Brad de Long wants government to borrow $500bn to spend on infrastructure.

The US government can currently borrow for 30 years at a REAL rate of interest of 1% (i.e. after taking inflation into account). Brad de Long wants government to borrow $500bn to spend on infrastructure.

Now what’s the point of borrowing money (even at 1%) when you can print the stuff at no cost? Of course the knee jerk reaction to the phrase “print money” is “inflation”. But as David Hume pointed out over two hundred years ago, money supply increases are not inflationary except to the extent that they are spent: i.e. except to the extent that they increase demand. And all demand is ultimately demand for labour.* Thus creating jobs for X people as a result of printing will be no more inflationary than creating jobs for X people as a result of borrowing.

Of course the demand stemming from that extra money may cause excess inflation in two years time: especially if there is a significant rise in demand for US exports or a rise in consumer confidence. But in that case the extra money will just have to be reined in via extra tax (and/or less public spending) and “unprinted”. Pretty much the same scenario obtains if the “borrow” option is adopted: that is, given excess inflation, governments can raise interest rates, which involves the central bank selling government bonds and withdrawing money from the private sector.

Second, infrastructure projects get trotted out every time there’s a recession – Pericles advocated the idea in ancient Greece two and a half thousand years ago. Now why does the optimum mix of infrastructure and other forms of public and private spending change just because GDP expands a bit slower than normal? It doesn’t! In short, an ALL ROUND increase in spending, public and private, is preferable to the bizarre collect of pet projects that politicians, economists, greens, etc etc come up with every time there’s a recession: infrastructure schemes, windfarms, bridges to nowhere – the list is endless.

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*Reason why all demand is ultimately demand for labour is as follows. First, I’ll cheat a bit and classify profits as the “wage” of a particular type of labour: the entrepreneur.

The cost of anything is made of the cost of the capital equipment, materials and labour needed to make it or supply it. And in turn the cost of the latter capital equipment and materials is made up of the cost of the capital equipment, materials and labour needed to make it or supply it. And in turn the cost ………you get the picture.

Ultimately, 100% of the cost of anything is the cost of the labour. Or if you don’t like classifying “profit” as “labour”, then 100% of the cost anything is the cost of labour and entrepreneur’s “labour”, i.e. profit.

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Velocity of circulation of money.

I took the first chart above and superimposed the figures given by Mariner Eccles (p.710) for the velocity of circulation in the 1920s/30s. Hat tip to Zerohedge for the first chart.

This is all very unscientific. I’ve no idea whether the figures given by Eccles for the 1920s are comparable to the figures given in the Reuters chart. But the RELATIVE changes in velocity around the time of the 1929 crash seem to be more violent than in the recent credit crunch . . . so far. Perhaps there is a treat in store for us: perhaps we’ll go right off the bottom of the chart in a year or two. Sweet dreams.

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What’s the optimum long term debt to GDP ratio?

The answer is easy. Advocates of Modern Monetary Theory (MMT) answered that question long ago. Though the question still seems to puzzle some authorities. For example Brad de Long (who I normally greatly respect) says:

“As to what is the appropriate debt-to-GDP ratio to pursue in the long run, that is a difficult empirical question….”

As one of the leading MMTers, Warren Mosler has pointed out (2nd last paragraph), there is no point in government debt rising to the point where government has to pay any interest on such debt. I.e. government should not issue interest paying debt.

Put another way, most of the alleged and popular reasons for government borrowing are bunk, as I point out here.

The only reason for having government issue liabilities is to ensure that the private sector has sufficient net financial assets to ensure that the private sector spends at a rate which brings full employment. Indeed, the latter point is simply a re-statement of Keynes’s “paradox of thrift” point. That is, if the private sector is intent on saving money, rather than spending it, the result will be excess unemployment unless government prints enough money to satisfy the private sector’s savings desires.

Just Google the phrases “private sector net financial assets” and “savings desires”. You’ll find MMTers grossly over-represented in the first ten or twenty items that Google finds.

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Mariner Eccles.

This is an extract from page 708 of evidence given by Mariner Eccles to the US Committee on Finance in 1933. Hat tip to Bill Mitchell.

Why was it that during the war when there was no depression we did not insist upon balancing the Budget by sufficient taxation of our surplus income instead of using Government credit to the extent of $27,OOO,OOO,OOO? Why was it that we heard nothing of the necessity of balancing the Federal Budget in order to maintain the Government credit when we had a deficit of $9,000,000,000 in 1918 and $13,000,000,000 in 1919? Why was it there was no unemployment at that time and an insufficient, amount of money as a medium of exchange? How was it that with one billion less gold then than we now have we were not concerned about our gold standard?

How was it that during the period of prosperity after the war we were able in spite of what is termed our extravagance - which was not extravagance at all; we saved too much and consumed to little - how was it we were able to balance a $4,000,000,000 annual Budget, to pay off ten billion of the Gov¬ernment debt, to make four major reductions in our income tax rates (otherwise all of the Government debt would have been paid), to extend $10,000,000,000 in cedit to foreign countries represented by our surplus production which we shipped abroad, and add approximately $100,000,000,000 by capital accumulation to our national wealth, represented by plants, equipment, buildings, and construction of all kinds? In the light of this record, is it consistent for our political and financial leadership to demand at this time a balanced Budget by the inauguration of a general sales tax, further reducing the buying power of our people? Is it necessary to conserve Govern¬ment credit to the point of providing a starvation existence for millions of our people in a land of superabundance? Is the universal demand for Government economy consistent at this time? Is the present lack of confidence due to an unbalanced Budget?

