Tuesday, 26 February 2013

Free banking versus full reserve banking.

Free banking is a system under which central banks play a minimal role or don’t exist, and under which anyone can set up a bank and issue their own bank notes.
For the great and the good, particularly those on the political left, that’s anathema. They’ll claim the state (i.e. the great and good) knows best, and should regulate banks. That’s “great and good” as in “we lot who have made a complete mess of regulating banks over the last ten years and brought you the credit crunch, the subsequent austerity, etc”.
Moreover as George Selgin and other free banking advocates have shown, the historical record of free banking is good: it involved relatively little inflation and few bank failures, credit crunches, etc.
However, there is a crucial weakness in free banking, namely that the occasional bank failure DID OCCUR in free banking regimes, and the political reality is that the population nowadays just wont stand for ordinary depositors losing their money in the event of a bank failure. From which it looks like state sponsored deposit insurance is here to stay. 
But therein lie problems, as follows.
1. State sponsored deposit insurance for free banking is almost a contradiction in terms: i.e. the whole idea of free banking is that the state plays no role in banking. As this advocate of free banking put it, “Government deposit insurance does not fit into a free banking system.”
So free bankers and full reserve bankers agree that state sponsored insurance is unacceptable.
2. State sponsored deposit insurance is a subsidy of banking. (Granted there does not need to be any subsidy element in the case of insurance for SMALL BANKS (as is the case with FDIC). But in the case of SYSTEMIC FAILURE, and larger banks, only the state can do a rescue, and that equals a too big to fail subsidy.) And a state funded TBTF subsidy contradicts the basic idea behind free banking.
3. State sponsored or not, deposit insurance is pretty much a nonsense anyway. Reason is thus.
There is a big range of different ways of saving (e.g. investing in a property to let, investing in the stock exchange – which itself offers a huge range of different investments all with varying levels of risk, etc, etc.)  Now what’s the point of going for a risky investment and then insuring against the risk? That makes no sense – unless of course you’ve spotted some mug who charges an artificially low premium.
And that’s very much what is involved in state sponsored risk insurance! That is, if your risky investment goes wrong the taxpayer coughs up. (At least that’s the case with systemic failure rather than the failure of a small bank.) What more can you ask for? Heads I win, tails the taxpayer loses. You’d have to be stupid to turn down an offer like that. But of course that arrangement is not in the interests of the country as a whole.
So clearly the latter “deposit insurance / subsidy” nonsense needs removing. And there is a simple way of doing it: full reserve. 

Full reserve.
Under full reserve, depositors who want 100% safety can have it, but no risks are taken with their money. In contrast, those who want their money invested carry the risk.
And that very much answers one of the main criticisms of central banks made by free bankers, namely that central banks are the CAUSE of banking problems, moral hazard in particular. E.g. see paragraph headed “What about deposit insurance” here.
So free bankers ought to welcome full reserve banking in that under full reserve, taxpayer exposure is minimal.

Should commercial banks do stimulus?
The only remaining significant different between full reserve and free banking is that under full reserve, the commercial bank SYSTEM cannot expand the aggregate amount of money: only the state and central bank can do that.
In effect, commercial banks cannot do stimulus under full reserve (or at least one form of stimulus). Now given that everyone looks to government and central bank to do stimulus when needed, why let commercial banks do it as well? That’s duplication of effort.
Moreover, the commercial bank system is just brilliant at effecting stimulus just when it’s NOT NEEDED: that is commercial banks lend MORE during an asset price bubble and exacerbate the bubble. (E.g. see chart here showing the rapid expansion in the UK of commercial bank money/loans relative to the monetary base in the three years before the crisis.)

Thus barring commercial banks from effecting stimulus (a la full reserve) is a thoroughly good idea.

Full reserve banking beats free banking.

Monday, 25 February 2013


The credit rating agency Moody’s (viewed with derision by the Chinese government and ignored by Warren Buffet) has just downgraded UK government debt.
Well the markets don’t seem to agree with Moodys. At least the UK’s creditors get less of a reward in real terms for each dollar of UK debt than they do for other major countries. By “real terms” I mean the real or “inflation adjusted” rate of interest.
In fact taking the yield figures from this Financial Times site, and inflation figures from here, the inflation adjusted yields on the debt of Germany, UK, US and Japan are -0.2%, -0.55, +0.4% and +0.6% respectively.
In other words creditors are prepared to take a lower yield for the privilege of holding UK debt than holding the debt of other countries.  Or to put that more crudely, the UK is ripping its creditors off more ruthlessly than other major countries (if you count this God forsaken, rain soaked island where I live as a “major country”).
Britannia waves the rules.
The above is however a very crude back of the envelope calculation. Errors and omissions expected.

Sunday, 24 February 2013

Helicoptering does not damage central bank independence.

Stephen Grenville, visiting fellow at the Lowy Institute for International Policy, gives us the benefit of his views on Adair Turner type overt monetary funding of deficits. That’s in this Vox article. (h/t to MikeNorman).
It would have been nice if Grenville had studied the literature on this subject before giving us the questionable benefit of his views.

