Sunday, 6 January 2019

Why QE green bonds?



Richard Murphy and Colin Hines propose a “National Investment Bank” in the Guardian which issues “Green Bonds” which the Bank of England then “QEs”: i.e. the BoE prints money and buys up those bonds.

The trouble there is that having government or any nationalised institution (like a National Investment Bank or government itself) issue bonds with the BoE then buying back those bonds is that that all nets out to “government prints money and spends it” (sometimes known as “overt money creation” – OMC).  So why not do the latter and not bother with the investment bank or green bonds?

In contrast, I can see the point of green bonds which are not QEd: people with money to spare might be prepared to do a bit for the environment by lending to green projects at a rate of interest below the going rate on bog standard government debt.


Friday, 4 January 2019

A brief 200 word history of banking.


Several centuries ago, bankers thought up a trick, namely to accept deposits from customers and lend on relevant money, while telling depositors their money was 100% safe.

That of course is fraudulent: reason is that loaned out money is never totally safe. And indeed that fraud becomes blatantly obvious when the inevitable happens: banks fail, or the entire bank system looks like failing.

But the latter fraud brings bankers great riches, and as long as you’re rich, the establishment will see you as respectable. You can earn your millions from drug dealing, extortion, or a chain of brothels. It really doesn’t matter: long as you’ve got loads of dosh, the establishment (i.e. politicians, bank regulators, academic economists, the British royal family, the Church of England, etc) will see you as respectable. For example the going price for a seat in the UK House of Lords is about a million pounds.

So instead of clamping down on the above fraud, the establishment comes to the rescue of commercial banks and assists in the above fraud. That is, commercial banks are rescued, plus they are  protected via deposit insurance, the “too big to fail” subsidy, and so on.

“Generous” donations by bankers to politicians’ “election expenses” assist politicians to see sense in connection with the above matters.

Net result:  bankers laugh all the way to the bank, if you’ll excuse the pun.

Monday, 31 December 2018

How come human beings can talk?


The German economist Heiner Flassbeck highlights the fact that human beings are largely incapable of distinguishing between two senses of the same word: in particular, in his native German language, the word for debt is the same as the word for guilt. That means Germans tend to think that debtors are all guilty: totally illogical of course.

Much the same goes for the word “austerity” which has two quite separate meanings: first, inadequate demand, and second, inadequate public spending (even assuming demand is adequate). About 99% of English speakers who use the word fail to clarify in what sense they are using it. But that doesn’t really matter for them. After all, they’re not really interested in solving austerity related problems (in any sense of the word). Normally the motive for wielding the word is to do some so called “virtue signalling”.

In view of the above failure to understand or use words properly, it’s a wonder is that human beings can talk at all…:-)

Incidentally Heiner Flassbeck and yours truly published (quite separately) a possible solution for Greece and similar countries a year or two ago. That’s to let Greece impose import tariffs. See here.

However, there’s been little interest in that idea, and for reasons alluded to above, namely that Greece is a godsend for virtue signallers. In contrast, if you suggest an actual solution for the Greek problem which requires a concentration span of more than five seconds to get to grips with, then virtue signallers’ eyes glaze over.

And that’s the end of this thoroughly cynical article.


Sunday, 23 December 2018

Why should money lenders be backed by taxpayers?


Under the existing deposit insurance system, people who deposit money at banks with a view to having their money loaned out by their bank are guaranteed against loss by taxpayers. With a view to explaining the flaws in that system, let’s start by considering money and banks from first principles.

1. “Money is a creature of the state” as the saying goes. That is, there has to be general agreement in any country as to what the country’s basic form of currency will be. Plus there has to be some sort of state controlled organisation to issue that currency. Reason is that if too much is issued, excess inflation ensues and if too little is  issued, there is  excess unemployment. (I’m assuming the currency comes in fiat form as is normal nowadays and let’s assume the currently unit is a “dollar”. Plus I’ll assume that the “state controlled organisation is a “central bank”).

2. Assume a hypothetical economy which is switching from barter to money for the first time and that at least initially, commercial banks are barred from issuing money. In that scenario, people and firms will borrow from and lend to each other, sometimes direct person to person (or firm to firm etc) and sometimes via commercial banks.

