April 9th, 2009

As the financial crisis continues, a lot of people are asking a lot of questions and a lot of people are trying to answer them. I have yet not heard one account of what will happen that has left me feeling sure about what's going on. I've written a few times on this blog about some of my different takes on what's going on - still I'm pretty much in the dark as everyone else and I'm constantly re-evaluating the situation.

By far the most common thing talked about is the great depression. A lot of people seem to think that this is just another depression with a possible inflationary twist - I would count myself as one of those people - from time to time. Just recently I wrote a piece partly covering the IT-bubble, where I was trying to point out that it was overcome fairly painlessly; and from some recent considerations I think that this crisis could actually be overcome with far less pain than what many are saying.

I've mentioned it myself before (as have many others), that the debt-GDP ratio in particularly USA has risen a lot since the late 70's. This is generally the argument to show that this has basically the same premise as the great depression (GD). But the debts causing the GD had come about in only a few years time (roaring 20's), whereas the debts of today have come about over the course of 30 years. When comparing the debt-GDP graph to the one of interest rates it looks pretty clear that the two follow each other. When things crashed in the beginnings of the GD (or during it's entire course) - there were certainly never zero interest rates like today.

The debt that preceded and made the GD come about was created in a financial environment that was very different than the one of today. The loan-economy, if you will, was something new and the people in charge of interest rates were unfamiliar with the impact that too high interest rates would have. Today pretty much everyone has loans and most of us see loans as a great way to afford things that we want and that we will be able to pay off during the course of our lives. It's all very simple - if it is possible to borrow a lot of money without it ever becoming too expensive to maintain, then people will be doing so - it's a very handy way to get cars, houses and so on, without having to save all that money first.

So, what might be passing most people by is that this could be a new type of economy, where a very large part of the population want to use loans to make their lives better and easier; Therefore, one might actually have to adjust economic thinking to a new healthy level of debts in society that runs much higher than it used to back in the early 1900's. To me it's a bit annoying reading these constant comparisons of what happened at a specific time in history and how todays events seem to follow the same pattern - almost as if it is the exact same thing - which it never is.

It's no big secret that the current financial crisis started with too high interest rates which then created the housing crash which in turn gave us the derivatives meltdown (which may or may not be over). All these problems have given a large contraction in demand and a loss of asset values. Still it is possible that all this is temporary and that lending and the world economy will resume pretty much as it did after the IT-bubble. There are real imbalances and deficits that need to be sorted out as well, but that does not have to mean that people will be loosing their jobs (for example read my investing in china or america posts).

Will things resume as normal, or is this debt-hype for real? I know this contradicts what I've said before, but there's a real possibility that things could resume as before, even though things look very gloomy. If people can borrow almost for free, I strongly suspect that they will begin to do so sooner or later - they can't really hold out forever. One should neither discount the generally much higher accumulations of wealth in the world today as compared to the days of the GD. All that money could easily be put to use in still plentiful opportunities of wealth creation.

I could be very wrong here and it's possible that I had it right in my first assessments. Maybe things are falling so hard that they cannot start leveling out or turning up at this point, perhaps we have to suffer a very long time of low economic activity (while people pay off their loans) and perhaps the imbalances created by free trade are too big. Or maybe the real pull-back has already happened and the smart money is already moving back into good stocks that have dropped heavily and are now beginning a long period of appreciation - while 'contrarians' and all the scared analysts are saying that this is just a dead cat bounce...

And perhaps further 'toxic assets' will be paid for by monetization - furthering the inflationary scenario, under an otherwise fairly normal economy. I've talked about the derivatives meltdown before and the AIG-linked milking of US-taxpayers - this thing is perhaps not so much anymore a financial bomb, but really a political one... I urge everyone to watch this interview: