This article was originally published in 2013 on SeekingAlpha, and is presented here as a reminder of the nature of credit/debt and its economic impact.

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Without a doubt, everyone is still looking for the economy to turn around in a meaningful manner, because we’re wondering why all the monetary tools, new and old, have failed to deliver. Certainly some jobs are being created and GDP pops here and there, but the condition is hardly inspiring. The one thing that is always fascinating is how humanity repeats the errors of the past, maybe because history is not a favorite school subject or too much time is spent on trivial facts that add nothing to our common wisdom. Nouriel Roubini recently wrote “Bubbles in the Broth,” and the relevant excerpt from the article is shown below.

And yet, through it all, growth rates have remained stubbornly low and unemployment rates unacceptably high, partly because the increase in money supply following QE has not led to credit creation to finance private consumption or investment.

The key phrase is “finance private consumption,” an expectation that is now the economic status quo, although it was never meant to be. Most everyone knows about supply and demand, and for illustration purposes the chart that follows clearly demonstrates the principle as it relates to equilibrium and price discovery. But there are factors that need to be explored.

Both supply and demand can be financed, but the cost of financing is always covered by the same side of the equation: demand. If a business (supply) borrows to finance inventory buildup, the intent is to have the cost of debt paid by the buyer (demand). But if a buyer uses a credit card to finance a purchase, the cost of debt is paid by the buyer, not the business. Thus, the equilibrium can be extremely distorted when today’s demand for products and services are financed by the buyer’s future earnings and debt costs. Let’s stipulate one simple fact: debt was designed for investment, not consumption.

So why 1959? That is the year that credit cards with revolving credit lines were introduced, and the shift of future consumption into the present started to infiltrate the consumer’s consciousness. While financing major purchases and acquiring “needs” within reason, much like the mortgage did in 1934, can be at times justified, the practice transitioned into financing “wants” and keeping up with the Joneses. Truth be told, consuming future “needs” or “wants” today magnifies the side effects when a disruptive economic event occurs, and humanity as a group cannot see well into the future and assess the ramifications of today’s choices. But this is not strictly an American story because U.S. consumer debt financed global economies.

But, in a larger context, what’s the significance of 1959? Everyone is searching for that economic crystal ball, and in that vein I introduce the theory “Generational Economic Cycle.” To keep the subject short for the time being, a complete Generational Economic Cycle is 72 years in length and is divided into three 24-year phases. The theory is quite simple (illustrated below and will expand fully at a latter date) and is modeled after the product life cycle: an idea, product or service — a “cyclical value” — is introduced, or reintroduced after a cycle completes, and then stabilized. The market or society accepts the cyclical value and then it expands or consolidates its power. Finally the cyclical value reaches a climax and contraction begins due to saturation or failure, thus completing the cycle. As a side note, power consolidation is not an economic term, but the theory also applies to sociopolitical domains because everything revolves around economics and everyone has something to sell.

With the theory now in place, let’s examine U.S. Consumer Credit data, published by the Federal Reserve. As the chart below shows, “Total Consumer Credit” experienced a decline during the last recession — an event that is hardly observable throughout history — and then resumed its ascent. For the record, there was an “adjustment” by the Fed along the way, and that’s why the spike is marked.

But not all is quite as it seems, and the following chart displays “Total Revolving Credit” (credit cards) and student loans held by the Federal Government. Notice that despite the introduction taking place in 1959, revolving credit data starts in 1968 and by 1983, the theory’s “acceptance” point, the total was $79 billion. By 1990, and only seven years later, the total had tripled to $238 billion, with the $1 trillion mark being crossed in December of 2007.

Many believe that the credit market is on the mend, but that belief is faulty. A review of the recent Consumer Credit – G.19 report highlights the weakness, with revolving credit declining from $1,005.2 trillion to $814.7 billion between 2008 and September 2013, a 18.96% reduction. Meanwhile, non-revolving credit increased from $1,646.2 trillion to $2,218.7 trillion, a 34.78% increase. To clarify, non-revolving loans in this Fed report include student, personal and auto, but not mortgages.

The catch here is that student loans rose a whopping $483.3 billion, leaving a meager $84.6 billion for auto loans and $4.6 for personal loans since 2008. Overall, a net reduction of over $100 billion is in place when students loans are removed. The “not seasonally adjusted” data is used because the “Motor Vehicle Loans” category is not present under “seasonally adjusted.”

There’s an additional fact on the auto loan front, and the article “How the Fed fueled an explosion in subprime auto loans” was mentioned a while back.