3. Where depositors choose to have their money loaned on by commercial banks it would be fraudulent of banks to promise those depositors they are guaranteed to get their money back and for the simple reason that loaned out money is never totally safe (although that sort of promise was common prior to WWII: in the 1920s and 30s the fraudulent nature of that promise became blatantly obvious when ordinary depositors lost billions as a result of the hundreds of banks collapsing in the US. So given that those depositors stand to make a loss, they are not actually depositors: they are more in the nature of shareholders in relevant banks.

 



4. A possible optional extra to the above arrangement is to let commercial banks create and lend out their own home made money, as occurs in the real world at present. Those DIY dollars take the form of promises by relevant banks to pay money to whoever.

5. However, that DIY money does not really comply with normal definitions of the word money unless it is guaranteed by taxpayer / government backed deposit insurance. That is, if that DIY money is NOT BACKED in that way, then such “money” is in effect equity / shares as explained above.

6. Now what’s wrong with depositors wanting to have their money loaned on with the risk being carried by some sort of deposit insurance, particularly if that insurance system is run on commercial lines, i.e. assuming it pays for itself? Well the problem is that if people who deposit money at banks with a view to the bank lending on their money are entitled to deposit insurance, what about those who deposit money at any other investment intermediary like a stockbroker or unit trust (“mutual funds” in the US) with the same end in view, i.e. earning interest or dividends?

7. Another popular excuse for deposit insurance is that such insurance boosts the banking industry. Indeed that was the excuse given by the UK’s Independent Commission on Banking (sections 3.20 to 3.24). They claimed deposit insurance encouraged borrowing, lending and investment. (Actually the way the ICB put that point was to say that if deposit insurance WAS WITHDRAWN “the economic costs would be very high.” But that’s the same as saying deposit insurance boosts the economy and withdrawing it harms the economy.)

8. Moreover, the ICB were vague on exactly what form the alleged “costs” would take. For example, if they were trying to suggest the decline in borrowing due to a withdrawal of deposit insurance would raise interest rates and thus cut demand, that is not much of an argument: reason is that any fall in demand can be countered simply by having government and central bank create more base money and spend it into the economy (and/or cut taxes).

Plus current very low interest rates are not an unmixed blessing: they are often cited as a contributory cause of excess debts and asset price bubbles.

9. The next problem is that both the above “stockbroker and mutual fund” point and the latter “ICB / boosts the economy” point can be extended to yet further sectors of the economy. For example, taxpayer backed insurance for ships would probably be popular: if you’re a shipowner, being insured by an insurance company that cannot possibly fail has distinct attractions. So such insurance would “boost” the shipping industry and hence the economy as a whole, if the ICB argument is valid.

10. This is clearly getting silly: i.e. what is needed here is some form  of natural dividing line between valid forms of state interference or assistance for banking, shipping and so on, and on the other hand, INVALID  forms of assistance.

11. Well there is actually a natural dividing line which is that it is widely accepted that it is not the job of taxpayers or governments to back COMMERCIAL activity, unless there are obvious reasons for doing so, e.g. social reasons. (I actually argue that point in more detail in an article entitled “A New Justification for Full Reserve Banking”).

To illustrate, long ago in Europe, education and health care were commercial activities: people had to pay for tutors and medical treatment. It was then decided that for social reasons, governments should take over much of that work. But that sort of social reason hardly applies to money lending, i.e. banking, or shipping.

12. Now anyone who deposits money at a bank with a view to having their money loaned out so as to earn interest is clearly into commerce just as much as where they deposit money with a stockbroker with the same aim in view.

In contrast, there is a clear social case for everyone having a totally safe method of storing and transferring money where their motives are not commercial, i.e. where they do not aim to have their money loaned out. Indeed the latter “totally safe” facility is a basic human right.


Conclusion

The advocates of full reserve banking are right: the bank system should offer totally safe accounts for those who want them, while those who want their money loaned out so as to earn interest should bear relevant risks, just as they do when they deposit money with a stockbroker or unit trust.

And of course a consequence of that arrangement is that it is impossible for banks to fail: that is, if a bank makes silly loans, all that happens is that the value of the above mentioned shares / equity falls in value.

Saturday, 22 December 2018

Should banks take climate risks into account?



The latest article (at the time of writing) from the New Economics Foundation is “Greening the Banks” by Frank Van Lerven.

The article claims “Climate change has the potential to wipe out trillions of pounds worth of assets, making the devastation of the 2008 Global Financial Crisis seem like a walk in the park.” That is followed a few sentences later by “This poses severe financial risks…”.

