The London School of Economics doesn’t like free speech.

Unless you’ve been living on another planet for the last ten years, you’ll be aware that universities have lost the reputation they once had for free speech and open debate. This new “academic bigotry”, to coin a phrase is nicely described in this Spectator article. I particularly like the opening paragraph.

I actually dealt with this subject a month or two ago on this blog, and mentioned that comments on LSE blog articles seem not to get published if they criticise relevant articles.
 
That is not to suggest that NON-ACADEMIC authors are any different: the point is that universities are supposed to be all about free speech and open debate. They have a duty to promote those two.

Moreover, it is basically dishonest to allow comments after an article and then fail to publish the comments that disagree with your article. That is, the perhaps naïve assumption made by many readers is that ALL COMMENTS (apart perhaps from grossly offensive or blatantly stupid comments) will be published. I.e. if authors want to publish just complimentary comments, they should say so in their articles. But of course that would make them look stupid. Much better the above mentioned “dishonest” ploy.

Anyway, the latest example “LSE terror of free speech” is this article. I left two critical comments, but neither was published. The moral is: don’t take the absence of criticism in the comments after an article as evidence that those who have read the article approve of it. There may be loads who think the article is rubbish, but the author has chosen not to publish their comments.

Re how many comments I don’t publish on this blog of mine, the answer is “virtually none”, and I’ve no good reason to censor comments in that I find abusive or offensive comments are rare in the extreme. I very occasionally don’t publish a comment which is plain stupid. I do that about once every six months.

The main reason I have comment moderation is to get rid of comments which are clearly off topic and aimed at selling or promoting something: they normally include a link to some firm with some product on offer. A common example (no doubt because this blog is largely concerned with banks, lending, etc) is pay day lenders trying to sell their wares.

But even the latter “commercial” comments are less frequent than they used to be, thus I might switch off comment moderation in the near future and see how it goes.

__________

Stop press (3rd Aug). Bill Mitchell of "Billyblog" who I mentioned in my earlier article on this subject, continues to be a bit selective as to which comments get published. One of mine wasn't published a couple of days ago, though in fairness he has published at least 90% of my comments over the last five years or so.













 

Adam Smith on the non inflationary effect of privately issued money.

Warning: this article (as the above title rather implies) is concerned with a somewhat technical point about the history of economic ideas – not something that is of interest to some people maybe. Anyway…

Seeking Alpha recently published an article of mine entitled “To enable private banks to create and lend out money, households must first be driven into debt.”

The basic argument was that assuming the state has issued enough base money to keep the economy working at capacity, then any attempt by private banks to add to that money supply will be inflationary, which means that in order to keep inflation under control, the state must impose some sort of deflationary measure like raising taxes and confiscating some of the private sector’s stock of base money. That in turn will drive a significant number of households and firms into debt: and potential debtor / borrowers is exactly what money lenders (i.e. private banks) want.  In short, private banks solve a problem which they themselves create!

Adam Smith actually considered this issue, but claimed the effect of introducing private money WOULD NOT be inflationary because all of the excess supply of money resulting from private money creation would be spent abroad. That’s in Ch2 Book2 of his “Wealth of Nations”. See the final paragraph below for Smith's actual words.

Adam Smith was certainly a great thinker, but the latter idea about excess quantities of money all being spent abroad is plain bizarre. Certainly A PROPORTION will be spent abroad: indeed, when the average household comes by a windfall, it basically just augments spending on the various items the average household spends money on ANYWAY. That includes housing, cars, restaurant meals, and yes, foreign holidays, imported cars and so on.

And I dare say the PROPORTION of consumer spending that goes on imports in the event of a windfall is HIGHER than the equivalent proportion in the absence of a windfall. But Smith’s idea that 100% of windfall money is devoted to imports or foreign investments is clearly wrong.


Interest.

Another error Smith makes is that he treats privately issued money as a direct substitute for base money (which consisted of gold in Smith’s day). Base money and privately issued money are very different animals.

