Financial Black Holes and Economic Stagnation: An Explanation
"I believe that banking institutions are more dangerous to our liberties than standing armies. Already they have raised up a monied aristocracy that has set the government at defiance. The issuing power (of money) should be taken away from the banks and restored to the people to whom it properly belongs." ~ Thomas Jefferson (1743-1826), 3rd U.S. President.
Presently, one has the net impression that today's governments, both in Europe and in the United States, have their fingers plugging the holes in the financial dike, but fear that that the entire dam could collapse in the not too distant future with dire economic consequences.
Let's see if we can make sense of it all.
Let's say to begin that most financial crises are the direct result of unsustainable debt levels relative to income that need to be wrung out of the economic system. It has happened in the past (notably in 1873, in 1907 and in 1931, for example), and numerous times in developing countries, and it will undoubtedly happen again in the future. The process is more often than not always the same: some large banks, corporations, consumers or governments take on too much risky debt that becomes unsustainable when economic conditions change, thus launching the entire economy into a devastating process of debt deflation. Sometimes, it may take decades to overcome such a debt deflation and it usually creates an environment of economic stagnation when aggregate demand collapses.
What makes the current financial crisis so troublesome is not only that debt levels are historically high for some countries, but also because the usual instruments and procedures to reduce the debt burden, while doing the least damage to the real economy, have been rendered inoperative, due to a large extent, to the poisonous so-called financial “innovations” that have taken place since 1999 in the general climate of wholesale financial deregulation. As a consequence, financial debt in many countries creates a sort of financial black hole that siphons off money income and prevents it from being re-circulated back into the economy. This creates a serious deficiency of demand (when consumers spend less, when corporations postpone investments and when governments adopt austerity programs) that translates into low output growth, economic stagnation and high unemployment.