At car dealers across the United States, loans to subprime borrowers like Nelson are surging – up 18 percent in 2012 from a year earlier, to 6.6 million borrowers, according to credit-reporting agency Equifax Inc. And as a Reuters review of court records shows, subprime auto lenders are showing up in a lot of personal bankruptcy filings, too.

Certainly the Fed’s goal through QE was, and is, to facilitate credit creation and drive consumption. Or is it? Maybe initially, but I’ve stated before that the “wealth effect” is now the true objective via the stock market. It doesn’t really matter because it’s a dismal failure either way.

Then there’s velocity of money, and the chart above doesn’t require deep analysis, apart from the fact that deflationary and weak economic activity is in play, and cash hoarding is in fashion. The graphic that follows illustrates the Generational Economic Cycle theory with the credit card/revolving credit domain in place.

I don’t foresee the demise of the credit card, and it will be “reintroduced” to an unsuspecting generation in due time because “that time will be different.” On a broader credit context, taking on debt to finance a house or a car within strict affordability guidelines may be a necessary evil, but widely understood. However, financing a $50,000 car when one can only truly afford a $25,000 vehicle is what creates future financial pain, and although it will drive present economic output up, it will eventually kill the goose of the golden eggs.

What happens? 2007! Default, reset, restructure, and that is the only way out, creating unpleasant personal memories that will last a lifetime and shape a generation’s behavior for years to come. Meanwhile and understandably, the corporate world’s objective is to maximize revenue and profits, and the dependence on financed consumption is extremely obvious, creating an obstacle that must be circumvented.

What older generations can never convey to newer generations are the first hand experiences, memories and the resulting sentiment. As a new generation starts Phase 2 in the cycle (acceptance), the new participants may sympathize with the stories told by their parents and grandparents but never truly appreciate the impact, and then proceed to commit the same errors while reaching for the climax, and the “this time is different” mantra lives on forever.

Irving Fisher understood the consequences of debt, and although he never saw a full fledged credit card, he wrote “The Debt-Deflation Theory of Great Depressions” in 1933. His observations are simple to comprehend and painfully current, and for those seeking that magic economic bean on the horizon they’ll need high powered telescopes.

There may be equilibrium which, though stable, is so delicately poised that, after departure from it beyond certain limits, instability ensues, just as, at first, a stick may bend under strain, ready all the time to bend back, until a certain point is reached, when it breaks. This simile probably applies when a debtor gets “broke,”or when the breaking of many debtors constitutes a “crash,” after which there is no coming back to the original equilibrium. To take another simile, such a disaster is somewhat like the “capsizing” of a ship which, under ordinary conditions, is always near stable equilibrium but which, after being tipped beyond a certain angle, has no longer this tendency to return to equilibrium, but, instead, a tendency to depart further from it.

“Tendency to depart further from it.” Yes, indeed! Revolving credit turned into a perpetual consumption of the future, and, as it contracts, there is a ripple effect and the last wave hasn’t arrived on our shores yet. Roubini’s call to “finance private consumption” is made without a second thought, because that is the prevailing mindset and training, regardless of the fact that the buyer always carries the debt burden, and is poorer for it.

The stance is understandable, because, as perverse as it is, credit in its various forms has been the de facto and deviant financial instrument that drove consumption, becoming the cornerstone of the U.S. economic engine and the world. Add uncontrollable government debt on a global scale to the equation that must be serviced through higher taxes, austerity or both — an apparent endless cycle — and the house continues to be built on a cracked foundation.

I recently read an article by Nobel Prize winner Robert Shiller, and the discussion continues on whether economics is a science. I submit that economics is the study of economic inputs and outputs driven by human behavior without an understanding of the behavior itself. In addition, most economic theories pre-date the birth of the credit card, and are ill prepared to forecast the long-term consequences of humanity’s economic choices. Maybe black swans are not as black as once thought.

Certainly one would want to know the stock market’s gyrations in advance, and there were 72 years between 1929 and 2001. But I would like to provide an interesting fact that will bring perspective to the subject. The high point on the Dow Jones Industrials Average in 1929 was 381.17, and the closing low in 2009 was 6,547.05. Considering that it would take $12.55 in 2009 to buy anything worth $1 in 1929 due to inflation, the DJIA’s low in 2009 was worth 521.68 in 1929 dollars, or a mere 37% above the market high of 1929. That’s disturbing considering that 80 years had passed.

Price is not the guide, and events, sometimes subtle, mark the spot. Lastly, the most advertised feature is the market’s ability to discount the future, and it has become gospel without verification, while perceptions and emotions control the flow. Truth is that the market is extremely myopic of the underlying reality and oceanic sized economic currents, and then has a tendency to respond violently when the perceived beauty removes the mask and turns into a beast.

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