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Deflation and the Role of Non-Self-Liquidating Credit

The 2014 edition of Conquer the Crash reiterates the role of debt in a deflationary crash:

Deflation nearly always manifests as a contraction in the amount of outstanding debt.

The contraction begins when the amount of debt becomes unsustainable.

Moreover, bank credit expert Hamilton Bolton made this observation:

Deflation of non-self-liquidating credit usually produces the greater slumps.

Let's return to Conquer the Crash for an explanation of non-self-liquidating credit:

Non-self-liquidating credit is a loan that is not tied to production and tends to stay in the system. When financial institutions lend for consumer purchases such as cars, boats or homes, or for speculations such as the purchase of stock certificates, no production effort is tied to the loan. Interest payments on such loans stress some other source of income. Contrary to nearly ubiquitous belief, such lending is almost always counterproductive.

With the above in mind, take a look at this graph and read the accompanying excerpt from the September 2018 Elliott Wave Financial Forecast:

Getting Personal - Change in new loans extended in the first half of 2018 compared with 2017

Consumer lending is setting records. This graph, from The Wall Street Journal on August 25, shows a new high in the value of total personal loans in the first half of the year. The Journal reports that “lenders pitch the loans as a way for consumers to pay for projects or activities that might have otherwise taken months to save for.” “Take a trip,” says Barclays PLC. “Add a new deck,” says Citizens Financial. These and other lenders sent out 1.26 billion solicitations in the first half of 2018. Another $140 billion in credit may seem like a drop in the bucket, but the new high in personal loans rests atop a new all-time high in credit card debt. In May 2018, outstanding credit card debt hit $1.04 trillion, surpassing the May 2008 extreme by 2%. Says one observer, “The bet is that this time it won’t end so badly.”

But there are already subtle signs that such an even worse ending is near. For one thing, a Bloomberg article on August 22 notes that credit card lenders blinked in the first quarter of the year, reducing the average line of credit available to “subprime consumers” by 10%. “The pullback is a reversal after years of banks loosening their underwriting standards as part of a push to grab market share in credit cards.”

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