In regards to this article by Minyan Mish that was linked on the Buzz:

Minyan Mish writes truthfully. The ultimate barometer for credit expansion or contraction is the risk premium people attach to assets. When they want to take a lot of risk, credit expands and the money supplied by central banks gets into the system. When they want to take less risk, borrowing curtails and possibly reverses. But, and this is a big “but,” people are proven to really not determine proper risk and the degree of this can for long periods be “artificially” influenced by over-active central bankers.

Behavior studies show people in general, especially at the individual level, are very poor at really understanding risk, they tend to over-estimate and under-estimate risk. The reason could be as simple as people just don’t like to think about it. When high risk become so evident that people have to think about it, they over-react to eliminate it. When it is not evident they tend to ignore it.

Today’s central bankers, led by the maestro himself, understand this and can dramatically influence people’s risk levels. How many times have we heard about the Greenspan put? That works over time to re-enforce people into taking more risk than they should. The Fed also understands the link between volatility and risk taking: when things get volatile, by definition people are trying to reduce risk. The Fed can and does do things to try to influence volatility. Remember when Greenspan gave that famous speech on ARMs? He was able to convince borrowers they were better off taking out an ARM than a fixed mortgage. After that speech, 40% of all new mortgages were ARMs. What did this accomplish? When borrowers take out a fixed mortgage, they are long a very valuable option - they can re-finance. Whoever wrote the mortgage, like a Fannie Mae (FNM) or bank, is short that option. As interest rates move the mortgage issuer must dynamically hedge that short option by buying bonds when they go up and selling them when they go down. The huge size of the mortgage market relative to the publicly traded Treasury bond market was causing very high volatility in bonds and “scaring” investors. Greenspan intentionally cajoled investors into using ARMs to get them to sell out that option. This consequently “crushed” the volatility in bonds and consequently influenced investors to increase their risk.

The government can also affect the velocity of money somewhat through institutions like FNM and Freddie Mac (FRE) (GSE). When lenders balk at making new loans because of quality, the GSEs can step in and make them, thus relieving the market process of pricing risk. This is why over $3 trillion in mortgage debt is held at the GSE level.

And finally you can read in several papers written by the Fed some of the desperate measures they may use to force the market to take risk. In one paper they actually suggest negative interest where banks CHARGE you money to keep it on deposit. Another crazy scheme would be to create a two-tiered currency system - one kind of dollar for foreigners and one kind for U.S. citizens, the two not being fungible.

But ultimately Mish is right. The market cannot be forced to take risk and the level of overall debt affects that. As the service of that debt gets larger it begins to crowd out the ability to take on more debt and it eventually reduces consumption as well. This is the deflationary cycle that Mish and Prof. Reamer think is so near.