There was a lot of liquidity preference on display at Flemington last week. The bubbly and the boutique beers were flowing. Why, there was even a dash of irrational exuberance on the betting. It was a welcome reprieve from the doom and the gloom.
Elsewhere, there is an even greater demand for liquidity preference, that is, the real stuff.
With both the Federal Reserve and the Reserve Bank of Australia furiously cutting rates to stave off recession, the old textbook adage about the asymmetry of monetary policy rings true.
It's the mantra that a central bank can pull on a string to curb a boom but it can't push on a string to reverse a slump. The focus on interest rate cuts getting us and the rest of the world out of the economic storm is therefore entirely misplaced.
In his General Theory of Employment, Interest and Money, J. M. Keynes called an extreme version of this problem, the liquidity trap. The liquidity trap can essentially take two forms.
First, the monetary authority finds that at some point it cannot push interest rates down any further because liquidity preference may become ''virtually absolute'' in that everyone prefers to hold cash rather than hold a debt or investing in a bond.
Right now, ''animal spirits'' or business expectations are overwhelmed by an avalanche of bad economic news. The profit expectations of businessfolk have become so demoralised that lower rates will not elicit any response.
Of course, it is not just the business sector that is fearful. The London Daily Telegraph reported that individual real estate agents there can, at best, sell only two houses a month despite the interest rates there having been drastically lowered. We are beginning to see the same pattern here with auction clearance rates falling.
Why buy if there is likely to be further downward pressure on prices? And it is falling prices, or deflation, that gives liquidity preference biting force.
In America, the nominal interest rate is near zero but there is timidity in lending behaviour. Since people do not expect to make great returns on realty, shares or tangible capital goods they keep their assets in liquid form. A Sargasso Sea of dead cash results. Money reverts to becoming frozen desire.
While a central bank can certainly inject liquidity into the monetary system via financial intermediaries, if they, in turn, are unwilling to lend, then we are still locked into a liquidity trap situation.
Monetary reinflation will simply not work unless banks are willing to lend and there is some accommodating business and consumer confidence.
The last time the liquidity trap appeared in an industrialised economy was in Japan a few years ago when it was going through a deflationary cycle following the bubble economy. Before he became chairman of the Federal Reserve, Ben Bernanke went off to Japan to see the problem at first hand.
A student of the Great Depression, Bernanke gave a controversial speech in which he recommended full-scale monetary reflation to banish the Japanese economy of the deflationary psychology it was enveloped in.
Bernanke noticed how deflation can undermine monetary policy when the cash rate hits zero with the central bank out of ammunition. Moreover, deflation makes the real value of debt even if issued at 0 per cent rates increase in weight. That is, you have to pay back the loan when the real value of money is increasing.
Not an immodest chap, Bernanke believes he has found a way out of the liquidity trap. A lifetime of academic research before he became a central banker convinced him that all depressions are initially caused by monetary contraction.
The prescription, then, is to not just reduce the cash rate to zero, but the central bank should intervene in the Forex market to effect a depreciation of the currency.
Lastly, there should be monetary and fiscal policy loosening in tandem. He favours tax cuts, financed by printing up the money so there is no increase in government debt.
It's a prescription that has resulted in him being dubbed ''Helicopter Ben'' by Wall Street operators in the sense that it's akin to throwing bundles of cash out of a helicopter.
The Americans will probably have to do this but only when Barack Obama gives the nod. This is some time off, meaning that America and the rest of us will have to stew in our own juices.
It is only next year that we will be allowed to go on a Bernanke bender.
Alex Millmow is president of the History of Economic Thought Society of Australia.
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