Ann Pettifor’s “Just Money”.

The book which AP wrote with Victoria Chick, “The Economic Consequences of Mr Osborne” was a decent piece of work: it demolished Osborne’s pro-austerity ideas. However, “Just Money” is a poor piece of work by comparison. AP has some odd ideas as to how banks work. Mistakes in the book (numbered) are as follows.

1. AP’s definition of money is strange. It certainly doesn’t resemble the standard definition in most dictionaries of economics or economics text books: something like “a medium of exchange, i.e. anything widely accepted in payment for goods and services or in settlement of debts”.

She employs about three pages trying to tell us what money is (p.3-8). The nearest she gets to a definition is “money is a social construct – a social relationship based primarily and ultimately on trust.”. 

Well now SOME FORMS OF MONEY are based on trust: e.g. bills of exchange (effectively IOUs) which were widely used in the 1700s and 1800s. On the other hand the big merit of money in some cases (e.g. gold coins) is precisely that it enables trade to take place where there is a LACK OF TRUST, or where the two parties doing business do not know each other.

Indeed on p.8 she says “Money is not, and never has been a commodity like a card, or oil, or gold – although coins and notes have, like your credit card, been used as a convenient measure of the trust between individuals engaged making transactions.” What? So gold coins have never been a form of money – only a “measure of trust”? I’m baffled.

2. On page 26 comes a pronouncement which AP obviously thinks is important because it’s a paragraph all on its own. It reads: “Savings are not needed for investment.”  Indeed, that idea is repeated on p.104 where she says “Under a well-managed banking system, and with the sagacious use of bank money, surplus wealth is no longer needed for loans and investment.”

Well that’s good news. So if someone wants to build a house, there’s no need for them to abstain from current consumption (i.e. save) so as to fund the building of the house? Or alternatively, if they borrow the funds needed for the new house, no one else in the country needs to abstain from consumption (i.e. “save”) so as to fund the house building?

This is truly wondrous news. Let’s fire ahead with a massive house building program, not to mention new rail lines, motorways, hospitals, and so on. Apparently no saving or sacrifice of current consumption is needed for us to enjoy these goodies.

But it gets better. The near infinite amounts of real wealth that can be made to emanate from banks (i.e. offices full of people plus computers) can be used to fund not just capital investment, but CURRENT spending as well. AP claims (p.127) that “Because there need never be a shortage of finance, we can afford to undertake this huge transformation and care for the ageing population, the young and the vulnerable.”

I wonder why no one else tumbled to this near inexhaustible fount of wealth?

Of course it’s true that assuming the economy is not at capacity (or unemployment is above NAIRU if you like), that the creation of money out of thin air and spending it will raise demand and hence numbers employed. That’s true of both central bank and commercial bank created money. However, it’s difficult to get private banks to lend in a “below capacity” scenario, whereas there is no difficulty in having the state create and spend more (or cut taxes – the option the political right prefers).

But (and putting it another way) assuming an economy is at capacity, there is no way extra GDP can be squeezed out of the system by more lending, and AP makes no mention of that “at capacity / below capacity” distinction.

And there are further drawbacks in relying on commercial bank lending so as to get out of a recession. First, once a commercial bank loan has been spent, the stimulatory effect ceases. I.e. INCREASING commercial bank lending is stimulatory, whereas simply maintaining a high level of debt or lending does not have any stimulatory effect. (Indeed, Steve Keen, I’m fairly sure, takes this even further, and claims the stimulatory effect is related to the SECOND power of the size of commercial bank lending: i.e. the “rate of acceleration” of the volume of such lending. Personally I don’t understand that, but he may have a point.).

In contrast, creating and spending central bank money brings a PERMANENT INCREASE in what advocates of Modern Monetary Theory call “private sector net financial assets” (i.e. base money plus national debt), thus the stimulatory effect is permanent.

3. Page 29 claims (also a paragraph all on its own): “Commercial bankers do not lend the deposits of their customers on to borrowers.”

Then how come banks go bust? How come bank runs have occurred over and over? Reason is that banks DO LEND ON DEPOSITS, and in the case of incompetently run banks, and when too many depositors want their money back, those banks just don’t have enough money to repay depositors because . . . wait for it . . . .  the relevant money has been loaned on! And it’s been loaned on in an incompetent manner which means the money is lost, which means the bank cannot get it back. Or alternatively it may have been loaned in a competent manner except that the bank cannot get enough of it back quickly enough to pay the bank’s creditors (which was what happened to Lehmans). 

