Saturday, 31 January 2015

Weeping and wailing over Greek austerity.

I’m getting tired of people who weep and wail about austerity in Greece – unless the weepers and wailers have some nice simple solution to the problem, in which case I’m all ears.

The popular chant “austerity doesn’t work” is fatuous. That chant doesn’t begin to solve the basic problem.

For the benefit of the uninitiated, the basic problem is as follows, and it’s quite simple. If you just stop weeping and wailing for a minute, it’s easy enough to grasp.

If a country in a common currency area becomes uncompetitive, it’s external balance of trade deteriorates and it runs into debt. For a country with its own currency, that problem is solved by devaluing its currency. E.g. the UK’s currency fell 25% in value in 2008, and no one I know personally even noticed.

In contrast, for a country WITHOUT its own currency the only real option is to cut wages and profits in money terms. That’s called “internal devaluation” and it comes to the same thing as the above “regular” devaluation. And just like regular devaluation, there isn't a big effect on living standards in the relevant country in that the above mentioned wages and profits are themselves a big constituent in the cost of goods and services consumed in the relevant country.

Unfortunately the only really effective way of cutting those wages and profits is to cut aggregate demand in the relevant country: i.e. have a period of deficient demand, and that means excess unemployment – possibly lasting for many years.

And that is a HUGE DEFECT in common currencies. That’s the basic problem.

Moreover, there is no absolute guarantee that regular devaluation or internal devaluation will work. If the elasticity of supply and demand for a country’s exports and imports are sufficiently low, neither form of devaluation will work. Indeed Wynne Godley claimed that that was the case for the UK about twenty years ago. And if neither form of devaluation works, the only remaining solution is mass emigration from the relevant country, and that to a significant extent has been the solution for Greece for many decades. And if emigration goes on for long enough, obviously the country just becomes an area that specialises in “extensive agriculture”: that is (like agriculturally unproductive areas of Australia) where large amounts of land are used in combination with few other in puts like labour or machinery or fertiliser.


Debt jubilees.

A popular alleged solution for Greece is debt forgiveness or a debt jubilee. Unfortunately that simply kicks the can down the road. It completely fails to deal with the above competitiveness problem.


Other solutions.

In contrast to the above fatuous non-solutions, one possibly realistic solution recently suggested by Simon Wren-Lewis (Oxford professor of economics) is to organise a MODERATE increase in unemployment in uncompetitive countries, rather than the sort of catastrophic levels of unemployment we currently see in Greece. As Wren-Lewis points out, it is possible that the fall in wages, profits and prices in the problem country would be almost as fast as where the unemployment level is in the “catastrophic” range.

But the disadvantage there is that an increase in demand is involved which means the country draws in more imports which means it goes further into debt .


My proposed solution.
Another solution which I suggested long ago is as follows.

As pointed out above, regular devaluation can take place overnight, whereas internal devaluation involves years of pain. However, IN THEORY it would be possible to organise a more or less overnight internal devaluation. One would have to get almost everyone in the relevant country (wage earners, entrepreneurs, pensioners, etc) to agree the same percentage cut in pay.

In a country with a high degree of social cohesion, a country where everyone trusted everyone else, a country where everyone behaved responsibly, that would work. But unfortunately that’s not Greece. Greece is more in the nature of a country where everyone tries to cheat everyone else. E.g. the scale of tax avoidance by the elite as well as by doctors, lawyers and taxi drives exceeds by a big margin the tax avoidance that takes place in other countries.

Friday, 30 January 2015

Bank so called liquidity.

The Basel regulators are trying to raise the amount of liquid assets that banks hold, and one of the assets that is allegedly liquid for these purposes are mortgage backed securities (MBSs). See 2nd last para here. Are you laughing yet?

If not, remember it was those MBSs that played a big role in sparking off the crisis. This Basel “solution” to bank problems is a bit like trying to cure a alcoholic by giving him crates of whiskey.

Of course there will be worthy sounding rules and hoops that MBSs will have to jump through before they qualify for the above role. But then the dodgy MBSs that sparked off the crises were deemed OK by credit rating agencies.

I might be wrong, but this sounds like just one more of the impressively complex new rules that banks have to obey which boil down to nothing.

Thursday, 29 January 2015

OMG. Mark Carney advocates fiscal union for the EZ.

Mark Carney (governor of the Bank of England) advocated fiscal union for the Eurozone (EZ) in this recent speech. As he put  it, “Europe’s leaders do not currently foresee fiscal union as part of monetary union. Such timidity has costs.”

The basic flaw in fiscal union is thus. If the people in any geographical area see themselves as being one and the same people (culturally and in other ways) then fiscal union will follow almost automatically. In contrast, if the above cultural etc union is not there, then passing laws designed to bring fiscal union just won’t work.

To illustrate, if German taxpayers saw Greeks as fellow Germans who had had a spot of bad luck, then there’d be few problems extracting taxes from Germans to support “Greek Germans” in southern Europe, EVEN IF there was no formal fiscal union. Indeed, at the time of German reunification, West Germans saw East Germans as Germans and (apart from a few grumbles) were prepared to dish out billions to help East Germany.

And for an illustration of how fiscal union doesn’t work even where two peoples are VERY CLOSE culturally etc, look at Scotland. Around half the Scottish nation doesn't want fiscal union with the rest of the UK. And that’s despite sharing the same language, race and religion. And despite having enjoyed fiscal union for over two centuries and despite having fought side by side in two world wars.

Moreover, even if German generosity towards Euro periphery countries were to increase significantly and EZ fiscal union was implemented, a decline in competitiveness in one or more periphery countries cannot go on for ever. To illustrate with an extreme example, fiscal union does not mean that people in uncompetitive areas / countries will get away with doing one hour’s work a week and expect to get the same wage as people in competitive areas / countries.

If lack of competitiveness is just a TEMPORARY phenomenon in every EZ country, then fiscal transfers will help deal with periods of uncompetitiveness in any given country. But if the tendency to corruption and awarding everyone unearned pay increases  is a PERMANENT feature in periphery countries (and that seems to be case in Greece) then fiscal union won’t spare them much pain in the long run.

Wednesday, 28 January 2015

Keynes versus market monetarism.

