It’s all about the confidence, stupid

Groan, moan: it’s the end of the world! The banks are going to collapse and we’ll lose all our savings. Pull yer money out now and sock it under the mattress. Oh!! And we’ll all be murdered in our beds!

Endless stories of the worst financial crisis since 1929 are beginning to wear a bit thin.

Has the amount of MONEY in the world suddenly decreased? NO!

What’s happening right now comes from 3 things:

1. The dumbo yankees loaned a whole buncha money to a bunch of useless suckers who never had a chance of paying it back. These people bought houses and then could not meet the payments, so walked out. Banks left with empty houses is NOT a good look, especially if you can’t sell them to somebody else. A building industry that kept building in the face of evidence that the houses could not be paid for did not help.

2. Following on 1, the bankers left holding the derelect houses lost a bit ‘a repsect from the other bankers, so confidence in lending between bankers took a bit of a hit.

3. Following on from 2, the loss of confidence has led to a desire to be a bit more careful about loaning money to ANYBODY – and to demanding higher interest (the “risk premium”) for the privelige.

This sequence of steps leads to an economic contraction, and as confidence drops and the lack of confidence spreads, the money (which amount has not changed) ends up being stuffed in socks or kept under the metaphorical bed instead of circulating in the economy. Money that does not circulate has a big effect – a long time ago the effect of spending $1 was roughly calculated (I think by John Maynard Keynes) as creating about $2.50 of economic social activity.┬áSo withdrawing money from circulation sucks.

Somewhere along the way, the Irish Government decided to guarantee all bank deposits. This is fine for boosting local confidence and avoiding a run on the local banks. Oh damn! There is a downside: The smart money all promptly moves to where the guarnantee is. This is why government guarantees have suddenly sprung up in Europe, UK, USA and now here in the tin-pot great-brown land of OZ. If you want to keep capital in a country, you have to play the same games – sensible or otherwise – that everybody else is playing.

A lack of confidence has other symptoms: share markets fall. Share markets have an inherent higher risk than cash, a fact which is forgotten during boom times. But when confidence wanes, the money gets pulled out to stick in cash management or term deposits. The effect of many sellers and less buyers is the same as in any other market subject to such forces: prices fall. For the last 15 years, share market investors have known good times and rising share prices. Bad times, when they came, were brief. Compacency and an expectation of double-digit returns every year, forever, were the expected norm. Suddenly, these investors have seen the good times stop, and they are bailing out in droves – desperate to avoid further losses. Prices fall.

Funny thing about a share market loss: you only lose money when you sell.

It all highlights the difference between price and value: PRICE IS WHAT YOU PAY. VALUE IS WHAT YOU GET. During a panic, the sellers don’t care so much about price or value, they’re spooked and care only about getting out. Which seems like a good time to buy… when you can see the whites of their eyes and smell the fear!

Confidence will come back, the money will start to circulate again. But right now we also need the dumb-as-shit politicians to shut the hell up and stop whining, the journalists likewise. They are in danger of making the situation far worse by eroding confidence further and creating a self-fulfilling prophesy.

3 Comments

I had the ‘fun’ job of working as a graduate trainee/lending manager at ANZ bank during the 17.5% interest rate dramas of 1989; then had the privilege of helping TSB bank repossess homes in England in 1991/92 following the same kind of US lending practices featured today.

….will we ever learn?

More importantly, will we sell our house at a decent rate????

Comment by Kath Lockett | October 17th, 2008 5:57 am | Permalink

Chinese proverb says if you take all your money out of the bank and put it in plastic bag, don’t cry if bag is stolen…

OK, it’s not a proverb, more something I said to someone in 2004…

Comment by Michael Lee | October 18th, 2008 2:00 pm | Permalink

Sucinctly put! How quickly we forget the lessons of the past! Couldn’t agree more with you re press paranoia and stupid politicians who know nothing. I watched Quentin Dempster this week trying very hard to get Kev to admit that we’re about to enter a Depression he was almost ‘gleeful’ in his persistence that the world is going to end!

Comment by Baino | October 19th, 2008 6:43 am | Permalink

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