Sunday, 24 May 2015

OMG: Niall Ferguson opens his mouth again.

Niall Ferguson has a talent: concentrating so many flawed arguments into each paragraph that it takes a large amount of time to rebut it all. Dean Baker and Simon Wren-Lewis have dealt with some of Ferguson's material.

I’ll deal with just two of Ferguson’s points.

First, he argues that since inflation in the UK was above the 2% target for the first half of the recent recession, the UK should not have applied the level of stimulus that it did. Well the answer to that is that (amazing as this might seem) the Bank of England did actually notice that inflation was above target. After all, one of the main jobs of the BoE is to keep inflation near the target.

However, the BoE thought that much of that inflation was cost push, to which extent there wouldn’t have been much to gain inflation-wise from holding back on stimulus. And as it’s turned out, the BoE was right: that is, DESPITE applying a fair amount of stimulus when inflation was above target, inflation in the event actually declined. Indeed, for the first time in about fifty years, inflation is actually NEGATIVE in the UK at the time of writing.

The debt in 2040.

Second, Ferguson claims that if current and/or recent increases in the debt were to continue, by 2040 we’d have a debt to GDP ratio of five (which is way above the current Japanese “two” or 200% ratio).

Well the flaw in that argument is so elementary that it’s EXTREMELY BORING for me to have to set it out. Apologies to readers who are bored stiff by the next paragraph or two, but it’s not my fault.

The answer to Ferguson’s above boring deficit/debt point is that deficits and hence debt growth have been high in recent years and as a result of attempts to deal with the recession. And obviously if those deficits were to continue, then the debt would be very large by 2040.

However, it is a fact of history (and Ferguson claims to be a historian so he should know this) that recessions do not last for ever: regular as clockwork economies return to normal, and moreover experience booms or bouts of “irrational exuberance” from time to time (at which point SURPLUSES rather than deficits become appropriate). 

Thus Ferguson’s assumption that the deficit will continue at anywhere near its present or recent rate is nonsense.

Would a 500% debt:GDP ratio matter?

And not only that, but would it really matter if the debt:GDP ratio DID RISE to 500%? Well the answer to that will be second nature to advoctes of Modern Monetary Theory, but way beyond the comprehension of Naill Fergson (and indeed others at Harvard, e.g. Kenneth Rogoff).

The answer is that there isn't much difference between base money and national debt at low rates of interest as recently pointed out by Martin Wolf in the Financial Times*. And if the private sector is determined at accumulate state liabilities (base money and debt) even at low rates of interest, there is not much that the state can do about it.

If the state DOES NOT supply the private sector with the state liabilities that the private sector wants, the private sector will simply try to save (save money that is), and as Keynes pointed out, saving money instead of spending it tends to raise unemployment. Keynes called that the “paradox of thrift”.

But long before 2040, it could go the other way, that is, the private sector’s desire to save could decline: i.e. the private sector might try to spend away its stock of national debt and base money. In that case demand and inflation might easily become excessive, in which case it would make sense for the relevant government and central bank to run a surplus, i.e. grab money off the private sector and “unprint” it (and/or cut public spending).

At the extreme, the national debt might decline to some record low figure, like 30% of GDP. We just don’t know. And it really doesn’t matter whether the debt is 30% or 300% of GDP as long as interest on the debt is kept down. Personlly I’m happy with any old rate of interest as long as its NEGATIVE in real terms, i.e. negative after adjusting for inflation. That way the relevant country profits from it’s creditors! What’s not to like about that?


* As Wolf put it, “Central-bank money can also be thought of as non-interest-bearing, irredeemable government debt. But 10-year Japanese Government Bonds yield less than 0.5 per cent. So the difference between the two forms of government “debt” is tiny…”

Thursday, 21 May 2015

Leading economists back Positive Money and MMT, sort of.