Base money is a net asset as viewed by the private sector. In contrast, money issued by private banks is not: reason is that for every dollar of money issued by private banks there is a dollar of debt owed by bank customers to such banks. I.e. private banks, as I explain in my Seeking Alpha article, manage to muscle in on the money creation business only because they can lend at below the prevailing rate of interest. And they can do that because it costs them nothing to come by the home made money they lend out: that is, they do not need to earn or borrow it – they just print it.

Thus the addition to the money supply that private banks are responsible for will not be spent on consumer goods, as Smith implied (and indeed as I implied just above): the extra money will be invested. Indeed, a sizeable proportion of money borrowed from private banks goes to mortgages.


Adam Smith's actual words.

Let us suppose, for example, that the whole circulating money of some particular country amounted, at a particular time, to one million sterling, that sum being then sufficient for circulating the whole annual produce of their land and labour. Let us sup¬pose, too, that some time thereafter, different banks and bankers issued promissory notes, payable to the bearer, to the extent of one million, reserving in their different coffers two hundred thousand pounds for answering occasional demands. There would remain, therefore, in circulation, eight hundred thousand pounds in gold and silver, and a million of bank notes, or eighteen hundred thousand pounds of paper and money together. But the annual produce of the land and labour of the country had before required only one million to circulate and distribute it to its proper consumers, and that annual pro¬duce cannot be immediately augmented by those operations of banking. One million, therefore, will be sufficient to circulate it after them. The goods to be bought and sold being precisely the same as before, the same quantity of money will be sufficient for buying and selling them. The channel of circulation, if I may be allowed such an expression, will remain precisely the same as before. One million we have supposed sufficient to fill that channel. Whatever, therefore, is poured into it beyond this sum cannot run in it, but must overflow. One million eight hundred thousand pounds are poured into it. Eight hundred thousand pounds, therefore, must overflow, that sum being over and above what can be employed in the circulation of the country. But though this sum cannot be employed at home, it is too valuable to be allowed to lie idle. It will, therefore, be sent abroad, in order to seek that profitable employment which it cannot find at home. But the paper cannot go abroad; because at a distance from the banks which issue it, and from the country in which payment of it can be exacted by law, it will not be received in common payments. Gold and silver, therefore, to the amount of eight hundred thousand pounds will be sent abroad, and the channel of home circulation will remain filled with a million of paper, instead of the million of those metals which filled it before.

State issued money is better than privately issued money.

The superiority of state issued money can be illustrated by considering two hypothetical economies. In one, people and firms want a form of money, but there is negligible lending and borrowing: a “neither lender nor borrower be” economy if you like. And in the second hypothetical economy, there is a significant amount of lending and borrowing, but very little demand for money (i.e. little demand for idle balances in current / checking accounts).

In the first, the “want money but don’t want to borrow” economy (as in any economy) it would cost nothing to issue base money (i.e. state issued money). As Milton Friedman put it, "It need cost society essentially nothing in real resources to provide the individual with the current services of an additional dollar in cash balances."

In contrast, where a bank customer wants the bank to supply the customer with a stock of PRIVATELY ISSUED money, the bank has to check up on the credit-worthiness of the customer, perhaps take collateral off the customer, check up on the value of the collateral and allow for bad debts. Those items are significant costs.

Conclusion: the state issued money system is clearly cheaper to operate.


A “little demand for money” economy.

Now let’s consider an economy where there is negligible demand for money, but households and firms do want to engage in a significant amount of lending and borrowing. In that scenario, there is no difference as far as costs go between a “state money” system and private money system. Reason is that the above mentioned costs involved in lending (allowing for bad debts etc) apply in both cases. That is, ANY LENDER has to check up on the credit-worthiness of borrowers.

So to summarise, in the first hypothetical economy, state issued money is better than privately issued money, while in the second hypothetical economy neither a state issued nor a privately issued money system can be said to be better than the other. And since real world economies lie somewhere between the above two hypothetical extremes, it follows that state issued money is better than privately issued money.


Net financial assets.

And there is a final nail in the coffin of private money as follows.

When a private bank creates a dollar of money, it creates a dollar debt at the same time, or as the saying goes, private money “nets to nothing” (e.g. see this article by Bill Mitchell). Put another way, when the state creates money, there is rise in the private sector’s net financial assets, while that is not the case with private money creation.

