Monday, 30 November 2015
Richard Murphy has thought of a new form of QE: yes – yet another.
First there was conventional QE (printing money and buying private sector assets, mainly government debt held by the private sector).
Then there was “Green Infrastructure QE”. Then there was Peoples’ QE.
And now – roll of drums – there’s “Climate QE for Paree”. That’s a cute name: guaranteed to fool most people.
The first important point to note is that printing money and increasing public spending was first advocated (far as I know) by Keynes in the early 1930s. It would be nice if Murphy gave credit where credit is due and gave himself correspondingly less credit.
As for the idea that we should spend more on infrastructure and/or climate change related stuff, I’m all for that. I’d like to see the price of petrol and diesel doubled tomorrow.
However, the idea that we should print money and spend that on infrastructure and/or global warming reduction confuses two issues as follows.
1. “Print and spend” is a method of imparting stimulus: desirable if the economy is at less than capacity, or put another way, if we don’t have full employment. Or put a third way, print and spend is desirable if unemployment is above NAIRU, but not otherwise.
Also, THERE ARE other ways of imparting stimulus, for example interest rate cuts, or (as proposed by market monetarists) buying up even more privately held assets, like stock exchange quoted shares. I don’t favour that market monetarist idea, but it’s a possibility, and if for some reason someone proves that method of imparting stimulus OTHER THAN print and spend are the best ones, then that’s the end of Peoples’ QE or Climate QE for Paree.
2. There’s the question as to how much we ought to spend on infrastructure and global warming reduction measures. Now there’s absolutely no reason to think the optimum amount to spend on those two will necessarily equal the optimum amount of “print and spend” that’s needed for stimulus purposes.
To put all that another way, it’s always possible that households and/or businesses go into a fit of irrational exuberance, and demand rises dramatically, in which case no stimulus would be needed at all – in QE form or any other form. What then happens to anti global warming expenditure?
To summarise, the logical procedure is to decide first how much to spend on infrastructure, global warming reduction, and then fund that out of tax, borrowing or “print and spend”: it really doesn’t matter which. Second, decide every month or so whether stimulus needs adjusting (something the BoE MPC already does).
Economists have a specific term (which I’ve forgotten) for funding particular forms of spending from particular forms of tax (e.g. funding the Navy just from income tax) and that idea is widely regarded by economists as nonsense. However that idea can sometimes be politically expedient, because it appeals to the untutored.
As for funding a type of spending (e.g. global warming reduction stuff) from print and spend, that’s even worse because in some years no stimulus is needed, in which case the source of funding for global warming reduction expenditure dries up altogether.
Sunday, 29 November 2015
When a widget maker fails, government doesn’t rescue of those who funded the widget maker, and quite right. Bankruptcy of widget makers indicates resources should probably be allocated to something else. But if a bank fails, government rescues those who funded the bank, i.e. relevant depositors. Bank failures probably indicate that too much borrowing and lending is taking place, i.e. that there’s too much debt. Deposit insurance thus helps ensure that that misallocation of resources continues.
Governments only have a motive for the above nonsense where two of the basic activities of banks can be combined, namely first lending, and second, accepting deposits which are supposed to be totally safe. Banks force governments to assist the first activity by forcing them to underwrite or insure the second.
The alternative and better option is to separate lending from deposit accepting. Under that arrangement, only deposits made at the central bank or put into government debt are insured by government. Plus under that “separation” arrangement lending is funded (as in any normal corporation) by shareholders, bondholders and the like (who can lose their money). There again, there is no need for state organised insurance.
Friday, 27 November 2015
This article entitled “Money Creation in the Modern Economy” (by sundry Bank of England authors) claims that loans are the source of commercial bank created money. Plenty of other literature makes that claim. As the opening sentence of the BoE article puts it, “This article explains how the majority of money in the modern economy is created by commercial banks making loans.” There is actually a glitch in that claim, as follows. (The BoE authors do say that there are reservations to be made to the “loans create money” idea, but not everyone pushing that idea makes the appropriate reservations.)
Obviously when a commercial bank grants a loan to some individual / borrower, and the relevant money is spent, that money ends up in the bank account of some other individual or individuals.
However, let’s assume, to keep things simple that the economy is at or near capacity / full employment. In that case, the inflationary effect of spending the new money must be matched by an equal amount of “spending abstinence”, i.e. saving by others, else excess inflation ensues. And if those others do not intend to use their new stock of money for a significant period, chances are they’ll put it into a term or savings account. At least if they’ve got any sense, that’s what they’ll do (with a view to earning more interest).
But the longer money is locked up for, the less money like it is. In fact when it comes to measuring the money supply, many countries draw the line between money and non-money at somewhere around the two month point. That is, if money in an account can be accessed within two months it is counted as money; if not, it isn’t.
Even if recipients of the new money DON’T put it into a term / savings account, i.e. assuming they put it into a current / checking account, that new money, again, cannot be spent, else inflation rears its ugly head. Thus that new money is effectively not money: it’s more in the nature of a long term loan to the relevant bank (which in turn makes possible a long term loan to the borrower we started with above).
Indeed banks recognise that a proportion of the money in current / checking accounts is in effect a form of long term saving: that’s one reason why banks know they’re safe lending that money on.
As to how recipients of new money are induced not to spend their new stock of money, the central bank might raise interest rates so as to induce more saving and forestall the inflation that would otherwise occur. But it’s possible those recipients increase their saving VOLUNTARILY.
In the above sort of scenario, commercial banks are simply engaged in their traditional activity, namely intermediating between borrowers and lenders.
Unemployment is above NAIRU.
In contrast to the above assumption that unemployment is above the level at which inflation gets serious (NAIRU), if unemployment is at NAIRU, i.e. the economy is not at capacity, then loans would indeed create money, i.e. the central bank would allow that to happen.
“Borrowers” owe banks, or vice-versa?
Another glitch in the “loans create money” idea is that when commercial banks create money, it is arguably not loans that do the creating, and for the following reason.
In an economy where people wanted a form of money (created by commercial banks), but didn’t want long term loans, people would simply deposit collateral at banks, have banks open accounts for them, and have banks credit money (created out of nothing) to those accounts.
But that process does not create any sort of long term debt. In fact banks, if anything, are indebted to bank customers, rather than the other way round. Reasons are thus.
Bank X would owe customer Y the collateral deposited (i.e. the bank must return the collateral at some stage). Second, there’s the artificial debt owed by the bank to the customer, that debt commonly being known as “money” (if you have $Z in your bank, the bank owes you $Z). And third, customer Y owes a debt to the bank in that Y undertakes to repay the newly created money to the bank at some state (maybe not till Y dies). So that’s two debts owed by the bank to the customer, and one debt owed by the customer to the bank!
Of course if a bank customer spends a significant amount of their new stock of money and simply leaves their account with a smaller balance than the initial balance, that constitutes a loan by the bank (and other depositors) to the customer in question. But on the above assumption, namely that people are simply after a form of money, not long term loans, than no customer would do that: the balance on each customer’s account would bob up and down around the original balance. E.g. the balance would tend to be ABOVE the original balance when the monthly pay cheque arrives, and BELOW the original balance three or four weeks later.
Assuming an economy is at or near capacity, then loans do not result in money creation. Second, where money creation takes place, it’s not long term loans which create that money
Thursday, 26 November 2015
If bank regulators think that some level of bank capital, say 10%, means that the chance of a bank failing is vanishingly small, then it follows that the remaining 90% of bank funders (i.e. debt holders) run no risk, even if there’s no deposit insurance. But if those 90% were converted to shareholders, they’d also run no risk. Thus those shareholders wouldn’t charge any more for funding the bank than the latter debt holders. Ergo, once a bank has enough capital to make failure near impossible (e.g. the latter 10%) the capital ratio might as well be raised to 100%. Doing that won’t make any difference to the cost of funding the bank.
Wednesday, 25 November 2015
The opening sentence of this Financial Times article reads, “Mark Carney signalled that the Bank of England stands ready to increase capital requirements for banks temporarily as a way to curb excessive lending while interest rates stay low.”
First, what’s the point of a cut in interest rates (designed to encourage lending) and then negating that with higher capital requirements? Bit like driving a car with the accelerator and brake pedal permanently on the floor.
Second, it’s a popular myth that because bank shareholders demand a higher return than debt holders, that therefore increasing the capital ratio will increase the cost of funding the bank (or indeed any corporation). Shareholders demand a higher return because in the event of trouble, their hair gets cut first. However if the amount of equity is say doubled, then the risk PER SHARE his halved: thus there’s no effect on the total cost of funding the bank.
In fact taking that to the extreme, and comparing a bank funded just by equity as compared to one funded just by debt, in theory there’d be no difference in funding costs because the chance of funders losing X% of their stakes is exactly the same in both cases.
