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This week, with his pronouncement that "credit is the lifeblood of a healthy economy," President Obama reiterated what has been one of his most common themes in diagnosing our economic problem. The president has relied on this bedrock belief to propose policies that place the restoration of credit as the highest priority. However, despite his seemingly earnest intentions, the president and his economic advisors have misdiagnosed the ailment. Savings, not credit, is the lifeblood of a healthy economy. When not used properly credit can be like a cancer that sickens an otherwise healthy economy.
What everyone seems to have forgotten at this point is that credit does not come from thin air. Even in a system in which bank reserves are leveraged many times, someone has to put savings in a bank for the bank to turn around and make a loan. As a result, the bedrock is the savings, which allows for the credit to flow. Credit extended without adequate savings inevitably leads an economy into disaster.
The primary mechanism that has injected credit where it does not belong is the massive credit card industry that has developed in the United States over the last generation. The ease with which these cards may be obtained and the degree to which Americans now rely on them for routine purchases has created a culture of credit that simply has no precedent in a healthy economy. Until this culture has been reformed, America's fight to restore economic vitality will be a lost cause.
However, this week a much discussed opinion piece in the Wall Street Journal by top banking analyst Meredith Whitney, indicated that many Americans besides the president are still looking toward credit as the means of economic salvation. In her piece, Ms. Whitney writes,
...Undeniably, consumers look at their unused credit balances as a "what if" reserve. "What if" my kid needs braces? "What if" my dog gets sick? "What if" I lose one of my jobs? This unused credit portion has grown to be relied on as a source of liquidity and a liquidity management tool for many U.S. consumers. If credit is taken away from what otherwise is an able borrower, that borrower's financial position weakens considerably. With two-thirds of the U.S. economy dependent upon consumer spending, we should tread carefully and act collectively.
In order to keep the economy functioning, Ms. Whitney asks the credit card providers and the federal government to keep credit lines open, so that millions of Americans can keep on spending. However, while such actions would certainly keep our phony economy propped up a while longer, it would further weaken the very foundation upon which a real economy will eventually have to be rebuilt.
Without a doubt, Americans, and all other people for that matter, benefit from having access to "rainy day money." But Americans should be saving for a rainy day, not adopting the attitude that if it rains I'll whip out my credit card. If Americans need to pay for a suddenly ill dog, to straighten their kid's teeth, or to pull them through a period of unemployment, they should save some of their present earnings.
But saving money requires a reduction in spending, and that is something that modern economists, within and without the Administration, cannot abide. A drop in spending will create a sharper contraction in our economy - which is now comprised of 70% consumer spending. But this is no reason to discourage the process. The option to go into debt in the event of an emergency is no substitute for building personal savings for such events. Not only does such a strategy jeopardize the solvency of individuals or families when they are at their most vulnerable, but it deprives society of badly needed savings.
Currently, with so many financially strapped Americans looking to draw on their credit lines, the fallacy of this 'savings substitute' is easily revealed. With lenders' capital depleted, and falling home prices, and rising unemployment putting borrowers at greater risk of default, credit is naturally harder to come by. Had only a small percentage of borrowers needed to access their credit card "rainy day funds" there would have been no credit crisis. But with a deluge drenching so many at once, there was simply not enough credit umbrellas to go around. Had Americans actually been saving money instead, everyone would have his own umbrella and would not now be looking to borrow someone else's.
Most importantly, as savers bank their earnings into "rainy day funds," in addition to earning interest, those savings are available to businesses to make capital investments, produce goods and services, and provide employment. Without access to those savings, such investments cannot be made, and society is worse off as a result.
Lastly, savings can always be relied upon whereas credit is ephemeral. Remarks this week from the Chinese premier Wen Jiabao should serve notice to all Americans that the day will soon come when the Chinese stop lending us their umbrellas. When that happens, the average American will be soaked to the bone.
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This article has 63 comments:
I believe you've completely missed the point. Mr. Schiff's argument is that this line of reasoning is EXACTLY THE WRONG FOCUS required to solve this problem:
"...while such actions would certainly keep our phony economy propped up a while longer, it would further weaken the very foundation upon which a real economy will eventually have to be rebuilt."
Mr. Schiff's argument is that an ounce of prevention is worth a pound of cure. And right now, we need about a ton of cure.
On Mar 14 03:20 PM ED K wrote:
> A very timely and informative post.Ms. whitney's thoughts hit the
> nail right on the head,especially the "RAINY DAY THEORY",great stuff!!!!!
Now that Discover Financial is incorporated as a bank holding company so that it can receive TARP funds, the industry has metastasized to further undermined the stability of the US government. The US Treasury is paying credit card bills!
