Economy Chokes as Banks Hoard Cash

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The Federal Reserve and the U.S. Treasury are pumping billions and billions of dollars into the financial system to try and ease the credit crisis. Unfortunately, there’s a little hiccup in the system—banks aren’t pushing the money through the system by lending it out.

When banks won’t lend out the money they have been given, there is no way for that money to multiply in the fractional-reserve banking system. And if the money doesn’t multiply in the fractional-reserve banking system, there is simply not enough money to pull us out of this recession.

After all, if businesses and consumers can’t get access to money via credit, they can’t spend it.

[VIDEO] Economy Chokes as Banks Hoard Cash

The Multiplier Effect of Money

The fractional-reserve banking system allows money to multiply on top of itself. Here’s how it works:

When banks receive money on deposit, they are only required to keep 10 percent of that money on reserve. They are free to lend the other 90 percent out to other individuals and institutions.

So if someone deposits $10,000 at a bank, the bank is then able to take that $10,000 and lend $9,000 ($10,000 x 0.9 = $9,000) of it out to someone else while keeping $1,000 ($10,000 x 0.1 = $1,000) of it on reserve.

In essence, the bank magically turns $10,000 into $19,000—thanks to the fractional-reserve banking system.

Banks are Hoarding

The fractional-reserve banking system only works if banks are lending money. If deposits are coming in but loans aren’t going out, the money supply can’t grow—which is exactly what is happening.

According to the Federal Reserve, banks are hoarding cash. As you can see in this chart, banks currently have nearly $800 billion in excess reserves when they had virtually $0 in excess reserves at the beginning of 2008.

Excess Bank Reserves

The Money Multiplier is Crashing

The excessive bank hoarding is choking the monetary system. As you can see in this chart, the monetary system had a healthy multiplier effect of approximately 1.6 (160 percent) at the beginning of 2008. However, the multiplier effect actually dropped below 1.0 (100 percent) at the beginning of 2009. This means the monetary base was actually contracting.

Money Multiplier

The Cold Hard Truth

Until banks stop hoarding cash and money is able to multiply in the marketplace once again, the economy will continue to stagnate.

Keep you eye on these indicators for signs of recovery.