Wednesday, 6 March 2013

Richard Werner says government should borrow from private banks – I’m baffled.

At the end of a letter in the Financial Times, an economics Prof. for whom I have a lot of respect, Richard Werner, says government should borrow from private banks. I’m puzzled.
Given that the government / central bank machine can create money ex nihilo at no cost and in limitless quantities whenever it wants, why does need to go begging to private banks? Private banks will obviously take their cut, and to what benefit for the country as a whole?
Werner’s exact words:
…it is high time for lenders to realise that they need to kick-start the bank credit money supply, and can do so immediately by stopping the issuance of government bonds and instead funding the public sector borrowing requirement by having the Treasury enter into loan contracts with the money creators – the banks. That would constitute true quantitative easing of the kind I called for in Japan in the 1990s and it would create a full-blown recovery within six months.


  1. Replies
    1. Yes - a gilt is a loan contract as would government borrowing from private banks be a loan contract. But the fact that two things are similar on one respect does not mean they are similar in others: elephants and mice are both mammals.

      The central question here is: if the objective is stimulus, what’s the point in the government / central bank machine borrowing when it can create and spend any amount of money it wants anytime (regardless of whether it borrows from the market in general or from private banks)?

      And in the particular case of borrowing from the market in general, the borrowing per se withdraws money from the private sector, which has an anti-stimulatory effect (the OPPOSITE of the desired effect). Bonkers.

      In the case of borrowing from private banks, there is no withdrawal of money from the private sector in general, so that’s a slight improvement. But still, why borrow stuff you can produce yourself for free and in infinite quantities. Also bonkers.

    2. I agree

      but creating money is still a bank-to-spending-entity loan contract at the functional level.

      There is saving in excess of investment in the non-government sector which leads to a build up of reserves at the central bank which the central bank then (could) offset by 'lending' to the Treasury.

      Or viewing it from slightly further around the spending cycle, the central bank creates money and 'lends' it to Treasury which then spends it part of which creates excess savings stored at the central bank.

      It's all loan contracts.

      "And in the particular case of borrowing from the market in general, the borrowing per se withdraws money from the private sector, which has an anti-stimulatory effect"

      Not really because you are sticking it back into the private sector via Treasury spending. All you are doing really is selling the loan contract that the Bank of England could create to the private bank, so that they get the interest income.

      So the difference is that borrowing from the central bank is 'free' (Treasury gets the bank dividend from whatever interest they pay), whereas with a private bank doing the lending the bank gets the interest income and whoever bought bank equity gets the dividend.

      Apparently under neo-liberal economics the government has to 'discipline' its spending by giving public money to rich bankers. It's the rule.

    3. the idea is that the government is obligated to issue a treasury by congressional mandate (we all get its not necessary, but thats how it is) so if a bank is creating the credit than there needn't be that sterilization of the stimulus, nor the crowding out effect

  2. Werner believes in "crowding out." From Princes of the Yen (2002) he states (p.275):

    During the 1990s, most fiscal spending was funded not through money creation, but through borrowing from the private sector. Such fiscal spending must crowd out private activity. Fiscal policy becomes a zero-sum game that merely reallocates existing resources.

    He thinks that "unlike fund raising via the capital merkets, borrowing from banks will not withdraw puchasing power from other parts of the economy, as banks can create new money out of nothing." So, to his way of thinking, in the first case there is no net gain in "new money" while in the latter case there is.

    1. Nice to hear from someone who has read Werner’s book. If he thinks fiscal policy is a 100% zero sum game (i.e. has no effect) I think he is going too far (for reasons set out my Mike Norman a day or so ago). But my hunch is fiscal policy does raise interest rates and thus crowd out a bit of private investment spending unless the central bank takes countervailing measures (i.e. buys back some of the extra government debt).

      So I seem to be partially in agreement with him, i.e. I think fiscal policy without central bank “countervailing measures” is the worst option. So I agree with him that having government borrow from private banks is better. But I still object to the government / central bank machine borrowing something (i.e. money) from private banks when the “machine” can produce any amount of money itself at no cost.

    2. "my hunch is fiscal policy does raise interest rates"

      Look at the charts: there's a direct inverse relationship between government deficits/debt and long-term interest rates (in the UK and US, I don't know about other countries).

      Basically the CB sets the base rate and long-term rates wobble around a bit above it.