What the public and the business men of this country are interested in is a revival of employment and purchasing power. This would automatically restore confidence and increase profits to a point where the Budget would automatically be balanced in just the same manner as the inddividual, corporation, State, and city budget would be balanced.

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Why don’t PIGs devalue their currencies?

There is a way that European periphery countries could solve their problems in 24 hours – at least in principle. And that is to organise a substantial and instantaneous cut in ALL wages. This would amount to a devaluation of their currencies. Indeed this is the ultimate objective of the long drawn out and extremely painful deflation currently being imposed on these countries.

A wage cut of X% in a given country would not of course cut living standards by anywhere near X% for the simple reason that the cost of goods and services in each country is made up mainly of the cost of local labour needed to make and get those goods and services to market. And this simple point would have to be drilled into the heads of the population before proceeding with this “wage cut / devaluation” policy.

There are of course HUGE political difficulties in organising an instant all round cut in wages. That is, as suggested just above, the local population would be up in arms. Thus a large and expensive advertising campaign would be needed to teach the local population some basic economics.

And there is the knotty problem as to how far employers could cut their own “wages” (i.e. profits) at the same time. But one answer to this is to include in the above campaign something to the effect that “If you don’t like the profit that employers are making, don’t just sit there complaining: become an employer. Set up your own business.”

The costs of the above campaign would be huge. But the costs of the existing “deflation lasting several years” policy is HUGE as well.

Moreover, once the rationale of the “instant wage cut / devaluation” policy became widely understood throughout Europe, future problems deriving from lack of competitiveness of individual countries would be much easier to deal with.

Of course lack of competitiveness is not the only PIG problem: debts are a problem as well. But any bank or creditor is happy to lend to someone in debt as long as the debtor is competitive and is earning money.

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Afterthought (28^th Sept 2011). A way of persuading PIG citizens of the merits of the above type of “fast devaluation” would be something along the following lines.

Look at the UK. It devalued its currency by about 25% in 2008. Nine out of ten UK citizens had no idea at the time that this was happening. There was no dramatic effect on living standards. The whole episode was one huge non-event.

 

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Paul Volker says low interest rates cause asset bubbles. No kidding?

Congratulations to Paul Volker for his statement of the bleed’n obvious, namely that “if money is too easy for too long, we’ll have more asset bubbles”

First we have a credit crunch caused by excessive and irresponsible borrowing. And the solution the world adopts is . . . . wait for it . . . . . to cut interest rates so as to encourage more borrowing.

But seriously, we have a conundrum: the economy needs boosting, but if we boost it via low interest rates, that is liable to cause bubbles. So what’s the solution? Well I’ve spelled out the solution several times already on this blog. But there is no harm in repeating it.

Indeed, Australian economist Bill Mitchell on his blog repeats the same points over and over and over and over and over and over and over and over. That is not because he is stupid. It’s because the bulk of the human race is stupid. I.e. to get a point across to the bulk of the human race, it’s no use explaining a point in any sort of intelligent or logical or concise fashion. The only way of getting a point across is to repeat it over and over and over and over and over.

Harold MacMillan, former British premier once said that his speeches consisted of nothing more than repeating the same point over and over – with slight variations of course so as to avoid blatantly insulting the audience.

Anyway, there is a method of boosting economies which does not involve low interest rates, and that is, as advocated by MMT, to simply create new money and spend it into the economy: in particular, channel the money into the pockets of middle and low income groups because they are more likely to spend such money quickly than the wealthy. As to interest rates – to hell with them. Let them look after themselves. Let them find their own level.

It is a generally accepted principle in economics that the price of anything should be the market price, unless market failure can be demonstrated. So unless anyone can demonstrate market failure in the case of interest rates, rates of interest should be determined by market forces.

Moreover, why boost an economy just via a narrow range of activities or assets: the ones most influenced by interest rate changes. You might as well boost an economy via firms and households whose names begin with the letters A-M and ignore the “L-Zs”.

But the elite can’t bear to see money being wasted on the less well off. Given a recession and the availability of some extra money to deal with the recession, the elite would rather use the money to tinker with the various levers and knobs at their disposal: interest rates, investment incentives, job creation schemes, infrastructure projects, bridges to nowhere, green projects, special measures for “small and mediums size enterprises”. Very touchy feely, that last one. Moreover, if you are a politician, being seen to back SPECIFIC projects which allegedly “create jobs” is probably a better vote winner than boring old tax cuts, or an all round increase in public spending.

And finally, the basic purpose of an economy is to produce what PEOPLE – that is the consumer – want. If there is insufficient demand, then the PEOPLE should be given more spending power. Market forces can then sort out how much of that extra spending is diverted to investment, small and medium size enterprises, and so on.

