I wrote a few days ago that the amount of currency held by the public is a very good measure of the public’s level of fear about the stability of the banks and financial system. The numbers are produced weekly by the Research Department of the Federal Reserve Bank of St. Louis.

Increase in Currency Holdings Over Year Ago Levels

The chart above shows that the level of fear is still very high. People have taken about $90 billion of $20 and $100 bills out of their bank accounts to keep at home under the mattress.

Increase in Currency Holdings Over Previous Month

The increase in currency holdings appears to be abating, however, as you can see in the chart above, which measures the increase over month earlier levels. Withdrawals, which had been running $10-$15 billion per month, have now decelerated to less than $5 billion in April.

These numbers bear watching. Whenever people conclude that the all-clear whistle has blown and banks are not going to fail there is going to be a flood of money being re-deposited into banks. That will make bank reserves swell even higher. It will give banks an additional $90 billion of zero cost deposits and the resulting $5-$10 billion of increased earnings, And it will be the signal for the next round of bank stock price increases.

I am heavily invested in financial stocks today for these reasons.

JR

The chart below shows the amount of currency held by the public through last Friday. Can you detect a pattern? When people get scared, as they are now, they pull money out of the bank, out of money funds, and out of their brokerage accounts and stick it under the mattress.

 
When this happens, the initial impact is to shrink bank reserves by draining off increases in the monetary base outside the banking system. This is important because (at least until 2 weeks ago)the monetary base was growing quite slowly. During the period 9/27/07 to 8/27/08 the monetary base increased at a 2.6% annual rate, while bank reserves increased by just 0.9%. Both are too low to allow banks to provide working capital to their growing business customers, let alone to solve a credit freeze. That’s why I have been complaining about the Fed’s sterilization policy and that’s why I have been advising the administration, in a series of White House conference calls, that the rescue plan cannot succeed unless it has the proper Fed policy to support it.

Over the past 2 weeks, of course, all this has changed. The Fed has nearly doubled reserves, from $98.3B on Sept. 10 to $166.3B on Sept. 24. It is too soon to tell if this is a new policy (i.e., if they have abandoned sterilization), or if it is a one-time hail Mary pass. It would help if the Fed would clarify this in writing.

The increase in currency holdings also highlights one more thing. I think it is dereliction of duty for policy makers and political leaders to use fear as a weapon. Can you imagine Winston Churchill, or FDR, or President Reagan intentionally scaring people? In my book, a real leader helps people remain calm in difficult situations and helps them marshall their energies to fix whatever issues need to be addressed. At least since 9/11, we have used fear as a tactic for mobilizing public support for various policies and for manipulating people’s behavior. But fear, over long periods of time, is physically and psychologically debilitating. And fear tactics undermine the public’s willingness to respond when there is a genuine problem. I can’t help wondering how much of today’s fear is a reaction to that history.
JR

I mentioned a Benjamin Franklin quote a few days ago in a story discussing the damage that has been done in history by ordinarily decent people who have become frightened by a chaotic event which has penetrated the patina of our illusion of order.

They that give up essential liberty to obtain a little temporary safety deserve neither liberty nor security. Benjamin Franklin

Franklin’s experience in both the American and French revolutions gave him a full palette of atrocities as examples of frightened man’s inhumanity to man.

These events always appear to be non sequiturs when observed from the comfort of our living rooms. The Turk threatening Venice in Othello; Plague in Spain and war with the Moors led Isabella to expel the Jews from Spain in 1492; Plague in Italy burned Savonorolla in Florence; in Italy, 2 million unemployed and 50% inflation led to food riots in 1920, the occupation of the factories by 500,000 workers in September 1920, and the March on Rome by fascist squadristi in October 1922, made 39 year old (former Socialist) newspaper editor, Benito Mussolini Italy’s youngest Prime Minister; the Great Depression triggered the election of Hitler and the Holocaust that followed. But they are not random acts; they are the inhumane acts of frightened people. Unfortunately, people will do almost anything to restore our imaginary sense of order.

History also provides examples of leaders great enough to stand up against reactionary pressures to restore both order and humanity. Thomas Jefferson, for example, acted the moment he became President to rescind the Alien and Sedition Acts, which had been passed by a fearful Congress and signed by John Adams in 1798.

There is an opportunity today to provide the same leadership Thomas Jefferson showed 200 years ago. But it will require courage to stand up to the mob, tell them it’s time to calm down, that we’re OK now, that it’s time to go back to work. And it will require selfless dedication to forego the popularity and easy political gains to be had by fanning the flames of people’s fears. We badly need that leadership today.

The American public was so frightened by the attacks on 2001 that we stand up and cheer whenever a political leader promises the return of our sense of security. This has fostered reactionary policies we have not seen since the days of Joe McCarthy. End-runs around due process and right to trial (Guantanamo), end runs around restrictions on search and seizure in the Patriot Act, the bloated Homeland Security and TSA programs, restrictions on visas of all kinds, the finan cial terrorism of Sarbanes-Oxley, and the rampages of Elliott Spitzer are the practical manifestations of our fears.

We have allowed our fears to compromise our lives and our principles in ways Benjamin Franklin would have found dangerous and destructive of ourselves. Fear is by far more destructive than terrorists. Our sense of security lives in our minds, not in our airports. That is where it will ultimately be restored. It couldn’t be soon enough.

JR