Monday, 29 February 2016

The Swiss government and Vollgeld.

The Swiss government (surprise, surprise) sees eye to eye with the Gnomes of Zurich when it comes to monetary reform. That is, both of them want to “get back to business as usual chaps” rather than see any fundamental reform of banks and the monetary system.

In particular, the Swiss government rejects the idea that private banks should be barred from printing / creating money. The Swiss government’s reasons (according to this Economist article) are as follows.

Central bank liabilities.

First up is this. “As the central bank issued more money . . . its liabilities (cash) would rise without any increase in its assets. This, the government fears, would undermine confidence in the value of money.”

The answer to that is that while base money does appear on the liability side of central banks’ balance sheets, that money is certainly not a liability in the normal sense of the word. That’s because:

i) Taking the UK as an example and as regards £20 notes, while those notes say that the Bank of England “promises to pay the bearer £20” (presumably in gold), you’ll get sweet nothing from the BoE if you turned up and asked for gold or anything else in return for your £20 notes. So in what sense are BoE notes or dollar bills any sort of real liability of the relevant central bank?

ii) The extent to which central banks really are independent of government is always debatable, and whether they are nominally “independent” doesn’t make a VAST different there. Anyway, if you classify a central bank as simply an arm of government which is perfectly legitimate way of looking at it, then base money is no sort of liability of “the state” (i.e. central bank and government combined) and for the simple reason that the state can grab chunks of that money off the private sector whenever it wants via tax. That’s very different to the debt you owe your bank in respect of your mortgage: you can’t just grab £X off the bank with a view to reducing the debt you owe your bank by £X.

Indeed, the main “asset” possessed by most central banks is simply bits of paper issued by their treasury saying in effect “we owe you $X”. Those bits of paper are commonly known as government debt.

But government and central bank are, to repeat, both part of the state apparatus. Thus central bank so called “assets” are about as real as an IOU issued by your right hand pocket, and put into your left hand pocket in exchange for cash loaned by your left hand pocket to your right hand pocket.

Incidentally, the fact that some central banks are nominally in private hands is irrelevant. The important point is: what RULES do those banks have to abide by? To illustrate, the Bank of England is owned by the UK Treasury solicitor, according to the second paragraph of this Wiki article. But I rather doubt the “Treasury solicitor” whoever her or she is, takes one penny from the millions of pounds of profit made by the BoE every year. The Treasury solicitor will simply get the standard salary appropriate for bureaucrats with the skills and experience of the Treasury solicitor.

Money like liabilities.

Second, the Swiss government claims that “There would need to be heavy-handed rules to make sure that banks did not create “money-like” instruments.”  There are several answers to that as follows.

1. There are all sorts of strange “instruments” circulating as money in the world’s financial centres, but for the vast majority of transactions (buying a house or car or doing the weekly shopping) it’s pretty clear what constitutes money and what doesn’t.

2. Economists have never claimed there is a sharp dividing line between money and non-money. To illustrate, you are free to try issuing your own money in the form of IOUs written on scraps of paper, and good luck to you. And for another example, you are free to try using bottles of whiskey as money: that might work in the case of a whiskey drinker to whom you owe money (you might be able to give him the bottle of whiskey to settle your debt to him). But otherwise, bottles of whiskey are such an inconvenient form of money that they aren’t counted as money, and quite right.

In short, it is not the aim of those wanting to ban privately issued money to ban ALL FORMS of privately issued money. For example it is not normally their aim to ban local currencies like the Lewis pound or the Bristol pound in the UK. The aim is to ban about 95% of what is normally classified as privately issued money, that is money issued by commercial banks.

Moreover, banks have to obey numerous “heavy handed” rules AS IT IS. Put another way, banking will probably always involve a game of cat and mouse between banks and regulators, regardless of whether we ban privately issued money or not.

Also, the accusation “heavy handed” is a joke when you consider that the Dodd-Frank regulations consists of about ten thousand pages and counting.

Bank funding costs.

Third, the Swiss government claims that “The government also worries that the change would hobble Swiss banks, including multinational giants such as UBS and Credit Suisse, which would face mammoth restructuring costs.”

The simple answer to that is “Modigliani Miller”. Messers Modigliani and Miller were two (Nobel laureate) economists who set out some very good reasons for thinking the cost of funding a bank (or any other corporation) is not influenced by its capital ratio. The arguments for and against MM are complicated, and this is not the place to go into them, but suffice it to say that Google is 90% funded by equity, and Google is not exactly a failure, which rather suggests that high or very high capital ratios are not a big problem.

Bank insolvency.

Fourth, the Swiss government makes the bizarre claim (according to The Economist) that “Even once the new system is in place, a bank could still become insolvent or suffer a liquidity squeeze…”. Well sorry but insolvency is to all intents and purposes impossible in a “no privately issued money” system. Reason is that under that system, lending entities are funded just by equity (or something similar) and equity is not a debt. That is, a bank which is funded just by equity owes nothing to anyone. How can it possibly become insolvent?

Last time I looked at the state of sundry banks closed down by FDIC, it was apparent that not a single one would have been insolvent had it been funded just by equity. The worst ever failure was a bank in Chicago whose assets declined to just 10% of book value. That is (roughly speaking) nine out of ten of its borrowers turned out to be totally bust with no assets left for the bank to grab. That’s an extreme scenario which must have involved criminality, far as I can see.

Having said that, THERE ARE variations on the “no privately issued money” theme which do retain a bit of privately issued money, and in which lenders can thus become insolvent. Personally I favour root and branch reform: i.e. simply ban anything resembling money issuance by money lenders and that makes insolvency as likely as Zurich being bit by a large meteorite.


Fifth, there is the claim that “Even though it did not accept retail deposits, Lehman Brothers still collapsed, and nearly brought down the global financial system as it did so.”

So what’s the implication supposed to be? Are they saying that because a bank doesn’t have short term liabilities in the form of retail deposits, that therefor it doesn’t have any short term liabilities? If so, that claim is plain wrong.