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Laugh of the year: Bernanke claims bank bail outs cost the taxpayer nothing.

See here.

Runner up in the laugh of the year contest is Rupert Merdoch’s claim that he knew nothing about phone hacking.

And third prize goes to Jack Straw, Britain’s former foreign minister, for his claim that he knew nothing about the torture of those “rendered” to Libya from the UK before Gadaffi’s removal from power.

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Rubbish from Nouriel Roubini.

For low grade drivel, this article by Roubini takes some beating. The article is an eight point plan to avoid a depression.

First, Roubini trots out a nonsensical piece of conventional wisdom, namely, in his own words that “First, we must accept that austerity measures, necessary to avoid a fiscal train wreck, have recessionary effects on output.”

The phrase “fiscal trainwreck” is slap-dash and imprecise because it fails to distinguish between the part of the deficit which is structural, and the part which is supposed to bring stimulus. I’ll deal with the structural part first.

Dealing with the structural deficit is child’s play. At least there are absolutely no technical difficulties that cannot be explained to an adult of average I.Q. in three minutes.

A structural deficit occurs when government fails to collect enough tax and resorts to borrowing instead. Reversing this process is easy: cut borrowing and raise taxes (or cut spending). There may be political difficulties in doing this, but there absolutely no technical difficulties. Moreover and contrary to Roubini’s claims, NO AUSTERITY need be involved. That’s because as long as the AMOUNT OF tax increase and borrowing reduction are such that the deflationary effect of the former equals the stimulatory / inflationary effect of the latter, there is no net effect. I.e. there is no net effect on demand, GDP, numbers employed, etc etc, i.e. NO AUSTERITY. (The issue is actually A BIT more complicated than suggested in the latter sentence, but the latter sentence is more or less correct.)

As distinct from the structural deficit, there is the “stimulus deficit”, that is the extent to which government runs a deficit with a view to doing some Keynsian “borrow and spend”. Well the alternative to borrow and spend, as Keynes, Milton Friedman and others pointed out is to go for “print and spend” (and/or print and reduce taxes). Again, as long as stimulatory / inflationary effect of the printing equals the deflationary effect of the reduced “borrow and spend”, then again, there is no austerity, no net effect on inflation, or GDP or anything else.

Roubini’s second point starts “while monetary policy has limited impact when the problems are excessive debt and insolvency rather than illiquidity….”. No, monetary policy can have a substantial effect even given excess “debt and insolvency”. Here’s how: channel money into the pockets of middle and low income earners. They will tend to spend a relatively large portion of that money, compared to the elite.

The evidence is that when the average household’s income rises, its spending rises, fantastic as that might seem. The latter point will be blindingly obvious to the average mentally retarded snail, but it seems to way above the heads of economics professors (and not just Roubini).

Roubini’s third point is worth quoting in full (in italics):

Third, to restore credit growth, eurozone banks and banking systems that are under-capitalized should be strengthened with public financing in a European Union-wide program. To avoid an additional credit crunch as banks deleverage, banks should be given some short-term forbearance on capital and liquidity requirements. Also, since the US and EU financial systems remain unlikely to provide credit to small and medium-size enterprises, direct government provision of credit to solvent but illiquid SMEs is essential.

Well that’s great, isn’t it? Governments have already shafted taxpayers with a view to rescuing banksters. Now Roubini wants a few more trillion to be given the assortment of depraved fraudsters, spivs and conmen that make up Wall Street.

I’ve got a better idea: channel the trillions into household pockets and let a few banks go bust. Don’t close them down of course – just wipe out the shareholders, unsecured creditors, etc. Then have government wind down the relevant banks or sell them to the highest bidder. If the highest bidder for a bank bids $1, so be it.

Roubini is under the illusion that the only form of salvation for employers can come as a result of loans: that is having employers grovel in front of the above mentioned Wall Street fraudsters in the hope of getting a loan (or grovel in front of government bureaucrats in the hope of same). There is of course an alternative (mentioned above). That is simply to channel funds to households rather than banks. That way employers get the cash they want from customers rather than banks.

Fourth, Roubini wants big hand outs for European periphery countries. Well obviously that will solve the problem in the short term, but it does not solve the longer term problem of such countries’ lack of competitiveness relative to core countries. Moreover, German taxpayers are getting understandably sick of subsidising periphery irresponsibility. Rather than make fatuous statements about hand outs for the irresponsible, perhaps Roubini could solve a more difficult problem, namely how does Angela Merkel persuade Germans to carry on supporting Greek fraudsters, and do Germans really have much of a moral obligation to continue supporting Greeks bearing gifts.

As to Roubini’s fifth, sixth, seventh etc ideas, can you really be bothered with them? I can’t. Of course if one trots out ideas at random, sooner or later one will come up with a good idea. By the same token, let a chimpanzee press keys at random on a piano for long enough, and eventually you’ll hear a Mozart sonata (after waiting a billion years). I can think of quicker ways of getting to hear a Mozart sonata when I want to listen to one.

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The Peterson Foundation thinks foreigners fund the budget deficit – tee hee.

