Monday, 30 November 2015
Richard Murphy has thought of a new form of QE: yes – yet another.
First there was conventional QE (printing money and buying private sector assets, mainly government debt held by the private sector).
Then there was “Green Infrastructure QE”. Then there was Peoples’ QE.
And now – roll of drums – there’s “Climate QE for Paree”. That’s a cute name: guaranteed to fool most people.
The first important point to note is that printing money and increasing public spending was first advocated (far as I know) by Keynes in the early 1930s. It would be nice if Murphy gave credit where credit is due and gave himself correspondingly less credit.
As for the idea that we should spend more on infrastructure and/or climate change related stuff, I’m all for that. I’d like to see the price of petrol and diesel doubled tomorrow.
However, the idea that we should print money and spend that on infrastructure and/or global warming reduction confuses two issues as follows.
1. “Print and spend” is a method of imparting stimulus: desirable if the economy is at less than capacity, or put another way, if we don’t have full employment. Or put a third way, print and spend is desirable if unemployment is above NAIRU, but not otherwise.
Also, THERE ARE other ways of imparting stimulus, for example interest rate cuts, or (as proposed by market monetarists) buying up even more privately held assets, like stock exchange quoted shares. I don’t favour that market monetarist idea, but it’s a possibility, and if for some reason someone proves that method of imparting stimulus OTHER THAN print and spend are the best ones, then that’s the end of Peoples’ QE or Climate QE for Paree.
2. There’s the question as to how much we ought to spend on infrastructure and global warming reduction measures. Now there’s absolutely no reason to think the optimum amount to spend on those two will necessarily equal the optimum amount of “print and spend” that’s needed for stimulus purposes.
To put all that another way, it’s always possible that households and/or businesses go into a fit of irrational exuberance, and demand rises dramatically, in which case no stimulus would be needed at all – in QE form or any other form. What then happens to anti global warming expenditure?
To summarise, the logical procedure is to decide first how much to spend on infrastructure, global warming reduction, and then fund that out of tax, borrowing or “print and spend”: it really doesn’t matter which. Second, decide every month or so whether stimulus needs adjusting (something the BoE MPC already does).
Economists have a specific term (which I’ve forgotten) for funding particular forms of spending from particular forms of tax (e.g. funding the Navy just from income tax) and that idea is widely regarded by economists as nonsense. However that idea can sometimes be politically expedient, because it appeals to the untutored.
As for funding a type of spending (e.g. global warming reduction stuff) from print and spend, that’s even worse because in some years no stimulus is needed, in which case the source of funding for global warming reduction expenditure dries up altogether.
Sunday, 29 November 2015
When a widget maker fails, government doesn’t rescue of those who funded the widget maker, and quite right. Bankruptcy of widget makers indicates resources should probably be allocated to something else. But if a bank fails, government rescues those who funded the bank, i.e. relevant depositors. Bank failures probably indicate that too much borrowing and lending is taking place, i.e. that there’s too much debt. Deposit insurance thus helps ensure that that misallocation of resources continues.
Governments only have a motive for the above nonsense where two of the basic activities of banks can be combined, namely first lending, and second, accepting deposits which are supposed to be totally safe. Banks force governments to assist the first activity by forcing them to underwrite or insure the second.
The alternative and better option is to separate lending from deposit accepting. Under that arrangement, only deposits made at the central bank or put into government debt are insured by government. Plus under that “separation” arrangement lending is funded (as in any normal corporation) by shareholders, bondholders and the like (who can lose their money). There again, there is no need for state organised insurance.
Friday, 27 November 2015
This article entitled “Money Creation in the Modern Economy” (by sundry Bank of England authors) claims that loans are the source of commercial bank created money. Plenty of other literature makes that claim. As the opening sentence of the BoE article puts it, “This article explains how the majority of money in the modern economy is created by commercial banks making loans.” There is actually a glitch in that claim, as follows. (The BoE authors do say that there are reservations to be made to the “loans create money” idea, but not everyone pushing that idea makes the appropriate reservations.)
Obviously when a commercial bank grants a loan to some individual / borrower, and the relevant money is spent, that money ends up in the bank account of some other individual or individuals.