A traditional bank almost by definition (regardless of whether it has retail depositors or not) borrows short and lends long. That’s an inherently risky strategy. ANY bank can judge the risks incorrectly there. Lehmans did, as did Northern Rock, as did hundreds of banks thru history.

It’s time we disposed of that sort of nonsense, particularly if it leads to recessions that last longer than the second world war, which is what the 2007/8 bank crisis sparked off.

Saturday, 27 February 2016

Barter didn’t precede money?

It has become fashionable of late to attack Adam Smith’s claim that barter preceded the introduction of money. For example the sub heading of this article reads, “Adam Smith said that quid-pro-quo exchange systems preceded economies based on currency, but there’s no evidence that he was right.”

So what sort of “evidence” would authors of the above sort of article expect to find? I mean do they think that cave-man societies would leave written records stored in libraries? Or they think Australian Aboriginees from 20,000 years ago would leave articles stored on 21st century hard discs describing how they did or didn’t engage in barter?

The reality is that Chimpanzees engage in barter: for example it is common for one chimp do do favors (like grooming) for another with a view to getting favors in return in the future. As for the idea that cavemen never swapped fur, meat etc with each other, the idea is straight out of cloud cuckoo land.

Moreover, barter was common between East European countries prior to the collapse of communism. E.g. Czechoslovakia sent machinery to Russia and Russia sent crude oil in  return. Cash was not involved in all those types of deals.

Barter is common today in the 21st century. For example the typical husband / wife or girl friend / boy friend relationship is to some extent a barter relationship. That is, for example, the male does favors for the female in exchange for sexual favors from the female.

Friday, 26 February 2016

Private banks are counterfeiters.

Counterfeiting traditionally consists of a private individuals printing copies of state issued paper money and spending it. In contrast, private banks print money and hire it out. There really isn't much difference: it’s like the difference between stealing a car and selling it and in contrast, stealing a car and hiring it out.

As William Paterson (who went on to found the Bank of England) put it in the late 1600s "The bank hath benefit of interest on all moneys which it creates out of nothing." And three centuries later Messers Huber and Robertson made the same point in their work “Creating New Money”. As they put it, “Allowing banks to create new money out of nothing enables them to cream off a special profit. They lend the money to their customers at the full rate of interest, without having to pay any interest on it themselves.”

Also, allowing private banks to print money is to subsidise inefficiency and for the following reasons.

Money creation by private banks is clearly more expensive than having central banks do the job because private banks have to check up on the reliability and credit worthiness of those to whom they supply money. Plus they have to allow for bad debts.

And that’s true even where bank customers are after a stock of money or “float” for day to day transactions, rather than a long term loan. To illustrate, in a hypothetical economy where no one wanted a long term loan, but people DID WANT a stock of money with which to do daily transactions, private banks would still have to check on the credit worthiness of those wanting a stock of money and ask for collateral from the less credit worthy.

In contrast, if all money is supplied to an economy by its central bank, there is no need for the central bank to check up on anyone’s credit worthiness: the central bank / government just creates and spends into the economy whatever amount of money is needed to keep the economy ticking over at full employment.

So given that privately issued money is inherently inefficient, how come such money predominates? That is, how come about 95% of the money in circulation is privately rather than publicly issued?

Well the answer is as above.  That is, when it comes to granting loans, if you can simply print the money you lend out, rather than have to actually pay for it by attracting such money from savers, you can undercut existing saver / lenders.

In fact, and as explained by George Selgin, if the only form of money in an economy was base money, and private banks were then introduced and allowed to create money, that private money would eventually drive state money to near extinction. It wouldn’t ENTIRELY extinguish it because private banks need state money to settle up between themselves. Or at least they find state money very useful for settling up purposes. (Incidentally, Selgin doesn't favor the abolition of private money, but he did set out the above "drive to near extinction" phenomenon very nicely.)

And finally, the above paragraphs are not to suggest that all new loans come from freshly created private money. That is, the reality is that once created, private money is scarcely ever withdrawn. I.e. the stock of private money and indeed state issued money expands year after year. But that periodic INCREASE in the stock of money is of course “new” or freshly issued money.

Although . . it’s not entirely unrealistic to say that money vanishes whenever a loan is repaid and that it appears from nowhere when a loan is granted – a point which might seem to contradict the latter point that the stock of money expands year after year. Actually those are just two different ways of looking at the same phenomenon.

Wednesday, 24 February 2016

How Randall Wray should have attacked debt based money.


The vast majority of money in circulation is issued or created by private banks rather than central banks. And it is often claimed that “loans create deposits”, i.e. that private banks when they grant a loan simply create the relevant money out of thin air and give it to the borrower. Thus, so the story goes, privately created money necessarily involves debt creation, or quote a popular phrase, “Without debt there’d be no money”.

That all gives rise to the phrase “debt based money”. And in view of the negative overtones of the word debt, that leads many to argue that there is something wrong with so called debt based money.

L.Randall Wray (professor of Economics at the University of Missouri-Kansas City)  has written a few articles recently criticising the “debt based money” concept and on the grounds that the alternative form of money, i.e. central bank issued money (base money), is also a debt of sorts.

Wray’s articles produced several responses e.g. from Eric Lonegran, Brian Romanchuk and from me. I argued among other things that central bank / government issued money, if it is a debt, is so different in nature to a normal debt that basically it is not a debt at all. For example the so called debtor (i.e. central bank / government) can simply wipe out any amount of the so called debt it wants whenever it wants via tax. That is, when the government machine says “We’re raising taxes by $X, and you households and corporations better pay up else you go to prison”, then government is essentially wiping out $X of the so called “debt” it owes the private sector. And that’s clearly very different to the debt you owe your bank in respect of your mortgage: there is absolutely no way you can wipe out that debt by simply announcing the debt no longer exists – and the bank manager goes to prison if he objects.

So to summarise, Wray’s argument that base money is also a debt isn't brilliant. Now for a better argument (hopefully).

The real flaw in “debt based money”.