4. Page 13 claims “Money or credit does not exist as a result of economic activity, as many believe. Like the spending on our credit card, money creates economic activity.” Oh yes?

Then what about very simple non-money economies (e.g. economies where barter plays a larger role than in today’s economies)? The reality is that “economic activity” takes place in non-money economies. Money comes later.

Put another way, once non-money economies reach some level of complexity, it tumbles to all and sundry that transactions done via money are more efficient than transactions done in other ways. (To some extent that’s because everyone realises that barter transactions are inefficient,  but also money often seems to have arisen because some king or emperor realises that taxes can be collected more efficiently if the  ruler introduces a form of money, but there is some argument as to exactly how important those and other factors have been in the history of money.)

5. The next apparently insightful statement (because it’s in italics) is: “The level of employment and activity in an economy depends critically on the rate of interest. Too high a rate stifles enterprise, creativity and initiative and renders debts unpayable.”

Now that’s difficult to reconcile with the fact that interest rates in the 1980s were about three times present levels, yet the economy was about as near full employment or “capacity” then as its nowadays.

Moreover, the fact that the average rate of interest on mortgages in the 80s was about three times present levels did not mean that mortgagors were evicted en masse because their debts were “unpayable”. What mortgagors did was to use their common sense and take on less debt!!!

Of course a SUDDEN and large rise in interest rates would hit debtors adversely, but high interest rates AS SUCH are not a problem.

As for the idea that a “high a rate stifles enterprise” that is also nonsense. A high rate of interest stifles a PARTICULAR FORM OF economic activity, namely investment related activity. But there’s no reason for not enjoying full employment given a relatively high rate of interest: all we need do (as any advocate of Modern Monetary Theory will explain) is to create and spend enough money into induce the private sector to spend at a rate that brings full employment (plus expand public spending if the political party in power so wishes). Though of course in that scenario, employers will go for a slightly lower “capital equipment to labour” ratio than given a low rate of interest.

But note that there are numerous costs involved in running capital equipment other than interest (e.g. depreciation, energy consumption, etc). Thus the effect of an interest rate rise on investment is not DRAMATIC. Indeed, two recent studies indicate there is very little effect. See here and here. Or as Jamie Galbraith put it, “firms borrow when they can make money and not because interest rates are low”.

6. AP gets environmental matters hopelessly confused with strictly economic matters (as indeed does Positive Money). Now I’m all in favour of doubling the price of petrol and investing in windfarms, etc, but … she claims (p.41) that “A low rate is also fundamental I argue, to the health of the ecosystem.”  

Now there is a slight problem there, namely that AP claims a low rate of interest boosts economic activity, and of course, the more economic activity there is, all else equal, the more we despoil the environment. Indeed, she herself says “… ‘easy credit’ leads to an expansion of consumption.” (p.48).

So what’s best for the environment according to the “AP theory of interest rates and the environment”: a low rate of interest or a high one? I’m baffled (yet again). 

This confusion is repeated towards the end of the book (p.125) where she says  “It is my contention that there is a direct link between the de-regulated, uncontrolled expansion of credit, increased consumption and rising greenhouse gases. By isolating consumption from the creation of credit, environmentalists are fighting a losing cause. By failing to understand how ‘easy money’ finances ‘easy consumption’ and with it rising toxic emissions, eco warriors are missing a trick.”

So easy money, i.e. low interest rates, encourages easy consumption? Sounds reasonable. I mean if interest rates are low, you can afford a bigger mortgage and a bigger house, can’t you? But the next sentence tells us:

 “By failing to understand that repayments on high levels of expensive debt lead to, and demand rising exploitation of the earth’s scarce and precious resources, environmentalists will fail to check rising greenhouse gases and the depletion and extinction of species.”

So now it’s all change. Apparently “expensive debt”, i.e. high interest rates, are bad for the environment.       

7. As to the idea that a high rate of interest damages the environment, AP’s reasoning here is that a high rate forces borrowers to sweat their guts out so as to make repayments, and that increased economic activity despoils the environment. She says:

 “Too high a rate demands ever-rising extraction of the earth’s assets, to generate resources for repayment.” And:

 “In other words, the earth’s limited resources have to effectively be cannibalised to repay the world’s creditors.”

All very emotionally satisfying stuff for those on the political left and the more naïve environmentalists. Unfortunately it’s all nonsense.

