Money Be Tight (for econ-geeks)

Romney has (had?) a chance against Obama and the chart below tells you why. No seriously, it does, and I’ll (try to) explain it.

This podcast explains the chart pretty well. Look at the blue line. That is a measure of the change in money (M3) in the economy. Notice that it falls spectacularly starting in 08. That’s  a contraction in the money supply, which causes recessions, basically. Some argue about the importance of M3, but I’m now becoming convinced it matters. How did that happen? And whose fault is it?

Well, it’s the banks doing it. It’s the banks, banks, banks. They hold 85% of the money in the economy (the rest is government money) and so they dictate monetary policy. QE?Drop in the ocean.

So… why? Why are banks working against us (and themselves)?

First policy error: the Basel 3 regulations forced banks to hold more capital, which they don’t have. More capital, you’ll note, is normally a good thing.

Sure, in the long run, but how is a bank in 2009 supposed to operate (lend money, not run tight money) if they need to hold twice as much capital per loan as before? And after a big massive mistake (housing bubble/crisis) that has left them with less (negative?) capital than before? Really don’t want to go to equity markets because they’re paying sub-book and you’re worried about signalling weakness.

How about operations? Can the banks earn their way back out of zombiehood without taking risk?

With the fed’s interest on reserves program they can. Banks take checking deposits (free money, protected by FDIC) and park it at the fed and earn .25% per year on it. Buy longer Treasuries and you juice that more without a penny of allocated capital. Bang, let’s lend to the government then.

This isn’t strictly Obama’s fault but he could have nominating fed board members (to empty seats) and given Bernanke some loose money allies.

In the last two administrations there have been two failed “dream teams” of economic policymakers. First was Bernanke at the Fed and Hank Paulson at Treasury. They managed to not notice that money was incredibly tight and bail out their buddies at the big banks. That latter point still steams me up.

Next came the economic dream team of Obama. These folks also missed the tight money signs went all-in for fiscal stimulus.

We are left with crappy employment, slow growth and, incredibly, a continuing tight money policy.

It’s slowly getting better but it isn’t easy to tell when banks are going to be feeling bullish enough to actually operate again.We could well have years of stagnation ahead of us, folks. YEARS.

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