One problem with the debt based money idea is that at the moment when a private bank grants a loan of $Y, no net debt is created. Reason is that the bank sets up two equal and opposite debts. First there is the $Y the bank owes the borrower and that’s called “money”, and the bank undertakes to become indebted to anyone the borrower chooses when the debtor says so (using his/her cheque book, debit card or whatever). Money is debt owed by a bank to a bank customer. Second, the equal and opposite debt is the obligation on the borrower to repay the first debt at some point.

Next, there is a crucial distinction between bank customers who simply want a supply of money, and bank customers who want loans. Suppose a private bank were to set up in an economy where money previously didn’t exist, and it offered some wondrous new stuff called “money” to anyone wanting to dispose of the inconvenience of barter. Also assume the bank announced that each unit of money was equal to the value of a gram of gold or some other rare metal.  That would not of itself create long term debts.

The bank would simply credit money to the accounts of those wanting money (maybe after collateral was deposited); then, any money paid out of one account would necessarily arrive in someone else’s account (assuming for the sake of simplicity that there was no physical cash).

In short, everyone’s account would bob up and down above and below the original amount credited to their account, thus there’d be no long term debts.

Would the bank charge interest to those whose balance was below the original amount credited? Well it could, but assuming everyone’s account is ABOVE the amount originally credited as often as it was BELOW, then account holders would be equally justified in charging the bank interest. All in all, the charging of interest would be a waste of time.

It would make sense for the bank to charge for ADMINISTRATION COSTS, but that’s not the same as genuine interest (indeed, that’s one of the weaknesses in debt based money: it’s inherently expensive to create compared to base money).

To summarise, where a private bank simply creates money as distinct from granting a long term loan, bank customers don't incur net debts over a full 12 month period. Plus the charging of interest wouldn’t make much sense.


In contrast there are long term loans, e.g. for mortgages which often last decades.

A long term loan necessarily involves the transfer of REAL RESOURCES for an extended period, and interest is what is charged for borrowing those real resources. For example where someone gets a mortgage for $100k, that enables them to acquired a big lump of valuable real resources or wealth, commonly known as a “house”.

Now there is absolutely no way a bank can produce real wealth / resources. That is, a bank is simply a collection of offices, full of computers, bank staff, etc. Banks don’t produce bricks, concrete, timber joists and the other stuff needed to build a house.

Banks simply issue bits of paper or book-keeping entries that enable one set of people and firms to purchase stuff off other people and firms in a more convenient way than occurs under barter. Thus when a bank grants a loan for an extended period, the real stuff that the borrower comes by is not produced by the bank: it’s produced (in the case of houses) by those who run and work in brick kilns, saw mills and so on.

Put another way, when a bank grants loans to a set of borrowers, and assuming the economy is at capacity, some other set of people must save, i.e. produce more than they consume, else the economy overheats: inflation becomes excessive. And those savers normally demand interest.

In short, when interest is charged by a bank, the bank is simply passing on the interest that the bank itself has had to pay to savers. Of course banks charge borrowers significantly more than banks have to pay to savers, but to repeat, that’s for administration costs of one sort or another: salaries paid to bank staff, something to cover bad debts, upkeep of bank buildings and so on.

In short, the idea that there is something wrong with privately issued money because a debt arises whenever such money is issued is nonsense. Also the popular claim that we, the people, have to pay interest on the money supplied to us by private banks is nonsense. Banks DO CHARGE for administration costs involved in creating money, but they do not charge what might be called “genuine interest” on that money. In fact banks don’t even charge genuine interest on loans: what they do is PASS ON the interest they have to pay to savers, and then add something to allow for administration type costs and of course something for profit (i.e. a reward for one particular type of saver, namely shareholders).

So is privately issued money without fault?

Having argued that the alleged debt element in privately issued money is non-existent or not a problem, that’s not to say that privately issued money is without fault. For example, private banks act in a pro-cyclical way: that is, they create and lend out money like there’s no tomorrow in a boom. Then come the bust, their money creating and lending activities grind to a halt. That’s the exact opposite of what we’d like them to do.

So should we prohibit privately issued money? Well that’s a big question: not one I’ll deal with here.


P.S.  (25th Feb).  There's a new article just out by Eric Lonergan which also criticises Wray.

Friday, 19 February 2016

The Pigou effect.

And that would raise the real value of the world’s monetary base, i.e. gold, which would tend to increase demand (the more money people have, the more they spend).

That’s called the “Pigou effect”. But of course that’s not a brilliant way of raising demand.

Keynes on banks.

Strikes me he got several things right in this passage:

“This talk of mine follows on addresses from Sir Josiah Stamp [technocrat and progressive] and Lord D’Abernon [financier and diplomat]. They have told you in different ways how the behaviour of the financial system and the banking system is capable of suddenly going off the rails, so to speak, and interfering with everyone’s prosperity for obscure and complicated reasons which are difficult to understand and probably impossible to explain in a popular way. It is a matter which ought to be left to the experts. They ought to understand the machine. And they ought to be able to mend it when it goes wrong.

It is hopeless to expect the man in the street even to discover what is amiss; far less to put matters right. Unhappily, however, the machine is not well understood by anyone. In a sense there are no experts. Some of those representing themselves as such seem to me to talk much greater rubbish than an ordinary man could ever be capable of. And I daresay there are people – I am sure there are – who will say the same about me and my ideas. In other words, the science of economics, of banking, of finance is in a backward state.” (Keynes, Radio Address, ‘The Slump’, 12 April 1931).

(Hat tip to Geoff Tily)

Full reserve banking solves every banking problem.

Almost every day I spot a problem which full reserve solves. For example, today I spotted a conversation on Twitter to which Anat Admati contributed. (AA is an economics prof at Stanford who specialists in banking).

Presumably her point is that given that most bank profit and loss accounts and balance sheets are works of fiction, would be shareholders have little idea what they’re investing in, thus they’re reluctant to invest in bank shares. Even if that’s not her point, the latter “work of fiction” problem is still worth addressing. So let’s address it.