Positive Money and MMT have featured prominently on this site of mine for years. So it’s good to see three leading economists in The Guardian backing an idea that PM and MMT have have backed for an equally long time if not longer. That’s the idea that in a recession, the state should simply create new base money and spend it and/or cut taxes (or as some MMTers put it, “create fiat” and spend it).

The three economists are Mark Blyth, Eric Lonergan and Simon Wren-Lewis. (Incidentally, I am NOT an official spokesman for PM.)

The need for “create and spend”, as the article makes clear, is especially urgent given that what with monetary policy having arguably run out of steam, some new form of stimulus may be needed. However, in saying that, the authors diverge from PM thinking in that PM advocates that “create and spend” is the best form of stimulus even where monetary policy has NOT RUN OUT of steam.

That is, in their submission to Vickers (authored jointly with Prof Richard Werner and the New Economics Foundation), PM criticised interest rate adjustments, and righly so. My own main beef with interest rate adjustments is that they are DISTORTIONARY. To illustrate, when interest rates are cut, lending and borrowing based activity expands, whereas non-lending based activity does not. That makes as much sense as imparting stimulus by boosting just car manufacturing, restaurants and garages, with everything else from hospitals to hotels being ignored. There is also plenty of evidence that interest rate adjustments do not actually work too well.

A second “divergence” from PM policy comes in this passage in the Guardain article: “Parliament needs to equip the Bank with the infrastructure to administer payments, and determine in advance the recipients. An equal payment to all households is likely to be the least controversial rule.”

Well that would certainly be ONE WAY of implementing “create and spend”, and that’s nowhere near the first time that’s been advocated. But why go to all the bother of setting up an entirely new system for disbursing new money when we already have such systems in place: existing public spending programs, plus there are sundry taxes that could be cut. There’s VAT, income tax, payroll taxes – the list goes on and on and on.

Moreover, the above “distribute to households” system suffers the same defect as interest rate adjustments: it’s distortionary. That is, there is a HUGE CHUNCK of the economy which is NOT DEPENDENT on households’ tendency to spend: the existing public sector – health, education and so on.

If stimulus is to be politically neutral, the public sector should have it’s share of stimulus, shouldn’t it?

Wednesday, 20 May 2015

The Economist’s ideas on why debts are so high.

The Economist claims there are two reasons why we’re “addicted to debt” (to quote the title of their article). First, one of the main forms of debt, i.e. mortgages, involves tax perks. Second, The Economist claims that people over-estimate the safety of debt.

Doubtless those are valid reasons, but there is a third reason, namely that we subsidise the commercial banks that create much of the debt: there’s the small matter of that $13 trillion of public money was used to rescue banks in the recent crisis in the US. (Yes that’s trillion, not billion.)

Of course that’s not to say that private banks got a subsidy worth thirteen trillion. But certainly some of that public money was loaned to private banks at a near zero rate of interest.

It’s impossible to say what a REALISTIC rate would be. No doubt that varies from bank to bank. But as a rough guide, Warren Buffet loaned five billion to Goldman Sachs during the crisis at 10%.

Now if you can borrow a few billion (or perhaps trillion) at 0% when the realistic rate is 10%, well that’s one hell of a subsidy, isn't it?

As for any idea that the dozy corrupt incompetents in high places and their bankster / criminal friends have any intention of ceasing to rob taxpayers with a view to subsidising banks, well that’s just pie in the sky. One of my local radio stations, Smooth Radio, has an advert at least once a day saying quite explicitly that bank deposits in the UK are backed by UK taxpayers. I assume the same goes for other regions in the UK.

Perhaps a more accurate summary of the situation would be thus. Politicians are near 100% clueless when it comes to banking and banksters know it. Banksters only have mutter something about economic growth being hit if bank lending declines, and politicians fall for it every time. Thus banksters have no trouble at all in wheedling billions of dollars and pounds of free money out of politicians every year.

Tuesday, 19 May 2015

Maturity transformation is an example of the fallacy of composition error.