To illustrate, if it suddenly transpires that the assets of a bank are worth half their book value, then in the case of the equity funded bank, the shares will drop to half their initial value (on the simplifying assumption that the value of shares is determined just by the value of the underlying assets and not by the bank’s perceived prospects).
As to the debt funded bank, the bank will be wound up and the assets sold off. Debt holders will get back – wait for it – half their initial stake in the bank!
The pre-crisis house bubble.
Third, the pre-2007/8 crisis bubble took place DESPITE interest rates that were higher than today’s. Thus there is not much reason to suppose that low interest rates have much effect on bubbles.
Of course there’s an appealing logic in the idea that low rates cause bubbles. It runs something like, “Low rates induce people to borrow more, which pushes up house prices”.
Well that “borrow more when rates are low” phenomenon is entirely predictable and doesn’t constitute a bubble. A bubble is a feed back loop which can take off at any time. It runs something like this. House prices rise, which induces everyone to think they will rise further, which induces everyone to invest more in housing, which causes house prices to rise even further.
That can happen regardless of whether interest rates are high or low. To repeat, it actually did happen just prior to 2007.
Fourth, bank capital should be at a level that means there is a vanishingly small possibility of taxpayers having to rescue banks. Reason is that any such rescue constitutes a subsidy of banks.
Now if bank capital is actually at that level or above it, then raising bank capital further will not bring additional safety. On the other hand if bank capital is sufficiently low that THERE IS a possibility of banks being rescued, then bank capital should sod*ing well be raised anyway.
Fifth, if low rates do in fact promote bubbles, that’s just extra support for the idea pushed by Positive Money and others (me included) that interest rate adjustments are not a clever way of adjusting demand. Interest rate changes only influence the behavior of borrowers and lenders. A significant proportion of households do not have mortgages, nor do they lend significant amounts. Same goes for some employers. Why should the latter lot of households and employers be excluded when stimulus is the order of the day?
All in all, Carney’s idea is a litany of false logic. Though to be fair, he is trapped in a system in which false logic reigns supreme, so it’s not entirely his fault.
Tuesday, 24 November 2015
I dealt with one paper by Malcolm Sawyer and a co-author here recently. He actually published another paper at much the same time (June of this year) on the same topic. That topic was full reserve banking (FRB), and the title of the second paper is “The Scourge of Green Monetarism”. The latter is examined in the paragraphs below.
The word “green” is a reference to the fact that the UK’s Green Party has adopted the FRB ideas of Positive Money. Some points are common to both papers, so I’ll ignore those, as I have already dealt with them.
There is nothing wrong with Sawyer’s p.1, where among other things he introduces two terms: exogenous and endogenous money. The former is central bank created money or “base money” as it is sometimes called, while endogenous money is commercial bank created money.
Demand for and supply of money wouldn’t match?
At the top of p.2 Sawyer says that under FRB (i.e. an economy where only government or central bank created money is allowed) there’d be “..a mismatch between the amount of money which the central bank creates and the amount of money which the public is willing to hold.”
Well I have news: the above sort of mismatch arises under the existing system.
For example market monetarists like David Beckworth often claim (I think correctly) that the recent recession arose to a significant extent out an excess desire by the private sector to save money. But that in turn is just a repetition of Keynes’s “paradox of thrift” point.
So to the extent that the last seven years or so of excess unemployment are attributable to the above mismatch, FRB could hardly be worse than the EXISTING SYSTEM.
FRB resembles monetarism?
The second part of p.2 is the start of Sawyer’s claim that FRB closely resembles monetarism. As he puts it, “FRB shares many similarities with the ill-fated proposals of Friedman (1960) and others for the achievement of a specified growth rate of the stock of money.”
Well one problem with the latter claim is that if the state creates new money and spends it, and/or cuts taxes, there is an obvious monetary effect: the money supply rises. But there is also a fiscal effect: public spending rises and/or taxes are cut. Thus Sawyer’s claim that PM’s ideas amount to pure monetarism is very questionable.
Annual money supply increases.
A second problem is that a basic element of monetarism, at least a la Milton Friedman, was that it envisaged a small and fixed annual increase in the money supply. In contrast, PM advocates nothing of the sort. PM advocates that (much as under the existing system) stimulus should be varied from year to year dependent on the circumstances: e.g. whether there is excess inflation or whether the economy is in recession.
Mild monetarism is widely accepted.
Third, as distinct from monetarism a la Friedman, monetarism in a milder form is widely accepted in economics. That is, it’s widely accepted that the size of the monetary base has some sort of effect on inflation and output, as Robert Mugabe so ably demonstrated.
Why was QE implemented? Because the authorities thought that if the holders of government debt were given base money instead, there’d be some sort of stimulatory effect. Thus in that PM claims the amount of base money in private sector hands has some sort of stimulatory effect, that claim is completely uncontroversial.
FRBers ignore cost push inflation?
Page 6 of Sawyer’s paper then makes this bizarre claim:
“The FRB approach retains the monetarist perspective that the growth of the money supply (however defined) can control the rate of inflation, and that inflation is a money demand phenomenon which is to be controlled through manipulation of demand (and in the monetarist perspective through control of the money supply). Hence it ignores any role for cost-push inflation and imported inflation, and is willing to accept, if required, the reduction of employment in order to constrain inflation.”
The first of the latter two sentences just repeats the idea that there’s something wrong with the idea that the money supply has some sort of effect. To repeat, that idea is entirely uncontroversial.
As for the idea that because you think the money supply has some sort of effect that therefore you are ignoring “cost push” and “imported” inflation, that’s just nonsense. The Bank of England clearly thinks the size of the money supply has an effect: that’s why it implemented QE. Plus the BoE, as is widely appreciated, has paid careful attention in recent years to the extent to which inflation is cost push. Indeed, it would be a dereliction of duty on the part of the BoE if it ignored the possibility that inflation is partially cost push.
As for the idea that about “willing to accept, if required, the reduction of employment in order to constrain inflation”, it’s widely accepted that there is a trade-off between inflation and unemployment: i.e. that idea is not peculiar to FRB.
Next, Sawyer says “The full reserve proposals are designed to place the stock of money under the direct control of the central bank.”
Not strictly true. Under FR (at least as proposed by Positive Money), the stock of money is controlled by SOME SORT OF committee of independent economists. That COULD BE an existing central bank committee. But it might just as well be an entirely new committee, or some committee in the Treasury.
Of course that’s a minor blemish in Sawyer’s paper, but there seem to rather a large number of blemishes, large and small, in Sawyer’s paper.
Next, Sawyer says, “The purpose of the control of central bank issued money is to influence, if not set, inflation and output. This assumes that the central bank is indeed able to control its issue of money, and that the money issued by the central bank will be placed in transactions accounts…”. Wrong again.
It is extremely unlikely, given a money supply increase, that every single person in the country with a bank account would put all of their share of a money supply increase into either their transaction account or their investment account. Likewise it is extremely unlikely that given an increase in the money supply under the EXISTING SYSTEM, the whole of that increase would be put into current/checking accounts rather than deposit/term accounts. (The latter two types of account, incidentally are very roughly the equivalent of the transaction and investment accounts under PM’s FRB system).
But even if 100% of a particular money supply increase did go into investment accounts, that would not, contrary to Sawyer’s suggestions, destroy the stimulus effect of the extra money. Reason is that more money in investment accounts would tend to cut interest rates which would encourage more investment, and that is stimulatory.
Sunday, 22 November 2015
Malcolm Sawyer and Giuseppe Fontana published a paper a few months ago entitled “Full reserve banking: More ‘Cranks’ than’ Brave Heretics’”.
As regards the insult “crank” (which is repeated several times in the text of the paper), Sawyer and Fontana (S&F) ought to have thought a bit more about who they’re insulting before firing ahead with the insult. Reason is that the advocates of full reserve banking (FRB) are not limited to the ones which S&F concentrate on, namely Positive Money and the New Economics Foundation. (The latter two can certainly be described as “unorthodox”, though “crank” is going too far.)
S&F’s real problem is that other advocates of FRB include Milton Friedman, John Cochrane (currently professor of economics in Chicago), Lawrence Kotlikoff (currently professor of economics in Boston) and the economics Nobel laureate, Merton Miller. Are they all cranks as well? Since S&F don’t mention that the latter four’s acceptance of FRB, I conclude that S&F don’t know about the latter four’s support for FSB, and thus that S&F are not up to speed on this subject.
But obviously I need to substantiate the latter criticism of S&F, so here goes.
S&F’s paper is actually riddled with mistakes. I’ll deal with them in the order in which they appear in the paper. The first two mistakes are not desperately important. They’re under the headings “Mistake No 1” and “The Chicago school” just below, and readers can skip those if they like. But when an author makes numerous minor errors, that is an additional reason for thinking he has a poor grasp of the relevant subject, so I’ve included the minor mistakes.