Keynes said that in a recession, government should borrow or print money and use that money to expand public and/or private spending. (See 2nd half of 5th para here.)

Market monetarism (MM) says that in a recession, government should print money and buy private sector assets. So which is right?

Both K and MM expand the private sector’s stock of cash and/or bonds, which will induce the private sector to spend more. So to that extent there’s no difference between the two.

However, MM raises the price of assets relative to the price of “current consumption” items, which is a problem. That is, on the not unreasonable assumption that the latter ratio was optimum just prior to a recession, then on implementing MM, the ratio will no longer be optimum.

And there is a second “ratio problem” with MM, as follows.

Assuming there’s an optimum allocation of assets as between public and private sectors (again, a not unreasonable assumption) at the start of a recession, MM will disturb that optimum allocation. To illustrate, the effect of MM will be to force a proportion of the population who would like to own their own homes to rent from the state instead.

Conclusion: Keynes beats market monetarism. 


Incidental postscript.

As pointed out above, K seemed to be indifferent as between the borrow / bonds option and the print / cash option. Personally I can’t for the life of me see the point of the state borrowing money when it can print the stuff. But that’s a separate issue to the above K versus MM argument, which is why I’ve put my “personal views” here in a postscript.

Another incidental thought. I suspect K was in private equally dismissive of the borrow / bonds option. And I suspect the REASON he kept very quiet about that in public was that he knew he was surrounded (as we are today) by econonomic illiterates who chant “inflation” every time the words “money” and “print” appear in the same sentence.

Tuesday, 27 January 2015

Privately created money involves fraud and theft.

Private banks create money when they lend, as pointed out in this recent Bank of England work. That point was actually being made decades ago in some economics text books, e.g. R.G.Lipsey’s “Principles of Economics”.

To be more accurate, if loans are being REPAID to a bank at the same rate as new loans are granted, the bank does not on balance create money. On the other hand, the TOTAL STOCK of private bank created money tends to rise, year after year, so as distinct from the latter “repayments equals new loans” scenario, private banks ARE INTO THE BUSINESS of creating entirely new money in that the total stock of privately created money expands most years.

An alternative and perfectly valid way of looking at this process is to say that money is destroyed when a loan is repaid and created when loans are granted. The difference between those two ways of looking at the process is not important.

Money creation brings benefits.

In favor of private money creation, there is the point that money is useful stuff, ergo creating it brings benefits. And certainly if there were no central bank, then private banks would be performing a useful service in creating money. Indeed, that’s exactly what those proverbial goldsmiths did when they first issued paper receipts for non-existent gold a few hundred years ago.

However, we have central banks nowadays, thus the question arises as to whether money is best produced by 1, private banks, 2, central banks or 3, both types of banks (as is currently the case).


Privately created money involves big risks.

Privately created money has several serious problems. It gives rise to bank runs and credit crunches plus private money creation is a form of fraud and theft. We’ll start with bank runs and credit crunches.

Money is a liability of a bank: in the case of a loan, it’s an entirely artificial debt owed by a bank to a borrower which the bank undertakes to transfer to anyone else when instructed to do so by the borrower using the borrower’s cheque book, debit card or similar. Moreover, the debt is advertised by the bank as being money and a characteristic of money is that it is FIXED IN VALUE (inflation apart).

That is, we expect for example a $100 bill to be worth very nearly $100 in a months time, as distinct from for example shares which can fall or rise dramatically in value in 24 hours.

The net result is as follows. After a borrower has spent what they’ve borrowed and the relevant money has been deposited in some private bank, the private bank system then has a liability that is fixed in value and an asset (the loan the borrower) which can fall in value. That is, some borrowers fail to repay their debt.

The latter scenario (having a liability that is fixed in value and an asset that can fall in value) is clearly risky. That risk works out OK roughly nine years out of ten. But the inescapable reality is that in the tenth year it all goes wrong:  the brute fact is that private banks have gone bust by their hundreds over the centuries.

In short, risk is an inherent characteristic of private money creation. Or as  “Douglas Diamond and Raghuram Rajan say in the abstract of this paper, and in reference to the liquidity / money creation that private banks offer: “We show the bank has to have a fragile capital structure, subject to bank runs, in order to perform these functions.”


Private money creation is fraudulent.

Not only does private money creation involve the near inevitability of 1929 crashes and credit crunches, it can also be argued to be fraudulent. That is, for a bank to promise its creditors they’ll be able to get $X back for every $X deposited when in fact the money concerned has been put at risk is either totally fraudulent or at least semi-fraudulent. It’s little different from borrowing money from a friend, promising to repay it, and then putting the money on a horse or a roulette table. As Martin Wolf, chief economics commentator at the Financial Times put it, “If we were not so familiar with banking, we would surely regard it as fraudulent”.

(Incidentally I’m not arguing that banning private money creation would bring a total end to bouts of irrational exuberance or the opposite, i.e. recessions. But the ban would certainly help.)

Private money creation is theft.

Money printing is profitable, as counterfeitors will attest. And what private banks do is essentially the same, but private bankers wear smart suits, drive smart cars and they take great care to befriend top politicians. That makes bankers immune from prosecution.

To explain why private money creation equals theft, let’s concentrate on the process whereby private banks EXPAND the money supply as distinct from RECYCLING existing money.

When a private bank grants a loan, the borrower spends the money and gets themselves a car or whatever. So as a result of a few book-keeping entries, the borrower manages to acquire a real and valuable assets. Nice work if you can get it! And at the same time, the rest of the community loses a real and valuable asset and in exchange gets some book-keeping entries (or numbers in a computer, which is the form that book-keeping entries take nowadays).

Someone has been diddled, haven’t they?

And do the bank and borrower ever need to repay the loan? Well not if that new money becomes a PERMANENT ADDITION to the money supply. Let’s illustrate that point by reference to paper money as distinct from the above digital or book-keeping money.

Suppose everyone decides they want to carry an additional £10 around with them, the central bank / government would need to create an extra £10 per person, and spend that money into the private sector (in the form of extra spending on roads, law and order, education or whatever).

In a sense then, government “profits” in that it manages to acquire real goods and services (roads etc) in exchange for silly bits of paper which cost next to nothing to print.

