International Law

Why Money Sitting is the Sidelines

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Like most intellectuals, my understanding of the economists' concept of hoarding and recession is predicated by Paul Krugman's discussion of the Washington D.C. baby co-op, the Sweeney's co-op, that issued scrip to its babysitters for payment, and then ran into some problems.

Here is the story about hoarding and recession, from Slate.

(Here is also an interesting paper on recessions using the co-op hoarding story.)

"What happened in the Sweeneys' co-op was that, for complicated reasons involving the collection and use of dues (paid in scrip), the number of coupons in circulation became quite low.

As a result, most couples were anxious to add to their reserves by baby-sitting, reluctant to run them down by going out. But one couple's decision to go out was another's chance to baby-sit; so it became difficult to earn coupons.

Knowing this, couples became even more reluctant to use their reserves except on special occasions, reducing baby-sitting opportunities still further.

In short, the co-op had fallen into a recession."

When a smart guy like Krugman uses the phrase "complicated reasons", it really means that he doesn't know why.  The decision to hoard could have been because nobody really did want to go out; but if it was, on the other hand, a spectacular mass miscalculation, then Krugman owes the reader some explanation how this all failed.

Krugman goes on to state:

"Its story tells you more about what economic slumps are and why they happen than you will get from reading 500 pages of William Greider and a year's worth of Wall Street Journal editorials.

And if you are willing to really wrap your mind around the co-op's story, to play with it and draw out its implications, it will change the way you think about the world."

And the moral of the story is: print more money.

What can we learn from this story for today's credit failures?  Consider this interesting story in Marketwatch about the hoarding of money in this recession.

"Cloutier compared today's situation to what happened in Louisiana and Texas in the early 1980s, when Hibernia Corp. of New Orleans was forced to sell off assets in Texas.

After making a strong comeback, the banking group became part of Capital One several years ago.

"The money is going to sit on the sidelines until they announce they're going to do something with these [big banks]," Cloutier said.

"Nobody is going to put fresh capital into the banking business when your major competitor is going to be continuously bailed out by the United States government with more and more money."

That appears to me a very sound conclusion.  Money will set on the sidelines, not go into solvent and healthy banks because their competitors have access to free money.

So, we should stop printing the damn stuff and let the bankruptcy market sort out the loser, and encourage the sideline investors to buy into the solvent banks.

Full post as published by Misleading Advertising Law on February 17, 2009 (boomark / email).