No. of Recommendations: 6
Why invest or take any risks at all if the cash in your mattress is going to be worth more a year from now anyway? And this is as true of companies as it is of individuals. With no risk taking or capital expenditures, things get pretty slow.
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Isn't this true today though? We have relatively risk-free options today such as savings accounts. Returns from those risk-free options are positive, yet massive money still flows into riskier assets like stocks in the hunt for higher returns.
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What am I missing?
Real short term policy interest rates are positive at the moment, which is fairly unusual. This is one reason I am collecting interest rather than buying stock...the exact unwillingness to take risks or allocate capital to productive endeavours that I mentioned. Not coincidentally, it's the exact reaction that the monetary authorities WANT to happen to cool an overheating economy because too many people are taking capital risk. Taking risks with your capital is a good thing for the economy, but you don't want it to step over the line into irrational exuberance. In any case the current situation won't last.
The current situation of positive real short rates isn't like deflation. You can get positive real rates in two different ways: we have positive inflation and higher rates (OK), not zero rates and deflation (bad). The second scenario is the one to avoid.
Plus, if significant mattress stuffing or the like did occur, wouldn't a reduction in money available to loan lead to higher market-driven interest rates, luring people to pull more money out of mattresses? (an equilibrium effect?)
I'm not sure, in general. But in particular I'm not sure that mattress stuffing would lead to scarce capital and higher rates on offer. First, a deflationary environment involves cash hoarding: usually it's in cash deposits, not physical cash in mattresses, so the financial system is stuffed to the gills with deposits they can't use because nobody wants to borrow and do stuff with the money. Second, even if they wanted to and thought they needed to, banks and other lenders would not be able to afford to offer high real rates, as they economy is in the pits and everybody's hurting, including them.
Jim