But of course we don’t object to that profit because government is owned by the people: put another way, when a new road is built, we all benefit. In contrast, and in the case of a private bank and borrower, it’s the private bank and borrower who make the profit, not the community. Why do we let them get away with it?

Also, note that where a loan brings about a permanent increase in the money supply, the borrower DOES NOT (contrary to popular perception) borrow from the bank. At least no REAL GOODS OR RESOURCES are transferred from the bank to the borrower. Put another way, bank staff do not sweat their guts out making the new car or whatever the borrower acquires.

The only job performed by the bank is an administrative one: e.g. checking up on the value of the collateral supplied by the borrower. Thus the bank, strictly speaking, has no reason to charge interest: it DOES HAVE a reason to charge for the above ADMINISTRATION COSTS, and will almost certainly CALL THAT interest. But it’s not actually interest.

In contrast, in the case of RECYCLING (in the above sense), a private bank obviously gets the money it lends out from somewhere: it gets the money from depositors, bond-holders or shareholders. And the latter three will want interest or some sort of return on their money. And clearly the bank has to pass on that interest to borrowers. So in that case, borrowers pay BOTH the above administration costs and what might be called “genuine interest”.

To summarise, private money creation involves bank runs, credit crunches, fraud and theft! How low can you get?

So is there an alternative way of supplying the economy with the money it needs?  Well yes: have the CENTRAL BANK supply as much money as we need. And money creation is a job that central banks already perform: indeed they’ve been performing that task on a unprecedented scale in recent years in the form of QE.


Banning private money inhibits lending?

There might seem to be a problem in banning private money creation and having the central bank supply our money needs instead, and that’s that as pointed out above, lending by private banks seems to be inextricably tied to money creation. And if that were the case, then obviously banning private money creation would inhibit or bar lending by private banks.

However, as already intimated, it is legitimate to say that no money creation in fact takes place when most loans are granted in that ROUGHLY SPEAKING, loans repaid to a private bank each month equal new loans granted. Put another way, in that private banks just re-cycle EXISTING MONEY, they don’t create new money.

And if all money were CENTRAL BANK CREATED, the granting of loans would not be inhibited in that private banks just engage in the latter recycling process. Put another way, if there were a FIXED STOCK of central bank money, and private bank money were banned, then obviously expanding the money supply would not be possible.

But of course the latter is a total and complete non-problem because central banks and governments can and do expand the stock of central bank created money any time they want. QE is just one method.

Conclusion: privately created money has nothing going for it. It involves fraud and theft. It’s a left-over from those goldsmiths who issued paper receipts for non-existent gold, and made a fortune doing so. Private money creation only continues because of general ignorance about money: in particular the fact that private bankers run rings round economically illiterate regulators and politicians.

Saturday, 24 January 2015

Mark Carney thinks bank capital might be expensive.

At least that’s what Carney (governor of the Bank of England) suggested recently in Davos. According to this article, “Mr. Carney said that making banks maintain even higher levels of equity could increase their costs, and those costs would probably get passed on to the banks’ customers.”  That “expensive capital” story is often spun by commercial banks when trying to avoid better capital ratios, and it looks like Carney may have fallen for it.

So let’s go through this from the beginning. It’s not difficult: in fact it’s desperately simple.

It might seem that bank capital is expensive compared to debt (e.g. bonds or deposits) because the return demanded by shareholders is higher than that demanded by debt holders. Well that difference in return is explained by the very simple fact that shareholders are first in line for a hair-cut when the bank is in trouble. Obviously shareholders want a bigger return!

However, it’s false logic to conclude that if bank capital ratios are increased that the TOTAL return demanded by all bank funders at a particular bank (shareholders, depositors etc) will rise. Reason is that the total risks involved in running a bank are determined SOLELY by the nature of the bank’s assets (its loans and investments). E.g. a bank that specialises in NINJA mortgages obviously runs a bigger risk than one specialising in conventional mortgages.

In contrast, whether those funding the bank are composed mainly of shareholders, bond-holders or depositors HAS ABSOLUTLY NO INFLUENCE on the above “total risk”. Ergo changing the composition of funders (e.g. increasing shares at the expense of bonds or deposits) has no effect on the total return demanded by bank funders.

Indeed, the latter very simple point was the point made by Messers Modigliani and Miller, a point for which helped them get a Nobel Prize.

The messy real world.

Unfortunately in the real world, the Modigliani Miller theory (MM) doesn’t work out quite as simply as the above simple bit of theory suggests. That is, there are host of complexities (half of them unnecessary) that muddy the picture in the real world. And that is music to the ears of banksters and academics in the pay of banksters: those complexities enable them  to churn out thousands of words of waffle which actually boil down to nothing, and which don’t basically rebut the above simple theory. And that, combined with bribes paid to politicians by bankers enables bankers to avoid better capital ratios, often as not.

The tax treatment of debt.

For example, there’s the point that the tax treatment of debt is different to the treatment of shares: interest on debt can be debited to profit and loss accounts. But dividends can’t. Well that “tax” point is wholly irrelevant because tax is an ENTIRELY ARTIFICIAL imposition: it doesn’t reflect underlying economic realities.

But that’s not how some academics see it: they seem to think that because debt is good value for money on account of those tax advantages, that therefor the REAL COST of debt is lower than the REAL COST of capital.

Anat Admati touched on the latter point in a recent tweet:

Admati is professor of economics at Stanford.


Another flawed “bank capital is expensive” argument is thus.

Given inadequate capital ratios of the sort of that prevailed before the crunch, clearly the chance of bank insolvency is too high. And we all know who carries much of the cost stemming from bank insolvency in the case of large banks: the taxpayer.

It follows that as bank capital ratios are raised, significant costs are removed from taxpayers and loaded onto shareholders. So as capital ratios rise, the TOTAL COST of funding banks does rise. But of course that rise is due to the removal of a subsidy: an entirely justifiable removal. MM remains unscathed!

Shadow banks.

