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Night Owl

Credit Boom

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I think most of us would agree that the house price boom has been driven by cheap, available credit. Just imagine if you had collected all the loan or mortgage offers you got in the last few years into one big pile. According to credit action, the amount of debt has grown from 600 billion in 2000 to an amazing 1.1 trillion today, so there can be little doubt that credit is being extended (see http://www.creditaction.org.uk/debtstats.htm). The thing I really don't understand is where all this credit has come from.

Many housing bulls would argue that interest rates are low because investors feel confident that inflation has been defeated. House buyers are happy to take out large mortgages because of lower repayments and the stable economy. Even if you accept these arguments, you still have to explain where the money that drove the boom came from. One place it could have come from is savings. Perhaps people have decided to switch more of their investments into bonds, which is non-inflationary because the bond holder no longer has access to the money. Another possibility is that banks have switched from lending in other areas to focus on the housing market. Personally, I find it hard to believe these arguments.

I guess the immediate reaction of most people on HPC would be that the additional credit come from an increase in the money supply, distributed through the banking system. I think this is part of the answer but it has the problem that, compared to housing at least, price inflation has remained pretty low. When new money is created as a mortgage, that money still ends up paying someone, so ought to end up circulating in the economy, driving up prices. The only way it wouldn't be circulating is if people are now stashing away more cash than before and the velocity of money has slowed. I'm not convinced that we have suddenly become a nation of savers. I guess you could argue that the increase in the money supply has been offset by a significant rise in productivity but have we really stepped up wealth creation?

One argument I have occasionally heard is that the rise in productivity has occurred overseas and there are foreign investors buying up bonds. I am a physicist, not an economist, so I shall draw it like a Feynman diagram (sorry!)


The up and down arrows show the flow. So basically the productive foreign manfacturers are sending us cheap goods, which means we don't notice a rise in the money supply so much. The demand for bonds, meantime, depresses bond yields. The circulation of money from the consumer back round to the borrower, who then goes and spends it, explains how you get an increase in indebtedness without an increase in the money supply. There are probably more complicated variations of this diagram, where the foreign investors invest in companies that are engaged in lending or perhaps in complicated financial instruments that use bonds.

The trouble with this argument is surely that the influx of goods would leave us with a huge trade deficit. We have a trade deficit to be sure but only $116 billion. I am not really sure what goes into the trade figures mind you. Could the trade figures be missing this effect somehow? So basically, I am at a loss to explain where all this credit has come from.

Any opinions?

Night Owl

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You probably want to read this thread:


Watch the videos, they are very informative (although some would say one sided, make you own mind up), however it will take you a good few hours!

I'm pretty well convinced the money is created ("out of thin air") by the Federal Reserve and pushed into our markets by the UK banks.

Watch, have a read and let me know what you think.

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