Saturday, January 24, 2009

Thirteen Steps to a Credit Crunch

Juan Ramón Rallo Julián describes in plain English the thirteen steps that led to the global economic crisis.

  1. Banks grant new loans on a massive scale and the interest rate drops.
  2. Credit expansion drives malinvestments in projects far from consumption which were not profitable before the credit expansion..
  3. Capital goods rise in price.
  4. Prices climb on the stock market.
  5. The capital structure is artificially lengthened.
  6. Large accounting profits appear in the capital-goods sector.
  7. The capital-goods sector demands more workers.
  8. At some point the rate of growth in credit expansion ceases. The interest rate climbs. The stock market crashes.
  9. Consumer goods prices grow faster than wages, in relative terms.
  10. Accounting profits appear in the consumer sector (demand increases).
  11. The capital-goods sector sustains heavy accounting losses.
  12. Workers are laid off in capital-goods industries.
  13. Bank defaults mount. Marginally less solvent banks face serious difficulties. Credit crunch.
The current situation is precisely this: we face a credit crunch stemming from the creation of bad debt by the banking system (based on hyperabundant money) and the central banks. The recession seems to be inevitable: malinvested assets will undergo a severe adjustment due to the sale or the repossession of assets on a massive scale, which is necessary to repay the debt.
A problem cannot be solved, if the causes are not understood. I urge you to read the full article, particlarly the clear explanation that he gives for each of these thirteen points.

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