Euquant

Today we are caught in what John Maynard Keynes (the economist who solved the riddle of the Great Depression) called “the paradox of thrift”. The paradox is playing itself out as follows-- everybody is making themselves and everyone else worse off by hoarding cash and over saving. What an irony this is for an economy that was until recently characterized by excessive spendthrift behavior.

In a nutshell, everyone now has an abnormally high precautionary demand for money –and this is how it plays out. Retail banks have gobbled up the big investment banking houses and are now sitting on piles of money. They are skeptical about lending because they are being heavily regulated by the Federal Reserve, afraid that borrowers will not be able to repay loans (given the high unemployment rates) and determined not to repeat the near bankruptcy experiences of the recent financial collapse.

Corporations are therefore sitting on retained earnings so as to have a pool of funds to invest or meet their operating expenses should the situation arise. Mid-and small size businesses are preserving working capital by drastically reducing their workforce and operational costs. All the talk of the loans being made available to small businesses is not move them. Small businesses know that generally speaking to companies that need loans to not qualify for them and those that can qualify do not need them. They also know that if they hit hard times the banks will not save them.

Finally, consumers have been hit so hard by the recession, collapsing housing market is housing and stock market decline that they do not have money to spend even if they wanted to. And furthermore they are unable to get any credit from the banks. Therefore, they have decided to try and save every additional penny they get; hence the savings rate is reaching historic proportions. Welcome to the Paradox of Thrift! Until this psychological cycle is broken, do not expect the unemployment rate to decrease by much.

Thomas “Danny” Boston