Monday, February 16, 2009
This is my longest-running theme: namely, that this recession has not been the result of a monetary squeeze or a shortage of money, contrary to the popular belief that the economy has ground to a halt because banks are not lending and credit markets are frozen. M2, my favorite measure of money, has grown about 10% in the past year, and has surged at a 17% annualized rate over the past four months. The problem is not a shortage of money but a shortage of buyers, which in turn is the result of a sudden aversion to counterparty risk. Granted, secondary lending activity (of the sort that gave us CDOs and Asset-Backed Securities) has ground to a halt, but that does not mean that credit creation has collapsed. On the contrary, total bank credit is up 4.5% in the past year.
The secondary markets served the function of distributing the credit created by banks from the far corners of the globe, and into the nooks and crannies of our own economy. Indeed, money was funneled from global lenders to borrowers everywhere, which is why the collapse of our housing market has led to losses worldwide. There is plenty of money out there today, but it is harder for some borrowers to get their hands on it. Today, many lenders prefer to only invest in government securities, having been severely burned in the past by lending via asset-backed paper they assumed was relatively safe. This is why the U.S. government will be able to finance a mega-deficit this year and only pay about 2% in interest to do it.
In short, there is an abundance of money out there, but a shortage of holders of that money that are willing to lend it to borrowers with less than sterling credentials. This is the primary justification for all the federal bailout programs, since at the end of the day what those activities amount to is the U.S. government buying the paper that no one wants, in exchange for the Treasury securities that everyone wants.
So the key to restoring our economy to a healthy state is to boost confidence, reduce perceived counterparty risk, and generally increase the market's willingness to take risk. Tax cuts on capital could have gone a long way to fixing the problem, but alas, they have been passed over in favor of politicially motivated spending which will do very little to address the economy's underlying problems.
The doomsayers out there mostly assume that we are caught in the grips of a liquidity trap (in which no amount of money creation is sufficient to boost demand) and/or we are in being sucked into a deleveraging death spiral that won't end until vast sectors of the global economy are devastated. What they most likely ignore is that economies, especially ours, are incredibly dynamic, and that makes forecasting the future very difficult. It is risky to assume that any trend that is readily observable will continue forever. Recessions are not self-perpetuating.
I have been operating under the assumption that the vast majority of the real-estate-related losses have been absorbed by the holders of affected securities. I think that home prices are in many areas already at levels which have stimulated buying demand, thus acting to put a floor under those prices. With money policy extraordinarily easy, I have been thinking that investors will not want to sit on mountains of cash indefinitely, especially when they see that sensitive asset prices (e.g., oil, commodities, real estate) are stabilizing, and especially when that cash is paying them almost nothing in interest. The confidence that has been lacking to date can be restored as animal spirits and the profit motive come back to life. In other words, I am a believer in the market's ability to fix itself, and I see more examples of that happening.
It still pays to be optimistic, even thought the stimulus package is awfully depressing.
Posted by Scott Grannis at 1:22 PM