Friday, March 28, 2014

Money III: Liquidity Trap

If you have been following along with our Money and Money II posts, you know that we have been deconstructing the idea that money is a store of value, at least for any length of time. In fact, we would go so far as to say that if money itself becomes a long-term store of value, then the economy will be bad. One way this can happen is if the economy falls into the "liquidity trap."

The trap arises out of a widespread desire to hold onto one's money rather than spend it or even invest it. The value of money rises over time (that is, there is deflation) and the money in circulation goes down. The money supply may or may not dwindle, depending on whether the cash stuffed under mattresses is counted or not. Either way, however, economic activity goes down, aggregate pay goes down, and unemployment goes up.

The reasons for the desire to hold on to cash--what is, in effect, a decline in confidence--can be many things, but the reasons are related to expectations. If people expect that cash will be hard to get in the future, they will save it now.

Since people generally prefer cash to financial instruments in a liquidity trap, there is an effect on strategies with respect to debt. These strategies differ depending on one's economic strength relative to others. The rich will tend to pay off debts and lend less. (This is where the central bank role in the liquidity trap comes in. The central bank can add reserves to the banking system, but the rich are reluctant to lend and many are reluctant to borrow at all economic levels. The extra liquidity does not really help the economy.)

Some of the poor, being closer to the edge and needing to obtain a minimum amount of cash right now, might try to cut their own costs even more. Also they might try to work extra hours, take lower pay, work multiple jobs, and emulate the rich as well as they can by paying their debts. This is the so-called "race to the bottom," an attempt by workers to compete with one another, follow society's rules, and find out just how little a human being can live on. This is not a road to prosperity, though the rich will speak very well of such people. The rich will honor their determination, honesty, integrity, and dedication to hard work. The rich generally do not praise them for their intelligence, however.

On the other hand, other poor people might throw society's rules out and borrow as much as possible, figuring that it is better to have the money in hand now than to worry about how to pay off debts in the future. Naturally, lenders are not happy with this attitude and approach, so they fight them with as many social weapons as they can, including legal sanctions as far as possible. The rich punish them with poverty (that is, austerity), blame, and by socially marginalizing them. (In today's world, think of the Greeks, how they are treated and how they are spoken about.)

A liquidity trap therefore is generally an advantage for the rich. In particular because the government, which does want its people to be as successful and productive as they can be, cannot pull its people out of the trap using monetary policy and may not be able to use fiscal policy to do the job. (Because of politics and its own financial situation.) A stubborn ongoing liquidity trap is one reason why the Great Recession in the US has had such long-lasting effects.

Under the system, liquidity traps will not happen in the internal markets. That is, millions of people will not lose their jobs, their houses, and much of their savings simply because banks become reluctant to lend. Cash will not be allowed to become the preferred store of value in the internal markets. No one will have to be concerned where the money for their livelihoods--their basic needs--will come from.

Of course, if the rich want to create liquidity traps in their own markets, we would not want to stand in their way. Support

The way capitalism should be.

Socialism for the socialists and capitalism for the capitalists.

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