Er  - no I don’t think it does. Reason is that climate change is coming sufficiently slowly that no bank is likely to be caught out by those risks. To illustrate, central London may well be flooded and have to be evacuated at some point, and clearly that will involve a huge loss in the value of assets which back bank loans, e.g. houses and office blocks. But that flooding, according to climate scientists, will not happen SUDDENLY: e.g. by this time next year. It will take around fifty or a hundred years to materialise. 



Of course it could be argued that there are LESS PREDICTABLE risks arising from climate change than the latter flooding. But if the extent of a risk cannot be predicted, it’s a bit difficult, by definition, to quantify it!
 

The NEF article also considers the loss in value of assets in the form of a contraction of the fossil fuel industry. Well if governments WERE TO significantly contract those industries, and that certainly needs doing, it would be daft to try to do it all in one or two years. I.e. a minimum of about five years would make more sense.

In that case, again, banks have time to adjust.


Penalise dirty lending?

Next, under the heading “Penalise Dirty Lending”, the article proposes extra capital requirements for bank loans which fund CO2 emitting activities. Well the obvious problem there is that extra capital requirements involve little extra expense for banks. Indeed, if the Modigliani Miller theory is right (at least as it applies to banks) there is no extra expense at all!!

Certainly any extra expense via the latter means will be MINUTE compared to the extra expense for motorists that derives from tax on petrol and diesel. Tax accounts for around 65% of the price of petrol and diesel for motorists in the UK at the moment. That dwarfs any extra costs that might be loaded onto “dirty lenders” and CO2 emitters via the capital requirement method.


Conclusion.
 

Something urgently needs to be done about global warming. But there are effective ways to solving that problem and ineffective ways. I prefer the former.

Friday, 21 December 2018

The IPPR falls for the “fiscal space” myth.


The fiscal space myth is an idea which is popular with plonkers in high places, particularly at the IMF and OECD. It’s the idea that if a national debt is too high, interest on that debt will also tend to be high, which in turn will allegedly make it difficult for a government to implement fiscal stimulus (i.e. “borrow and spend”) come a recession.

Well if interest rates on the debt are relatively high, that means there is plenty of scope for implementing stimulus via interest rate cuts! So to that extent, the fiscal space idea is nonsense! Plus as Keynes pointed out  nearly a hundred years ago, a solution for recessions is for governments and central banks to simply create money and spend it (and/or cut taxes) - i.e. there is no need to incurr more debt in order to implement stimulus.

As for the IPPR, there is a passage in a work of theirs (authored by Tony Dolphin and entitled “Setting the Fiscal Rules”) which goes as follows.

“The long-run fiscal objective of the UK government should be to reduce the ratio of government debt to GDP. Academic research has not come up with a definitive answer to the question of what the optimal level of debt might be. But debt in the UK has doubled since the onset of the financial crisis and, as a result, it may be harder to respond to a future severe downturn in economic activity through an easing of fiscal policy. Debt needs to be reduced to create room for it to be increased again if needed.”

Let’s take that sentence by sentence. First: “The long-run fiscal objective of the UK government should be to reduce the ratio of government debt to GDP.”

Really? Why so?

Government debt, as MMTers keep pointing out, is a private sector asset. What’s wrong with the private sector having paper assets? Darned if I know.

Of course if the rate of interest paid on the debt is excessive, then certainly the debt needs to be reduced. On the other hand if the rate of interest is zero or near zero, then government debt comes to much  the same thing as base money (bundles of £10 notes if you like). What’s wrong with the private sector having bundles of zero interest yielding £10 notes, if that’s what the private sector wants? Again, darned if I know.

Next Dolphin says “Academic research has not come up with a definitive answer to the question of what the optimal level of debt might be.” Well MMTers have answer for that, which is that since private sector spending almost certainly with private sector net assets, the debt (plus the stock of base money) needs to be whatever induces the private sector to spend at a rate that brings full employment. MMTers sometimes refer to the sum of the latter two quantities, government debt and base money, as “Private Sector Net Financial Assets”.

As for how much of PSNFA should consist of debt and how much should consist of base money that’s not too important, since as already intimated, the two merge into each other: that is, base money is effectively debt which yields no interest (as pointed out by Martin Wolf in the Financial Times a year or two ago).

