Is capitalism dead? According to Richard Duncan of Macro Watch, capitalism died decades ago and has been replaced by a system based entirely on credit, which he calls creditism. On a recent FS Insider podcast, Duncan explained his theory and how it developed in the U.S.
What Is Creditism?
Classical economic theory was built on the premise that money is gold—thus creating a natural limit on credit growth. When President Nixon removed the ability to exchange US dollars for gold, effectively erasing the gold backing of the US dollar, the global financial system rapidly shifted.
From that point on, the economy began to function in ways classical economic theory cannot explain. This is a direct result of removing constraints on how much credit can be created, Duncan explained. At that point, credit growth began accelerating at such a rapid pace that it became the main driver of economic growth. The Fed was suddenly free to create as many dollars as it wanted.
The amount of reserves the banking system was required to hold relative to deposits was steadily reduced. This is the required reserve ratio and it is the only limiting force on how much money banks can lend. As banks can hold less in deposits to cover outstanding debt, they can increase the amount they lend. This causes credit to explode, Duncan said. By 2007, the effective required reserve ratio was barely above zero, meaning the money multiplier was practically infinite, Duncan noted.
“After all the constraints on credit creation were removed,” Duncan explained, “the U.S. economy didn't have to rely on savings anymore. And that was when our economic system evolved from capitalism—where the growth dynamic is fueled by investment and savings… into what I call ‘creditism,’ which is not driven by investment in savings, but instead is driven by credit creation and consumption,” Duncan said.
As long as credit keeps growing rapidly, Duncan stated, the economy grows rapidly. But problems emerge when debt levels are so high that debtors’ ability to repay is curtailed. We saw this play out in 2007 when the private sector was so heavily indebted it couldn't continue paying interest on debt, triggering defaults. At that point, Duncan said, we would have collapsed into a new Great Depression, except that the Fed and world governments stepped in and began injecting credit back into the system.
This led to swelling budget deficits. Since 2007 the government debt—that is, public debt—has increased from $6 trillion to $18 trillion. This is what has fueled further credit expansion, and thus economic growth. Creditism was kept on life support through aggressive government intervention and credit creation, Duncan stated. As a result, our system relies on credit growth to continue.
“However you choose to look at it, there is no longer any difference between money and credit,” Duncan said. “You can think of what the Fed did as either creating money or creating credit. They're the same thing now that money is no longer backed by gold.”
Recipe for Recession
Since 1950, anytime total credit growth is below two percent—defined as total credit adjusted for inflation—the U.S. goes into recession. Furthermore, Duncan noted, recession doesn't end until credit expansion begins. Since 2007 and the aggressive expansion of government debt, credit has been expanding, but just above two percent, which Duncan refers to as the ‘recession threshold.’
It’s not enough to drive economic growth; asset price inflation is needed as a supplement. Essentially, the Fed established a policy to inflate stock and property prices to stoke a wealth effect, subsidizing the U.S. economy and fueling growth. This made the Fed rapidly shift policy after the December 2018 stock market correction. Instead of raising rates, as it had said it was going to do in 2019, the Fed put increases on hold. Now, the U.S. central bank is cutting rates again.
This is keeping total net worth at all-time highs, but it is also forcing the Fed to continue cutting rates to protect asset prices.
“There will be more than one cut in interest rates,” Duncan predicted. “The Fed in a sense is a hostage of the stock market. If the Fed doesn't cut rates now, the stock market will fall very sharply. That will destroy wealth, reduce consumption and cause the economy to go into recession. … The Fed must make the stock market keep going higher, and ideally the property market as well, in order to keep the economy out of recession, or something worse.”
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