  3. Ralph,

    Looks like you have many libertarians over there too same as over here in the US... these folks just cant see govt possessing the fiscal authority you point out... so to them, "govt has to borrow"... "govt has no authority", etc..

    It's a classic libertarian/authoritarian dichotomy... libertarians have been winning for quite a while (looks like going on 2,000 years to me) but our current economic malaise may finally lead to their overthrow if they dont come up with something soon to get our economies at higher output/employment....

    I was wondering if your Queen still had authority to do the equivalent of a "Platinum Coin" issuance like we were proposing over here in the US last month?

    Can the Queen issue currency directly in any denomination? That might be an option to get on top of the libertarians short term...


    1. The Queen is just a figurehead really. No, she can't issue UK currency. However the govt can borrow directly from the BoE, or just tell the BoE to credit bank accounts on its behalf, but it doesn't tend to do that these days as it's frowned upon and the govt likes to be seen to be "responsible". Oh and they're probably scared that any direct "monetisation" of deficits might send the pound plummeting in FX markets.

  4. Basically what Werner is saying is that the Treasury should deficit spend and sell bonds to banks, and then the banks should hold on to the bonds and not sell them on to non-banks. This would lead to a overall net increase in bank deposits.

    That's all he's saying.

    But he doesn't say how or why the banks would choose to keep all these bonds.

    For his plan to have the intended effect (i.e. a net increase in bank deposits), either a) there would have to be no additional demand for government bonds from non-banks, or b) the government would have to oblige the banks to keep all the bonds and not sell them on to non-banks.

    Makes you wonder whether Werner actually knows what he's talking about

  5. I think he meant that "as long as" we have this peculiar system, the acute debt crisis has to be resolved not through austerity but by more debt to private banks in one way or another. However this is just a temporary measure, in the future a monetary reform will be necessary.

    At the moment the government / state is by EU-rules prohibited to borrow directly from the central bank. And even if it could, it would be impossible to circulate the central bank money directly to the public, simply because the public is not allowed to have their individual accounts at the Central Bank.

  6. Something has gone wrong with Blogger, which is why I’m placing this comment from “Kodexkodex” here manually. Kodexkodex’s comment:

    I think he meant that "as long as" we have this peculiar system, the acute debt crisis has to be resolved not through austerity but by more debt to private banks in one way or another. However this is just a temporary measure, in the future a monetary reform will be necessary.

    At the moment the government / state is by EU-rules prohibited to borrow directly from the central bank. And even if it could, it would be impossible to circulate the central bank money directly to the public, simply because the public is not allowed to have their individual accounts at the Central Bank.

  7. Sounds like Richard Werner wishes his banker-friends to make even more risk-free profits by lending to the government at rates of interest they want. Imagine in the USA private banks borrowing from the FED at zero interest and lending to the treasury at whatever rate they wish. Would have the same effect it has now with our healthcare system (which is the biggest scam in history of mankind) where insurance companies insure the healthiest part of the population and pass on to the government the sickest (over65) and then private hospitals bill the government what they wish to keep the old-age alive in their hospitals as long as they want.

  8. Ralph,

    I'm just struggling(*) to read "Where does Money Come From?", to which Richard Werner is among 4 contributing authors, and was staggered to read on pages 72-73 that coins and notes are NOT debt-free....hmmm....I thought Positive Money said that they were on the website, but I haven't checked.

    However, even more surprised to read on page 73: "The only way in which the money supply can be increased by the Government or central bank is the purchase of assets from the non-bank private sector, or in the case of the Government, by borrowing from commercial banks in the form of loan contracts." has that bit of input come from Richard Werner, I wonder? If so, then this is at least consistent with his letter. Have you tried asking him directly for further explanation Ralph?

    As for the EU rules forbidding direct borrowing from the central bank, the ever inventive Simon Thorpe has a way around that. Please look for his blogspot.

    To Y7: from the wording that Ralph has quoted, Werner seems to be ruling out creating more bonds, so by loan contracts, he must mean something else. Presumably.

    * - Struggling because (in the edition I have, from NEF, with a blue and turquoise hardback cover), the typeface size is TINY!

    Was there a previous paperback edition of this? I ask, because I have seen photographs of a book with this title on various sites, and the appearance is different, and it had the Positive Money imprint.