Another popular argument against better capital ratios is that the effect will just be to drive business towards the unregulated sector: shadow banks. Well the answer to that is to regulate shadow banks the same was as regular banks are regulated. Or as Adair Turner (former head of the UK’s Financial Services Authority) put it, “If it looks like a bank and quacks like a bank, it has got to be subject to bank-like safeguards..”

Of course it will never be possible to regulate every single shadow bank including the very smallest. But that doesn’t matter. As long as every institution that behaves like a bank and which has a turnover of more than roughly $10m a year is regulated, that cracks the problem.

If someone lends $100 to their next door neighbour, they’re acting as a bank strictly speeking. Clearly it would be absurd to regulate that sort of lending.

Friday, 23 January 2015

Adair Turner criticises labour market flexibility.

I normally agree with Turner, but not with this article of his entitled “Have we become too flexible?”

His basic point (set out essentially in his final four paragraphs) is that labor market flexibility depresses wages, and lower wages is the last thing we need right now, what with inadequate aggregate demand. OK, let’s think about this.

First, let’s assume that when the labor market becomes more flexible, it also becomes more efficient: that is, output per head rises. Obviously there are possible circumstances where the latter does not obtain: for example if the rules governing the labour market were changed to those that govern a slave labor market – i.e. employers could order employees to do absolutely anything on pain of being flogged – then that would improve flexibility. However, a slave labor market would doubtless not bring all round benefits and probably wouldn’t raise output per head.

Now the INITIAL EFFECT of improved flexibility can easily be that employers pay less to employees for a given type of work. E.g. trade unions have often tried to insist that particular types of work be carried out only by fully qualified employees – union members to boot and at the union wage. And if employers can scrub that union imposed rule and employ unskilled employees instead, then the wage paid for the type of work concerned will fall. And it’s doubtless that point that induces Turner to think that more flexibility equals falling wages.

But that’s actually nonsense and for the following reasons. Suppose EVERYONE’S wage (including the “wage” of employers) is halved. Does that mean anyone is worse off? Clearly not: there’s no affect whatever on the REAL WAGE. The fall in money wages is exactly compensated for by a doubling in the value of money. Everyone is back where they started.

And the same point applies to a cut in money wages for a specific group or groups of employees: the net result is a decline in the AVERAGE money wage paid to everyone. But there’s no reason to assume a change in the AVERAGE REAL WAGE.

So, more flexibility improves output per head. And that output will clearly be shared between employers and employees.

Now let’s make the very reasonable assumption that the EXACT WAY that additional output is split between employers and employees does not change just because a group of employers manage to impose greater flexibility. For an example of a “way” in that additional output is split, the labor market might work in some sort of optimal way: i.e. additional output might be split in a way that maximises GDP. Alternatively employers might have some sort of market power and might be able to grab the lion’s share of that increased output.

Whichever of the latter two scenarios obtains, there is no reason to think that WAY additional output is split is going to change just because there’s an improvement in labor market flexibility.

In short, improved labor market flexibility brings increased output (despite the fact that the INITIAL effect can be a drop in money wages for SPECIFIC groups of employees). And that increased output will inevitably be shared somehow or other between employers and employees.

And there’s nothing inherently wrong with that. To repeat, there may be SPECIFIC CASES where employers (or employees) grab more than their fair share of increased output. But that’s a separate point. It doesn’t alter the fact that increased output stemming from increased flexibility is basically desirable.

Thursday, 22 January 2015

Page 3.

I fully support feminism. The display of interesting female bits in public is a disgrace.

Wednesday, 21 January 2015

Central bank accounts for everyone?

Dirk Neipelt (professor at Bern University) tentatively advocates the above, (which amounts to full reserve banking (FR)) in this recent Vox article entitled “Reserves for everyone…”. But I’m not sure how far he realizes he’s advocating FR. Certainly he doesn’t cite any of the well-known advocates of FR stretching back to the 1930s, e.g. Irving Fisher (1930s), Milton Friedman (1960s), etc. On the other hand he does make one reference to “narrow banking”, which on some definitions is the same as FR.

What Neipelt does advocate is letting everyone have an account at the central bank (CB): i.e. let everyone have a stock of base money.

Of course, many central banks would not want the hassle involved in opening accounts for every other household and firm. But that problem is easily solved: have commercial banks act as AGENTS FOR the central bank. Another solution (already up and running in the UK) is to have some sort of separate government run bank organise the relevant accounts. And in the UK that is currently done by “National Savings and Investments”.

NSI currently doesn’t offer ALL THE services you’d expect of a deposit accepting entity / bank, e.g. it doesn’t offer cheque books or debit cards. But letting it do so wouldn’t be difficult.


As Neipelt rightly says, CB money is as near totally safe as it’s possible to get. That’s in contrast to commercial bank created money, billions of dollars of which vanished into thin air in the 1930s.

Re Neipelt ‘s claim that a “reserve only” system “could undermine deposit-financed credit creation..” that’s a popular and flawed objection to FR. Under FR, anyone is free to have their money loaned on to whoever they wish (NINJA mortgagors, safe mortgagors, or whatever). The big difference as compared to the existing system is that those making the latter choice carry ALL THE RISKS, as opposed to the existing system where the taxpayer carries some of the risk (e.g. via TBTF).

So FR does “undermine deposit financed credit creation” in that it increases costs for borrowers: but only because the latter (TBTF etc) subsidy of lenders is removed. What’s wrong with that? Subsidies misallocate resources.

Deposit insurance.

Re his claim that “As a by-product, public ‘insurance’ of bank deposits could be scaled down..”, actually “public insurance” of banks can be removed altogether. At least if lending entities are funded just by shares rather than by money, then it’s impossible for lending entities / banks to go insolvent. Though the value of their shares can decline to the point where they become takeover targets. (Entities funded just by shares cannot go insolvent because they owe nothing to anyone - certainly not to shareholders. In contrast, money is liability of a bank which is more or less fixed in value.)

Loans granted by CBs.

Neipelt also raises this question: “Would central banks lend funds only to financial institutions or also to the broader public, and at the same policy rates?”

My answer that is that there’s no excuse for central banks to lend to anyone. Certainly CBs shouldn’t get involved in COMMERCIAL loans of any sort, i.e. loans to “the broader public”.

