Paul Solman: Several weeks ago, former Fed Chairman and economic boom cheerleader Alan Greenspan said this before Congress: “Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity, myself included, are in a state of shocked disbelief,”
For those who doubt that economic history and ideology repeat themselves, I came upon this paragraph the other day from “The Great Crash of 1929,” written by economist John Kenneth Galbraith, in 1955:
“The market will not go on a speculative rampage without some rationalization. But during the next boom some newly discovered virtuosity of the free enterprise system will be cited. It will be pointed out that people are justified in paying the present prices – indeed, almost any price – to have an equity position in the system. Among the first to accept these rationalizations will be some of those responsible for invoking the controls. They will say firmly that controls are not needed. The newspapers, some of them, will agree and will speak harshly of those who think action might be in order. They will be called men of little faith.”
As regulars of this page are aware, I occasionally pose questions to myself when I feel a particular topic needs to get covered. (Thanks, by the way, for the several thousand questions from you, the readers, which have already come in; please, continue to send them.)
For today, a question many of you have asked, and to which I’ve given some not very satisfactory answers in the past, I think. Let’s see if I can improve upon them this time.
The question: When the government issues new Treasury debt and puts it into the banking system, does that mean more dollars in the world, and thus inflation?
The answer: Well, not necessarily. To explain, let’s take a step back and ask a prior question: What exactly IS an economy? It’s the way in which we put our resources to work: our land, our raw materials, our labor, our technology. Plus, the resources others provide in return for our promise to pay them back (loans, for instance).
Now when you stop to think about it, we’ve got as much land as we had before this crisis started; about the same amount of raw materials (give or take); a bit more labor, due to immigration; quite a bit more technology, since it’s increasing at an accelerating pace; and the rest of the world is taking our promises (mainly, our government IOUs – Treasury notes, bills and bonds) as if they were the safest investment on earth. Which, unfortunately, they may be.
Leaving aside the issue of whether more is better, we should thus HAVE more than ever. Why, then, the fear of a deep recession, a depression even?
Answer, because an economy is the MOBILIZATION of resources – the institutional arrangements that lead to their most efficient use. Nobel laureate Robert Solow will explain this in terms of finance and credit in an upcoming interview on the NewsHour, but more broadly, as I’ve pointed out before here, 20th century English economist John Maynard Keynes wrote that such mobilization depends upon “spontaneous optimism”: the expectation of future rewards that gets us off our duffs and onto the track.
The danger is what you might call spontaneous pessimism, leading to “depression” in both senses of the word. You take your money out of the stock market and put it under a mattress. Banks take their money back from borrowers to beef up their reserves — putting the money in the vault. That means when I apply for a car loan, I can’t get one. Car sales go down further, etc. Multiply that story a million times over, and you’ve got the downward spiral that IS recession – or worse – with massive unemployment.
Massive unemployment, of course, is nothing more or less than a massive DEmobilization of resources, due ultimately to a lack of optimism – a mass idling in which many of us are forced back on our duffs, our desire to work notwithstanding.
What, then, is a government to do? Restore confidence, of course. But how? Basically, there are only a few ways to go.
One is purely psychological. Call it the FDR “Fireside Chat” approach. (Below is Roosevelt’s first inaugural in early March, 1933, when he famously speaks of having only fear itself to fear.)
And/or his first Fireside chat, eight days later, when he gave the financial system a breather by euphemistically declaring a ‘bank holiday’.
“We have nothing to fear but fear itself.” Hear that from someone you trust, and you might well think, “Yeah, I feel better now, and that suggests that lots of other folks will too. Hmmm. Good time to buy some stock, I guess, since everyone else soon will and stocks are cheap at the moment, right, but soon won’t be.”
Or the bank thinks, “Okay, it’s time to lend money to Paul for that car he covets, since he’ll do okay in a recovering economy.” (Actually, I seem to be counter-cyclical: the worse the economy gets, the more people listen to me. I guess that means the hypothetical bank was stupid not to lend to me money to buy that hypothetical car. What fools!)
