It’s a funny old world just now!
The President of the United States recently pressured the heads of the nations’ largest banks to increase lending to
small business and home-owners. Obama claimed that the banks, as recipients of federal bailout funds, had an unusually heavy responsibility to take such measures in order to create more jobs and help nurse the economy back to health. All of this was done very publicly and with much fanfare. Worldwide press coverage was universally favorable.
Seems reasonable, doesn’t it?
But it is not. You are being duped. I can’t tell whether whoever writes this stuff for Obama knows the truth and skilfully skirts it, or just writes flowing prose with no connection to the truth that curries voter buy-in by blaming Wall Street and Corporate America for all that’s wrong in the world.
First of all, the Federal Reserve is now paying banks to not lend. You heard that right: the US Federal Reserve is paying banks interest on both their required reserves, which are portions of deposits they are required to retain, and their excess reserves, which are deposits the banks could lend but haven’t. Here’s the opening paragraph of the press release:
Release Date: October 6, 2008
For release at 8:15 a.m. EDT
The Federal Reserve Board on Monday announced that it will begin to pay interest on depository institutions’ required and excess reserve balances. The payment of interest on excess reserve balances will give the Federal Reserve greater scope to use its lending programs to address conditions in credit markets while also maintaining the federal funds rate close to the target established by the Federal Open Market Committee.
Historically, the cost to banks of holding excess reserves has been the interest they would have earned if they had been lent. Banks hold excess reserves as a sort of cash management tool; insurance that if the bank manager misjudged their customers’ demand for cashing checks, for example, the bank wouldn’t hit the headlines as the first bank since the Great Depression that “ran out of money!” But that insurance cost them.
Now, the Federal Reserve is paying banks to hold excess reserves. They are paying banks to not lend, while President Obama scolds them for not lending! Either he doesn’t know about the Fed’s new policy, doesn’t care, or doesn’t understand. I frankly don’t know which is worst.
Secondly, how is increased lending supposed to create new jobs? Bear with me here, because the bold, brash economic truth of the matter is a bit more complicated than the press coverage and the teleprompters would have you believe.
Profits enable growth: income growth, job growth, wage growth, new businesses, more choices, and a higher quality of life. Profits are created when a business hires labor and buys or rents physical capital, combines them using processes, software, expertise, creativity, and risk-taking, and produces a product or service that a free society chooses to purchase. There is simply NO other way to create profits.
Now you need both a business to make the good, and a customer to buy the good, before you have profits. But increasing demand alone does not create profits or jobs. The way to see this is to imagine that we were at capacity output right now: increasing demand would simply increase prices, not output or jobs.
Lending to businesses – assuming they can generate enough cash flows to pay the interest charges — fuels their demand for productive capital. But the capital could sit in the corner gathering dust. It is the profit motive of businesses – what they choose to do with the new capital that the lent dollars enabled – which incents business to hire more labor and produce more efficiently. Not a scolding from the President. Particularly a President who has made it clear that he believes that “now is not the time for profits”; that the greed and excess of fat cats on Wall Street led to the financial crisis ; and that insurance companies take advantage of Americans. Not a President who presides over a Congress which is spending at record rates and raising taxes on business at every turn!