Saturday, 21 June 2014

Ann Pettifor’s bizarre ideas on money.

Ann Pettifor has just published an article entitled “Out of thin air. Why banks must be allowed to create money”. Unfortunately it’s behind a paywall (at the latter link, anyway). Stop press (25th June): she's just put a near identical article online for free.
She objects to the idea put by numerous economists and groups of economists namely that private banks should be barred from creating money. The latter “bar” amounts to, or is part and parcel of full reserve banking, a system advocated by Laurence Kotlikoff (economics prof at Boston), Milton Friedman, John Cochrane (economics prof at Chicago), Positive Money and numerous others.
The article is riddled with mistakes and self-contradictions. (Incidentally quotes from her article are in green below.)

Her reasons.
 AP’s first reason, or should I say “so called reason” for opposing full reserve is:
“…the notion to my mind is preposterous. It is an approach reminiscent of the misguided and failed monetarist policy prescriptions for controlling the money supply in the 1980s.”
And that’s it. Now if that’s a “reason”, then clearly I don’t understand the meaning of the word reason. If AP could explain exactly what similarities between full reserve and monetarism she has in mind, then we’d all be a bit wiser. Of course I can see SOME SIMILARITIES, but it’s not the job of those reading an article to GUESS what the author is trying to say. However, as it happens, I DID DEAL with one or two similarities between full reserve and monetarism on p.28 here.

AP’s second reason.
This is that “…the proposal that only money already saved should be made available for lending assumes that money exists as a  consequence of  economic activity, and equals savings.”
Now the first flaw there is that the latter passage contradicts another passage from AP’s article which says that money DOES INDEED exist “as a consequence of economic activity”. She says:
“….it is the myriad numbers of Britain’s borrowers who are the real spur for the creation of money. When entrepreneurs and other borrowers apply for loans, they help create money (deposits) ‘out of thin air’. If entrepreneurs and other borrowers do not apply for loans (because interest rates are too high, terms too tough, confidence low or business slack) the money supply shrinks…”
Second, advocates of full reserve do not “assume that all money exists as a consequence of economic activity”. Quite the contrary. Full reserve, as is clearly explained by its advocates, SPECIFICALLY involves, and indeed gives a much bigger role to a form of money that is produced from thin air (by the central bank): a form of money that certainly does not come into being “as a consequence of economic activity” (although of course the state, whether running a full reserve system or not, normally tries to relate the amount of money in circulation to total “economic activity” in some sort of rational way). But Robert Mugabe demonstrated (as if we didn’t already know) that the state can if it chooses, print ludicrously large amounts of money that are totally UNRELATED to “economic activity”.
Indeed, AP herself a few sentences earlier states, correctly, that full reserve “would give a small committee – independent of the state – a monopoly on money creation.”

“Independent” central banks.
Most readers will immediately notice an apparent inconsistency there, namely that AP claims the committee is independent of the state, whereas I suggested just above that “the state” does money creation. The explanation for that apparent inconsistency is simply that one can regard the committee as part of the state or not: it’s semantics. Indeed the committee would have very much the same responsibilities as the Bank of England Monetary Policy Committee. And it is debatable as to how independent of the state so called “independent central banks” really are.

Commercial bank created money.
AP’s next two sentences, which come immediately after the one quoted above are:
“But that is to get things the wrong  way around. Rather, it is credit   that functions as money, and it is credit that creates economic activity and employment. Deposits and/or savings are the   consequence of the creation of credit and its role in stimulating investment and employment.”
Well that’s a perfectly good description of PRIVATELY CREATED money, or commercial bank created money. But the fact that that type of money has characteristic X, Y and Z does not mean that government or state created money has to have the same characteristics. Indeed, it clearly doesn’t!! For example, as Positive Money (and indeed advocates of Modern Monetary Theory) have pointed out a hundred times, for each dollar of commercial bank money, there is a dollar of debt, while in contrast, central bank or state created money is “debt free” to use Positive Money parlance. In short, commercial bank and central bank money are two very different animals.