Incidentally, I’ve made most of the above points about a hundred times before on this blog, but if MMTers keep explaining basic simple points about economics till they’re blue in the face, the incompetents in high places at the IMF, OECD and IPPR may eventually understand them.


Thursday, 13 December 2018

Guiseppe Fontana and Malcolm Sawyer’s claim that full reserve advocates are “cranks”.


Guiseppe Fontana and Malcolm Sawyer (F&S) published a paper in the Cambridge Journal of Economics in 2016 entitled “Full Reserve Banking: More ‘Cranks’ Than ‘Brave Heretics’”.

The paragraphs below are quick summary of reasons for thinking that if any group of people are cranks, its Fontana and Sawyer rather than advocates of full reserve banking (FRB).

I’ve actually dealt with Fontana & Sawyer’s ideas on FRB before on this blog (Google: Ralphonomics..Sawyer….full reserve). But I thought I’d do a proper paper in the new year and place it at the Munich Repec. The draft of that paper is proceeding nicely, but I thought I’d do a quick summary or “taster” of it meanwhile. Some of the points below are repetitions of points made in the latter blog articles and some are new. So here goes….

1. F&S accuse FRB advocates of “disregarding established theoretical literatures”.

Well now that’s an odd claim given that the main target of F&S’s criticisms are works authored by  Ben Dyson (founder of Positive Money) and co-authors, and the fact that Ben Dyson and Andrew Jackson wrote a book entitled “Modernising Money” which contains around 160 works in its list of references.

Being moderately well acquainted, if not intimately acquainted with 160 works on a particular topic, does not equal “disregarding established theoretical literatures” on that topic in my books. But what do I know?

2. One of the main arguments for full reserve was put by Joseph Huber in his work “Creating New Money” (p.31), which is that the right of commercial banks (aka money lenders) to simply create the money they lend out from thin air is a subsidy of those money lenders.

F&S however do not deal with Huber’s point. Plus Huber does not appear in F&S’s list of references. That rather raises the question as to exactly who is guilty of “disregarding established theoretical literatures”.

Another point which calls into question F&S’s grasp of “established theoretical literatures” is they seem to be unaware that several Nobel laureate economists have backed FRB, e.g. Milton Friedman, Maurice Allais and Merton Miller.

F&S do mention Friedman, but not his support for FRB. As for Miller and Allais, they are not mentioned at all.

3. F&S devote between a quarter and a third of their paper to criticising an idea put by some advocates of FRB, including Dyson & Co, namely what is sometimes called “overt money creation” (OMC).  That’s the idea that the state (i.e. government and central bank), when stimulus is needed, should simply create new base money and spend it (and/or cut taxes).

The problem with that criticism of FRB is that OMC is not an inherent characteristic of FRB: it’s simply for the form of stimulus favoured by SOME FRB advocates. To illustrate, Ben Bernanke and Adair Turner have made approving noises about OMC without at the same time advocating FRB. (For Bernanke, see passage starting “So, how could the legislature….” here)

Put another way, it would be perfectly possible to implement FRB while sticking with the existing methods of adjusting demand, like interest rate adjustments.

4. In their section 2 sub-section 4, F&S challenge the claim made by FRB advocates that “The new supply of bank loans creates an equal increase in the amount of outstanding debt in the economy.”

Well the first problem there is that it’s not just FRB advocates who make that claim: it’s a fairly widely accepted truism in economics that commercial bank created money “nets to nothing”. I.e. that for every dollar of such money there is a dollar of debt owed to a commercial bank.

For an example of an economist who is not an FRB advocate but who nevertheless supports the latter “nets to nothing” point, see articles entitled “Deficit spending 101 – Part 3” and “Money Multiplier and other Myths” by Bill Mitchell.

Thus it rather looks like F&S have not got to grips with the basic book-keeping entries that commercial banks make when granting loans.

5. F&S’s section 2, subsection 5 starts with the bizarre claim that “The current accounting of money as a debt–credit relationship is a relic of the past, when banknotes were backed by and redeemable for gold.”

Well that will be news to Bill Mitchell. It will also be news to the authors of numerous economics text books. For example Armen Alchain and William Allen in their book “University Economics” Ch29 say “A possibly surprising idea is that debt is money, provided the debt is a particular kind owed by a commercial bank….”.

