Money Go Round!
Way down below in this post you’ll find a good story, courtesy of The Monkey Cage. (Go ahead, read it now . . .) Good stuff seems to happen in that little world, except, as one commenter at The Monkey Cage pointed out, nowadays many parties cannot agree on what their debts are. Yet, even if that’s true, the story could be seen to illustrate individuals paying down a portion of their debts, couldn’t it?
In any event, this actually demonstrates the “velocity of money” concept, i.e. what happens when money actually moves around in an economy. However, note that in the story below nothing was produced in all the exchanges; debt was reduced. This is a good analogy as to where we are presently, although lately, money appears to be slightly on the move again with actual things and services being produced and provided, albeit at decession* (TM) levels. The concern intrudes that the rebound we’re seeing now, unaccompanied as it is by employment gains, is merely due to a cyclical rebuilding of inventories – and at a much lower level than previously. That’s a slippery slope that could result in another down leg for the economy as a whole if no recovery to previous inventory levels via employment gains follows. We have not yet begun, however, to see the full effect of the fiscal stimulus, and should it match the better expectations, a recovery in employment ought to result and then we can all exhale . . .
Yet recently, despite massive inflows of cash into the banking system, very little money is reaching the public. In fact, a dollar in the bank courtesy of the Federal Reserve or consumer deposits actually produces 86 cents, a negative return to the economy, so to speak. Our economy, when healthy, produces money through the fractional reserve sy
stem wherein banks must hold 10% of their deposits in reserve, and may lend out the rest. Thus, one dollar loaned out at Bank A produces, in total, about nine dollars more as each deposit in Banks B, C, D, etc. permits additional fractional lending by each succeeding bank, based upon successive deposits. In healthy times this produces spending on things and services. It’s often called the “M1 multiplier effect” (see chart at right). What’s missing now, and what the dip below 1.0 indicates is that banks are themselves hoarding money and not loaning it out and consumers are hoarding money in deposits and actually repaying loans. It’s the “paradox of thrift” writ large, and economic activity grinds to a halt. No one loans; no one spends; bupkus.
Well, for some comic relief, here’s the story promised at the outset, via Bob Goldfarb. Pass it along to Ben Bernanke, and, most importantly, to your local banker.
It is August. In a small town on the South Coast of France, holiday season is in full swing, but it is the rainy season not much business is taking place. Everyone is heavily in debt. Luckily, a rich Russian tourist arrives in the foyer of the small local hotel. He asks for a room, puts a 100 Euro note on the reception counter, takes a key, and goes upstairs to inspect the room.
The hotel owner takes the banknote and rushes to his meat supplier, to whom he owes E100.
The butcher takes the money and races to his wholesale supplier to pay his debt.
The wholesaler rushes to the farmer to pay E100 for pigs he purchased some time ago.
The farmer triumphantly gives the E100 note to a local prostitute who gave him her services on credit.
The prostitute goes quickly to the hotel, as she owed the hotel for her hourly room use to entertain clients.
At that moment, the rich Russian comes back down to reception, informs the hotel owner that the proposed room is unsatisfactory, takes his E100 back, and departs.
There was no profit or income. But now no one has any debt and the residents of the small town look optimistically towards their future.
* Decession – coined here, a decession is a recession deeper than the worst U.S. recession but less severe than the Great Depression. Decessions have characteristics both greater and different than previous major U.S. recessions.
