“New car sales fall as buyers shun debt,” says a Wall Street Journal headline.

Just what we expected, but so long coming we had begun to wonder.

Americans represent nearly 20% of the world’s consumption. And the U.S. economy, too, is more dependent on consumption spending than any economy ever has been. If American consumers don’t spend more, the whole shebang falls apart.

We are witness to something that doesn’t happen very often – like the eruption of a volcano or the collapse of a bridge – the first stage of a credit contraction. So far, the effects have made the headlines, but it has not yet affected most people. So far only at the top and the bottom of the credit structure are people getting pinched, squeezed and punished.

At the bottom, of course, are the ordinary homeowners.

“I’ve got a tiny little house on the edge of London,” explained a colleague yesterday. “I’ve got to sell it, because I put a contract in on another place. But it’s been on the market for three months now, and only four people have even looked at it. I’m getting very nervous.

“The problem is that it is a starter home. And the banks don’t want to lend to people who are buying starting homes. They’re the worst credit risks, because they don’t earn much money and don’t have much in assets. Naturally; they’re just starting out. But this is completely different from a couple of years ago, when the banks would lend to anyone...”

The people at the bottom are beginning to feel anxious. Many have never, ever seen a time when house prices were not rising and mortgage credit was not readily available. Many loaded up with debt when the going was good. Now that the going ain’t so good, they regret it.

House mortgage debt in the United States grew by $10 trillion since ’99. As a percentage of disposable income, it rose from 64% to 100% with more new debt added than in the previous 45 years combined. Add in consumer installment debt and the ratio rises to 131%.

Of course, when you add that much financing to a society, the financing industry is bound to make money. As a percentage of profits, more and more of America’s profits have come from ‘financing’ as opposed to manufacturing. Wall Street got rich, handed out billions of bonuses, built mansions in the Hamptons and in Greenwich, CT, bought huge collections of monstrous art and generally made itself obnoxious.

But now, at the upper end of the credit structure, Wall Street firms are getting sold off. After billions in losses, shareholders are giving CEOs the old heave-ho.

First, Warren Spector of Bear Stearns (BSC) got axed.

Then, it was Peter Wuffli at UBS (UBS).

He was followed by Stan O’Neal of Merrill Lynch (MER). O’Neal made the headlines for generating two big numbers, the largest losses, at an estimated $18 billion, and the largest ‘golden parachute’, at $180 million. What are compensation boards thinking? Why not give the guy a kick in the pants instead? They must think shareholders are idiots; and they’re probably right!

After the O’Neal story died down, along came Chuck Prince of Citigroup (C), America’s largest bank. The firm is expected to write down $5 billion this quarter. Chuck was chucked out.

And today’s news brings a new victim, H&R Block (HRB) finance chief Trubeck.

Between the honchos at the top and the householders at the bottom are thousands of deals, and millions of ordinary people.

The deals are feeling the pressure. “Bond issuance plunges,” reports Bloomberg.

And ‘default swaps’ - a form of insurance against bad loans – are rising to record prices, indicating a level of fearfulness not seen on Wall Street for many, many years.

The people in the middle must be getting a little sour, too. When the financing for deals slows, so do the new projects, the new companies, and the new jobs.

And so does the financing for new houses and new cars and all the other new things that make an economy grow.

Let’s go back to the numbers above. $10 trillion in new mortgage debt was added in the United States over the last seven years. That debt is another potential source of deflation, dear reader.

Yesterday, we looked at the bull market in gold. We wondered how and why it might come to an end. If the credit contraction were to worsen, we concluded, the price of gold – in dollars – might go down.

When credit expands, more money enters the system and prices rise. But then, there comes a time when the debts must be paid. Then, people have to take money out of the system; they have to cut back on their expenses in order to put aside the money to pay back the loans. The credit contraction phase is typically a phase of falling prices; as more and more currency is withdrawn in order to pay debts (and, incidentally, build up savings), less and less currency is available to buy things.

But wouldn’t the financial authorities simply emit more paper money?

Ah, yes, they would try. But that is what we learned from Japan. Once a credit contraction begins, it is very difficult to reverse. The Japanese tried monetary policy – with a central bank lending rate of “effectively zero.” And they tried fiscal policy – with the largest government deficits in the developed world. Still, prices fell.

Ben Bernanke has spent years studying the Japanese example. If we ever got in that sort of jamb, he says, he’d drop money from helicopters in order to break the contraction cycle.

We’re a long way from there. So far, we seem to be only at the beginning of a credit contraction. The average person doesn’t even feel it. When the squeeze begins, only the outer edges feel it first, the top and bottom of the credit structure.

But will it eventually involve everyone; and will the Bernanke Fed need to drop money from helicopters in order to get the economy moving again? Maybe, but then we’d really see the price of gold soar!

Bill Bonner is the President of Agora Publishing. For more on Bill Bonner, visit The Daily Reckoning.