M&M’s: This Isn’t Sweet
Dolors & Sense
by Sanford Rose
KISSIMMEE, FL—(Weekly Hubris)—10/11/10—The country has an M&M problem. Bank reserves, called high M (high-powered money), have ballooned, but the amount of currency and checkable deposits, called regular M, has not.
The ratio of the money supply to the monetary base (reserves and currency), which used to run around 2.5, is now down below 1.
Money just isn’t circulating. The Federal Reserve keeps expanding its balance sheet (creating reserves), but the banks can’t lend those reserves.
Bank lending does not depend on reserves, although reserves are needed to back the deposits that result from loans. Rather, the amount of lending depends on the availability of capital to backstop the loans.
Banks have plenty of reserves, which are other people’s money. Although they also say they have plenty of capital, which is shareholders’ money, they actually don’t.
The capital that appears on bank balance sheets is phantom capital. Because the banks know that the money to backstop loans doesn’t really exist, they won’t aggressively seek loan customers, even if there were a lot of creditworthy loan customers around, which there aren’t.
What to do? There isn’t much point in having the Fed create more reserves by buying up Treasuries or mortgages. Same old, same old.
The only way to restore the sweet M&M taste (a healthy ratio of regular M to high-powered M) is to make sure that the bank reserves being created by the Fed are actually used. And that can be done only if the government itself spends them.
But the government won’t spend them because too many people prate about rising indebtedness, runaway deficits and robbing future generations.
If you want to know what really steals from our posterity, conjure with these facts. Unemployment, running at 10 percent, is about 5 percentage points above its equilibrium rate (the rate that is consistent with stable inflation). That amount of slack translates into a loss of about $1.5 trillion in output every year. That’s wealth that could have been created to bequeath to our posterity.
The failure to consider pushing the economy toward reasonably full employment through a suitably aggressive fiscal stance is the real robbery here.
Sanford Rose
Sanford Rose, of New Jersey and Florida, served as Associate Editor of Fortune Magazine from 1968 till 1972; Vice President of Chase Manhattan Bank in 1972; Senior Editor of Fortune between 1972 and 1979; and Associate Editor, Financial Editor and Senior Columnist of American Banker newspaper between 1979 and 1991. From 1991 till 2001, Rose worked as a consultant in the banking industry and a professional ghost writer in the field of finance. He has also taught as an adjunct professor of banking at Columbia University and an adjunct instructor of economics at New York University. He states that he left gainful employment in 2001 to concentrate on gain-less investing. (A lifelong photo-phobe, Rose also claims that the head shot accompanying his Weekly Hubris columns is not his own, but belongs, instead, to a skilled woodworker residing in South Carolina.)