Turner would damage central bank independence?
One of his concluding claims is that the above policy might, as he puts it, “damage central bank independence”. Well, amazing as this might seem, advocates of a Turner type policy (who have actually been at it long before Turner adopted / copied their idea) are well aware of the latter potential problem.
That is, a Turner type policy involves a merge of fiscal and monetary policy (as pointed out by Mervyn King here). And given that governments traditionally do fiscal, while central banks do monetary policy, a Turner type policy runs the obvious risk of giving politicians access to the printing press, and secondly, (a point missed by Grenville) the risk of central banks interfering with political decisions.
Well now, there is a simple way of avoiding the two latter risks. As pointed out in this work, it’s to have decisions on STIMULUS taken by some sort of independent committee of economists (in fact EXISTING committees like the Bank of England Monetary Policy Committee would do). While in contrast, STRICTLY POLITICAL DECISIONS, like what proportion of GDP to allocate to public spending, and how that spending is allocated, are taken (as they already are) by the electorate and politicians.
In fact central banks ALREADY HAVE the last word on stimulus, in that if a government goes what a central bank regards as too much fiscal boost, the central bank just negates that boost via an interest rate increase
All in all, to avoid the risk to central bank independence to which Grenville refers, requires a VERY SMALL change to what committees like the Bank of England Monetary Policy Committee already do.

Distorting bank balance sheets.
Grenville’s second concluding claim is that a Turner type policy would distort commercial bank balance sheets in that it would allegedly force them to hold more reserves than they otherwise would. That claim is actually nonsense because it confuses what might be called banks’ NET HOLDING of reserves (or “monetary base”) with their GROSS holdings. I’ll explain.
The large majority of government debt is not held by banks. In the US and UK banks only hold 2 and 10% of government debt respectively. That’s according to Credit Writedowns.
So if a Turner policy is introduced, no doubt the private sector as a whole ends up holding more monetary base. But the vast majority of those “holders” are private sector non-bank entities.
Of course those entities lodge their monetary base holdings at commercial banks who in turn deposit same at the central bank. But commercial banks are simply acting as go-betweens or AGENTS. That is, a Turner policy does needn’t result in commercial banks NET HOLDING of monetary base increasing. I.e. while the amount of monetary base owed by central banks to commercial banks does rise, the amount owed by commercial banks to their customers ALSO RISES.
Moreover, commercial banks are free to use their stock of monetary base to buy government debt or any other asset anytime. Thus Grenville’s idea that some sort of balance sheet distortion is forced on commercial banks doesn’t stand inspection.

Fifteen love to Turner and other advocates of merging fiscal and monetary policy. I look forward to more attempts at ace serves coming from opponents of that policy.

Friday, 22 February 2013

Labour to give taxpayers’ money to Labour voters.

“People who lose their jobs after many years of work would receive higher benefits than those who have not held down a career under proposals being drawn up by Labour.” So says the opening paragraph of a report on p.2 of today’s Financial Times (1).
I could have phrased that a bit better and as follows.
People who have spent years holding the country to ransom with a view to obtaining unwarranted job security in the unionised, Labour supporting public sector will be additionally rewarded by Labour with higher benefits. In contrast, those who have performed the invaluable public service of making up for the above labour market inflexibility by getting a series of short term jobs will be penalised.
The stench arising from that proposal almost equals the stench arising from the money laundering carried out by Labour prior to the last general election: they gave about £20m to various trade unions allegedly for “training”. And those same unions by a remarkable coincidence then gave about £10m to the Labour Party.
And the stench from that about equals the stench arising from bankster contributions to the Tory Party.
1. Article entitled “Labour looks at help for ‘strivers’.

Wednesday, 20 February 2013

Countering the job destroying effect of minimum wages.

The U.S. minimum wage is rising from $7.25/hr to $9. The obvious advantage is improved income for low skill employees who keep their jobs, and the obvious disadvantage is increased unemployment amongst the low skilled.
There is actually an escape from that dilemma. It’s to let employers pay any wage they like, even $1/hr (with the state making up the wage to the minimum acceptable take home pay). But where the wage is below some threshold, (say $9/hr), the state has the right to nab the employee and allocate him/her to a job where the relevant employer is prepared to pay more, or where state employment agencies think the skills of the employee would be better used.
The nuisance involved in having reasonably productive employees nabbed would induce employers to pay those employees the min wage or more. I.e. it’s only the genuinely unproductive employees who would get subsidised.

One advantage of the above system that is that there are an almost infinite number of potential jobs if you count an activity with an output of $1/hr or less as a “job”. Thus the latter system has the potential to bring about a HUGE REDUCTION in unemployment.
Second, the better availability of jobs makes it easier to impose some sort of workfare sanction on the unemployed. That is, if there is a dire shortage of jobs, it’s a bit difficult to say to a member of the dole queue “get yourself a job within a month, else your unemployment benefit stops”. In contrast, if there are ten million $1/hr jobs to choose from, it’s relatively easy to impose the latter sanction. And that in turn means a significant number of the unemployed, instead of doing $1-9/hr jobs, or remaining unemployed, would get themselves normal / regular / unsubsidised jobs.

As to disadvantages, an obvious one is the bureaucratic expense of having state employment agencies allocate labour.
Second, if the system was run in any sort of a lax way, it would encourage unproductive work.
Third, labour turnover would increase. On the other hand there is no harm in those who temporarily cannot find a job to which they are well suited trying a variety of different jobs: the very fact of their being unemployed may be evidence that their previous type of employment is obsolete or demand for the relevant skills has declined, and thus that they are going to HAVE TO try something different. And the latter point applies particularly to youths: it’s a good idea for youths to try a variety of different types of work so as to see which type suits them.
Plenty of millionaires started their working lives with a series of dead end jobs.