However, let’s assume, to keep things simple that the economy is at or near capacity / full employment. In that case, the inflationary effect of spending the new money must be matched by an equal amount of “spending abstinence”, i.e. saving by others, else excess inflation ensues. And if those others do not intend to use their new stock of money for a significant period, chances are they’ll put it into a term or savings account. At least if they’ve got any sense, that’s what they’ll do (with a view to earning more interest).
But the longer money is locked up for, the less money like it is. In fact when it comes to measuring the money supply, many countries draw the line between money and non-money at somewhere around the two month point. That is, if money in an account can be accessed within two months it is counted as money; if not, it isn’t.
Even if recipients of the new money DON’T put it into a term / savings account, i.e. assuming they put it into a current / checking account, that new money, again, cannot be spent, else inflation rears its ugly head. Thus that new money is effectively not money: it’s more in the nature of a long term loan to the relevant bank (which in turn makes possible a long term loan to the borrower we started with above).
Indeed banks recognise that a proportion of the money in current / checking accounts is in effect a form of long term saving: that’s one reason why banks know they’re safe lending that money on.
As to how recipients of new money are induced not to spend their new stock of money, the central bank might raise interest rates so as to induce more saving and forestall the inflation that would otherwise occur. But it’s possible those recipients increase their saving VOLUNTARILY.
In the above sort of scenario, commercial banks are simply engaged in their traditional activity, namely intermediating between borrowers and lenders.
Unemployment is above NAIRU.
In contrast to the above assumption that unemployment is above the level at which inflation gets serious (NAIRU), if unemployment is at NAIRU, i.e. the economy is not at capacity, then loans would indeed create money, i.e. the central bank would allow that to happen.
“Borrowers” owe banks, or vice-versa?
Another glitch in the “loans create money” idea is that when commercial banks create money, it is arguably not loans that do the creating, and for the following reason.
In an economy where people wanted a form of money (created by commercial banks), but didn’t want long term loans, people would simply deposit collateral at banks, have banks open accounts for them, and have banks credit money (created out of nothing) to those accounts.
But that process does not create any sort of long term debt. In fact banks, if anything, are indebted to bank customers, rather than the other way round. Reasons are thus.
Bank X would owe customer Y the collateral deposited (i.e. the bank must return the collateral at some stage). Second, there’s the artificial debt owed by the bank to the customer, that debt commonly being known as “money” (if you have $Z in your bank, the bank owes you $Z). And third, customer Y owes a debt to the bank in that Y undertakes to repay the newly created money to the bank at some state (maybe not till Y dies). So that’s two debts owed by the bank to the customer, and one debt owed by the customer to the bank!
Of course if a bank customer spends a significant amount of their new stock of money and simply leaves their account with a smaller balance than the initial balance, that constitutes a loan by the bank (and other depositors) to the customer in question. But on the above assumption, namely that people are simply after a form of money, not long term loans, than no customer would do that: the balance on each customer’s account would bob up and down around the original balance. E.g. the balance would tend to be ABOVE the original balance when the monthly pay cheque arrives, and BELOW the original balance three or four weeks later.
Assuming an economy is at or near capacity, then loans do not result in money creation. Second, where money creation takes place, it’s not long term loans which create that money
Thursday, 26 November 2015
If bank regulators think that some level of bank capital, say 10%, means that the chance of a bank failing is vanishingly small, then it follows that the remaining 90% of bank funders (i.e. debt holders) run no risk, even if there’s no deposit insurance. But if those 90% were converted to shareholders, they’d also run no risk. Thus those shareholders wouldn’t charge any more for funding the bank than the latter debt holders. Ergo, once a bank has enough capital to make failure near impossible (e.g. the latter 10%) the capital ratio might as well be raised to 100%. Doing that won’t make any difference to the cost of funding the bank.
Wednesday, 25 November 2015
The opening sentence of this Financial Times article reads, “Mark Carney signalled that the Bank of England stands ready to increase capital requirements for banks temporarily as a way to curb excessive lending while interest rates stay low.”
First, what’s the point of a cut in interest rates (designed to encourage lending) and then negating that with higher capital requirements? Bit like driving a car with the accelerator and brake pedal permanently on the floor.
