The Rise of Credit Culture
During the 1920s, many Americans stopped saving and started investing, treating their brokerage account as a savings account, much like many Americans treated their homes in our most recent housing bubble. But a brokerage account is not a savings account, nor is a house. The value of a savings account depends on how many dollars you put in. But the value of a brokerage account or a house depends solely on the perception of others. If someone thinks your assets have value, then they do, but if they don’t think they have value, then they don’t.
In a credit-based economy, whether the economy does well or poorly, is largely based on people’s perceptions. If people think things are great, then people borrow and spend currency, and the economy flourishes. But if people have the least bit of anxiety, if they have doubts about tomorrow, then watch out!
In 1929, the stock market crashed, the credit bubble burst and the U.S. economy slid into depression.
The Mechanics of a Depression
The popping of a credit bubble is a deflationary event, and in the case of the Great Depression, it was massively deflationary.
When we take out a loan from the bank, the bank does not actually loan us any of the currency that was on deposit at the bank. Instead, the second the pen hits the paper on that mortgage, loan document or credit card receipt that we are signing the bank is all to create those dollars as a book entry. In other words, we create the currency. The bank is not allowed to do it without our signature. We create the currency, and the bank gets to charge us interest on the currency we created. This brand-new currency we just created then becomes part of the currency supply. Much of our currency supply is created in this way.
But when a home goes into foreclosure, a loan gets defaulted on, or someone files bankrupt, that currency simply disappears back into currency heaven where it came from. So as credit goes bad, the currency supply contracts, and deflation sets in.
This is what happened in 1930-1933 and it was disastrous. As a wave of foreclosures and bankruptcies swept the nation, one-third of the currency supply of the U.S. evaporated into thin air. Over the next three years, wages and prices fell by one-third.
From the book: “Guide to Investing in Gold and Silver” by Michael Maloney
