banks.
This is the famous and widely denied crowding-out effect. The Federal government’s debt certificates are trusted; the private capital markets are less trusted. In order for the private capital markets to continue to operate in such a hostile environment, they will have to offer greater economic returns than Treasury debt. It will become more expensive for private companies to attract long-term investment, precisely because individual banks are failing.
...
The problem is not the collapse of the banking system as a whole. The problem is the crowding out by government, especially the Federal government, of capital that would otherwise have gone into the private sector. The threat is the long-term erosion of confidence in the private capital markets.
This is not a minor threat. This is a major threat. It threatens the long-term growth of the American economy. It threatens the long-term growth of an economy which is heavily indebted to foreign investors. When foreign investors perceive that growth has stopped, they are going to cease lending money to Americans to sustain their present patterns of consumption. The dollar will fall. The price of imported goods will increase. The public will have to readjust its household budgets. When the public must readjust spending patterns, the result is recession. In a major readjustment of their budgets, the result is a deep depression. We have not seen this since the 1930s.
When we read of more bank failures, we will grow more nervous. It is not that tens of millions of depositors will go down to their banks and take out currency. A few million people may do this to a limited extent, but most people will not. This is because they do not have sufficient reserves in their bank accounts to enable them to take out $1000 in currency and not use that money to spend on household bills. So, they won’t do this. (You probably should.)
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