Credit-is it harmful?

I ask a question you’ll likely not hear anywhere else. Has the very concept of credit been beneficial to us and our economy over the long-run? That may seem like a resounding yes to some. Yet, let’s look at the downsides of credit to be fair in comparison. There is a very important context in which I raise this issue. Government control of our lives. There are two main issues related to finance which has allowed this to morph into a web of control over our lives. Fiat money and credit. Fiat money, which means creating money out of thin air, has allowed the Federal Reserve to manipulate our economy at its whim since it’s inception. Along with the ability to set interest rates, they have the ability to instantaneously alter our economy one way or the other. That is far too much power invested in a single entity. Yet, we allow it to happen and even encourage it. The campaign to simply audit the Fed has been derailed time after time. I would think that people would be marching in the streets demanding a thorough and honest accounting of our what is happening with our nation’s money supply. Yet, we have little concern for it in our society today.

The Fed can create inflation or deflation. Currency manipulation not based on true market conditions should equate to a criminal offense. Yet, most people view it in the opposing way believing that absent the Fed, we would have utter chaos in the markets and the financial sector would collapse. This lack of understanding how free markets work by the general populace will provide the cover needed for the Fed to continue operating uninhibited. I think if people truly understood the level of control they have extended to the Fed over the money in their pocket, they would quickly change their view. You know, I cringe when I hear Obama make his claims that if people just understood his health care monstrosity, they would come to love it. Yet, in the case of their money, this view holds true. They would cringe if they knew how the system worked.

Credit is not a creation of the Fed. It has been around for a long, long time. It was not that long ago when credit was looked down upon. Many of you may remember your grandparents that lived through the Great Depression. They despised buying on credit. If they didn’t have cash for a purchase, they didn’t need it. Today’s younger generations have no concept of this. They acted that way with good reason. They saw firsthand the consequences of credit during the 1930’s. They understood then the need for savings rather than credit.

Credit creates a middleman, sometimes a whole network of middlemen. Like sharks, they lie in wait for you to make a mistake and then move in for the kill. Our economy and way of life is so firmly entrenched in credit, it may be impossible to ever change it. Credit at face value seems like a reasonable scenario. Based on one’s good payment history and financial standing, lending money seems like a fairly low-risk proposition. Or better yet, extending credit with collateral posted to back it up. However, that is nowhere close to reality in today’s world. Low documentation loans. No documentation loans. Bad credit loans. No credit loans. Unsecured credit. Get a job and bring in one paystub and get credit. The list goes on and on.

The idea of something for nothing fits in nicely with the view in society today. Bailouts and government handouts have become the norm. The concept of credit has been stretched as well to become accepted practice. The detrimental fallout from this idea is probably impossible to accurately measure. Just consider the sheer volume of bankruptcies and foreclosures. Then add in the amount of people living check to check just barely getting by. The bulk of these are stretched so tightly due to the items they  have purchased on credit. The employment picture in no doubt contributes to this, however, I would contend that they were leveraged too greatly to begin with. How many people do you know that have compiled an adequate rainy-day fund for emergencies? Remember, a minimum of 6 months TOTAL living expenses? We were supposed to save this before we started playing with credit. It’s a reflection of society as a whole in that we simply expect material items right away without saving the money first.

Consumer spending accounts for 70% of our economy in the U.S. today. When we experienced the recession in 2007-2009, consumer spending only dropped an average of 2-3%. Yet this had an astounding negative impact on the economy. When the economy tightens just a little, people slow the rate of spending. They delay some purchases, usually the big-ticket items first. Sometimes it may be simply due to uncertainty, perhaps from the political environment, that causes them to save money. This has an immediate impact on business. Businesses then slow hiring, unemployment rises, people spend even less accordingly, and we have the inevitable chicken and egg scenario.

Many businesses operate on such a thin margin, they must obtain cash loans every pay period just to meet expenses. Why is this? Credit. They have creditors that are slow to pay and create a nearly constant cash crunch. This is what I’m talking about when I say compare the good with the bad. This is a monster that was created. It is dependent on all aspects functioning smoothly. When one segment slips up, it creates a chain reaction crash. Credit is considered absolutely necessary, yet it ‘s more of  a mindset of society.

Take a look at the housing crisis. This crash was precipitated by the derivatives market. One can debate what was the trigger that caused the collapse, but how it collapsed is not really a debate. The derivatives market is based on leveraging. You are betting on a future outcome. In the case of mortgages, they were sliced up into smaller pieces, repackaged with other mortgage pieces, and resold on the derivatives market. We now know that a whole array of different investment entities were buyers in this market. Retirement funds, even your local communities, were players here. And it was all based on the belief that housing values would always rise and that the homeowners would keep paying. We know the history there.

This was another entire industry that was credit based. Homeowners buying ever larger homes without a proper vetting of their credit worthiness. Home equity loans were piled on top of this without merit. By design, people then spent the equity money on big-ticket purchases they wouldn’t have normally been able to purchase. It’s a vicious cycle. Whether it’s business or personal, credit exchanges immediate gratification for risk. The risks would be mitigated if people simply had proper savings habits. They would have a cushion. When you have a Fed that is directly responsible for creating the boom/bust cycles in our economy, you’re playing with fire by living on the edge.

This idea I propose of much, much more stringent credit standards and improved savings habits won’t find much support in the popularity polls. Both businesses and consumers alike have this mindset ingrained into their psyche. It’s simply the accepted way of life. Yet, for all of the perceived benefits of credit, the very high cost would seem to outweigh it in my view. Not just the cost of interest on the credit. The amount of control you must hand over to a third-party whether that be government, the Fed or a company extending credit. If we were to return to standards that required credit to be earned beforehand, the amount of defaults would decrease substantially. Fiscal accountability in government, in lending and in personal budgeting would only serve to strengthen our economy. This won’t happen because of the tremendous amount of money to be made with the system in place. The derivatives market is valued at over $600 trillion. Yes, trillion. No, that much wealth doesn’t exist on the entire globe. Derivatives values are much like fiat money, just made up out of thin air. Having consumers and businesses alike return to the days of fiscal sanity would deprive the middlemen of the massive fortunes they are accruing at our expense. I only wish that those who question alternatives to the system in place would scrutinize it with the same vigor. When you do this, eventually the light bulb goes off and you realize you are the one greatly screwed.

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