It makes sense given that credit card debt and Foreign capital inflows are not included in our money stock. It's an observational fact that credit card useage and the US's debt obligations to countries like China has grown rapidly over the past 30 years. That fact alone can explain why our tech bubbles and our housing bubbles and the resulting "pops" have served to increase the volatility of our business cycles.
Theoretically, a person can hold their permanent income in four forms: money, financial assets, physical assets, and credit (imbued with human capital - potential for future earnings and consumption smoothing).
First, there is something to be said for a strictly Keynesian explanation as not all financial assets are equal, and classical economists like Friedman ignore non-probabilistic uncertainty in their models.
But, what is missing from strictly classical and a strictly Keynesian models is the "credit" part. As mentioned in a previous post(s), this is not however lost on heterodox economists like Hyman Minsky.
If you combine Keynesian liquidity preferences with Minsky cycles you get the following:
To start off let's assume (rightly) that the US becomes more "spend-happy," and is now more willing to spend on credit and to borrow from foreign entites for consumption and investment.
This has the effect of reducing money demand because more purchases are willing to be financed with debt as opposed to cash or deposits. The lower interest rate helped add to the frenzy of investment already occuring. But then...
1. An de-stabilizing even occurs (housing bubble bursts, etc)
2. Uncertainty (as separate from probabilistic risk) rises
3. Demand to hold money rises and liquidity is constrained
4. Interest rates rise and consumption and Investment fall
You are now left with a choice: Where do you put your money?
-Not in your physical assets because the uncertainty of their return has risen
-Not in your financial assets certainly for similar reasons
-Not as cold hard money because in the United States, over the last couple decades, our savings rate has declined as we have become more consumerist and have been more willing to borrow from our future expectations, and from abroad to finance our capital investments. In fact, our savings rate over the last few years has been aroudn 0, and sometimes negative. It makes more sense to pay off this debt - the negative savings we did via credit - in order to avoid interest payments, as opposed to just stuffing money in a mattress or keeping cash on hand.
What this means is that in times of crisis (like this one), people may be taking money out of banks and financial instruments to try to pay down their bad debt that they racked up - the very debt that got them into their current dire straights. The problem is that while paying down private debt is theoretically similar to the positive effect that paying off gov't debt, private debts fail easier and are corrupted by un-market friendly practices ironically set up by the free market ("fixed" rates that can be variable within 2 weeks notice, huge late fees, misleading balloon payments/interest, etc). Not to mention a lot our private debt has been securitized into things so complex we can't even know the value of! All this means that perhaps aggregate hoarding and keeping cash-on-hand is inevitable for a time.
Even when the debts can be paid, some public debt is a good thing (eduction spending, infrastructure), but some of this private debt is likley just excess or debt taken on due to "herd" behavior.
How did the debt get them there: by providing an incentive to consume and invest beyond one's means. By providing an incentive for self-fulfilling prophecy of a Minsky cycle, whereby individuals and firms expect future incomes to be great enough to pay for current spending and this "rush to greed" fulfills that expectation for a time until "reality" sets in and the market crashes.