Money Supply

Fiscal Conservatism 605

We are living in strange times, but perhaps these days, the new normal is strange.

The other day, I read that the big banks no longer want large quantities of cash. It costs them money to hold it, since interest rates are so low and they have more cash than they can lend. Companies are hoarding cash and have nowhere to put it other than the bank. With the economic uncertainty and the many negative federal policies, they don't want to hire workers or expand, so they stockpile their profits.

With such low interest rates, anyone who wants to borrow money and is qualified has already taken out a loan, so there probably isn’t any big pent-up demand for new loans. Banks are therefore flush with cash and are buying treasury bonds at zero or even negative interest rates.

Imagine that. The bank would rather lose money than have it sit, doing nothing. Hard to believe.

As the Fed continues to push out its planned increase in interest rates, the world economy continues to send mixed signals and anti-austerity fatigue is making itself felt in various ‘populist’ movements around the world that want to essentially default on their debt and start over. Wouldn’t it be nice to just stop paying your mortgage and keep your house? The long-term problem with many of these economies in Europe has not been felt yet, which will be when the 20-somethings and 30-somethings want to move out of their parents’ house but have no money, no job, and no experience.

Well, unless you count working at Starbucks being a barista. I hear they are still hiring. But I think we are experiencing a "coffee bubble" as well. By the way, I had a large coffee at a Cumberland Farms the other day for 99 cents, plus tax. It was quite good, and I got to make it myself which was an advantage over Dunkin Donuts. I like DD, but they often get my order wrong, and it is more than twice as expensive as Cumberland Farms. But I digress.

Not being an economist (and that may be a good thing), I don’t really understand why inflation hasn’t started to take off. Maybe it’s because the Fed targets a 2% inflation rate and the Economy Gods are just not going to cooperate with Democrats.

I wonder if easy money and zero interest rates are continuing to disrupt the normal spending patterns of the typical American consumer. We keep hearing that consumer spending accounts for two-thirds of the GDP, so we cheer when people spend. But if all this “free money” is causing people to spend at an artificially high rate, then this may stop when interest rates go up. Then we will have another economic dip to deal with.

This could happen because now, there is no incentive to save money so you might as well buy something. Or you can buy it now by taking out a loan with very low interest rates. Either an interest rate increase for loans or a savings rate increase for deposits could significantly change this spending equation for consumers. And that could mean that when interest rates normalize, people will spend less and we will have a six- or 12-month recession while the economy catches back up to where we should have been all along.

What makes this even scarier is that our "recovery" is so anemic. If this is the upside to six-plus years of economic stimulus, I don't want to see the downside.

Think of it this way. Everyone is buying a new car now because they can get it at 2% or 3% interest. The money is almost free, so if you need to upgrade, now is a good time. But when interest rates go up, everyone who needed a car will already have bought one and financed it, so car sales will nosedive. So our stimulus has resulted in a short-term boom in car sales, but when the bust comes, how many layoffs will there be? How many factories will close? How many former workers will need long-term support?

Many years ago, our currency was backed by gold and our coins were made of silver. Today, these valuable metals have been taken out of our currency and our bills are no longer backed by gold. So our entire monetary system relies on trust, trust by the American people, and trust by people around the world. Being the world’s reserve currency is critical to keeping up that confidence. But there have been moves by other countries, like the Chinese, to have multiple currencies act as reserve currencies. This could spell big trouble for us if people start worrying about our federal debts and deficits, or if our inflation rate increases, and investors no longer want to hold U.S. dollars because they aren’t backed up by gold and are depreciating faster than the interest rate for holding onto them.

Artificial financial stimulus has got to be a zero-sum game. You do some stimulation and you get a short-term bump in the economy, in spending, in whatever. Then, when you balance that off with destimulus, it follows that you’d have a short-term drag. The thinking must be that when the economy is bad, you stimulate to improve it, and when it gets better, you destimulate because you must but you are on better economic footings and can weather the negative effects better at that time. But what happens if the economy never really takes off after the first stimulus? Do you just keep stimulating? Do you never try to reverse it? And what will that do to consumer confidence in the long-run?

Perhaps we will find out.

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