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Friday, 16 January 2009
9/11 Caused the US Financial Crisis, Not a “Saving Glut” in China
Do not forget the principle that every transaction has a supply side and as well a demand side. Do not forget the principle that every economic argument has its counter balance “on the other hand.”
9/11 Caused the US Financial Crisis, Not a “Saving Glut” in China
Thomas Wilkins 10 January 2009
The “saving glut” story acquired a new proponent and advanced to a higher level as US Secretary of Treasury Henry Paulson recently confided in an interview interpreted by the Financial Times of London. The ‘saving glut’ discussion was nurtured by US Federal Reserve Chairman Ben Bernanke when he addressed the Virginia Association of Economists for the Sandridge Lecture on March 10, 2005. No finger pointing to China existed in Bernanke’s then lecture. However, in Paulson’s “valedictory interview” with the Financial Times in Washington published on January 1, 2009 , Krishna Guha positioned Paulson into a corner. The ‘saving glut’ story rises to a higher plane….namely, to a hypothesis that it “helped to foster the credit crisis by pushing down global interest rates and driving investors towards riskier assets.” This appears a way for Mr. Guha to infer without direct quotes that Mr. Paulson believed the ‘saving glut’ caused the financial crisis. This though is a hypothesis, subject to confirmation by evidence.
Do not forget the principle that every transaction has a supply side and as well a demand side. Do not forget the principle that every economic argument has its counter balance “on the other hand.” This was a complaint voiced by President Harry Truman who said that he wished he could meet a “one-handed economist” who did not refer to “on the other hand.” The counterbalance to the ‘saving glut’ causality hypothesis is that 9/11 caused the financial crisis. If we define this crisis as being mainly caused by bad loans, then the Chinese did not cause the crisis because the Chinese did not make the bad loans.
Recall please the front page headlines after 9/11/2001.
The labour market weakened as unemployment rose. Manufacturing, construction, travel, retail, entertainment, restaurants, and temporary help industries shed jobs. The average workweek and aggregate hours declined while unemployment insurance claims rose.
Industrial production, consumer consumption, residential construction, housing starts, new home sales and consumer sentiment all declined.
In the business sector, investment in equipment and building weakened as business inventories rose.
The marching orders of the US Federal Reserve System is to keep inflation at acceptable levels but also to keep the arteries of the real economy pumping fresh blood cells to nourish economic activity. Is it any wonder that under these conditions the US Federal Reserve slashed rates to 1% in the Federal Funds market? Let’s face it, many people, not just in the US but worldwide, suffered from dysfunctional mental activity, sometimes delirious and manic, needing hospitalization to protect themselves.
Refer to your money and banking textbooks. What happens when the Federal Reserve moves Federal Funds down sharply? An enormous amount of reserves are created in the banking system. What do bankers do when they have reserves? They try to lend it out. What happens when they lend out? There is something called the multiplier effect which means a 10% reserve requirement, for example, can create 10 times the dollar amount of banking deposits if there is no “liquidity trap.” ( for a discussion of “liquidity trap” See ChinaStakes December 17, 2008 “The ‘Liquidity Trap’ Could Happen.”)
Now turn to your basic business administration text books. Bankers make a profit on the difference in their cost of money and what they can get as loans. Bankers have fixed costs to maintain branches for customers to come to, electricity and heating bills to light and cool their offices, and employees to be on hand to run receiving in and lending out money.
What happens when there are decreasing spreads, that is the difference between the rate paid on incoming money and the rate earned on outgoing loans decreases? The banks have to reduce headcount and branches or they have to make more loans to offset their shrinking spreads.
The banker’s mantra was very simple. Make more loans. Find more customers to borrow money. As every business person knows, some activity is profitable, but not all activity is profitable. In retrospect, the whole world knows that many loans went sour. The pungent smell from this sourness is now conveniently referred to as “the financial crisis.”
This “financial crisis” is not new to mankind. Just recently, Japan suffered through its “lost decade” in the early 1990’s, followed by the Asian financial crisis, the Russian crisis. You can go back to the tulip crisis in Holland centuries ago. To say that our current crisis was caused by a “saving glut” is stretching the tale a bit thin.
Recall what US Secretary of Treasury Andrew Mellon said in the 1930’s during The Great Depression: “Liquidate labor, liquidate stocks, liquidate the farmers—purge the rottenness from the system.” This sounds like what is happening today and is at the opposite end of the spectrum from the ‘saving glut’ hypothesis.
Today’s financial crisis emanates more from the stresses caused by 9/11 than from other causes!
Today’s crisis reminds me of William Jennings Bryan who opposed the banking industry in his now famous “Cross of Gold” speech given at the 1896 Democratic National Convention in Chicago.
The person who can best explain today’s crisis is dead but his reasoning lives on. He was economist Irving Fisher. He argued that “at some point of time, a state of over-indebtedness exists; this will tend to lead to liquidation, through the alarm either of debtors or creditors or both. Debt liquidation leads to distress selling and to contraction of deposit currency as banks loans are paid off, and to a slowing down of velocity of circulation. This contraction of deposits and of their velocity, precipitated by distress selling, causes a fall in the level of prices, a still greater fall in the net worth of business, precipitating bankruptcies and a like fall in profits, which in a ‘capitalistic,’ that is, a private-profit society, leads the concerns which are running at a loss to make a reduction in output, in trade and in employment of labor. These losses, bankruptcies, and unemployment leads to pessimist and loss of confidence.”