AP then claims
“Employment, as we all know from our own experience, generates income–wages, salaries, profits and tax revenues. A share of this income can then be set aside as savings. To restrict all economic activity to savings would be to contract economic activity to an ever-diminishing sum of existing savings.”
Quite what the phrase “restrict economic activity to savings” means I’m not clear. But in any case (as AP herself rightly points out) if she means “savings” in the sense of “savings in the bank”, the latter are not restricted to an extent that does any harm under full reserve, and for the simple reason that “the committee” produces money / savings from thin air as an when needed.

Back to the Middle Ages?
AP’s next paragraph reads:
“Furthermore, the restriction of all lending to existing savings would lead to higher rates of interest, because the level of savings is much lower than the level of potential economic activity and employment. Savers would be in a position to demand a higher return on the loan of their savings.  This would return society to the dark ages, when investment and economic activity was subject to the whims of great feudal landowners, putting the financial elite in control of society’s surpluses or ‘savings’.”
Well shock horror. I’m quaking in my boots. Back to the “dark ages” eh?
But seriously, there is a major flaw in AP’s above argument which is that if lending declines, then debt also declines (and by exactly the same amount to the nearest penny, all else equal). And it’s generally agreed that private sector debt is currently excessive. Indeed AP herself has written an entire book deploring debt levels!!!
So does she want debt / loans to rise or not?
But she’s right to point out that full reserve DOES RESTRICT lending somewhat, and there’d certainly be a finite rise in interest rates. The basic reason is that under full reserve, lenders carry the full risks involved in lending, unlike the existing system where the taxpayer bails out incompetent lenders. I.e. full reserve removes bank subsidies.
But what’s wrong with removing bank subsidies? Indeed, removing those subsidies was one of the declared objectives of the UK’s Vickers commission, Dodd-Frank and other bodies which have considered how to improve the banking system in recent years (an objective those bodies have spectacularly failed to achieve).
And as to the idea that a rise in interest rates means a return to the “dark ages” that’s just hog wash. Interest paid by mortgagors in the UK in the 1980s was about THREE TIMES the current rate. But strange to relate, the sky did not fall in in the 1980s. Indeed, economic growth was far better than over the last few years when interest rates have been at record lows. (Not that I’m saying that a SUDDEN rise in interest rates to the 1980s level wouldn’t be disruptive. But a SLOW rise would give all and sundry time to adjust and wouldn’t be a problem.)

The history of money.
Next, AP claims “As Douglas Coe and I explain in a recent PRIME report, the UK monetary system – complete with the power to create money ‘out of thin air’– was established back in 1694 with the goal, among others, of facilitating commercial transactions and the financing of the king’s wars.”
Well that’s not true in that Henry I (who became King of England in 1100) introduced tally sticks to England, and issued them himself in large quantities. And tally sticks (usually made of wood) come to much the same as printing pound notes or dollar bills: it’s all money created “out of thin air”.  

Those robber barons again.
A few sentences later, AP says, “Society’s long struggle to evolve away from dependence for economic life on the savings of the few (the ‘robber barons’) was precisely the point of the development of a sound monetary system. It called for a financial system that could provide the whole spectrum of society – individuals, farmers, entrepreneurs and the state – with affordable finance for the     achievement of personal and public economic and social goals. If directed at productive activity, affordable finance can be used to meet society’s essential needs. In countries without sound monetary systems, there literally is no money. In these countries, only the savings of the fortunate are made available for lending at, invariably, usurious rates of interest. The result is that poverty is deeply entrenched, investment negligible and unemployment high.” 
I’m moved to tears. Anyway, what’s that phrase “there is literally no money” doing there? Advocates of full reserve do not propose a system where there is “no money”. They propose a system where the only or at least the main form of money is state created money.
And what is “unsound” about the state creating some or all our money? AP doesn’t explain. Thanks to QE, the proportion of money in the US which is now state or central bank created has shot up. And far from that having caused a disaster in the US, employment levels in the US are now pretty much back where they were prior to the crunch (though that’s doubtless partly explained by discouraged potential workers quitting the workforce ).   But certainly that big increase in state created money (which Positive Money calls “debt free money”) has not caused the sky to fall in in the US.
The above quote from AP’s article basically just makes the point that commercial banks can benefit an economy which has no banks and no money. Well true. But that doesn’t prove that a well-run “state money only” system isn't even better: e.g. it can dispose of some of the deficiencies of the private banking system that became glaringly obvious five years ago.