Over the last decade or so, banks managed to get away with a number of fraudulent, semi-fraudulent and very risky activities. First there was NINJA mortgages. Second, any bank can in theory crash anytime due to derivatives (despite the recent and alleged improvements to bank regulation). Third there were those CDOs that turned out to be worth a lot less than face value. Now you really can’t blame people for not investing in that nonsense.

In contrast, under full reserve, investors are given a number of clear choices as to what they invest in. In fact the number of possible options is almost limitless. However, one option that all banks must offer under full reserve is to lodge depositors’ money in a totally safe manner. And “totally safe” means the money is simply lodged with the central bank and/or invested in short term government debt.

Apart from that, banks offer what are in effect mutual funds which invest in a variety of more risky stuff. For example a fund could invest just in mortgages where the house owner had a minimum 50% equity stake in the house. That investment would be very near 100% safe.

A second option would be more risky mortgages, even NINJA mortgages. If a number of people want to put their money into that sort of risky investment, why not let them?

 A third option would be just loans to businesses.

A fourth option or variable is the extent to which any of those mutual funds mess with derivatives. A mutual fund might bar derivatives altogether. Or it might not.

To summarise, under the existing system, bank shareholders have little idea what risks they run. In contrast, under FR, those risks are made clear. And if it turns out very few people want to fund risky stuff like NINJA mortgages, than that’s that. Very few people will be able to get NINJA mortgages: arguably a good outcome. 

Wednesday, 17 February 2016

Bernanke claims that interest on reserves is not a subsidy of banks.

Given the large stock of reserves that commercial banks now have as a result of QE, the Fed can no longer raise interest rates by keeping banks short of reserves. Or so Bernanke argues. As he puts it (I’ve put his words in green italics):

“In the past, the Fed achieved the desired level of the federal funds rate through market operations that affected the amount of bank reserves in the system. By making bank reserves more scarce, the Fed pushed up the price of reserves—the federal funds rate. By making reserves more plentiful, it pushed down the funds rate.

However, as a consequence of the large-scale asset purchases that the Fed undertook between 2008 and 2014 to help support the US recovery—purchases that were financed by the creation of bank reserves—the quantity of reserves in the system is now very large. Because banks are essentially satiated with reserves, modest changes in the supply of reserves will no longer have much influence on the federal funds rate. Rather than varying the supply of reserves, the Fed now manages the federal funds rate by changing the rate of interest it pays on reserves (as well as the interest rate it offers in so-called reverse repo transactions with money market funds and other private-sector institutions).”

Hasn’t he unwittingly admitted to a weakness in his own argument there? That is, as he rightly says, interest rates can be adjusted by adjusting the availability of reserves, or put another way, if the reserve requirement imposed on banks is adjusted, that will influence interest rates without there being any need to pay interest on reserves to commercial banks. E.g. if the amount of reserves that banks are required to hold is RAISED, will tend to raise interest rates. To that extent, there’s no need to pay interest on reserves to banks. Certainly that’s what China does.

Reserves / base money is essentially money issued by government or “the state”. Physical money ($100 bills, £10 notes, etc) are also a form of state issued money. Now if someone (or a bank) wants to build up a stock of that money and for the sake of argument, keep it under their mattress or lodge it at the central bank, then that’s their right. But there’s no good reason they should be REWARDED at the taxpayers’ expense for doing that.

Economics: a fatuous exercise in re-inventing the wheel.

In the early 1930s Keynes said that one way out of a recession would be for the state to print money and spend it (and/or cut taxes).

Roll forward almost a century, and there’s a great “new” idea in the air called “QE for the people”. It consists of – wait for it – having the state print money and spend it!

To be more accurate, it’s not so much professional economists who back QE for the people, as AMATEURS (like me). In addition to me, there’s MMTers, who in effect back QE for the people (though they don’t call it that). And half the supporters of MMT are amateurs.

Plus there’s Positive Money which is staffed almost exclusively by amateurs. You really have to wonder what so called “professional” economists have been doing for the last century, don’t you?

Tuesday, 16 February 2016

A flaw in negative interest rates.

I left the comment below after this Financial Times article on negative interest rates.

There’s a glaring flaw in negative rates: they make possible negative output – that is forms of “production” which actually destroy wealth rather than create it.

To illustrate, if I can borrow at minus 10%, I could buy 100 houses with borrowed money, leave them empty for a year, burn down 5% of them just for fun, then sell the remaining 95 at the end of the year and come away with a profit.

Of course no one would engage in a BLATANTLY pointless activity like that. But in most businesses, it is not obvious whether the activity is worthwhile or pointless, other than by looking at the bottom line. E.g. if a firm consumes ten different chemicals and produces three end product chemicals, how does it know that's worthwhile other than by looking at the bottom line? Under a negative interest rate regime, the value of the chemicals produced could be less than value of the chemicals consumed, and the firm could still come away with a profit.

Monday, 15 February 2016

Randall Wray versus Positive Money.

Positive Money objects to the creation of money by private banks among other things because those banks create money when they grant loans, thus allegedly, privately created money increases debts.

Certainly commercial banks do create money when they grant loans. This Bank of England article starts, “This article explains how the majority of money in the modern economy is created by commercial banks making loans.”

Randall Wray is professor of Economics at the University of Missouri-Kansas City in Kansas City. In a recent article he argues that objections to the above “debt based” money are weak because debt is also inherent to the alternative form of money, namely state issued money (base money).

I’ll argue below that both Positive Money and Wray make a few mistakes there.

Does “debt based” money increase debts?

Positive Money claims that without “debt based” money, total debts would decline. That is, Positive Money argues for a “no privately issued money” system: a system which over the decades has been backed by a number of economics Nobel laureates, Milton Friedman included. (See in particular the second half of Ch3 of Friedman’s book “A Program for Monetary Stability”).

I agree with PM, Friedman etc that there is much to be said for a “state money only” system. However, I don’t agree that because money is made out of debt, so to speak, that that necessarily increases the total amount of debt. One reason is that the total amount of debt VASTLY EXCEEDS the total amount of money we need.

