Credit Card Strains and the Austrian Trade Cycle

``The ultimate cause, therefore, of the phenomenon of wave after wave of economic ups and downs is ideological in character. The cycles will not disappear so long as people believe that the rate of interest may be reduced, not through the accumulation of capital, but by banking policy. Ludwig Von Mises On the Manipulation of Money and Credit, p. 139

Figure 2: stockcharts.com: Credit Card Next? Slowing Retail and Financials

We have to admit the recent rebound in the equity markets appear to have lifted the S & P retail index away from its downward path (see topmost panel) as shown in Figure 2. However, it is too soon to say with confidence that the storm has passed.

Meanwhile, the financial index, found at lower pane below the retail index, responsible for 20% of the S&P 500 industry weighting and close to two-fifths of the profits still undergoing the angst from the recent liquidity crunch.

Aside from mortgages, one of the financial channels which US consumers access to support their spending patterns is through credit cards.

This from the Financial Times, ``Credit card companies were forced to write off 4.58 per cent of payments as uncollectable in the first half of 2007, almost 30 per cent higher year-on-year. Late payments also rose, and the quarterly payment rate - a measure of cardholders' willingness and ability to repay their debt - fell for the first time in more than four years.”

Let us not forget that as part of the income flow securitization, where three general features (wikipedia.org) are found—pooling and transferring of receivables, structuring and issuing securities, servicing, allocating payments and monitoring, credit cards constitute an important part of such asset backed securities, usually either as Master Trust or Issuance Trust.

And further deterioration in credit card payment schedules or actualized losses could likely to lead to subprime mortgages-like losses in several financially engineered products. The illiquidity contagion phenomenon is indeed spreading.

In figure 2, both Master Card (main window) and American Express (lower window) have similarly reflected infirmities in share prices. Are they today, telling us of the state of US consumers?

With strains over at the credit markets, the burden grows for the credit market represented by Credit Rating Agencies.

Established rating agency Moody’s President Mr. Brian Clarkson sees an unprecendented bout of illiquidity where in an interview with Reuters (covered by Bloomberg) he says, ``I've been in the marketplace for 20 years ... what we're experiencing is an extreme lack of confidence and lack of liquidity. I have never seen this before," Clarkson told Reuters in an interview. "A lot of it has to do with transparency: it's not clear who owns what."

As we have pointed out in the past, symptoms of transparency, illiquidity, common holder factor problems, crisis of confidence and others are simply reflective of the business cycle underpinned by the credit cycle. The great Ludwig von Mises, describes of the Austrian Theory of the Trade cycle in 1943, which appears to set the tone in today’s economic and financial landscape (highlight mine),

``Once the reversal of the trade cycle sets in following the change in banking policy, it becomes very difficult to obtain loans because of the general restriction of credit. The rate of interest consequently rises very rapidly as a result of a sudden panic. Presently, it will fall again. It is a wellknown phenomenon, indeed, that in a period of depressions a very low rate of interest-considered from the arithmetical point of view-does not succeed in stimulating economic activity. The cash reserves of individuals and of banks grow, liquid funds accumulate, yet the depression continues…

``It has often been suggested to "stimulate" economic activity and to "prime the pump" by recourse to a new extension of credit which would allow the depression to be ended and bring about a recovery or at least a return to normal conditions; the advocates of this method forget, however, that even though it might overcome the difficulties of the moment, it will certainly produce a worse situation in a not too distant future.”

``Finally, it will be necessary to understand that the attempts to artificially lower the rate of interest which arises on the market, through an expansion of credit, can only produce temporary results, and that the initial recovery will be followed by a deeper decline which will manifest itself as a complete stagnation of commercial and industrial activity. The economy will not be able to develop harmoniously and smoothly unless all artificial measures that interfere with the level of prices, wages, and interest rates, as determined by the free play of economic forces, are renounced once and for all.”

Are the Austrians right and we could be facing the inevitable turn of the trade cycle?