6. Another indication that F&S do not understand the basic book-keeping entries done by central and commercial bank comes in this passage of theirs.

F&S start by quoting a passage from one FRB advocate, Herman Daly which is thus. “With 100% reserves every dollar loaned to a borrower would be a dollar previously saved by a time account depositor (and not available to the depositor during the period of the loan), thereby re-establishing the classical balance between abstinence and investment. With credit limited by saving (abstinence from consumption) there will be less lending and borrowing and it will be done more carefully.”

F&S then say…

“The second inconsistency is that it is not clear where the prior savings alluded to by Daly and other advocates of FRB have come from. It is technically impossible for banks as a whole to collect deposits without at the same time granting loans for the same amount. Therefore, at least initially there must have been a process of credit creation in the economy, which was completely unconstrained and unrelated to pre-existing resources. More importantly, the quote above indicates an inherently deflationary bias of FRB proposals, which is likely to produce recessions and financial instability.”

Well for anyone who understands how banks, commercial and central, actually work, the question as to where the latter “prior savings” come from is not too difficult. It is thus. Under present arrangements, governments engage in fiscal stimulus which consists of their borrowing $X, spending $X back into the private sector and giving bonds  worth $X to those they have borrowed from. The result is that private sector paper assets rise by $X. Hey presto: we have uncovered a source of “prior savings” (of a sort, anyway)!

Of course central banks can then create base money and buy back those bonds as they see fit (with a view to cutting interest rates and/or implementing QE). In that case, the latter bonds in the hands of the private sector are converted to dollars. But that just alters the nature of the “prior savings” a bit. But note that those dollars have been created WITHOUT a commercial bank making a loan, which according to F&S is impossible.

And moving on to OMC (where the state by-passes the latter bonds and simply creates money and spends it), if the state simply creates $X and spends it, then private sector “prior savings” rise by $X. And that’s just a slightly different way of creating those allegedly “impossible to create” dollars.

To summarise, that all makes a nonsense of F&S’s claim that “It is technically impossible for banks as a whole to collect deposits without at the same time granting loans for the same amount.”

7. In section 3 (and in their abstract), F&S accuse FRB of having a “deflationary bias”.

Well it’s certainly true that lending and borrowing are more difficult under FRB, i.e. that interest rates would be higher. But any deflationary effect of that is easily countered by standard stimulatory measures, the one favoured by most FRB advocates being OMC. Magic: problem solved!

Moreover, as Milton Friedman rightly said, stimulus dollars cost nothing in real terms. So the solution to F&S’s alleged problem is costless.

Plus it is far from clear that the low interest rates that obtain at the time of writing are an unmixed blessing: they have resulted in record levels of debt and an unprecedented rise in house prices.

8. In their section 3, F&S make the revelatory pronouncement that “However, one of the main lessons from the work of Minsky and other Post Keynesian economists is that the demand for and supply of bank loans via the financing of the production of goods and services (investment) are an integral aspect of the operation of real-world economies.”

Good heavens – so bank loans are an essential part of 21st century economies? You learn something every day, don’t you?

I suspect we’d all be aware that bank loans are a good idea without any assistance from Minsky or Post Keynsian economists. I mean was no one aware that bank loans are good idea BEFORE Minsky and Post Keynsians appeared on the scene?

And another flaw in the latter F&S claim is that bank loans do not suddenly become impossible under FRB: all that happens (to repeat) is that interest rates rise a bit.

9. In their section 4, F&S claim that the difference between the transaction accounts and investment accounts under FRB is sufficiently small that banks would be able to turn investment accounts into what are effectively transaction accounts and thus get instant access money to fund loans.

Well that depends on exactly how the two types of accounts are structured. Clearly it would be POSSIBLE to have the difference between the two so small that there is effectively no difference.

On the other hand under the type of FRB system advocated by Laurence Kotlikoff, investment accounts simply take the form of unit trusts (mutual funds in US parlance), no different from the hundreds of unit trusts already available. Far as I know, no one has claimed that such unit trusts constitute instant access money. Certainly if anyone putting £X into a unit trust tried to claim they had a right to have their £X back when the trust performed poorly, they’d be laughed at.

10. F&S make the tired old claim that under FRB, the cost of transaction (aka instant access) accounts would rise for bank customers.

Well true: costs certainly would rise. But costs (aka bank charges) are only as low as they are at the moment because instant access accounts are subsidised by banks’ money lending activities. 

