Thursday, March 5, 2009

A Thousand-Foot View of the Credit Crisis

Big changes are taking place in the world economy due to the shock of the credit crisis. These changes have come on too quickly and severely, but the changes themselves aren’t all bad.

For this discussion it’s convenient to think of all people as being either spenders or savers (as I did once before). Spenders borrow from savers for consumption, and savers lend to spenders with the promise of getting paid back with interest.

It turns out that the promised levels of interest on borrowed money were illusory. Spenders are defaulting on loans, and savers are eating the losses. Even when bad debts are covered by the government, this amounts to a flow of money from savers to cover the bad debts.

During the long period leading up to the credit crisis, spenders were being permitted to consume more than their fair share of resources. The world economy adapted to this situation by producing goods and services consumed by spenders. The world produced too much clothing for shopping addicts and too many flashy cars.

Now that spenders have had their lines of credit cut off, there has been a huge shift in spending patterns. The economy will have to adapt to demand that includes more of the consumption habits of savers and less of spenders. Right now the pendulum has swung too far towards very low consumption. But when things settle out, our world will have less reckless consumption, at least until the next financial bubble arrives.

I’m looking forward to a world with more practical goods and services. Goods aimed at spenders aren’t going to go away; they are just going to make up a smaller fraction of our economic output. That’s a good thing.


  1. In our society, all our needs are quite easily met with relatively modest means. Everything else has to be marketed to us.

    I guess some products meet both wants and needs. Potato chips, for example.

    It's nice to have so many options when it comes to consumption, but I don't purchase most of it.

  2. This was a great post MJ. You've really nailed it here.

  3. Simple & straightforward Mike; great post.

    It really does put into perpsective the new shift in the economic landscape where savers will have to be rewarded for their behaviour because they're not going to pick up any slack left over from the spenders.

    I think we're about to see the world's greatest savers (babyboomers) save like you've never seen saving before as they attempt to meet their retirement/lifestyle goals in the face of massive portfolio losses.

  4. Nurseb911: I think you may be right that baby boomers will start saving significantly more. However, in my limited experience, the greatest savers are those who lived through the depression.