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Wednesday, October 8, 2008

More evidence that debt from credit is at heart of crisis

Minsky theory predicts this.

People have negative borrowing-on-credit growth for the first time in a LONG time. This means people are taking more of their money and putting it against their debt - especially given that revolving credit card debt growth is negative. This is exactly what we would expect. So the Fed can pump all the money it wants into the economy. New spending will not happen until consumers and investors pay for the debt created by their past consumption and investment. When people pay this debt it goes right back to the banks --- where the money is tied up in the first place!

To quote post-Keynesian structuralism (like a crystal ball....):

Furthermore, Goodhart (1993) suggests that with the growth of wholesale

money markets and liability management, the distinction between situations of

illiquidity and conditions of insolvency has been erased in such a way that the

central bank’s role as lender of last resort involves a serious risk of loss. He also

warns that, in today’s more competitive conditions, a central bank would find it

increasingly hard to persuade banks to join in and share the burden of potential

loss from the rescue of an insolvent bank. He concludes, ‘this could lead to

serious problem for central banks. They may not have sufficient funds of their

own … to accept the potential losses involved in a future rescue exercise’

(Goodhart, 1993, p. 421). Here, the expression of liquidity preference for the

central bank operates through the amount of funds made available to banks. For

the central bank, the decision to place funds with the ‘risk-insolvent’ bank

involves the creation of new debts (i.e. change in the size of its portfolio). When

liquidity preference rises, the central bank is less willing to face a potentially

large insolvency problem, and there is no alternative but the partial or total

intervention of the government.

Credit-money is endogenous folks. The Fed can set the rate, but it's ultimately up to people and banks whether or not to lend. And reducing interest rates is not the way to do it - not when there are so many outstanding debts and in the midst of economic malaise.


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