Why the Next Recession Will Be the Catalyst for Depression

This is why a recession will catalyze a collapse of the credit-asset bubble-dependent economy down to its foundations.

Narrative control works by having a pat answer for every skepticism and every doubt. Boiled down, the dominant narrative holds that the Federal Reserve (central banking) and the central government have the tools to quickly reverse any dip in GDP, a.k.a. recession, and return the economy to expansion.

The unstated foundation of this narrative is that recessions are bad, as only permanent expansion is good. That this isn’t “free market capitalism” doesn’t bother anyone, because the whole point of central banking and government is to eliminate the rough edges of “free market capitalism” with the sandpaper of “state capitalism,” which creates or borrows as much money as needed to smooth over any spots of bother, a.k.a. recessions.

That recessions are essential market dynamics is not part of the narrative, which is conveniently binary: recessions bad, expansion good. Markets reflect human emotions, famously fear and greed, which manifest as debt and speculation, a.k.a. animal spirits: when we’re confident and feeding off an expansion that appears to have no limit, then we borrow more money (debt expands) and “allocate the capital” (i.e. place it at risk to reap a future gain) to increasingly risky speculative investments.

This allocation of borrowed money into speculative assets pushes the price of those assets higher, increasing the collateral to support further borrowing to fund more speculation. In this manner, debt, asset valuations, collateral and speculation all fuel one another in a seemingly endless expansion that makes every participant richer.

This pyramiding of debt and “wealth” generates two self-liquidating dynamics: interest and risk. All debt comes with interest, the compensation due those who put their money at risk by lending it to the borrower. This debt service rises as debt expands, and also as risk increases: the riskier the speculation and the borrower, the higher the interest rate paid by the borrower.

Central banks can play games to reduce interest rates even as risk and interest payment rise, but since central banks own only a fraction of the total outstanding debt, their ability to “corner the market” is nil.

Their gaming the system to enable further expansion of debt and speculation functions not by actually buying up the majority of the new debt, it functions as a signal: the Federal Reserve has our back, they will bail out / recapitalize any lender losses while suppressing interest rates below what the unfettered market would demand, and so the pyramiding of debt, speculation and “wealth” can continue, apparently indefinitely.

But signaling has intrinsic limits, for it doesn’t increase the income needed to service additional debt or guarantee speculations will pay off. These are the Achilles Heels of the central banking perpetual motion machine: for the vast majority of borrowers, both private and public, income doesn’t automatically increase as debt increases. Income is influenced by market factors (supply and demand), technologies, state interventions (subsidies, stimulus spending, etc.) and the expansion or contraction of debt, interest rates and speculative investments.

In the total-economy context, what matters are total factor productivity gains and the distribution of those gains to wage earners, enterprises, owners of assets and the state, which collects taxes from all three of the private-sector classes. This distribution changes with social, political and financial tides.

The past 50 years have seen productivity gains flow to capital (corporations and owners of assets) at the expense of wage-earners. This means households and small businesses must service debt from a shrinking share of the economy. As a result, borrowing more becomes increasingly risky for both borrower and lender.

As more of the output goes to corporations and owners of assets, their collateral, income and creditworthiness rise, meaning they can borrow more at lower rates of interest than wage earners and small enterprises. The more they can borrow, the more they can own and the more they can earn.

These are the core engines of extreme wealth and income inequality. The rich get richer because they have the means to borrow more income-generating assets at lower rates than wage earners. And unlike wages, this asset-generated income rises as assets increasing in value support additional borrowing as they serve as collateral.

On the most fundamental level, if economic expansion no longer increases the income of household borrowers enough to service more debt, the entire structure of expanding debt, collateral and speculation is destabilized. Ultimately, assets generate income from either 1) issuing more debt, 2) investing more in risk assets or 3) consumer spending. All three are interconnected, i.e. tightly bound, as any decline in the expansion of debt, investing or spending eventually bleeds through to reduced ability to service more debt and the end of the expansion of debt.

Since debt is inherently risky–borrowers can default, i.e. stop paying interest and principal on the debt–then depending on expanding debt for economic expansion is also increasing risk, especially if household earnings are stagnating while debt and interest payments are increasing.

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