Second, it’s a popular myth that because bank shareholders demand a higher return than debt holders, that therefore increasing the capital ratio will increase the cost of funding the bank (or indeed any corporation). Shareholders demand a higher return because in the event of trouble, their hair gets cut first. However if the amount of equity is say doubled, then the risk PER SHARE his halved: thus there’s no effect on the total cost of funding the bank.
In fact taking that to the extreme, and comparing a bank funded just by equity as compared to one funded just by debt, in theory there’d be no difference in funding costs because the chance of funders losing X% of their stakes is exactly the same in both cases.
To illustrate, if it suddenly transpires that the assets of a bank are worth half their book value, then in the case of the equity funded bank, the shares will drop to half their initial value (on the simplifying assumption that the value of shares is determined just by the value of the underlying assets and not by the bank’s perceived prospects).
As to the debt funded bank, the bank will be wound up and the assets sold off. Debt holders will get back – wait for it – half their initial stake in the bank!
The pre-crisis house bubble.
Third, the pre-2007/8 crisis bubble took place DESPITE interest rates that were higher than today’s. Thus there is not much reason to suppose that low interest rates have much effect on bubbles.
Of course there’s an appealing logic in the idea that low rates cause bubbles. It runs something like, “Low rates induce people to borrow more, which pushes up house prices”.
Well that “borrow more when rates are low” phenomenon is entirely predictable and doesn’t constitute a bubble. A bubble is a feed back loop which can take off at any time. It runs something like this. House prices rise, which induces everyone to think they will rise further, which induces everyone to invest more in housing, which causes house prices to rise even further.
That can happen regardless of whether interest rates are high or low. To repeat, it actually did happen just prior to 2007.
Fourth, bank capital should be at a level that means there is a vanishingly small possibility of taxpayers having to rescue banks. Reason is that any such rescue constitutes a subsidy of banks.
Now if bank capital is actually at that level or above it, then raising bank capital further will not bring additional safety. On the other hand if bank capital is sufficiently low that THERE IS a possibility of banks being rescued, then bank capital should sod*ing well be raised anyway.
Fifth, if low rates do in fact promote bubbles, that’s just extra support for the idea pushed by Positive Money and others (me included) that interest rate adjustments are not a clever way of adjusting demand. Interest rate changes only influence the behavior of borrowers and lenders. A significant proportion of households do not have mortgages, nor do they lend significant amounts. Same goes for some employers. Why should the latter lot of households and employers be excluded when stimulus is the order of the day?
All in all, Carney’s idea is a litany of false logic. Though to be fair, he is trapped in a system in which false logic reigns supreme, so it’s not entirely his fault.
Tuesday, 24 November 2015
I dealt with one paper by Malcolm Sawyer and a co-author here recently. He actually published another paper at much the same time (June of this year) on the same topic. That topic was full reserve banking (FRB), and the title of the second paper is “The Scourge of Green Monetarism”. The latter is examined in the paragraphs below.
The word “green” is a reference to the fact that the UK’s Green Party has adopted the FRB ideas of Positive Money. Some points are common to both papers, so I’ll ignore those, as I have already dealt with them.
There is nothing wrong with Sawyer’s p.1, where among other things he introduces two terms: exogenous and endogenous money. The former is central bank created money or “base money” as it is sometimes called, while endogenous money is commercial bank created money.
Demand for and supply of money wouldn’t match?
At the top of p.2 Sawyer says that under FRB (i.e. an economy where only government or central bank created money is allowed) there’d be “..a mismatch between the amount of money which the central bank creates and the amount of money which the public is willing to hold.”
Well I have news: the above sort of mismatch arises under the existing system.
For example market monetarists like David Beckworth often claim (I think correctly) that the recent recession arose to a significant extent out an excess desire by the private sector to save money. But that in turn is just a repetition of Keynes’s “paradox of thrift” point.
So to the extent that the last seven years or so of excess unemployment are attributable to the above mismatch, FRB could hardly be worse than the EXISTING SYSTEM.
FRB resembles monetarism?
The second part of p.2 is the start of Sawyer’s claim that FRB closely resembles monetarism. As he puts it, “FRB shares many similarities with the ill-fated proposals of Friedman (1960) and others for the achievement of a specified growth rate of the stock of money.”
