Loading...
Symbols:
Authors:

Caught in a Liquidity Trap

by: John Mason October 08, 2008    

John M. Mason

About this author:
Become a Contributor Submit an Article
  • Font Size:
  • Print

Is this what a liquidity trap looks like?

A liquidity trap gives one the feeling that the monetary authorities are pushing on a string. The amount of liquidity the Federal Reserve and other central banks around the world have provided for the financial markets has been huge. The Paulson Plan was supposed to create confidence that illiquid assets would now have some liquidity. The Fed Plan to purchase commercial paper was supposed to create confidence that illiquid assets would now have some liquidity.

Yet, the financial markets remain silent.

Seemingly, no one wants to commit because no one is sure about the solvency of other participants in the financial markets.

Bernanke spooked the financial markets again yesterday as he talked about a possible cut in interest targets …which he did follow through on this morning.

The message the market heard, however, was how dire things were. And, the market asked, What does Bernanke know that we don’t?

The absence of leadership seems to reach new heights daily. (See Mase: Economics and Finance for October 7, 2008.)

But now we are apparently in a liquidity trap. Consumers are pulling back their spending…the latest figures out on consumer credit even show a decline. Businesses are consolidating and cutting spending and hiring plans. State and local governments are going to the Federal Government to get cash to help them meet payrolls. And, then the Federal Government…

Get out your old copy of Keynes’ General Theory.

Related Articles

This article has 9 comments:

  •  
    Oct 08 02:33 PM
    "Get out your old copy of Keynes’ General Theory" and toss it in the fireplace full of burning logs where it belongs.

    You can't continually borrow your way to prosperity.

    Is anyone surprised that nobody is lending?

    Given the spontaneous changes in "the rules" for each government bailout (and their impact on creditors and shareholders) is it any wonder that nobody wants to risk being a counterparty to the next possible bailout case?

    Mostly banks are just borrowing from the FED so they can have cash to point at and call 'reserves' for their illiquid balance sheets. Any more lending would require even more FED borrowing to a) replace money lent out, and b) increase reserves to account for new loan amount.

    Until banks can earn enough profits to write off MBS losses and leave wholly owned reserves (not borrowed FED reserves) they will be unlikely to wish the added risk of loaning to parties of questionable risk.

    How they will manage to generate those profits without making risk-laden loans remains to be seen.
    Reply
  •  
    Oct 08 02:56 PM
    They're lending down the street. Not a big bank though. They're only lending one mortgage, one car loan, at a time.
    Reply
  •  
    Oct 08 03:11 PM
    Smarty_Pants
    I agree with you entirely...that is the point...
    Keynes just defined the situation.
    Mase
    Reply
  •  
    Oct 08 03:34 PM
    Alex is right. Local lending will continue regardless of what transpires on Wall Street.

    The only ones who 'needed' the bailout were the big banks and businesses whose business models relied heavily on short-term borrowed money for day-to-day operations.

    Those who operate wholly on revenues and profits will only be hurt by the bailout as they will be penalized with higher fees/taxes to keep the high rollers afloat.

    Mase: Didn't mean to imply disagreement with your conclusions. Just pointing out that there isn't much upside to lending while there is a big potential downside. This is likely the primary reason why short term credit markets have seized up.

    Keynesianism eventually runs into reality at some point, usually irreversably.
    Reply
  •  
    Oct 08 05:36 PM
    The liquidity trap was and is a thought experiment which Hank personally does not buy. For example, Hank knows that there is no such thing as an American who does not want money. It is just a matter of how you package things. So. he will soon do some inventive things that will surprise you. Oh! you are already surprised? Will get ready for more.
    Reply
  •  
    Oct 08 05:56 PM
    Keynes?

    Wasn't he the father of most of the economic theories that transformed England from a world power a the end of WW II into an IMF bailout candidate by the 1970s?
    Reply
  •  
    Oct 08 05:59 PM
    Keynes was also the person who said..."When the facts change, I change my mind. What do you do?"
    The father cannot always be held responsible for those that do not change their minds when the facts change and the irresponsible use of his work.
    Reply
  •  
    Oct 08 06:35 PM
    Given the disruptions of the normal markets and the impossiblility of plugging each hole in the dike, I would say we are on our way to a serious depression. We will have to implode and start all over again is my take on this sorry saga. The hands of the next administration is going to be tied into a knot that will take years to untie. The way this bubble is being handled is sinful IMHO,,,MarvinMBA
    Reply
  •  
    Oct 08 06:36 PM
    Trying to save the ship of state is just going to bankrupt the ship owner.
    Reply
More by John M. Mason
Investment Resources
Money Managment
Research
Seeking Alpha provides these ads as a service to its leading contributors
Articles on related themes
Today's Market
Government Policy
Bonds
Dollar/Currencies