Maturity transformation is one of the basic activities of commercial banks: it consists of “borrow short and lend long”. That is, commercial banks accept money from depositors (and bondholders and shareholders) and lend to mortgagors, businesses, etc. The “maturity” of deposits is short: i.e. the money is available on demand or at short notice. In contrast, mortgages last for years if not decades. That is, the “maturity” there is LONG. Thus banks according to the conventional wisdom and according to the text books perform a valuable service: they “transform” short maturity into long maturity, i.e. banks enable those who are only prepared to lose access to their money for relatively short periods to nevertheless gain some of the benefits (i.e. the relatively high interest rates) that come from lending out money for LONG periods.

The fallacy of composition error is where some policy benefits INDIVIDUAL households or firms, with the conclusion being drawn from that that similar benefits must also be conferred on ALL OR MOST households and firms, or on the economy as a whole.

To illustrate the fallacy of composition flaw in maturity transformation, let’s take a simple hypothetical economy, as follows.


A hypothetical economy.

Everyone has stock of base money (in physical form or at an account at the CB) to the tune of £X per person. That amount of money induces the population to spend at a rate that brings full employment. In addition, supply and demand for loans is such that each person in half the population lends £Z to each person in the other half.

Loans by one person to another involve the creditor losing access to their £Z for duration of loan, unless they can find someone else willing to take on the loan, i.e. act as creditor.

A commercial bank sets up in business.

A commercial bank then sets up in business and makes an amazing offer to everyone. The bank says to potential lenders, “instead of lending DIRECT to those who want to borrow, why not deposit your money with us, and we’ll do the lending. Plus we’ll guarantee you instant access to your money instead of your waiting for the above mentioned replacement creditor to appear. Plus you’ll continue to get interest.” That bank also takes over the job of creditor in respect of EXISTING loans.

The bank of course knows that it’s highly unlikely that all depositors or even a significant proportion of them will want to withdraw all their money on the same day, so this amazing wheeze thought up by the commercial bank works.

There is however a problem, which is that lenders’ stock of instant access money has risen: and that means that aggregate demand rises. Indeed on the very reasonable assumption that people keep their stock of instant access money to a minimum and try to spend away any excess stock, then lender’s EXCESS STOCK of instant access money will be £Z per person. So the central bank will have to raise taxes and withdraw base money from the economy (to the tune of £Z per lender). And there’s no question but that peoples’ stock of money is related to their weekly spending: what do people do when they win a lottery?

The fallacy of composition.

So what has the commercial bank achieved? It hasn’t improved the population’s liquidity one iota: that is, the amount of instant access money has not increased.

To summarise, when the commercial bank is first set up, each lender thinks they’re getting a bargain: their stock of instant access money rises, and the only downside is that the bank takes a cut. However, in the aggregate there’s no increase in instant access money after government has taxed away the excess instant access money. And that’s where the fallacy of composition lies.

Other benefits of commercial banks.

Another benefit that commercial banks confer is EFFICIENCY (e.g. they have staff with legal qualifications who specialise in drawing up agreements with mortgagors.) And that’s doubtless more efficient than     INDIVIDUAL lenders and borrowers getting together and trying to cobble together legally binding contracts, or hiring a lawyer on a one off basis for each mortgage or other loan arranged.

That increased efficiency probably compensates for the above mentioned cut that banks take. But the fact remains that increased stock of instant access money brought about by the commercial bank’s maturity transformation system is a mirage: it’s a fallacy of composition.


Of course the above is an over simplified version of the real world. But introducing the complexities of the real world won’t change the basic outcome, far as I can see. For example, people’s weekly spending is no doubt related their TOTAL NET ASSETS as well as being related to one particular form of asset: instant access money.