Well one problem with the latter claim is that if the state creates new money and spends it, and/or cuts taxes, there is an obvious monetary effect: the money supply rises. But there is also a fiscal effect: public spending rises and/or taxes are cut. Thus Sawyer’s claim that PM’s ideas amount to pure monetarism is very questionable.
Annual money supply increases.
A second problem is that a basic element of monetarism, at least a la Milton Friedman, was that it envisaged a small and fixed annual increase in the money supply. In contrast, PM advocates nothing of the sort. PM advocates that (much as under the existing system) stimulus should be varied from year to year dependent on the circumstances: e.g. whether there is excess inflation or whether the economy is in recession.
Mild monetarism is widely accepted.
Third, as distinct from monetarism a la Friedman, monetarism in a milder form is widely accepted in economics. That is, it’s widely accepted that the size of the monetary base has some sort of effect on inflation and output, as Robert Mugabe so ably demonstrated.
Why was QE implemented? Because the authorities thought that if the holders of government debt were given base money instead, there’d be some sort of stimulatory effect. Thus in that PM claims the amount of base money in private sector hands has some sort of stimulatory effect, that claim is completely uncontroversial.
FRBers ignore cost push inflation?
Page 6 of Sawyer’s paper then makes this bizarre claim:
“The FRB approach retains the monetarist perspective that the growth of the money supply (however defined) can control the rate of inflation, and that inflation is a money demand phenomenon which is to be controlled through manipulation of demand (and in the monetarist perspective through control of the money supply). Hence it ignores any role for cost-push inflation and imported inflation, and is willing to accept, if required, the reduction of employment in order to constrain inflation.”
The first of the latter two sentences just repeats the idea that there’s something wrong with the idea that the money supply has some sort of effect. To repeat, that idea is entirely uncontroversial.
As for the idea that because you think the money supply has some sort of effect that therefore you are ignoring “cost push” and “imported” inflation, that’s just nonsense. The Bank of England clearly thinks the size of the money supply has an effect: that’s why it implemented QE. Plus the BoE, as is widely appreciated, has paid careful attention in recent years to the extent to which inflation is cost push. Indeed, it would be a dereliction of duty on the part of the BoE if it ignored the possibility that inflation is partially cost push.
As for the idea that about “willing to accept, if required, the reduction of employment in order to constrain inflation”, it’s widely accepted that there is a trade-off between inflation and unemployment: i.e. that idea is not peculiar to FRB.
Next, Sawyer says “The full reserve proposals are designed to place the stock of money under the direct control of the central bank.”
Not strictly true. Under FR (at least as proposed by Positive Money), the stock of money is controlled by SOME SORT OF committee of independent economists. That COULD BE an existing central bank committee. But it might just as well be an entirely new committee, or some committee in the Treasury.
Of course that’s a minor blemish in Sawyer’s paper, but there seem to rather a large number of blemishes, large and small, in Sawyer’s paper.
Next, Sawyer says, “The purpose of the control of central bank issued money is to influence, if not set, inflation and output. This assumes that the central bank is indeed able to control its issue of money, and that the money issued by the central bank will be placed in transactions accounts…”. Wrong again.
It is extremely unlikely, given a money supply increase, that every single person in the country with a bank account would put all of their share of a money supply increase into either their transaction account or their investment account. Likewise it is extremely unlikely that given an increase in the money supply under the EXISTING SYSTEM, the whole of that increase would be put into current/checking accounts rather than deposit/term accounts. (The latter two types of account, incidentally are very roughly the equivalent of the transaction and investment accounts under PM’s FRB system).
But even if 100% of a particular money supply increase did go into investment accounts, that would not, contrary to Sawyer’s suggestions, destroy the stimulus effect of the extra money. Reason is that more money in investment accounts would tend to cut interest rates which would encourage more investment, and that is stimulatory.
Sunday, 22 November 2015
Malcolm Sawyer and Giuseppe Fontana published a paper a few months ago entitled “Full reserve banking: More ‘Cranks’ than’ Brave Heretics’”.
As regards the insult “crank” (which is repeated several times in the text of the paper), Sawyer and Fontana (S&F) ought to have thought a bit more about who they’re insulting before firing ahead with the insult. Reason is that the advocates of full reserve banking (FRB) are not limited to the ones which S&F concentrate on, namely Positive Money and the New Economics Foundation. (The latter two can certainly be described as “unorthodox”, though “crank” is going too far.)
