Saturday, 31 January 2015
I’m getting tired of people who weep and wail about austerity in Greece – unless the weepers and wailers have some nice simple solution to the problem, in which case I’m all ears.
The popular chant “austerity doesn’t work” is fatuous. That chant doesn’t begin to solve the basic problem.
For the benefit of the uninitiated, the basic problem is as follows, and it’s quite simple. If you just stop weeping and wailing for a minute, it’s easy enough to grasp.
If a country in a common currency area becomes uncompetitive, it’s external balance of trade deteriorates and it runs into debt. For a country with its own currency, that problem is solved by devaluing its currency. E.g. the UK’s currency fell 25% in value in 2008, and no one I know personally even noticed.
In contrast, for a country WITHOUT its own currency the only real option is to cut wages and profits in money terms. That’s called “internal devaluation” and it comes to the same thing as the above “regular” devaluation. And just like regular devaluation, there isn't a big effect on living standards in the relevant country in that the above mentioned wages and profits are themselves a big constituent in the cost of goods and services consumed in the relevant country.
Unfortunately the only really effective way of cutting those wages and profits is to cut aggregate demand in the relevant country: i.e. have a period of deficient demand, and that means excess unemployment – possibly lasting for many years.
And that is a HUGE DEFECT in common currencies. That’s the basic problem.
Moreover, there is no absolute guarantee that regular devaluation or internal devaluation will work. If the elasticity of supply and demand for a country’s exports and imports are sufficiently low, neither form of devaluation will work. Indeed Wynne Godley claimed that that was the case for the UK about twenty years ago. And if neither form of devaluation works, the only remaining solution is mass emigration from the relevant country, and that to a significant extent has been the solution for Greece for many decades. And if emigration goes on for long enough, obviously the country just becomes an area that specialises in “extensive agriculture”: that is (like agriculturally unproductive areas of Australia) where large amounts of land are used in combination with few other in puts like labour or machinery or fertiliser.
A popular alleged solution for Greece is debt forgiveness or a debt jubilee. Unfortunately that simply kicks the can down the road. It completely fails to deal with the above competitiveness problem.
In contrast to the above fatuous non-solutions, one possibly realistic solution recently suggested by Simon Wren-Lewis (Oxford professor of economics) is to organise a MODERATE increase in unemployment in uncompetitive countries, rather than the sort of catastrophic levels of unemployment we currently see in Greece. As Wren-Lewis points out, it is possible that the fall in wages, profits and prices in the problem country would be almost as fast as where the unemployment level is in the “catastrophic” range.
But the disadvantage there is that an increase in demand is involved which means the country draws in more imports which means it goes further into debt .
My proposed solution.
Another solution which I suggested long ago is as follows.
As pointed out above, regular devaluation can take place overnight, whereas internal devaluation involves years of pain. However, IN THEORY it would be possible to organise a more or less overnight internal devaluation. One would have to get almost everyone in the relevant country (wage earners, entrepreneurs, pensioners, etc) to agree the same percentage cut in pay.
In a country with a high degree of social cohesion, a country where everyone trusted everyone else, a country where everyone behaved responsibly, that would work. But unfortunately that’s not Greece. Greece is more in the nature of a country where everyone tries to cheat everyone else. E.g. the scale of tax avoidance by the elite as well as by doctors, lawyers and taxi drives exceeds by a big margin the tax avoidance that takes place in other countries.
Friday, 30 January 2015
The Basel regulators are trying to raise the amount of liquid assets that banks hold, and one of the assets that is allegedly liquid for these purposes are mortgage backed securities (MBSs). See 2nd last para here. Are you laughing yet?
If not, remember it was those MBSs that played a big role in sparking off the crisis. This Basel “solution” to bank problems is a bit like trying to cure a alcoholic by giving him crates of whiskey.
Of course there will be worthy sounding rules and hoops that MBSs will have to jump through before they qualify for the above role. But then the dodgy MBSs that sparked off the crises were deemed OK by credit rating agencies.
I might be wrong, but this sounds like just one more of the impressively complex new rules that banks have to obey which boil down to nothing.
Thursday, 29 January 2015
Mark Carney (governor of the Bank of England) advocated fiscal union for the Eurozone (EZ) in this recent speech. As he put it, “Europe’s leaders do not currently foresee fiscal union as part of monetary union. Such timidity has costs.”
