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Is it really different this time?
Recessions are nothing new. From the chart above, there has been 5 recessions (grey areas) in the last 30 years in the US. A recession is usually a few quarters of negative GDP growth. After some help from the government and the reserve bank in the form of incentives and interest rate cuts, the recession ends. The economy starts growing and all is well again. The last recession started in December 2007 and appears to have ended in Q3 of 2009 when the GDP growth turned to positive again.
After 18 months of recession, we started to see signs of recovery and the hot discussion early last year was what type of recovery we will have – U-shape, L-shape, V-shape, W (double dip recession) or square root shape (flat after the initial V). The stock market (which tends to be ahead of the real economy) seems to be predicting a V or square root shaped recovery and many people are looking at recent history to predict what will happen in the next few years. If we look at history, we should expect GDP to continue to grow again as it always has in the last 30 years. However, last week I saw another chart created by The Market Ticker that showed one major difference between this recession and previous recessions.
The chart above shows that unlike previous recessions, credit has contracted in all sectors except the federal government since the recession started in December 2007. And this happened despite the Federal Reserve Bank printing an extra trillion dollars and lowering interest rates to near zero! Why didn’t credit grow? Perhaps there were no more credit worthy borrowers left to lend to. Perhaps borrowers have already maxed out their ability to borrow. When property prices were rising, people could always use their equity as collateral to borrow more but property prices have been falling and 1 in 4 people with mortgages are already “underwater” i.e. owe more money than what their property is worth. From the two charts shown above, it looks like the previous recoveries have been funded by credit expansion but the US may have hit “peak credit” in 2007 and further expansion is no longer possible and in fact the curve may go the other way and as credit continues to contract. Although I don’t have much data on Europe, it looks like a similar situation is happening in the Eurozone as their loans and money supply is also contracting at an accelerating pace.
Credit or debt can only be retired in 3 ways:
- Debtor repays debt the proper way i.e. capital with interest.
- Debtor asks to “restructure” debt.
- Debtor defaults on the debt.
The lender stands to lose some or all of his capital in cases 2 and 3 and it looks like a lot of debt is being retired this way. Personal bankruptcy filings rose by a third in 2009 largely driven by foreclosures and job losses. Business bankruptcies rose by 38% in 2009 as well. According to the President of Automated Access to Court Electronic Records, “Numbers have been going steadily up“. Debt defaults are not limited to individuals and businesses. Countries are doing it too. Iceland which is bankrupt is choosing not to repay its debt to Britain. If debt is being retired by method 2 and 3, there will be less capital available for future lending leading to further credit contraction.
If past recoveries have been funded by credit expansion, and if credit is contracting instead of expanding, maybe things will be different this time. I just ordered a book from Amazon.com called “This Time is Different: Eight Centuries of Financial Folly
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