S&F’s real problem is that other advocates of FRB include Milton Friedman, John Cochrane (currently professor of economics in Chicago), Lawrence Kotlikoff (currently professor of economics in Boston) and the economics Nobel laureate, Merton Miller. Are they all cranks as well? Since S&F don’t mention that the latter four’s acceptance of FRB, I conclude that S&F don’t know about the latter four’s support for FSB, and thus that S&F are not up to speed on this subject.
But obviously I need to substantiate the latter criticism of S&F, so here goes.
S&F’s paper is actually riddled with mistakes. I’ll deal with them in the order in which they appear in the paper. The first two mistakes are not desperately important. They’re under the headings “Mistake No 1” and “The Chicago school” just below, and readers can skip those if they like. But when an author makes numerous minor errors, that is an additional reason for thinking he has a poor grasp of the relevant subject, so I’ve included the minor mistakes.
Incidentally, Sawyer produced another paper on the same subject in the same month as the one dealt with here. That other paper is entitled “The Scourge of Green Monetarism”. Several arguments and points are common to both papers. I’ll deal with the points that are unique to the “scourge” paper in the near future.
The first paragraph of the paper deals with the various phrases used to describe FRB. As the authors put it “A range of terms are used such as 100 per cent reserve banking, positive money, sovereign money as well as full reserve banking…”.
As to “positive money”, that’s the name of an ORGANISATION: called “Positive Money”. I’ve read a huge amount about full reserve banking, and have written a book on the subject, but I’ve never seen the phrase “positive money” used as a synonym for “full reserve banking”.
The Chicago school.
Next, the second half of p1 says the paper will concentrate on the ideas put by Positive Money (PM) and New Economics Foundation authors (PM & Co), but not the ideas of the Chicago school. As S&F put it, “….in this paper we do not further consider those coming from the ‘Chicago proposals’ tradition.”
Well there’s a problem there, which is that PM & Co specifically say, “Our proposal is similar in spirit to and modernizes those put forward by the leading monetary economists of the twentieth century, namely Irving Fisher (1936), Milton Fiedman (1960), and James Tobin (1987).” Now Fisher was very much a member of the Chicago school: at least the differences between Fischer’s ideas and the Chicago school’s were minimal.
The latter quote comes from the submission to Vickers made by PM, the NEF and Richard Werner.
On p.2, S&F repeat a criticism of FRB that has been made a dozen times by others, namely that FRB is only concerned with clearing banks or what might be called “regular banks”, and not with shadow banks. As the authors put it, “The FRB proposals only relate to clearing banks, and not to the rest of the financial system.”
That is a simple minded criticism of FRB and the answer is equally simple, namely that any organisation which acts in a bank like manner, whether it calls itself a bank or not, should obey the same regulations. As Adair Turner put it, “If it looks like a bank and quacks like a bank, it has got to be subject to bank-like safeguards.”
If shops selling alcohol were allowed to ignore the law on alcoholic drinks as long as they called themselves “hardware stores” or “wedding dress” shops, the law would look an ass.
To summarise, if bank regulations apply only to organisations that CALL THEMSELVES banks, then those regulations would be a farce, as S&F rightly suggest. The solution is to apply the above “Turner principle”.
Net financial assets.
On p.4 (item (i)) S&F try to challenge a point made by FRB advocates namely that the existing bank system enables private banks to profit from seigniorage.
As part of their argument, S&F distinguish between commercial bank created money and central bank money (i.e. “base money”). They point out that the latter is a net asset as viewed by the private sector, while the former is not. (That incidentally is a point which every MMTer is very well aware of).
S&F conclude from that that “Thus, there is no seigniorage for banks..”
OK, let’s illustrate this with the simplest possible example. Joe Bloggs wants some money so he deposits collateral at a bank, which in turn credits £X to Bloggs’s account. Bloggs then spends it and obtains £X of goods in return. Now ASSUMING that that £X of new money continues to circulate as money, i.e. assuming holders of the money never demand anything back from Bloggs or Bloggs’s bank, then Bloggs and his bank have obtained £X of real goods in exchange for bits of paper, or mere book – keeping entries. Or if you like, Bloggs makes a profit, with the bank taking it’s cut. That’s seigniorage.