    I am guessing that NEF took a larger book and photo-reduced the content to fit on smaller pages. I've seen this done before, and it's madness! Very user-unfriendly. For 14.99 + postage, I expected better. The giveaway is that the footnotes and endnotes are microscopic. No one in their right mind would have consciously chosen that size of type for's an unplanned side-effect I think. Pity. I really wanted to like this book.

    1. Taking your paragraphs in turn:

      1. The idea that coins are not debt free is news to me as well. Wiki defines the monetary base as notes AND coins in circulation, plus bank reserves, etc etc. Monetary base is debt free. And if coins are part of the monetary base, then they’re also debt free, far as I’m concerned.

      2. I’ve got an earlier version of the book, so I can’t find your p.73 quote. The first half of the quote is OK by me. The second half about government borrowing from commercial banks is dodgy . . . “government” in the sense of government departments or local authorities . . they may have limited freedom to borrow from commercial banks, and that would increase the money supply. But I’m not an expert on that. But far as I know the Treasury doesn’t borrow from commercial banks.

      3. I contacted Richard Werner once by email. But he is not ultra-communicative – probably amongst other reasons because has got better things to do than answer emails from me, like teaching students.

      Re your para starting “To Y7”, and looking again at his FT letter, his main aim seems to be to reduce (or stop increasing) government debt. But my objection to that idea is that when the BoE does QE (i.e.buys back debt) it effectively nullifies the debt. The government bonds held by the BoE may be COUNTED as part of the national debt, but as I pointed out in a letter in the FT a few months ago, those bonds might as well be torn up: they are meaningless. There have been articles in the FT and Wall Street Journal making the same point: government bonds in the hands of a central bank might as well be torn up. So I don’t see why Werner is so keen to cut that pseudo debt.

      Re the book, my copy measures 17 x 24 cm, and the print size is normal for a book.

  9. Ralph,

    Many thanks for your comprehensive reply. Well, I have (cheekily) taken it upon myself to contact Professor Werner, and (politely) suggest he reply to you here.

    While looking up his details, I found the following paper on the Southampton University website. Although it is 3 years old, it may cast some light on his thinking in these areas:

    (But what does "to monetize fiscal
    policy" mean?).

    (My copy of Where does Money come from" is about 13.7 X 21.5 cm, so yes smaller. They should have had it proof-read by a presbyopic old fogey...perhaps they are only interested in a younger, more energetic readership).

    1. Monetise fiscal policy . . . I assume he just means QE. I.e. fiscal policy equals government borrows by selling bonds and then spending the cash so obtained. “Monetising fiscal policy” (aka QE) equals having the central bank print money and buy those bonds.

      I honestly think Werner is in a muddle here, as is the Bank of Japan. As far as I’m concerned this is all very simple stuff and the advocates of Modern Monetary Theory are one of the few groups who have got their heads screwed on here.

  10. Further to my previous posting, I may have found an answer to my own question at the end, in another of Professor Werner's papers, this one also mainly about Japan, but demonstrating a lot of principles behind Prof. Werner's thinking. The paper is:

    and at the top of page 25, he says (about the bank of Japan): "Finally,
    it lent directly to the government in order to monetise fiscal policy " - so I guess that basically means "printing money" and effectively giving it to the government.

    There are some other interesting points. In a footnote, a rather nice point for money reformers to have up their sleeve:

    The balance sheet of a central bank is unlike that of a company. Applying the same principles as used
    with companies or banks to the central bank’s accounts misses the main point of its function: a central
    bank’s liabilities are legal tender. They cannot therefore be considered liabilities in the true sense, since
    they do not carry any servicing costs and do not need to be redeemed. A central bank will always make
    a profit on its asset purchases, since it obtains valuable assets for free. From this it is also clear that the
    purpose of a central bank is never to make profits—making money is something it can literally do. Its
    purpose is monetary policy: the creation and allocation of purchasing power.
    " (footnote 8, page 24).

