BEST OF DOUG NOLAND

January 5, 2006

We today face a torrent of disinformation, propaganda, imaginative "analysis" and a slew of wishful thinking when it comes to the true state of our financial and economic systems. At this manic stage of the Credit Bubble, we should expect nothing less. And I guess it is no coincidence that we have a full-fledged monetary quack about to take the helm at the Federal Reserve. But, most fortunately, economic history offers us a wealth of pertinent insight to help keep us "grounded." I hope readers enjoy tidbits of wisdom from…. little known but clearly exceptional American economist, Charles E. Persons. I wish everyone a Merry Christmas and Happy Holidays!

"The thesis of this paper is that the existing depression was due essentially to the great wave of credit expansion in the past decade. There is a lamentable lack of comprehensive and accurate data concerning this process of debt creation. But highly suggestive information may be assembled regarding the growth of bank loans and investments; the increase in mortgage indebtedness, urban and rural; the increasing volume of securities outstanding; and the expansion of installment credit… [I]n the six years after 1922, loans and investments held by banks had increased over $18 billon. This is over 45 per cent…

The great field of credit expansion in the last decade lies in the realm of urban real estate mortgages… We have undoubtedly expanded the credit structure, spending today and postponing the accounting until tomorrow. We have been guilty of the sin of inflation. And there will be no condoning the sin nor reduction of the penalty because the inflation is of credit rather than a monetary one…

Thus the area covered by credit sales enlarges and the volume of credit expansion increases. As in monetary inflation the immediate results seem favorable. Credit expansion results in business activity, in full employment, in optimistic outlook and in a flood of gratulatory literature proclaiming us wiser than our predecessors… But the evidence is consistent and cumulative. The past decade has witnessed a great volume of credit inflation. Our period of prosperity in part was based on nothing more substantial than debt expansion.

Several financial devices of recent invention have contributed to this process of debt inflation… The Federal and Joint Stock Land Banks refinanced a growing proportion…of rural land mortgages into long term paper. This gave the borrowers security… Of similar tendency but more obvious in its recent developments is the newly originated and rapidly introduced device of urban real estate bonds. As a method of credit inflation this plan could hardly have been bettered… The volume successfully sold rolled up with the speed of the proverbial snowball traveling down a steep hill. The fruits of such sales gave us building activity and contributed to the flush times of the decade…

The fundamental question regarding installment sales is of this sort. The method per se is unexceptional. Granting that sound credit principles are applied such sales are safe. But it is highly probably that a considerable volume of the sales recently made were based on credit ratings only justifiable on the theory that flush times were to continue indefinitely… It so happened that this new credit method coincided in the time of its introduction with the origination of new consumption goods of the widest popular appeal… This process of debt inflation went on apace… Temporarily we have spent, enjoyed and stimulated business activity.

When the process of expanding credit ceases and we return to a normal basis of spending each year no more than we earn that year, there must ensue a painful adjustment period…

When the accounts are footed we shall have learned new lessons respecting the evils of credit inflation. This dear bought wisdom we may place beside our knowledge of the evils of monetary inflation purchased at an equally dear price. And we may venture a pious hope that the joint lessons will induce growth of the wisdom to foresee, caution to move less rapidly and more surely in the path of progress…

The essential point here is that during the period of introduction of these new financial devices and while the newly opened reservoirs of credit are filing, we have a temporary increase in the nation’s purchasing power. A combination of circumstances has rendered this expansion of large dimensions in the decade just closed…

The check to expansion is sharp and is intensified by the excesses inevitably associated with periods of over-rapid expansion. Such a course of events is clearly proven by the evidence as to credit expansion in the period 1920 to 1929. The depression into which the nation fell in the latter year was undoubtedly due in part at least to these developments in our complicated economic structure. Manifestly these events are too recent and our records too incomplete to attempt to measure their relative importance as compared with other factors of great weight. But there can be no doubt that their influence was large."