Article by Megan Green on CBDC in the Financial Times.

 

Title of the article is “Central banks need to go slow on digital currencies”. 

FT articles are normally behind a paywall, but this one does not seem to be: at least I looked it up on a computer which does not have a subscription to the FT, and I could see the entire article.

Anyway, an important argument for “going slow” she doesn't mention is that the ACTUAL ADMINISTRATION of accounts which are 100% backed by reserves can perfectly well be farmed out to private / commercial banks. Indeed advocates of full reserve banking have been advocating the latter for DECADES.

Under full reserve (aka “100% reserves” aka “narrow banking”) depositors have a choice between two types of account. First, as just mentioned, accounts which are 100% backed by reserves, and second, accounts which are not. The former are of course totally safe, whereas if anything goes wrong with the latter, there is no help available from taxpayers, e.g. in the form of deposit insurance or bank bail outs. The latter accounts pay a higher rate of interest to reflect the additional risk.

Of course the SPEED at which money is transferred via “farmed out” accounts might be slower than under genuine CBDC accounts, but the speed offered by traditional high street banks is good enough for a large majority of account holders. Have you ever had cause to complain about the speed at which commercial banks transfer money via debit cards? I haven't.

Examples of advocates of full reserve who also advocate the farmed out arrangement include Milton Friedman. See Ch3 of his book “A Program for Monetary Stability” (published in 1960) under the heading “How 100% reserves would work”. See also “Towards a twenty first century banking and monetary system”, p.7. See also the book “Modernising Money” by Ben Dyson (founder of Positive Money).

The big advantage of farming out is of course that commercial banks already have the staff and expertise needed to deal with millions of accounts held by households and small firms. Central banks do not.

Less intermediation.

Next, Megan Greene says, “With CBDCs, businesses and individuals could hold accounts directly with the central bank. While that could provide efficiency, it would end the role of banks in financial intermediation.”

The phrase “financial intermediation” is a bit vague, but presumably she means CBDC reduces the extent to which bank loans are funded via deposits: i.e. it it cuts down on that PARTICULAR FORM of “financial intermediation”. In contrast it does not cut down on loans funded via equity, which is what many mutual funds do – some of which are incidentally run by banks.

She then says in relation to the latter decline in lending that “Fewer loans would be made, a drag on overall growth. To make up for the lost fees, banks might charge more for payment services and accounts.”

She makes a mistake there that dozens of others have made. It is obvious that less lending means less demand and less growth ALL ELSE EQUAL. But there is a very simple and zero cost solution to that, which is to implement more stimulus. As Milton Friedman said, it costs nothing in real terms to create more money and spend it into the economy, something that central banks and governments have done on an unprecedented scale since the 2008 bank crisis.

So the net effect of less intermediation combined with more stimulus would be GDP remaining about the same, but with less debt based economic activity and more non-debt based activity. Given the weeping and wailing that comes from the great and the good about the allegedly excessive amount of private debt, it is no clear why that would be particularly bad outcome.

Moreover, it is PRECISELY funding loans via deposits (I.e fractional reserve banking) which has been responsible for hundreds of bank failures thru history and for the 2008 bank crisis, which had catastrophic economic consequences. Thus her idea that disposing of the “deposits fund loans” system would be a “drag on growth” is a joke.

In other words, Megan Green's idea that funding loans via deposits promotes growth is true AS LONG AS IT WORKS. But inevitably at some point it won't work, at which point the whole “funding loans via deposits” idea comes crashing down.

 

Running to safety.

Next, she says “Since CBDCs are backed by the central bank, they are safer. In a crisis, that might lead to a run on banks as customers switch out of cash.”

Well the first bit of evidence that that would not happen is that personal accounts at high street banks are ALREADY PROTECTED by deposit insurance. There is of course a limit to that deposit insurance cover: it's €100,000 in the EU. But a wild guess that's sufficient for 99% of households.

Secondly, in the UK (and doubtless some other countries) people have actually been free FOR DECADES to open accounts with state run savings banks. In the UK there is “National Savings and Investments”.

NSI certainly does not offer the speed and flexibility of CBDC or of a traditional high street bank. But for anyone who wants to flee to safety, NSI would be ideal. But there was no large scale dash for NSI during the 2008 crisis.

And of course there is no reason to be inconvenienced by the latter lack of flexibility of NSI: to gain the advantages NSI for the bulk of your money, while retaining the flexibility you need for day to day transactions, all you need do is keep enough for day to day transactions in a traditional high street bank account, while placing the rest with NSI.