The basic flaw in fiscal union is thus. If the people in any geographical area see themselves as being one and the same people (culturally and in other ways) then fiscal union will follow almost automatically. In contrast, if the above cultural etc union is not there, then passing laws designed to bring fiscal union just won’t work.
To illustrate, if German taxpayers saw Greeks as fellow Germans who had had a spot of bad luck, then there’d be few problems extracting taxes from Germans to support “Greek Germans” in southern Europe, EVEN IF there was no formal fiscal union. Indeed, at the time of German reunification, West Germans saw East Germans as Germans and (apart from a few grumbles) were prepared to dish out billions to help East Germany.
And for an illustration of how fiscal union doesn’t work even where two peoples are VERY CLOSE culturally etc, look at Scotland. Around half the Scottish nation doesn't want fiscal union with the rest of the UK. And that’s despite sharing the same language, race and religion. And despite having enjoyed fiscal union for over two centuries and despite having fought side by side in two world wars.
Moreover, even if German generosity towards Euro periphery countries were to increase significantly and EZ fiscal union was implemented, a decline in competitiveness in one or more periphery countries cannot go on for ever. To illustrate with an extreme example, fiscal union does not mean that people in uncompetitive areas / countries will get away with doing one hour’s work a week and expect to get the same wage as people in competitive areas / countries.
If lack of competitiveness is just a TEMPORARY phenomenon in every EZ country, then fiscal transfers will help deal with periods of uncompetitiveness in any given country. But if the tendency to corruption and awarding everyone unearned pay increases is a PERMANENT feature in periphery countries (and that seems to be case in Greece) then fiscal union won’t spare them much pain in the long run.
Wednesday, 28 January 2015
Keynes said that in a recession, government should borrow or print money and use that money to expand public and/or private spending. (See 2nd half of 5th para here.)
Market monetarism (MM) says that in a recession, government should print money and buy private sector assets. So which is right?
Both K and MM expand the private sector’s stock of cash and/or bonds, which will induce the private sector to spend more. So to that extent there’s no difference between the two.
However, MM raises the price of assets relative to the price of “current consumption” items, which is a problem. That is, on the not unreasonable assumption that the latter ratio was optimum just prior to a recession, then on implementing MM, the ratio will no longer be optimum.
And there is a second “ratio problem” with MM, as follows.
Assuming there’s an optimum allocation of assets as between public and private sectors (again, a not unreasonable assumption) at the start of a recession, MM will disturb that optimum allocation. To illustrate, the effect of MM will be to force a proportion of the population who would like to own their own homes to rent from the state instead.
Conclusion: Keynes beats market monetarism.
As pointed out above, K seemed to be indifferent as between the borrow / bonds option and the print / cash option. Personally I can’t for the life of me see the point of the state borrowing money when it can print the stuff. But that’s a separate issue to the above K versus MM argument, which is why I’ve put my “personal views” here in a postscript.
Another incidental thought. I suspect K was in private equally dismissive of the borrow / bonds option. And I suspect the REASON he kept very quiet about that in public was that he knew he was surrounded (as we are today) by econonomic illiterates who chant “inflation” every time the words “money” and “print” appear in the same sentence.
Tuesday, 27 January 2015
Private banks create money when they lend, as pointed out in this recent Bank of England work. That point was actually being made decades ago in some economics text books, e.g. R.G.Lipsey’s “Principles of Economics”.
To be more accurate, if loans are being REPAID to a bank at the same rate as new loans are granted, the bank does not on balance create money. On the other hand, the TOTAL STOCK of private bank created money tends to rise, year after year, so as distinct from the latter “repayments equals new loans” scenario, private banks ARE INTO THE BUSINESS of creating entirely new money in that the total stock of privately created money expands most years.
An alternative and perfectly valid way of looking at this process is to say that money is destroyed when a loan is repaid and created when loans are granted. The difference between those two ways of looking at the process is not important.
Money creation brings benefits.
In favor of private money creation, there is the point that money is useful stuff, ergo creating it brings benefits. And certainly if there were no central bank, then private banks would be performing a useful service in creating money. Indeed, that’s exactly what those proverbial goldsmiths did when they first issued paper receipts for non-existent gold a few hundred years ago.
However, we have central banks nowadays, thus the question arises as to whether money is best produced by 1, private banks, 2, central banks or 3, both types of banks (as is currently the case).
