The ‘high-powered money’ problem | FT Alphaville

The ‘high-powered money’ problem

Fed dissenter Richard Fisher has taken to speaking in the language of Ben Bernanke’s own Great Depression paper “Nonmonetary effects of the financial crisis in the propogation of the Great Depression“, possibly to emphasize his point against the Fed chairman.

The big problem, as he sees it, is cash. Not monetary policy per se.

Cash — and by extension US Treasury debt– (or what you might call high-powered money) is piling up in US bank reserves, where it’s failing to fulfil any economic function whatsoever. In fact it may be contributing to capital destruction since banks and clients — now keen on keeping as much of that cash in insured quotas — have been faced with the Herculean task of splitting deposits into insurable sums across multiple accounts at alternative banks just to achieve guaranteed capital preservation. This service costs administratively. It’s also a service which has been made more expensive by the recently introduced FDIC bank insurance fee.

Sources tell us some major US banks have found themselves paying negative interest rates of as much as 1 basis point on their total cash reserves.

Small wonder then that the likes of Bank of New York Mellon have decided to implement a deposit fee.

As Fisher noted on Wednesday in remarks at a forum in Texas:

I have posited both within the FOMC and publicly for some time that there is abundant liquidity available to finance economic expansion and job creation in America. The banking system is awash with liquidity. It is a rare day when the discount windows―the lending facilities of the 12 Federal Reserve banks―experience significant activity. Domestic banks are flush; they have on deposit at the 12 Federal Reserve banks some $1.6 trillion in excess reserves, earning a mere 25 basis points―a quarter of 1 percent per annum―rather than earning significantly higher interest rates from making loans to operating businesses.

These excess bank reserves are waiting on the sidelines to be lent to businesses. Nondepository financial firms—private equity funds and the like―have substantial amounts of investable cash at their disposal. U.S. corporations are sitting on an abundance of cash―some estimate excess working capital on publicly traded corporations’ books exceeds $1 trillion―well above their working capital needs. Nonpublicly held businesses that are creditworthy have increasing access to bank credit at historically low nominal rates.

Of course, the reason to worry is that a lot of this has happened before. During the Great Depression, no less.

Indeed, the parallels between what’s happening now and what happened then are building by the minute.

For example, it was always Bernanke’s theory that non-monetary effects played a far greater role in turning the financial crash of 1929 into a Great Depression, than monetary policy.

With monetary policy arguably becoming ineffective once again, these non-monetary effects are once again being eyed by some committee members as the key factors that could turn a very bad global crisis into a global financial catastrophe.

Note here Fisher’s point:

My concern is with the transmission mechanism for activating the use of the liquidity we have created, which remains on the sidelines of the economy.

I posit that nonmonetary factors, not monetary policy, are retarding the willingness and ability of job creators to put to work the liquidity that we have provided. I have spoken to this many times in public. Those with the capacity to hire American workers―small businesses as well as large, publicly traded or private―are immobilized.

Not because they lack entrepreneurial zeal or do not wish to grow; not because they can’t access cheap and available credit. Rather, they simply cannot budget or manage for the uncertainty of fiscal and regulatory policy. In an environment where they are already uncertain of potential growth in demand for their goods and services and have yet to see a significant pickup in top-line revenue, there is palpable angst surrounding the cost of doing business. According to my business contacts, the opera buffa of the debt ceiling negotiations compounded this uncertainty, leaving business decisionmakers frozen in their tracks.

His view is that the antics of a few rogue politicians may have critically compromised the liquidity transmission mechanism in the financial system. Fatally. After all, who wants to let go of their cash, in an environment in which they have no idea what might happen next?

Thus, too much idle cash now becomes the problem.

At which point it’s worth revisiting Milton Friedman and Anna Schwartz’s Depression classic,A Monetary History of the United States, 1867-1960” — specifically the “Great Contraction” chapter.

Here you’ll find a couple of very notable charts reflecting what happened last time “high-powered money” started building up without a comparable increase in the overall money supply:

So, if there is any lesson to be learned from the Great Depression, it’s about how to handle the “progressive erosion of borrowers’ collateral relative to debt burden” and what we do if and when all that cash on account starts being withdrawn and stuffed under mattresses.

Of course, the prolifigacy of credit cards and debit cards is unlikely to make the second risk a material one in this day and age. What’s more, mattress stocks are hardly insured, and thus not necessarily preferable.

That said, if insured money really has become a Giffen good, the theory naturally assumes — in an Alice-through-the-looking-glass type of way — that money has also become an inferior good. In normal times you wouldn’t be seen dead keeping wealth invested in interest-charging deposits.

If, however, you consider that money is best understood as a yet-to-be redeemed tax credit, that possibly says more about the nature of what savings and wealth have become than anything else.

If savings — a.k.a. collateral — are to be eroded, the man or institution that stands strongest in the end, is the one who has managed to insure as much of that capital and principal as possible. The assumption being that further down the line how much you earn will become more important than how much you manage to accumulate or hoard.

And that’s a problem for anyone reaching the end of their natural working life.

Thus, what we may have is a financial crisis coupled — or at least partly exaggerated — by a demographic crisis. Too many savers are now ready to cash-in on  accumulated wealth. Wealth they expect to be there, even though on a wider economic scale it’s never been replaced by the indebted younger generation.

Savings, collateral and hoarded wealth will all naturally suffer as a result. The last category mostly dependent on how legislation plays out (what degree gold and land rights are maintained and respected, for example).

Or what you could say is that savings and collateral may become inferior goods versus high incomes. (The high income being the most preferable good of all.)

And that’s a whole new bunch of nonmonetary economic effects to consider.

Related links:
Introducing the 2011 deposit crisis
– FT Alphaville
Shadow banking – from Giffen goods to Triffin troubles
– FT Alphaville
When a government bond becomes a Giffen good
– FT Alphaville
The Fed’s secret QE equivalent
– FT Alphaville