by Gary North
by Gary North
"What, me worry?"
From its beginning in 1954, the official representative of Mad Magazine has been Alfred E. Newman. He is a dim-witted looking fellow, always smiling. His slogan is, "What, me worry?"
Half a century ago, I took an image of Alfred and turned it into a campaign poster. I was running for student body president at my high school. I pasted a poster with my name and his picture on it on every locker on campus. I did it twice. I won.
Today, the person I defeated is a professor of business. He was one of the 535 economists who issued a public warning about the anti-growth effects of Obama's tax hikes.
He is worried. So am I. He and I are still in the labor force. We see what is coming for those who aren't.
"What, me worry?" You bet!
In contrast, ever since March of 2009, stock market investors have been sticking with Alfred. He still speaks for my generation, most of whom are retired, as well as for those aged 35 to 55, who haven't a snowball's chance in Yuma of retiring. They're not worried.
But their bankers are. One statistic more than any other reveals just how worried they are.
THE MONEY MULTIPLIER
The Federal Reserve publishes this statistic. I have a link to it on www.GaryNorth.com, under the free department, "Federal Reserve Charts." You can check it weekly. Here is what it looks like these days.
This graph tracks what is sometimes referred to as the velocity of money. It is an indicator of the number of exchanges for money per unit of time. A dramatic increase or decrease in this statistic is rare. People stick to their budgets pretty closely. Bills get paid monthly. Expenditures reflect closely people's monthly incomes.
Ever since the September 2008 financial crisis, this statistic has fallen as never before. It looks as though it went over a cliff.
Why? It was not that people stopped spending. Bills must be paid. Companies still meet their payrolls. The basics get taken care of.
What happened is that banks stopped lending. Bankers looked at the financial markets, and they abandoned faith in Alfred E. Newman.
Use Photoshop to put a beard on Alfred's image, and then shave off most of his hair, and the image bears a remarkable resemblance to Ben Bernanke. Anyway, I see such a resemblance. So do most bankers.
Since September 2008, the Federal Reserve System has approximately doubled the monetary base. It has bought T-bills and Fannie Mae and Freddie Mac debt. It has lent newly created money to buy toxic assets from large American banks. It has loaded up on assets, creating new money to pay for this. Its balance sheet is twice as large.
Yet this money is not flowing into the economy. It is flowing into the banks, but the banks are parking it with the Federal Reserve System. The FED pays them the going rate for overnight money, something in the range of one-tenth of one percent. This is not what I would call a compelling rate of interest. Yet, for bankers, it is very compelling. They prefer to lend this money to the FED, which refers to this money as excess reserves, rather than lend it to producers or consumers.
"Wait a minute," you should be thinking to yourself. "If the banks pay 2% to depositors and then turn the money over to the FED at a tenth of a percent, the banks will be bled dry. They can't make it on volume."
Banks are walking away from far higher rates of return. They are carrying the existing system by lending to high-interest borrowers who still use their credit cards, but only if the borrowers are making their monthly payments. But banks are no longer willing to lend most of their post-September legal reserves to the general public. They prefer to let the FED sit on the money. They are walking away from the interest they could earn on a trillion dollars of available reserves.
This is unprecedented. It is happening all over the Western world. Commercial bankers are not lending the reserves that central banks have made available to them through massive purchases of debt. The banks bought the debt. The recipients — when not banks themselves (toxic asset sales) — deposited this money in their banks. The banks then turned the money over to the central banks that created it.
The fractional reserve multiplication effect has broken down. The money multiplier isn't multiplying any longer.
CENTRAL BANK POLICY
This is good news for central banks. They have been able to fund a financial system that came close to crashing last September. They have been able to re-capitalize the largest banks, which were facing bankruptcy because of bad loans to over-leveraged hedge funds. The primary purpose of every central bank is to preserve the banking cartel by protecting the largest banks. These are the multinational banks.
This is not the official purpose of central banking. For example, the two-fold official purpose of the Federal Reserve System is to maintain high employment and the purchasing power of the dollar. This is public relations fluff. The dollar has depreciated by over 95% since the FED opened for business in 1914. This is revealed by the inflation calculator of the Bureau of Labor Statistics, a Federal government agency. The unemployment rate has always fluctuated wildly in recessions. The recession of 2007—9 is no different.
There have been some major bank failures and a few dozen local bank failures. The FDIC has depleted its reserves of T-bills. The Federal Reserve and the Treasury have subsidized these liquidations. The losses continue anyway. Commercial real estate is plummeting, and will produce hundreds of billions of dollars in losses for commercial banks. The residential housing market continues to plummet, with waves of mortgage re-sets scheduled for 2010 and 2011. There is end in sight.
But the FED has kept the largest banks, now gutted, from going under. It has done this by doubling its balance sheet.
This balance sheet serves as legal reserves for commercial banks. Because commercial bankers are petrified, they are not lending to the general public. They are lending to the FED. This has enabled the FED to achieve half of its two-fold assignment: preserve the purchasing power of the dollar. The Consumer Price Index is down slightly over the last 12 months. It only rose by a tenth of a percent in 2008 — the lowest in over half a century. The Median CPI, which I have used for many years as a better guide than the CPI, is in the 2% to 2.5% range. It is low, though not so low as the CPI.
On the other hand, the refusal of commercial banks to lend has undermined the other half of the FED's official assignment: preserve high employment. Month after month, the unemployment rate rises. This shows no signs of abating. But it is far easier for the FED to blame external market conditions for rising unemployment than it would be for the FED to explain (say) 50% price inflation.