As to CB loans to commercial banks, the only generally accepted excuse for those sort of loans arises where commercial banks are in trouble, and CBs lend according to Walter Bagehot’s criteria, namely at penalty rates and in exchange for decent collateral. But the latter policy involves problems.

First, once you allow “Bagehot” type lending, political pressures ensure that the lending is at rates well below the “penalty” rate. And second, the collateral can be nearer junk than first class. That’s exactly what happened in the recent crisis. And that amounts to a subsidy of commercial banks.

Second, if lending entities / banks are funded just by shares rather than deposits, it’s impossible for those lenders to go insolvent. So the need for Bagehot type lending just doesn’t arise!

Funding for lending.

Having said just above that the “only generally accepted” excuse for CB lending is the Bagehot excuse, there have of course been various exceptions, e.g. the UK’s so called “Funding for Lending” scheme. However, for most of the last century, the only widely accepted excuse for CB lending has been the Bagehot excuse, while schemes like Funding for Lending have been small scale and temporary.

Completely ban private money creation?

Neipelt seems to envisage letting everyone have an account at the CB, while letting commercial banks continue with private money creation. So should we do that, or aim for a straight ban on privately created money?

Certainly the bulk of the advantages in cutting down on private money and boosting CB money come with doing just that (i.e. insisting on a big rise in commercial bank capital ratios). I.e. raising lending entities’ capital ratios from roughly 30% to 100% (which equals a total ban on private money) does not bring huge benefits. However, I favour the 100% figure, and for several reasons, as follows.

1. 100%, to repeat, does bring finite benefits.

2. 100% is a nice clear line in the sand. Anything less, and the banking lobby will just bribe and cajole regulators and politicians into a gradual relaxation of capital ratios, till we’re back with the ridiculously risky ratios that existed prior to the crunch. Indeed, the bank lobby in the US is currently proving highly adept at dismembering Dodd-Frank.

3. Resources are optimally allocated where there are no subsidies. A total removal of bank subsidies means that depositors are in line for hair-cuts when things go seriously wrong (as in Cyprus recently). But a stake in a bank which involves sharing in profits and losses is what’s known as a “share”. Or at least it’s getting near to being a share.

So to that extent and by definition, a total removal of bank subsidies (aka optimally allocating resources) means a total ban on private money.

(H/t to Mike Norman.)


PS ( 22nd Jan 2015). Also (No.4), anything less than 100% means banks can engage in a trick allegedly employed by Barclays during the crisis, which is to lend large sums to a borrower on condition the latter use some of the money to buy shares in the bank. To the extent that that trick works, a hefty capital ratio (say 30 to 50%) means that sub 100% capital ratios are no sort of constraint on bank expansion.

Tuesday, 20 January 2015

Is transforming liquid savings into long-term loans important?

Mark Carney, governor of the Bank of England thinks so. At least in this speech of his (p.3), he says, “Success would be a global financial system that maximises its full potential to ensure that…..  liquid savings are transformed into long-term loans…”

The UK’s so called “Vickers commission” report on banking makes the same claim (sections 3.20 and 3.21).

Well now, the most “liquid” of all assets or savings is money, so I assume that’s what Carney is referring to, or at least I assume it’s ONE OF the types of saving he is referring to. As to Vickers, money is quite clearly what is being referred to.

So, does it matter whether as much “saved money” as possible is transformed into loans?

Well as viewed from a micro economic perspective, i.e. as viewed by an individual household or firm, there’s much to be said for maximising the proportion of savings that are loaned out rather than   taking the form of pound notes or dollar bills stuffed under the proverbial mattress.

But as anyone who has got half way through an introductory economics text book knows, it is very dangerous to extrapolate from the microeconomic to the macroeconomic. More often than not, that doesn’t work. The currently fashionable tendency by twits in high places to treat government, and in particular government debt, in the same way as a household’s debt is a classic example of this mistake.

In contrast to savings as viewed by households (microeconomics), there are savings as viewed by the country as a whole (macroeconomics). Here, “liquid savings”, are not (as Carney and Vickers seem to think) some sort of valuable asset which must if possible be used. Money is simply a book-keeping entry, and banks (both commercial banks and central banks) can create such “entries” in infinitely large amounts any time. I.e. those “entries” are as inherently worthless as $100 bills and £10 notes.

Far from straining ourselves to ensure that every unit of money saved is loaned on, there are some very good reasons for NOT LENDING MONEY ON. E.g. throughout history, banks have gone bust precisely because they have loaned out too much, with the result that when depositors’ form queues outside such banks wanting their money back, the money isn't there: a “bank run”.

So how do we ensure bank runs don’t take place? Well it’s easy: forbid banks from lending out money unless relevant depositors have specifically given permission for their money to be loaned out, and for a longish period. Or alternatively, have lending funded just by shares in the lending entity. That’s different from the existing system under which banks can lend out the large majority of the contents of depositors’ checking or current accounts without permission from depositors.

Of course requiring the above “permission” would reduce the proportion of deposits that were loaned on, which might cause grief for Carney and Vickers. But actually things are not that simple.

The latter reduced amount of lending would certainly cause a decline in total amounts loaned – at least initially. But that would cause a decline in aggregate demand, and government and/or central bank would have to react to that. And a very good way of returning demand to its initial level would be exactly what we have in practice done over the last three years or so. That’s fiscal stimulus followed by QE. And the latter amounts to printing new base money and spending it into the economy (and/or cutting taxes).

(By “fiscal stimulus”, I mean having government borrow and spend, and/or cut taxes. Then comes QE, which consists of the central bank printing money and buying back those government bonds. Net effect comes to the same thing as the government / central bank machine simply printing money and spending it, and/or cutting taxes.)

So, the latter money creation would result in everyone having a larger stock of money, some of which they’d let their bank lend on. Thus the above INITIAL reduction in amounts loaned out would be partially reversed by the latter money creation.

But it probably wouldn’t be TOTALLY reversed. I.e. the net effect would be (assuming the economy remains at capacity) less lending based activity and more non-lending based activity. That is, a proportion of households and firms would be able to do whatever they wanted to do (e.g. buy property) WITHOUT borrowing rather than WITH THE ASSISTANCE of borrowing. Now is that some sort of disaster?