Privately created money involves big risks.
Privately created money has several serious problems. It gives rise to bank runs and credit crunches plus private money creation is a form of fraud and theft. We’ll start with bank runs and credit crunches.
Money is a liability of a bank: in the case of a loan, it’s an entirely artificial debt owed by a bank to a borrower which the bank undertakes to transfer to anyone else when instructed to do so by the borrower using the borrower’s cheque book, debit card or similar. Moreover, the debt is advertised by the bank as being money and a characteristic of money is that it is FIXED IN VALUE (inflation apart).
That is, we expect for example a $100 bill to be worth very nearly $100 in a months time, as distinct from for example shares which can fall or rise dramatically in value in 24 hours.
The net result is as follows. After a borrower has spent what they’ve borrowed and the relevant money has been deposited in some private bank, the private bank system then has a liability that is fixed in value and an asset (the loan the borrower) which can fall in value. That is, some borrowers fail to repay their debt.
The latter scenario (having a liability that is fixed in value and an asset that can fall in value) is clearly risky. That risk works out OK roughly nine years out of ten. But the inescapable reality is that in the tenth year it all goes wrong: the brute fact is that private banks have gone bust by their hundreds over the centuries.
In short, risk is an inherent characteristic of private money creation. Or as “Douglas Diamond and Raghuram Rajan say in the abstract of this paper, and in reference to the liquidity / money creation that private banks offer: “We show the bank has to have a fragile capital structure, subject to bank runs, in order to perform these functions.”
Private money creation is fraudulent.
Not only does private money creation involve the near inevitability of 1929 crashes and credit crunches, it can also be argued to be fraudulent. That is, for a bank to promise its creditors they’ll be able to get $X back for every $X deposited when in fact the money concerned has been put at risk is either totally fraudulent or at least semi-fraudulent. It’s little different from borrowing money from a friend, promising to repay it, and then putting the money on a horse or a roulette table. As Martin Wolf, chief economics commentator at the Financial Times put it, “If we were not so familiar with banking, we would surely regard it as fraudulent”.
(Incidentally I’m not arguing that banning private money creation would bring a total end to bouts of irrational exuberance or the opposite, i.e. recessions. But the ban would certainly help.)
Private money creation is theft.
Money printing is profitable, as counterfeitors will attest. And what private banks do is essentially the same, but private bankers wear smart suits, drive smart cars and they take great care to befriend top politicians. That makes bankers immune from prosecution.
To explain why private money creation equals theft, let’s concentrate on the process whereby private banks EXPAND the money supply as distinct from RECYCLING existing money.
When a private bank grants a loan, the borrower spends the money and gets themselves a car or whatever. So as a result of a few book-keeping entries, the borrower manages to acquire a real and valuable assets. Nice work if you can get it! And at the same time, the rest of the community loses a real and valuable asset and in exchange gets some book-keeping entries (or numbers in a computer, which is the form that book-keeping entries take nowadays).
Someone has been diddled, haven’t they?
And do the bank and borrower ever need to repay the loan? Well not if that new money becomes a PERMANENT ADDITION to the money supply. Let’s illustrate that point by reference to paper money as distinct from the above digital or book-keeping money.
Suppose everyone decides they want to carry an additional £10 around with them, the central bank / government would need to create an extra £10 per person, and spend that money into the private sector (in the form of extra spending on roads, law and order, education or whatever).
In a sense then, government “profits” in that it manages to acquire real goods and services (roads etc) in exchange for silly bits of paper which cost next to nothing to print.
But of course we don’t object to that profit because government is owned by the people: put another way, when a new road is built, we all benefit. In contrast, and in the case of a private bank and borrower, it’s the private bank and borrower who make the profit, not the community. Why do we let them get away with it?
Also, note that where a loan brings about a permanent increase in the money supply, the borrower DOES NOT (contrary to popular perception) borrow from the bank. At least no REAL GOODS OR RESOURCES are transferred from the bank to the borrower. Put another way, bank staff do not sweat their guts out making the new car or whatever the borrower acquires.
The only job performed by the bank is an administrative one: e.g. checking up on the value of the collateral supplied by the borrower. Thus the bank, strictly speaking, has no reason to charge interest: it DOES HAVE a reason to charge for the above ADMINISTRATION COSTS, and will almost certainly CALL THAT interest. But it’s not actually interest.