The Chinese PM's comments this week were meant to serve warning to our profligate spending, and for the U.S. to stay out of Chinese affairs.
Debt is ultimately serfdom.
Allowing banks to fail in true capitalistic fashion would put America out of work.
The real issue is that we have offshored employment to third world countries and imported their cheap goods to save money, using credit due to the lack of employment.
A handful of elite businessmen have gotten rich.
The country as a whole now has to introduce protectionism to put people back to work.
Pricking the real estate bubble is common sense to me.
While our wages become comparable to third world countries, there's no way we'll afford present day housing prices.
The Chinese threaten to sell a trillion in T-Bills if we devalue our dollar, what they don't realize is that selling those T-Bills will help us devalue the dollar.
Devaluing will put us back to work.
The party's over, back to the old fashion way of making money - working for it.
Our government is taking from the ants to pay for the grasshoppers. If you have saved, your savings value is being rapidly eroded by the current government policies of supplying liquidity in humongous amounts. At the same time there is no return (interest) to be gained from your savings. If you saved rather than borrowed you have not been as wise as those who have lived the life of material excess. Butter before guns is the appropriate philosophy of life. It appears the current political administration is sympathetic to this view and is doing like Geo W and his cronies ... You know, striking while the iron is hot!
On Mar 14 09:52 PM The hand wrote:
> consumer's going deeper in debt during a recession only inhibits
> recovery.
>
>
Warm_Paw, the Chinese do realize this, of course. The fact that they are even posturing in this direction should tell you how dire the situation is.
On Mar 14 08:54 PM Warm_Paw wrote:
> The Chinese threaten to sell a trillion in T-Bills if we devalue
> our dollar, what they don't realize is that selling those T-Bills
> will help us devalue the dollar.
We are in a box without the insight nor will to build a way thru the wall or over the top. So,back to those others that also own Trillions,they will also have a dis-incentive. Apology for sounding like a commercial,but one of the best insights is from Chuck Butler of Everbank. His 'Daily Phenning' is pretty neat look at currencies.
Without jobs, credit doesn't work. Without credit, America doesn't work.
Now that that "Future" is here, we should put Micheal J. Fox in that DeLorean, and blast him back in time to kick some ass before it's too late!
It won't happen, even after China dumps its dollars.
As long as people like Paul Krugman and "most other economists" flood the media with talk of spending our way out of this crisis, the brainwashing continues.
To get on this savings track its going to have to hurt real bad.
On Mar 14 08:54 PM Warm_Paw wrote:
> The government doesn't have a choice but to pump us out of this mess.
>
> Allowing banks to fail in true capitalistic fashion would put America
> out of work.
> The real issue is that we have offshored employment to third world
> countries and imported their cheap goods to save money, using credit
> due to the lack of employment.
> A handful of elite businessmen have gotten rich.
> The country as a whole now has to introduce protectionism to put
> people back to work.
> Pricking the real estate bubble is common sense to me.
> While our wages become comparable to third world countries, there's
> no way we'll afford present day housing prices.
> The Chinese threaten to sell a trillion in T-Bills if we devalue
> our dollar, what they don't realize is that selling those T-Bills
> will help us devalue the dollar.
> Devaluing will put us back to work.
> The party's over, back to the old fashion way of making money - working
> for it.
We do not need the poison of debts that we cannot pay back, nor the reliance upon the magnanimous behavior of those whose interests do not include our well-being.
On Mar 14 04:56 PM Habitual Saver wrote:
> I can't disagree with one word in this piece. Almost like I wrote
> it myself. I find it hard to understand why our illustrious leaders
> think that the cure for our present illness is drinking more of the
> poison that made us sick in the first place. Americans and Companies
> need to learn how to tighten their belts and live within their means.
On Mar 14 11:06 PM WesAttaway wrote:
> A great article. My concern has always been that since the basic
> problem is that Americans have been spending more money than they
> have then how can we expect "demand" to go back to where it was.
> The answer is perfectly explained in this article. Without a continuation
> of unsupportable credit we can't do it. Smart businesses are already
> readjusting to the reality of decreased demand.
thanx again.
i think you would approve my system of keeping savings in the form of gold and silver and working capital in fiat money. the fiat money is used to raise the level of savings in hard currency. i find safety deposit boxes the easiest, cheapest storage. if obahahahamahahaha decides to villianize the prudent who have saved this way to justify confiscation in the name of the good of the collective, i believe i will have warning as the setup begins since i am always wary of bloated govt. and the parasitic politicians. i pay attention to the lies of the day.