Irving Fisher seems to win the argument in my opinion, not the ‘saving glut’ hypothesis. I suspect that Henry Paulson’s memoirs will disavow the inferences from the Financial Times’ “scoop.”
1 comment:
9/11 Caused the US Financial Crisis, Not a “Saving Glut” in China
Thomas Wilkins
10 January 2009
The “saving glut” story acquired a new proponent and advanced to a higher level as US Secretary of Treasury Henry Paulson recently confided in an interview interpreted by the Financial Times of London. The ‘saving glut’ discussion was nurtured by US Federal Reserve Chairman Ben Bernanke when he addressed the Virginia Association of Economists for the Sandridge Lecture on March 10, 2005. No finger pointing to China existed in Bernanke’s then lecture. However, in Paulson’s “valedictory interview” with the Financial Times in Washington published on January 1, 2009 , Krishna Guha positioned Paulson into a corner. The ‘saving glut’ story rises to a higher plane….namely, to a hypothesis that it “helped to foster the credit crisis by pushing down global interest rates and driving investors towards riskier assets.” This appears a way for Mr. Guha to infer without direct quotes that Mr. Paulson believed the ‘saving glut’ caused the financial crisis. This though is a hypothesis, subject to confirmation by evidence.
Do not forget the principle that every transaction has a supply side and as well a demand side. Do not forget the principle that every economic argument has its counter balance “on the other hand.” This was a complaint voiced by President Harry Truman who said that he wished he could meet a “one-handed economist” who did not refer to “on the other hand.” The counterbalance to the ‘saving glut’ causality hypothesis is that 9/11 caused the financial crisis. If we define this crisis as being mainly caused by bad loans, then the Chinese did not cause the crisis because the Chinese did not make the bad loans.
Recall please the front page headlines after 9/11/2001.
The labour market weakened as unemployment rose. Manufacturing, construction, travel, retail, entertainment, restaurants, and temporary help industries shed jobs. The average workweek and aggregate hours declined while unemployment insurance claims rose.
Industrial production, consumer consumption, residential construction, housing starts, new home sales and consumer sentiment all declined.
In the business sector, investment in equipment and building weakened as business inventories rose.
The marching orders of the US Federal Reserve System is to keep inflation at acceptable levels but also to keep the arteries of the real economy pumping fresh blood cells to nourish economic activity. Is it any wonder that under these conditions the US Federal Reserve slashed rates to 1% in the Federal Funds market? Let’s face it, many people, not just in the US but worldwide, suffered from dysfunctional mental activity, sometimes delirious and manic, needing hospitalization to protect themselves.
Refer to your money and banking textbooks. What happens when the Federal Reserve moves Federal Funds down sharply? An enormous amount of reserves are created in the banking system. What do bankers do when they have reserves? They try to lend it out. What happens when they lend out? There is something called the multiplier effect which means a 10% reserve requirement, for example, can create 10 times the dollar amount of banking deposits if there is no “liquidity trap.” ( for a discussion of “liquidity trap” See ChinaStakes December 17, 2008 “The ‘Liquidity Trap’ Could Happen.”)
Now turn to your basic business administration text books. Bankers make a profit on the difference in their cost of money and what they can get as loans. Bankers have fixed costs to maintain branches for customers to come to, electricity and heating bills to light and cool their offices, and employees to be on hand to run receiving in and lending out money.
What happens when there are decreasing spreads, that is the difference between the rate paid on incoming money and the rate earned on outgoing loans decreases? The banks have to reduce headcount and branches or they have to make more loans to offset their shrinking spreads.
The banker’s mantra was very simple. Make more loans. Find more customers to borrow money. As every business person knows, some activity is profitable, but not all activity is profitable. In retrospect, the whole world knows that many loans went sour. The pungent smell from this sourness is now conveniently referred to as “the financial crisis.”
This “financial crisis” is not new to mankind. Just recently, Japan suffered through its “lost decade” in the early 1990’s, followed by the Asian financial crisis, the Russian crisis. You can go back to the tulip crisis in Holland centuries ago. To say that our current crisis was caused by a “saving glut” is stretching the tale a bit thin.
Recall what US Secretary of Treasury Andrew Mellon said in the 1930’s during The Great Depression: “Liquidate labor, liquidate stocks, liquidate the farmers—purge the rottenness from the system.” This sounds like what is happening today and is at the opposite end of the spectrum from the ‘saving glut’ hypothesis.
Today’s financial crisis emanates more from the stresses caused by 9/11 than from other causes!
Today’s crisis reminds me of William Jennings Bryan who opposed the banking industry in his now famous “Cross of Gold” speech given at the 1896 Democratic National Convention in Chicago.
The person who can best explain today’s crisis is dead but his reasoning lives on. He was economist Irving Fisher. He argued that “at some point of time, a state of over-indebtedness exists; this will tend to lead to liquidation, through the alarm either of debtors or creditors or both. Debt liquidation leads to distress selling and to contraction of deposit currency as banks loans are paid off, and to a slowing down of velocity of circulation. This contraction of deposits and of their velocity, precipitated by distress selling, causes a fall in the level of prices, a still greater fall in the net worth of business, precipitating bankruptcies and a like fall in profits, which in a ‘capitalistic,’ that is, a private-profit society, leads the concerns which are running at a loss to make a reduction in output, in trade and in employment of labor. These losses, bankruptcies, and unemployment leads to pessimist and loss of confidence.”
Irving Fisher seems to win the argument in my opinion, not the ‘saving glut’ hypothesis. I suspect that Henry Paulson’s memoirs will disavow the inferences from the Financial Times’ “scoop.”
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