When a government collects insufficient tax, it borrows instead, and the result is a budget deficit. Borrowing takes the form of issuing government bonds, e.g. Treasuries in the US, and obviously foreigners buy some of those bonds. This leads numerous folk to conclude that foreigners to some extent fund the deficit. The flaw in this argument is thus.

If a government fails to collect enough tax, and simply prints money to fund the relevant spending, the effect is inflationary (assuming the economy is already at NAIRU). Thus some form of deflationary counter-measure is needed: that is, demand from DOMESTIC sources must be curtailed.

One such deflationary measure is to borrow from domestic sources, i.e. sell government bonds. But there is a problem here, namely that foreigners will buy a proportion of these bonds. But the latter does not achieve the desired objective, namely curtailing domestic demand. That is, those foreigners, had the bonds not been available would not have spent the relevant money on consumer goods (and hence created demand) in the country that issued the bonds. To that extent, selling bonds to foreigners is a COMPLETE WASTE OF TIME.

Alternatively, those foreigners might in the absence of those bond sales have lent to some other entity in the country concerned. But there again, their switching from lending to those other entities to lending to government does not have a deflationary effect.

To put it figuratively, if foreigners buy $X of bonds issued to fund a budget deficit, government will just have to issue ANOTHER $X of bonds, and hope that DOMESTIC entities buy those bonds.

I argued here that all government borrowing is a farce. That is, government “borrowing” in the sense of paying interest to anyone is a farce. (Non interest yielding monetary base could be construed as a debt owed by central banks to holders of said base, but this so called debt is irredeemable, so it is not really debt.)

The above uselessness of incurring debt to foreigners on which one pays interest is just one aspect of the farcical nature of government debt.

Examples the above “foreigners fund the budget deficit” mistake are thus.

The Peterson Foundation makes the mistake (pages 14-16 & 28). See also the sub-heading here, and the first sentence here.

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Afterthought – a few hours after putting the above online…..  I’ve just noticed an article published by Warren Mosler today which also makes the above point about the uselessness of government paying interest to anyone. The article concerns a “mini-currency”, the so called “buckaroo”, set up at the University of Missouri-Kansas City. It was set up to facilitate trade between students and the university authorities. As the article puts it, “The UMKC, as well as the students, have failed to identify any public purposes that may be served by having the UMKC pay interest on buckaroo savings, so the 0 interest rate policy remains in place.”

 

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The marginal product of labour.

As unemployment falls, the marginal product of labour falls. That is, each succeeding person hired becomes progressively less suitable for the vacancy they fill. This occurs because the fewer unemployed there are to choose from, the less likely an employer is to be able to find the perfect employee to fill each vacancy.

When this “product” or output of those hired falls to the minimum wage, union wage, etc etc, unemployment cannot be reduced any further, else employers tend to resort to poaching each other’s employees (consciously or not) rather than take labour from the dole queue, thus inflation kicks in.

So what’s the solution? It’s easy – in principle. Just subsidise those marginal employees.

Identifying the marginal employees is easy at first: they are the unemployed. But there is a problem: as time passes, the unemployed who have been subsidised into work are no longer “marginal”, i.e. they are not the least productive people in each firm.

This is for several reasons. First they gain firm specific skills and begin to become economic propositions even without any subsidy. Second, the pattern of supply and demand for different types of labour on each local labour market, and within each firm, is constantly changing: types of labour which were in surplus, and which were thus “marginal” one month, may not be in surplus six months later.

So how do we ensure that employers claim the subsidy only in respect of those employees who are genuinely marginal?  Easy: call the employer’s bluff. That is, limit the time each subsidised employee stays with a particular employer, or remove such employees from subsidised jobs at a random interval after they start their subsidised job. Employers DO MIND losing valuable employees, but they DON’T MIND losing peripheral or marginal employees.

Additional rules.

There are of course a number of refinements or additional rules that could be added to the game. For example an obvious way for employers to cheat would be claim the subsidy in respect of employees who were not marginal (i.e. who were economic propositions without the subsidy). And then when the subsidy expired for a given employee, the employer could simply continue employing the employee on a normal or unsubsidised basis. The solution to that problem is to bar employees from returning to a given employer for several months if the subsidy expires before the employer has voluntarily ceased to claim the subsidy.

Disadvantages.

A disadvantage of the above system is that it would involve bureaucractic expense. But then half the problems of the labour market stem from artificially imposed bureaucratic interferences: union wages, minimum wages, unemployment benefits, etc. These may be worthy “interferences” but they constitute a move towards having labour allocated by the bureaucracy rather than by the market.

So there is a choice: a genuinely free labour market, or a bureaucratically run / regulated labour market. If you want the latter, don’t complain about bureaucratic expense.

Another disadvantage is that turnover amongst the least skilled and talented would rise. But then many people quite happily work for temporary employment agencies, and that often involves several “jobs” a week. So the “high turnover” point is a weak objection.

The Edmund Phelps subsidy.

Phelps* advocated a subsidy of ALL low paid labour. The disadvantages of that idea relative to the above “marginal” idea as follows.

1. The total number of people subsidised under the Phelps subsidy would be far more than under the marginal version, thus taxpayer costs be higher. But those costs should NOT be seen as consisting entirely of REAL or RESOURCE costs.

