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The Real Reason Banks Aren’t Lending

Marshall Auerback here.

Our Treasury Secretary has conceded that it is still a “tough economy” for most Americans, and warned it’s possible the unemployment rate will go up for a couple of months before it comes down. Given the constellation of recent economic data that has come out, Tim Geithner is probably correct.

The US economy is showing signs of slowing, as the fiscal stimulus is dissipating and spending contractions at the state and local government level increasingly undermine the injections from the federal sphere. Worse, it appears that much of the growth has resulted largely from a replenishment of inventories, a process which largely seems to have run its course. Excluding this inventory re-stocking, underlying growth was a very tepid 1.5% annualised. Fiscal drag from state spending contraction could well reduce overall consumption even further in the quarters ahead, an ominous trend for future growth and employment prospects. While we may not experience a “double dip” in purely technical terms, it will certainly feel like a return to recession for most Americans if Geithner’s assessment is anywhere close to being accurate.

At this stage, there is a widespread belief that government fiscal stimulus has run up against its “limits” on the grounds of “fiscal sustainability” and the need to retain “the confidence of the markets”. Consequently, goes this line of reasoning, as private credit conditions improve the private sector must pick up the baton of growth where the public sector leaves off. If this proves insufficient, there is room for an expansion of monetary policy via “quantitative easing“.

Recent speeches by the Fed suggest that they are indeed laying the groundwork for such a return to quantitative easing, or “QE2″ as the markets are now calling it. It’s not the name of a ship-liner: quantitative easing essentially means that the central bank buys up high yielding assets and exchanges them for lower yielding assets. The premise is that the central bank floods the banking system with excess reserves, which will then theoretically encourage the banks to lend more aggressively in order to chase a higher rate of return. Not only is the theory plain wrong, but the Fed’s fixation on credit growth is curiously perverse, given the high prevailing levels of private debt. More borrowing is the last thing the highly stressed and leveraged American household requires today.

As we have argued many times in the past, credit growth follows creditworthiness, which can only be achieved through sustaining job growth and incomes. That means embracing stimulatory fiscal policy, not “credit-enhancing” measures per se, such as quantitative easing, which will not work. QE is based on the erroneous belief that the banks need reserves before they can lend and that this process provides those reserves. But as Professor Scott Fullwiler has pointed out on numerous occasions, that is a major misrepresentation of the way the banking system actually operates:

In the U. S., when a bank makes a loan, this loan creates a deposit for the borrower. If the bank then ends up with a reserve requirement that it cannot meet by borrowing from other banks, it receives an overdraft at the Fed automatically (at the Fed’s stated penalty rate), which the bank then clears by borrowing from other banks or by posting collateral for an overnight loan from the Fed. Similarly, if the borrower withdraws the deposit to make a purchase and the bank does not have sufficient reserve balances to cover the withdrawal, the Fed provides an overdraft automatically, which again the bank then clears either by borrowing from other banks or by posting collateral for an overnight loan from the Fed.

The point of all this is that the bank clearly does not have to be holding prior reserve balances before it creates a loan. In fact, the bank’s ability to create a new loan and along with it a new deposit has NOTHING to do with how many or how few reserve balances it is holding.

What is required to drive lending is a creditworthy borrower on the other side of the bank lending officer’s desk, which means an employed borrower, whose income allows him to sustain regular repayments. Absent that, there will be no lending activity. It is pointless to blame the evil bankers for this of state affairs, since they don’t control fiscal policy, which is the remit of the Treasury.

For all the talk from policy makers about not repeating the mistakes of Great Depression, we seem to be perilously close to doing precisely that. This is largely based on a poor understanding of the economic dynamics of that period, even by that noted scholar of the Great Depression, Ben Bernanke.

Most people believe the economy crashed between 1929 and 1932 and then remained depressed until the Second World War, which finally mobilized the economy’s idle resources and brought about a full recovery. That’s complete bunk if you calculate the unemployment data correctly (see here for an explanation) . Even leaving aside the unemployment calculations, it is abundantly clear that, once the Great Depression hit bottom in early 1933, the US economy embarked on four years of expansion that constituted the biggest cyclical boom in U.S. economic history. For four years, real GDP grew at a 12% rate and nominal GDP grew at a 14% rate. There was another shorter and shallower depression in 1937 largely caused by renewed fiscal tightening (and higher Federal Reserve margin requirements). This second depression has led to the misconception that the central bank was pushing on a string throughout all of the 1930s, until the giant fiscal stimulus of the wartime effort finally brought the economy out of depression.

That’s incorrect. The financial dynamics of the huge economic recovery between 1933 and 1937 are extremely striking. Despite their insistence that changes in the stock of money were behind all the cyclical ups and downs in U.S. economic history, even economists Milton Freidman and Anna J. Schwartz in their “Monetary History of the United States” conceded that the money aggregates did not lead the U.S. economy out of the depression in 1932-1933.

More striking, private credit growth seemingly had nothing to do with the takeoff of the economy. Industrial production, off the 1932 low, doubled by 1935. By contrast, bank credit to the private sector fell until the middle of 1935. Because of the collapse in nominal income during the depression, the U.S. private sector was more indebted than ever in the Depression lows. Yet somehow it took off and sustained its takeoff with no growth in private credit whatsoever. The 14% average annual increase in nominal GDP from early 1932 to 1935 resulted in huge private deleveraging, largely as a consequence of aggressive fiscal stimulus.