But the private sector’s propensity to spend is clearly related to its stock of such assets (money in particular), in the same way as the propensity of a household to spend varies with the amount of money it has.

So…in a “private money only” system, the private sector has zero net financial assets, and that’s a problem because it is highly unlikely that a zero stock of net financial assets is enough to induce the private sector to spend at a rate that brings full employment. Put another way, given an attempt to implement a “private money only” system, it is likely the state will have to boost the private sector’s stock of money / financial assets with state issued money so as to bring about full employment.

Conclusion: privately issued money benefits the issuers of that money, i.e. Wall Street bankster / criminals,  but no one else.

Random charts - 31.

Text in pink on the charts below was added by me.

Random charts - 30.

Text in pink in the charts below was added by me.

Private money creation and private debts.

It might seem that private banks perform a useful function in creating and lending out money. And indeed they do, assuming the state does not create an adequate amount of money. Indeed the latter deficiency arguably existed under the gold standard: i.e. in the 1800s the amount of gold could not be expanded fast enough to keep pace with rapidly expanding output in the countries which were then industrialising.

However, nowadays things are very different: we have a flexible monetary base. Or put another way, governments and their central banks (i.e. “the state”) can print and spend any amount of money into the economy. So does private money printing serve a purpose any longer? Arguably it does not, and for the following reasons.

The state can, at least in theory, create and distribute whatever amount of money is needed to keep an economy ticking over at full employment, i.e. at “capacity”. Getting that amount of money creation exactly right is not easy, but in principle full employment is easily achieved. (Incidentally I’m using the phrase “full employment” in the conventional sense, that is to refer to an unemployment level of roughly 5%: I’m not referring to a situation where there is literally zero unemployment.)

So what does privately issued money bring to the party? Well on the assumption that an economy already enjoys full employment thanks to the latter money printing by the state, the answer is “not much”. Certainly allowing private banks to create and lend out money in the latter economy which already enjoys full employment CAN BE allowed, but the effect is to raise demand and that cannot be allowed if the economy is already at full employment, else excess inflation ensues. Thus some sort of deflationary measure has to be implemented to counter that additional demand, and that will almost certainly consist of confiscating state created money from households and employers via tax. Alternatively the state can wade into the market and offer to borrow at above the going rate of interest, which comes to much the same thing: money is removed from the private sector. The net effect is that some households and employers are driven into debt. And that, lo and behold, provides a ready market for those private banks which want to print and lend out money.

Thus to enable private money creation, households must first be driven into debt. That’s the gist of my latest article at Seeking Alpha. It’s entitled:

“To enable private banks to create and lend out money, households must first be driven into debt.”

Only an economist would claim that printing excessive amounts of money has no effect.

Izabella Kaminska in a recent Financial Times article claimed that stimulus cannot be implemented by having central banks print money with governments spending it (and/or cutting taxes) because central bank issued money must be backed by real assets. Title of the article is “Central bank digital currencies: the asset-side limitation.”

That argument is nonsense, and for the following reasons.

There are numerous examples, stretching back over two thousand years, of kings, rulers, governments etc declaring that the form of money they’ve decided to issue shall be the basic form of money in the relevant country. And that simple declaration works. In particular, it works if the state declares that its form of money is legal tender and that taxes must be paid in that form of money – or else. Or else you go to prison, have your property confiscated, or whatever.

The threat of prison or some other punishment is ample inducement for everyone to acquire a stock of government money so as to be able to pay taxes. That in turn gives that money value.

In contrast, assets owned by the ruler / government are irrelevant (though doubtless most rulers do own a substantial stock of assets). Having the military and legal power to collect taxes is what really matters.

Moreover, that reliance on tax collecting powers is very much in evidence at the time of writing in 2017. That is, the main asset of most central banks is government bonds. But why do the latter mere bits of paper have any value? It’s to a significant extent because everyone knows that the governments which issue those bonds can help themselves to near limitless amounts of money anytime by simply robbing taxpayers. Whether government actually owns substantial assets is near irrelevant.

With a view to bolstering her case, Kaminska cites a Vox article which makes similar claims about the futility of helicopter drops. Title of the article is “Helicopter money: The illusion of a free lunch.” And it’s written by two Bank of International Settlements individuals, plus one from the Bank of Thailand.