Incidentally, Sawyer produced another paper on the same subject in the same month as the one dealt with here. That other paper is entitled “The Scourge of Green Monetarism”. Several arguments and points are common to both papers. I’ll deal with the points that are unique to the “scourge” paper in the near future.
The first paragraph of the paper deals with the various phrases used to describe FRB. As the authors put it “A range of terms are used such as 100 per cent reserve banking, positive money, sovereign money as well as full reserve banking…”.
As to “positive money”, that’s the name of an ORGANISATION: called “Positive Money”. I’ve read a huge amount about full reserve banking, and have written a book on the subject, but I’ve never seen the phrase “positive money” used as a synonym for “full reserve banking”.
The Chicago school.
Next, the second half of p1 says the paper will concentrate on the ideas put by Positive Money (PM) and New Economics Foundation authors (PM & Co), but not the ideas of the Chicago school. As S&F put it, “….in this paper we do not further consider those coming from the ‘Chicago proposals’ tradition.”
Well there’s a problem there, which is that PM & Co specifically say, “Our proposal is similar in spirit to and modernizes those put forward by the leading monetary economists of the twentieth century, namely Irving Fisher (1936), Milton Fiedman (1960), and James Tobin (1987).” Now Fisher was very much a member of the Chicago school: at least the differences between Fischer’s ideas and the Chicago school’s were minimal.
The latter quote comes from the submission to Vickers made by PM, the NEF and Richard Werner.
On p.2, S&F repeat a criticism of FRB that has been made a dozen times by others, namely that FRB is only concerned with clearing banks or what might be called “regular banks”, and not with shadow banks. As the authors put it, “The FRB proposals only relate to clearing banks, and not to the rest of the financial system.”
That is a simple minded criticism of FRB and the answer is equally simple, namely that any organisation which acts in a bank like manner, whether it calls itself a bank or not, should obey the same regulations. As Adair Turner put it, “If it looks like a bank and quacks like a bank, it has got to be subject to bank-like safeguards.”
If shops selling alcohol were allowed to ignore the law on alcoholic drinks as long as they called themselves “hardware stores” or “wedding dress” shops, the law would look an ass.
To summarise, if bank regulations apply only to organisations that CALL THEMSELVES banks, then those regulations would be a farce, as S&F rightly suggest. The solution is to apply the above “Turner principle”.
Net financial assets.
On p.4 (item (i)) S&F try to challenge a point made by FRB advocates namely that the existing bank system enables private banks to profit from seigniorage.
As part of their argument, S&F distinguish between commercial bank created money and central bank money (i.e. “base money”). They point out that the latter is a net asset as viewed by the private sector, while the former is not. (That incidentally is a point which every MMTer is very well aware of).
S&F conclude from that that “Thus, there is no seigniorage for banks..”
OK, let’s illustrate this with the simplest possible example. Joe Bloggs wants some money so he deposits collateral at a bank, which in turn credits £X to Bloggs’s account. Bloggs then spends it and obtains £X of goods in return. Now ASSUMING that that £X of new money continues to circulate as money, i.e. assuming holders of the money never demand anything back from Bloggs or Bloggs’s bank, then Bloggs and his bank have obtained £X of real goods in exchange for bits of paper, or mere book – keeping entries. Or if you like, Bloggs makes a profit, with the bank taking it’s cut. That’s seigniorage.
In contrast, if the holders of the new money eventually want something back from Bloggs and Bloggs’s bank, and they’re only prepared to hold it if paid interest, then that’s a case of the bank intermediating between lenders (holders of the new money) and a borrower (Bloggs). No seigniorage is involved there.
Intermediation and seigniorage.
Later on the same page and still under item i), S&F say “The profits for banks come from the difference between the rate of interest on loans (with allowance for default) and the costs of deposits including operating costs and any interest payments.”, the suggestion being that the latter is the source of bank profits, not seigniorage.
Well the answer to that is that those two sources of profit are not mutually exclusive: that is, there is nothing to stop banks making a profit from BOTH activities, and that’s in fact what they do (a fact alluded to in the above “Bloggs” illustration.)
Base money doesn’t cause inflation?
Under item ii) on p4, S&F claim that advocates of FRB are wrong to claim that the amount of money printed by the central bank influences inflation. As he puts it “This leads the FRB school into the mistaken belief that inflation can be controlled by the rate of increase of the money supply.”
Well the words “Robert” and “Mugabe” spring to mind. The idea that the amount of money issued by the state has no effect on inflation is straight out of la-la land. Moreover, those CURRENTLY IN CHARGE of western economies (who are not advocates of FRB for the most part) clearly also think the amount of base money in circulation has some sort of inflationary and output increasing effect: that’s why they’ve run large deficits and implemented QE (all of which boils down to much the same as the FRB idea, namely have the state print money and spend it in a recession).
Incidentally, S&F shouldn’t strictly speaking use the phrase FRB in that as they say, they are concerned specifically with PM & Co’s VERSION of FRB, not FRB in a more general sense, i.e. a sense that includes the proposals of the Chicago school, (never mind Milton Friedman or Lawrence Kotlikoff’s versions of FRB). But that’s a minor blemish in S&F’s paper, and it’s a blemish I’m also guilty of in this article. The blemish is certainly minor if, as I claimed above, there is not much difference between the various versions of FRB.
The stock of money.
Next, (p4, item iii)), S&F accuse FRB advocates of claiming that commercial banks alone decide the size of the money supply, i.e. that non-bank entities (e.g. households) have no say in the matter. As he puts it “The amount of money will adjust to that which is required for these transactions purposes. Thus it is not correct to say, as the FRB advocates maintain, that the amount of money is solely determined by the banks…”.
My answer to that is that far as I know advocates of FRB all aware that if households have more transaction money than they need, they’ll tend to dispose of the surplus. I.e. it’s pretty obvious they’ll do a variety of things with that surplus, e.g. use it to repay loans, put it into term accounts, buy stock exchange investments and so on. S&F don’t actually cite any FRB advocates who claim the above obvious nonsense.
Would FRB enhance financial stability?
Page 6 sees the start of a section entitled as above.
S&F say, “The first, and perhaps obvious, point to make is that the FRB proposals would only directly affect a small, if important, part of the financial system. It would impact on the creation of money and hence on banks narrowly defined, but not directly on the role of banks as financial intermediaries between savers and investors..”
My answer to that is “point taken”. However, FRB advocates do not claim that FRB would totally eliminate booms and busts. But, as S&F say, FRB does deal with one factor that contributes to the problem, namely that banks create and lend out money like there’s no tomorrow in a boom.
Ignore private money creation?
Next, and still on the subject of financial stability, S&F make this bizarre claim: “In our discussion here it is not necessary to consider the causes of a single bank failure, often arising from corruption and incompetence, and whether such failure that can be attributed to its role as money creator.”
Well it is precisely the fact of issuing money that makes banks vulnerable and contributes to financial instability!!!!!!
Money is a liability of a bank which is fixed in value (inflation apart). In contrast, the assets of banks (the loans and investments it makes) can turn out to be worth a lot less than book value. Think Spanish and Irish property loans. At that point, the relevant bank is insolvent, or likely to be insolvent.
In contrast, if the liabilities of a bank are VARIABLE in value, e.g. if a bank is funded just by shares, bonds that can be bailed in or something like that, then insolvency is impossible. Plus shares, bonds and the like are not money. Thus (to repeat) it is precisely the fact of issuing money that makes commercial banks vulnerable, as indeed is suggested by Douglas Diamond in the abstract of this paper. As he puts it and in reference to banks’ liquidity or money creation activities, “We show the bank has to have a fragile capital structure, subject to bank runs, in order to perform these functions.”
The solution to that problem as John Cochrane explains is to dispose of the money on the liability side of bank balance sheets, and replace it with what he calls “non runnable” debt (e.g. shares).
Taxpayers to the rescue!!!
S&F than say “As an aside it could be noted that any liquidity issues can be readily dealt with by the central bank as lender of last resort.”
Well of course!! If you’ve got a sugar daddy willing to come to your rescue it doesn’t matter how incompetent you are. And if you want a phenomenally rich sugar daddy, what better than a central bank with the freedom to print limitless amounts of money and backed by taxpayers? Problem is that that constitutes a subsidy of banks, and subsidies do not make economic sense.
Incidentally it could be argued that central bank / government assistance for commercial banks CAN BE implemented on a commercial basis, in which case there would be no subsidy involved. Indeed, the FDIC is self-funding. But the FDIC only caters for small banks. When it comes to large banks or a series of large banks, state assistance is the only option that that assistance JUST ISN'T offered on a commercial basis: politicians would far rather quickly paper over the cracks in the bank system (the source of much of the money for politicians’ election expenses) than have banks face brute commercial reality and fail.
