Wednesday, February 8, 2017

Secular Strangulation

Martin Wolff (chief economics’ commentator at the Financial Times, London) defines secular stagnation as “chronically deficient AD”. The deceleration in R-gDp and inflation stems from not putting savings back to work outside of the payment’s system (a decline in money velocity, AD, and N-gDp). The 35 year bull market in bonds parallels this deceleration.

This “blue print” was presented in “Should Commercial Banks Accept Savings Deposits?”, Savings and Loan League’s, proceedings of the 1961 Conference on Savings and Residential Financing, May 11 & 12, 1965, pg. 40-48, by Professor Lester V. Chandler in his theoretical approach.

Chandler: “But surely a more basic and, over a longer run, a far more important objective is to secure some desired behavior of the level of spending for output—to achieve a certain level of gDp, or to cause the level of gDp to increase at some desired rate (sounds analogous to Scott Sumner’s N-gDp targeting on his blog “Money Illusion”?).

Chandler’s theoretical explanation was: (1) that monetary policy has as an objective a certain level of spending for gDp, and that a growth in time (savings) deposits involves a decrease in the demand for money balances, and that this shift will be reflected in an offsetting increase in the velocity of demand deposits, DDs.

Leland James Pritchard, Ph.D., economics, Chicago 1933: “This hypothesis rests upon the fact that the payment’s velocity of funds shifted into time deposits becomes zero, and remains at zero so long as funds are held in this form. The stoppage of the flow of these funds generates adverse effects in our highly interdependent pecuniary economy, as would any stoppage in the flow of funds however induced. It is quite probable that the growth of time deposits shrinks aggregate demand and therefore produces adverse effects on gDp.”

And: ”the stoppage in the flow of monetary savings, which is an inexorable part of time-deposit banking, would tend to have a longer-term debilitating effect on demands, particularly the demands for capital goods”.

In other words, from the standpoint of the commercial banks, DFIs, the monetary savings practices of the public are reflected in the velocity of their deposits and not in their volume. Whether the public saves, or dis-saves, chooses to hold their savings in the CBs, or transfers them to the NBs, will not, per se, alter the total assets, or liabilities of the CBS - nor alter the forms of these assets and liabilities.

I.e., Chandler’s theory was obviously denigrated by Cambridge economist, Alfred Marshalls’ “Money Paradox”. Thus Alfred Marshall’s “Cash Balances Approach”, P = M/KT, came to fruition in 1981 with the saturation in DD Vt.

As SA author WYCO Researcher said: “The velocity stayed fairly stable for decades, but then increased sharply partially because technology dramatically changed the payment methods/speed.”

I.e., the financial innovation on commercial bank deposits, reflected by its deposit rate of turnover (95% of all demand drafts clear thru transaction accounts), plateaued with the widespread introduction of ATS, NOW, and MMDA accounts in 1981. Money velocity has decelerated ever since (as savings increasingly became impounded and ensconced within the payment’s system - as encouraged by the complete removal of Reg. Q deposit ceilings):

fred.stlouisfed.org/series/MZMV

The cash balances approach points out that the desire to hold more or less cash, rather than non-monetary assets, has its repercussions on the supply of, and the demand for, money. Adjustments in prices relative to the volume of money and real balances continue, unless interrupted, until a point of indifference is reached.

However, if the public on balance considers the real worth of its cash balances deficient, this will bring about an increase in the demand for money and a decreasing in its supply. The velocity of money will decline, and if prices tend to be sticky, sales, production, employment, and payrolls will fall off. This will lead to reduced bank lending, a decline in the volume of money (and this will not be compensated by an appropriate decline in prices). Under these circumstances equilibrium is never reached, and the public in seeking to increase its real balances so reduces its effective purchasing power as to create a condition of chronic stagnation.

What happened (the subpar R-gDp performance and slow recovery) was that Bankrupt u Bernanke destroyed non-bank lending/investing by the remuneration of excess reserve balances, IBDDs (inducing dis-intermediation for the non-banks exclusively). Thus, the non-bank’s, assets (& corresponding liabilities), dropped $6.2 trillion, vs. the CB system's growth of $3.6 trillion. The 1966 S&L credit crunch is the economic paradigm and precursor (lack of funds, not the cost of funds).

This is the cause of Larry Summers’ secular stagnation or an excess of savings over investment opportunities as originally described by Alvin Hansen in 1938 (as predicted in 1958 by Dr. Pritchard).

Keynesian economists have finally achieved their objective: that there is no difference between money and liquid assets.

The way to increase money velocity and force investors to buy riskier assets (risk-on) would have been, and still is, to get the CBs out of the savings business.

- Michel de Nostredame

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