The first flaw in this article is the claim that helicopter money is never withdrawn from the private sector. The authors say, “The central bank credibly commits never to withdraw the increase in reserves.”

The authors do not actually quote any advocate of helicoptering to back that idea, and I’m not surprised, because the “never withdraw” element is not an essential ingredient in helicoptering.

It is true that the type of helicoptering advocated by Milton Friedman involved “no withdrawal”. That’s in his 1948 American Economic Review paper “A Monetary and Fiscal Framework…”. On the other hand it is more usual for advocates of helicoptering to argue that in most years a deficit is needed, while a surplus (i.e. “withdrawal”) will occasionally be needed given a serious outbreak of Greenspan’s irrational exuberance (i.e. excess demand).


Ricardian equivalence.

The Vox authors’ claim that there must be a promise not to withdraw is pretty obviously based on Ricardian equivalence, an idea which has long been popular with academic economists, despite it being obviously unrealistic.

Ricardian equivalence is the idea that consumers are forward looking and behave totally rationally. As far as helicopter drops are concerned, this means consumers will not increase their spending if they think government will in future withdraw that money, because consumers will allegedly need their increased stock of money to pay the taxes that make possible the withdrawal.

However, the idea that the average household thinks in that manner is just a joke.  As Joseph Stiglitz put it, "Ricardian equivalence is taught in every graduate school in the country. It is also sheer nonsense."

In other words households behave much as you would expect: if they find they have more money in their bank accounts, they’ll spend a significant proportion of it. And indeed the empirical evidence supports that: for example the Bush tax cuts resulted in extra household spending by those whose taxes were cut.

The Vox authors then argue that helicoptering is likely to result in permanent zero interest rates. Specifically they say, “Either helicopter money results in interest rates permanently at zero – an unpalatable outcome to most, including those that advocate monetary financing – or else it is equivalent to either debt or to tax-financed government deficits, in which case it would not yield the desired additional expansionary effects.”

Well the first problem with that idea is that helicoptering will not result in permanent zero rates if the actual amount of helicoptering is relatively low. To take an extreme example, if the Fed did just one dollar’s worth of helicoptering, the effect would pretty obviously be negligible. Same goes for a million dollars worth.

However, if the amount of helicoptering was such that zero interest yielding base money replaced all government debt permanently, then that would of course constitute a permanent zero rate policy. But what’s so “unpalatable” about that?

A permanent zero rate was not regarded as “unpalatable” to Milton Friedman and Warren Mosler (founder of Modern Monetary Theory). Those two individuals specifically argued for permanent zero rates.

Admittedly there seems to be a problem with zero rates, which is that it makes interest rate cuts in the event of a recession difficult. There is of course the option of negative rates, but the latter are widely regarded as problematic.

However, dealing with recessions and excess inflation via interest rate adjustments is decidedly illogical and for the following reason. Given a recession (i.e. inadequate demand), whence the assumption that the recession must to down to inadequate borrowing, lending and investment and hence that interest rate cuts are called for? The recession may equally well be caused by a decline in one of the other constituents of aggregate demand, e.g. a fall in general consumer confidence or exports.

Moreover, the basic purpose of the economy is to produce what people want (both the items they normally purchase out of disposable income and the stuff they vote to have government supply to them in the form of public spending). Thus given inadequate production, the obvious or logical solution is to give household more of the stuff that enables them to buy goods and serves, and that stuff is called “money”. And the other obvious solution is to increase public spending. Both those two can be done via helicoptering.

To summarise, contrary to suggestions by Kaminska and the Vox authors, printing money and handing it out or spending it does actually have an effect (gasps of amazement). The initial effect is a rise in demand, and if too much printing is done (e.g. a la Robert Mugabe) the effect is excess inflation (more gasps of amazement). Moreover, if helicoptering goes far enough it can result in permanent zero interest rates but there is nothing obviously wrong with that.

Random charts 29.

Large text in pink on one of the charts below was added by me.

Positive Money at Durham Miners' Gala.

First picture taken during the speeches by Jeremy Corbyn and other speakers: crowds listening are in the background.

