Lenders and Borrowers "Just Say No" to New Credit

The desire of lenders to lend and of borrowers to borrow has shriveled dramatically.

The conventional economic thinking about interest rates, lending and borrowing goes like this: When money is cheap, people and banks are more inclined to borrow and lend, respectively. The money is used to expand businesses and make purchases, resulting in economic growth.

But if that's the case, the economy should be booming. It's not.

Interest rates have been historically low for years now, yet the economy is barely treading water.

In fact, history shows the exact opposite of conventional thinking: that falling interest rates are rarely bullish for the economy – they're bearish.

Why is a decline in interest rates bearish in [today's] environment? Because it means a decline in the demand for credit. When people want less of something, the price goes down. [emphasis added]

Conquer the Crash, second edition, p. 431

The above excerpt from Conquer the Crash, Robert Prechter's 2002 bestseller, updated with a second edition in 2009, put a recent headline into context.

Slower Consumer Credit as People Use Plastic Less (Reuters, May 7)

The article continues, "Consumer credit recorded its smallest increase in eight months in March as Americans cut back on credit cards to fund purchases, Federal Reserve data showed."

You might ask, "But look at the housing market. Aren't low interest rates helping to boost that sector of the economy?"

Consider this insight from a Las Vegas Review-Journal opinion piece authored by the owner of a Henderson, Nev., real estate firm.

Traditional residential real-estate had no interest from Wall Street, but because of the extremely low interest rates engineered by the Federal Reserve, investors are starving for a return on their money. The cash flow from rentals are filling a void that the low-interest environment has created.

The ironic part of this policy is the Fed pushed down rates intending to promote home ownership by allowing homeowners affordable mortgages. Instead the policy has fueled the major hedge funds to purchase homes with cash above current market value. Then the funds will rent the home to the same people who were trying to buy the home. The result is renters pay twice what their mortgage payment would be if they had access to inventory.

And then there's this insight regarding low interest rates and small business:

The Fed’s interest rate activities are suppressing the availability of credit to smaller businesses. Bank loans to unincorporated businesses – which are huge job creators in a normal economy – have actually declined during the last two years.

Forbes, Feb. 13

On May 13, Investor's Business Daily reports: "Major Banks Open Spigot To Small Business, Which Isn't Thirsty for Credit."

The Federal Reserve's efforts to spur lending and borrowing are doomed to fail, and only independent-minded investors understand why: When investor psychology shifts to conservatism, there's nothing anyone can do to force lenders to lend or borrowers to borrow.

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