There is no particular merit in cross subsidisation: e.g. there is no particular merit in apple growers subsidising potato growers. Indeed, cross subsidisation is normally frowned on in economics.

11. A  final indication that F&S have little grasp of basic central bank and commercial bank transactions and book-keeping entries is that in their section 5 they say “Another controversial aspect of FRB proposals is the claimed relationship between the money creation process and budget decisions. Currently, the government decides the level of expenditure, and then the Treasury finances it through a loan from either commercial banks or the central bank.”

That quote should cause your jaw to drop, or to cause you to fall off your chair laughing.

First, governments do not finance expenditure, at least in the first instance, “from either commercial banks or the central bank”.  The reality is that government spending is financed mainly via tax.

Next, to the extent that income from tax is not enough to cover spending, governments resort to borrowing, though in some years there is no need to resort to borrowing because tax covers spending.

Next, where borrowing does take place, governments do not borrow primarily from “commercial banks or the central bank”. What they actually do is offer to borrow, with absolutely ANYONE being entitled lend, i.e. to purchase government bonds. The main purchasers (contrary to F&S’s suggestions) are pension funds, insurance companies and foreign entities of one sort or another (e.g. foreign governments). E.g. this source gives the proportion of government debt purchased by domestic commercial banks as just 4%.

https://www.justfacts.com/nationaldebt.asp
Next, government spending is not covered in the first instance by loans from central banks. To repeat, governments borrow from all and sundry. Relevant central banks may or may not subsequently create money and buy back some of the bonds issued by government (i.e. in effect, lend to governement ). Central banks will do that if they think interest rate cuts or QE is needed, but not otherwise.


Conclusion.

I do not wish to suggest that advocates of FRB never make mistakes. Indeed F&S do correctly identify one or two. But, to put it mildly, Fontana and Sawyer are not exactly up to speed on the subject of full reserve banking: if anyone is a “crank”, it’s Messers Fontana and Sawyer.

As for whether I’ll submit my paper to the Cambridge Journal of Economics, I certainly won’t. They appear to be more interested in pseudo intellectual wind and waffle than actually solving economic problems.









Guiseppe Fontana and Malcolm Sawyer’s claim that full reserve advocates are “cranks”.
Guiseppe Fontana and Malcolm Sawyer (F&S) published a paper in the Cambridge Journal of Economics in 2016 entitled “Full Reserve Banking: More ‘Cranks’ Than ‘Brave Heretics’”.

The paragraphs below are quick summary of reasons for thinking that if any group of people are cranks, its Fontana and Sawyer rather than advocates of full reserve banking (FRB).

I’ve actually dealt with Fontana & Sawyer’s ideas on FRB before on this blog (Google: Ralphonomics..Sawyer….full reserve). But I thought I’d do a proper paper in the new year and place it at the Munich Repec. The draft of that paper is proceeding nicely, but I thought I’d do a quick summary or “taster” of it meanwhile. Some of the points below are repetitions of points made in the latter blog articles and some are new. So here goes….

1. F&S accuse FRB advocates of “disregarding established theoretical literatures”.

Well now that’s an odd claim given that the main target of F&S’s criticisms are works authored by  Ben Dyson (founder of Positive Money) and co-authors, and the fact that Ben Dyson and Andrew Jackson wrote a book entitled “Modernising Money” which contains around 160 works in its list of references.

Being moderately well acquainted, if not intimately acquainted with 160 works on a particular topic, does not equal “disregarding established theoretical literatures” on that topic in my books. But what do I know?

2. One of the main arguments for full reserve was put by Joseph Huber in his work “Creating New Money” (p.31), which is that the right of commercial banks (aka money lenders) to simply create the money they lend out from thin air is a subsidy of those money lenders.

F&S however do not deal with Huber’s point. Plus Huber does not appear in F&S’s list of references. That rather raises the question as to exactly who is guilty of “disregarding established theoretical literatures”.

Another point which calls into question F&S’s grasp of “established theoretical literatures” is they seem to be unaware that several Nobel laureate economists have backed FRB, e.g. Milton Friedman, Maurice Allais and Merton Miller.

F&S do mention Friedman, but not his support for FRB. As for Miller and Allais, they are not mentioned at all.