Numbers listening according to my estimate was between 5,000 and 15,000.

Second picture taken earlier in the day from the other direction, i.e. from where the crowds were during speeches. 

Richard Murphy, the national debt and MMT.

Richard Murphy recently wrote an article entitled “Why we need more national debt”. It’s a good article. My main complaint is that few of his ideas are original, but he should be congratulated for repeating them, because they need repeating. I’ll summarise the article below and list a few of the people who have expressed the same ideas before.

His first two large paragraphs (starting “First some facts..”), say there is no essential difference between national debt and money (base money to be exact). Warren Mosler (founder of MMT) made that point a good ten years ago. And I’ve repeated the point ad nausiam on this blog over the years. Plus Martin Wolf (chief economics commentator at the Financial Times) made that point a couple of years ago.

MMTers sometimes refer to the sum of debt and base as “Private Sector Net Financial Assets” (PSNFA). I’ll use that phrase below.

Murphy then makes five numbered points. The first is that inflation whittles away the value of PSNFA, thus on the not unreasonable assumption that the value of PSNFA needs to be maintained (especially relative to GDP), then the stock needs to be topped up. And that can only be done via a deficit.

I’ve been making that point for YEARS. Richard Murphy is one of the very few people on planet Earth I’ve come across who gets that point as well. Simon Wren-Lewis (Oxford economics prof) is another. And I do spend several hours a day reading what economists are saying. Though obviously I can’t cover everything. So congratulations to Richard Murphy for that.


Pensioners.

His second claim is that pension funds need safe assets to invest in, and PSNFA fulfills that role. Actually if pension funds do not have assets to invest in, they can always go for the “pay as you go” option. That’s how most state pension systems work: i.e. there are no pension fund investments because today’s fund contributors pay for today’s pensions.

But to the extent that pension funds don’t want to or can’t do that, their demand for PSNFA is clearly part of the overall demand for PSNFA.

His third point is that demand for safe assets (to over-simplify a bit) also comes from non-bank firms: clearly also true.

His fourth point is that if the nominal rate of interest on government debt is low enough and inflation is high enough, then the REAL rate of interest is negative: i.e. the creditor subsidizes the borrower (government). Again, that’s a point I’ve made at least a dozen times on this blog.

His fifth point is that interest on the debt is not a huge problem in that it gets recycled into the economy: e.g. interest is paid to pension funds. Well that’s pretty obvious, but that point fails to address an elephant in the room, namely the question as to what the OPTIMUM rate of interest on the debt is. As MMTers often point out, a country which issues its own currency can pay any rate of interest it likes on its debt.

Milton Friedman and Warren Mosler advocated a zero rate. I.e. the said in effect that PSNFA should consist entirely of base money. I think that’s right, or at least nearly right. Possibly a very low rate of interest should be paid (something between zero and the rate of inflation, as rather suggested by Murphy). A merit of that is the debt, i.e. bonds, are not as liquid as cash. Thus in the event of the private sector going mad and trying to spend the whole stock of PSNFA at once and causing hyperinflation, the inflation would be muted somewhat.

Murphy’s final point is to criticize the idea that the debt needs to be repaid. Correct: in practice the debt (as a proportion of GDP) normally gets whittled away by a combination of inflation and rising real GDP. Also a point I’ve made over and over on this blog.


Conclusion.

A final criticism is that Murphy’s article could be taken to be suggesting a LARGE rise in the debt (or to be more accurate, in PSNFA). Given that (as pointed out by Warren Mosler) the interest on the debt tends to rise with a rise in the size of the debt itself, and given that interest on the debt is currently within the bounds suggested by Murphy himself (i.e. between zero and the rate of inflation),  it is not obvious why we need a HUGE increase in the debt.

A GRADUAL rise to take account of inflation and real growth is fine by me, but there is no argument for a LARGE rise.

To summarize, I’m awarding nine out of ten to Richard Murphy, though none of his points are original. MMTers like me have been making the above points for a long time. In short, if you’re a member of the 1% of the population interested in original ideas, keep  an eye on what MMTers are saying and on this blog – untill I become so old and confused that I can’t think, which may be quite soon…:-)

Random charts. 28.

Text in pink on these charts was added by me.