2. The Phelps subsidy involves subsidising many people who would have been employed anyway: that reduces the incentive to get work out of such employees, and that certainly is a REAL cost.

3. The marginal idea gives the option of taking the marginal product of labour down to zero or near zero, which might seem a silly objective. But it could be justified, first, in “work experience” or training grounds. Second, it could  be justified on what might be called “workfare” grounds. That is, one way of calling the bluff of unemployment benefit spongers is to tell them to turn up at some place of work (even if they don’t do very much) else their benefit gets cut.

Third, the fact that no one is prepared to pay anything for a product does not prove the product is worthless. That is, given excess unemployment, the reason people are not prepared to pay for extra units of all the products they already consume is not that they regard those extra units as worthless: if aggregate demand were to rise, those extra units WOULD  be purchased. So why not so to speak just produce a few extra units of everything and distribute the extra units to everyone – which is more or less what zero revenue product labour achieves under the above marginal idea. 

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* Phelps, E. S. (1997), Rewarding Work How to Restore Participation and Self-Support to Free Enterprise, Harvard University Press.

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US labour market began deteriorating well before the recent recession.

Employment to population ratio.

Hat tip to Economist’s View

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The Wall Street Journal’s daft anti-stimulus arguments.

One argument put by this WSJ article against stimulus is that stimulus money is often wasted. That is true, but the reason for this waste is easily dealt with, at least in principle.

This reason for the waste that often accompanies stimulus is that as soon as politicians and others get wind that extra money is available, a large assortment of cranks come out of the woodwork to push their own pet forms of spending, whether it’s Japanese style bridges to nowhere, or plain old fashioned pork.

But this failing does not prove that stimulus as such is wrong. The waste derives from letting people – politicians in particular – take economic decisions they are not used to taking. Put another way, where stimulus is in order, we should just expand the money available to EVERY entity and organisation which spends money.

For example as regards private sector spending, the main source of such spending is the CONSUMER. So part of any stimulus package needs to consist of feeding extra spending power into the pockets of ordinary households. That’s why advocates of Modern Monetary Theory have long advocated a payroll tax reduction.

That’s all very boring and does not attract attention to ego-centric politicians in the world’s capital cities. Plus the millionaires and billionaires who make up the elite can’t bear to see ordinary people have more spending power. However, the basic purpose of economic activity is to produce what PEOPLE or CONSUMERS want – not what makes politicians or the elite look good.

The public sector.

As distinct from expanding private sector spending, stimulus packages normally expand the public sector as well. And part of that will normally include, for example, having local / municipal / US state governments spend more. Fine. Give those local governments more cash and let them get on with it.

But to a significant extent, this is NOT what has happened in the current recession. What HAS happened is that thousands of bog standard productive jobs have been destroyed: fire-fighters, police, librarians and so on. And in their place we have a variety of farcical bridges to nowhere jobs to which the WSJ rightly objects.

And even LOCAL politicians should not have too much of a say in how the money is spent. They should allocate the extra cash to local police forces, local education authorities, etc and let the latter get on with it. Who knows how best to spend extra money in a particular school: the head teacher or a politician in some distant city?

Stimulus money has to be “repaid”?

The WSJ article then claims that “A dollar that eventually will be taken out of the private economy through borrowing or higher taxes to fund pointlessly expensive projects . . . .is not the way to nurture a recovery.”

The WSJ obviously doesn’t get the difference between macro and micro economics, because the above sentence applies profit and loss account principles (micro economics) to government and the economy as a whole (macro).

The first flaw in the above “eventually taken out” idea is that today’s deficit money JUST ISN’T necessarily “taken out” in years to come. Deficits accumulate as extra monetary base and/or extra national debt. Just look at the monetary base figures over the last few decades. Taking some figures from the latter source, the US base was $50bn in Jan 1960 and $600bn in Jan 2000. Children with a basic grasp of maths know that 600 is a bigger number than 50, though whether the WSJ has worked this out, I’m not sure.

And even where stimulus money IS EVENTUALLY “taken out” of the private sector, this has nothing to do with any waste or lack of waste.

The waste arises from the initial mis-allocation of resources, e.g. building bridges to nowhere. And that is the end of the waste, at least as far as the mis-allocation of capital expenditure goes.

Taking dollars out of the private sector simply involves changing numbers in computers: e.g. subtracting from household accounts and adding to government accounts. And the latter is a good idea if demand and inflation look like getting excessive. But if demand and inflation are well under control there is no point in removing these “numbers” from private sector accounts.

Put another way, the WSJ obviously thinks that “taking a dollar out of the private economy” involves removing REAL RESOURCES from the private economy. It doesn’t. Reason is that, as pointed out above, it only makes sense to “take dollars out” if inflation looks like getting excessive. That is, the purpose of “taking dollars out” is NOT to reduce the private sector’s consumption or turnover in REAL TERMS: the purpose is, or should be, to ensure that demand in money terms is not so excessive as to cause excess inflation.

The UK’s Independent Commission on Banking puts chickens and foxes inside the same the same “ring fence”.

