The Global Debt Machine Digests Another Crisis

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The Global Debt Machine Digests Another Crisis

It is an undeniable fact of life that human beings are short-sighted. This is nowhere more obvious than in the way we view financial risk and reward. When things are going well, we tend to see the future as endlessly rosy. When anything disrupts that view, then all is doom and gloom.

But that’s not the way real financial markets in a free market system work. It is natural for such systems to have ups and downs, and the so-called “bad times” are actually a good thing, because they mean that good times are coming. That’s precisely when smart investors identify the next new opportunity and prepare to take advantage of it before others catch on. History bears this out.

The long history of our economy has been marked by the inevitable run-up of debt during times of speculative optimism, followed by some sort of financial crisis, which is then followed, in turn, by reflation and prosperity. Until the Great Depression, those crises were permitted to go deeply enough that they rid the system of all the excesses accumulated in the prior run-up.

However, the government’s fiddling with the economy in the late 1920s and early ‘30s made the excesses so severe that the economy was unable to pull itself out of the crisis naturally. As a result, the Depression only truly ended because of the World War II boom funded by huge government deficits and a rationing system that forced consumers and businesses to invest. Ever since then, the Federal Reserve has worked closely with the U.S. government to ease the pain of each crisis and to moderate the worst excesses of each bubble.

This moderated business cycle has led to what the Bank Credit Analyst1 has termed “the debt supercycle.” In this cycle, the economy increasingly uses financial leverage to encourage domestic and global growth. For the most part, Americans fearlessly ride the upswing of the boom. Then, every time this cycle is on the downswing, many of those same people fear that we’ll never recover.

But, of course, we always do. Why? There are at least two reasons:

First, the natural market forces act to efficiently redeploy misallocated capital. It’s in the nature of our economic system to right itself. People operate on enlightened self-interest. And the crowd, if not every individual, turns out to be pretty smart.

Second, our government no longer sits back and lets the economy hurtle toward a catastrophe. For example, the recent Fed rate cuts signal that Ben Bernanke knows how to intervene to put the economy back on track...

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