It’s a bit like the form of money issued by King Henry I of England (who came to the throne in 1100AD).  He decided to make money out of wood: that is, he introduced tally sticks to England in a big way. Now did that have much effect on wood consumption? I doubt it. Given the amount of wood used to build houses, ships and to simply burn for cooking purposes, I’d guess Henry I’s tally sticks increased wood consumption by a miniscule 0.00001% or so.

Private banks can create money without creating debt.

Another weakness in Positive Money’s argument is that in a hypothetical society where people wanted a form of money, but no one wanted to incur long term debts, private banks would have no trouble supplying what people wanted. That is banks would (as now) credit the accounts of those wanting a float to tide them over from one pay day to the next (maybe after asking for collateral). And assuming the amount in each account simply bobbed up and down above and below the amount credited, no one would incur any sort of long term debt. (I expand on that point here.)

To summarise so far, there are weaknesses in PM’s argument which Wray COULD ATTACK. But curiously he doesn’t: instead he tries to argue that debt is inherent to state issued money in much  the same way as commercial bank issued money is a debt. And that argument of Wray’s is decidedly weak.

A loan of $X creates TWO $X debts, not one.

For example a major flaw in Wray’s argument is thus.

When a bank grants a loan of $X, it sets up TWO $X debts, not one. There’s the $X debt the bank owes the borrower and which is credited to the borrower’s account. That debt is commonly known as “money”. Second, there’s an obligation on the borrower to repay $X to the bank at some stage.

Now what Positive Money objects to is the SECOND of those debts. That is, PM argues in effect, “Why, in order to create money, should anyone have to go into debt?” But what Wray deals with is the FIRST debt: that’s the debt owed by the bank (or state) to the holder of the bank’s or the state’s money.

In short, Wray aims at the wrong target: a target that Positive Money is not concerned about.

Redeeming debts.

But the basic argument put by Wray in his recent article claims that a characteristic of debt is that it must be REDEEMED, and that since (allegedly) base money also has to be redeemed, then it follows that base money is a debt owed by the money issuer, i.e. the state.

As he puts it in his conclusion, “When the sovereign issues currency, she/he becomes a debtor. The sovereign’s currency is debt. The holder of the currency is the creditor. The most fundamental promise made by any debtor is the promise to redeem, by acknowledging his/her debt and accepting it. Those who themselves have debts to the sovereign can submit the sovereign’s debt in payment.”

What Wray means by “who themselves” is people who owe tax to the state. I.e. he claims that if someone owes tax to the state, that is clearly a debt. And since that debt can be settled using the state’s money, then that, so he argues, amounts to using two equal and opposite debts to cancel each other out. Ergo, so he argues, the state’s money is a debt owed by the state.

Base money never is redeemed!

Well the first problem with that argument is that base money, over the long term, just isn't redeemed. That is, the stock of base money just grows and grows from one decade to the next.

It’s true that occasionally in particular years states run budget surpluses which results in a net withdrawal of base money from private hands. But to repeat, over the long term base money is not redeemed.


A second problem with Wray’s argument has to do with tax. 

It is true, as he says, that tax is debt owed by some private sector entity to the state. But what is tax? It’s the power of the state to simply grab any amount of money it likes off households and firms whenever it wants. And those who don’t pay go to prison.

Now that’s a very different kettle of fish to the debt you owe your bank in respect of your mortgage: you can’t just say to the bank, “Hi folks. I’m not happy with the $100k I owe you in respect of my mortgage. So from now on it’s going to be $50k. Any argument and you go to prison.” In short, to call base money a debt owed by the state to the private sector is odd, given that the state can just wipe out any amount of that debt it likes anytime.

State spending.

Wray and his supporters might argue that when the state grabs $X of tax off the private sector, the state spends that money back into the private sector, thus on balance the state in a sense is not confiscating ANYTHING from the private sector.

Unfortunately that argument is flawed  because there’s nothing to stop the state grabbing money off the private sector and then DOING NOTHING with that money: in effect, tearing the money up. Indeed Wray himself, as a supporter of Modern Monetary Theory (MMT) doesn’t object to using that tactic when the economy needs cooling down.

That is, as MMTers often put it, the purpose of tax is not to fund government spending: the purpose is to counteract the inflation that would ensue if government simply printed excessive amounts of tax and spent it. Or as Abba Lerner (often said to be the founding father of MMT) put it, “An interesting, and to many shocking corollary is that taxing is never to be undertaken merely because the government needs to make money payments...... Taxation should therefor be imposed only when it is desirable that the taxpayers shall have less money to spend, for example, when they would otherwise spend enough to bring about inflation.”


There are weaknesses in Positive Money’s argument which Wray COULD ATTACK, but he doesn’t. Instead he mounts an attack which is none too clever. But notwithstanding that weakness in Positive Money’s argument, I still support the basic PM claim that we’d be better off if just the state issued money, rather than private banks issuing money.

I hope that’s not so complicated as to have caused too many nervous breakdowns and visits to shrinks!

P.S. Eric Lonergan wades into the debate here: 

And Brian Romanchuk wades in here:

Saturday, 13 February 2016

Advice for PC owners.

This blog is normally devoted to economics. But just for a change, and seeing as it’s a weekend, the material below sets out some advice about computers. It’s actually a letter from a woman asking for technical support and the letter she got in response. I’m sure this stuff will be helpful for most people.

Dear Tech Support,

Last year I upgraded from Boyfriend 5.0 to Husband 1.0 and noticed a distinct slowdown in overall system performance, particularly in the flower and jewelry applications, which operated flawlessly under Boyfriend 5.0. In addition, Husband 1.0 uninstalled many other valuable programs, such as Romance 9.5 and Personal Attention 6.5, and then installed undesirable programs such as: NBA 5.0, NFL 3.0 and Golf Clubs 4.1.

Conversation 8.0 no longer runs and House cleaning 2.6 simply crashes the system. Please note that I have tried running Nagging 5.3 to fix these problems, but to no avail.

What can I do?

Signed, Desperate.

The response she got a few days later was as follows.

