Reader Responses: The Paradox of Thrift

BY busadmin  April 30, 2009 at 11:00 AM EDT

piggy bank; via Flickr

You can watch one of Paul’s recent Making $ense pieces, The Paradox of Thrift, below. Here are a few reader reactions and Paul’s responses.

Question: I have a question related to your recent segment, Paradox of Thrift: Aren’t the allegedly bad and unintended consequences of thrift offset, at least partially, when money is saved in a bank, because the bank uses its deposits to generate money for itself and its depositors? —Salvatore, Williamburg, Va.

Paul Solman: That WOULD BE the case if banks were lending. The great problem is that the banks are depositing hundreds of billions more dollars with the Fed. They’re even doing it with the money the Fed is trying to pump into the economy by buying up iffy loans from the banks.

This is actually going to be the punchline of one of our upcoming “explainers,” which you, Salvatore, now don’t have to watch. See how efficient the Business Desk can be.

Question: I saw your segment on the “Paradox of Thrift” the other night and it got me to wondering. I can understand that if people actually hid cash in their mattress or buried gold coins in their back yard, then money would be out of circulation and thus not really available to the economy. But the vast majority of us don’t really do that. (At least I think most of us don’t do that.) We still put our savings in the bank and, even though the interest rate is now very low, the bank still usually pays us some interest.

In order to generate the funds used to pay the depositor interest, and to pay the operating expense of the bank, the bank needs to loan out the money at a higher interest rate than they are paying to the depositor. The bank depends on the spread between the interest it is paying and the interest it is earning. So it seems to me that the money we deposit in a bank is in fact available to the bank to make loans and thus it is not lost to the economy. In fact, it would seem that the higher the savings rate, the more banks need to lend out. Yet we hear that even as the savings rate goes up, banks are not lending. How can this be? —John Claudy, Arroyo Grande, Calif.

Paul Solman: You’re a bank. The whole world says you were too loosey-goosey in your lending – to homeowners, mortgage intermediaries, investment bankers, whomever. So, from risk-taking, you swing to risk-averse.

Moreover, the people and companies to which you would normally lend are themselves now squeezed by the downturn, FICO scores are deteriorating, etc. You’re more reluctant to lend on that basis alone.

Finally, the people and companies themselves have overborrowed and are now cutting back, so the demand for loans just ain’t what it used to be.

As to what the banks are doing with the money INSTEAD of lending, I’ve said it before, I’ll say it again: They themselves are depositing it – at the Fed. Which is exactly equivalent to keeping it in their vaults. That’s the real hoarding.