To summarise, trying to maximise the proportion of “liquid savings” loaned on is a badly flawed objective. A better objective is to treat lending just like any other commodity: maximise output (without output being subsidised) and to the point where the marginal unit sold is only just profitable.

And what do you know? That’s what full reserve banking consists of. That is, under full reserve, there is no sort of subsidy or rescue available to lenders (unlike the existing system where we have a host of subsidies for banks, TBTF, etc).

As to the total amount of money saved, that needs to be whatever induces the private sector to spend at a rate that brings full employment, i.e. keeps the economy at capacity. If that results in everyone having $10,000 in savings which is not loaned or (or which is stuffed under mattresses) what’s the problem? Printing that $10,000 costs nothing. Or 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.”

Monday, 19 January 2015

Osborne’s daft surplus idea.

George Osborne (the UK’s economically illiterate finance minister) wants government to run a surplus – more or less permanently. I’ve explained why that makes no sense in theory more than once on this blog.

But it’s nice to see the theory confirmed by a nice simple chart (see below). The chart shows US deficits (in orange) and surpluses (in blue) over the last 30 years or so. As you’ll see, surpluses are a rarity. And in total over that 30 years, they’re pretty much irrelevant compared to the total size of deficits.


Far as I know the sky isn't falling in in the US as a result of these more or less constant deficits.

Saturday, 17 January 2015

Ann Pettifor versus Positive Money.

There’s a difference of opinion between AP and PM over whether in the event of money creation by commercial banks being banned, there’d be any sort of deflationary or other undesirable effect. I’ll argue below that AP's arguments don't add up, while PM's answer to AP is unnecessarily complicated.

To put this in its historical context, the basic argument put by PM is close to the standard argument for full reserve banking put for example by Irving Fisher (in the 1930s), Milton Freidman (1960s), Laurence Kotlikoff and (very recently) Adam Levitin.

Ann Pettifor's argument is basically that if private banks cannot create and lend out money, then sundry viable investments based on bank loans will not take place. And PM responded recently with a publication entitled “Would a Sovereign Money System be Flexible Enough?” The basic answer to AP given in the latter work is that sovereign money creation can be as flexible as you like and in numerous different ways, thus any lack of flexibility deriving from the imposition of full reserve can be countered by a sufficiently flexible sovereign money system. (Incidentally, “sovereign money” is just a synonym for “base money”, and in a system where private banks can't create money, obviously the entire money creation process is then in the hands of the state or "sovereign").

The flaw in Pettifor’s argument.

Under full reserve banking, commercial banks cannot create money out of thin air, so to fund loans, they first have to attract funds from willing savers. And that might seem like a constraint on bank lending. The flaw in that argument is that the latter constraint actually exists anyway – i.e. it exists under the current banking system. Thus full reserve would not increase that constraint.

To illustrate why the constraint already exists, it’s best take two possible scenarios in turn: first, the economy is at capacity (aka full employment), and second, it isn't.


The economy is at capacity.

If the economy is at capacity and banks spot new and viable lending opportunities and banks lend out newly created money to those borrowers, that will increase demand. But that’s not possible if the economy is at capacity, else excess inflation ensues. Hence the government / central bank will have to calm things down with an interest rate increase or similar. The net effect, roughly speaking is no extra borrowing.

Ergo under the EXISTING SYSTEM, and assuming the economy is at capacity, commercial banks cannot lend more unless additional new savers are found. Put another way, assuming the economy is at capacity, any demand increasing effect stemming from extra lending must be matched by the deflationary effect of extra saving, all else equal. So the above mentioned “constraint” exists anyway.


The economy is not at capacity.

Alternatively, if the economy is NOT AT capacity, then there might seem to be some merit in commercial banks creating and lending out new money: that would have a stimulatory effect which is just what’s needed when the economy is operating at below capacity.

Unfortunately there is a major flaw in the latter argument, which is that commercial banks JUST DON’T lend out additional sums come a recession! In fact they do the opposite: they act in a pro-cyclical fashion. That is, they create and lend out new money like there’s no tomorrow in a boom (just what’s not needed). Then come the bust, they call in loans and their “lending out new money” activities grind to a halt (again, just what’s not needed).

Put another way, come a recession, it’s in practice governments and central banks which get us out of the problem (by running deficits, cutting interest rates, etc). It’s not private banks that get us out of the problem (although given long enough, arguably free markets eventually recover from recessions).

To summarise, if under the existing system the economy is at capacity, commercial banks have to find savers to fund new loans. Thus AP’s alleged constraint (namely that under full reserve, banks have to find savers before they can lend) is irrelevant. Alternatively, if the economy is NOT AT capacity, then commercial banks’ ability to create and lend out new money just doesn’t take place. Thus contrary to AP’s claims, banning private money creation has no effect!

In short, AP’s basic objection to full reserve doesn’t add up.


Positive Money’s answer to Ann Pettifor.

PM’s basic answer to AP is that the alleged reduced flexibility that commercial banks have under full reserve can be countered by any degree of flexibility in the “sovereign money” creation system.

And PM then goes into numerous details (see p.8 in particular) on how flexible a sovereign money creation system can be. E.g. according to PM it can give preference to loans for new house building as distinct from loans for purchasing existing houses. Or it can create a fixed amount of new money every year, which as PM rightly points out is what Milton Friedman advocated.

Well those various forms of flexibility are irrelevant because as shown above, AP’s basic objection to full reserve doesn’t add up. Put another way, “flexible sovereign money creation” doesn’t need to rescue full reserve for the simple reason that full reserve isn't in trouble.

Or put it yet another way, sovereign money creation (QE etc) under the EXISTING banking system has to be highly flexible because of the glaring deficiencies in the existing system ( e.g. credit crunches followed by five years of recession).

And as to whether sovereign money creation would need to be MORE FLEXIBLE under full reserve, it wouldn’t and for the simple reason that some of the major problems of the existing system disappear under full reserve. For example, under full reserve, it’s impossible for a bank (or “lending entity” to be more accurate) to go insolvent for the simple reason that it doesn’t owe anything to anyone: it’s funded entirely by shares. So….. no credit crunches! Or at least the severity of booms and busts ought to be much reduced.