3. F&S devote between a quarter and a third of their paper to criticising an idea put by some advocates of FRB, including Dyson & Co, namely what is sometimes called “overt money creation” (OMC).  That’s the idea that the state (i.e. government and central bank), when stimulus is needed, should simply create new base money and spend it (and/or cut taxes).

The problem with that criticism of FRB is that OMC is not an inherent characteristic of FRB: it’s simply for the form of stimulus favoured by SOME FRB advocates. To illustrate, Ben Bernanke and Adair Turner have made approving noises about OMC without at the same time advocating FRB. (For Bernanke, see passage starting “So, how could the legislature….” here)

https://www.brookings.edu/blog/ben-bernanke/2016/04/11/what-tools-does-the-fed-have-left-part-3-helicopter-money/
Put another way, it would be perfectly possible to implement FRB while sticking with the existing methods of adjusting demand, like interest rate adjustments.

4. In their section 2 sub-section 4, F&S challenge the claim made by FRB advocates that “The new supply of bank loans creates an equal increase in the amount of outstanding debt in the economy.”

Well the first problem there is that it’s not just FRB advocates who make that claim: it’s a fairly widely accepted truism in economics that commercial bank created money “nets to nothing”. I.e. that for every dollar of such money there is a dollar of debt owed to a commercial bank.

For an example of an economist who is not an FRB advocate but who nevertheless supports the latter “nets to nothing” point, see articles entitled “Deficit spending 101 – Part 3” and “Money Multiplier and other Myths” by Bill Mitchell.

http://bilbo.economicoutlook.net/blog/?p=381
http://bilbo.economicoutlook.net/blog/?p=1623
Thus it rather looks like F&S have not got to grips with the basic book-keeping entries that commercial banks make when granting loans.

5. F&S’s section 2, subsection 5 starts with the bizarre claim that “The current accounting of money as a debt–credit relationship is a relic of the past, when banknotes were backed by and redeemable for gold.”

Well that will be news to Bill Mitchell. It will also be news to the authors of numerous economics text books. For example Armen Alchain and William Allen in their book “University Economics” Ch29 say “A possibly surprising idea is that debt is money, provided the debt is a particular kind owed by a commercial bank….”.

6. Another indication that F&S do not understand the basic book-keeping entries done by central and commercial bank comes in this passage of theirs.

F&S start by quoting a passage from one FRB advocate, Herman Daly which is thus. “With 100% reserves every dollar loaned to a borrower would be a dollar previously saved by a time account depositor (and not available to the depositor during the period of the loan), thereby re-establishing the classical balance between abstinence and investment. With credit limited by saving (abstinence from consumption) there will be less lending and borrowing and it will be done more carefully.”

F&S then say…

“The second inconsistency is that it is not clear where the prior savings alluded to by Daly and other advocates of FRB have come from. It is technically impossible for banks as a whole to collect deposits without at the same time granting loans for the same amount. Therefore, at least initially there must have been a process of credit creation in the economy, which was completely unconstrained and unrelated to pre-existing resources. More importantly, the quote above indicates an inherently deflationary bias of FRB proposals, which is likely to produce recessions and financial instability.”

Well for anyone who understands how banks, commercial and central, actually work, the question as to where the latter “prior savings” come from is not too difficult. It is thus. Under present arrangements, governments engage in fiscal stimulus which consists of their borrowing $X, spending $X back into the private sector and giving bonds  worth $X to those they have borrowed from. The result is that private sector paper assets rise by $X. Hey presto: we have uncovered a source of “prior savings” (of a sort, anyway)!

Of course central banks can then create base money and buy back those bonds as they see fit (with a view to cutting interest rates and/or implementing QE). In that case, the latter bonds in the hands of the private sector are converted to dollars. But that just alters the nature of the “prior savings” a bit. But note that those dollars have been created WITHOUT a commercial bank making a loan, which according to F&S is impossible.

And moving on to OMC (where the state by-passes the latter bonds and simply creates money and spends it), if the state simply creates $X and spends it, then private sector “prior savings” rise by $X. And that’s just a slightly different way of creating those allegedly “impossible to create” dollars.

To summarise, that all makes a nonsense of F&S’s claim that “It is technically impossible for banks as a whole to collect deposits without at the same time granting loans for the same amount.”

