The unavoidable may be avoided for years, yet the brutality of a Credit cycle’s downside in the end will be commensurate with the duration and scope of boom-time excesses. And the changed Credit environment changes so many things. The maladjusted economic structure will eventually give way, ushering in a cycle of deteriorating fundamentals – including stagnant household incomes, faltering profits and deteriorating government finances. The pie will not only be shrinking, but most will come to see a fortunate few unfairly taking an ever increasing share to the detriment of everyone else. The system will be viewed as inequitable, unjust and flat out broken. The social mood turns sour, as most incomes stagnate (or worse) and perceived financial wealth withers. Faith in institutions will wane. Post-Bubble policymakers will invariably be viewed as inept. Optimism is supplanted by pessimism. As always, wrenching bear markets create disdain and hostility.
Credit’s downside, along with accompanying bear markets, over time instills wreaking ball havoc upon the Credit structure. In the final analysis, Credit is everything and always about confidence. During the Credit expansion, constructive fundamentals and general optimism bolster the perception that Credit is sound and that most Credit instruments will be vehicles of wealth generation. As a Credit bust ensues and the economic and asset price backdrop deteriorates, ever-increasing swaths of Credit instruments are viewed as impaired or even dubious. The entire Credit and financial structure, having grown to incredible stature during the boom, turns brittle and unstable- with trouble generally starting out on the “periphery” before eventually rotting away at the “core.”
Policymakers will not accept defeat without one hell of a fight. Dreadful policy errors will be repeated and compounded. Government officials will go to increasing inflationary lengths to bolster incomes and economic output, support asset markets, and stimulate Credit growth. Such measures typically enjoy initial success, though such a policy course will invariably lead to an expanding governmental role in the economy and an interventionist role in the Credit and asset markets. To be sure, increasingly unsound finance will be mispriced and poorly allocated.
Stubborn refusal to admit policy mistakes along with increasing desperation ensure things will only get worse. Over time, it all regresses into a perilous confidence game. Government intervention and monetary stimulus inflate confidence for awhile, although such actions only weaken the underpinnings of the Credit structure. In reflecting upon the late-twenties excesses that set the stage for collapse and depression, Keynes referred to the “whirlwind of speculation.” I expect there will be appoint when the markets begin to narrow the gulf between the (speculative) market’s perception of policy efficacy and the outright limits of governmental control and market intervention. ”When the development of a country becomes the byproduct of the activities of a casino, the job is likely to be ill-done.”