Money creation in a wider economic context.
Next, in AP’s article, comes a section with the above title. It starts:
“Money creation must be understood within the context of the economy as a whole. To do so, it is important to emphasise that the money for a loan is not in the bank when a firm or an individual applies for a loan. It is the application for a loan that results in the creation of deposits, as the Bank asserts.  Without applications for loans, there would be no deposits. In other words, while the banker or bank clerk plays a critical risk-assessment role in the ‘creation of money out of thin air’, and while the state plays an equally critical role in transforming that private loan into public fiat money, it is the myriad numbers of Britain’s borrowers who are the real spur for the creation of money. When entrepreneurs and other borrowers apply      for loans, they help create money (deposits) ‘out of thin air’.”
Let’s start with the phrase “it is important to emphasise that the money for a loan is not in the bank when a firm or an individual applies for a loan.”
That’s actually debatable. Certainly prior to the crunch, commercial banks were creating and lending out money like there’s no tomorrow. But that was what caused the crunch! In other words it is precisely the ERRATIC nature of the money / loan creation process carried out by commercial banks that is one of the problems.
In contrast, during the depths of the crises, commercial banks were doing what they usually do in a slump: bring their money / loan creation activities to a grinding halt, which is exactly what we don’t need. And in that scenario, and contrary to AP’s suggestions, it can well be argued that “money for a loan” is indeed “in the bank”: at least, given no NET INCREASE in loans, it follows that new loans are in effect funded by the repayment of other loans.

Converting base money to private money.
Next, there’s the phrase “while the state plays an equally critical role in transforming that private loan into public fiat money..” Now I’m not sure what that’s supposed to mean, but if AP is suggesting that central banks ACTUALLY CONVERT commercial bank created money at any stage into CENTRAL BANK money, that is a howler that would get the red pen through it in an economics exam. Central banks never, never, never convert private bank created money into state money, or “central bank created money”.
Or to be more accurate, it could be argued that central banks / governments do print state created money and in effect buy up chunks of commercial bank money which is not worth the paper it’s printed on when the state is mounting a taxpayer subsidised rescue of failing banks. (Alistair Darling created £60bn at the click of a computer mouse for two failing UK banks at the height of the crisis). But NORMALLY, central banks DO NOT CONVERT commercial bank money to state created money.

Allocating new money.
AP’s next mistake is where she says:
“Ensuring that the financial system is the servant, not master, of the economy cannot be achieved on the basis of flawed monetary and economic theory. Nor can a more democratic allocation of finance be achieved by centralising the creation of money in the hands of a small, unaccountable committee of men and women.”
Well the advocates of full reserve (e.g. Positive Money) SPECIFICALLY AND CLEARLY state that the ALLOCATION OF FINANCE or allocation of new money should NOT BE decided by the above committee!!!!!!!!
What the committee does (much like the existing Bank of England Monetary Policy Committee) is simply to decide on the AMOUNT OF stimulus needed (or “anti-stimulus” if inflation looms and the economy needs damping down). As to ALLOCATION, e.g. deciding what proportion of GDP is allocate to the public sector, or how much is spent on education, roads, law enforcement, etc, that remains ENTIRELY WITH the electorate and democratically elected politicians. Indeed, the existing Monetary Policy Committee bends over backwards to avoid interfering in politics, and Positive Money’s committee would do likewise.

No one can borrow under full reserve?
The final bit of nonsense in AP’s article is this:
“To strip both entrepreneurs and bank clerks of decision-making about loans would be to strip society of many varied decisions about the necessity for and affordability of money. Yet this is what Martin Wolf and Positive Money effectively call for.”
What makes AP think that full reservers want to “strip entrepreneurs and bank clerks of decision-making about loans”? Indeed as AP HERSELF rightly points out, under full reserve, firms or households wanting a loan apply to banks or other “lending entities” just as they do now ( but with the difference that those entities cannot lend unless they’ve got “money in the kitty”).   

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