Thus when government raises taxes in the above scenario so as to cut demand, as well as confiscating instant access money, lenders’ net assets are ipso facto also confiscated. Ergo the demand reducing effect is more powerful than might at first seem, ergo government will not tax away quite as much money as suggested above. Ergo lenders end up with more instant access money than suggested above. Ergo they’ll try to find some other asset to invest their excess instant access money in. But purchasing the latter asset is likely to increase demand, so that’s not allowable (on the above assumption that the economy is already at capacity).

This is complicated!!!

Saturday, 16 May 2015

Abolish cash so as to make negative interest rates easier?

One flaw in the “let’s abolish cash” argument is thus.

One motive for doing so is to make the imposition of negative interest rates easier, which in turn makes it easier to impart stimulus in a recession. I.e. the argument is that if zero interest rates don’t solve the problem, then negative rates might.

One problem with that idea is that interest rate adjustments are an inherently illogical way of imparting stimulus. That is, if there’s a recession, there is no prima facie reason to assume it’s caused by lack of investment or borrowing based activity, rather than a drop in demand for ice cream, cars, condoms, you name it. Ergo the logical response to a recession is simply to raise ALL FORMS of demand -  unless there’s VERY SPECIFIC evidence that lack of investment spending is the culprit. And even there, a drop in borrowing and debts does not necessarily prove that potential borrowers have got it wrong: there may be good reasons for reducing investment, borrowing and debts.

And having raised demand GENERALLY, employers (public and private sector) are quite capable of working out for themselves how much of their increased cash flow should be devoted to more borrowing and investment - no need for nanny state to tell them.

A second flaw in negative interest rates is that they can, at least in theory, result in negative output.

So the conclusion is: “down with negative interest rates” - although that could be interpreted the wrong way...:-)

Thursday, 14 May 2015

Inane drivel from Neil Wilson on full reserve banking.

Neil Wilson has a good grasp of some areas of economics: in particular Modern Monetary Theory.

However this article of his on full reserve banking (FR) is trash. His attempt to summarise the basics of FR is straight out of la-la land. That’s in contrast to other critics of FR who at least have some idea what FR consists of. For example this article criticising FR by Brian Romanchuk summarises the basics of FR correctly. (That’s under his heading “The Proposals” at the start of his article). In fact I can’t flaw Brian Romanchuk’s summary.


Uri Geller and magic.

The first three hundred or so words of Neil Wilson’s article consist of accusing advocates of full reserve (FR) of trickery and magic. There are links to magician sites, references to Uri Geller and so on. That’s a bizarre way of starting an article which is supposed to be serious economics.

If Neil Wilson is trying to say that some advocates of FR engage in propaganda rather than logic, that’s certainly true. Indeed Positive Money (which advocates FR) is quite clearly a CAMPAIGNING organisation as well as publishing material which is completely serious. But the same goes for most areas of economics: part propaganda and part logic.

Incidentally, and re Positive Money, I’ll refer to “PM & Co” below. That’s a reference to the three authors of a submission to the Vickers commission: Positive Money, Prof Richard Werner and the New Economics Foundation.

The basics of FR.

Anyway Neil Wilson’s attempt to summarise FR appears under his heading “The Fundamentals”. He starts “Sovereign money stimulates the economy by increasing the price of and therefore reduces the level of bank lending and then replaces that in the economy by increased government spending or tax cuts. And that’s it.”

(Incidentally “Sovereign money” is just an alternative name for FR.)

Well if you actually read the works of FR advocates (Milton Friedman, Laurence Kotlikoff, John Cochrane, Positive Money, John Kay, etc) nowhere will you see the idea advanced that the basic objective is to raise the cost of borrowing and make up for that with more government spending. It MAY WELL BE that FR does raise the cost of borrowing, but that’s a side effect.

Anyway, to continue with the Neil Wilson effort, the next paragraph reads. “The basic theory is that increasing the price of bank lending automatically selects the correct projects to receive bank lending.”