Another attraction of the NSI is that those with accounts there are not limited to the UK £80,000 deposit insurance limit: they can deposit up to £1million in complete safety.

The Financial Times gets to grips with MMT.

 
 

Seems the Financial Times has now got to grips with MMT, i.e. the idea that given any sort of recession, government and central bank should simply create money and spend it up to the point where inflation looms. Plus the actual amount of money printed (or, pretty much the same thing, the resulting increase in the national debt) is irrelevant.

My only criticism of that FT article (written by the “editorial board” of the FT) is the popular claim (para starting "Recent QE programs...") that it is hard to unwind QE and revert to the higher interest rates that prevailed prior to the 2007 bank crisis. Actually the latter is easy to do: just raise the deficit to a level higher than it need be and counter the resultant excess increase in demand with higher interest rates. I look forward to the economics profession tumbling to that one.

But the MMT response to the latter idea is that the optimum rate of interest on government debt is zero. Milton Friedman thought likewise – see his para starting “Under the proposal…” in his American Economic Review article ("A Monetary and Fiscal Framework...")

So on that basis, it would not even be a good idea to return to the pre 2007 set up. At least that's certainly the correct conclusion assuming all government spending is CURRENT rather than CAPITAL spending.

It is of course often claimed that governments should borrow to fund capital spending, but Friedman didn’t seem to go along with that idea, and I criticised the idea yesterday on this blog.

Incidentally my above claim that government debt is pretty much the same as simple straightforward cash needs qualifying. Certainly SHORT TERM government debt which pays a near zero rate of interest is very close to cash. In contrast, longer term debt which pays significantly above zero is not the same, and I do not favour a deficit which is so large that government and central bank then have to counter the resultant excess demand by artificially raising interest rates to an excessive extent.

_________

P.S. 26th Aug 2021.  On second thoughts, my above claim that it is easy  to revert to the higher interst rates that existed prior to QE would be easy, is not too clever. At least that would be difficult for an INDIVIDUAL country to do since all sorts of problems would arise from its intereset rates being out of line with that of other countries. In contrast, if every country or at least a majority of large countries went for that higher interest rate policy, that would be more manageable.

Government should not borrow to fund capital spending.

 
 

 

The idea that government should borrow to fund capital spending, like a bridge, is a popular one. After all, households and private sector employers often borrow to fund such spending, so it might seem that government should do likewise.

However, one weakness in the latter argument is that private sector entities DO NOT always borrow to fund capital spending. For example if you want a new car and happen to have enough cash to pay for it, why borrow?

So borrowing, it would seem, only makes sense if you’re short of cash. But governments ARE NEVER short of cash in the sense that they can grab near limitless amounts of cash from taxpayers any time, plus they (along with their central banks) can print and spend a certain amount of money most years.

As for how much government SHOULD CHARGE those who use government funded capital projects, like a bridge, there is no question but that the charge should be enough to pay for whatever interest a private contractor would have had to pay to build the bridge or whatever the item of capital investment is.

Of course sometimes it is not feasible to charge those using a particular publically owned investment in the same way as people are sometimes charged at toll bridges. But in that case, the amount that a private contractor would have had to pay by way of interest should still be taken into account when deciding what bridges or other items of public investment are worthwhile and which are not.

To summarise, in the ideal world, the amount people are charged for using publically owned assets should not be influenced by whether those assets were originally funded via tax or government borrowing: i.e. they should be charged an amount that covers interest REGARDLESS of whether interest was actually paid or not.

And that in turn means that if government DOES TRY to borrow to fund capital projects, the only net effect is to enable the cash rich to lend to the less well off. But the rich can lend to the less well-off anytime ANYWAY!!! So what’s the point of government facilitating or encouraging the latter process, i.e. encouraging the less well-off to go into debt?

All government is doing there is in effect acting as a banker – a banker which is artificially powerful in the sense that government bonds are artificially secure because government has the right to grab near limitless amounts of money from taxpayers anytime if any government funded projects go wrong. Normal private sector bankers do not enjoy that luxury.

 

Conclusion.

My provisional conclusion is that government should not borrow to fund capital spending, though others may well spot a flaw in the above argument.!!

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The market won’t deal with global warming? You don’t say!

 

Can you spew out a torrent of sophisticated sounding words which boil down to statements of the blitheringly obvious? Then you’d do well as a journalist.