7. In section 3 (and in their abstract), F&S accuse FRB of having a “deflationary bias”.

Well it’s certainly true that lending and borrowing are more difficult under FRB, i.e. that interest rates would be higher. But any deflationary effect of that is easily countered by standard stimulatory measures, the one favoured by most FRB advocates being OMC. Magic: problem solved!

Moreover, as Milton Friedman rightly said, stimulus dollars cost nothing in real terms. So the solution to F&S’s alleged problem is costless.

Plus it is far from clear that the low interest rates that obtain at the time of writing are an unmixed blessing: they have resulted in record levels of debt and an unprecedented rise in house prices.

8. In their section 3, F&S make the revelatory pronouncement that “However, one of the main lessons from the work of Minsky and other Post Keynesian economists is that the demand for and supply of bank loans via the financing of the production of goods and services (investment) are an integral aspect of the operation of real-world economies.”

Good heavens – so bank loans are an essential part of 21st century economies? You learn something every day, don’t you?

I suspect we’d all be aware that bank loans are a good idea without any assistance from Minsky or Post Keynsian economists. I mean was no one aware that bank loans are good idea BEFORE Minsky and Post Keynsians appeared on the scene?

And another flaw in the latter F&S claim is that bank loans do not suddenly become impossible under FRB: all that happens (to repeat) is that interest rates rise a bit.

9. In their section 4, F&S claim that the difference between the transaction accounts and investment accounts under FRB is sufficiently small that banks would be able to turn investment accounts into what are effectively transaction accounts and thus get instant access money to fund loans.

Well that depends on exactly how the two types of accounts are structured. Clearly it would be POSSIBLE to have the difference between the two so small that there is effectively no difference.

On the other hand under the type of FRB system advocated by Laurence Kotlikoff, investment accounts simply take the form of unit trusts (mutual funds in US parlance), no different from the hundreds of unit trusts already available. Far as I know, no one has claimed that such unit trusts constitute instant access money. Certainly if anyone putting £X into a unit trust tried to claim they had a right to have their £X back when the trust performed poorly, they’d be laughed at.

10. F&S make the tired old claim that under FRB, the cost of transaction (aka instant access) accounts would rise for bank customers.

Well true: costs certainly would rise. But costs (aka bank charges) are only as low as they are at the moment because instant access accounts are subsidised by banks’ money lending activities. 

There is no particular merit in cross subsidisation: e.g. there is no particular merit in apple growers subsidising potato growers. Indeed, cross subsidisation is normally frowned on in economics.

11. A  final indication that F&S have little grasp of basic central bank and commercial bank transactions and book-keeping entries is that in their section 5 they say “Another controversial aspect of FRB proposals is the claimed relationship between the money creation process and budget decisions. Currently, the government decides the level of expenditure, and then the Treasury finances it through a loan from either commercial banks or the central bank.”

That quote should cause your jaw to drop, or to cause you to fall off your chair laughing.

First, governments do not finance expenditure, at least in the first instance, “from either commercial banks or the central bank”.  The reality is that government spending is financed mainly via tax.

Next, to the extent that income from tax is not enough to cover spending, governments resort to borrowing, though in some years there is no need to resort to borrowing because tax covers spending.

Next, where borrowing does take place, governments do not borrow primarily from “commercial banks or the central bank”. What they actually do is offer to borrow, with absolutely ANYONE being entitled lend, i.e. to purchase government bonds. The main purchasers (contrary to F&S’s suggestions) are pension funds, insurance companies and foreign entities of one sort or another (e.g. foreign governments). E.g. this source gives the proportion of government debt purchased by domestic commercial banks as just 4%.

https://www.justfacts.com/nationaldebt.asp
Next, government spending is not covered in the first instance by loans from central banks. To repeat, governments borrow from all and sundry. Relevant central banks may or may not subsequently create money and buy back some of the bonds issued by government (i.e. in effect, lend to governement ). Central banks will do that if they think interest rate cuts or QE is needed, but not otherwise.


X Conclusion.

I do not wish to suggest that advocates of FRB never make mistakes. Indeed F&S do correctly identify one or two. But, to put it mildly, Fontana and Sawyer are not exactly up to speed on the subject of full reserve banking: if anyone is a “crank”, it’s Messers Fontana and Sawyer.

As for whether I’ll submit my paper to the Cambridge Journal of Economics, I certainly won’t. They appear to be more interested in pseudo intellectual wind and waffle than actually solving economic problems.