Tim Geithner should be aware of this, but like his old colleagues at the Fed, his main obsession remains deficit reduction, which is why he is now expending considerable political capital on allowing the Bush tax cuts for the wealthy to expire. Ironically, one of the more amusing aspects of this particular issue is the sight of Republicans such as Mike Pence and Eric Cantor arguing that job creation is more important to Americans than deficit reduction (hence, we should extend the Bush tax cuts for the wealthy, even as their party fought vociferously against extending unemployment insurance benefits for the past several months).

The reasoning of Cantor and Pence is perverse, but on balance — however disingenuous and politically insincere — we support the GOP’s born again support for job creation over deficit reduction. We just wish they would refocus on something that would really help reduce unemployment, such as a Job Guarantee Program. A disproportionate amount of the stimulus program has been enjoyed by those who least need it. We would like to see the Obama Administration at least begin to make the case that fiscal stimulus, whether via tax cuts or direct public investment, is still required to generate more demand and employment. They should not concede anything in this area to the politically insincere GOP, which never met a tax break for the top 2% of the population that they didn’t like.

There might well be very good reasons, on grounds of social equity, to minimize the income gap between the rich and the poor, but Geithner and Obama are not making the case for the elimination of the tax breaks on these grounds. Rather, they continue to do so on the basis that this is the “fiscally responsible” thing to do. This is also consistent with the President’s odd championing of a “bipartisan commission” to study entitlement “reform”, where the focus appears to be on cutting Medicare and Social Security — in effect gutting the Democrats most substantial social legacy of 20th century.

The only concern about government deficit spending should be a whether it generates inflation, in which case it should of course be slowed down. None of those critique the ongoing fixation on fiscal sustainability, or “pork”, or “entitlement reform”, do so on the basis that there are “no limits” on government deficit spending, as has been alleged. What we do argue is that deficit cutting per se, devoid of any economic context, is not a legitimate goal of public policy for a sovereign nation. Deficits are (mostly) endogenously determined by the performance of the economy. They add to private sector income and to net financial wealth. They will come down as a matter of course when the economy begins to recover and as the automatic stabilizers work in reverse (i.e. tax receipts rise and social welfare expenditure comes down). When our policy makers begin to understand this, we can stop with the counsel of despair and actually do something that reduces unemployment today, not years from now — when it will be far too late.

Cross-posted from New Deal 2.0.

Marshall Auerback

About 

Marshall Auerback, has 29 years experience in the investment management business, serving as a global portfolio strategist for Madison Street Partners, LLC, a Denver based hedge fund. He also has also worked as an economic consultant to PIMCO, the world’s largest bond fund management group. He is a Fellow at the Economists for Peace and Security, a Research Associate at the Levy Institute, and a non-executive director of Pinetree Capital in Toronto, Ontario, Canada.

36 Comments

  1. Scott says:

    Hi Marshall:

    I really like this argument much more than the “deficit terrorist” argument. It raises questions in a reasonable manner. First, as much as I hate it, I interpret your argument as one of advocating stabilizers more than deficit spending in and of itself. That is a tempered argument and one I think that is understood by constituencies. I’m opposed to deficits because I feel like we will run deficits until we cannot run deficits no longer. That’s what the political climate demonstrates to me. However, if you have an economy with 100 people and all people are guaranteed 1 unit of income at all times and the rest agree to pay a percentage of their income to ensure that then when income falls, there is an automatic stabilizer where we borrow against future income to pay that 1 when we otherwise could not, it makes sense. MMT is irrelevant then because we don’t need a theory, only borrowing capacity and all parties are agreed. The rules are in place, no one screams, and we all get some security. Simple Keynesian counter-cyclical prescriptions. We just need these rules in place now, not only when s hits the fan. The system is set up now to spend and borrow it all like we’re off to the races and then worry about the bad times when we get there and this puts you in a position to defend why that is not a problem. Minsky proposed a 20% government share to provide this service. This was 1986, but now we’re up higher than that and the inflation barrier is slowly increasing as more and more boomers become tied to inflation linked incomes. I think the various “5 year plan” arguments are consistent with my view. Say we’re not going to fix this now because the immediate pain is not something we want, but the credible plan will be presented, and everyone will know what the rules are as we impose them. This is very different than our current crisis management regime. I have personal opinions on how likely this outcome is which keeps me leaning towards deficit hawk stance.

    I read your thesis as fiscal stimulus will lead this economy out of the dumps, as proven by the fiscal stimulus during the great depression along with other points you have made in the past. I won’t counter this because I would like more explanation as to why increasing aggregate demand is the panacea you propose it to be. I read Keynesianism in two different lights. The first, is that if the cash flows do not validate the debt payments, then the loans go bad and business bust due to lack of cash flow and not necessarily lack of demand. That’s probably a Minsky view but it is based on past business decisions. Second, if I do not spend, then that’s income denied to someone else, the Paradox of Thrift. I just want your opinion on the quality of aggregate demand if you ever decide to comment on this in future posts. Should past business decisions be validated at all costs in the name of the paradox of thrift. Here is why I’m concerned.

    1.No one is demanding product because the product sucks
    2.No one is demanding product because they don’t need it
    3.If you maintain funding to those producing sucky products, the products still suck
    4.If those producing products are producing them based on fiscally stimulated demand, as soon as the fiscal stimulus runs out, we all realize again the product sucks
    5.Every dollar spent on sucky products is a dollar wasted
    6.If the maker of a road is the first to get the stimulus and builds a road, then that is a dollar going to a road which very well could be a sucky product

    I think you get my point this far, but my real point is that if we continue all this suckyness and suckyness builds jobs and offices on sucky products, how do we ever get out of this hole without adjusting our economy to an economy that produces what people want? I’m assuming that the reason why sales are down is because consumers are no longer buying what they don’t need, hence suckiness.