(Incidentally under PM’s system, IT IS POSSIBLE for lenders to go bust because they are funded partially by depositors rather than shares. Thus I prefer the full reserve systems advocated by Friedman, Kotlikoff and Levitin. But even under PM’s system, the chance of insolvency can be reduced to vanishingly small levels if capital ratios are high enough.)

Friday, 9 January 2015

Who creates the money that funds QE?

I say central banks do. Frances Coppola says COMMERCIAL banks do. In particular she says “The only institutions that can create the money used for economic transactions in the real economy are commercial banks…”. She is overstating her case there.

But this is a complicated and partially semantic argument. This is my attempt to unravel the complexity.

According to a work called “Quantitative Easing” and published by the House of Commons Economic Policy and Statistics Section, paragraph 3.1:

“Central banks have the ability to ‘create’ money. This happens electronically rather than through the physical printing of extra bank notes. The banks will then use this money to fund purchases of assets. The Bank has mainly purchased government bonds. Purchases of government bonds will increase commercial banks’ deposits at the Bank of England.” (Incidentally I’m almost certain that “The Bank” refers to the Bank of England.)

So that seems simple enough: it’s the central bank that creates the money.

However, in the US, the central bank, the Fed, only deals with so called “primary dealers” when it wants to purchase government debt. And primary deals are all banks.

Now that’s slightly different to the UK where the Bank of England purchases debt direct from both commercial banks and other financial institutions like insurance companies and pension funds.

According to Standard Life:

“QE is a way for the world’s central banks to boost the economy and avoid deflation. They ‘create’ money — not actually printing it but electronically — and use it to buy assets from financial businesses. Typically they buy government bonds. The banks, insurance companies and pension funds selling such bonds…”.

So…where the central bank buys from commercial banks, the procedure is (far as I can see) that the CB announces it’s in the market for government debt, so commercial banks create some money and run out into the market and purchase government debt which they will sell to the CB a short time later.

In that case, it can indeed be argued that the money for QE is created by commercial banks. On the other hand those commercial banks wouldn’t create that money unless they knew that a short time later they were going to be reimbursed with CB created money. So who “creates the money that funds QE?” It’s a bit of a chicken and egg question. It’s semantic.

On the other hand where the CB purchases debt DIRECTLY off non-bank institutions like insurance companies and pension funds, then CB money is presumably created first. (Though it wouldn’t be impossible for commercial banks to have some agreement with insurance companies etc under which the latter don’t get paid till commercial banks have pocketed money obtained from the CB.)

 Give everyone an account at the central bank?

A further point which reduces the relevance of commercial bank created money is that there is nothing in theory to stop everyone having an account at the CB. That is, the only reason that CBs limit the number of entities that can open accounts a CBs is to keep things simple for CBs.

An if everyone DID HAVE an account at the CB, then commercial banks would become irrelevant to the QE process: that is, to effect QE, CBs would just create money out of thin air, and give it to government bond holders in exchange for their bonds. The latter individuals / entities might at some later date transfer that money to an account at a commercial bank, but that’s by the by.

And letting everyone have an account at the CB is not an outlandish idea. William Hummel advocates that idea. And the Fed has recently been activity considering the idea. Plus in the UK, anyone can open an account at “National Savings and Investments” which is a government run savings bank. NSI does not give customers cheque books or plastic cards and it does not offer loans. But money can be withdrawn and transferred to a commercial bank within 24 hours. So that’s getting very close to letting everyone have an account with the government / CB machine.

Commercial bank created money.
In contrast to the above rather semantic question as to whether it’s commercial banks or CBs that create the money that funds QE, there are cases where money is DEFINITELY created by commercial banks and not by CBs: that’s where such a bank lends out money created out of thin air to mortgagors and businesses. And commercial banks do that a thousand times a day.

So with a view to maintaining a clear distinction between the latter form of money creation and money creation that funds QE, I’m claiming that when it comes to mortgage and business loans, the relevant money is DEFINITELY created by commercial banks. In contrast, when it comes to the money that funds QE, I’d call that “CB created” money. But like I say, that’s a bit semantic.

Thursday, 8 January 2015

A move towards full reserve banking.

According to this Wall Street Journal article, the US central bank, the Fed, has been considering letting everyone or at least a bigger range of people than previously have an account at the Fed.

They’re not actually going ahead with the idea, but it’s interesting that they’ve been considering it.

Those accounts would come to the same thing as Positive Money’s “safe accounts”.

Another advocate of full reserve banking who also advocates letting everyone have an account at the Fed is William Hummel.

In contrast, the rules of full reserve ARE BEING imposed on money market mutual funds in the US according to this Forbes article by Keith Weiner. By “rules of full reserve” I mean the following.

1. Where an MMF (or any bank or bank-like entity) promises to return to investor / depositors $X for every $X deposited, then the MMF can only invest that money in an ultra-safe manner: i.e. lodge the money at the central bank or invest in short term government debt.

2. The corollary of that of course is that where the MMF / bank invests in anything else (e.g. lends to mortgagors or businesses), the MMF cannot promise to return to depositors the exact sum deposited. Thus deposits become more like shares.

Tuesday, 6 January 2015

Does Mark Carney intend removing all bank subsidies?

Mark Carney (governor of the Bank of England) gave the impression he favours removing all bank subsidies in this speech at the end of last year. In particular, he said:

“Banks were in receipt of large public subsidies. In Brisbane we reached a watershed in ending too big to fail, with agreements to take forward proposals on total loss absorbing capacity for globally systemic banks. Globally systemic banks that fail will in future be resolved without recourse to the taxpayer and without jeopardising financial stability.”

Now there is a problem there, namely that the TBTF subsidy is not the only bank subsidy. There is also deposit insurance which in the UK is provided free of charge to depositors thanks to the ever generous taxpayer. Plus there is the lender of last resort facility which is supposed to offer loans as prescribed by Walter Bagehot, namely at “penalty rates” and in exchange for first class collateral. In contrast, during the recent crisis, loans were offered at FAVOURABLE rates not penalty rates, plus some of the collateral was of questionable quality. So effectively lender of last resort is a bank subsidy. But let’s concentrate on deposit insurance.

