Tuesday, 30 December 2008

We have a crises of confidence


what we have is not a crisis of liquidity but rather a crisis of confidence. With tremendous excess reserves, it is obviously not the case that banks are not lending money because they do not have the money to loan. Instead, they are afraid that other institutions, including even other banks, will not pay it back. The banks do not have confidence in each other. Businesses, also, are not inclined to borrow money and take risks. Further, consumers are not spending because they are afraid they could lose their jobs.

By continuing to throw money at the banks, the government is on the road to prolong the recession and effect massive inflation when confidence is restored and the economy then has too much liquidity. By making money available to the banks essentially for free, the Fed does not guarantee that the banks will loan out the money to businesses. There is no motivation to lend money at low rates when capital preservation (i.e., lack of confidence) is still a leading issue.

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