Thursday, December 01, 2011

Fed's Monetalism will fail: It cannot save the world economy

.... This is "Nothing but a drop in the bucket"! I really detest the fact that there is still a fundamentalist intiutive ideology of monetalist theory dominating this world economy....! We've got to learn what J.M. Keynes mentioned about the "liquidty-trap"!

Speaking of European mal-functioning economy, the fundamental reason why Euro failed was the compromised role of fiscal policy and financial market regulation. Therefore, the further liquidity into the current European economy will not be effective enough, and only leaves negative changes more than positive changes.



I am sure that these money injected without any fundamental reconstruction of the fiscal structure will just flow into the "saving" rather than averting a further recession or even a depression!

Futhermore, this injection of US$ will definitely cause the further depreciation of the long run US bonds!

The hypowered money theory offered by the monetalist theory does not work because the velocity of money flow is already very low! Extra supply of the hypowered money does not induce a high velocity of money; it is an opposite! The hypowered money only works in the situation that the velocity is already high! The velocity of money is exogenous; not endogenous like what the monetalists say!




As I am now reading a wonderful book written by Prof. Stiglitz about the paradigm of monetary transactions, I know the monetary policy by central banks' role is too weak to influence/control over the monetary transactions in the market. The interest rate, reserve requirement, and money supply are less likely to direct the flow of the monetary transactions. The monetarist theory completely ignores the different characteristics of individuals and financial institutions; they only assume all of us are risk neutral, there is no risk of bankruptcy taken for account, and influences from the information about credit rating!

Monetarists believe that the interest rate and the volume of lending activities are determined merely by the supply of money available. However, in the real world, private banks and financial instutitions are more likely to set their interest rate and control their volume of lending activities by means of the risk premium of borrowers (consisitency and volatility of change in their profit rate, risk of bankruptcy, risk of assymetric information about borrowers, credit rating of borrowers, etc). This fact infers that the traditional macroeconomic policy via the monetary policy seldomly works to control the macroeconomic environment. The characteristics of each individual economic agent is the key issue to analyse the money lending activity.

Majority of these lenders, assisted by the central banks, have already become risk averse so that they are less likely to increase the volume of their lending activity. But, even though, they keep themselves as either risk neutral (acting as what Monetarists assume) or risk lover (becoming more active to invest in a tough economic climate), and then they lend high volume of funds, the risk of bankruptcy still remains same unless the structural change in the real market takes place. They may probaly invest more funds even though these targets of their investment become riskier. However, they will either charge the high interest to cover the unseen risk of these borrowers or charge a moderate interest rate and burdern a high risk of the bankruptcy of themselves. Either case scenario is tough because it is either increasing the cost for borrowers (and eventually induces borrower's bankruptcy, and then loss or even bankruptcy of lenders) or increasing the risk of bankruptcy of both lenders and borrowers. The market becomes more voluatile when the economic sitations becomes worse, the balance sheet of both lenders and borrowers becomes very inconsistent i.e. their profit/loss is unpredictable. In this case, even though the volume of money transaction is stimulated by the central banks' monetary policy, it will end up with the high interest rate (for the security of lenders) or gambling of lenders (welcoming risk of investing with a moderate interest rate to risker borrowers).

All in all, even though the central banks' action offers the sizably low interest rate and/or the high volume of quantitative easining, private banks and any other financial institutions may increase their own interest rate due to the high risk of bankruptcy involved in this investment under this current economic climate. Borrowers still suffer from unchanged or even increased interest rate. The exective members of banks and financial institutions gain benefit from securing the existence of their work place due to the central banks' assistance to their corporate finance by the quantitative easing. Those who can spread their aggregate income to their saving will be benefited, but this kind of individuals tend to be minority under such a tough economic climate. Thus, this action is irrelevant to encouraging the high volume of money lending.

* If you would like to know why and how the structural change of EU economy is emerged, please read "Friday, June 03, 2011
Europe in crisis...! (Click here to read!)
"


I often wonder why these big guys in these superior positions have never learnt from history although they are supposed to be educated? When we learn from the history, only relying on the monetary policy channel does not work under the deflationary pressue i.e. the recession period = socio-economic stagnation. The perpetuation of it always caused rise in the oppressive political groups such as Natiz and Japanese National Shintoists.

Only the remarkable legendary economist claimed the danger of deflation is J.M. Keynes. Unfortunately, majority of economists in the history tend to underestimate the impacts of deflation. It is because the deflation is a unique phenomenon which can be only seen in the nations and the globe whose capitalism is developed and spread out. So, many classical economists had not seen deflation during they were alive. The first experience of the recession (and then deflation) simultaneously taking place in the entire globe could be the depression from 1920s to 1930s. J.M. Keynes was the first and probably the last economist who warned the danger of deflation.... When we forget about what Prof. Keynes warned, this world will inevitably be drawn into the "depression"...!

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