Anyway, confidence is restored, the banks start lending, and your money comes out from under the mattress to buy stock or into a money market fund, which invests in the bonds of GMAC (the debt of the General Motors Acceptance Corporation). GMAC then also has the money to bankroll my new Chevy if the bank won’t lend to me because I’ve denounced its no-lending policy in this column. The stock market rises and so do car sales.
A second way the government might play the confidence game is the one it’s been trying: by shoring up the financial system. The idea here is to force lenders to lend by giving them the money to do so. That was the plan behind the TARP – the Troubled Asset Relief Program: to buy up banks’ Troubled Assets (like lousy mortgage-backed securities). With only GOOD loans on their books, the banks would again be credible businesses to THEIR investors and would no longer be afraid to lend.
In fact, the government has rolled back the TARP and instead provided money directly to banks and other financial institutions, in the hopes they would lend it out again. This hasn’t worked yet, though.
The other main way government can try to restore confidence is by providing more money for lending and spending through “fiscal policy” — a national employment program such as the New Deal, whose WPA (Works Progress Administration) kept my own dad, among many others, gainfully, gratefully and productively employed as an artist ($24 or so a week) during much of the 1930s.
Note that after the psychological pep talk, these policies are about spending dollars. And thus we meander back to the original question about more dollars creating inflation.
The government gets the money for new spending in one of two ways: by borrowing it or, in effect, printing it. Either way, you’d think, would constitute an increase in the world’s supply of dollars. Obviously, if more are “printed,” there would be more out there. But if we BORROW more, we simply create new dollar-denominated loans. That means we promise to pay back in dollars in the future. If we don’t plan to take those dollars from our citizens in taxes, we may well simply print them to cover the loans. That too would be the creation of more dollars – in the future.
So, doesn’t all these printings imply inflation, which is, typically, defined as more dollars chasing the same amount of goods and services? Well, here’s why the answer is “maybe not,” at least in the short term.
Suppose every one of us panics today and decides we’re not going to spend a dime beyond what’s necessary to survive. We don’t even sell our investments. We just stop buying. Period. Would that be inflationary?
Of course not. It would be just the opposite. With no one spending, prices would go DOWN, because too FEW dollars would be chasing the same amount of goods and services.
In other words, it’s not just how much money EXISTS, but how quickly it circulates — its “velocity” — that counts.
The Fed has famously and controversially pumped several hundred billion dollars into U.S. banks. But the banks have increased their deposits at the Fed by almost exactly the same amount, beefing up their balance sheets. They’re fearful of making loans perhaps; or maybe they just can’t find borrowers these days.
But regardless of the reason, the fact is they’ve been circulating almost NONE of the money the government has tried to pump into the economy. At the moment, governments all over the world are trying to provide the “liquidity” – money that will actually be USED – to make up for all the money that ISN’T being used. And it isn’t working. We are not experiencing INflation but the threat of DEflation – money INCREASING in value because so little of it is being spent.
President-elect Obama has promised a major economic stimulus effort, and not just sending checks to “consumers” that will be saved instead of spent. As a result, we can expect government spending on projects like energy, education and such that represent investments in our future productivity. But even if it just sends out checks, the government will be doing more deficit spending. The inflation question is thus raised — by the fear that those new deficits will be covered with borrowing and/or the Fed printing more money, now or later.
But the hope is the following: that this fiscal expansiveness will mobilize America’s resources before they get seriously sidelined: the off-our-duffs effect. That would encourage economic growth, which would mean more businesses growing, more workers employed. They in turn would generate income – more wealth — and pay taxes on it.
If this added wealth is enough to offset the deficits incurred, there would be no need to print money in the future to cover them. And therefore there would be no inflation. The extra money would simply have been a tool to mobilize us into producing what we would otherwise NOT have produced, because we hid our money away.
That, at least, is the hope.