In contrast, in the case of RECYCLING (in the above sense), a private bank obviously gets the money it lends out from somewhere: it gets the money from depositors, bond-holders or shareholders. And the latter three will want interest or some sort of return on their money. And clearly the bank has to pass on that interest to borrowers. So in that case, borrowers pay BOTH the above administration costs and what might be called “genuine interest”.
To summarise, private money creation involves bank runs, credit crunches, fraud and theft! How low can you get?
So is there an alternative way of supplying the economy with the money it needs? Well yes: have the CENTRAL BANK supply as much money as we need. And money creation is a job that central banks already perform: indeed they’ve been performing that task on a unprecedented scale in recent years in the form of QE.
Banning private money inhibits lending?
There might seem to be a problem in banning private money creation and having the central bank supply our money needs instead, and that’s that as pointed out above, lending by private banks seems to be inextricably tied to money creation. And if that were the case, then obviously banning private money creation would inhibit or bar lending by private banks.
However, as already intimated, it is legitimate to say that no money creation in fact takes place when most loans are granted in that ROUGHLY SPEAKING, loans repaid to a private bank each month equal new loans granted. Put another way, in that private banks just re-cycle EXISTING MONEY, they don’t create new money.
And if all money were CENTRAL BANK CREATED, the granting of loans would not be inhibited in that private banks just engage in the latter recycling process. Put another way, if there were a FIXED STOCK of central bank money, and private bank money were banned, then obviously expanding the money supply would not be possible.
But of course the latter is a total and complete non-problem because central banks and governments can and do expand the stock of central bank created money any time they want. QE is just one method.
Conclusion: privately created money has nothing going for it. It involves fraud and theft. It’s a left-over from those goldsmiths who issued paper receipts for non-existent gold, and made a fortune doing so. Private money creation only continues because of general ignorance about money: in particular the fact that private bankers run rings round economically illiterate regulators and politicians.
Saturday, 24 January 2015
At least that’s what Carney (governor of the Bank of England) suggested recently in Davos. According to this article, “Mr. Carney said that making banks maintain even higher levels of equity could increase their costs, and those costs would probably get passed on to the banks’ customers.” That “expensive capital” story is often spun by commercial banks when trying to avoid better capital ratios, and it looks like Carney may have fallen for it.
So let’s go through this from the beginning. It’s not difficult: in fact it’s desperately simple.
It might seem that bank capital is expensive compared to debt (e.g. bonds or deposits) because the return demanded by shareholders is higher than that demanded by debt holders. Well that difference in return is explained by the very simple fact that shareholders are first in line for a hair-cut when the bank is in trouble. Obviously shareholders want a bigger return!
However, it’s false logic to conclude that if bank capital ratios are increased that the TOTAL return demanded by all bank funders at a particular bank (shareholders, depositors etc) will rise. Reason is that the total risks involved in running a bank are determined SOLELY by the nature of the bank’s assets (its loans and investments). E.g. a bank that specialises in NINJA mortgages obviously runs a bigger risk than one specialising in conventional mortgages.
In contrast, whether those funding the bank are composed mainly of shareholders, bond-holders or depositors HAS ABSOLUTLY NO INFLUENCE on the above “total risk”. Ergo changing the composition of funders (e.g. increasing shares at the expense of bonds or deposits) has no effect on the total return demanded by bank funders.
Indeed, the latter very simple point was the point made by Messers Modigliani and Miller, a point for which helped them get a Nobel Prize.
The messy real world.
Unfortunately in the real world, the Modigliani Miller theory (MM) doesn’t work out quite as simply as the above simple bit of theory suggests. That is, there are host of complexities (half of them unnecessary) that muddy the picture in the real world. And that is music to the ears of banksters and academics in the pay of banksters: those complexities enable them to churn out thousands of words of waffle which actually boil down to nothing, and which don’t basically rebut the above simple theory. And that, combined with bribes paid to politicians by bankers enables bankers to avoid better capital ratios, often as not.
The tax treatment of debt.
For example, there’s the point that the tax treatment of debt is different to the treatment of shares: interest on debt can be debited to profit and loss accounts. But dividends can’t. Well that “tax” point is wholly irrelevant because tax is an ENTIRELY ARTIFICIAL imposition: it doesn’t reflect underlying economic realities.
