Wednesday, 18 June 2014
Money creation a la Pimco.
Paul McCulley (chief economist at Pimco) had an article in the Financial Times yesterday saying that the Fed is moving towards applying the same rules to shadow banks as apply to regular banks, and ended with this paragraph:
“The Fed is taking vital steps towards turning shadow banking – and the shadow money it creates – into a public-private partnership, much as was done with regular banking 100 years ago. This is wise. Individuals and small businesses are not alone in needing a safe form of private money.”
Certainly applying the same rules to each type of bank makes sense. Or as Adair Turner put it, “If it looks like a bank and quacks like a bank” it should be treated like a bank.
But “quacking” apart, there are flaws in McCulley’s argument, as follows.
First, what’s the merit in his “public-private partnership” given that a government and central bank (gbc) can create and spend any amount of money into an economy anytime? I.e. private money creators just aren’t needed. So what’s the point of the “partnership”?
Moreover, while private money creation leads to chaos (the recent crisis was largely a run on shadow banks in the US), gcb can create and net spend an amount of money that keeps employment as high as is compatible with avoiding too much inflation.
Of course, gcb is far from 100% competent at the latter task, but even the advocates of private money creation agree that it’s desirable to for gcb to counter the business cycle by for example adjusting interest rates, implementing QE or whatever (and that involves money creation).
Incidentally, by “net-spend” I mean create and spend money into the economy net of money WITHDRAWN from the economy (i.e. tax). In short the amount of “net-spending” equals the deficit.
And then there is McCulley’s final sentence: “Individuals and small businesses are not alone in needing a safe form of private money.”
Clearly businesses and households should be able to lodge money in a totally safe manner if they want. But where gcb underwrites privately created money, it is effectively subsidising the loans and investments made with that money. (That’s what private banks do with money they get from depositors and other creditors: they lend most of it on). And subsidies are not justified unless some very good social justification can be found for a subsidy.
Ergo the best policy in this area is:
1. For private money creation to be banned or severely restricted.
2. For gcb to provide a totally safe method of lodging money for those who want total safety. Indeed, that function is already performed in the UK by gcb to a limited extent: National Savings and Investments provides that service.
3. As for the lending function that private banks perform, there is no reason for gcb (i.e. taxpayers) to subsidies or underwrite that process.
And what do you know? That’s what full reserve banking is.