    In conclusion, we’re in an economic, political, and consumer pickle here. I prefer the latter to lead the way, but let us know why I’m wrong.

    In time, if you can go that direction it would be helpful.

    • MMT is not a theory; it’s an operational depiction of how things actually
      work in a post-gold standard world. Similarly, the manner in which I
      describe bank lending is an actual depiction of how it works if you are actually
      on the bank lending desk, not the highly stylised variant one sees in the
      economic textbooks. These are facts, not polemics.

      I recognize that the term “deficit terrorist” offends some people, and I
      have stopped using it to a large degree, but I do think the impact of the
      policies being advocated by the brigade which says that all government
      deficits are bad can engender harm of a magnitude not unlike that of an act of
      terrorism. Yes, the sin may be one of ignorance, rather than direct
      commission and in that regard, the term is probably inappropriate. But I also find
      that much of the discussion of government deficit spending takes on an
      almost theological hue with many people, who allow their ideological biases
      about government to misrepresent or ignore the impact of the consequences of
      what they advocate. A major problem for the US government now is that the
      stimulus at the federal level is being increasingly undermined by the cuts
      occurring in public spending at the state and local government levels. The
      US federal system is working against itself. Further while private investment
      has been growing modestly, private consumption has tapered off again. Pain
      IS being experienced by around 90% or more of most Americans. I really
      don’t understand how much more you want, but my point is always the same: 15%
      underemployment is de facto evidence that we have a lack of aggregate
      demand and if you can explain to me how that can be filled in the absence of
      government spending (or tax cuts) I’d be interested in understanding how
      you’d do it. By increasing private debt? That got us into this mess. By
      increasing exports? Depends really on other nations, such as China and
      Germany and in any case, is it really optimal to be exporting our economic
      output, rather than consuming it at home?

      I’ve suggested some concrete policies (as have others), such as the Job
      Guarantee program. I don’t agree with your characterization of American
      products all being “sucky” (you think the Chinese toys we import are that
      great?), so I really don’t understand what your point is or what you would
      propose.

      In a message dated 8/4/2010 22:04:54 Mountain Daylight Time,
      writes:

      • JB McMunn says:

        “MMT is not a theory;””

        What does the “T” stand for, and when did this gather enough concrete evidence to support it graduating from a theory to fact?

        It’s a theoretical construct, not to be confused with reality.

        • MMT is a term which has developed, and obscures as much as it elucidates
          for precisely the reasons you suggest. But it does describe an operational
          reality.Love it or hate it, our sovereign government spends by crediting
          bank accounts. Over the past 20 years, MMT has investigated, analyzed, and
          documented the sordid operational details. Frankly, I prefer Abba Lerner’s
          term, “functional finance” to describe what we outline, but MMT has gravitated
          into the lexicon so we’ll use it, even though it incorporates that
          dreadful word, “theory”. But you can’t use that to dispute the main point. We
          can lecture for hours on the balance sheet manipulations involving the
          Treasury, the Fed, the primary security dealers, the special depositories, and
          the regular private banks every time the Treasury buys a notepad from
          OfficeMax. As Randy Wray has said,
          “We did the work, so you do not have to do it. And believe me, you do not
          want to do it. You can skip directly to the conclusion: “Yes, government
          spends by crediting bank accounts, taxes by debiting them, and sells bonds to
          provide an interest-earning substitute to low-earning reserves. Q.E.D.”

          A few libertarians and Austrians now get this, although instead of
          thanking us for a job well done, they immediately attack us for explaining how
          things work. Now, why would they do that? Because they fear that if we tell
          policymakers and the general public how things work, democratic processes
          will inevitably blow up the government’s budget as everyone demands that wine
          flow freely through the nation’s drinking fountains whilst workers retire
          from government jobs at age 28 on generous pensions provided at the public
          trough. And off we go to Zimbabwe land, with hyperinflation that destroys
          the currency and sucks the precious body fluids from our economy.”

          In a message dated 8/5/2010 11:55:17 Mountain Daylight Time,
          writes:

          JB McMunn (unregistered) wrote, in response to Marshall Auerback:

          “MMT is not a theory;””

          What does the “T” stand for, and when did this gather enough concrete
          evidence to support it graduating from a theory to fact?

          It’s a theoretical construct, not to be confused with reality.

          Link to comment: http://disq.us/jk1g0

      • Scott says:

        Thanks for the response. I’m learning and speaking as I go so I’m by no means an expert on anything, but I’m doing the dual tract between Keynsian and Austrian economics. I think your point below on Austrians is correct. They begin with the Fed and monetary science so they are probably more apt to understand modern monetary theory, as technically, there’s really no difference. It works how it works. I’ll continue my trade cycle studies and that is where I’m stuck. I just see some holes between aggregate demand and the capital structure of the economy. I don’t think you can fix capital invested in things that are now worthless (e.g. surplus housing inventory) by increasing aggregate demand. Hopefully, and you are an optimist on this point, softening the blow helps. I get that, I just don’t necessarily see how we cannot take some stripes and let time heal as well as capital and labor naturally adjusts to the demands of consumers going forward.