Second, I go into the subsidy question in more detail here.
How long would FRB last?
The fourth section of Sawyer’s paper is entitled as just above. He argues basically that banks would circumvent the rules of FRB. There are numerous answers to that point, as follows (and numbered).
1. FRB does not aim to totally eliminate all forms of privately created money. For example most FRB advocates (in my experience) favour local currencies like the Bristol pound.
2. There is a MAJOR PROBLEM facing any bank or similar entity trying to circumvent the rules, which problem S&F don’t mention. It’s as follows.
The ease with which money can be issued is related to the size of the entity that issues it. To illustrate, plastic cards issued by or cheques drawn on well known banks are widely accepted. In contrast, IOUs issued by some medium size City of London hedge fund are completely useless for 99% of transactions outside the City of London, e.g. shopping at supermarkets.
Plus, while it may be hard to keep an eye on what every small shadow bank or hedge fund is doing, it’s relatively easy for the authorities to see what the largest banks (regular and shadow) are doing. Thus keeping tabs on the vast bulk of the potential sources of privately issued money shouldn’t be difficult.
3. S&F assume that FRB advocates claim that money in deposit or term accounts where access takes 7 or 14 days is not counted as money. Well if S&F are arguing that money available in 7 days is effectively the same as instant access, I quite agree. But I’ve no idea where S&F get that 7-14 days from. Two or three months is the time normally cited I my experience. Plus that two or three months is a common dividing line between money and non money used by several countries around the world when measuring their money supply.
4. The rules of FRB are simplicity itself compared to Dodd-Frank. And if you want an example of useless bank regulations, look no further than Dodd-Frank. As Richard Fisher, former head of the Dallas Fed, put it, “We conclude that Dodd-Frank has not done enough to corral “too big to fail banks” and that, on balance, the act has made things worse, not better.”
5. If S&F are trying to claim banks haven’t circumvented EXISTING regulations to any great extent, than that’s just a joke. In the US, banks have had to pay a good $100bn in fines for various crimes. Thus if banks DO CIRCUMVENT the rules to some extent under FRB, the extent of circumvention could hardly be worse than under the existing system.
Budget deficits and money creation.
S&F’s fifth section is entitled as just above, and they make the bizarre claim that “The full reserve banking proposals in contrast constrain government expenditure through setting down a rule as to how much money can be created.”
As PM & Co make clear, under FRB government is free to raise tax by any amount it likes and spend the relevant money. Indeed the latter “tax and spend” decision is quite clearly a POLITICAL decision and it would be wholly wrong for a central bank (or PM’s “Money Creation Committee”) to interfere or in any way influence that decision.
Indeed, that point is so obvious that (to repeat) it is bizarre that S&F think the likes of Positive Money or Richard Werner would be unaware of it.
S&F then repeat the above ridiculous point several times, e.g. a few sentences later they say “…if the growth of the money supply was on track to exceed the target, then the central bank would be forced to deny financing for government expenditure.”
The answer is (to repeat) that under the PM/Werner/NEF system, governments are free, as they are now, to increase “government expenditure” by any amount they like and by collecting extra tax.
What if there’s too much stimulus?
The first half of S&F’s p.14 claims that under FRB whoever decides on how much new money to create (i.e. how much stimulus there should be) might get it wrong. In particular, they might create too much new money in which case the private sector would “bid up prices”, i.e. inflation would ensue.
Well of course that’s a possibility! But are S&F trying to suggest that the authorities under the EXISTING SYSTEM always gauge the amount of stimulus correctly? Any idea that the amount of stimulus after the 2007/8 crisis was adequate given the seven years of excess unemployment that came after that crisis is just a joke. And remember that that crisis was largely the result of a chronic bank system.
If FRB is going to improve on the existing system, frankly it doesn’t have a very high bar to surmount: it could hardly be worse than the existing system.
Fiscal policy is “subordinate”?
In the second half of p.14, S&F claim that under FRB fiscal policy become “subordinate” to monetary policy, and that that is highly undesirable. In the authors’ words:
“The second point is the intimate link between the budget deficit and the change in the stock of money. It then becomes important as to whether the budget deficit determines the change in stock of money or whether the change in the stock of money determines the budget deficit. Under the FRB proposals it is clearly the latter. The central bank then imposes a target growth for the stock of money for the coming period (say year), and that in turn imposes a target for the budget deficit. Thus fiscal policy becomes completely subordinated to monetary policy.”
The reality is that under PM & Co’s FRB system, monetary and fiscal policy are joined at the hip, and there is no clear reason for saying that one is subordinate to the other. That is, if one implements stimulus by creating new base money and spending it, there is an obvious monetary element there: the money supply rises. But there is also an obvious fiscal element, namely that public spending rises (and/or taxes are cut).
Frankly I couldn’t care less which of those two effects is dominant, or whether the effect of the two is the same. And nor (far as I know) does PM. The important point is that as long as one of them works, then stimulus is effected, and unemployment falls.
On p.15 S&F claim that FRB would prevent the automatic stabilisers from working. Well that depends on the rules and conventions governing the money creation process.
Clearly if the rule was that the authorities shall decide how much new money shall be created and spent over the next year REGARDLESS of the arrival of a recession in that year, then FRB would indeed thwart the automatic stabilisers.
However, a more sensible rule – and it doesn’t take a genius to work this out – is that the authorities decide how much new money to create and spend on all items OTHER THAN automatic stabiliser items (like unemployment benefit). I.e. government would have freedom to spend more on unemployment benefit if the number of unemployed rose.
An alternative would be for the central bank or Money Creation Committee to keep an eye on the number of unemployed and adjust the amount of new money to create accordingly. That’s what might be called a “semi-automatic” system.
To summarise, S&F’s criticism relating to automatic stabilisers is one that is very easily dealt with.
Debt free money.
The sixth and final section of S&F’s paper entitled “Debt free money”, tries to cast doubt on the claim by Positive Money that base money is “debt free”. Unfortunately S&F don’t add anything of any interest to the debate on this topic.
It is widely recognised, and not just by FRB advocates, that money created by commercial banks is not debt free in the sense that for every dollar created, there is a dollar of debt. In contrast, base money is an asset as viewed by the private sector. Thus PM are right to make that point. MMTers (perhaps another lot of “cranks” in the eyes of S&F), often make the same point.
S&F also make the following not too clever point. “Hence the creation of money raises the net financial assets, and carries the implication that the more money is ‘printed’ the better off (wealthier) people will feel. Yet there is no increase in the capacity of the economy to produce.”
What – so printing bits of paper with £10 stamped on them doesn’t automatically cause factories complete with associated machinery to appear from nowhere? Did Positive Money ever say that the latter magic apparition would actually occur once the printing presses start rolling? Not far as I know.
The basic purpose of creating new money and spending it (and/or cutting taxes) is to raise demand, and that in turn (where there is inadequate capital investment) will cause office blocks to be erected, factories to be built and so on.
As I said, there is nothing of substance in this sixth and final section.
Friday, 20 November 2015
I set up a pro full reserve banking stall at an event in the North East of England recently, assisted by like minded people. Most of those taking an interest in our ideas had normal legs, but I particularly liked this eccentric fellow with leg extensions.
Thursday, 19 November 2015
Accepting deposits and lending on or investing the relevant money is one of the main elements of commercial banking.
Depositors place money in banks for two reasons. First for safety: most people think (probably rightly) that putting money in a bank is safer than putting it under their mattress. A second reason is to earn interest.
But those two reasons clash: money cannot possibly be totally safe if it is loaned on or invested. As Adam Levitin put in in the opening sentence of the abstract of a paper of his, “Banking is based on two fundamentally irreconcilable functions: safekeeping of deposits and relending of deposits.”
Deposits can be made safer if they are insured by a private insurer. But even private insurers can go bust, so that’s not totally safe.
An ostensibly better alternative is to have the state with its access to limitless amounts of taxpayers’ money do the insurance. But that almost by definition amounts to a subsidy of depositors and banks.
Moreover, what’s the state doing rescuing a bunch of people who have taken an obvious commercial risk which hasn’t paid off? If you start up small business or buy stock exchange quoted shares and it goes wrong, taxpayers don’t come to your rescue, and quite right.
The “obvious commercial risk” is the above mentioned nonsensical offer made by commercial banks, namely “deposit your money with us, and we’ll guarantee you get your money back at the same time as lending your money on, a process which clearly involves risks”. We might as well rescue people who set up as alchemists: offering to turn base metal into gold and who then find they can’t do it. Why don’t we rescue failed astrologers or tea leaf readers?