Dear Desperate,

First keep in mind, Boyfriend 5.0 is an Entertainment Package, while Husband 1.0 is an operating system. Please enter command: I thought you loved me.html and try to download Tears 6.2. Do not forget to install the Guilt 3.0 update. If that application works as designed, Husband 1.0 should then automatically run the applications Jewelry 2.0 and Flowers 3.5.

However, remember, overuse of the above application can cause Husband 1.0 to default to Grumpy Silence 2.5, Happy Hour 7.0, or Beer 6.1. Please note that Beer 6.1 is a very bad program that will download the Farting and Snoring Loudly Beta version. Whatever you do, DO NOT, under any circumstances, install Mother-In-Law 1.0 as it runs a virus in the background that will eventually seize control of all your system resources.

In addition, please, do not attempt to re-install the Boyfriend 5.0 program. These are unsupported applications and will crash Husband 1.0. In summary, Husband 1.0 is a great program, but it does have limited memory and cannot learn new applications quickly. You might consider buying additional software to improve memory and performance. We recommend: Cooking 3.0.

Good Luck!'

Thursday, 11 February 2016

Are university students brain dead?

I helped organise a seminar last Saturday on bank and monetary reform. We asked those attending to fill in a questionnaire which asked, among other things, the occupation of those present.

The seminar was in a university building and we advertised the event extensively in university buildings and the surrounding neighborhood. Of the 43 who responded to the questionnaire, there wasn’t one single student. In contrast, 14 of the 43 said they were retired.

That chimes with a point made to me by a full time employee of Positive Money recently, namely that there’s a significant bias among PM supporters towards the older and male section of the population.  (PM campaigns for bank and monetary reform)

You’d think that given we’ve had a serious recession for the last seven years sparked off by a defective bank system, that students (if they seriously want to make the world a better place) would take some interest in bank and monetary reform. Maybe they find screaming insults at Donald Trump and David Cameron less intellectually taxing and more emotionally satisfying.

For more evidence that students are brain dead, see here, here and here.


Wednesday, 10 February 2016

Never mind negative interest rates: all interest rate adjustments are fundamentally flawed.

There are fundamental flaws in the whole notion that demand should be regulated by adjusting interest rates. They are not mentioned often enough and they are as follows.

First, the basic purpose of economic activity is to produce what people want: both privately and publicly produced goods and services (roads, education, etc). As to what proportion of GDP should be allocated to those two types of spending, that’s a purely political question: it’s one of the main issues that differentiates the political left from the political right. But certainly it’s true that the basic purpose of economic activity is to produce what people want.

That being the case, if there is inadequate demand, the solution is (gasps of amazement) to up the production of the goods and services that people want, and that can be done first by giving people more of the stuff that enables them to purchase goods and services and that stuff is called “money”. For example money can be channeled into household pockets via tax cuts. Second and as regards publicly produced goods, output of those goods can be increased by having government print or borrow money and spend that money on those goods.

Interest rates.

An alternative method of adjusting demand is to adjust interest rates. But all that does (allegedly) is to adjust investment spending. Or to be more exact, it adjusts investment spending primarily by firms and households which are dependent on borrowed money when it comes to investing: i.e. some firms and households have plenty of cash and do not need to borrow in order to invest. (Incidentally, “investment goods” includes stuff like fridges, cars etc).

Now if households and government are given the freedom to buy more, they’re guaranteed to want a wide variety of different goods and services, thus it does not make sense to adjust just one type of spending, namely investment spending by entities that are short of cash.

Of course when investment spending changes there is a trickle down effect: e.g. increased spending on roads increases the incomes of contractors and their employees. Nevertheless, trying to adjust only investment spending (and at that, only for entities that are short of cash) when the object of the exercise is to adjust almost all types of spending is nonsense. We might as well increase aggregate demand by boosting sales of just cars, computers and ice-creams. That too would have a trickle-down effect.

That’s one basic flaw in interest rate adjustments.

Skilled labor.

A second basic flaw is that it’s not easy to suddenly expand just one relatively narrow sector of the economy, whether it’s the investment goods sector, agriculture or any other sector. Each sector needs specific types of skilled labor. Those types of skilled labor may not be available even if unemployment is higher than normal. That is, all else equal, it’s much better to expand all sectors rather than just one.

The evidence.

In addition to the above theoretical weaknesses in interest rate adjustment, THE EVIDENCE is that interest rate adjustments are not all that effective. See here and here.

As Jamie Galbraith put it, “Business firms borrow when they can make money, not because interest rates are low”.

Having criticised interest rate adjustments, there are SOME possible arguments for the alternative to interest rate adjustments, namely fiscal policy. But the arguments are not brilliant. Let’s run thru them.


A possible excuse for concentrating on interest rate adjustments is that the reaction of the real economy to such adjustments might be QUICKER than in the case of tax cuts or extra public spending. However, reaction times or “lags” actually seem to be similar.

Central bank independence.

Another excuse for interest rate adjustments is that if central banks have their very own method of adjusting demand – quite independent of anything that politicians do – that effectively keeps politicians away from the printing press, because central banks can overrule anything the politicians do.

One answer to that is that the evidence seems to be that there is no relationship between the degree of central bank independence and inflation. Put another way, and surprising as this might seem, when politicians DO HAVE access to the printing press, they don’t normally act in an irresponsible manner, though Robert Mugabe is an obvious exception. (See chart here.)

Indeed, since the 2007/8 crisis it’s the Fed that has done most of the printing (in the form of QE), while politicians have been far too timid: they’ve been in a state of near nervous breakdown over the size of the national debt. That is, it’s the Fed that has in a sense been “irresponsible” and politicians who have been responsible.

A second answer to the above claim that central banks must have their own method of adjusting demand is that assuming it is desirable to keep politicians away from the printing press, there are ways of doing that other than giving the central bank its own method of adjusting demand. To illustrate, it would be perfectly possible to have some independent committee of economists (possibly even based at the central bank) decide how much stimulus was suitable in the next six months or so, while purely political questions, like what proportion of extra spending goes to the public and private sectors are left with politicians. That is, the latter committee could decide that $Xbn of extra spending is suitable in the next six months, while politicians decided how to allocate that extra spending. Indeed, a system just like that is advocated in this work (p.10-12).