The purpose of the ring-fence is to separate retail banking from the riskier investment banking activities: i.e. to separate the essential money transfer functions which cannot be allowed to fail from the risky, clever clever stuff. (Of course there are still systemic risks from the clever clever instiutions, (e.g. Long Term Capital Management), but the basic money transfer system is more important.)

The basic problem with the ICB proposal is that they’ve put BOTH risky AND stuff which is supposed to be safe (i.e. not to be contaminated by risky stuff) inside the ring fence! It’s a bit like putting foxes inside the chicken coop.

Paragraph 2.27 says that deposits from and loans to individuals and firms or corporations should be inside the fence. But this involves significant risk. How in God’s name does one stop banks lending to firms, particularly large ones, which turn out to be thoroughly dodgy and high risk?

Still on para 2.27, the ICB says that loans to “non financial companies” should be inside the fence. That’s just asking for squabbles over exactly what constitutes a “financial company”. I can see lawyers earning big fees there. Or as Martin Jacomb put it in the Financial Times, “The fingfencing proposal involves much detailed regulation.”


Some small retail depositors actually WANT risk.

The next problem is that some small depositors actually WANT to expose themselves to risk, and why not? There is nothing wrong with the basic idea behind capitalism, namely that people can take a risk and possibly make money or lose money.

As pointed out above, the ICB ring fencing does not guard small retail depositors against risk, but just supposing it DID guard those depositors against risk, that is a nonsense in that some small retail depositors actually WANT to have a flutter or take a risk. They are not catered for under the ICB regime.

So what is the solution to all this? Well the solution was given very eloquently by Mervyn King, governor of the Bank of England. As he said, “If there is a need for genuinely safe deposits, the only way they can be provided, while ensuring costs and benefits are fully aligned is to insist such deposits do no coexist with risky assets”.

In other words why not give depositors a choice. Choice No 1 is to have an account which is 100% safe and taxpayer backed. But in keeping with Mervyn King’s principle outlined above, the money in such accounts cannot be invested in commerce or exposed to any kind of risk. The money can only be deposited at the central bank or perhaps invested in government securities.

On the other side of the fence so to speak is choice No 2. This is for customers to let banks invest their money any way the bank sees fit. Alternatively banks could offer a range of accounts with different levels of risk, or other characteristics, like “money will only be invested in the UK”. But that is a minor detail. The important point is that the money is used for commercial purposes, and it is NOT the job of taxpayers to subsidise commerce. Thus there would be no taxpayer funded rescue if it all goes wrong.

The latter “two choice” system involves minimal regulation. For example there is no need to distinguish between financial and non financial firms. Investing in ANY firm is commerce. The investment will thus earn more interest than the safe No 1 choice above. But there is no taxpayer funded guarantee.

Likewise there is no need for regulators to look in detail at what loans banks are making and try to decide whether individual loans are too risky to be acceptable. Indeed the very idea that regulators are able to make this judgement is laughable. Banks themselves are scarcely able to quantify the riskiness of those they lend to: look at the disastrous loans they made prior to the crunch.

As to what to do with the commercial or risky activities or divisions of banks, those can only be made less of a systemic risk by reducing leverege, enlarging capital requirements, insisting on bail-ins and so on.

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Afterthought (26th Oct 2011): I just noticed that the Guardian’s City editor, Jill Treanor, is also critical of the commission’s hazy ideas as to what does and does not go inside the fence. She says, “The commission is vague about whether banking to large companies should be in or outside the ringfence.”

If only Dani Rodrik understood MMT.

Dani Rodrik trotts out, and goes along with the alleged dilemma that 99% of the elite in the US and Europe think they face. This is that stimulus is needed, but governments are already heavily in debt and can thus allegedly cannot afford much more stimulus.

The latter so called dilemma is a complete non-problem for those of us who understand Modern Monetary Theory (MMT). Rodrik’s solution to the problem is to have what he calls an “independent board” solve the problem. Well that was easy, wasn’t it? Let’s solve the world hunger problem and global warming by appointing committees to solve those two problems. Put another way, the $64k question which Rodrik doesn’t answer is exactly what ideas and principles does his “board” use to solve the problem. The principles / ideas should be as follows.


The structural debt and deficit.

Re the structural part of the debt, reducing it is child’s play: just print money and buy back the debt (i.e. Q.E. it). To the extent that that is too stimulatory or inflationary, just raise taxes and use the money collected to buy back more debt. The money printing element is stimulatory/inflationary, while the tax element is deflationary. Mix the two in the right proportion, and the net effect is neutral. I.e. GDP remains unaltered, as does the total number employed, etc etc. Meanwhile big chunks of debt disappear.

Of course the latter wheeze COULD to some extent result in debt being replaced with monetary base, which might seem a bit of a cheat. Explaining the reasons why this is not a cheat leads us nicely into the question as to how to deal with the “non-structural” part of the debt and deficit, i.e. the stimulus element. After that it will hopefully be apparent why no “cheat” is involved.


The stimulus element.

Rodrik makes a big mistake when he says that “Everyone agrees that the country’s public debt is too high and needs to be reduced over the longer term.” Well MMTers don’t agree it is too high. In the view of MMTers, private net financial assets (of which the debt is an important part) need to be whatever induces or “stimulates” the private sector into spending at a rate that brings full employment.