The abuse of credit by credit card companies is legendary. It has been sold to the gullible on the premise of a better life (at double digit interest rates) and only now has the realization sunk in that this may have been overdone. And now these companies want a bail-out?
By all means keep credit flowing, but ensure the onus of responsibility equally rests on careful corporate decisions on whom to bestow it. Real credit is not a right, it must first be earned. Nor is it a lasso to be used to snare the innocent or unwary.
With Alberts havinga 'AAA+" credit rating they can borrow money at 1% intrest.
This is while the Alberta Heritage Fund currently sitting on 16 billion cash can earn around 4% intrest.
It just makes good economic sense to borrow if your own money makes you more invested elsewhere.
About a year ago ( before the crash)i was offered 5% intrest on a 5 year locked in savings account.
This small Credit Union guarantees 100% of all deposits backed by the Alberta Government.
I deposited 50,000 into the account for 5 years.
And turned around 2 months later and took a 15,000 loan
at prime plus 1 % at the time.
this worked out to 4.5 % intrest on the loan.
Its just good economics to borrow if you in a position to implement it.
And remember borrowing cash with cash as collateral is the best risk reward you can get.
crudeoiltrader.blogspo...
Well, without proper income, no one is going to save any money.
Compared to what the upper classes are earning, the working/middle class incomes are a joke.
Unfortunately, with the cost of living being what it is (and it's going to get a lot worse), sometimes the average American has to pull out and use his/her credit card just for the unseen emergencies that come their way.
Where I live there are no credit cards as such, only a Visa debit card, and I've grown to appreciate its low cost usefulness more as time goes on. I had a checking account overdraft (line of credit really) but it was costing too much in service fees, as was the checking account itself. I was once in the credit card trap while in the U.S. and it can get to be pretty horrible.
However, to go back to a rational system where you spend as you earn would take a major revolution in the way people think - I think it will be forced on us rather than voluntary. There is always a small minority of survivalist and alternative life stylers, and maybe their (our) day is coming now.
Maybe Obama's idea is to get us off this rocky road we are on and then try to go to a more rational way of living, but by then it will be too late.
Thank you for supporting my position, I know you said it better.
Thanks for this very important article Peter. Credit cards have transformed our economy much like easy mortgage money transformed our stable housing market.
Before credit cards, we wrote checks. (Yes I am that old!) If you didn't have the money, you didn't make the purchase. But with the proliferation of credit cards, you didn't have to wait. You could have it now. When you received your credit card bill, you were informed that the minimum balance required was something very reasonable so you paid the minimum balance, often not realizing that you were paying 19 or 20% interest on your new "loan."
Credit cards and second mortgages drawn for consumptive purposes are the two primary reasons that consumer indebtedness not counting primary mortgages, went up from 60% of net income in the 90's to 130% at the beginning of the current crisis.
The consumer has retrenched to shore up his or her balance sheet. Making more credit available to the consumer now is counterproductive and dangerous. Income and savings are the key to resolving this crisis and that will take time.
You were one of the first to point out the contradiction between the government encouraging consumer spending in a consumer debt crisis.
The credit card companies are likely doing what is right. That is pulling back those who are hopelessly overextended already. For those who want to borrow money at huge rates of interest with fee structures that would make a loan shark blush... go for it!
For me, the learning is that, though the leverage or borrowing is helpfull to have a multipler effects but that should not temp us to be too adventurous as this phase and should have limitations.
So it is not that we need to take a U turn from spending to saving but having a right balance of the two.
I wish I had been as wise as he was. The bank I worked for was closed this year. It is said that we were a victim of the downturn in the economy, even the FDIC agrees. That certainly is true to a point but did we properly underwrite credit and capacity? Did the appraisals of the collateral realy support the loans? If we and everyone else had acted prudently would we be in this situation?
I know that I spent more than I should have. I have borrowed for things I should have saved for. I did it and so did at least half of those who have posted here supporting the principles we know we should follow. We must change our ways but first we must admit that we are part of the problem, well at least most of us are...
If we listen to the President and try to spend our way out of this with our credit cards and HELOCs we will soon find ourselves even lower than today.
People get that they need to save more and pay down debt but taking away their lines of credit while their jobs are also disappearning is a sure road to a despression rather than just a severe recession.
Time is the missing ingredient to most suggested cures for our economic sickness and time is what it will take.
Peter Schiff gets the basics but he keeps messing up on how to apply what he knows.
