Tuesday, 25 November 2014

Andrea Leadsom.

Andrea Leadsom is a UK politician who has served on various banking committees and knows a fair amount about the subject. She took part in the parliamentary debate on money creation on 20th November. However, it would have been good if she had better acquainted herself with full reserve banking or what she calls a “sovereign money” system before speaking on the subject. I’ll deal with her reservations and questions about sovereign money (SM). Her words are in black italics, and my comments are in green.
I will touch on what we are doing to change the regulations and the culture, but first I will set out why we do not believe that the right solution is the wholesale replacement of the current system by something else, such as a sovereign monetary system. Under a sovereign monetary system, it would be the state, not banks, that creates new money. The central bank, via a committee, would decide how much money is created and this money would mostly be transferred to the Government. Lending would come from the pool of customers’ investment account deposits held by commercial banks.
Such a system would raise a number of very important questions. How would that committee assess how much money should be created to meet the inflation target and support the economy?
Answer: in much the same way as EXISTING committees of economists determine how much stimulus is suitable. Those committees are two in number in the case of the UK: the Bank of England Monetary Policy Committee and the Office for Budget Responsibility (OBR). Moreover, over the last two years we have actually had a sovereign money system in that we have implemented fiscal stimulus and followed that by QE. That comes to the same thing as government printing money and spending it (and/or cutting taxes).
If the central bank had the power to finance the Government’s policies, what would the implications be for the credibility of the fiscal framework and the Government’s ability to borrow from the market if they needed to?
The “credibility of the fiscal framework” does not inspire a huge amount of confidence or “credibility” under the EXISTING SYSTEM, in that fiscal stimulus is determined by politicians, who (as David Hume pointed out over 200 years ago) have a habit of borrowing too much rather than raise taxes, and with a view to ingratiating themselves with voters. Or at least such “credibility” was distinctly lacking until the arrival of one of the above mentioned committees of economists, namely the OBR.
The arrival of the OBR has not changed things out of all recognition of course, but most people have more confidence in committees of economists than in politicians (though of course decisions which are clearly political, like what proportion of GDP is allocated to public spending should always be left in the hands of politicians and the electorate).
What would be the impact on the availability of credit for businesses and households?
Seriously: can’t Ms Leadsom work that one out for herself? Anyway, the answer is that an SM system removes all forms of bank subsidy, thus lending costs would probably rise somewhat. But far from reducing GDP, the effect ought to be a RISE in GDP, and for the simple reason that subsidies misallocate resources (i.e. reduce GDP).
Would not credit become pro-cyclical?
Hilarious. We’ve just experienced a near disastrous episode of “cyclicality”: the credit crunch. Indeed had not governments bailed out banks with TRILLIONS of dollars of public money, the world economy would have half collapsed.
In short, SM may have its faults, but it can’t possibly be worse than the existing system.
Would we not incentivise financing households over businesses, because for businesses, banks would presumably expect the state to step in?
The VAST MAJORITY of bank lending is ALREADY devoted to “financing households” (i.e. mortgages), rather than businesses!  As to why “the state” is more likely to rescue banks that have loaned to businesses, I’m baffled. And I’m even more baffled as to why that would exacerbate the existing preference that banks have for mortgages rather than loans to businesses.
Would we not be encouraging the emergence of an unregulated set of new shadow banks?
Obviously banks will try to get round any rules, and setting up shadow banks is a possible way round rules. But that applies to ALL LAWS relating to banks. If Ms Leadsom thinks that problem will be far worse as a result of SM that other forms of bank regulation, she needs to tell us why.
In any case, I suspect most advocates of SM fully agree with the point made by Adair Turner, namely that “If it looks like a bank and quacks like a bank” it should be treated like a bank and obey banking law. In short, shadow banks should be regulated just like regular banks.
Would not the introduction of a totally new system, untested across modern advanced economies, create unnecessary risk at a time when people need stability?
That’s a completely fatuous, all purpose argument against change of ANY SORT. Steam powered railways, aeroplanes, computers, you name it were all “untested systems” at some stage.
And finally, I particularly like this phrase uttered by Ms Leadsom later in the debate. In reference to the alleged defects of SM, she said, “we would then be looking at a committee of middle-aged, white men deciding what the economy needs..”
Well the first flaw there is that WE ALREADY HAVE two committees of “middle-aged, white men” determining “what the economy needs”. To repeat, that’s the Bank of England Monetary Policy Committee, and second the OBR.
But second, Ms Leadsom manages to combine racism, sexism and ageism in one short phrase. Is that some sort of record?