If that level of assets happens to be larger than ever before, so be it. If it happens to be smaller than ever before, so be it.

A predictable response to the latter point is that debt involves paying interest, and there must be some limit to the interest rate burden that governments can carry.

Well at the moment, the REAL rate of interest on US debt is NEGATIVE!!!!! So there is not much of a problem there. However, if rates turn significantly positive in the future, then obviously there is a problem: a problem which calls for a solution.

And the solution is simply to have the above mentioned government issue net financial assets consisting of NON INTEREST PAYING debt: i.e. cash, or monetary base. Put another way, if a government wants to spend more, what on earth is the point of it borrowing something (i.e. money) which it can produce in infinite quantities itself? Paying someone else to borrow something which you produce yourself for free is RAVING BONKERS!!!

Milton Friedman in 1948 advocated a monetary / economic system which incorporated the latter idea: i.e. a system under which governments issue no interest paying debt. (See page 250).

It would be nice of today’s so called economists had actually studied economics and knew about ideas which are now over sixty years old.

Readers will hopefully have tumbled to why the above “cheat” in connection with the structural debt and deficit is no cheat at all. Assuming the interest paying debt is reduced (or, a la Friedman, abolished), then the monetary base needs to be whatever “stimulates” the private sector into spending at a rate that brings full employment without too much inflation. If that level of monetary base is $1 per person, so be it. If it happens to be $10,000 per person, who cares? The IMPORTANT point is to bring about full employment.


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Krugman, invasions by aliens, Keynes and hole digging.

Anti-Keynsians have been putting their foot in it big time recently by taking Keynes’s parable about pointless hole digging seriously.

Keynes made the point that the multiplier works even if the form of spending that sparks of a “mulitiplier episode” is pointless, like having people dig holes and fill them up again all day. At the same time he made it perfectly clear (for the benefit of the humourless) that he did not actully favour pointless hole digging.

Krugman, making the same point, gave as an example, spending money on defending the world from an invasion by aliens from outer space: an invasion which in the even turns out to be a false alarm.

Unfortunately a number of less than sophisticated folk have taken Keynes’s hole digging and Krugman’s hypothetical alien invasion seriously.


Two examples of these humourless economists are thus.

1. Wall Street Journal Op Ed article (para starting “The authors are careful….”).

2. The Cobden Centre

The moral is: keep humour, irony and words with more than two syllables out of debates on economics, else those simpletons will get the wrong end of the stick.

Actually economics is so complicated that it’s VERY GOOD IDEA to keep humour and all unnecessary words and syllables out of it.

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The economically illiterate Tim Geithner now wants stimulus!

The main headline in today’s Financial Times is that Geithner is calling for stimulus. Would this by any chance the same Tim Geithner who earlier on in the recession was a staunch OPPONENT of stimulus? The same Tim Geithner who is part responsible for the unemployment and poverty being experienced by millions of Americans?

If I was Tim Geithner I’d have died of shame by now. But then in the West’s elite don’t know the meaning of the word shame.

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Obama’s employment subsidy: not much use.

The idea that employers should be rewarded in proportion to the number of new or additional employees they take on is as old as the stars. The idea is a waste of time given very high levels of unemployment because a straight rise in demand is simpler and just as effective.

As to lower or “NAIRU” unemployment levels, the idea works for a short time. That is, it reduces NAIRU for a short while, perhaps up to a year or so, but loses its effect thereafter.

Conclusion: the idea is not much use. For a detailed analysis of the idea, see here.




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This is the best economics article for months.

This article by Simon Jenkins in The Guardian is brilliant.

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Congratulations to the Swiss for printing lots of money.

Faced with a sharply appreciating Swiss Franc, the Swiss are at last reacting in a logical way: printing Swiss Francs in whatever volume is required for those who want to hold them. This will NOT be inflationary because the demand for these additional Francs is a demand to HOLD Francs, not spend them. As David Hume pointed out in his essay “On Money” two hundred years ago, additions to the money supply are not inflationary until and to the extent that the additional money is actually spent.

Hopefully the rest of the world will tumble to the latter point before we get too far into a Japanese lost decade. That is, weak demand in the US stems from a desire by the private sector to hoard or hold more money than is usual (in addition to the effect of deleveraging).

The solution to the latter problem is to print money and spend it (and/or cut taxes). And if inflation looks like getting excessive, do the opposite: raise taxes and rein in money and “unprint” this money.

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Bruce Bartlett opposes a payroll tax reduction.

As Dean Baker put it “In elite Washington circles ignorance is a credential.” This seems to be particularly true of “elite members of the elite”: former presidential advisors, e.g. Martin Feldstein and Bruce Bartlett.

Bartlett in a New York Times article tries to argue against a payroll tax reduction, and gives some hopeless arguments to back his case. Plus a payroll tax reduction is one of the main measures advocated by adherents to Modern Monetary Theory, Warren Mosler in particular. So this is an additional reason for looking at the alleged weaknesses in payroll tax reductions put by Bartlett. Bartlett’s first argument is thus (in italics).

