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wonderpup

The Paradox Of Credit

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Most people have heard of the paradox of thrift; if we all chose to save rather than spend to ensure our future prosperity the resulting collapse of demand would make us all worse off than before.

But I think there is another paradox at work in the present that was not foreseen- the paradox of credit- more specifically cheap credit.

The basic idea behind QE is simple- create billions from thin air to buy up assets from the banks in order to lower the price of credit to the economy in the hope that the forces of 'creative destruction' are unleashed as entrepreneurs can more easily fund new business's and established firms can more easily grow.

But there are other ways that cheap credit can be deployed- it can be used to refinance existing debt, or buy back shares or to stave off bankruptcy or to fund M&A activity ect- none of which has much to do with 'creative destruction' at all but are close to being the opposite of that process.

Instead of all this cheap credit unleashing a wave of innovation and productive investment as intended we can get an opposite effect in which the dynamic forces of capitalism are shut down by the ability of zombie companies to utilize that cheap credit to preserve their existence well past the point where they should have died- so in place of creative destruction we end up with the entrenchment of the incumbent failing order.

At it's heart QE is quite an extraordinary idea because it amounts to the notion that, since the economy is 'too big to fail' then failure must be designed out of the system- but Capitalism without failure is what?

It seems to me that the Central Bankers are trying to achieve the impossible- they want the 'creative' but without the 'destruction'- but in trying to bring this about they have created for themselves the paradoxical situation in which their 'stimulus' has been put to work- as a preservative.

It's as if the Central Bankers were handing out Viagra only to find that people were using it to treat their lumbago. :lol:

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The fundamental flaw of QE was a misunderstanding of where most bank lending ends up (Adair Turner has pointed this out).

Most bank lending goes to fund purchases of existing real estate; of the rest a significant proportion of commercial lending goes to fund the purchase of existing business (through either private equity lead buy-outs or share re-purchases), consumer lending in the UK would (I guess) mostly go on foreign cars, holidays and tat.

Hence in the UK QE has done little to improve the productive capacity of the UK. instead it has inflated the values of companies and real estate. In addition it has allowed the government to keep borrowing large amounts from the bond markets without pushing up interest rates.

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QE was explained by the BoE as a method to support asset values.

The theory was as assets increased or at least held their values, this would lead to confidence, more borrowing for wealth creating projects, more jobs, more tax take and all the rest of the ingredients for a recovery.

Hasnt worked...but it has led to asset values keeping their values in the main.

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QE is like giving a liver transplant to an alcoholic: The brief period of recovery is accompanied by promises of rehabilitation and expressions of thanks before the pattern of destructive behaviour reasserts itself anew. In effect, a matter of treating the symptoms rather than the cause.

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I've been thinking about this recently.

Like a lot of people on here I've built up a lot of savings but credit has rendered these savings almost pointless.

If I want to buy a car me being able to pay cash is of no advantage to me, people don't sell cars they sell finance on cars.

If I want to buy a house someone will borrow 5x their income and outbid me.

So the question is whether to join them, liquidise all my savings/house, leverage to the moon and buy a slightly bigger house or just stand back bemused.

I've gone for the latter so far, and I'm lucky to have a very rational wife but I can see how people get sucked in.

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I've been thinking about this recently.

Like a lot of people on here I've built up a lot of savings but credit has rendered these savings almost pointless.

If I want to buy a car me being able to pay cash is of no advantage to me, people don't sell cars they sell finance on cars.

If I want to buy a house someone will borrow 5x their income and outbid me.

So the question is whether to join them, liquidise all my savings/house, leverage to the moon and buy a slightly bigger house or just stand back bemused.

I've gone for the latter so far, and I'm lucky to have a very rational wife but I can see how people get sucked in.

Looks like it has gone that way......so to counteract it, buy a car privately, sell your car privately, choices......who says a middle man should be part of a transaction, the purchaser or the seller, nothing wrong with that but it costs.......all it takes is trust....trust in who you deal with, not difficult. ;)

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I've been thinking about this recently.

Like a lot of people on here I've built up a lot of savings but credit has rendered these savings almost pointless.

If I want to buy a car me being able to pay cash is of no advantage to me, people don't sell cars they sell finance on cars.

If I want to buy a house someone will borrow 5x their income and outbid me.

So the question is whether to join them, liquidise all my savings/house, leverage to the moon and buy a slightly bigger house or just stand back bemused.