But that’s not how some academics see it: they seem to think that because debt is good value for money on account of those tax advantages, that therefor the REAL COST of debt is lower than the REAL COST of capital.
Anat Admati touched on the latter point in a recent tweet:
If banks aren't as attractive to equity investors, maybe too much of their current value is due to debt subsidies. http://t.co/D6xGHjiTQ0
— Anat Admati (@anatadmati) January 23, 2015
Admati is professor of economics at Stanford.
Another flawed “bank capital is expensive” argument is thus.
Given inadequate capital ratios of the sort of that prevailed before the crunch, clearly the chance of bank insolvency is too high. And we all know who carries much of the cost stemming from bank insolvency in the case of large banks: the taxpayer.
It follows that as bank capital ratios are raised, significant costs are removed from taxpayers and loaded onto shareholders. So as capital ratios rise, the TOTAL COST of funding banks does rise. But of course that rise is due to the removal of a subsidy: an entirely justifiable removal. MM remains unscathed!
Another popular argument against better capital ratios is that the effect will just be to drive business towards the unregulated sector: shadow banks. Well the answer to that is to regulate shadow banks the same was as regular banks are regulated. Or as Adair Turner (former head of the UK’s Financial Services Authority) put it, “If it looks like a bank and quacks like a bank, it has got to be subject to bank-like safeguards..”
Of course it will never be possible to regulate every single shadow bank including the very smallest. But that doesn’t matter. As long as every institution that behaves like a bank and which has a turnover of more than roughly $10m a year is regulated, that cracks the problem.
If someone lends $100 to their next door neighbour, they’re acting as a bank strictly speeking. Clearly it would be absurd to regulate that sort of lending.
Friday, 23 January 2015
I normally agree with Turner, but not with this article of his entitled “Have we become too flexible?”
His basic point (set out essentially in his final four paragraphs) is that labor market flexibility depresses wages, and lower wages is the last thing we need right now, what with inadequate aggregate demand. OK, let’s think about this.
First, let’s assume that when the labor market becomes more flexible, it also becomes more efficient: that is, output per head rises. Obviously there are possible circumstances where the latter does not obtain: for example if the rules governing the labour market were changed to those that govern a slave labor market – i.e. employers could order employees to do absolutely anything on pain of being flogged – then that would improve flexibility. However, a slave labor market would doubtless not bring all round benefits and probably wouldn’t raise output per head.
Now the INITIAL EFFECT of improved flexibility can easily be that employers pay less to employees for a given type of work. E.g. trade unions have often tried to insist that particular types of work be carried out only by fully qualified employees – union members to boot and at the union wage. And if employers can scrub that union imposed rule and employ unskilled employees instead, then the wage paid for the type of work concerned will fall. And it’s doubtless that point that induces Turner to think that more flexibility equals falling wages.
But that’s actually nonsense and for the following reasons. Suppose EVERYONE’S wage (including the “wage” of employers) is halved. Does that mean anyone is worse off? Clearly not: there’s no affect whatever on the REAL WAGE. The fall in money wages is exactly compensated for by a doubling in the value of money. Everyone is back where they started.
And the same point applies to a cut in money wages for a specific group or groups of employees: the net result is a decline in the AVERAGE money wage paid to everyone. But there’s no reason to assume a change in the AVERAGE REAL WAGE.
So, more flexibility improves output per head. And that output will clearly be shared between employers and employees.
Now let’s make the very reasonable assumption that the EXACT WAY that additional output is split between employers and employees does not change just because a group of employers manage to impose greater flexibility. For an example of a “way” in that additional output is split, the labor market might work in some sort of optimal way: i.e. additional output might be split in a way that maximises GDP. Alternatively employers might have some sort of market power and might be able to grab the lion’s share of that increased output.
Whichever of the latter two scenarios obtains, there is no reason to think that WAY additional output is split is going to change just because there’s an improvement in labor market flexibility.
In short, improved labor market flexibility brings increased output (despite the fact that the INITIAL effect can be a drop in money wages for SPECIFIC groups of employees). And that increased output will inevitably be shared somehow or other between employers and employees.
And there’s nothing inherently wrong with that. To repeat, there may be SPECIFIC CASES where employers (or employees) grab more than their fair share of increased output. But that’s a separate point. It doesn’t alter the fact that increased output stemming from increased flexibility is basically desirable.