First, the tax cut only helps those with jobs. While many have low wages and undoubtedly are spending all their additional cash flow, those with the greatest need and most likely to spend any additional income are the unemployed.

Well obviously a payroll tax reduction doesn’t help EVERYONE: for example pensioners are not assisted by this tax reduction. A mentally retarded six year old can think of groups not assisted by a payroll tax reduction. But the important point about a payroll tax reduction is that it channels money into the pockets of a VERY LARGE group of the sort of people who are likely to spend a fair proportion of any increased income, that is, middle and lower income groups.

Having done that, if a government wants to assist the groups NOT ASSISTED by a payroll tax reduction (e.g. pensioners), then so much the better.

Perhaps Bruce Bartlett prefers the main stimulatory measures taken to date: QE and giving billions to banksters. The latter two measures shovel VAST amounts of money into the pockets of a MINUTE portion of the population. And not only that, but the recipients of the money include the wealthiest people in the country – exactly what Bartlett argues against! God first makes mad those he wishes to destroy.

Bartlett’s second and third reasons are that the payroll tax reduction will simply be saved by employees rather than spent. He does not cite any evidence to back this point. Well I can cite evidence. The evidence is that (surprise, surprise) peoples’ weekly expenditure varies with their income!

Of course, and equally obviously, A PROPORTION of any increased income will be saved. That is entirely predictable. For actual studies of household reactions to changes in income (temporary and permanent) see:

http://onlinelibrary.wiley.com/doi/10.1111/j.1745-6606.1984.tb00322.x/abstract
http://www.nber.org/digest/mar09/w14753.html

http://www.kellogg.northwestern.edu/faculty/parker/htm/research/johnsonparkersouleles2005.pdf

http://finance.wharton.upenn.edu/~rlwctr/papers/0801.pdf

http://ideas.repec.org/p/kud/kuiedp/9611.html

Bartlett’s reason No. 4 is that cutting the cost of employees will not work in that labour costs are nowhere near as big a problem for employers as lack of demand or lack of sales. At last: a half intelligent point. A significant proportion of the elite in the US and Europe have not tumbled to the blindingly obvious point that sales create jobs. But at least Bartlett has. So congratulations are in order there.

Bartlett’s fifth and final reason is that the payroll tax finances benefits of one sort or another, thus a reduced payroll tax will induce employees to save in order to compensate for the loss of those benefits.

The first flaw in that argument is that it fails to distinguish between saving in the form of accumulating cash, and in contrast, saving in the form of storing up other assets, like a house, qualification, etc.

When people save for pensions, a significant portion of the saving is not just plonked in deposit accounts and left there, which WOULD be deflationary. The latter effect is what Keynes called the “paradox of thrift”. What actually happens is that a significant portion is invested in real assets: office blocks, factories, etc.. And the effect of the latter saving is stimulatory.

Moreover, even if for some strange reason it was impossible to invest peoples’ savings in office blocks, factories, etc it is highly unlikely that employees would allocate ALL their increased cash holdings to boosting their bank deposit accounts. That is, it is EXTREMELY unusual where a cause has two possible effects for just one of the effects to be in evidence.

Take the above mentioned evidence as to what households do with increased income. It is POSSIBLE they’d spend it ALL, and save none of it. But the evidence is that they do a bit of both.

Or again, suppose the price of apples rises. One extreme possibility is that consumers react by buying exactly the same volume of apples and ignore the price increase. The second extreme possibility is that they spend EXACTLY THE SAME amount as before on apples, and do all the adjustment via cutting the volume of apples purchased. But the latter is a highly unusual effect. What nearly always happens when consumers face a price increase for a particular commodity is a compromise between the above two extremes.

Conclusion: nine out of ten to MMT and one out of ten to Bruce Bartlett.




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Andrew Sentance and the confidence fairy.

The so called “confidence fairy” is a term used for the most part by advocates of Modern Monetary Theory (MMTers) to describe a popular but largely mythical obstruction to economic growth. This is the extent to which business confidence in government finances impinges on economic growth.

So far as I can see from actual surveys of business opinion, this confidence or lack of it is near irrelevant compared to other problems which entrepreurs face or think they face, e.g. lack of orders, shortage of skilled labour, taxes, etc etc. E.g. see page 18 here.

This survey gives entrepreneurs main problems as being, first, poor sales, and second, taxes.

See also page 26 here.

This gives excess regulation, tax and lack of demand as the main problems.

The URL of a third survey giving similar results is thus:

http://www.blumshapiro.com/pub/articles/BlumShapiroCBIASurvey.pdf

But the latter was unavailable when I put this post online. Might be a temporary problem.

But empirical evidence, the truth, reality and so forth, are of no great concern to a large portion of the human race, in particular those who believe in fairies, unicorns, astrology etc. Andrew Sentence in an article in today’s Wall Street Journal appears to be a firm believer in unicorns – sorry I meant the confidence fairy. He cites no evidence to back his claim: presumably this is because the evidence does not exist. For some strange reason, Andrew Sentence was a member of the Bank of England’s Monetary Policy Committee.

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Afterthought, 4th Sept: Just noticed Brad de Long making a similar point.







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