I've gone for the latter so far, and I'm lucky to have a very rational wife but I can see how people get sucked in.

We share your dilemma. It's something that Mrs EC and I discuss occasionally (usually after we've been treated like the poor relation by someone who's just bought another car/second home/flash holiday on credit).

We tend to keep ourselves sane by working out how long our current lifestyle would last if all household income dried up tomorrow and then estimating what that time period would be for our "richer" acquaintances.

I don't know how you put a value on a good nights sleep.....

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Most people have heard of the paradox of thrift; if we all chose to save rather than spend to ensure our future prosperity the resulting collapse of demand would make us all worse off than before.

But I think there is another paradox at work in the present that was not foreseen- the paradox of credit- more specifically cheap credit.

The basic idea behind QE is simple- create billions from thin air to buy up assets from the banks in order to lower the price of credit to the economy in the hope that the forces of 'creative destruction' are unleashed as entrepreneurs can more easily fund new business's and established firms can more easily grow.

But there are other ways that cheap credit can be deployed- it can be used to refinance existing debt, or buy back shares or to stave off bankruptcy or to fund M&A activity ect- none of which has much to do with 'creative destruction' at all but are close to being the opposite of that process.

Instead of all this cheap credit unleashing a wave of innovation and productive investment as intended we can get an opposite effect in which the dynamic forces of capitalism are shut down by the ability of zombie companies to utilize that cheap credit to preserve their existence well past the point where they should have died- so in place of creative destruction we end up with the entrenchment of the incumbent failing order.

At it's heart QE is quite an extraordinary idea because it amounts to the notion that, since the economy is 'too big to fail' then failure must be designed out of the system- but Capitalism without failure is what?

It seems to me that the Central Bankers are trying to achieve the impossible- they want the 'creative' but without the 'destruction'- but in trying to bring this about they have created for themselves the paradoxical situation in which their 'stimulus' has been put to work- as a preservative.

It's as if the Central Bankers were handing out Viagra only to find that people were using it to treat their lumbago. :lol:

Companies such as Microsoft and Oracle amongst others have gone in for an absolute orgy of long term bond issuance underpinned by QE. They have been issuing low yielding instruments with 40 year maturities. I am absolutely gobsmacked that anyone is buying this stuff since sooner or later inflation will kill the value of these securities and the chances of either company being around to buy them back at maturity must be pretty low. Low interest rates are therefore not only stifling the function of destruction in a capitalist economy they are also encouraging yet more people to take stupid risks with the money they have.

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Not really.

(creative) destruction happens all the time. But destruction of the entire economy when it was entirely avoidable would be pretty stupid.

On your first point - Clearly Germany haven't heard of the Paradox of Thrift or its consquences now being played out.

On your main point - I suspect you may be arguing that the real rate during the recession/depression hadn't changed from that obtaining prior. Clearly it had and QE reflects this. You are implicitly saying ZIRP and QE are somehow "wrong" rather than correct for the circumstances.

Edited by R K

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one flaw in the original post, not everyone wants to be a Consumer, not everyone needs material or money or some pointless status to feel happy.

the people pushing consumerism on us seem themselves to be accumulating a lot of wealth.

an end to debt slavery might be no bad thing.

Edited by TheCountOfNowhere

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Low interest rates are therefore not only stifling the function of destruction in a capitalist economy they are also encouraging yet more people to take stupid risks with the money they have.

Absolutely - the lack of yield for savers has pushed people into all sorts of speculative investments - not least of course, bonds and housing. I think that the stick of low interest rates has had at least as much influence as the carrot of forever HPI in the current BTL mania. Lots of people who would never have dreamt of putting their money at risk are piling in after years of effectively zero interest on their savings, so if we do ever get a meaningful rise in rates the reverse effect is going to work both ways, and 2.5% on a BTL is not going to look very attractive when you can better it in the bank.

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Absolutely - the lack of yield for savers has pushed people into all sorts of speculative investments - not least of course, bonds and housing. I think that the stick of low interest rates has had at least as much influence as the carrot of forever HPI in the current BTL mania. Lots of people who would never have dreamt of putting their money at risk are piling in after years of effectively zero interest on their savings, so if we do ever get a meaningful rise in rates the reverse effect is going to work both ways, and 2.5% on a BTL is not going to look very attractive when you can better it in the bank.