What are bankers afraid of? The thing Will Rogers was afraid of in the 1930's. Homespun Will spoke for the nation when he said that he was more interested in the return of his money than the return on his money. So are the bankers.
Commercial bankers see that the economy is in a recession. Risk of default rises in a recession. Bankers know that they are beyond criticism by the government or by the Federal Reserve if they deposit funds with the FED. They know they will get this money back. They are in the safest investment the economy offers to bankers. They are beyond criticism from agencies that are in a position to impose negative legal sanctions. The bankers want safety more than return. They want immunity from legally effective criticism. They want safety. So, the money multiplier has fallen like a stone. This has kept price inflation low.
The greatest source of new jobs is small business. In second place are medium-size businesses. Economists and policymakers have known this for at least two decades. But small businesses are among the highest-risk borrowers. Those that survive do hire workers. Those that do not survive fire workers and stiff their bankers. In the aggregate, small business loans pay off, but bankers in a recession know that the odds of survival get lower. They decide to seek safer borrowers.
So, central bank policy has kept panic from spreading to the general public. There have been no runs on the banks. There has been no replay of the bank runs of the Great Depression. A bank run today involves taking digital money out of one bank and transferring it to another bank. The money supply does not shrink. The system as a whole survives. The cartel survives. This is the FED's #1 purpose, and it has served its clients well. Its clients are commercial banks.
The public has posted digital thumbnail photos of Alfred E. Newman onto their bank statements. So have the retirement fund managers who act on behalf of the public.
The commercial bankers have not.
GREEN SHOOTS VS. "SHOOT ME SOME GREEN!"
The buzz words among optimists is: "green shoots." These green shoots are evidence that economic springtime beckons. The cold, dark winter is receding. The experts who did not predict the dark winter — who denied it even existed — are confident that there are signs of economic growth. These signs are in the form of less-bad news.
The premier mark of economic recovery is that small businesses are again hiring. They are borrowing to launch new projects. Their owners have seen compelling evidence of an economic turnaround. They are ready to commit new capital to meet the demand of buyers in the future. They are ready to go to their bankers and say "Shoot me some green."
This is not happening.
When it does happen on a widespread basis, the chart of the money multiplier will reverse. We will see a sustained increase in the multiplier. This will indicate a change in the assessment of bankers regarding the prospect of recovery. They will decide, case by case, that business borrowers are sufficiently confident regarding their firms' prospects that they are willing to place their businesses' collateral on the line.
This is not happening.
Bankers want to see confident businessmen. They want to see businesses with collateral worth repossessing in case of a default. They want to see businessmen who put their companies' future at risk for the sake of expansion. Bankers are not going to shift their banks' funds out of excess reserves at the local Federal Reserve Bank on the basis of Ben Bernanke's sharp-eyed perception of green shoots, or some unknown fund manager's appearance on CNBC, who assures viewers that it's time to get back into the stock market. They are going to shift funds when they are confident that they will get the money back from the corporate borrower.
This is not happening. Why isn't it happening? It has to do with businesses whose collateral is suspect. Toxic investments are now perceived as toxic.
It has to do with businessmen who regard their companies as their life's work, and who are unwilling to place the survival of their companies at risk on the basis of green shoots. Green shoots in general are neither here nor there for a business owner who is must place his company's survival at risk. It is the local market that counts for him, and his niche in that local market, that matters.
It has to do with bankers who know they have made rotten loans in the past, whose banks' balance sheets would call in the FDIC if the assets legally had to be marked to market: a sale price based on a rapid sale. It was only April's reversal of the Financial Accounting Standards Board — under intense pressure from the government — that saved these banks from insolvency. The FASB allowed creative reinterpretation of FAS 157, which mandated market pricing of bank assets. These bankers are not interested in risking any more of their banks' capital in a series of premature loans to local businesses.
It has to do with commercial real estate loans. Local banks that sold mortgages to Fannie Mae and Freddie Mac were not hurt by the collapse of residential real estate. But they took their depositors' money and invested in companies developing commercial real estate. These ventures are the next shoe to drop. Banks need liquidity to cover for the losses that are now inescapable. Money lent to local businesses is not liquid.
For whatever reason, commercial bankers are telling Bernanke, "Show us the money!" The story of the green shoots may convince fund managers that happy days are just about here again, but it has not persuaded the bankers who have the money. When bankers are lending to the FED at the federal funds rate — a tad over 0% — the people with the money needed to water those green shoots are turning thumbs-down on the green shoots story.
They are frightened. Talking heads on CNBC aren't. Take your pick.
Those who predict price inflation believe that the money multiplier will turn upward again. They just don't know when.
Those who predict price deflation believe that the money multiplier will not turn upward again. Indeed, it must fall much further. Prices are close to stable today. To get to significant decline — 5% or more per annum — the money multiplier must continue its downward path.
I am in the inflationist camp. But until I see a sustained reversal of the money multiplier, I will continue to predict relatively stable consumer prices.
But not for real estate. It will continue downward. Families' net worth will continue to fall. There will be deals. Commercial rents will continue to fall. There will be deals. Small local banks will continue to go belly-up. There will be deals . . . for big banks.
That is the goal of the Federal Reserve System: to create deals for big banks at the expense of little banks. It always has been. The FED is not about to change at this late date.
Small bank managers are scared. They should be.
How about you? Do you think the fractional reserve banking system is on your side? Do you think fiat money is productive capital? Do you think you will retire in comfort, based on government promises? Do you think you're in good hands with Big State? If so, sit tight. Do nothing new. Just keep repeating Ben Bernanke's mantra.
"What, me worry?"
June 13, 2009
Copyright © 2009 Gary North