Rescuing commercial ventures which fail is a blatant misallocation of resources. Or in the specific case of banking, and in the words of Walter Bagehot, “…any aid to a present bad bank is the surest mode of preventing the establishment of a future good bank”.
Of course bankster-criminals are very good at easing politicians and governments into the position where the failure of several large banks is a possibility, and hence where VERY SEVERE disruption of the economy is a possibility. That’s a situation where governments, rather than let several large banks fail, take the morally hazardous decision to rescue those banks. Wads of cash in brown envelopes (euphemistically called “contributions to election expense”) help to ease politicians into the position where they have to rescue the assortment of astrologers and tea leaf readers and Ponzi scheme operators sometimes known as “bankers”.
But that doesn’t justify the existence of the present bank system any more than the failure of large numbers of alchemists threatening the economy would justify taxpayer funded rescues of alchemists.
The offer to turn base metal into gold is blatantly fraudulent. Likewise the claim that money which is invested or loaned on is totally safe is also blatantly fraudulent. It’s a Ponzi scheme: nothing more, nothing less.
Commercial banks should not be allowed to get anywhere remotely near the situation where the failure of their Ponzi scheme threatens the economy. Same goes for astrologers, tea leaf readers and crystal ball gazers.
And finally, banksters (and some deluded academic economists) like to claim that commercial banks create liquidity, or they claim that commercial banks create the most liquid asset of all, i.e. money. Well it’s true that commercial banks do perform that role. But the way they do it involves risk.
In contrast, the state can issue whatever amount of money is needed to keep the economy ticking over at the full employment level, and at no risk. At least there’s no risk in the sense that the central bank that issues the money will go bust.
There is of course the risk that too much state issued money is issued, which results in excess inflation. But then governments nowadays see it as their job to control aggregate demand ANYWAY (e.g. via interest rate changes, budget deficits, QE, and so on). The latter activity can always go too far with the result that inflation gets out of hand.
Wednesday, 18 November 2015
In his article in today’s Financial Times, Wolf effectively says in his final para if the private sector hoards more money than usual, that doesn’t matter because the state can simply issue more of the stuff to satisfy the desire of the private sector (or some part of it) to save.
In Modern Monetary Theory phraseology the state can easily satisfy the private sectors “savings desires”. MMTers also have their own phrase for the sum of base money and government debt: they call the pair “Private Sector Net Financial Assets”.
The logic behind that phrase is that money issued by PRIVATE banks is not a form of saving in that for every dollar issued, there is a dollar of debt (as pointed out over and over by Positive Money). In contrast, in the case of central bank issued money (base money), there is no corresponding private sector debt. There is a SORT OF debt in that base money is IN THEORY a debt owed by the state to the private sector. But it’s a strange sort of debt. For example the so called debtor can grab any amount of money it wants off the so called creditor any time via a great system called "taxation". In contrast, you can’t wipe out your mortgage by grabbing money off the bank that granted you the mortgage.
As to government debt, that’s simply a promise by the state to give you some of it’s “funny money”, i.e. base money, at some point in the future. So that’s an equally strange debt.
As for Turner, as Bill Mitchell (an MMTer) points out in his blog post today, many of Turner’s proposals in his recently published book are pure MMT. And as Mitchell points out, it would have been nice if Turner had given credit where credit is due.
But of course, MMT ideas also derive to a significant extent from Keynes. For example the MMT “savings desires” point is simply Keynes’s “paradox of thrift” idea. We all stand on the shoulders of giants.
Reverting to the point that it doesn’t matter if hoarded money is not spent or invested, that point is relevant to the full reserve banking argument. Advocates of full reserve (like me) claim that savers’ money which those savers want to be totally safe should be kept in a totally safe manner, e.g. simply lodged at the central bank.
Many of the opponents of FR (e.g. Vickers) object to that non-use of money. Money you might think should always be put to use. Well, as Martin Wolf said (to repeat), it doesn’t matter if hoarded money is not used.
The idea that money should always be used if at all possible is actually an example of the perils of using microeconomic ideas at the macroeconomic level. That is, from the perspective of a microeconomic entity like a household or firm, obviously it makes sense to invest spare money if possible.
In contrast, at the macroeconomic level, if everyone in the country wanted to keep $1,000 in physical cash under their mattress against a rainy day and hardly ever dipped into it, that would be no problem at all. The state would simply crank up the printing press, and distribute the money to everyone.
Tuesday, 17 November 2015
Lerner was a friend of Keynes’s. Lerner is often said to be the founding father of Modern Monetary Theory. There isn't much difference between the two men’s ideas: just a difference in emphasis here and there.
Here are some excerpts from Lerner’s book “The Economics of Control” (published in 1944). MMTers will hopefully like these excerpts, as will a few other folk I suspect.
The excerpts are from the end of chapter 23 and beginning of chapter 24.
On national debt.
“…the size of the national debt (when held by citizens of the country) is a matter of almost no significance beside the importance of maintaining full employment. The national debt is not a burden on posterity because if posterity pays the debt it will be paying it to the same posterity that will be alive at the time when the payment is made.”
Lerner’s point there is essentially the same as Keynes’s famous phrase “Look after unemployment, and the budget will look after itself.”
On the subject of national debt being a private sector asset, Lerner says, “The greater the internally held national debt, the greater the amount of private property held by members of society, either directly as private individual owners of government bonds, or indirectly through the corporations and banks that own the bonds…”.
“The purpose of taxation is never to raise money but to leave less in the hands of the taxpayer. . . . taxation should never be imposed merely as a means of raising money for the government on the grounds that the government needs the money. The government can raise all the money it needs by printing it if the raising of the money is the only consideration.”
The latter point is technically correct and MMTers often repeat it. But personally I’m wary of it: it gives the impression that MMTers think a country can do a Robert Mugabe and get away with it.
Lerner was keen on the idea that we should look at EFFECTS, not numbers.
“The rational procedure is to judge all actions only by their effect and not by any vague notions of their propriety or impropriety. “By their fruits shall ye know them.” The effects of a tax are two fold. It increases the money in the hands of the government and, by decreasing the money left in the taxpayer’s hands, it makes him spend less. The first effect is unimportant…..The important effect is the second, and the question of taxing or not taxing should be governed entirely by whether the effect on spending by the individual taxpayer is desired or not…”
Personally I’d go further and say that money in the hands of a money issuer (e.g. government / central bank) is meaningless. To illustrate, a central bank can create a trillion, trillion, trillion dollars at the click of a computer mouse whenever it wants. That reduces each dollar to a nonsense.
Warren Mosler, a leading MMTer summed it up best when he said that central banks should be likened to the umpires in a tennis match. Umpires produce points (dollars) from nowhere and as appropriate. And they WITHDRAW points (dollars) when they think appropriate.
To illustrate the above “effect” point, suppose government wants to spend an extra $1bn next year and suppose it decides to get that from tax rather than borrowing, how much extra tax should it collect? The obvious answer, i.e. $1bn, is the wrong answer. The correct answer is that government should collect whatever amount negates the inflationary effect of spending an extra $1bn. The actual amount needed to do that “negation” will be very different as between where the tax is collected from the rich as distinct from the less well off.
On confusing macro with micro.
It would be nice if Western politicians had read and understood this passage at the start of the 2007/8 crisis.
“The level of economic activity is affected by the spending, taxing, and borrowing activities of the government. In a purely capitalist economy these activities will for the most part have the effect of accentuating cyclical fluctuation in economic activity. The government budget will be drawn up in the image of the budget of a business or a corporation. When times are good the revenue from taxes will be high and the government, federal and local, will believe it proper to undertake socially beneficial activities in excess of the current revenues by borrowing more for these activities on the strength of the expected continuation of the high tax yields. This will result in a net increase in total demand because the government spends the whole of the proceeds from taxes and loans, while the citizens contract their expenditure by only a part of the increased tax payments (except perhaps the very poor) and perhaps by only a very small part of the money loaned to the government.
In bad times the government will feel that it is proper to retrench, and not to go in for the luxuries of government spending on defence or parks or roads. It will be considered "unsound finance" to increase its debt in times of declining revenue from the taxes out of which the debt must be serviced. Attempts will even be made to reduce the national debt by raising higher taxes to repay some of the debt and bring it into a better "balance" with government tax revenue. The effect of such a policy of "sound finance" will be to reduce incomes still further, both by the decrease in government spending of borrowed money and by the decrease in private spending because of the higher taxes whose revenue serves to repay debt. The depression will be deepened by much more than this net direct decrease in government and private spending. This is because the decrease in spending acts just like a decrease in investment. Income must fall as much as will reduce the gap between income and equilibrium consumption by an amount just equal to the net direct reduction in spending.
……In the end the government is forced, against its will, to stop this and actually do something to improve the economic situation.”