In contrast, if the holders of the new money eventually want something back from Bloggs and Bloggs’s bank, and they’re only prepared to hold it if paid interest, then that’s a case of the bank intermediating between lenders (holders of the new money) and a borrower (Bloggs). No seigniorage is involved there.
Intermediation and seigniorage.
Later on the same page and still under item i), S&F say “The profits for banks come from the difference between the rate of interest on loans (with allowance for default) and the costs of deposits including operating costs and any interest payments.”, the suggestion being that the latter is the source of bank profits, not seigniorage.
Well the answer to that is that those two sources of profit are not mutually exclusive: that is, there is nothing to stop banks making a profit from BOTH activities, and that’s in fact what they do (a fact alluded to in the above “Bloggs” illustration.)
Base money doesn’t cause inflation?
Under item ii) on p4, S&F claim that advocates of FRB are wrong to claim that the amount of money printed by the central bank influences inflation. As he puts it “This leads the FRB school into the mistaken belief that inflation can be controlled by the rate of increase of the money supply.”
Well the words “Robert” and “Mugabe” spring to mind. The idea that the amount of money issued by the state has no effect on inflation is straight out of la-la land. Moreover, those CURRENTLY IN CHARGE of western economies (who are not advocates of FRB for the most part) clearly also think the amount of base money in circulation has some sort of inflationary and output increasing effect: that’s why they’ve run large deficits and implemented QE (all of which boils down to much the same as the FRB idea, namely have the state print money and spend it in a recession).
Incidentally, S&F shouldn’t strictly speaking use the phrase FRB in that as they say, they are concerned specifically with PM & Co’s VERSION of FRB, not FRB in a more general sense, i.e. a sense that includes the proposals of the Chicago school, (never mind Milton Friedman or Lawrence Kotlikoff’s versions of FRB). But that’s a minor blemish in S&F’s paper, and it’s a blemish I’m also guilty of in this article. The blemish is certainly minor if, as I claimed above, there is not much difference between the various versions of FRB.
The stock of money.
Next, (p4, item iii)), S&F accuse FRB advocates of claiming that commercial banks alone decide the size of the money supply, i.e. that non-bank entities (e.g. households) have no say in the matter. As he puts it “The amount of money will adjust to that which is required for these transactions purposes. Thus it is not correct to say, as the FRB advocates maintain, that the amount of money is solely determined by the banks…”.
My answer to that is that far as I know advocates of FRB all aware that if households have more transaction money than they need, they’ll tend to dispose of the surplus. I.e. it’s pretty obvious they’ll do a variety of things with that surplus, e.g. use it to repay loans, put it into term accounts, buy stock exchange investments and so on. S&F don’t actually cite any FRB advocates who claim the above obvious nonsense.
Would FRB enhance financial stability?
Page 6 sees the start of a section entitled as above.
S&F say, “The first, and perhaps obvious, point to make is that the FRB proposals would only directly affect a small, if important, part of the financial system. It would impact on the creation of money and hence on banks narrowly defined, but not directly on the role of banks as financial intermediaries between savers and investors..”
My answer to that is “point taken”. However, FRB advocates do not claim that FRB would totally eliminate booms and busts. But, as S&F say, FRB does deal with one factor that contributes to the problem, namely that banks create and lend out money like there’s no tomorrow in a boom.
Ignore private money creation?
Next, and still on the subject of financial stability, S&F make this bizarre claim: “In our discussion here it is not necessary to consider the causes of a single bank failure, often arising from corruption and incompetence, and whether such failure that can be attributed to its role as money creator.”
Well it is precisely the fact of issuing money that makes banks vulnerable and contributes to financial instability!!!!!!
Money is a liability of a bank which is fixed in value (inflation apart). In contrast, the assets of banks (the loans and investments it makes) can turn out to be worth a lot less than book value. Think Spanish and Irish property loans. At that point, the relevant bank is insolvent, or likely to be insolvent.