Should interest rate adjustments be banned?

Given the above litany of problems with interest rate adjustments it’s tempting to suggest we abolish them altogether. Indeed, the work mentioned just above advocates just that. Personally I wouldn’t go quite that far.

Fiscal policy does have a potential problem, which is that a large scale reversal of fiscal stimulus can be politically difficult.  That is, it’s easy enough to slash taxes while leaving government spending untouched (i.e. in effect print money and hand it out to everyone). But a sudden and drastic reversal of that, should it prove necessary, may be politically difficult. Households’ take home pay would be slashed which might lead to riots.

Thus I suggest interest rate hikes should always be there as a backup tool to be used in emergencies. But apart from that “emergency” point, the case for interest rate adjustments is very weak.

Tuesday, 9 February 2016

The effect of negative interest on reserves depends on whether banks can discriminate between new borrowers and existing ones.

Unless I’ve dropped a clanger, which is more than possible. Anyway, what I mean is this.

The initial effect of negative rates is simply to impose costs on commercial banks. E.g. commercial bank X which has $1bn in reserves and which previously paid / received no interest on those reserves, and which then has to pay 1%, would face a bill of 1% times $1bn, i.e. $10million pa.

Commercial bank X now has a bigger incentive to lend more because for every $100 loaned, about $90 ends up being deposited with OTHER banks. That means that bank X owes the latter banks $90 in reserves, which of course bank X is happy to dispose of.

However, in order to persuade its customers to borrow more, bank X has to reduce the interest charged. Assuming bank X can discriminate between new borrowers and existing ones, the latter “additional loans” strategy will work for bank X. Of course other banks will be attempting the same ploy. Nevertheless, the net result ought to be additional loans for the economy as a whole, far as I can see. Reserves become a sort of hot potato which every bank tries to pass on to other banks.

However, banks’ EXISTING customer / borrowers are not going to be too pleased when they find out that NEW borrowers who are identical in every respect to themselves are being offered loans at a lower rate. But if the small print in loan agreements bars existing borrowers from re-newing their loans, there’s not much they can do about it. So in that case, negative interest rates on reserves WILL increase lending.

On the other hand if, or to the extent that existing borrowers can re-new their loans at the new lower rate, then negative interest on reserves won’t work. Reason is that (to repeat) the initial effect is to impose a cost on banks, and assuming banks were earning a standard return on capital prior to the negative rates, and assuming they have to continue to earn that standard return, they banks just have to pass on the cost of negative interest on reserves to customers. I.e. interest charged to borrowers will RISE. Ergo total amount loaned will FALL.

Or have I missed something?

Monday, 8 February 2016

Former senior Barclays Bank executive pontificates on full reserve banking.

The individual concerned is Geoffrey Gardiner, former director of the Financial Services Division of Barclays Bank, and the article is here.

I could of course try to deal with Gardiner’s article in the comments after the article. But the relevant site is a University of Missouri - Kansas City site, which tends not to publish comments which are too critical. Universities nowadays, far from being havens of free speech and debate, are if anything, centres of bigotry: e.g. see here, here and here.

I’ve re-produced Gardiner’s article, which is quite short (700 words) and interspersed that with my own comments in green italics. Here goes. (Incidentally, there’s nothing wrong with the first third or so of the article).

Jurists have demonstrated that every right must have a corresponding duty, or it is worthless.

The same is true of financial assets: for every creditor there has to be a debtor.

Money is assignable debt. The debt should be negotiable, that is it can be transferred to another owner without reference to the knowledge of the debtor.

There are primary debt and secondary debt. An example of primary debt is when a borrower draws down a bank loan by making a payment to someone. That someone pays the money received into a bank account, thus creating the credit which finances the loan. New money has been created.

The new money can then circulate in either of two ways. It can be spent, which means the payee becomes the new holder, and the payee too can spend it. Thus new money can be spent over and over again until it gets used to repay a debt, when it ceases to exist.

Or the new money can also be lent on, creating secondary debt.

Although banks are said to create money by granting loans, really the bank is only a midwife: money is created by the borrowers.

It is possible to make sure that the only money created by primary debt is state debt.

To achieve it every one has to be a customer of the central bank and all his or her payments and receipts will be recorded there. The accounts are to be called ‘transaction accounts’. The central bank will not make loans to the public but only to the state. The state’s payments will become deposits in the transaction accounts of the members of the public who receive payments from the state.

As Positive Money (PM) literature explains, there is no need for “everyone” to be a “customer of the central bank”, although that’s certainly one option, an option which PM coincidentally has just recently started to advocate. It’s also an option advocated by William Hummel.

The other option is for existing commercial banks to act as AGENTS for the central bank: i.e. commercial banks offer customers totally safe accounts where money is only lodged at the central bank and/or invested in short term government debt (an option advocated by Milton Friedman). Money market mutual funds will soon be offering that sort of account in the US, incidentally.

Customers will be allowed to make transfers from their transaction accounts to commercial banks which will use them to make loans to people or businesses up to the limit of its deposits and no further. The bank will make a loan by transferring money from its own transaction account to the transaction account of the borrower. In its own books it will credit ‘transaction account’ with the amount of the loan and debit the account of the borrower, following normal bookkeeping principles of ‘debit value in’ and  ‘credit value out’. In the books of the central bank these transactions will of course be reversed.

Note. A transaction account at the central bank may never be overdrawn as that would be allowing the customer to create money.

The system of transaction accounts at the central bank will be used to keep track of the population. Every person will be allocated an account at birth and vital details will be recorded and updated. The records will include a record of the person’s genome. The bank will issue identity documents. The transaction account number will be the person’s identity and passport number, and also the number of his or her tax account. Transaction account statements will be sent automatically to the tax office, which will have the duty to debit it with all assessed taxes. Every immigrant or visitor to the country will get an account and give similar identity details.