Monday, 16 November 2015
Chapter 12 of Turner’s recently published book, “Between Debt and the Devil” claims that full reserve banking (FR) is flawed. I dealt with what I think are some weaknesses in Turner’s criticisms of FR here yesterday.
What he calls his “most fundamental” reservation about FR is that “..there may be some positive benefits to private rather than public creation of purchasing power.”
He continues, “..it could still be true that not only debt contracts but also banks can play a useful role in mobilizing capital investment that would not otherwise occur.”
Well the answer to that is that under FR, banks “mobilize capital investment” just as they do under the existing system. That is, under FR, banks collect the savings of millions of savers and lend them out to borrowers. All that changes is the EXACT WAY banks do that job.
Turner’s next sentence reads, “Maturity-transforming banks enable long-term investments to be funded with short-term savings: that might seem like an illusion, a sort of confidence trick, but it may be a useful one. Inevitably it creates instability risks, but some instability may be the inevitable and reasonable price to pay to gain the benefits of investment mobilization and thus economic growth.”
Well there is more than one flaw in that sentence. First, if by “investment” Turner means industrial and commercial investment, the bulk of that is funded by equity and bonds. I.e. bank loans play a relatively small part, at least in the UK.
Second, maturity transformation (i.e. “borrow short and lend long”) is a mirage, and for the following reasons.
Assume an economy where maturity transformation (MT) is not allowed, and assume the economy is at capacity, i.e. at the full employment level.
You might think that where MT is banned, private money creation is necessarily also banned or at least severely curtailed, and hence the economy couldn’t possibly attain full employment. In fact if private banks don’t issue enough money, central banks can easily issue whatever amount of money is needed to keep the economy at full employment. Indeed, as Robert Mugabe so ably demonstrated, the state or central banks can take that process too far and cause hyperinflation.
Also assume that in our hypothetical economy, everyone has the assortment of assets they want, liquid and illiquid assets in particular. Next, assume the law on banking is changed and MT is allowed. The effect will be to turn a proportion of savers’ relatively ILLIQUID assets into much more liquid assets, if not into actual money.
But that will cause savers to try to spend away their surplus stock of money / liquid assets. Thus demand rises. But a rise in demand is not permissible because the economy is already at capacity. Thus government will need to raise taxes and confiscate a proportion of the private sector’s stock of cash, or impose some other deflationary measure. In short, little or no extra investment spending takes place!
Another problem with Turner’s theory has to do with the “instability” to which he refers. As he rightly says, MT involves risks. And how have we dealt with that risk (at least in the UK over recent decades)? Well government, out of the kindness of its heart (i.e. the long suffering taxpayer) has had to foot the bill when banks collapse. In short, any extra investment that may have come about as a result of MT has been gratis a SUBSIDY. And subsidies not make economic sense (except where there is a good social case for them, as there doubtless is in the case for example of kid’s education).
In short, subsidies reduce GDP, thus the idea that “MT plus subsidies” promotes growth is very questionable.
FDIC type insurance.
Of course instead of blatant subsidies, depositors can be safeguarded by some sort of FDIC type insurance. And assuming that’s on a self-funding or commercially viable basis, then there is no subsidy.
But that idea has weaknesses as well which I dealt with in detail here. One weakness is that if bank shareholders and the FDIC insurer both gauge the risk correctly, they’ll charge the same for bearing the risk. Thus in theory there shouldn’t be any difference as between funding a bank by depositors protected by FDIC type insurance on the one hand, and via shareholders on the other. (A bank funded just by shareholders does not of course do any MT).
Incidentally, I was using the word “shareholder” in a loose sense just above. That is, under some versions of FR, those who want their money to be loaned on would buy into a unit trust / mutual fund of their choice. But mutual fund stakeholders are effectively shareholders.
Another problem with FDIC type insurance which a “shareholder funded” bank (i.e. an FR bank) does not have: it’s that bankers will never stop lobbying politicians to have the state insure banks at an unrealistically cheap rate. To date (as pointed out above), bankers have been very successful in that regard.
Yet another problem is that if you are insured by some FDIC type third party rather than going for self-insurance as per FR, there’s a temptation to take excessive risk and keep the profits when that works, and in the knowledge that the insurer will foot the bill when the risks don’t work out. And that phenomenon partly explained the 2007/8 crisis.
The pros and cons of MT are complicated. Turner’s analysis is too simple. The analysis in the above paragraphs is hopefully better, and those paragraphs indicate that the merits of MT are largely or entirely an illusion.
Sunday, 15 November 2015
Adair Turner is a former head of the UK’s Financial Services Authority. I agree with much of the thrust of his recently published book “Between Debt and the Devil.” But his criticisms of full reserve banking (in his Chapter 12) leave room for improvement to put it politely.
The paragraphs below deal just with that Chapter 12, and one of Turner’s criticisms of full reserve (FR) runs as follows.
“Moreover, any risks of private credit creation need to be balanced against the risks that would arise if we instead relied entirely, as the Chicago Plan proposed, on fiat money creation to increase nominal demand. For if we allow governments to run money-financed fiscal deficits, there is a danger that they will do so in excess or will allocate the spending power inefficiently for short-term political advantage.”
What – so politicians never boost demand before elections under the EXISTING system? The phrase “pull the other one” springs to mind.
A second criticism Turner makes of FR is that even if money creation by private banks is banned, “..near-money equivalents and new credit and purchasing power can be created outside banks. If promissory notes are believed to be low risk, they can be used as a money equivalent…”.
Well the first answer to that that is that advocates of FR don’t advocate a complete ban on non-state issued money. For example, most supporters of FR in my experience have no objections to local currencies like the Bristol pound.
Second, what FR advocates do propose is that money creation by the ten or twenty largest banks (regular banks AND shadow banks) should be banned, and that represents a HUGE CUT in the amount of private money creation.
Third, money is defined in economics dictionaries as something like “anything widely accepted in payment for goods and services”. Now every high street shop accepts central bank notes (e.g. Bank of England £10 notes) and credit and debit cards issued by well-known private banks and card issuers.
However, high street shops certainly won’t accept Turner’s “promissory notes”. And those promissory notes are no use when buying a car or house.
Thus while Turner’s promissory notes arguably count as a form of money in financial centres, like the City of London, they’re not much use anywhere else in the country. Thus those notes are not a fully fledged type of money.
A third criticism that Turner makes of FR is thus.
“…the development of shadow banking illustrates the remarkable ability of innovative financial systems to replicate banklike maturity transformation and thus the creation of near-money equivalents outside the formal banking system. The challenge of constraining credit and money creation would not be wholly resolved by requiring the formal banking sector to hold 100% reserves.”
That point is partially answered above: i.e. while promissory notes are a form of “near-money”, they certainly are not what might be called “100% proof” or “genuine” money.
Another answer was spelled out very eloquently by Turner himself when he said in reference to shadow banks which up to now have avoided some of the regulations that apply to regular banks, “If it looks like a bank and quacks like a bank, it has got to be subject to bank-like safeguards…”.
If some drug is deemed harmful, then it makes no difference who makes or sells it – a lone individual or a multinational corporation – any such manufacture or sale should be banned.
However, in a sense, stopping private money creation is easier than stopping dangerous drug production. That is, dangerous drugs are indeed produced by individuals and families, and it’s clearly difficult to keep tabs on all those small producers. In contrast (to repeat), the smaller the organisation that tries to issue money, the less money-like is its so called money.
Indeed, someone who lends £10 to his next door neighbour is acting like a bank. There is clearly no need to regulate that sort of lender.
A fourth criticism of FR made by Turner relates to debt jubilees. That is, Turner casts doubt the idea put by Messers Benes and Kumhoff, namely that some sort of debt jubilee should be or has to be implemented when FR is first set up. That idea is indeed nonsense: there may be arguments for debt jubilees, but there is no need whatever to lump the introduction of FR and debt jubilees together. Plus I don’t know of any other advocates of FR who agree with that “lump together” idea.
Thus that weakness in Benes and Kumhoff’s argument is not a weakness in the overall argument for FR.
Turner also backs the existing bank system because of the maturity transformation it involves. As he puts it, “…banks can play a useful role in mobilizing capital investment that would not otherwise occur. Maturity-transforming banks enable long-term investments to be funded with short-term savings..”
I’ll deal with that point in a separate post in a day or two because this post is already long enough, plus the maturity transformation point is complicated.
Full reserve reduces debts.
A final irony about Turner’s criticisms of FR is that (as the title of his book more or less implies) he argues that one of the causes of the crisis was excessive private debts. As the opening sentence of Part II of his book puts it, “The most important reason the 2008 crisis was followed by such a deep recession and weak recovery was excessive private credit creation in the preceding decades.”
