There is great irony in the fact that U.S. led Global Credit Inflation and attendant Asset Bubbles of unprecedented dimensions are fostering (over)investment in global goods-producing capacity, a backdrop that is perceived by the New Paradigmers as ensuring ongoing “slack” and quiescent “inflation.” This is dangerously flawed analysis, and I find it at this point rather ridiculous that policymakers cling to such a narrow (“core-CPI”) view of “inflation.” I suggest Mr. Fisher, Dr. Bernanke, Dr. Poole and others read (or, perhaps, re-read) the classic, Banking and the Business Cycle – A Study of the Great Depression in the United States, by C.A. Phillips, T.F. McManus, and R.W. Nelson, 1937….

The authors’ delved into considerable detail and analysis elucidating the various factors and mechanisms that supported “a much larger superstructure of credit than was previously possible.” Certainly at the top of the list was the expansion of the Federal Reserve System, along with various factors and avenues that significantly reduced bank reserve-to-deposit requirements and financial innovation generally. To be sure, however, the “hyper-elasticity of the Federal Reserve System” and the fractional-reserve banking apparatus from the ‘twenties is Inflationary Child’s Play in comparison to the virtually unchecked securities-based Credit systems of our day. 

The contemporary U.S. Credit system (evolving to the status of the backbone of the global Credit mechanism) comprised of banks, the GSEs, global central bank dollar holdings, brokerage firms, the MBS and ABS marketplaces, hedge funds, finance companies, insurance companies, etc., operate today generally unrestrained from either reserve or capital requirements (not to mention a gold standard). And, in the final analysis, ‘this implies nothing less than a revolution in the monetary system not only of the United States but of all countries…’ Moreover, ‘changes occurring in the [global financial] system [are] intimately connected with the structural changes in the [global] economic system…’ 

“The stock market crash provided the shock to confidence which definitely and dramatically started the depression on its downward course, revealing to most persons for the first time the inherent instability of the conditions which had prevailed for several years.” (page 161)

And while “Banking and the Business Cycle” does not pursue this line of reasoning, it is my view that the 1929 crash was inevitable due to the extreme nature of speculative leveraging and deep structural maladjustment, and it was as well the impetus for an unavoidable collapse of system liquidity. One never knows from where the shock to confidence will emanate, while today’s intertwined global Credit apparatus has an unknown multitude of highly leveraged marketplaces that would qualify as potential financial dislocation catalysts. Yet one can look to today’s Highly Extraordinary Global Credit and Speculative Boom Environment and state unequivocally that the system is acutely vulnerable to any break in confidence, panicked speculator deleveraging, or even any meaningful downturn in Credit growth. Admittedly, the Global Credit Bubble has quite a head of steam. But, then again, so might global interest rates.