Every credit card holder is not buying yachts and vacations. Many are just trying to keep food on the table since employment is so hard to get and has been hard to get for years. Now that same credit card holder will get a meager stimulus that will have to be used to pay back the credit cards. This should do wonders for our economy! Meanwhile, the slippery scheming goes on. I say rip up the cards; cancel the accounts; bury your money in the backyard( BofA quickly informed me that having over $40,000 in cash is considered hoarding which is illegal) So, chance it. Bring these schemers and the politicians out into the street and make them squirm till every orifice bleeds!!!
never had the first credit card. always refused to borrow. never made monthly payments except on my first home which was paid off 18 yrs. early. credit cards looked like madness to me. i do use a debit card but that is a different animal.
you give good advice but i would add to buy some gold and silver with some of that cash to protect value. eventually the piper will return for payment at the rate currencies are being diluted.
> The Chinese are divesting themselves of dollars as we speak. They'll be the largest owner of natural resource companies by the end of the next year or two. Can't say I can blame them.
Washington could not be making it any clearer to the world that the US has no intention of paying back our loans with nothing more than monopoly money.<
Just today news:
Iran, China sign $3.2 billion gas deal
TEHRAN, Iran (AP) — State TV says Iran and China have signed a $3.2 billion gas deal to produce more than 10 tons of liquid natural gas.
The deal was signed in Tehran between Iran LNG Company and a Chinese-led consortium, the report said.
The Chinese company will build a line to liquefy gas in Phase 12 of the giant South Pars Gas Field in southern Iran. It didn't give further details.
The United States is pushing for China and others to abide by United Nations sanctions aimed at pressuring Iran to rein in its nuclear program.
Iran has trumpeted recent energy deals as a vindication against U.S. efforts to isolate Tehran.
PS
1. The USA are paying dearly for its indiscriminate support of Israeli international outlaw actions.
2. As for Peter Schiff article, it is excellent. The longer America foolows the failed Bush & Obama & Congress policies, the more desperate situation America is getting in.
Where do you suppose that savings comes from?
Money is credit. Saving is credit. Your income is just money that someone else borrowed and spent. The total amount of credit/debt must, by definition, at least be equal to the total amount of savings and money in circulation.
If all debt/credit was wiped away, all money would be wiped away as well. That means severe deflation until we are ultimately left with a barter economy. We couldn't all just "spend what we earn" because there wouldn't be anything at all for us to earn. Someone has to borrow the money from the banking system in the first place.
Credit is the lifeblood of the economy because money is the lifeblood of the economy. Credit is money, and money is credit.
You all need to wake up and realize that we don't have a commodity system of money anymore.
It's frightening that you are a financial professional and have such a poor understanding of the money creation process.
The credit card companies do not do this to lose money. They make money on the fees they charge the vendors. The vendors do not pay these fees to lose money. They prefer a sale to a non-sale and know that a credit card payment presents a low-risk loan.
Of course, not all credit card holders are creditworthy, and banks would do well to winnow the wheat from the chaff. That need not undermine the usefulness of responsible credit.
Home equity loans and other collateral-based loans are also not worrisome, assuming the collateral is sufficient and the borrower is worthy.
However, the massive borrowing by the US gov't is atrocious and frightening. It is foolish for the US gov't to forgo moderate borrowing when the rates are low and the capital is available. But there is nothing moderate about the Obama deficits.
On Mar 16 03:09 PM timwalsh300 wrote:
> And yes, Peter, credit DOES come from thin air. Banks don't need
> deposits to make loans. They simply need to borrow reserves (which
> are printed "from thin air") from the Federal Reserve through the
> discount window. That's where all money is born. That's where people
> get reserves in the first place that they later deposit at the bank.
>
>
> It's frightening that you are a financial professional and have such
> a poor understanding of the money creation process.
On Mar 16 03:02 PM timwalsh300 wrote:
> You all need to wake up and realize that we don't have a commodity
> system of money anymore.
On Mar 16 12:08 AM William Cowie wrote:
> Great article. Interesting how politicians of every stripe have become
> unable to grasp simple concepts!
It doesn't matter how one feels about our monetary system (fiat vs. commodity money, or how money is created). I'm just describing how it works. The fact is that money is credit. If all debts were repaid, we'd have no money. Everybody here is talking as if we still trade a finite number of gold coins. Everything that Peter Schiff talks about is based on false premises about the structure of our monetary system.
More likely today, when a new loan is made (i.e. a new deposit is created) there will be upward pressure on the Fed Funds rate (as banks try to meet their reserve requirements to cover the new deposits), so the Fed will purchase Treasury notes from the public. The public will then deposit this money in banks. The banks will then lend/borrow it among each other and satisfy their reserve requirements.
The only limit on the amount of credit that can be created by a bank is that bank's equity. And deposits have nothing to do with equity. A deposit is, in fact, a liability from the bank's perspective (reserves that they are borrowing). Banks only increase their equity by collecting interest and fees.