But one of the effects of FR is to REDUCE DEBTS! Indeed, the world is awash with people who deplore the size of private sector debts in one breath, and in the next, they advocate lots of lovely bank lending (which funds investments that “would not otherwise occur”) because that allegedly promotes economic growth.
FR forces banks to fund loans just from equity or equity like liabilities rather than from deposits. To the extent that that disposes of bank subsidies, that will clearly raise the cost of loans. The result will be a rise in interest rates and hence a reduction in loans and debts.
However, there is no reason to assume any reduction in aggregate demand or numbers employed because of any cut in demand stemming from FR. Any such cut can easily be countered with standard stimulatory measures: the stimulatory measure preferred by several FR advocates being to simply have the state print money and spend it into the private sector (and/or cut taxes). Plus the removal of unjustified subsides ought to increase GDP, not reduce it.
As for any idea that a rise in interest rates is some sort of problem, mortgagors in the 1980s were paying up to THREE TIMES the rate of interest that they pay nowadays. I don’t remember that being a huge problem.
Saturday, 14 November 2015
Why are we renting our money supply from the banks that conjure it from nothing? https://t.co/cSiRRTDhuf pic.twitter.com/601XtWHV5z— Positive Money (@PositiveMoneyUK) November 12, 2015
The idea that we rent our (privately created) money supply could be questioned on the following grounds.
People who want to borrow from banks certainly pay what might be called a “rent”. That is, they pay interest plus they pay for the administration costs involved in setting up a loan (e.g. checking up on the value of the collateral deposited in exchange for the loan).
But it could be argued that that rent is simply what any borrower would pay to any lender, including those who borrow from a non-bank entity of some sort. Moreover, what might be called the “outright owners of money”, i.e. those with a positive balance at their bank, don’t pay any rent. Indeed, if anything it’s the reverse: the bank pays interest to the depositor.
The answer to the above criticisms of the “we rent our money” argument is as follows.
In the real world (as intimated above) LENDING gets very mixed up with money creation. But in order to separate the two, let’s assume a hypothetical country where no one wanted to borrow or lend, but people DID WANT a money supply.
In that scenario, everyone or most people would, 1, deposit collateral at some bank, 2, have the bank open accounts, and 3, have those banks credit each person’s account with whatever float or day to day spending money each person thought they needed to tide them over from one payday to the next. Or perhaps most people would want a bit more money than that, but that’s a minor technicality.
Now people would clearly have to pay for the administration costs incurred by banks in supplying that above money. So the conclusion is that we do in fact hire the money supplied by private banks, irrespective of any lending that those banks do.
In contrast, supplying the economy with base money is almost costless.
How private money displaces base money.
If base money is costless and privately issued money does cost a significant amount to produce, it is legitimate to ask why about 95% of our money is private rather than public / base money. Put another way, how does private money manage to displace public money?
George Selgin provides an explanation here (see in particualar his 5th paragraph). It’s an explanation which I think is “the truth, but not the whole truth”. I.e. he misses out a step in the argument. (Incidentally, Selgin does not favour a “base money only” system)
After assuming a base money only economy, he says:
“Suppose next that fractional reserve banking is legalized and that…. it becomes so popular that all the old warehouse banks embrace it. Will inflation result? Of course it will—but only for a time. As fractionally-backed notes (or deposit credits) take the place of their 100-percent reserve predecessors, the demand for monetary gold, and hence the demand for gold in general, declines, causing the value of gold to decline with it. Because prices are expressed in terms of an (unchanged) gold unit, the price level has to rise.”
My explanation, for what it’s worth, is thus.
Assume a fractional reserve bank or banks set up in an FR or “base money only” economy, and the bank wants to lend. It could of course attract deposits and pay interest to depositors. But why bother? The bank can simply create money out of thin air and charge interest to those borrowing that freshly produced money.
The result (as Selgin points out) is inflation. But why would those new fractional reserve banks be bothered by that inflation? If you can effectively print money, and hire it out at interest, the fact that that money loses value at a significant rate won’t bother you.
Thus the conclusion is that even though privately issued money is inherently more expensive to produce than publicly issued money, the interest that private banks get from the money they print and hire out more than compensates.
Friday, 13 November 2015
The Economist trotts out the old myth that a country that issues its own currency can go insolvent because of a relatively high national debt. As they put it “As more Japanese workers retire, domestic saving is falling and spending on the old soaring. Even a modest rise in borrowing costs could bring insolvency.”
I’ve demolished this sort of nonsense several times over the years. So what do I do apart from demolish it yet again? Darned if I know. So here goes.
First, the point about “spending on the old soaring” is only of marginal relevance. If that spending increase does take place, then it helps solve the problem which the Economist article addresses, namely how to raise demand in Japan! So that’s that minor point dealt with.
As to what would happen if holders of Japanese debt demand a higher rate of interest, the first point to note is that only becomes a problem (if indeed there is a problem) as debt becomes due for rollover: at which point the Japanese government (JG) faces the prospect of paying more interest.
One option is to pay the interest and send the bill to Japanese taxpayers. No “insolvency” there. But I don’t favour governments paying a rate of interest much above zero. So that’s not my preferred option. Thus what does the Japanese government do if it doesn’t want to pay a higher rate of interest? Well it’s easy: pay off creditors on “rollover day” and tell them to get lost. That would mean in effect that as regards relevant government bonds, interest paid by JG would drop from a miserable 0.5% (which is about what it pays at the moment) to zero percent.
The only possible and minor problem is that printing money and paying off creditors (which are nearly all Japanese nationals by the way) has a slight stimulatory and/or inflationary effect. That is, QE is stimulatory.
But seems from experience in the West that the stimulatory / inflationary effect is pretty feeble. Plus to the extent that there is a stimulatory effect, that again helps solve the very problem that the Economist article addresses, namely how to raise demand in Japan.
And the REASON why the stimulatory effect is feeble is that government debt paying around 0.5% interest and cash are much the same thing. Both are (at least in theory) government liabilities, but one pays a very slightly higher rate of interest than the other.
As Martin Wolf, chief economics commentator at the Financial Times put it, “Central-bank money can also be thought of as non-interest-bearing, irredeemable government debt. But 10-year Japanese Government Bonds yield less than 0.5 per cent. So the difference between the two forms of government “debt” is tiny, particularly since the BoJ intends to reverse its monetary expansion at some point.”
As to what to do if the stimulatory effect is too much, that’s easy: all JG has to do is to grab money off the Japanese private sector. Governments (revelation of the century this) do have the power to expropriate any amount of money they like any time from their citizens.
That expropriation should deal with any excessive and hence inflationary spending by the Japanese private sector.
Why stabilise the debt?
Later, the Economist article says “Other studies are less dire, but nonetheless suggest that far bolder measures than anything under consideration will be needed to stabilise the debt.”
Hang on: why is there any need to stabilise the debt at any particular level? If Japanese households want to hold $50,000 each of Japanese government bonds, the Japanese government should let them, and pay them virtually no interest.
In fact if JG doesn’t issue that debt, households will just cut their spending so as to acquire the stock of savings they want. As a result, unemployment will rise. In short, governments really don’t have any option but to supply the private sector with the stock of savings or paper assets that the private sector wants.
Tuesday, 10 November 2015
And it’s hopeless. I’ll run through the arguments, most of which I’ve seen a dozen times before.
First, the author (Leonid Bershidsky) describes the change to 100% reserve with the emotive word “cataclysmic”. That’s in stark contrast to what Milton Friedman said on the subject. He said “There is no technical problem in achieving a transition from our present system to 100% reserves easily, fairly speedily, and without any serious repercussions on financial or economic markets.” (That’s from Ch3 of Friedman’s book “A Program for Monetary Stability).
Next, even if a change is “cataclysmic”, that is not a good argument against the change. The change from the feudal regime in Europe of the Middle Ages to present day democracy was arguably “cataclysmic”. The changes brought by the industrial revolution were arguably “cataclysmic”. That’s not an argument against democracy or industrialisation.
Next, Bershidsky says “a process whereby banks would gradually repay the central bank for the 100 percent reserves, would be immensely complicated.”
The first answer to that point is much the same as the answer to the above “cataclysmic” point. That is, if a change is complicated, that’s irrelevant: the important point is how the ULTIMATE BENEFITS stack up against the cost or “complexity” of the change. I’m 99% sure that Bill Gate’s found his first operating system “complicated” to set up. The ultimate benefits have been ASTRONOMIC.
Second, the above “repayment” system far from being complicated is simplicity itself. All that happens is that the central bank takes over some of the assets of existing banks (e.g. mortgages) and collects interest and capital repayments for the next 20 years or so. Where’s the “complexity” is there?
