What Credit Can You Trust When Trust Disappears?


In a real financial crisis, people reach for something real to hold on to.

Following the Crash of 1929, for instance, Americans ran to their banks and took out so much cash that 10,000 banks closed. They were out of money.

In the crisis of 2008, people were confused. In an era of credit money, what is real?

In the event, they too rushed to take out cash.

According to former congressman Paul Kanjorski, a member of the House Banking Committee, depositors took out $550 billion in less than two hours…

Had the authorities not stepped in with a massive cash injection…this would have bankrupted every bank in the nation in less than 24 hours.

When trust disappears

To remind readers, we have set off on a long, winding road. We are skipping along it, cheerfully anticipating the end of the world.

What we are trying to figure out now is how our modern credit-based money system will survive the next crisis.

When the next crisis comes, people are sure to want ‘money’ in hand; they always have.

But how can you hoard money you cannot see? How can you stockpile credit? What can you trust when trust disappears?

All financial systems suffer shocks from time to time. When they do, promises tend to be marked down sharply.

No one knows for sure who can pay and who can’t. No one can borrow because no one can lend. Credit vanishes. All that’s left is cold, hard cash.

The Fed can step in, as it did in 2008, and backstop all the credit in the world.

But what good is it in a real financial crisis?

Imagine the local auto dealer. He goes into his bank to refinance his business loan.

‘Are you selling any cars?’ asks the loan manager.

‘Are you kidding? Nobody’s buying.’

‘Then I can’t lend you any money. You won’t be able to repay.’

It doesn’t matter that the Fed is pushing down the cost of credit through ZIRP and QE. Banks still need willing and able borrowers before they can make loans.

Now, imagine that across the whole economy. Credit may be available. But not to the people who are desperate for cash.

Besides, it is credit that has caused the crisis: Too many people owe too much money they can’t pay.

Fear and uncertainty

Yes, the Fed will promise that ‘no bank will fail’ and act as lender of last resort.

But that won’t make insolvent businesses suddenly profitable. It won’t cause people to buy cars…or build houses…or spend money.

Stock prices will be slashed in half. GDP growth will turn negative. Housing sales will come to a halt. We’ve already seen that show once in this young century.

And you can imagine — because we lived through it so recently — how banks and businesses will take the news that their collateral is giving way beneath their feet. They will cut off lines of credit. They will cancel investments. They will lay off employees by the hundreds of thousands.

They will default on their debt and refuse to lend to anyone else.

Fear and uncertainty will spread. The economy and everyone in it will rush for cash. Lines will form at ATMs. And within hours, the cash will run out.

Why didn’t that happen in September 2008?

It almost did. But three things prevented a total meltdown:

1) There was less debt than today: about $8 trillion less in America, and about $57 trillion less worldwide

2) The world economy was still in growth mode. China was still growing (at least according to the official figures) at 8% a year. Commodities were becoming more expensive. There were still many areas in which investment was paying off.

3) The Fed still had some ammunition to fight the downturn. Short-term interest rates were at 2%. Now, it has been at the ‘zero bound’ for six years.

The forgotten depression

It would have been better to let the crisis of 2008 take care of itself. Free markets are remarkably robust and self-healing. (Just look at the ‘forgotten depression’ of 1921 — what Jim Grant of Grant’s Interest Rate Observer refers to as ‘The Crash That Cured Itself.’)

Instead, the PhDs who work for the Department of the Treasury and the Fed believe they can do better. They fought an excess debt problem by giving the world more debt.

And now they have a system that is more vulnerable to a crisis than ever before.

Although this has greatly enriched the banks, the cronies and the speculators, it has made the situation of the middle classes worse.

There are fewer real ‘breadwinner’ jobs today than there were in 2007 and real median household income is lower.

In 2009, the Fed chairman was ranked, in the popular imagination, somewhere between Abraham Lincoln and Jesus Christ. But after six years of failure…with policies that obviously rob the many to pay off the few…the public will be less ready to believe a new messiah is on hand when the next crisis comes.

Suspicious and fearful, they will rush the ATMs sooner rather than later.


Bill Bonner,
for the Daily Reckoning Australia

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Bill Bonner

Bill Bonner

Best-selling investment author Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter companies. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail The Daily Reckoning.
Bill Bonner

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1 Comment on "What Credit Can You Trust When Trust Disappears?"

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slewie the pi-rat
slewie the pi-rat
1 year 7 months ago

starting a cash-craving, ravenous, rapacious, fear-driven, ATM bank run is no small order, in the US.
twice, i encouraged people to go to the ATMs during Super Bowl half-times, and stop out the cash supply at the line of scrimmage, while completely partied up.
hell, i practically begged them to do it!
two years in a row, i went for the ultimate Hail Mary, and during prime time, too.
zip. zilch. nada.
sis. boom. bah. da.

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