Banking Crisis

Book Review: Great Diagnosis Of Credit Bubble, Not So Sure About The Cure

Tom Burroughes, Group Editor, London, 10 August 2012

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Yet another book rages about the dire effects of over-leverage. But while the diagnosis is interesting, the cure seems far-fetched.

Yet another book bemoaning the credit binge – and wondering what to do about it - has hit my desk. Richard Duncan’s effort, The New Depression: The Breakdown of the Paper Money Economy, is a book that contains a fascinating and powerful diagnosis of how we got to our current pass. But in his understandable enthusiasm to show how to head off disaster, he makes an astonishing proposal at the end that made my jaw drop.

This 179-page book, published by John Wiley & Sons, lays out statistics so eye-wateringly shocking that make the book worthwhile on those grounds alone. There are lots of tables and charts which ram home just how leveraged the Western economy has become. Take this item as early as page 2: “It is immediately apparent that credit expanded dramatically both in absolute terms and relative to gold in the banking system and to the money supply. In 1968, the ratio of credit to gold was 128 times and the ratio of credit to the money supply was 2.4 times. By 2007, those ratios had expanded to more than 4,000 times and 6.6 times, respectively. Notice, also, the extraordinary expansion of the ratio of credit to GDP.  In 1968, credit exceeded GDP by 1.5 times. In 2007, the amount of credit in the economy had grown to 3.4 times total economic output.”

Duncan blames a number of factors for the West’s credit hangover: central bank hubris (foreign as well as domestic), fractional reserve banking and reduced reserve ratios; the severance of a link between money and gold (a theme I have written about before); high public spending, and some – not all – financial deregulation. While I might quibble with some of the finer details, Duncan is undoubtedly effective in putting across the facts. I like his chapter (4) where he says monetarists such as the late Milton Friedman made the mistake of not taking sufficient account of credit when they sought to explain the impact of money supply growth in an economy. For as Duncan says, under modern fractional banking, and the disintermediation of banks from financial transactions, there is little difference these days between credit and money.

For example: “Meanwhile, because of financial innovation, credit has become more like money. Most credit instruments have long met the three criteria that define money. They can serve as a medium of exchange, they are a store of value, and they are a unit of account. In the past, however, they were not liquid. Now they are.” (page 57).

Anyway, as the book proceeds to the various ghastly scenarios (depression, stagnation, high inflation), Duncan states (page 133): “the economic process itself is no longer driven by saving and investment. Instead, it is driven by borrowing and consumption.” It is hard to argue with that, given the foregoing.

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