There would of course scope for argument as to what a mortgage is worth in the case of dodgy NINJA mortgages. But a few hours haggling would sort that out. As to bog standard UK mortgages, they aren’t in the NINJA category. That is the value of those mortgages will be within 1% of book value.
100% reserve is deflationary?
Next, Bershidsky makes a claim I’ve seen a dozen times before. As he puts it: “Then, if banks are only allowed to lend money they have made from commissions and interest, borrowed from the central bank or from depositors, they will probably provide less funding to the economy than they are providing now.”
Well they wouldn’t “probably provide less funding”: they’d DEFINITELY provide less funding. Reason is that under 100% reserve, banks can only lend on money that relevant depositors are prepared to put at risk. That’s as distinct from the existing system under which banks can lend on money which is insured by governments (i.e. taxpayers). That featherbedding of the “borrow and lend” process is wholly unjustified.
As the cut in demand that would result from less bank funding, that’s easily dealt with by standard stimulatory measures. Moreover, less “bank funding” means less debt, and half the world is having a nervous breakdown over the size of private sector debts. Assuming those nervous breakdowns are justified, then less debt won’t do any harm.
Next, Bershidsky makes the bizarre claim that having just the central bank create money is “a tiny step removed from central planning”.
Central planning actually consists of government bureaucrats, rather than market forces, deciding the amount of almost every product to be produced in the next five years or whatever. That includes the amount of steel, aluminium, sulphuric acid and ten thousand other items.
In contrast, there isn't one single advocate of 100% reserve banking I know of who proposes anything remotely like that. In particular, it would be very odd of the arch proponent of free markets, Milton Friedman, advocated 100% reserve (which he did) if 100% reserve bore any resemblance to central planning.
The only “centralising” that takes place under 100% reserve is that the state decides how much new money to issue with a view to determining how much stimulus should be implemented. But the state (i.e. central bank and government) ALREADY DECIDE how much stimulus to put into effect. It’s just that they do it in a slightly different way under the existing system.
Thus it is debatable as to whether 100% reserve would give us any more “centralising” than we already have.
First, let’s consider current as opposed to capital spending. Should government borrow so as to fund current spending? Clearly not. This year’s current spending should be paid for out of this year’s tax.
Now for borrowing to fund capital spending.
One reason to borrow is that if a capital investment is significant compared to any entity’s annual income or turnover, it will suffer a significant drop in consumption if the investment is paid for out of one year’s income. E.g. if you paid for a new car out this year’s salary, that might severely reduce your standard of living this year.
But that point does not apply to governments. The cost of a large bridge or a hundred miles of new road is a minute proportion of total government spending.
Another popular excuse for government borrowing is that it allegedly spreads the cost of capital items across the generations that will benefit from relevant capital items (e.g. bridges). The problem with that argument is that it involves time travel. That is, it just ain’t possible for people in 2030 to sacrifice time, labour, effort etc so as to produce the concrete and steel needed to build a bridge in 2015.
Steel consumed in 2015, unless I misunderstand the laws of Physics, must be produced in 2015 or earlier.
A third reason why microeconomic entities like firms and households borrow so as to fund capital spending is that they just don’t have the necessary cash to fund the capital spending. But that point does not apply to governments. Governments have access to near infinite amounts of cash: first they can grab near limitless amounts off taxpayers, and second, they can print the stuff.
Anti cyclical matters.
A forth reason for government borrowing is to cool down an overheating economy. But if that’s the objective, why concentrate on just ONE sector of the economy, i.e. the “borrow and lend” sector? That is, why not cut a broader range of types of spending by raising taxes and cutting public spending?
To increase government borrowing so as to cut aggregate demand is a bit like placing an extra tax just on restaurants and garages so as to cut demand.
Moreover, if government wants to borrow more so as to cut demand, what it needs to do is to borrow money and do nothing with the money. That’s not borrowing in the normal sense of the word, which is use REAL RESOURCES belonging to someone else and on a temporary basis: the intention being to return those resources to the owner at some stage.
Government borrowing (in the normal sense of the word borrow) is pointless.
Monday, 9 November 2015
Klein in this Financial Times article says he supports full reserve (FR) banking. His actual words were “….proponents have included Milton Friedman, James Tobin, researchers at the International Monetary Fund, John Cochrane, and Martin Wolf. (And me.)”
However, Klein does make some criticisms of FR. In relation to Iceland’s proposed FR system his first criticism is thus:
“Sigurjonsson’s report makes a convincing case that private lenders aren’t the best judges of how much money the economy needs to sustainably grow. Why should central bankers and politicians be any better?”
The answer to that is that it’s widely accepted that lending by private banks is pro-cyclical. That fact stares you in the face from any money supply chart. The chart below shows the steep rise in private bank lending prior to the 2007/8 crisis.
But quite apart from that, WE ALREADY HAVE “central banks and politicians” attempting to iron out fluctuations in GDP, unemployment levels and so on. Indeed, if government and central bank don’t do that job, then no matter how inefficiently, who else does do it? Thus having “central banks and politicians” trying to counteract cycles is not a peculiarity of FR. FR simply advocates a slightly different way implementing those anti-cyclical efforts.
Klein advocates full blown monetarism?
Shortly after that, Klein says “If Iceland were successful in centralizing the control of nominal purchasing power, the appeal of policymaker discretion should vanish and a simple money-growth target would suffice.”
Well a fixed annual increase in the money supply was what Milton Friedman advocated and that didn’t work too well. In defence of Friedman, his idea is not completely daft: i.e. anyone can be forgiven for thinking that a fixed and small annual money supply would work. But the fact is that it didn’t work too well. So that’s that.
If Klein now thinks that monetarism a la Friedman is actually desirable, most economists would regard that as a joke. But I’m broad minded: I’m happy to listen to explanations from Klein that support his pro-monetarist belief.
Next, in the paragraph starting “Those are minor criticisms.” (and subsequent paragraphs), Klein argues that the FR system Iceland envisages would be as liable to runs as the existing system. As he puts it, “banks would be almost exactly as vulnerable to runs as they are in today’s system”. To explain Klein’s concerns, it is necessary to delve into the detail’s of Iceland’s proposed system.
Iceland’s proposed system (far as I can see) is a direct copy of Positive Money’s FR system. And under that system, those who want a bank to lend on their money put their money into so called “Investment Accounts”. Those accounts are not protected by taxpayers, plus instant withdrawal of fund is not allowed: depositors have to wait a few months to withdraw. And therein lies the first weakness in Klein’s claim that those accounts would be subject to runs. Runs occur where depositors have a right to INSTANT ACCESS to their accounts. So when there’s a suspicion that a bank is in trouble, queues appear outside relevant bank branches (as at Northern Rock). The queues consist of people demanding instant access.
In contrast, with investment accounts, a run would be a slow motion affair, and that gives the bank time to find alternative sources of funding. Thus Klein is clearly wrong to claim that FR banks would be as subject to runs as existing banks.
Moreover, there’d be nothing to stop the terms governing those investment accounts including a clause to the effect that in the event of the bank having problems, depositors’ access to their money can be extended by the bank. After all: those depositors have absolutely no cast iron guarantee they’ll get any of their money back at all, given that there is not government backing for those accounts. So they’d be daft to object to having access to their money delayed: that delay might enable them to eventually get their money back.
Milton Friedman and Lawrence Kotlikoff.
Next, the above “run problem” to which Klein refers is not actually a weakness in FR as a whole: it’s a peculiarity and weakness in the Positive Money / Iceland version of FR.
That is, in other versions of FR, in particular Milton Friedman and Lawrence Kotlikoff’s versions, those who want their money loaned on buy what are essentially shares in a unit trust (“mutual fund” in US parlance). Under that arrangement, insolvency of the investment department of a bank (i.e. those mutual funds) is plain impossible.
To illustrate, if 90% of relevant borrowers turn out to be dud (which is about as likely as being hit by a meteorite), all that would happen is that the value of the mutual fund shares would drop to 10% of their book value.
If you have a SHARE in a corporation as distinct from a FIXED VALUE claim on the corporation, there is no point in running, as John Cochrane explains.
Next, Klein claims that in the event of a number of bank failures (i.e. failures of the lending or investment department of banks) “you could expect a sudden spike in the cost of borrowing.”
True, but what’s wrong with that? If there were a series of failures in the food retailing industry, that would indicate that the industry had overestimated the size of the potential market and had pitched its prices too low. If market forces were working properly, the result would be that a number of retailers would go out of business, and the remainder would raise prices.
That’s in contrast to the existing and barmy set up where when there’s a series of bank failures, or near failures, government comes riding to the rescue with the result that excessive lending and excessive debts get back to where they were before the problem exploded.
The world is awash with people (mainly politicians and economics commentators) who advocate more bank lending in one breath so as to promote “growth”, while in the next breath they deplore the rise in private sector debts (caused by those bank loans).