Monday, December 29, 2008

The Sand Bank

A few days ago, Jon Markman wrote: "My guess is that consumers will have the same response as banks: They'll hoard most new funds that come their way or pay down debt rather than buy more stuff. Obviously, a lot will leak into the economy, but probably not soon enough to make a huge difference."

I've been wondering about this for the past few months. What do the pundits mean when they threaten that the economy will suffer because people are now afraid to invest, and therefore businesses won't have the liquidity they need to thrive? Most people are not going to hide their cash in their mattresses, or put most of their money into gold coins. When they get scared, instead of investing in mutual funds, or fancy pension plans, or directly in stocks, they will put their money in the bank, or use it to buy government securities. Either way, it goes back into the public money pool, whatever they do, and eventually back into businesses, the "economy". Apparently what Markman and Co. are afraid of is that when the public gives their money to the banks, in their current mood the banks will not lend it out again to help business, but will use it in one way or another to cover liabilities already on their books.

But that's OK with me too. If the banks cover their liabilities, they will become more solvent, and will help themselves to return to the state where they will lend to businesses, thus hastening the recovery. And now that the US Government is a large holder of bank securities, covering the banks' liabilities will reduce the Government's liabilities as well, protecting the dollar from too precipitous a fall, which by frightening away foreign investors would also hurt business, as well as hurting our standard of living by reducing cheap imports too steeply. The process will be a little slower than it might otherwise have been, but the money 'hoarded' will go back into the economy.

I still don't understand exactly what's worrying them.



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