In other words, @netbacker, savings are not needed for lending. The money for a loan need not be in the bank when the bank lends.
— Ann Pettifor (@AnnPettifor) September 29, 2014
Tuesday, 30 September 2014
Fuddie duddies like me have always been under the impression that if we want to make an £Xbn investment, we have to sacrifice £Xbn of current consumption, i.e. we have to save. But according to Ann Pettifor this is not the case (as I understand her). At least that’s the impression I get from this, which she tweeted today.
And on page 26 of her book “Just Money”, there is a paragraph all on its own which says “Savings are not needed for investment.” And that’s 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.”
I’ve contacted the Nobel prize committee to propose her for a Noble prize in economics. Will someone second that?
Monday, 29 September 2014
I dealt with just under fifty (yes 50) criticisms of full reserve banking (FR) in section two of the book on the left - criticisms that range from the moderately well thought out to the laughable and hopelessly incompetent. But the criticisms keep coming and as a result of perusing Martin Wolf’s recently published book, “The Shifts and Shocks” I’ve just stumbled across a new one (Ch7). The criticism is made by Charles Goodhart, described by Wolf as the “doyen of British analysts of finance”. Obviously this is important stuff, so we should pay attention.
The criticism is made by Goodhart in a paper of his entitled “The Optimal Financial Structure” and is as follows (to quote, in green). He says in reference to full reserve:
“A problem with proposals of this kind is that they run counter to the revealed preferences of savers for financial products that are both liquid and safe, and of borrowers for loans that do not have to be repaid until some known future distant date. It is one of the main functions of financial institutions to intermediate between the desires of savers and borrowers, i.e. to create financial mismatch. To make such a function illegal seems draconian”
OK, let’s deal with that phrase by phrase.
First there’s that “revealed preference”. The phrase “revealed preference” is academic-ese for the much shorter and simpler word “want”. Academics have to sound technically sophisticated, and one way of doing that is use five times as many words as necessary, each of which is about five times LONGER than necessary to describe something.
Anyway, moving on . . . savers “want” financial products that are “both liquid and safe”. Well that of itself is not a brilliant argument for providing savers with same, i.e. with what they want. Drunks want large quantities of alcohol and many children don’t want to go to school. That is not a good argument for letting those two categories of people have what they want.
As to savers, there is no limit to what they “want”. One of the things they want is the combination of total safety and a return on their savings, which is a flagrant self-contradiction (a self-contradiction that FR disposes of). That is, if money is loaned on or invested with a view to earning interest, it is by definition not entirely safe. And the only way of providing total safety is by having the taxpayer back those savings or deposits, but that’s a subsidy of banking!
Next, FR does not, as claimed by Goodhart stop savers having “financial products that are both liquid and safe”. Under FR, savers are SPECIFICALLY PROVIDED with accounts that provide them with liquidity and total safety: accounts where the relevant money is simply lodged at the central bank and/invested in short term government debt. Indeed the UK government ALREADY PROVIDES savers with that facility in the form of National Savings and Investments.
Next, according to Goodhart, FR “runs counter to” borrowers desire for “loans that do not have to be repaid until some known future distant date”.
Not true. Under FR, borrowers can borrow from lending entities / banks just as they do under the existing system. The only difference is that those loans must be funded by shares, not deposits.
It is true that the latter form of funding raises the cost of supplying loans, but only to the extent that a subsidy of banks is removed (as explained in the book featured at the top of the left hand column). If we had a totally unwarranted subsidy of baked beans, then removing the subsidy would “run counter to the revealed preferences of” baked beans consumers for cheap baked beans. That is not a brilliant argument for subsidising baked beans.
And finally, there is Goodhart’s claim that “. It is one of the main functions of financial institutions to intermediate between the desires of savers and borrowers, i.e. to create financial mismatch. To make such a function illegal seems draconian”.
Essentially that is just a repetition of the point just above. That is, FR does not dispose of “intermediation”. But it does do intermediation in a different way to way that currently prevails in the case of banks and which needs taxpayer backing. (That backing is needed in order to provide savers with the “have your cake and eat it” luxury of having one’s money loaned on (which is inherently not entirely safe) while enjoying total safety.)
Note the phrase “in the case of banks” just above. That is, FR does not do intermediation in a substantially different way to that offered by non-bank corporations. For example, stock exchange quoted corporations are funded to a significant extent by shares. To that extent, when investing in non-bank corporations, savers can get the liquidity they want in that they can sell their shares any time, while corporations can get long term loans or funding.