Monday, 24 November 2014

A mistake by Larry Elliot.

Larry Elliot in The Guardian today questions the idea that decent capital buffers would prevent another crisis. That’s his passage: “In those circumstances it is irrelevant whether a bank’s capital buffer is 2% or 20% of risk-weighted assets. It won’t be enough when the crisis comes.”
Well never mind 2% or 20%. What about where lending entities are funded JUST BY CAPITAL, as per Laurence Kotlikoff’s version of full reserve banking. That’s a ratio of 100%. How exactly does a bank go insolvent in that scenario? It’s plain impossible. As George Selgin put it in his book “The Theory of Free Banking”, “For a balance sheet without debt liabilities, insolvency is ruled out”. (Not that Selgin advocates full reserve banking, incidentally).
Even if the ratio is 50% (as was common in the 1800s), the chance of a bank going insolvent is vanishingly small. But the moral is that the larger capital buffers are, the less likely is bank insolvency.
At 50%, the chance of insolvency is very small.
At 75% it’s verging on the impossible.
At 100%, it’s impossible to all intents and purposes.

But that's not to say that given the discovery that a significant proportion of bank loans are of the Spanish or Irish property type, there wouldn't be a bit of a recession. Given that discovery, aggregate demand would certainly fall unless government stepped in smartish with more deficit. But the important point is that BANK INSOLVENCY is ruled out, and hence threats of a collapse of the entire world economy are also ruled out. Plus there's no need for taxpayer funded subsidies or bail outs for banks. That is, given decent capital ratios, and given the above "discovery", government's attitude to banks can be, "f*ck you lot - you've c*cked it up and you can stew in your own juice. As to the decline in demand we can deal with that via GENERAL stimulus, not stimulus specifically targeted at Wall Street bankster/criminals."

Does maturity transformation achieve anything?

Maturity tansformation (MT) equals “borrow short and lend long”. It’s one of the basic activities of commercial banks.
Most economists, two of whom are listed below, think MT achieves something. In particular they think that it enables the short term savings of depositors to be “transformed” into long term loans. It seems that savings that would otherwise be unused can be usefully employed.
In fact MTing instant access accounts is a pointless activity.

Keep it simple.
Let’s start with a simple economy where there is no private bank created money. That is, there is an adequate supply of some sort of base money, perhaps gold coins or government issued fiat money. Plus I’ll assume the economy is at full employment equilibrium.  Plus I’ll assume to start with that no lending takes place. In that scenario, people and firms would maintain a sufficient stock of money to enable them to do day to day transactions. For example, wage earners would maintain a sufficient stock of money to tide them over from one pay day to the next, plus some of them would maintain a stock of “rainy day” money to deal with unforseen emergencies. Indeed, the economics text books refer to those two motives for holding money: they’re normally called the “transaction” motive and the “precautionary” motive.

Lending starts.
Now suppose people and firms start to lend to each other (via their banks) with a view to funding investments. You might think it would make sense for banks to fund loans by making use of some of the money that customers had placed with those banks. Of course that would mean that were all those customers to turn up at once and demand all their money back, banks wouldn’t have the money. But that wouldn’t matter because the chance of all customers, or even half of them, turning up at once is small.
And that of course is exactly what commercial banks do in the real world: that is, the vast majority of customers’ money which banks claim to be instantly available just isn’t there.
So MT has taken place and it seems to have achieved something: those loans have been funded with money that was apparently lying idle.

