Money Makes The World Go Around...If There Were Enough Of It!

The clinking clanking sound is of it disappearing from sight not flowing into our pockets! The Bank of England has published the latest UK Money Supply figures and they show the sharpest drop on record. The data is painting a very grim picture of life in Britain as draconian fiscal austerity drives that economy into the ground. http://www.guardian.co.uk/business/economics-blog/2012/jan/31/all-eyes-money-supply

The Bank of England has recently revealed a collapsing borrowing by households and firms in Britain on a scale not previously seen. It is clear that the December data shows that households are deleveraging (paying credit cards down) and business firms are now in full retreat similar to the worst of the recent downturn in 2009.

The other point to note is that it is the first time on record that households have actually paid off debts in a December month. The Christmas spending surge typically sees the opposite.

The British people were told that if the government cut its deficit then their tax burdens would be lower and that they would be able to spend more freely as a consequence. But of course new money only enters the economy when it is borrowed from banks..Either by government, companies or individuals.

If governments, companies and individuals pay down debt and do not borrow to replace it the amount of money in circulation falls. If this falls then the purchasing power of society falls and we enter recession.

The consistent trend is now for less private spending growth, which is exactly the opposite of what the British government, under the influence of mainstream macroeconomic thinking, claimed would happen. The reality is that households will not expand spending while unemployment is high and rising and business firms will not increase investment while the outlook is so bleak and they can meet all the current demand for goods and services with the existing capital stock.

It was just blind ideology that suggested it would be a private sector led spending surge to replace the contraction in demand as a result of the fiscal austerities.

Larry Elliot quotes a UK financial “analyst” as saying that “(t)he continued weakness of broad money and lending growth bolsters the case for the MPC to announce another round of quantitative easing (QE) at February’s meeting”.

Bill Mitchell asks some good questions and offers an excellent explanation here:
http://bilbo.economicoutlook.net/blog/?p=18007#more-18007

What they were thinking? Why any analyst would think the quantitative easing under these circumstances would be indicated is beyond our experience!

What it tells us is that they have a limited understanding of the links between the monetary operations of the central bank, the behavior of the commercial banks, and the macro economy. You can’t really make any sense of the realities of monetary operations if you don’t understand these linkages.

So the aim of QE in the Bank’s mind was to “inject money directly into the economy in order to boost nominal demand”. That is a central bank way of saying that there would be a serious recession which would severely damage economic activity and invoke a harsh deflationary spiral.

The Bank of England knows full well that bank lending is being constrained by a lack of credit-worthy borrowers and that loans are not constrained by available reserves. Loans create deposits and any reserves that might be required to ensure the payments system remains integral are added (in a variety of ways) later.

The mainstream belief is that quantitative easing will stimulate the economy sufficiently to put a brake on the downward spiral of lost production and the increasing unemployment. The illusion is that a bank is an institution that accepts deposits to build up reserves and then on-lends them at a margin to make money.

The conceptualisation suggests that if it doesn’t have adequate reserves then it cannot lend. So the presupposition is that by adding to bank reserves, quantitative easing will help lending. But this is a completely incorrect depiction of how banks operate.

Bank lending is not “reserve constrained”. Banks lend to any credit worthy customer they can find and then worry about their reserve positions afterwards. If they are short of reserves (their reserve accounts have to be in positive balance each day and in some countries central banks require certain ratios to be maintained) then they borrow from each other in the interbank market or, ultimately, they will borrow from the central bank through the so-called discount window.

They are reluctant to use the latter facility because it carries a penalty (higher interest cost). The point is that building bank reserves will not increase the bank’s capacity to lend. Loans create deposits which generate reserves.

The reason that the commercial banks are currently not lending much is because they are not convinced there are credit worthy customers on their doorstep. In the current climate the assessment of what is credit worthy has become very strict compared to the lax days as the top of the boom approached.

The money supply data tells us that there is an unwillingness to spend by the private sector and the resulting spending gap, has to, initially, be filled by the government using its fiscal policy capacity.

The solution? The Bank of England could create electronic money for spending straight into the economy and fund a rebuilding of our infrastructure, schools, ports, railways, hospitals, wind farms, etc etc. In that way they could spend money directly into the economy, put people back to work and put money into our hands to spend.

This is the way forward out of a spiral into recession..After all its only money and money is simply a human made means of exchange….and it does make the world go around.