    Back on pp19-20 is a point more germane to your blog article:
    "Concerning policy prescriptions to end banking crises and produce a sustainable
    recovery, the framework recommends an expansion in productive credit creation,
    while banning credit creation for non-GDP transactions. This can be achieved without
    additional costs to the tax payer in a number of ways, as elaborated by Werner since
    the early 1990s (see Werner, 2007, for references and a summary), such as:
    1. Expanding central bank credit to firms for investment (not financial speculation)
    2. Expanding central bank credit to the government (to fund the public sector
    borrowing requirement)
    3. Expanding commercial bank credit by
    (a) halting government bond issuance and instead raising the public sector
    borrowing requirement entirely from the banking sector (Werner, 1996, 1998).
    (b) providing government guarantees for bank loans to firms.
    (c) engaging in ‘credit guidance’ direct controls of bank credit (or publicprivate ‘coordination’ of bank credit), using the well established and
    successful methods of this tool (see Werner, 1998, 2007). This is the method
    China used to be the first major economy to emerge from the current financial
    crisis (Japanese-style ‘window guidance’) (see Chen and Werner, 2009).
    (d) relieving pressure on banks to tighten credit by suspending or loosening
    capital adequacy regulations, and having the central bank purchase NPLs at
    face value (in order to keep them on its balance sheet – any transfer to the
    government will result in crowding out and a negative impact on the economy).
    4. Expanding credit creation through the issuance of government money (e.g. United
    States Notes; in Japan: dasatsu)."

    So his point 3(a) here sounds like the very point you are querying, but here, it seems to be just one of several options, including 4. which seems to be basically printing "greenbacks".

    1. Thanks for that. It will be a good week before I have time go digest that. But I'll respond eventually.

  11. Thanks Ralph. I have another post to make on this subject, but while I have the link handy I'll post this, about a more recent paper which deals in part with this:

    Title: "How to End the European Financial Crisis
    – at no further cost and without the need
    for political changes"

    In part 2 of this he talks about governments borrowing from commercial banks and gives justification in some detail.

    And now that I've had chance to read "Where does money come from" (2nd edition) a bit more determinedly, I see there are several references and explanations of this topic.

    Very interesting.

    Best wishes,
    Mike Ellwood aka Montmorency

  12. Professor Werner kindly replied with a fairly full explanation of what he'd written in the FT letter. He said if I wanted I could shorten it and post it here. However, I think he wanted to check it before I posted it. I sent my version to him, but have not heard back.

    I don't want to post it without his OK, so I will just summarise my understanding of his position in my own words. Any errors or omissions here are therefore mine alone:

    His suggestion for the government to borrow from commercial banks via loan contracts is indeed a method for use under the present, unreformed system. Under the arrangements whereby the BoE was created, it was agreed the government would not create its own money, and the BoE only creates notes and coins, which is an insignificant proportion of money nowadays.

    The beauty of the proposal is that it could be introduced now, without any changes to the system, and without breaking any rules. Presumably it could also be introduced even if the BoE didn't like it, although I don't know if that would apply here. The government of the UK is a no-risk prospect for the commercial banks, and the interest rate should be low, lower than for bonds. The loan contracts could be short (e.g. 3 years), and could be "rolled over". They should be attractive for the banks as it would help them to build up their loan book in a safe way, and generally strengthen the banking sector. It would be beneficial for the economy in general, as it would increase the money supply, and this money would filter into the real economy via public spending in the first instance.
    ---------------end of summary------------------------------------------------------------------

    The more I think of it, the more I like this idea, although I do have some questions / worries:

    1. It might look like, and might actually be, an increase in government debt in the early stages, even though that debt would be cheaper to finance and work out cheaper to finance in the longer term. (And if I were in charge, I would use it as an opportunity to reverse the cuts since the 2010 election, but I don't suppose Gideon will do that). So it could be quite a hard sell, politically.

    2.  Prof. Werner says it will kick-start lending, but if the banks have a safe customer in the government, what incentive do they have for extending their lending to SMEs, for example? Hopefully, when the additionally-created money works its way through the system, there will be an increase in prosperity generally (even if only modest at first), so it might get things going.

    I posted a link to Prof. Werner's paper on solving the European debt crisis. I found a companion paper to it, so I'll post a link to that one, and the first one as well, so they are both here together:-

    How to End the European Financial Crisis
    The Euro-Crisis:
    A To-Do-List for the ECB

    In passing, I happened to notice that Vince Cable was scheduled to appear at a Banking conference on 6th March organised by Richard Werner, along with Charles Goodhart, and others. I wonder if either of them got an opportunity to bend Dr Cable's ear about monetary reform, or the borrowing from banks idea?