But there’s a catch as follows.
Creating or building those new investments (roads, houses, factories, etc) raises demand. And given the above assumtion namely that the economy is already at capacity, that isn’t possible without causing excess inflation.
Put that another way, to make real resources available to enable the creation of those investments, it is necessary to dissuade households, i.e. bank customers, from consuming so much. That can be done in the case of public investments by EXPROPRIATING money from bank customers in the form of tax. Or it can be done by raising interest rates, which would induce some bank customers to abstain from current consumption and place funds in saving accounts.

Current / checking account money cannot be “transformed”.
In short, current / checking account money (including the “precautionary” element) is money which each account holder WILL USE at some point in time. Thus such money cannot be MTed.  In contrast, deposit or term account money is money that the account holder is definitely given up access to for a specific period. That CAN BE MTed. Though clearly there is no sharp distinction between those two types of account.

New money.
The above can be put another way. Where a commercial bank DOES go throught the motions of MTing instant access money, it’s not actually MTing at all: it’s creating new money and lending it out. To illustrate, where £X in instant access accounts is allegedly loaned on, holders of those account still regard themselves as being the pround owners of £X, while the borrower ALSO HAS £X at their disposal. Hey presto: £X has been turned into £2X.

1. Vickers, J. (2012) ‘Some Economics of Banking Reform’. Oxford Department of Economics Discussion Paper 632. On p.5 Vickers advocates MT. He says: “banks engage in maturity transformation insofar as they ‘borrow short but lend long’. This brings huge efficiency benefits…..It is efficient because it reconciles the freedom for depositors to meet their short-term liquidity needs with the financing of long-term lending both to households (e.g. residential mortgages) and for corporate investment.”  
2.  Krugman says “I think of the whole bank regulation issue in terms of Diamond-Dybvig, which sees banks as institutions that allow individuals ready access to their money, while at the same time allowing most of that money to be invested in illiquid assets. That’s a productive activity, because it allows the economy to have its cake and eat it too, providing liquidity without foregoing long-term, illiquid investments.”

Sunday, 23 November 2014

Isabella Kaminska opines on full reserve banking – unfortunately.

I dealt with just under fifty (50) criticisms of full reserve banking (FR) here. The criticisms range between the moderately well thought out to the laughably stupid – mainly the latter.
The opponents of FR never seem to give up, and the latest clever clogs to claim they’ve spotted a flaw in FR is Isabella Kaminska in a Financial Times. She clearly knows precisely and exactly nothing about the subject. Her argument runs as follows.
She starts by making the point that central banks do not compete with commercial banks when it comes to granting loans to mortgagors and businesses. (She makes that point in a paragraph copied from a Bank of England publication. That’s the paragraph starting “The 1844 act…”.)
She then says, “This, we suggest, illustrates why Positive Money’s campaign to take the power to create money away from the banks is somewhat naive. Namely, because, a central bank with a clear-cut reputation to protect is never going to be as competitive as the private sector when “money printing” and risk is concerned. Which means, there will always be a market for some sort of entity to come in and undercut it in the private market.”
Now hang on. How is it possible to “undercut” another firm in providing some service or other, when that firm is not (as Kaminska correctly points out) actually providing that service? That is, as she correctly points out, central banks do no provide loans to mortgagors etc, so how can commercial banks “undercut” central banks there? This is nonsense.

Money creation and risk.
Next, note the way Kaminska runs “money printing” and “risk” together. The implication is that some sort of useful service is provided by that activity or combination of activities.
She’s begging the question!!
To expand on that, under the existing system, commercial banks create money when they lend, but there is no such thing as a totally safe loan or set of loans. So money creation by commercial banks involves risk. Indeed, banks have gone bust regular as clockwork ever since Roman times, a fact which seems to have escaped the notice of half the supporters of the existing banking system. Thus the existing system combines money creation with risk.
Now money is one of the basic and essential bits of plumbing that keeps the economy ticking over, so a system where the economy’s stock of money can disappear into thin air at any time is not too clever. As Irving Fisher put it, “The most outstanding fact of the last depression is the destruction of eight billion dollars-over a third-of our "check-book money"-demand deposits.”  
But there is an alternative! Indeed the alternative is already being implemented on an unprecedented scale: it’s to have CENTRAL BANKS not COMMERCIAL BANKS issue the money supply.
And there’s no risk there at least in that central banks cannot go bust.