Best of luck to people selling illiquid property portfolios or 40 year company bonds that turn to complete junk at the first interest rate rise. This is not going to end well, particularly in the UK.

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We share your dilemma. It's something that Mrs EC and I discuss occasionally (usually after we've been treated like the poor relation by someone who's just bought another car/second home/flash holiday on credit).

We tend to keep ourselves sane by working out how long our current lifestyle would last if all household income dried up tomorrow and then estimating what that time period would be for our "richer" acquaintances.

I don't know how you put a value on a good nights sleep.....

Precisely. I work in consultancy and my public sector work is drying up at the moment.

People keep asking me if I am worried, and yes I am a bit, but I've got 3 years of tax free salary saved up in the business which covers 100% of the living costs for my family of 4.

If I had a £2k a month and a £400 a month car loan then I'd be screwed.

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Not really.

(creative) destruction happens all the time. But destruction of the entire economy when it was entirely avoidable would be pretty stupid.

On your first point - Clearly Germany haven't heard of the Paradox of Thrift or its consquences now being played out.

On your main point - I suspect you may be arguing that the real rate during the recession/depression hadn't changed from that obtaining prior. Clearly it had and QE reflects this. You are implicitly saying ZIRP and QE are somehow "wrong" rather than correct for the circumstances.

By repeatedly lowering base rates at the first signs of economic distress and simultaneously flooding markets with liquidity the Keynesian central bankers were/are responsible for capital misallocation on an unprecedented scale. They were instrumental in creating the conditions which led to 2008, and the unrecovery we've experienced since.

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By repeatedly lowering base rates at the first signs of economic distress and simultaneously flooding markets with liquidity the Keynesian central bankers were/are responsible for capital misallocation on an unprecedented scale. They were instrumental in creating the conditions which led to 2008, and the unrecovery we've experienced since.

I wouldn't call our central bankers Keynesian, I highly doubt he would have thought pump priming with deficit spending was a good idea.

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On the QE front the money was never going to end up in the real economy as that takes effort. If you have £5bn to lend just think how many much work that involves lending it to small business. Now think how hard it is to lend money to say 5 hedge funds at £1bn each. Loans done, fees made and plenty of time for the weekend party. Lending it to the real economy too much effort.

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Instead of all this cheap credit unleashing a wave of innovation and productive investment as intended we can get an opposite effect in which the dynamic forces of capitalism are shut down by the ability of zombie companies to utilize that cheap credit to preserve their existence well past the point where they should have died- so in place of creative destruction we end up with the entrenchment of the incumbent failing order.

At it's heart QE is quite an extraordinary idea because it amounts to the notion that, since the economy is 'too big to fail' then failure must be designed out of the system- but Capitalism without failure is what?

It seems to me that the Central Bankers are trying to achieve the impossible- they want the 'creative' but without the 'destruction'- but in trying to bring this about they have created for themselves the paradoxical situation in which their 'stimulus' has been put to work- as a preservative.

Good interpretation Wonderpup.

I can only hope QE (and other stimulus) is also bait that leads to a prime hpc, for the main event back to creative destruction, and fresh lending in volume to new entrants breaking up VI positions.

That the years of banks restructuring in background is set to lead to a major creative-destruction event against those who are holding the overvalued assets. So many £650K+ for dog-end basic houses, many held on the pensioner/older side and so many owned outright, vs younger people income positions... something has to give.

The Nagging Fear That Qe Itself May Be Causing Deflation

Started by zugzwang, Jun 04 2014 09:44 PM

http://www.housepricecrash.co.uk/forum/index.php?/topic/198976-the-nagging-fear-that-qe-itself-may-be-causing-deflation/

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What is the big mystery here? Credit is simply society's way of taking a view on the future - based of course on past outcomes.

QE is nothing new - CBs have been reliably printing money to buy government bonds and lowering interest rates for 35 years.

There is an exponential at work which is why we see so much more government bonds being bought in recent years, but the underlying equation is the same,

Any society with some semblence of a free market which is placed in a hard money straight jacket - whether of the gold, positive money, Mises institute or inflation targeting flavours will develop credit instruments to work around the inherent inefficiencies of hard money (aka planned economy) regimes.

We may be at the point where we would be better off managing with a pure credit regime, without any actual money.

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The paradox of thrift is exemplified by Germany.

The paradox of spendthrift (credit) is exemplified by Greece.