        • Depends what happens as “time heals”. Long term unemployment leaves longstanding problems if left unaddressed. And the sad part is that there are some creative solutions out there. I would urge you to read Randy Wray’s “Understanding Modern Money”. Even a card-carrying Austrian like our esteemed Ed Harrison has read it and found some useful insights (and lived to tell the tale)! :)

        • Scott says:

          Marshall, I have and I understand deadweight loss and I respect your concern. It’s very optimistic of you to try and help those that do not know they are being killed not be killed. I’m stuck in a dead end job, but it’s a job. It’s really stagnant though. My earning years are wasting away too, but we got to move into the unknown, forward, and the only guiding principle we have at this point is to provide what people want. If that’s Ipads, then that is what it is, but I don’t see Apple getting any stimulus. Let’s stop the trying to maintain spending on the dionsaurs and let it flow to whatever the new apple is. If the new apple doesn’t show it’s face, I agree we’re all f’d, but we don’t know until then. What we do know is humans like to grow and consume and they like to choose, so that’s our only hope. I appreciate your responses and you definitely have society as your first concern so I respect that.

          • Avoiding spending money on the dinosaurs is a political point, and it is
            one in which I would agree.
            . Much of the infrastructure we built to take care of the baby boom is
            still with us, and will be with us for years to come, including houses,
            hospitals, schools, dams, highways, and public buildings. As the baby boomers
            age, we may have to convert schools to senior citizen centers and hospitals to
            aged care facilities. However, we took care of the baby boomers with
            relatively few workers in 1960, and common sense implies that we ought to be
            able to take care of them when they are elderly.
            The mainstream debate chooses to focus on the “financial” aspects of
            these projected changes arguing that they will imply rising budget deficits
            which they define as being unsustainable. The “budget costs or outlays” are
            financial not real constructs. Public policy cannot prepare for a retiring
            baby boom bulge through “advance funding”—that is, by accumulating a
            large trust fund? A social security trust fund (such as that existing in the
            United States) provides no “financial wherewithal” to pay for a possible
            future revenue shortfall. To put it simply, the trust fund is simply a case
            of the government owing itself, an internal accounting procedure. In, say,
            2050 when payroll tax revenues fall short of benefit payments, the trust
            fund will redeem treasury debt. To convert those securities into cash would
            require the Treasury to either issue new debt or generate tax revenue in
            excess of what will be required for other government spending in order to make
            the cash payment to the trust fund without increasing general budget
            deficits. This is exactly what would be required even if the Trust Fund had no
            “financial holdings”. Government cannot financially provision in advance for
            future benefit payments. Indeed, attempts to do so via the encouragement of
            deficit cuts today will simply exacerbate the “dependency” problem
            implied by ageing demographics. Maximizing employment and output in each period
            is a necessary condition for long-term growth. The emphasis in mainstream
            intergeneration debate and adverse demographics suggests that we have to
            lift labor force participation by older workers. Perhaps, but this is contrary
            to current government policies which reduces job opportunities for older
            male workers by refusing to deal with the rising unemployment.

            In a message dated 8/5/2010 9:59:02 P.M. Mountain Daylight Time,
            writes:

            Scott wrote, in response to Scott:

            Marshall, I have and I understand deadweight loss and I respect your
            concern. It’s very optimistic of you to try and help those that do not know
            they are being killed not be killed. I’m stuck in a dead end job, but it’s a
            job. It’s really stagnant though. My earning years are wasting away too,
            but we got to move into the unknown, forward, and the only guiding
            principle we have at this point is to provide what people want. If that’s Ipads,
            then that is what it is, but I don’t see Apple getting any stimulus. Let’s
            stop the trying to maintain spending on the dionsaurs and let it flow to
            whatever the new apple is. If the new apple doesn’t show it’s face, I agree
            we’re all f’d, but we don’t know until then. What we do know is humans
            like to grow and consume and they like to choose, so that’s our only hope. I
            appreciate your responses and you definitely have society as your first
            concern so I respect that.

            Link to comment: http://disq.us/jlslq

        • Scott says:

          final comment on this post ever. I read Wray’s article the first time I ever read it. I found not problems with it, presented it to “Scary Gary” (I’m a hack on that level, I’m about as secular as they get, but he does know his theory) and I got no response from him. I’ve been trying to find the hole in it since and the only hole is value. Who pays and how much. The answer I was looking for as found in Minskey’s comment on the inflation barrier can be lowered to a point where aggregate demand does not matter because unions or others can demand higher prices despite low capacity utilization. I’m running with this one. I think boomers will replace unions in this respect to the point where we get punishing inflation because their salaries will demand more and more out of the productive sector which shrinks over time. I also don’t see how capacity utilization factors in utility to produce current goods. An old machine that is underutilized cannot become quickly utilized to all of the sudden fill aggregate demand with not production costs involved. Even though we’re not war torn, we’re misallocated which makes our capital stock worth less than is presented by stats. I’ll take a six month hiatus with you Marshall. I think I covered my questions, I only got selective answers, but the last few sentences are my concern. Invictus’ post on Ritholtz in the last day raises similar concerns. Let’s change the way we look at the “R” word and instead start looking at your “creative” solutions that will never happen in America. Finally, I’ve been reading “American Lion” and that is a very good book to present Europe’s current delimma on centralization. 1830 and Jackson not only hated the bank, but he was out to preserve the Union. Not so different from the EU today minus the slavery and libertarian Americans.

          • Only problem with Jackson is that he eliminated our national debt and then
            continued to run budget surpluses and threw the country into a huge
            depression by 1837.

