Credit bubble systems diagram
April 28, 2008 § Leave a comment
- As long as there is growth, the system can expand, and credit is covered/secured by values of assets. Assets can be buildings, resources (food), shares, and just about anything that has perceived value.
- When the value of an asset is stable or shows an increase in value, the value of money that was lent is covered/secured.
- When the value of assets keeps increasing because more money is printed, we create a nasty loop: because the asset increased in value more money can be printed because the asset is re-evaluated by the bank. With seemingly low risk, new credit is given on the basis of an asset that has increased in value.
- It becomes attractive to speculate on the increase of the value of the asset. This creates more monies than the actual increase in value of the assets. In other words, the assets are no longer secured. I think a proper term for this would be “illusion of prosperity”. We believe we are getting richer, while we forget about inflation.
- This credit bubble has trust in its core. Trust that the value of the assets will be stable or even increases in the future.
- The danger lies in the moment when this trust collapses. When the trust collapses, so does the perceived value of the assets.
- JD: “perceived value of assets” has a positieve feedback to “trust”
- Graham Oakes: I think there’s a negative link between “perceived risk” and “speculation”. As the perceived risk goes down, people are more prepared to speculate. This gives a tight little feedback loop that helps drive the bubble.
- Graham Oakes: There’s also a meta-loop somewhere — as you go around the loop “growth drives expension drives new credit” a couple of times, you become confident that “this time it’s really different and there won’t be a bust”. I’m not quite sure how to model this, but the overconfidence it engenders encourages additional speculation and hence drives the bubble. Perhaps “perceived value of assets drives overconfidence drives speculation”?
- Graham Oakes: There’s also some sort of link between inflation and speculation — as inflation gets higher, you need to speculate more to try to keep ahead of it.
- Graham Oakes: What I can’t see in the diagram right now is the narrowing of spreads that’s also been driving speculation in recent years — people had to invest in increasingly risky areas in order to gain the returns that were looking for. There’s a diminishing returns dynamic somewhere in the system: after so much growth, you need to speculate ever harder to gain the returns you’ve become accustomed to.
- Graham Oakes: (I’m sure if I thought hard enough, I could connect every bubble and cloud to every other one. 😉 )
- In the European EEC we used to have (until 15 years ago), a stabilized food market. As in, producers were guaranteed a minimum price, and couldn’t go over a maximum price, and we had quota and buffers. Then we joined the global “free market”. Aaaaargh. *&#^%$# Adopting this market stabilizing strategy for global agricultural/pastoral systems, it could be worth for African and South American farmers to actually have a producing farm (that doesn’t empty soil because they could then afford to do proper farming).
- The prices for housing and food have been rediculously low the last two decades. So as consumer countries, we’ll just have to accept higher, stabilised prices.
- Another intervention that may help is to have an independent reserve currency that is not the dollar, and to have all countries on a global conference decide whether or not and when to print more monies.
- And another would be to oversee speculation better, as in oversee banks to make sure any speculation on food or oil markets is not possible, for that destabilizes.
- Oh, and burning food for biofuels would have to be stopped of course. I agree that the biofuel business is some brilliant farting strategy on a world scale, and it makes for some excellent distrust by other countries. The biofuel business would have to be looked at in closer detail as well, as is not even to compete with food by space or resources required for its production when its is based on other things than grain.