Central Banks' Futile Efforts to Avert Second Great Depression

The world's central banks moved recently to cut interest rates and increase liquidity in global markets. Most notably the Fed cut its base interest rate by 0.5%, but other central banks have also moved to lower the cost of borrowing and make more money available to banks and other borrowers. This is an effort to halt the tightening credit crunch that has been griping the world's markets since August. While they have calmed the tempest for now, the frenzied sell-offs will soon reappear, continuing the market's lurch towards a deep depression.

The reality is that our economies have become addicted to cheap credit. The economies expanded at an abnormal rate on that new money supply and it has spawned asset inflation bubbles and risky investments that now threaten those same economies. We cannot wean our economies off cheap credit by lowering interest rates and giving them more of the same stuff. Globally, assets are overpriced and the markets must contract to return to normal levels. Unfortunately, it is unlikely that we will be able to so carefully manage the deceleration of our economies that we can return them to their stable levels without entering a period of severe recession.

Some observers claim that the credit crunch is now over, and that we've successfully weathered the storm [1]. Others claim that while banks suffered in the recent turmoil, the so-called real world economy escaped unharmed [2]. Neither of these claims are accurate. While the credit turmoil may have subsided for now, the underlying problems which brought it about have not gone away, and it will resurface again with teeth. You cannot suck as much money out of a monetary system as the credit crunch is doing without feeling the effects. Both the banks, who remain exposed to an enormous amount of loans that will not be repayed, and the 'real-world' companies who are fed at both ends by the banks' credit cannot simply carry on unaffected as participants of a monetary system now circulating significantly less money.

The last decade has seen unprecedented and unjustified credit expansion. When that credit contracts, the assets priced by that credit will be revised downwards, people will feel poorer and spend less, and the economy will enter a deep recession. The record overdraft that was the credit bubble must be repayed. It took years of low interest rates to accumulate that debt. Setting them a couple of percent lower now in the face of the debt-collectors is not going to save us.