Economic Musings IV: How Bank Robbers cause Inflation
If a robber robs a bank and runs away with the money, never gets caught or if he gets caught has spent the money before that, has that caused inflation? No – the bank now has less money and thus its money holdings have decreased exactly as much as the robber’s holdings increased. But what if the bank gets “recapitalised”?
(See statistical material in our References section!)
Let’s say they had burglary insurance and the insurance company makes up for the loss. Under normal circumstances the insurance company would either have a bank account at another bank (or even the same bank for that matter) and would transfer that balance to the bank that was robbed or it would liquidate assets (that ironically the robber might even buy at that stage) – again, the amount of money in circulation or on deposit would not change – no inflation (and no deflation either – while the bank due to diminished funds could potentially not extend as much credit, that again would be made up by the newly won spending power of the robber – so, though to some it may sound a bit counterintuitive, we must state: no deflation).
So, let’s assume, the insurance company had undertaken to insure the bank against such a robbery, however, it had underestimated the risk and hence had not set enough money aside to make up the bank’s shortfall and after shelling out what little it had then had gone bankrupt – then the bank would have recouped some of the money (as much as the insurance company still could afford before going bankrupt after liquidating all its assets) and the rest went unrestituted. So, again, no inflation, no deflation, the total amount of money was kept stable by virtue of what was paid in one area was “mopped up” in another.
Now let’s say the insurance company was called AIG, they underestimated the risk as before but they were “too relevant” to let go bankrupt. Therefore a good Samaritan, either called the Fed or the state himself, graciously stepped in and made up for the shortfall. Then the insurance company could make up the loss to the bank, but the robber still had the money to spend. Again, it depends on where the good Samaritan took the money from: the state could issue new bonds, which in turn would be paid by market participants (even the robber, as before) with money already existing – that would still keep the amount of money available stable, no inflation, equally no deflation.
But what if the state does not himself borrow the money to recapitalise the insurance company from the market but sells the bonds to raise the necessary capital from the Federal Reserve? That “lender of the last resort” will oblige by creating the money!
It goes without saying that the same applies if the bank was recapitalised directly without the detour via an insurance company.
Now the net effect is that the amount of money available in that economy has effectively doubled. That’s called inflation. Whether, where and when it leads to higher prices (more money bidding against the same amount of goods on sale) is unpredictable – the robber may want to buy bonds, cigarettes, sex or candy, but, all other things being equal, the value of that money has decreased in direct proportion to the money recapitalised.
Without meaning to be derogatory – whether a robber robs 200,000 dollars or a debtor doesn’t repay the same amount (and we know, underwater home owners in distress and out of a job do not act out of criminal intent which cannot equally be said of everyone who sold them mortgages) – it makes not a cent difference to a bank’s balance sheet. So debt default cannot cause deflation per se, it would at best be neutral to the money in circulation or deposited! Nothing contracts here except maybe the self-esteem of the defaulting debtor. But if via some bail-out that money supply doubles this must to all intents and purposes be called inflation.
Now that you’ve come that far you might also want to read the refutation by ducati998 called “Bank Robbers and Economics – faulty reasoning” (as announced by his comment to this post). And stay tuned, CrisisMaven will respond with what he thinks is the refutation of that refutation.
P.S: There are discussions on other blogs (and in comments here) starting to gather speed on the Internet if, or why not, CrisisMaven could be right and if and why robbers differ from debtors in their net effect of failing to repay. CrisisMaven will respond to each class of argument (not each individual occasion – that’s beyond anyone’s time). However, there’s another class of arguments that’s sprung up, showing why and how the robber scenario, even if comparable to the defaulting debtor effect, would not be comparable with what “actually” happens. Well, please take each of CrisisMaven’s posts at face value: CrisisMaven has not argued whether “collateralised debt obligations” (CDOs) are different from normal mortgages (he will get to that and its after-effects eventually). No doubt, even the German WestLB through its Irish investment vehicle, would not have bought “collateralised robber delinquency debt” should the robbed bank, rather than seeking redress in court from the convicted felon, have instead securitised it and tried to sell it to anonymous buyers around the world. But that equally goes for today’s CDOs: had the buyers at the time had a notion the underlying mortgages would default, they equally wouldn’t have bought these CDOs! That’s a bit too easy to as an attempt to refute the core argument. What CrisisMaven solely has argued is that the monetary loss to a bank (and its balance sheet, q.v. ducati998 – we’ll get to that too) is absolutely equal and, if recapitalised from funds not saved previously (e.g. in insurance premiums) must inevitably be inflationary. So bear with me, all the other ramifications of today’s mortgage and credit markets were not dealt with here. The purpose of this post was, plain and simple, to dispel the widespread notion, parrotted in the media ad nauseam, that debt default causes deflation per se. If someone still devises an explanation why it would per se, CrisisMaven shall gladly take up the gauntlet, all other, finer, points should wait till later.