            In a message dated 8/5/2010 23:59:55 Mountain Daylight Time,
            writes:

            Scott wrote, in response to Scott:

            final comment on this post ever. I read Wray’s article the first time I
            ever read it. I found not problems with it, presented it to “Scary Gary”
            (I’m a hack on that level, I’m about as secular as they get, but he does know
            his theory) and I got no response from him. I’ve been trying to find the
            hole in it since and the only hole is value. Who pays and how much. The
            answer I was looking for as found in Minskey’s comment on the inflation
            barrier can be lowered to a point where aggregate demand does not matter
            because unions or others can demand higher prices despite low capacity
            utilization. I’m running with this one. I think boomers will replace unions in this
            respect to the point where we get punishing inflation because their
            salaries will demand more and more out of the productive sector which shrinks
            over time. I also don’t see how capacity utilization factors in utility to
            produce current goods. An old machine that is underutilized cannot become
            quickly utilized to all of the sudden fill aggregate demand with not
            production costs involved. Even though we’re not war torn, we’re misallocated
            which makes our capital stock worth less than is presented by stats. I’ll take
            a six month hiatus with you Marshall. I think I covered my questions, I
            only got selective answers, but the last few sentences are my concern.
            Invictus’ post on Ritholtz in the last day raises similar concerns. Let’s
            change the way we look at the “R” word and instead start looking at your
            “creative” solutions that will never happen in America. Finally, I’ve been
            reading “American Lion” and that is a very good book to present Europe’s
            current delimma on centralization. 1830 and Jackson not only hated the bank, but
            he was out to preserve the Union. Not so different from the EU today
            minus the slavery and libertarian Americans.

            Link to comment: http://disq.us/jm0x9

        • Scott says:

          You:
          “Government cannot financially provision in advance for
          future benefit payments.”

          This is a key MMT statement. If I understand MMT correctly as crediting and debiting accounts then this means that the government will never be able to save. Other than selling a Treasury bond or taxing and then buying a real asset with the proceeds is this the correct interpretation? It’s very interesting, as is MMT.

          My comments are defintely convoluted, but you took pains to deal with them. Thanks for that. After Keynes and Mises, it’s now time to go study Fisher and Friedman and see why debt deflation is so bad and take some looks at QTM. If it all comes down to sticky wages I’m going to be disappointed.

          The End.

          • Yes, the government can’t “save” because it doesn’t have “dollars in a lockbox”. As my friend Warren Misler likes to say, the government is the scorekeeper. Asking the government to “save” is as silly as asking a scoreboard at a football stadium to “save” points.

    • JB McMunn says:

      Usually when interest rates are this low it chases money into the stock market, but what we see instead is massive unloading of equity mutual funds in the retail sector and flight to the bond funds. The stock market is perceived as a rigged game and we don’t want to play any more. We’ve been hosed twice in the past 10 years and we’re tired of it.

      I carry no debt, have significant savings, and enjoy a substantial income. I am not spending right now. It has nothing to do with the quality of products. It is the simple fact that I am holding cash for the deflationary scenario and gold for the inflationary scenario. I don’t know what’s going to happen in terms of deflation or inflation because there are too many wild cards, but I do know that there is no way out of this problem except to go through it, which will be a very painful process. It’s called deleveraging.

      When people have lost faith you can flood the country with money, you can fire half the government workers, you can raise taxes or lower taxes – it doesn’t matter. Until I feel like I can come out of hibernation I’m not spending one nickel more than I have to.

      Perhaps I flatter myself that I represent a lot of people, but I don’t think so. I think this feeling is prevalent and its impact is underestimated. When people have no faith in Congress (20% approval rating) or the President (under 50%) where is the hope and optimism that will make them feel safe spending money? You can see this in the steadily declining Consumer Confidence Index. Pessimism rules and it’s getting worse.

      There is no economic formula for fixing malaise.

      • Yes, there is. You need the government to spend precisely to “ratify”
        this ex ante predisposition to save on the part of people such as yourself.

        No criticism at all in terms of your actions, but as I said before, all
        things being equal, if everybody does what you do and there is no
        countervailing action by the government, then you get the paradox of thrift.
        Any individual can increase her saving by reducing her spending—on
        consumption goods. So long as her decision does not affect her income—and there is
        no reason to assume that it would—she ends up with less consumption and
        more saving.
        Consider the example of John who usually eats a hamburger at Macdonald’s
        every day. He decides to forego one hamburger per week, to accumulate
        savings. Of course, so long as he sticks to her plan, he will add to her savings
        (and financial wealth) every week, just as you are doing in your actions.
        The question is this: what if everyone did the same thing as John—would
        the reduction of the consumption of hamburgers raise aggregate (national)
        saving (and financial wealth)?
        The answer is that it will not. Why not? Because Macdonald’s will not sell
        as many hamburgers, it will begin to lay-off workers and reduce its orders
        for bread, meat, catsup, pickles, and so on.
        All those workers who lose their jobs will have lower incomes, and will
        have to reduce their own saving. You can use the notion of the multiplier to
        show that this process comes to a stop when the lower saving by all those
        who lost their jobs equals the higher saving of all those who cut their
        hamburger consumption. At the aggregate level, there is no accumulation of
        savings (financial wealth).

        In a message dated 8/5/2010 11:50:48 Mountain Daylight Time,
        writes:

        There is no economic formula for fixing malaise.

        • JB McMunn says:

          I’m sorry Marshall but Wray’s “trust me, I’m an economist” doesn’t work. Equations and models are conceptual reference points, not laws of thermodynamics. I’d have an easier time swallowing it whole if there weren’t other people with a different set of equations making the same claims of validity and drawing different conclusions.

          You and I are in agreement that if everyone does what I’m doing then we get the paradox of thrift. Absolutely. No question. And that is transpiring right now and snowballing every day. Where we differ is that you claim you can get people to spend by appropriate levels of fiscal manipulation, and what I’m saying is that you can’t make people spend who aren’t comfortable spending.

