The Next Revolution in our Credit-Driven Economy. Schulte Paul

virtually all important choices in human life (when to marry, buy a home, go on vacation, go to university, expand a business, go to the hospital, have children) are predicated on the availability of credit. How can economics just leave this out? For decades, the science of economics has treated financial markets as a “harmless sideshow.”9 MIT economist Olivier Blanchard said, “We thought of financial regulation as outside the macroeconomic framework.”10

The Corporate Example

      Credit creation can make or break the balance sheet of the corporate sector and, therefore, the income statement. We should call the income statement the “outcome” statement, as it is a derivative of underlying trends in credit. In this way, the price-to-earnings ratio (P/E) and earnings per share (EPS) of a stock are meaningless and tell us nothing (we will see later that they may be a contra-indicator for investment timing and cause people to lose money!). To focus on earnings and EPS without an eye on credit and the way that credit affects national liquidity and the balance sheet of a company is to miss the big picture. Furthermore, focusing on GDP data, money supply, leading economic indicators, and fiscal positions is a waste of time without proper attention to the extent to which an economy is stretched too thin when it comes to the availability of credit and the savings that funds that credit.

      People borrow from a banking system whose capacity to lend is determined by how much these same people save. People go to banks to borrow their savings. Corporations do the same thing. Borrowings are loans (assets of a bank) and savings are deposits (liabilities of a bank). The savings of people and corporations create credit, and credit creates money supply. The ratio of bank loans to deposits (or savings) is the loan/deposit ratio (LDR). This can reach a low of 0.5 ($50 of loans for $100 of deposits) or so. This is the beginning of a credit cycle that makes for glorious asset price appreciation for a considerable period of time, usually for four to six years.

      A country that has its foot on the accelerator and is allowing credit growth to far exceed savings growth is running large current account surpluses. Domestic liquidity is sloshing around at an accelerating rate. This country can gun the engine of growth with credit up to an LDR of about 1.1 or 1.2 until they encounter trouble because the growth in credit has far exceeded the growth in savings. Examples today of highly liquid banking systems are the Philippines, Thailand, Indonesia, Singapore, Hong Kong, China, and much of Africa.