Ben Needs a Bigger Helicopter

“People are still scared. And, being so, they are doggedly sticky-fingered. Money, once created, turns over far more slowly than it did in the past.” Sanford Rose 

Dolors& Sense

by Sanford Rose

KISSIMMEE Florida—(Weekly Hubris)—11/12/2012—They call him Helicopter Ben because he’s supposed to have dropped enough cash to fuel the economic recovery. But Fed chairman Ben Bernanke didn’t accomplish that.

Ben doesn’t drop money. He drops only high-powered money, which are bank reserves. He’s dropped plenty in the last few years, but, seemingly, these reserves did not fall upon fallow soil but rather disappeared into a bottomless pit.

As they make loans, banks create deposits, and every dollar of deposits requires, by law and central bank regulations, a few cents of reserve backstopping. So, in theory, the normal operation of the banking system would begin soaking up the reserves generously provided by the accommodating Fed chairman.

And as people and businesses spent their loan proceeds, both M1, the narrowly defined money supply, consisting only of cash and demand deposits, and M2, the more representative money supply, consisting of M1 plus savings money, would expand enough to energize the recovery.

Alas, while the reserves to backstop the deposits that might have been created by the loans were there, the loans were slow to arrive.

Two reasons: (1) loan demand was weak because a frightened public was shedding old debts (deleveraging, it is called), not acquiring new ones;and (2) loan supply was stingy, because, while banks had plenty of reserves and deposit money, their willingness to lend depends less on the amount of these reserves than on the amount of shareholders’ funds, or bank capital, required to support every dollar of new credit.

Because they retained so many shaky loans on their balance sheets, banks were uncertain about the true value of their assets and therefore the amount of their residual capital.

Banks had enough of your money (deposits), but they didn’t think they had enough of their own to lend.

Still, after a period, in the early stages of the recession, when the representative money supply tanked, its rate of growth has since recovered to about its long-term average. The economy, however, has not picked up commensurately.

The reason echoes that for weak loan demand. People are still scared. And, being so, they are doggedly sticky-fingered. Money, once created, turns over far more slowly than it did in the past.

A few years ago, every dollar of new money(M2) resulted in about a $2 increase in economic output. Today, that same dollar generates only about $1.50 in additional output.

Rx: Although Ben has dropped in lots of bank reserves that, after a lag, began to produce as much of an increase in the money supply as in the past, given the reluctance of people to spend, and re-spend, that money, he needs to do still more. Quite a bit more.