          Spending requires confidence that the money spent can be replaced. When people have low confidence that they will be able to replace their money they hoard it. When they have absolutely no faith in the government (vide supra) or the financial system (ibid) that’s a very hard sell. You can manipulate the system all you like but until the perception changes the money sits under the mattress.

          That’s where I am right now. It doesn’t matter what anyone does because I don’t think this is fixable and if by some miracle it is fixable I have no faith that the people in charge will do it right.

          Quite honestly, I wish they’d leave everything alone. Every bright idea that is tried induces a new disequilibrium that the whole system has to spend time and energy adjusting to – or as the saying goes, the solution to a problem creates a new problem.

          We have already thrown vast amounts of money this and nothing happened. As Mark twain said, history doesn’t repeat itself but it often rhymes and Henry Morgenthau pretty much wrote the first stanza:

          “We have tried spending money. We are spending more than we have ever spent before and it does not work.…I say after eight years of this administration we have just as much unemployment as when we started…And an enormous debt to boot!”

          I really don’t want to read the rest of the poem.

          • I think you are mischaracterising Randy’s work. I don’t recall him every
            saying “trust me, I’m an economist”. Please give him a little credit and
            read what he has to say. I would suggest you start with his book,
            “Understanding Modern Money” and you’ll see that he deals with reality, not “models”
            or “conceptual reference points”.
            I’m sure you would be happy to leave everything alone. That’s what
            happened, as I recall, around 1930 and that turned out really well, didn’t it?
            As for the notion that the spending achieved nothing, I think there is ample
            evidence to contradict that claim. You have to consider what might have
            happened had the money not been spent. And consider this report from the CBO:

            On May 25, 2010, the _US Congressional Budget Office_
            (http://www.cbo.gov/) released a detailed study – Estimated Impact of the American Recovery
            and Reinvestment Act on Employment and Economic Output from January 2010
            Through March 2010 – _PDF document_
            (http://www.cbo.gov/ftpdocs/115xx/doc11525/05-25-ARRA.pdf) .
            The CBO present information that recipients of the stimulus funds under
            ARRA have provided estimating the “the number of jobs they created or retained
            with ARRA funding”. This information suggests that “nearly 700,000 FTE
            jobs during the first quarter of 2010″ were created by the fiscal stimulus.
            However, they note that there are several problems encountered when using
            this data which bias the impact. First, the jobs might have already been
            created without the stimulus (therefore overestimate impact).
            Second, the reports don’t consider jobs created by “lower-level
            subcontractors” (therefore underestimate impact).
            Third, “reports do not attempt to measure the number of jobs that may have
            been created or retained indirectly as greater income for recipients and
            their employees boosted demand for products and services” – the multiplier
            effects (therefore underestimate impact).
            Fourth, reports only cover a fraction of the stimulus capacity (therefore
            underestimate impact).
            The alternative method was to use their modelling capacity and historical
            evidence. They conclude that the impact of ARRA for the first quarter of
            2010 were:
            * Raised the level of real (inflation-adjusted) gross domestic
            product (GDP) by between 1.7 percent and 4.2 percent.
            * Lowered the unemployment rate by between 0.7 percentage points and
            1.5 percentage points.
            * Increased the number of people employed by between 1.2 million and
            2.8 million.
            * Increased the number of full-time-equivalent (FTE) jobs by 1.8
            million to 4.1 million compared with what those amounts would have been
            otherwise. (Increases in FTE jobs include shifts from part-time to full-time work
            or overtime and are thus generally larger than increases in the number of
            employed workers).
            They also said that these impacts “on output and employment are expected to
            increase further during calendar year 2010 but then diminish in 2011 and
            fade away by the end of 2012″.
            You have every right to disagree with someone, but you don’t have a right
            to confuse fact with fiction.

            In a message dated 8/5/2010 15:48:05 Mountain Daylight Time,
            writes:

            JB McMunn (unregistered) wrote, in response to Marshall Auerback:

            I’m sorry Marshall but Wray’s “trust me, I’m an economist” doesn’t work.
            Equations and models are conceptual reference points, not laws of
            thermodynamics. I’d have an easier time swallowing it whole if there weren’t other
            people with a different set of equations making the same claims of validity
            and drawing different conclusions.

            You and I are in agreement that if everyone does what I’m doing then we
            get the paradox of thrift. Absolutely. No question. And that is transpiring
            right now and snowballing every day. Where we differ is that you claim you
            can get people to spend by appropriate levels of fiscal manipulation, and
            what I’m saying is that you can’t make people spend who aren’t comfortable
            spending.

            Spending requires confidence that the money spent can be replaced. When
            people have low confidence that they will be able to replace their money they
            hoard it. When they have absolutely no faith in the government (vide
            supra) or the financial system (ibid) that’s a very hard sell. You can
            manipulate the system all you like but until the perception changes the money sits
            under the mattress.

            That’s where I am right now. It doesn’t matter what anyone does because I
            don’t think this is fixable and if by some miracle it is fixable I have no
            faith that the people in charge will do it right.

            Quite honestly, I wish they’d leave everything alone. Every bright idea
            that is tried induces a new disequilibrium that the whole system has to spend
            time and energy adjusting to – or as the saying goes, the solution to a
            problem creates a new problem.

            We have already thrown vast amounts of money this and nothing happened. As
            Mark twain said, history doesn’t repeat itself but it often rhymes and
            Henry Morgenthau pretty much wrote the first stanza:

            “We have tried spending money. We are spending more than we have ever
            spent before and it does not work.…I say after eight years of this
            administration we have just as much unemployment as when we started…And an enormous
            debt to boot!”