Well first, as just mentioned, it is very definitely not the “basic” objective of FR to raise interest rates. Indeed Neil Wilson doesn’t cite any passages from advocates of FR to back up the idea that raising interest rates is a basic objective of FR. And that’s for the very good reason that such passages don’t exist: at least I read hundreds of thousands of words by numerous advocates of Sovereign money / FR and don’t recollect any such passages.

As for the idea that low interest rates don’t “select the correct projects to receive bank lending” whereas higher interest rates do, I absolutely agree that that’s a barmy idea. If that WERE a central ingredient in FR, I’d have nothing to do with FR. However (and to repeat) the above “high interest rate” idea is simply a figment of Neil Wilson’s imagination. It’s straight out of la-la land.

In fact this la-la land stuff from Neil Wilson makes his accusations to the effect that advocates of FR are engaged in magic and hocus pocus look decidedly odd: the words “pot”, “kettle” and “black” spring to mind.

The “undemocratic” committee.

Given that Neil Wilson clearly hasn’t the faintest idea what he’s talking about, I’m not going to waste time going right thru every sentence of his article. However, I WILL DEAL WITH just one further mistake he makes, first because it’s actually a mistake made by SEVERAL opponents of FR (including Anne Pettifor and Bill Mitchell). Second, Neil Wilson himself seems to think it’s an important point or “myth”. He introduces this alleged myth with the words, “The final myth is by far the most pernicious and the most disturbing.”
I’ve actually tried to explain the flaw in this alleged myth to Neil Wilson several times, but he clearly doesn’t have the brain to grasp it. Maybe Anne Pettifor and Bill Mitchell don’t either – I’m not sure. It’s a point that I’d have thought the average fifteen year old could understand. Anyway the “pernicious myth” is as follows.

Under a sovereign money system (i.e. under FR as advocated by SOME, but not others), stimulus takes the form of the state simply creating new base money and spending it, and/or cutting taxes. And clearly if that’s how stimulus is done, then SOMEONE or some committee or whatever has to decide how much stimulus is required from time to time.

And PM & Co’s answer to the latter question is that some sort of committee of economists (much like the Bank of England Monetary Policy Committee) should do the deciding. That committee is called the “Money Creation Committee” by PM & Co – I’ll call that the MCC.

Now it’s that committee that causes the Wilson / Pettifor lot to go ballistic. They claim that involves having important economic decisions put into the hands of a selection of people who are not democratically elected, and that consequently that means the end of civilisation as we know it.

Well that objection from Wilson, Pettifor, Mitchell & Co is pure unmitigated nonsense and for the following five reasons.

1. Others also advocate “print and spend”.

Most MMTers advocate EXACTLY THE SAME form of stimulus as PM & Co: i.e. “create new money and spend it”. It’s just that most of them KEEP QUIET about who actually decides on the size of stimulus package. (And note that Neil Wilson and Bill Mitchell are MMTers)

Plus Keynes approved of “create and spend”.

So to that extent, the only difference between PM & Co and most members of the Wilson / Pettifor / Mitchell brigade is that PM ARE HONEST!!!!  To repeat, PM & Co are totally clear on WHO DECIDES on stimulus, whereas most members of the Wilson / Pettifor brigade skate over the issue.

2. “Undemocratic” committees already decide stimulus.

Over the last few years and reaction to the recession we’ve actually ADOPTED a “create money and spend it” policy. That’s because we’ve implemented fiscal stimulus and followed that by QE, and that comes to the same thing as “create and spend”.

And who exactly decides in the size of that stimulus package? Well – shock horror – it’s one of those horrendous “undemocratic” committees: in the case of the UK, the Bank of England Monetary Policy Committee!!!

Looks like various members of the Wilson / Pettifor / Mitchell brigade have no idea what’s going on at the moment – never mind what might take place under full reserve banking.

