mechanisms and stages of a deflationary spiral and depression from the scenario liquidity trap
1. We have a fragile international banking system in Canada despite their strong balance sheets. Banks have lost their source of funding was the market for securities backed by assets that allowed them to maintain high credit to businesses and individuals by securitizing. A supply of liquidity in this context only serves to quench the thirst of hoarding financial players wary and vulnerable, without bringing to offer extra credit. (See this )
2. Instead the interbank credit crunch led banks to restrict credit to businesses and households, despite significant decreases and continuous rates of central banks.
3. Firms respond by reducing or postponing their investments, they make layoffs to reduce their production levels. However, the reduction / deferral of some investment translates into lower production / employment of others. In this context, as we will see probably in the case of producers of automobiles, any injection of funding will, as in the banking sector absorbed to hoard rather than to invest or maintain employment.
4. Households lose confidence in the economy, lose income, lose jobs and see a reduction in nominal value of their financial assets and real estate while maintaining that their funding costs. This has several consequences. The most obvious is a likely drop in consumption caused by the loss of confidence which will be added as additional pressure on corporate earnings. This classic loop we know it. By cons, we know little about the multiplier effect of what will have been the restriction on consumer credit growth. And finally, we have no precise idea of the effect on the banking system, rising bankruptcies of households and businesses as well as the progression of late payment of debts that will be generated by the weakening of household incomes. We know that this loop may amplify the credit crunch and banks' thirst for cash.
5. To this we must add the effects of the downturn housing market. Inflation in the value of real estate was used as a lever for credit by households, along with the ease with which banks could securitize their portfolios of mortgages - and thus open new loans - fed the expansion of value of these assets. This positive loop, but actually vicious, between securitization, expansion of the value of real estate and household use of them as leverage for consumption, turns negative loop in which the weight of household debt coupled with the stagnation or decline in value of their homes, has a depressive effect on consumption and weakens the banks holding, beyond the securitization ultimate risk of default.
6. In conclusion, we must add the analysis of these mechanisms and the effect of market dynamics. Unlike the crisis of 1929 or the 1987, stock exchanges, the TSX, the New York Stock Exchange, are not at the forefront of this crisis which originated in the interbank market. Instead, these awards record these developments and amplify. They were strongly shaken by the disappearance of a class of actors structuring: the big investment banks, the slow implosion of values creates a phenomenon that multiplies the effect of the crisis of three interrelated ways. First, households that have significant direct or indirect investments (funds) in stock will see their assets decline in value. The impact of the reverse wealth effect is largely unknown but will be negative. To this we must add the most significant effect of a possible erosion of the basis of capitalization of listed companies, that can not recapitalize if share prices fall too steeply, especially as these movements may thrashing without basic reasons. This can be disastrous for some of them, especially banks, which are currently seeking capital and plans to issue new shares. Finally, the commitments of the major companies to the pension benefit plans are likely to act as an additional burden limiting the expansion of their activities.
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