Two sides of the same coin.

Part of the problem is finding the correct and responsible balance between the two for the benefit of both.

(using the words thrift and spendthrift isn't intended as a judgement on or criticism of either)

Edited by billybong

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QE is like giving a liver transplant to an alcoholic: The brief period of recovery is accompanied by promises of rehabilitation and expressions of thanks before the pattern of destructive behaviour reasserts itself anew. In effect, a matter of treating the symptoms rather than the cause.

The George Best recovery?

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I've been thinking about this recently.

Like a lot of people on here I've built up a lot of savings but credit has rendered these savings almost pointless.

If I want to buy a car me being able to pay cash is of no advantage to me, people don't sell cars they sell finance on cars.

If I want to buy a house someone will borrow 5x their income and outbid me.

So the question is whether to join them, liquidise all my savings/house, leverage to the moon and buy a slightly bigger house or just stand back bemused.

I've gone for the latter so far, and I'm lucky to have a very rational wife but I can see how people get sucked in.

I have been thinking of this too, a car has no real value after a few years so doesn't it make sense to find a car on modest pcp deal with 0% and just effectively "rent" it? Then if it all goes tits give it back to the finance company and all the time your "money" in the bank remains untouched. I can understand why most car firms now are finance companies who also make cars.

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You are implicitly saying ZIRP and QE are somehow "wrong" rather than correct for the circumstances.

Why "somehow"? The state and economics should be separated just like the state is separated from the church. Unless you still believe economic fascism (attempts to decree outcomes disregarding cause and consequence relationships, especially on the back of credit expansion) is something that has not been tried endlessly in the past millennia without a single relevant, positive example for the overall wealth of the nation concerned.

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The paradox of thrift is exemplified by Germany.

The paradox of spendthrift (credit) is exemplified by Greece.

Two sides of the same coin.

Part of the problem is finding the correct and responsible balance between the two for the benefit of both.

(using the words thrift and spendthrift isn't intended as a judgement on or criticism of either)

This is rather the nub of the matter

One country's excessive spending is funding other country's surpluses

In that respect the Germans are no better European neighbours than the Greeks and the Chinese are no more virtuous world citizens than the US or the UK

Finding a mechanism to control and redistribute current account surpluses has been an issue that has perplexed economists since the times of Keynes and Bretton Woods. Using floating exchange rates is one obvious mechanism but of course the Euro has effectively made that option useless in the EU. Without some form of surplus recycling mechanism the machine eventually fall to pieces usually with unpleasant consequences

Edited by stormymonday_2011

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Not really.

(creative) destruction happens all the time. But destruction of the entire economy when it was entirely avoidable would be pretty stupid.

On your first point - Clearly Germany haven't heard of the Paradox of Thrift or its consquences now being played out.

On your main point - I suspect you may be arguing that the real rate during the recession/depression hadn't changed from that obtaining prior. Clearly it had and QE reflects this. You are implicitly saying ZIRP and QE are somehow "wrong" rather than correct for the circumstances.

The problem is that if the only way to 'save' the economy is to impose a form of stasis that prevents market forces from doing their job you end up with the forest fire analogy in which suppressing the small outbreaks completely just sets you up over time for 'The Big One' where all that accumulated dry tinder finally ignites and burns down the whole lot.

To argue that the economy is now too big to fail is in effect to argue for the end of Capitalism. I take your point that there may have been an argument for short term intervention back in '08 (Though some-like David Stockman- dispute even this) but today the Bof E have kept interest rates at .5% for the sixth year running.

What started as a temporary measure to restore confidence has now become a permanent state of affairs- but if we assume that interest rates have some function, a function that is no longer being carried out, then I think it's not unfair to question what the thinking here is, and as far as I can see the theology behind the project is flawed- it assumes that cheaper credit always and everywhere equals growth, but in reality cheaper credit seems just as likely to equal stagnation if that credit is deployed not to rebuild the future but in an attempt to forstall it.

The reality seems to be that the crisis of '08 has not been prevented, only delayed in the hope that we could grow our way out of the deep hole we are in- my argument is that the weapon of choice designed to bring this growth about-cheap money- may in fact be among the reasons why that growth is not actually happening- cheap money is not acting as a stimulant to growth but as a crutch for the failed system that created the crisis in the first place, entrenching the same failed interests who that crisis threatened to sweep away.

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