In contrast, if the liabilities of a bank are VARIABLE in value, e.g. if a bank is funded just by shares, bonds that can be bailed in or something like that, then insolvency is impossible. Plus shares, bonds and the like are not money. Thus (to repeat) it is precisely the fact of issuing money that makes commercial banks vulnerable, as indeed is suggested by Douglas Diamond in the abstract of this paper. As he puts it and in reference to banks’ liquidity or money creation activities, “We show the bank has to have a fragile capital structure, subject to bank runs, in order to perform these functions.”
The solution to that problem as John Cochrane explains is to dispose of the money on the liability side of bank balance sheets, and replace it with what he calls “non runnable” debt (e.g. shares).
Taxpayers to the rescue!!!
S&F than say “As an aside it could be noted that any liquidity issues can be readily dealt with by the central bank as lender of last resort.”
Well of course!! If you’ve got a sugar daddy willing to come to your rescue it doesn’t matter how incompetent you are. And if you want a phenomenally rich sugar daddy, what better than a central bank with the freedom to print limitless amounts of money and backed by taxpayers? Problem is that that constitutes a subsidy of banks, and subsidies do not make economic sense.
Incidentally it could be argued that central bank / government assistance for commercial banks CAN BE implemented on a commercial basis, in which case there would be no subsidy involved. Indeed, the FDIC is self-funding. But the FDIC only caters for small banks. When it comes to large banks or a series of large banks, state assistance is the only option that that assistance JUST ISN'T offered on a commercial basis: politicians would far rather quickly paper over the cracks in the bank system (the source of much of the money for politicians’ election expenses) than have banks face brute commercial reality and fail.
Second, I go into the subsidy question in more detail here.
How long would FRB last?
The fourth section of Sawyer’s paper is entitled as just above. He argues basically that banks would circumvent the rules of FRB. There are numerous answers to that point, as follows (and numbered).
1. FRB does not aim to totally eliminate all forms of privately created money. For example most FRB advocates (in my experience) favour local currencies like the Bristol pound.
2. There is a MAJOR PROBLEM facing any bank or similar entity trying to circumvent the rules, which problem S&F don’t mention. It’s as follows.
The ease with which money can be issued is related to the size of the entity that issues it. To illustrate, plastic cards issued by or cheques drawn on well known banks are widely accepted. In contrast, IOUs issued by some medium size City of London hedge fund are completely useless for 99% of transactions outside the City of London, e.g. shopping at supermarkets.
Plus, while it may be hard to keep an eye on what every small shadow bank or hedge fund is doing, it’s relatively easy for the authorities to see what the largest banks (regular and shadow) are doing. Thus keeping tabs on the vast bulk of the potential sources of privately issued money shouldn’t be difficult.
3. S&F assume that FRB advocates claim that money in deposit or term accounts where access takes 7 or 14 days is not counted as money. Well if S&F are arguing that money available in 7 days is effectively the same as instant access, I quite agree. But I’ve no idea where S&F get that 7-14 days from. Two or three months is the time normally cited I my experience. Plus that two or three months is a common dividing line between money and non money used by several countries around the world when measuring their money supply.
4. The rules of FRB are simplicity itself compared to Dodd-Frank. And if you want an example of useless bank regulations, look no further than Dodd-Frank. As Richard Fisher, former head of the Dallas Fed, put it, “We conclude that Dodd-Frank has not done enough to corral “too big to fail banks” and that, on balance, the act has made things worse, not better.”
5. If S&F are trying to claim banks haven’t circumvented EXISTING regulations to any great extent, than that’s just a joke. In the US, banks have had to pay a good $100bn in fines for various crimes. Thus if banks DO CIRCUMVENT the rules to some extent under FRB, the extent of circumvention could hardly be worse than under the existing system.
Budget deficits and money creation.
S&F’s fifth section is entitled as just above, and they make the bizarre claim that “The full reserve banking proposals in contrast constrain government expenditure through setting down a rule as to how much money can be created.”
As PM & Co make clear, under FRB government is free to raise tax by any amount it likes and spend the relevant money. Indeed the latter “tax and spend” decision is quite clearly a POLITICAL decision and it would be wholly wrong for a central bank (or PM’s “Money Creation Committee”) to interfere or in any way influence that decision.
Indeed, that point is so obvious that (to repeat) it is bizarre that S&F think the likes of Positive Money or Richard Werner would be unaware of it.
