CRUNCH TAKES ITS TOLL
The arithmetic is simple. If V falls and M remains constant, prices (P) or real economic activity (T) must fall in order for the equation to balance. That’s precisely what’s happening. Credit extension by the banks has dried up, which can be seen as the same as the old practice of saving money under the mattress.
Prices have already fallen sharply – especially those of commodities, the resources necessary to keep the economy going. Reuters’ popular commodity index has been down for the past two months, from around 600 to currently just more than 400. But remember that it also rose in the previous nine months from 400 to 600. So that has so far only been a small bubble bursting.
If the velocity of circulation or the use of money and credit (V) falls a lot (such as now) that will spill over to the number of transactions (T), also called real economic growth. And there’s now no longer any doubt the world – from rich to poor – is heading for a fairly sharp recession next year. The recession has probably already started, but everybody is still too busy looking at monetary affairs rather than at the real economy.
The governments of all the world’s major countries are pumping a lot of money into their financial systems. They’re increasing money supply (M) a great deal in an attempt to make up for the fall in V and therefore try to prevent P and T from falling too much. So far, they haven’t had much success and business prospects don’t only look subdued, they look sombre – very sombre.
The current high Libor – the interest rates on the London interbank market, plus the risk margins added to it – tell exactly how expensive money has now become for ordinary trade and industry, and even for individuals, in various countries. The Libor rates in the table apply to the few banks that still lend money. Add between four and eight percentage points – that is, 4,32% plus 8% – to give 12,32% for the ordinary American who wants to borrow money. The same margins apply to other countries, such as Australia, to mention just one.