“Credit Cycle” Hypothesis and Global Geopolitical Risk

I am not aware of any research on the subject of “credit cycle”. With limited access to historical time series data, I would focus on connecting the dots for now and hope somebody will continue to shed more light on this concept with statistical analysis of time series datasets.

The “Credit Cycle” is a multi-decade cycle of credit expansion and credit contraction. Just as a stretched rubber band will inevitably contract, in order to maintain its physical integrity, the financial economy, centered by the Central Bank, will inevitably experience the period of credit contraction/implosion when the economy in general experience credit/debt exhaustion such that the marginal benefit of new credit extended to the participants of the economy becomes zero or even negative, and hence can no longer justify the risk/cost, even if the cost also approaches zero or even negative territory.

The following are three most recent periods where the US economy experienced “implosion” phase of a multi-decade credit cycle.

(1) 1929 – 1939
Some significant geopolitical events that have direct or indirect impact on the timing of the implosion phase of the multi-decade cycle. ( It is important to bear in mind that, although these extraneous events seemed to have been the CAUSE of the onset of the “implosion”, they could be manipulated to coincide with it so that people would not blame the economic malaise on the credit contraction dictated by the kinetic mechanism that is inherent in the financial economy. )
(a) The Great Depression started in Oct 1929, as the stock market on Wall Street crashed. Worldwide nominal GDP fell by 15% from 1929 to 1932.
(b) In 1933, many banks had closed. The gold convertibility was suspended.
(c) From 1937-38, a “deep recession” in the depression.
(d) The US started to recover after the onset of the WW2 in Europe.
Although there is no US Treasury yield data available for this period, one can probably have rough estimate of the the tremendous credit and liquidity constraints in the financial market on the basis of  the rate of bank failure. The implied real interest rate using today’s standard could be quite high.

(2) 1971 – 1981
(a) The collapse of the Bretton Woods I System in August 1971, as the US unilaterally terminated convertibility of the US Dollar to gold. The result was a depreciation of the dollar and other industrialized nations’ currencies. Because oil was priced in dollars, oil producer’s real income decreased.
(b) The Oil Crisis in October 1973. OPEC raised the posted price of oil by 70%, to %5.11 a barrel. Over time, the price rose to as high as $12 by 1974, creating a massive extraneous shock to the US and world economy.
(c)Nominal yield on 10-year US Treasury Note rose from about 6% in 1971 to more than 15% in 1981. After that, the yield started a multil-decade decline to as low as 1.5% in 2014.
Despite the jump in the yield, the real interest rate was low compared with that of 1930s, as the US Dollar was no longer convertible to gold,  and the inflation rate has shot up. Therefore, the nominal GDP, denominated in fiat currency US Dollar, grew nicely.

(3) 2015 – ???
The US and Global economies were rescued from almost “total collapse” of 2008 financial crisis by the unprecedented “easy money” policies adopted by various central banks, including Federal Reserve, ECB, etc. People all over the world know now that the reserve currency is not just fiat but “make believe” — Central Banks can print, or borrow from the “thin air”, unlimited amount of money. ( That is probably “In God We Trust” is printed on all US Dollar bills) All these monetary and fiscal measures have only served to postpone the onset of the “implosion” phase of this current credit cycle. Several financial industry Titans have commented that the credit expansion in US economy has reached the “saturation point”, where each addition unit of new credit/debt can no longer justify the risk of extending such credit/debt. The next to come is likely the contraction phase ( or implosion phase) of the cycle.

It will be hard to predict the exact outcome of this “implosion”, as we have so many unknowns in our financial economic systems: loosely regulated hedge funds, investment pools; financial derivative markets; the extreme dislocation of risk and award; and the last but not the least, the complacency stemmed from multi-decade of boom and perceived prosperity.

As usual, I think that some extraneous events will break out to disguise the fact that the credit “implosion” or contraction phase is intrinsic to the loosely-regulated financial economy. I hope that the list of possible events does not include WW3. But you have already known the answer, haven’t you?