Let’s take the biggest form of borrowing, namely mortgages. The decision by someone to borrow and buy a house does not of itself influence total resource consumption, and for the simple reason that that person could perfectly well obtain the same size house by renting. That is, if anything, what increases resource consumption is the decision by one lot of people to accumulate more capital than they really need, plus the willingness of others to borrow that capital.

8. On page 57, AP refers to “Josephine Bloggs” instead of the traditional Joe Bloggs. Now I’m all in favour of non-sexual language (to coin a phrase perhaps): I use it myself. But why do we have to go from being pro-male wicked sexists to pro-female wicked sexists?

I wouldn’t have mentioned the above slight flaw in AP’s book were it not for the fact that in the concluding section, she claims “…. there are two overlapping groups in society whose engagement in these issues is vital…. The first are women; the second, environmentalists.”

Now that will be emotionally satisfying for strident feminists and nutty environmentalists, but of course it’s blatant sexism! As for environmentalists, I’m all for reducing carbon dioxide emissions (to repeat). Unfortunately the average self-styled environmentalist can’t think their way out of a paper bag.

9. On pages 70-1 AP argues that in the bad old days a few centuries ago ordinary people could not borrow because nearly all wealth was in the hands of wicked rich folk, whereas now poor people can borrow. But that argument is rather spoiled when she says:

 “Today, thanks to the developed bank money system. . . traders can obtain access to credit if . . .  they have sufficient collateral.” Er – if they have sufficient collateral, then they aren’t poor, are they?

10. On page 71, AP makes the following strange claim. “Perhaps the most difficult aspect of the theory of bank money is this: bank money held in banks does not necessarily correspond to what we understand as income.”

Whaaat? Who ever said that “money held in banks” (which is a STOCK) can be equated with income (which is a FLOW). Whoever made the above claim is talking nonsense.  

11. On page 73, AP argues economies are seriously hampered when the money supply is limited to a stock of some precious metal, and that banks solved this problem by creating money out of thin air. She says:

 “Banking services were both necessary and sufficient to enable employment, or economic activity to take place across wide areas of activity, and across borders. There was no need - it turned out - to use limited supplies of gold (or silver, or any other commodity) as a means for which (instead of by which) goods and services could be exchanged…”

The reality is that the human race solved the above problem of limited supplies of precious metals long before banks arrived: they used so called “tally sticks” which were normally made of a near costless material, namely wood. (Not of course that I’m suggesting that tally sticks were as efficient as today’s commercial bank or central bank created money.)

12. Next, AP deals with the recent crisis and is all over the place on bank capital requirements. She says (scarcely believable this):

 “The response of governments to threats posed by an out-of-control, and effectively insolvent financial sector is to bow to the interests of finance capital. Governments of the OECD economies have abandoned efforts to manage, re-structure or re-regulate the global banking system so that it serves the real economy and wider society. Instead, politicians and regulators have tinkered with banks’ so-called capital requirements. The reason for this is a mystery to this author, because while banks may need capital to back up their own (often reckless) borrowing they do not, as explained above, need capital for the purposes of credit creation.”

This may be news for AP, but there is a HUGE AMOUNT OF LITERATURE out there which explains why capital ratios are important and why they need increasing. As the average Daily Mail reader probably understands, given a high capital ratio, a bank can make relatively large losses without going bust.

I also particularly like this sentence: “Yet, despite the fact that the banks did not ‘hold capital’ against their lending in the period before 1988…”

Eh? So banks had no capital prior to 1988? That’s news to me, and it will be news to almost every economist in the country. In fact according to Anat Admati (economics prof at Stanford) banks in the 1800s often had 50% capital ratios: way, way above the present dangerously low levels.

13. On page 52, AP claims that the way out of a recession is to encourage more borrowing funded investment. She says “How to create more borrowers? In the circumstances of a debt-fuelled slump, in which the private sector is inhibited from investing, the borrower of last resort - government - has to intervene, to borrow to stimulate investment and create employment.”

Well certainly the way out of a recession is to encourage more SPENDING. But whence the assumption that it has to be INVESTMENT SPENDING? Certainly if a recession is caused by a drop in CONSUMER spending, and assuming investment spending was at its optimum level before that drop, then there is no earthly reason to increase investment spending: to do so would be to take investment spending above it’s optimum level.

Indeed, the recent recession was largely a drop in consumer spending: by consumers with large mortgages who saw the price of their houses fall.