The Easy Credit of Central Banks can’t Stimulate when Recessions are Still Correcting Prices

Posted by PITHOCRATES - July 14th, 2012

Week in Review

Central banks have caused most of our financial woes today.  Easy credit created a frenzy of buying.  Pushing asset prices skyward.  America’s subprime mortgage crisis was caused by easy credit.  Well, that, and bad government policy like forcing lenders to lend even to people who were unqualified.  And they had their government sponsored enterprises (GSE), Fannie Mae and Freddie Mac, unload those toxic mortgages to unsuspecting investors.  You add this to the easy credit of America’s central bank, the Federal Reserve, and it created an incredible housing bubble.  That just didn’t burst.  It exploded.  Sending the U.S. into the greatest recession since the Great Depression.  The Great Recession. 

As housing prices fell back to earth homeowners found themselves underwater in their mortgages.  Some refinanced.  Some just walked away.  Some went through foreclosure.  Leaving the country littered with foreclosed homes.  And all of this financial destruction was brought to us courtesy of the Federal Reserve and their easy credit.  Despite all of this devastation our central bank has caused us some people still think that central banks can stimulate us out of the Great Recession.  Perhaps they’ll finally learn the folly of their thinking (see Roubini: My ‘Perfect Storm’ Is Unfolding Now by Ansuya Harjani, CNBC, posted 7/9/2012 on Yahoo! Finance).

“Dr. Doom” Nouriel Roubini, says the “perfect storm” scenario he forecast for the global economy earlier this year is unfolding right now as growth slows in the U.S., Europe as well as China.

In May, Roubini predicted four elements – stalling growth in the U.S., debt troubles in Europe, a slowdown in emerging markets, particularly China, and military conflict in Iran – would come together in to create a storm for the global economy in 2013…

Policy easing moves by the European Central Bank (ECB), Bank of England (BoE) and the People’s Bank of China (PBoC) last week did little to inspire confidence in global stock markets…

Bill Smead, CEO of Smead Capital Management, agrees that there is little central banks can do arrest the global slowdown.

Last week, he told CNBC that there is “virtually zero chance” that pump-priming by central banks will succeed, suggesting that policymakers should instead let the economic bust work itself through the system.

Yes.  We should let the economic bust work itself through the system.  Because that’s what recessions are supposed to do.  That’s why we call them corrections.  When rising prices create asset bubbles recessions come along and correct these prices back to where they should be.  Where the market would have had them had it not been for all of that easy credit.

Recessions aren’t pleasant.  But it’s the price we must pay.  Especially when we interfere with market forces to keep interest rates artificially low to stimulate economic activity.  Because the economic activity they stimulate is as artificial as the interest rates.  People don’t base their purchasing decisions on supply and demand.  They base them on the availability of easy credit.  Where people say things like, “I had no intention of buying a 3,000 square foot home for me and my wife but at these mortgage rates I’d be a fool not to.  And wouldn’t a Cadillac look just great in the driveway?  At these low interest rates I can afford both.  I mean, it’s not like I’m going to lose my job or anything.”

Of course people do lose their jobs.  And their homes.  And their cars.  What happens then?  Why, we have a subprime mortgage crisis.  And a Great Recession.  That’s what.

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One Response to “The Easy Credit of Central Banks can’t Stimulate when Recessions are Still Correcting Prices”

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