And finally, Goodhart objects to the “draconian” nature of FR. Well Galileo’s solution to an astronomical problem of the day, namely the apparently illogical movement of the planets, was “draconian”. He proposed that the Earth revolved round the Sun. In fact his solution was so draconian that he was put under house arrest for the final ten years of his life.
In short, the fact that a solution to a problem is “draconian” is not a good argument against the solution. And in fact FR has something important in common with Galileo’s idea: the solution in both cases is extremely simple.
Sunday, 28 September 2014
As she points out, to measure the size of the TBTF subsidy, it is necessary to look at more than the DIRECT TBTF subsidy enjoyed by large banks. As she puts it here (1):
"In this context, it is also important to appreciate the role played by government guarantees for counterparties of banking institutions. In a financial system with a complex network of inter- institution contracts, the individual institution benefits not only from government guarantees protecting its own creditors but also from government guarantees protecting the counterparties of those in which it invested. For example, the AIG bailout benefited many counterparties of AIG, not the least of these being the many banks that had purchased credit insurance from AIG."
1. Statement for Senate Committee on Banking, Housing and Urban Affairs Subcommittee on Financial Institutions and Consumer Protection.
P.S. (29th Sept 2014). According this Huffington article, Goldman Sachs managed to help itself to $2.9bn of taxpayers' money as part of the taxpayer funded bail out of AIG.
Saturday, 27 September 2014
It goes like this.
1. Neither of the two main activities of banks, accepting deposits or making loans should be subsidised.
2. Therefor all subsidies should be removed.
3. Removing subsidies by definition means that all bank creditors become shareholders, even where they are CALLED “depositors” or “bondholders”.
4. However, there is a legitimate demand for a totally safe way of lodging money, thus government should provide that service and on a non-subsidised basis: something that governments already do in various countries, e.g. National Savings and Investments in the UK.
5. And that all amounts to full reserve banking.
Friday, 26 September 2014
Banks run rings round politicians and regulators. But some politicians are particularly gullible, and the UK’s “business secretary” Vince Cable is one such.
This article by Nils Pratley entitled “Vince Cable has swallowed the bankers' line on capital” gets most of the details right on the subject of the gullible Vince Cable.
Vince Cable’s argument is simply that the tighter are bank regulations, the less will banks lend, which (all else equal) will reduce GDP. Well the simple answer to that is that there is no reason for “all else to be equal”. In particular, any deflationary or growth inhibiting effect stemming from stricter bank regulation can easily be countered by standard stimulatory measures: interest rate cuts, a larger deficit or whatever. Or to put it more bluntly, if demand is not sufficient to bring full employment, then more of the stuff that enables households to “demand” goods and services should be put into household pockets, and that “stuff” is called “money”. Plus of course, public spending can always be raised.
Nils Pratley goes wrong, however, when he says “asking banks to hold more capital should not impede lending.” Actually increasing bank capital requirements WOULD RAISE the cost of bank loans by a finite amount. Reason is that given very low capital ratios, taxpayers effectively carry much of the risk involved in bank lending, which is a subsidy of banks. I.e. as capital ratios rise, that subsidy ipso facto is withdrawn. (For more details on that, see the work featured at the top of the column to your left, in particular section 1.4 under the heading “Bank funding cost increases due to subsidy withdrawal.”)
However, the fact of raising the cost of one product (which necessarily means reducing the cost of all other products) WILL NOT reduce GDP if the reason for the latter rise in cost stems from removing an unwarranted subsidy. In fact the effect will be to INCREASE GDP, because unjustified subsidies distort markets and cut GDP.
In support of his claim that increased capital ratios increase rather than reduce lending, Nils Pratley quotes Mervyn King. Pratley says, “The key point is that more capital and more lending go hand-in-hand, as Sir Mervyn King stressed time and again when he was governor. "Capital supports lending and provides resilience.””
Now wait a moment. Obviously if a sugar daddy appears from nowhere and supplies more bank capital, then bank lending will rise all else equal. But more bank capital, if it materialises, won’t come from sugar daddies.
In the real and harsh world, more bank capital will only be supplied if it is PAID FOR. As explained in the above mentioned section 1.4, the ACTUAL AMOUNT banks will need to pay for more capital won’t be prohibitive (largely because of the Modigliani Miller theory). But banks will certainly have to pay a FINITE AMOUNT for more capital.
Raising bank capital requirements WILL REDUCE lending (and debts). But those raised requirements by their very nature mean the removal of a subsidy for banks, and subsidies distort markets and reduce GDP. Thus raising bank capital requirements would cut lending and debts, but RAISE GDP.
But whether Vince Cable understands all that is pretty doubtful.