The visible hand in economics

Keep the banks in mind

Posted on: August 18, 2008

I’m feeling sick today, so I won’t be able to write much.  As a result, I’m going to link to a good article over at the Rate’s Blog by Bernard Hickey.

I agree with his conclusion that the NZ banking system is in good hands – however, it is important to remember that it was trouble in the banking system that lead to the great depression.  As a result, the outlook for our banks will be incredibly important over the coming year – a factor that the RBNZ is definitely keeping an eye on.

Who knows, the real reason why the RBNZ is cutting rates and the RBA is on the verge of cutting may be issues in the banking sector (definitely something they would know and we wouldn’t).

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4 Responses to "Keep the banks in mind"

Thanks for the link Matt. Hope you get better soon.

… it is important to remember that it was trouble in the banking system that lead to the great depression.

To be fair, the main problem was the action or inactions of the Fed, rather than the actual banks.QUESTION: What happened during the Depression?

MILTON FRIEDMAN: We have to distinguish what we mean when we talk about the Great Depression. What you had was that in 1929 the United States was in a boom. It hit a relative high point. And the stock market crashed in October 1929. But that was not the cause of what caused the Great Depression. It was, in my opinion, a very minor element of it. What happened was that from 1929 to 1933 you had a major contraction which, in my opinion, was caused primarily by the failure of the Federal Reserve System, to follow the course of action for which it was set up. It was set up to prevent exactly what happened from 1929 to 1933. But instead of preventing it, they facilitated it.

The Depression, I may say, which started in 1929 was rather mild from 1929 to 1930. And, indeed, in my opinion would have been over in 1931 at the latest had it not been that the Federal Reserve followed a policy which led to bank failures, widespread bank failures, and led to a reduction in the quantity of money.

What happened was that for every $100 of money, by which I mean the cash that people keep in their pockets, and the deposits they have in the bank, for every $100 of money that there was in 1929, by 1933 there was only $67. The Federal Reserve allowed the quantity of money to decline by a third. While, at all times, it had the possibilities and the power of preventing that from happening.

“To be fair, the main problem was the action or inactions of the Fed, rather than the actual banks”

It was the cutting of the money supply by the Fed that helped propagate the bank failures that occurred, which in turn helped to contract the money supply etc etc – it was the old financial accelerator in action.

That was why I was saying that the RBA and RBNZ will want to keep an eye on the banks – as they don’t want to see that sort of spiral occur, even in the absense of a bank run.

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