    Best Wishes,
    Mike Ellwood

  13. Ralph,

    You might be interested in this paper by Richard Werner (more like PPT slides), from April 2012. The link is a bit long, so hope it works:

    Unorthodox Refinancing of Banks by the ECB

    It's aimed at Euroland's problems, but obviously applicable to the UK or elsewhere, and has a bit more detail.

    Interestingly robust comments about Europe!

    Mike Ellwood

  14. Werner on The Free Lunch blogspot

  15. More detail on govt borrowing directly from banks from Werner’s New Paradigm in Macroeconomics :
    Case 1 govt bond issuance (page 255/6 Using £ not ¥ as Werner)
    1.1 Govt issues £100bn bonds
    1.2 Bonds bought by insurance companies >> purchasing power drained from the economy (not used for private demand or investment) ie. -£100bn
    1.3 Govt stimulatory effect after receiving 1.2 above, amount spent £100bn >> purchasing power introduced into economy +£100bn
    1.4 Net stimulus result on economy (-£100bn + £100bn) = zero
    (ref: 1.2 Werner notes that the Japanese insurance companies used to use their money to make loans to SMEs but stopped this when they purchased bonds)
    Case 2 govt borrows from banks (page 256/7)
    2.1 Govt borrows £100bn from banks, with the banks creating the credit of £100bn to give to the govt >> this creates a £100bn asset (the loan) on banks’ balance sheets
    2.2 Govt’s deposit account credited with £100bn to be used for fiscal expenditure
    2.3 These Govt deposits of £100bn are withdrawn and spent, leaving the govt’s account; but the recipients of the money having stimulated the economy place them as deposits in their own bank accounts so +£100bn ends up somewhere in the bank system
    2.4 With loans to govt the banks’ loan book quality is enhanced and a truly new £100bn stimulus takes place
    For Werner’s explanations on how banks work see these YouTube interviews
    Charles Bazlinton

  16. I lost all respect for Werner when invited me to "take lessons" from Andrew Jackson as the solution to today's problems, and when he claimed that the Federal Reserve answers to no one and it is solely controlled by New York Finance. Never mind that he doesn't completely understand banking or fiscal policy, he makes political statements that simply baffle my mind, in a bad way.
    I remember him stating that reason why German finance system is strong is because of small commercial banks giving loans to the productive economy. LoL. Like Ellis Winningham said, someone call Varoufakis - all Greece needs is 1000 small banks and it's out of the crisis.

    1. I think the best thing ever produced by Werner was his submission to the UK’s Vickers commission (link below). That was 3 or 4 years ago, and he’s been backtracking on some of the ideas since then: in particular, in that submission he advocated having the state as the only money issuer. Now he’s saying private banks should issue money as well, which I don’t care for.

  17. Wall Street CEO's already figured out that "the government / central bank machine can create money ex nihilo at no cost and in limitless quantities whenever it wants."

    "Bank Of America Dumps $75 Trillion In Derivatives On U.S. Taxpayers With Federal Approval"

    To put $75 trillion in perspective, US GDP in 2012 was around $16.5 trillion. We blew a lot more than the $6 trillion they're claiming in Iraq and Afghanistan. Social Security's Trust Fund is around $2.3 trillion. Bank of America is just one Wall Street bank. They all have derivative exposure. I've seen estimates of $700 trillion, but I don't think anyone knows.

    Along with a lot other "welfare for the elites," that leads to, "the Wall Street bonus pool for last year is roughly double the total earnings of all Americans who work full time at the federal minimum wage."

    From Pavlina Tcherneva, Ph.D. @ptcherneva "Should the government spend willy-nilly on whatever it pleases since it doesn't face involuntary default?" and the answer to that question is most definitely NO. Not all deficits are created equal: some create more inequality and more rentier income, as it seems to be the case in the current crisis. Others can cause inflation. Yet others can directly create jobs, public investments, and productive capacity without generating inflationary pressures. In sovereign currency nations, a truly responsible government spending is one that is measured bot by the debt-(or deficit)-to GDP ratios, but by the real impact of that spending on the economy--job creation, poverty alleviation, stable prices, income distribution, social goods provisioning are all good measures for assessing how responsible government policy has been."

    1. Your first paragraph seems to suggest that if the state rather than private banks create money, that Wall Street will collar much of that money. Good point. Though with the right rules in place that can be prevented.

      I liked that 2nd link of yours: to the NY Times one. I publicised it on Twitter.


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