In any case, Peter Schiff is still wrong... more so than he will ever understand. For him, this is what you might call an inconvenient truth. It's better for his business to scare you all with lies about our monetary system and get you to buy his products.
On Mar 16 03:09 PM timwalsh300 wrote:
> And yes, Peter, credit DOES come from thin air. Banks don't need
> deposits to make loans. They simply need to borrow reserves (which
> are printed "from thin air") from the Federal Reserve through the
> discount window. That's where all money is born. That's where people
> get reserves in the first place that they later deposit at the bank.
>
>
> It's frightening that you are a financial professional and have such
> a poor understanding of the money creation process.
Credit is not money!
Money is anything that people will exchange for work.
It is the underlying assest that has value and is exchangable.
Schiff is trying to say gold is money and you are trying to say credit is money.
I will agree that the US dollar is credit, and that you can buy gold with US dollars, but that doesn't make either one of them money.
I could buy gold on US dollar credit, then, insure it's value by paying more US dollar credit and then sell the package for Euro dollar credit. It still isn't money, even if I insure it and package it again!
The problem now is that even the banks aren't accepting all credit as money and that causes a resession.
Go ahead and tell the banks that credit is money but don't expect a loan on anything but solid assest the bank can hold. What companies want banks to do now is provide credit to insure credit that was financed by credit because people like you think that it is money. If you still think credit is money I have some default swap land I would like to sell you.
On Mar 16 06:06 AM Kinja Rules wrote:
> The Chinese as well as All other Govt's of the World will always
> have their own best interests @ heart. It is a given. What is Shocking
> is that w/o a bullet fired China could easily topple the US, by sales
> in various bond related instruments. This is Really Sad. On the
> other hand, they still need US...
tis true that our fiat currency is just another form of debt. That is govt debt. That is why china and others no longer demanding our currency because they lack faith in our govt's policies can dramatically reduce the purchasing power of the dollar. The problem with simply expanding our debt money (the dollar) to manipulate the economy is threefold. First it is debt. Us taxpayers will now be paying interest on a higher amount of national debt forever. Second because by law we are all basically forced to settle debts by using this debt money we no longer really have a free market in money. The Fed somehow can gain real assets just by printing it because of thier monopoly by law. So we are in many ways being enslaved by the Fed. We are also enslaved because (by law the dollar being the only real liquid currency) we are all pretty much forced to either spend our money or place it in institutions that use it to enrich themselves. You can't place dollars under your mattress because the inflation theft. So we are all paying serious commissions are our work everyday to the Fed and the financial institutions in one form or another. Look at different country ETF's. You will find that financial services industry makes up an enourmous size of economies all over the world. Before the recent slide US financial services sector made up over 20% of the S&P 500. This is repeated all over the world. Essentially this form of debt money you feel so comfortable with has enslaved us. Even those without any non-dollar debt pay dearly every year to the benefit of the banksters. A gold and silver backed currency would not require interest payments. Because Gold and Silver are becoming harder to mine everyday that currency would be less prone to inflation. Heck the trading currency might even become more valuable with time. No more need for Social Security.
Basically everytime we expand our debt money the middle classes savings is wiped out and a new cycle begins. With each cycle we end up with less responsible people and more people living off of others. How many cycles it will take before all social order is lost I don't know but eventually anarchy will happen and another dark ages will begin. Unless of course we take Peter's advice above and go back to a savings based society and free up our currency options.
Even in this economy, the average American citizen can leverage credit to get OUT of debt, so long as they are responsible and willing to suffer some minor inconveniences.
The real cancer involved with debt is INTEREST (unless you're the bank). People do not understand how much money they are paying in the form of INTEREST For those with large amounts of debt, we should be shouting from the roof tops (yes, I understand many are no longer eligible for these offers due to poor credit) #1) Stick it to the banks and take advantage of 0% offers on balance transfers for 9-12 months...even if there is a 3-4% transfer fee, but pay these balances off before the low rate expires #2) Stop spending money like our government spends money, unless you have a printing press too #3) Stop spending more than you make #4) Stop making minimum payments on those balances. #5) Pay off your higher interest rate loans/credit cards first.
If the average American citizen used credit like this, and adopted these spending patterns, then it would cure much of the cancer we're experiencing. It wouldn't immediately help the economy, but AT LEAST it would provide a solid foundation for re-building the economy. It's too bad that political motivation and corporate greed will stand in the way of this and keep pushing the people towards slavery (in the form of debt).
I'm hopeful things can change, but debt is not the way out of debt. Mr. Schiff, I appreciate your voice in this regard.