            I really don’t want to read the rest of the poem.

            Link to comment: http://disq.us/jktvt

          • PS Henry Morgenthau said exactly what you said and FDR duly introduced a
            balanced budget in 1937. Result? Huge secondary relapse in activity and a
            massive increase in unemployment. Please read some history of the period.
            Morgenthau was comprehensively WRONG.

            In a message dated 8/5/2010 15:48:05 Mountain Daylight Time,
            writes:

            JB McMunn (unregistered) wrote, in response to Marshall Auerback:

            I’m sorry Marshall but Wray’s “trust me, I’m an economist” doesn’t work.
            Equations and models are conceptual reference points, not laws of
            thermodynamics. I’d have an easier time swallowing it whole if there weren’t other
            people with a different set of equations making the same claims of validity
            and drawing different conclusions.

            You and I are in agreement that if everyone does what I’m doing then we
            get the paradox of thrift. Absolutely. No question. And that is transpiring
            right now and snowballing every day. Where we differ is that you claim you
            can get people to spend by appropriate levels of fiscal manipulation, and
            what I’m saying is that you can’t make people spend who aren’t comfortable
            spending.

            Spending requires confidence that the money spent can be replaced. When
            people have low confidence that they will be able to replace their money they
            hoard it. When they have absolutely no faith in the government (vide
            supra) or the financial system (ibid) that’s a very hard sell. You can
            manipulate the system all you like but until the perception changes the money sits
            under the mattress.

            That’s where I am right now. It doesn’t matter what anyone does because I
            don’t think this is fixable and if by some miracle it is fixable I have no
            faith that the people in charge will do it right.

            Quite honestly, I wish they’d leave everything alone. Every bright idea
            that is tried induces a new disequilibrium that the whole system has to spend
            time and energy adjusting to – or as the saying goes, the solution to a
            problem creates a new problem.

            We have already thrown vast amounts of money this and nothing happened. As
            Mark twain said, history doesn’t repeat itself but it often rhymes and
            Henry Morgenthau pretty much wrote the first stanza:

            “We have tried spending money. We are spending more than we have ever
            spent before and it does not work.…I say after eight years of this
            administration we have just as much unemployment as when we started…And an enormous
            debt to boot!”

            I really don’t want to read the rest of the poem.

            Link to comment: http://disq.us/jktvt

  2. B_capp says:

    RyanClarke here …

    The real reason banks aren’t lending is BECAUSE THEY DON’T HAVE ANY MONEY TO LEND.

    When a bank gets a ‘NEW’ MILLION DOLLARS IN DEPOSITS … the bank may choose to LEND ON THE ORDER OF TEN MILLION DOLLARS to whomever the bank decides to lend … that’s with a 10% reserve requirement. Now assuming the Fed doesn’t tinker with reserve requirements … because they did in 1987 … and placing reserve requirements to the side …

    the problem is the two words ‘NEW’ and ‘DEPOSITS.’

    There are simply no ‘new deposits’ being introduced into the banking system by private citizens and corporations who have accounts with the U.S. banking system … as indicated by the ‘velocity of money slowing to a crawl’ over the past two years.

    You see, for every ‘private citizens or corporations’ sitting on a ‘ton of money’ … there are twenty ‘private citizens or corporations’ KNEE DEEP IN DEBT … and the banks don’t want to lend to this 95% of the ‘lending population’ for the obvious reason …

    The 5% of the ‘lending population’ the banks would like to lend to … don’t need a loan … and the banks know the other 95% of the ‘lending population’ would only use borrowed money … at the very best … to service existing levels of outstanding debt.

    Thus, the ‘money log jam.’

    • Well, you are basing your representation on the so-called fractional
      reserve system, and I’m afraid it just doesn’t work the way you indicate.
      Banks DO NOT use reserve balances to create loans. They create loans and
      deposits simultaneously out of thin air. They use reserve balances to settle
      payments or meet reserve requirements ONLY. If a bank is short reserve
      balances for either of these purposes, the Fed provides an overdraft
      AUTOMATICALLY at a stated penalty rate, which the bank then clears via the money
      markets or the cheapest alternative. Whether banks in the aggregate hold $1 or
      $1 trillion in reserve balances, there operational ability to create loans
      is the same: it is infinite (Though the creation of even 1 loan requires a
      willing, creditworthy borrow in the first place, of course.) Thus, neither
      the Fed, nor any other central bank actually provides reserve balances
      that banks can “lend or use” to purchase assets, but instead setting a cap on
      the cost of bank liabilities at different maturities when they do make
      loans or purchase assets. That is how loan creation works in post-gold standard
      world, in economies where there are freely floating non-convertible
      exchange rates. The belief that banks need reserve balances in order to lend is
      only applicable in a gold standard-type of monetary system. The correct
      conclusion is that the banks are fully capable of “getting money to struggling
      businesses” but are unwilling to do so under present circumstances because
      (a) aggregate demand is so weak that they cannot find credit-worthy
      customers worthy of extending loans to (relating to his earlier point); and (b)
      the budget deficit is currently not sufficient to engender any confidence
      among borrowers that the things they might produce by expanding production
      (with working capital borrowed from the banks) will be sold. Improving “
      creditworthiness” and credit will follow.