One of the central points in this long article in the Financial Times entitled “Kim Stanley Robinson: a climate plan for a world in flames” is the above alleged “insight”, namely that the market won’t deal with global warming – see section entitled “And don’t think that the market.”

Well I have news. Economists are famous for disagreeing with each other, but if there’s one thing they agree on, it’s that free markets do not deal well with what are called “externalities”, i.e. the temptation for firms in a free market to load costs onto the community at large. A factory which pours pollutants into a river is a classic example. So Robinson’s “insight” is actually no insight at all.

But with a view to trying to making his non-insight look super  sophisticated (remember that’s important if you’re to get your article published), Robinson says “That whole notion of rule by market was a catastrophic example of monocausotaxophilia, “the love of single causes that explain everything”, Ernst Pöppel’s joke neologism for a tendency very common in all of us.”

Well there’s a teensy flaw in Robinson’s mockery of “monocausotaxophilia”, namely that science actually attaches HUGE IMPORTANCE to monocausotaxophilia. Why were Einstein’s theory of relativity or Newton’s laws of motion held to be important? Reason (much to the disappointment of Robinson) is that those laws were SIMPLE explanations for a LARGE VARIETY of different phenomenon.!!!

Looks like Robinson is talking thru his rear end, at least on the subject of monocausotaxophilia.

Incidentally Ann Pettifor seems to be impressed by Robinson’s take on monocausotaxophilia. But no big surprise there: as regular readers of this blog will know, I don’t have a high opinion of Ann Pettifor, though she is of course brilliant at appearing plausible.

Do-gooders push for central banks to cut loans to polluters.

 

 

I’m all for dealing with carbon dioxide emissions in realistic as opposed to totally unrealistic ways. E.g. I’m all for subsidising wind turbines and solar power generation, plus high taxes on fossil fuels are a good idea.

Unfortunately it has become fashionable in think tank circles over the last year or two to push for central banks to limit lending to polluters, like coal mines. The logic or should I say “false logic” is all too appealing. It seems to go something like “central banks are powerful institutions, and something needs to be done about global warming, ergo central banks would be able to do plenty about global warming.”

The big flaw in that argument is that if a corporation is prevented from borrowing money to fund itself, it can easily fund itself via equity.  And indeed, the debt/equity ratios of different corporations are all over the place, which indicates there is not much difference between the cost of funding via borrowing and via equity.

For example, Google is funded almost entirely by equity: i.e. it borrows very little. If the do-gooders’ idea that curbing borrowing to corporations that pollute was valid, Google would be a disastrous flop. Far as I know Google has done extremely well ever since the day it was founded.

Tim Worstall on fractional reserve banking.

 

Tim is a productive individual: he writes one article PER DAY, (Saturdays and Sundays included) for the Adam Smith Institute, which I invariably look at, though don’t necessarily read right thru.

I just stumbled across a Forbes article of his from around ten years ago entitled “What caused the great financial crash.”

He rightly says that the big weakness in fractional reserve is the fact that it engages in “borrow short and lend long” (BSLL) which is risky. But he then makes the common mistake of claiming that to abandon BSLL would cut growth, and quotes Adam Smith in support of that view.

The mistake there is that Adam Smith lived in the days before we had a flexible monetary base: i.e. the money creation that results from BSLL certainly did assist growth in Adam Smith’s day. But we now have a flexible base, i.e. government and central bank can create whatever amount of money they need to bring about the desired amount of stimulus. Ergo, as I explain here, there is no need to run the risk that is inherent to BSLL.

QED.

Richard Murphy claims the multiplier matters.

 
He makes that claim in an article entitled “The multiplier shows that not all government spending is equal.”

I normally agree with Murphy, particularly since he started backing MMT. But his ideas on the multiplier leave room for improvement.

One of his main points seems to be that if government raises spending by £Xpa, and if the multiplier is large enough, then the increased economic activity will raise tax paid to government by roughly £Xpa, in which case that extra government spending may pay for itself, which is allegedly a plus. Incidentally that's a point to which Ann Pettifor has attached importance in some of her articles.

But suppose the multiplier is relatively small, and extra public spending DOES NOT pay for itself in the above sense. Why would that matter? All government and central bank need do is create and spend more base money so as to raise demand by the required amount. And creating base money (i.e. central bank issued money) costs nothing in real terms as Milton Friedman pointed out.  

As I explained in a Ralphonomics article entitled “The multiplier is totally irrelevant” over ten years ago, the multiplier, contrary to Richard Murphy’s claims, is irrelevant, at least as far as the above "pay for itself" point is concerned.