Gosh: so the central bank will have records about everyone! Shock horror. I have news for Geoffrey Gardiner: the tax authorities, the police and other organs of the state already have VOLUMINOUS amounts of information about everyone. So nothing much changes there.

In any case, and to repeat, there is no need for everyone to have an account at the central bank in order for PM’s system (i.e. full reserve banking) to work.


Use of coins and banknotes will be discouraged and eventually banned so that every transaction a citizen makes will be visible to the security services.

The decline of physical cash is taking place anyway, in case Gardiner the so called “banker” hasn’t noticed. Moreover, numerous economists, apart from full reserve advocates and PM supporters are currently discussing the desirability of banning physical cash.

And not only that, but there is no need whatever to ban physical cash in order for full reserve banking to work. In fact ALL PHYSICAL CASH nowadays is central bank issued. To that extent advocates of full reserve banking have no big problem with physical cash.


Credit cards will be forbidden.

Total and complete nonsense. Under full reserve, (Milton Friedman’s version, Lawrence Kotlikoff’s version of PM’s version) the bank industry is split in two. On half accepts deposits which are designed to be as safe as is possible in this world: the relevant money is simply lodged at the central bank or put into government debt. The other half lends in a more risky fashion (to mortgagors, businesses, etc) but that is funded by equity or equity like liabilities, like bog standard corporate bonds. There is nothing to stop the second half making loans via credit cards.

To complete the total control of the credit supply, trade credit will be forbidden as will be bills of exchange and peer to peer lending.

Complete and total garbage: none of the various versions of full reserve advocate forbidding one firm to supply goods to another and not ask for payment for a month or two.

Unfortunately secondary lending probably cannot be stopped entirely and no doubt, as in all recorded history, the public will devise methods of creating credit instruments and therefore money.

Note that it will not be possible to finance all government expenditure for ever from creation of state money as the quantity of money in circulation would be so great that the currency would become worthless as has happened so often in the past. Therefore some taxation will be inevitable.

Of course the banking system will be far less flexible and in particular the inability to overdraw will annoy many citizens.

More drivel: there is no “inability to overdraw”. As the advocates of full reserve – Friedman, Kotlikoff, PM etc - make perfectly clear, borrowing IS PERMITTED under full reserve. But only from entities that are funded via equity or equity type liabilities.

Tuesday, 2 February 2016

Historical quotes on banking.

The following historical quotes about banking are being handed out to all those coming to the meeting on banking in Newcastle-upon-Tyne (UK) on 6th Feb 2016.

"The bank hath benefit of interest on all moneys which it creates out of nothing." -
William Paterson, founder of the Bank of England in 1694, then a privately owned bank.

“It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.” - Henry Ford, founder of Ford Motors.

"Banking was conceived in iniquity and was born in sin. The Bankers own the Earth. Take it away from them, but leave them the power to create deposits, and with the flick of a pen they will create enough deposits to buy it back again. However, take it away from them, and all the fortunes like mine will disappear, and they ought to disappear, for this world would be a happier and better world to live in. But if you wish to remain slaves of the Bankers and pay for the cost of your own slavery, let them continue to create deposits." Sir Josiah Stamp, President of the Bank of England in the 1920s, the second richest man in Britain.

"The few who understand the system will either be so interested in its profits or be so dependent upon its favours that there will be no opposition from that class, while on the other hand, the great body of people, mentally incapable of comprehending the tremendous advantage that capital derives from the system, will bear its burdens without complaint, and perhaps without even suspecting that the system is inimical to their interests." - The Rothschild brothers of London writing to associates in New York, 1863.

"I am afraid the ordinary citizen will not like to be told that the banks can and do create money. And they who control the credit of the nation direct the policy of Governments and hold in the hollow of their hand the destiny of the people." Reginald McKenna, as Chairman of the Midland Bank, addressing stockholders in 1924.

"The banks do create money. They have been doing it for a long time, but they didn't realise it, and they did not admit it. Very few did. You will find it in all sorts of documents, financial textbooks, etc. But in the intervening years, and we must be perfectly frank about these things, there has been a development of thought, until today I doubt very much whether you would get many prominent bankers to attempt to deny that banks create it." H W White, Chairman of the Associated Banks of New Zealand, to the New Zealand Monetary Commission, 1955.

"When a government is dependent upon bankers for money, they and not the leaders of the government control the situation, since the hand that gives is above the hand that takes. Money has no motherland; financiers are without patriotism and without decency; their sole object is gain." - Napoleon Bonaparte, Emperor of France.

"I believe that banking institutions are more dangerous to our liberties than standing armies." - Thomas Jefferson, US President 1801-9.

"If the American people ever allow private banks to control issue of their currency, first by inflation, then by deflation, the banks and the corporations will grow up around them, will deprive the people of all property until their children wake up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs." - Thomas Jefferson in the debate over The Re-charter of the Bank Bill (1809).

"The government should create, issue and circulate all the currency and credits needed to satisfy the spending power of the government and the buying power of consumers. By adoption of these principles, the taxpayers will be saved immense sums of interest. Money will cease to be master and become the servant of humanity." Abraham Lincoln, US President 1861-5. He created government issue money during the American Civil War and was assassinated.

"The death of Lincoln was a disaster for Christendom. There was no man in the United States great enough to wear his boots and the bankers went anew to grab the riches. I fear that foreign bankers with their craftiness and tortuous tricks will entirely control the exuberant riches of America and use it to systematically corrupt civilisation." Otto von Bismark (1815-1898), German Chancellor, after the Lincoln assassination.

"That this House considers that the continued issue of all the means of exchange - be they coin, bank-notes or credit, largely passed on by cheques - by private firms as an interest-bearing debt against the public should cease forthwith; that the Sovereign power and duty of issuing money in all forms should be returned to the Crown, then to be put into circulation free of all debt and interest obligations..." Captain Henry Kerby MP, in an Early Day Motion tabled in 1964.

"... our whole monetary system is dishonest, as it is debt-based... We did not vote for it. It grew upon us gradually but markedly since 1971 when the commodity-based system was abandoned." - The Earl of Caithness, in a speech to the House of Lords, 1997.