In the UK, the muddle in high places is nicely illustrated by an advert which appears every day on one of my local radio stations (Smooth radio). The advert tells listeners that bank accounts are guaranteed by government, and at no cost to depositors. But it doesn’t say anything about this generosity being removed at any stage. And nor does Mark Carney’s above speech.

So do the authorities in the UK intend removing banks subsidies or not?


You might think that removing that subsidy wouldn’t be too difficult in that in the US there is the Federal Deposit Insurance Corporation which is a self-funding insurance system for banks. That would dispose of the UK’s subsidised insurance system.

But the trouble is that FDIC only covers small banks. Reason is that there’s only one institution that can rescue large banks, or a series of large banks, and that is government.

But there is a problem with having government insure depositors with the costs being covered by some sort of premium: it’s that politicians, thanks to populist pressures, would be tempted to cut the premiums to unrealistically low levels. Indeed, politicians are doing that right now in the UK: the “premium” (as mentioned above) is zero!

Political factors.

Obviously one important reason for not removing the deposit insurance subsidy in the UK is the public outcry that would ensue: once the plebs have been supplied with bread and circuses for a while, they react violently if free bread and circuses are removed. Thus if Mark Carney were to admit that the deposit insurance subsidy makes no economic sense, but that the reasons it will probably stay are political, then that would be a step forward. But Carney (along with the rest of the elite) don’t even seem to understand the latter point: that is, it’s debatable as to whether they even understand that deposit insurance as set up in the UK is a subsidy of banks.

Or perhaps they do understand the latter point, but don’t want to be aroused from their slumbers, i.e. don’t want to face all the hassle that would stem from admitting the point. Mustn’t rock the boat, must we chaps, especially when the existing system offers us extremely well paid employment and comfortable pensions.

Sunday, 4 January 2015

Why doesn’t every firm do some banking, asks Richard Werner.

Commercial banks create money when they lend. At least, when making a loan, a commercial bank does not need to get the money from anywhere: it can just credit the borrower’s account with money produced from nowhere. Hyman Minsky made roughly that point when he said: “Anyone can create money. The difficulty is getting it accepted.”
And that money creation seems a good business to get into.
To be more accurate, commercial banks do TWO THINGS: far as I can see, they both re-cycle existing loans / money and create new money.
So why doesn’t every garage and restaurant create some money? Richard Werner (professor of economics at Southampton University in the UK) addresses that question in a very readable paper published recently. It’s about 7,000 words. (Incidentally it was Werner who introduced the term “quantitative easing” to the English language.)

There is of course the obvious point that garages like to concentrate on selling and repairing cars, and indeed  customers pay good money for specialist skills. That helps explain why most garages don’t want to get deeply involved in banking (or running restaurants). But there’s something else going on.
After all, there are bound to be millions of cases where garage owners have a better idea as to the credit worthiness of a customer than the local bank. So why don’t garages create money for those customers?
Prof. Werner’s answer is that (at least in the UK) it’s largely down to an obscure rule enforced by the Financial Conduct Authority. The rule is the so called “client money rule”. (Incidentally, don’t take my summary of Werner’s paper as being totally accurate: if you want complete accuracy, read his actual paper.)
The client money rule stipulates that when any firm without a banking licence holds customers’ money, that money must be kept in a separate bank account (i.e. must be lodged with an institution that DOES HAVE a banking licence).
Obviously non-bank firms (e.g. garages) can hold small amounts of customers’ money for short periods (e.g. pre-payments for car repairs). But it’s the “client money rule” that stymies a garage, should it wish to branch out into banking. So… if a garage DID CREDIT £X produced from thin air to a customer’s account, that money would have to be immediately transferred to an account in a licensed bank.
It’s a bit like forcing anyone trying to get into the furniture storage business to lodge furniture in a rival’s warehouse: rather defeats the whole purpose of getting into the furniture storage business!

Why combine deposit taking with lending?
Another related question which Werner touches on, but doesn’t examine in detail, is the question as to why firms which accept deposits also specialise in making loans. Indeed, he claims that this question has never been satisfactorily answered. James Tobin, an economics Nobel Laureate, made a similar point when he said “The linking of deposit money and commercial banking is an accident of history..”.
My answer to that question is that if a firm made loans but didn’t attract deposits (or didn’t attract money by some other means, e.g. by selling bonds) it would run out of reserves (i.e. run out of base money). To illustrate, if a firm grants a loan using money created out of thin air, that “funny money” will get deposited in a variety of other banks when the money is spent. And those banks will want real central bank money, i.e. base money, when settling up with the firm that granted the loan. So anyone (garage or restaurant) wanting to create and lend out money, has to attract funds and hence base money from somewhere.
Now there is plenty of money sloshing around, and being held in checking / current accounts, and lenders can solve the latter “shortage of reserves” problem if they attract enough deposits. Plus banks don’t need to pay any significant interest on checking / current accounts. So if you’re into the money creation and lending business, there’s much to be said for accepting deposits as well.
Another good reason to attract deposits is that some governments underwrite those deposits (e.g. in the UK). So in effect, banks can attract funds to lend on and have taxpayers carry the risk. Why can’t we all offload our risks onto taxpayers?

So, should the UK dispose of the client money rule? Disposing of the rule would certainly increase competition in banking. On the other hand most countries don’t let any old Tom, Dick or Harry become a bank: you need a banking license in most countries. So to that extent, disposing of the client money rule wouldn’t make much difference.
Second, any firm that wanted to create and lend thin air money to customers has to attract funds to cover most of that money, and accepting deposits is one way of providing that “cover”. So lending and accepting deposits do rather go together (though of course investment banks don’t accept retail deposits). That tends to mean you either get into banking in a big way or not at all.
Third, there is nothing to stop a garage under the existing system acting as guarantor for a loan made by a local bank to one of the garage’s customers. So to that extent, garages can actually get into banking, despite the client money rule.
And fourth, there are big overheads involved in organising check books, debit cards and so on. And that’s plain impossible for a small garage. That point would help prevent garages becoming bankers even if the client money rule was abolished.
So I think Werner over-estimates the importance of the client money rule. Still, his point is interesting.