Wednesday, February 17, 2010

Law of Diminishing Returns of Credit Expansion

Brian Pretti and his team at Contrary Investor writes a series of excellent columns every month. Let's take a look at a recent one called Cycle Logical Issues http://www.contraryinvestor.com/mo.htm

The entire article is worth a read, but please consider a snip on the law of diminishing returns of credit expansion and the accompanying increase in economic volatility.

.... Here’s the question that may indeed morph into an investment theme for 2010 and beyond that we’d like to pose. Looking ahead, will the US economy be more or less volatile than we have experienced over what is close to the last thirty years? Yes or no?

Economic rate of change highs and lows from the fifties through the seventies was a lot broader than has been the case subsequent. We often hear a lot of folks explain this away as the US transforming itself from an industrial to a service based economy. Less manufacturing dependence has meant less overall economic volatility, etc. We've transferred the cyclical inventory and manufacturing swings offshore, right? But is that really the case?

Is it really just a function of domestic economic evolution, or is there something else going on here that ties right back into the keynote issue of the current economic and financial market cycle - credit?



Longer term this question of the linkage of the credit cycle to the character, texture and rhythm (volatility) of GDP looms very large as we see it. We have one final table of data for your consideration. As you review the decade by decade trends in the numbers, remember the shape and decade by decade acceleration in the macro US credit cycle we lived through over the last half century. Have a look.



Question - did we experience zero job growth in the last decade due to the nature of the US being a service economy? Did we simply stop creating service industry jobs? Or has it been the credit implosion and now lack of private sector credit creation that has engendered the drop in final demand and the coincident and necessary corporate cost cutting primary expressed in employment stats? Was the implosion in jobs in the 1930’s the result of the US “transformingâ€