“…We find ourselves still near the peak of the largest credit bubble in history. As faith in many of the more spurious 'asset' classes devised by 'financial innovation' has been shaken, faith in the ever increasing value of commodities has strengthened. However, commodities are not immune to the effects of a shift from credit expansion to credit contraction, despite justifications for endless price rises, such as apparently bottomless demand from China and the other BRIC countries.
“Every bubble is accompanied by the story that it is different this time, that this time prices are justified by fundamentals which can only propel prices ever upwards. It is never different this time, no matter what rationalizations exist for speculative fervour. BRIC demand only appears to be insatiable if we make our predictions solely by extrapolating past trends, but that approach leaves us blind to trend changes and therefore vulnerable to running off a cliff. Insatiable demand results from seemingly endless cheap credit, given that demand is not what one wants, but what one can pay for. When credit collapses, so will demand, and with it the justification for higher prices.
“While credit expansion (inflation) is a powerful driver of increasing prices, credit contraction (deflation) is a far more powerful driver of decreasing prices. Credit, having no substance, is subject to abrupt fear-driven disappearance. Confidence and liquidity are synonymous, and confidence is once again evaporating quickly, as it did in phase one of the credit crunch (October 2007-March 2009). As contraction picks up momentum, the loss of credit will rapidly lead to liquidity crunch, drastically undermining price support for almost everything. With purchasing power in sharp retreat, however, lower prices will not lead to greater affordability. Purchasing power typically falls faster than price under such circumstances, so that almost everything becomes less affordable even as prices fall.
“…We stand on the verge of a precipice. The effects of the first real liquidity crunch for decades will be profound. We are going to see prices fall across the board, but far fewer will be able to afford goods or assets at those lower prices than can currently afford them at today's lofty levels. The social effects of this will be enormous, and will spread to many more countries. The collapse of our credit pyramid will be the driving factor and it will sweep all before it like a hurricane for at least the next several years. Beware. “
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