      In a message dated 8/5/2010 01:03:57 Mountain Daylight Time,
      writes:

      • JB McMunn says:

        I agree with the final conclusion except that (b) is not a bank decision it’s a borrower decision. I also doubt that these small businessmen are thinking in terms of waiting until the budget deficit is bigger before they borrow. Go to the local Rotary Club breakfast or Chamber of Commerce meeting and explain that what this country needs is a big ol’ budget deficit so they can all feel more confident about borrowing some money. I’ll bet their pancakes get cold during the stunned silence.

        • Exactly! The government is the only entity that is capable of leveraging
          up and spending in this kind of environment..

          In a message dated 8/5/2010 12:31:18 Mountain Daylight Time,
          writes:

          JB McMunn (unregistered) wrote, in response to Marshall Auerback:

          I agree with the final conclusion except that (b) is not a bank decision
          it’s a borrower decision. I also doubt that these small businessmen are
          thinking in terms of waiting until the budget deficit is bigger before they
          borrow. Go to the local Rotary Club breakfast or Chamber of Commerce meeting
          and explain that what this country needs is a big ol’ budget deficit so they
          can all feel more confident about borrowing some money. I’ll bet their
          pancakes get cold during the stunned silence.

          Link to comment: http://disq.us/jk608

        • No, it’s both. The borrower can’t get a loan if the bank officer won’t
          extend it to him. A loan is a two-way contract between borrower and lender.

          In a message dated 8/6/2010 14:14:14 Mountain Daylight Time,
          writes:

          I agree with the final conclusion except that (b) is not a bank decision
          it’s a borrower decision. I

      • JB McMunn says:

        “Exactly! The government is the only entity that is capable of leveraging
        up and spending in this kind of environment..”

        Counterfeiting and writing bad checks usually ends badly, even when done by a sovereign nation. If this were a true Keynesian scenario where we had been running surpluses or break-evens during the good times and we had to deficit spend to dig ourselves out I’d be ok with it. However, we have been deficit spending like crazy for decades and I have a hard time believing that more debt – even when taken on by an entity that cannot be insolvent – is the answer.

        I’m willing to spend to keep people from starving and to keep a roof over their heads but that’s where I draw the line.

        • Yes, but that’s not what the US government does. You’re letting your
          ideological biases get in the way of an honest assessment here.

          In a message dated 8/5/2010 16:00:20 Mountain Daylight Time,
          writes:

          Counterfeiting and writing bad checks usually ends badly, even when done
          by a sovereign nation

  3. Ronald Pires says:

    Marshall ~
    The Austrians’ sentiment that the public might misuse MMT as an economic fountain of youth is not entirely without merit. But that is better, I suppose, than leaving the fountain unattended with only the banksters to “guard” it.

    • I think that is an excellent point and indeed, Ed has made it many times
      itself. I think it is the most legitimate critique one can make of MMT.
      Unfortunately, people like Ed aside, the attacks usually are not so well
      reasoned, but are predicated on ill-informed prejudice. But, even having due
      regard to that risk, what’s the alternative? 1930s style liquidation? I
      suppose that is a choice, but it’s not mine. Your fountain analogy is a very
      good one.

      In a message dated 8/6/2010 1:22:35 A.M. Mountain Daylight Time,
      writes:

      • JB McMunn says:

        “I think you are mischaracterising Randy’s work. I don’t recall him every saying “trust me, I’m an economist”.”

        Here’s what you said:

        “As Randy Wray has said, “We did the work, so you do not have to do it. And believe me, you do not want to do it. You can skip directly to the conclusion”

        Trust me, I’m an economist.

  4. What was the question? Is the economy ‘bad’?

    Why aren’t banks lending? Why should they? Any loan they make is instantly underwater unless it is for a perpetual motion machine or ‘fusion in a bottle’. I feel sorry for the economists, they just don’t get it. Without cheap fuel there is no ‘modern’ anything including a modern, manufacturing economy. ‘Modern’ that is running on empty is an obsolete style, like disco or Nehru jackets.

    The Fed can print money, what good does it do? It flows into the pockets of gangsters who sock it away as a future substitute for petroleum. It’s good to know what the elites’ priorities are; we can see from the Eurozone, which has stifled money creation so as to pump up the value of the euro. More- valuable euros mean a lower fuel bill and an escape from an inevitable energy crisis; better to sacrifice the working people and pensioners to the banks NOW in the name of ‘currency stability’ so that Europe’s wonderful automobiles have full petrol tanks.

    What happens here? The Eurofed has out- austeritied the USA which is fixated on cycling more credit into a system that is saturated with it. How is it all going to work? I personally agree with James Galbraith (and Michael Hudson and Marshall Auerback) that the US’ borrowing capacity is unlimited. Unortunately, recycling credit does not create value (output) and without value there is nothing to exchange for the fuel we require; the credit creates fuel demand that iraces ahead of the ability of producers to satisfy it. We really don’t HAVE an aggregate demand problem but a supply- of- value problem.

    At the same time, the fuel constraint makes inflation of any kind impossible as a wage- price spiral ends (always) with an oil price spike- then- crash/demand destruction/increased business failures and rising unemployment/excess (industrial) capacity. We repeat our mistakes (over and over and over and over) until we learn not to. Unfortunately, not repeating means abandoning our wonderful automobiles that we cannot conceive of living without.

    Each repeat of the same mistake at the largest (inflationary) scale knocks 20- 30% off of our productive economy. The current repetition of small inflationary attempts results in the current erosion of jobs and small businesses. How many repeats do we need, again?

    Until the establishment and its wise men (economists) recognize the centrality of energy in the money/finance dynamic – and act appropriately – any and all attempts to escape our rush to the New Feudalism will fail. Don’t believe me just sit back and watch.