Monday, 22 September 2008

Is there a credit crunch?

There is a credit crunch where banks and consumers find it difficult or impossible to get loans, at least in the United States. The existence of the credit crunch is actually quite puzzling. A few years ago, there was said to be a global credit glut, the newly industrialising countries have large amounts of capital from selling their goods abroad, there has been far more money transferred to oil producing countries than at any time in the past which should be available for investment internationally, and there has been continued growth in spending in the UK Premiership by multimillionaires which is a sure if crude indicator of the existence of spare capital.

So what's going on? Here are a few likely explanations.

The first is that past debt in the US economy has become so large that banks cannot lend much more without compromising their reserve ratios.

The second is that the borrowers have reached the limit to which borrowing boosts their disposable income, so that economic growth starts to decline as they pay back debt, leading to an economic downturn in which their ability to pay back debt declines in a cycle.

The third is that declines in the value of the US dollar means that international capital is less willing to convert into the currency as continuous decline means lower returns.

The fourth is that the new global distribution of wealth has not been accompanied by a corresponding redistribution in the ability to make loans, so that the newly rich are less able to lend their money efficiently in the US.

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