S&F then repeat the above ridiculous point several times, e.g. a few sentences later they say “…if the growth of the money supply was on track to exceed the target, then the central bank would be forced to deny financing for government expenditure.”
The answer is (to repeat) that under the PM/Werner/NEF system, governments are free, as they are now, to increase “government expenditure” by any amount they like and by collecting extra tax.
What if there’s too much stimulus?
The first half of S&F’s p.14 claims that under FRB whoever decides on how much new money to create (i.e. how much stimulus there should be) might get it wrong. In particular, they might create too much new money in which case the private sector would “bid up prices”, i.e. inflation would ensue.
Well of course that’s a possibility! But are S&F trying to suggest that the authorities under the EXISTING SYSTEM always gauge the amount of stimulus correctly? Any idea that the amount of stimulus after the 2007/8 crisis was adequate given the seven years of excess unemployment that came after that crisis is just a joke. And remember that that crisis was largely the result of a chronic bank system.
If FRB is going to improve on the existing system, frankly it doesn’t have a very high bar to surmount: it could hardly be worse than the existing system.
Fiscal policy is “subordinate”?
In the second half of p.14, S&F claim that under FRB fiscal policy become “subordinate” to monetary policy, and that that is highly undesirable. In the authors’ words:
“The second point is the intimate link between the budget deficit and the change in the stock of money. It then becomes important as to whether the budget deficit determines the change in stock of money or whether the change in the stock of money determines the budget deficit. Under the FRB proposals it is clearly the latter. The central bank then imposes a target growth for the stock of money for the coming period (say year), and that in turn imposes a target for the budget deficit. Thus fiscal policy becomes completely subordinated to monetary policy.”
The reality is that under PM & Co’s FRB system, monetary and fiscal policy are joined at the hip, and there is no clear reason for saying that one is subordinate to the other. That is, if one implements stimulus by creating new base money and spending it, there is an obvious monetary element there: the money supply rises. But there is also an obvious fiscal element, namely that public spending rises (and/or taxes are cut).
Frankly I couldn’t care less which of those two effects is dominant, or whether the effect of the two is the same. And nor (far as I know) does PM. The important point is that as long as one of them works, then stimulus is effected, and unemployment falls.
On p.15 S&F claim that FRB would prevent the automatic stabilisers from working. Well that depends on the rules and conventions governing the money creation process.
Clearly if the rule was that the authorities shall decide how much new money shall be created and spent over the next year REGARDLESS of the arrival of a recession in that year, then FRB would indeed thwart the automatic stabilisers.
However, a more sensible rule – and it doesn’t take a genius to work this out – is that the authorities decide how much new money to create and spend on all items OTHER THAN automatic stabiliser items (like unemployment benefit). I.e. government would have freedom to spend more on unemployment benefit if the number of unemployed rose.
An alternative would be for the central bank or Money Creation Committee to keep an eye on the number of unemployed and adjust the amount of new money to create accordingly. That’s what might be called a “semi-automatic” system.
To summarise, S&F’s criticism relating to automatic stabilisers is one that is very easily dealt with.
Debt free money.
The sixth and final section of S&F’s paper entitled “Debt free money”, tries to cast doubt on the claim by Positive Money that base money is “debt free”. Unfortunately S&F don’t add anything of any interest to the debate on this topic.
It is widely recognised, and not just by FRB advocates, that money created by commercial banks is not debt free in the sense that for every dollar created, there is a dollar of debt. In contrast, base money is an asset as viewed by the private sector. Thus PM are right to make that point. MMTers (perhaps another lot of “cranks” in the eyes of S&F), often make the same point.
S&F also make the following not too clever point. “Hence the creation of money raises the net financial assets, and carries the implication that the more money is ‘printed’ the better off (wealthier) people will feel. Yet there is no increase in the capacity of the economy to produce.”
What – so printing bits of paper with £10 stamped on them doesn’t automatically cause factories complete with associated machinery to appear from nowhere? Did Positive Money ever say that the latter magic apparition would actually occur once the printing presses start rolling? Not far as I know.
The basic purpose of creating new money and spending it (and/or cutting taxes) is to raise demand, and that in turn (where there is inadequate capital investment) will cause office blocks to be erected, factories to be built and so on.
As I said, there is nothing of substance in this sixth and final section.