And make no mistake: “undemocratic” central bank committees have the whip hand when it comes to determining the size of stimulus packages, not democratically elected politicians. That’s because (in the case of the UK at least) government has EXPLICITLY given the BoE responsibility for inflation. That means that politicians have given the BoE powers to override any fiscal stimulus that politicians might implement.

As to the US, much the same applies. Indeed market monetarists are always referring to what they call “monetary offset”: that’s the idea (just set out above) that if politicians implement stimulus, or too much stimulus, then the central bank may easily “offset” it.

But here’s the really strange thing. Despite the fact that stimulus is ALREADY DECIDED by “undemocratic” committees like central bank interest rate committees, VERY FEW objections to that fact have ever been raised by the Wilson / Pettifor brigade. In short, it’s blindingly obvious that their blather about “undemocratic” committees derives from their scratching around for any old bit of mud to throw at FR, rather than any sort of thoughtful analysis of FR.

3. The printing press.

There is a VERY GOOD REASON for giving “undemocratic” committees considerable powers: it’s that most of us do not want to see politicians having exclusive control of the printing press. I.e. about 90% of the population and 90% of economists (I’d guess) just don’t agree with the ultra-democratic ideas put by Wilson, Mitchell and Pettifor (assuming those “ideas” amount to anything coherent, which I don’t think they do).

4. Dispose of “undemocratic” committees?

Having said there are good reasons for “undemocratic”committees, that’s not to say we COULDN’T have a system where stimulus is ENTIRELY I the hands of politicians. FR is entirely consistent with doing that. I.e. (and the Wilson / Pettifor brigade will be in tears about this), undemocratic committees ARE NOT, repeat ARE NOT an essential ingredient in FR.

5. “Undemocratic” committees leave POLITICAL decisions to politicians.

As PM & Co have explained till they’re blue in the face, the fact that the MCC has the power to determine the TOTAL SIZE of a stimulus package DOES NOT, REPEAT NOT, REPEAT NOT, REPEAT NOT mean the MCC has powers over obviously POLITICAL decisions like what proportion of GDP is allocated to public spending, and how that spending is split between the usual public spending items like health, education, defence and so on.

Reason for that is, the MCC decides on the DIFFERENCE BETWEEN government income and expenditure (i.e. the size of the deficit). And that’s it. It does NOT, REPEAT NOT decide on obviously political matters. Indeed, in that respect, the MCC is very much like the existing BoE MPC (in the case of the UK).

Since members of the Wilson / Pettifor / Mitchell brigade seem to have extreme difficulty in understanding that point, I’ll repeat it red.

The fact that the MCC has the power to determine the TOTAL SIZE of a stimulus package DOES NOT, REPEAT NOT, REPEAT NOT, REPEAT NOT mean the MCC has powers over obviously POLITICAL decisions like what proportion of GDP is allocated to public spending, and how that spending is split between for example health, education, defence and so on.

Hope I’ve got that very simple point across. But I’ve got my doubts.

Wednesday, 13 May 2015

Another economist who can’t recognise a bank subsidy when it stares her in the face.

I drew attention yesterday to an economist (Bill Mitchell) who doesn’t seem to be able to recognise a bank subsidy when it stares him in the face. Another instance of the same failure is this Forbes article by Frances Coppola where she admits that the loans made by central banks to commercial banks during the recent crisis were at an artificially low rate, but doesn’t seem to think there’s anything wrong there.

I shouldn’t have to explain this, but it’s widely accepted in economics that subsidies do not make economic sense: that is, they result in a misallocation of resources. Even most of those who have never studied economics understand that.

The only exception (which again, is very widely understood) comes with subsidies for which there is a clear social justification, as for example in the case of education for kids.

Most of those who ponder the improvements that need to be made to bank regulation recognise that there is something fundamentally wrong with taxpayer funded subsidies or guarantees for private banks. As the UK’s Vickers commission put it, “The risks inevitably associated with banking have to sit somewhere, and it should not be with taxpayers.”