Wednesday, 30 March 2016

Cutting the national debt may do no good.

I like this picture from Lars Syll’s blog. It summarises much of Modern Monetary Theory.

In particular, government debt is an asset, as viewed by the private sector. The more paper assets the private sector has, the more it will tend to spend and the lower will unemployment be, all else equal.

So think twice before advocating a cut in the debt. If REAL interest on the debt (i.e. interest on the debt after adjusting for inflation) is around zero, the just leave it alone. In contrast, if government is paying any significant amount of REAL interest on the debt, then fair enough: reduce it.

Friday, 25 March 2016

Oooh: those (allegedly) horrendous private debts.

Steve Keen and many others keep trying to scare us with charts like the one below showing the rise in private debts over the last twenty years or so. 

One reason for not being scared is that interest rates have dropped significantly over that period. Thus (surprise, surprise) people and firms borrow more.

As to what would happen if interest rates rose again, well if they rose at the same gentle pace that they’ve declined over the last twenty years, that wouldn’t be a problem. In contrast, given a SUDDEN rise in interest rates, obviously there’d be problems: some mortgagors would go bust, as would some banks which had loaned too much to high risk borrowers.

That would cut aggregate demand, but that’s easy enough countered with standard stimulatory measures. Of course many governments and members of the economics profession are too dumb to realise we have the power to counter recessions. But at least in theory, recessions are easily countered.

As to banks going under, well small banks in the US are covered by the FDIC.

As to larger banks in the US, and non-insured banks elsewhere, the fact of banks going under being a cause of macro economic problems just proves the idiocy of our existing bank system. The solution is full reserve banking. Under that system, it’s plain impossible for banks to go insolvent, though it’s perfectly possible for them to see a sharp fall in their share prices, resulting perhaps in being taken over.

And finally, I’m still waiting to hear some FUNDAMENTAL THEORETICAL reason for thinking debts are too high. But never mind: I can come to the rescue there. I set out a basic and very simple reason for thinking debts are too high here. The reason is that the debt creation process is subsidised by taxpayers!!

How’s that for simplicity? To be more exact, I argue at the above link that money creation (aka money printing) by private banks is subsidised, and given that for every $ of that form of money there is a $ of debt, it follows that in subsidising private money printing, we’re subsidising debt creation.

So…if we abolish private money printing (which is what full reserve banking involves), the result is something nearer the optimum amount of debt, plus we’re more likely to avoid bank problems giving rise to macro economic problems.

What more do you want?

Thursday, 24 March 2016

Kocherlakota on helicopter money.

Narayana Kocherlakota wrote a Bloomberg article entitled “Helicopter Money Won't Provide Much Extra Lift”. His basic point is that there’s nothing a central bank can do that government and central bank in cooperation can’t also do.

As he puts it, “The crucial point here is that there's no need to employ helicopter money if the government is willing to use its powers to help central banks generate inflation.”

Well that’s the whole point: helicopter money is only contemplated when government (aka politicians) ARE NOT doing enough. So therein lies the basic merit of helicoptering.

But that raises a big problem, which is that the central bank then has to decide WHO to bestow it’s money on. Pensioners? Schools? Ordinary households? Some government department? That sort of decision (e.g. what proportion of spending goes the public sector rather than the private sector) is a clearly POLITICAL decision. And that’s not within the remit of central banks.

There is however a solution, which is for the central bank to distribute the money (e.g. as between public and private sectors) in the SAME PROPORTION as spending already is distributed between those two sectors. That’s pretty neutral politics wise. And as far as distribution WITHIN the public sector goes, the CB could again give different government departs and state bodies more money IN PROPORTION to their existing budgets.

Another important point that can be taken away from that discussion is that while politicians are clearly entitled to take political decisions, they are equally clearly not qualified to decide how much stimulus is suitable.

So… how about politicians sticking to political decisions, and central banks having complete control of stimulus (monetary and fiscal)?

Now what d’yer know? That’s exactly the split of responsibilities advocated four years ago in this work by Positive Money, Prof Richard Werner, and the New Economics Foundation.

Tuesday, 22 March 2016

Taxpayers subsidise private money creation.

The above is the title of a paper I’ve just published – about 6,000 words. This is an 800 word summary.

Money can be divided into two basic forms. First there is publicly created money (created by central banks and often referred to as “base money”). Second, as the opening sentences of this Bank of England publication make clear, private banks also issue a form of money. And in fact that privately issued money makes up the vast majority of money in circulation.

Base money, costs much less to produce than privately created money because private banks have to check up on the credit worthiness of borrowers before supplying them with money.  In contrast governments and central banks (aka “the state”) does not need to do those checks when creating and spending base money into the economy.

It might be claimed that the cost of private money creation is the cost of organising loans and hence that the cost of private money creation as such is not particularly high. The flaw in that argument can be illustrated by a hypothetical economy where people want a form of money, but no one wants a loan, particularly a long term loan.

Commercial banks in that scenario would simply credit money to people’s accounts as desired, after taking collateral in most cases no doubt. At that stage, all banks have done is make book-keeping entries: no transfer of REAL RESOURCES has taken place. So there’s no real debt.

Thereafter, as long as the balance on everyone’s account was ABOVE the original balance as often as it was BELOW, no one would be indebted to a bank or anyone else on average over the year. And remember that where someone’s balance goes $X “below”, some else’s must go $X above because money leaving one account must enter another (if we ignore physical cash).

Moreover,  there’s no question but that when people or firms in the real world get so called loans from a bank, they are not actually after a long term loan at all: in many cases, all they want is a float or stock of money to enable them to do day to day business. Thus the idea that the cost of private money creation is simply the cost of organising loans is flawed.

So if you were setting up an economy from scratch, or converting from a barter to a money based economy , the GDP maximising option would be publicly created money, not private money. Plus there is no reason why that regime would not produce a genuine free market or GDP maximising rate of interest.

However, despite the high cost of private money, it nevertheless manages to drive public money to near extinction (except in the current very low interest scenario).  George Selgin describes that “drive to extinction” process, which is not to suggest he’d agree with the arguments here.

The reason for the “drive to extinction” is that private banks can create and lend out money at below the going rate of interest because they are not burdened with one of the main costs normally involved in lending, namely earning money and abstaining from consumption (so that borrowers can consume.) Joseph Huber makes very much that point (2nd para, Ch 4).

When an economy is at capacity, the result of that extra lending is inflationary, so government has to withdraw base money from the economy, i.e. rob taxpayers,  in order to counteract the inflation, for example by cutting the deficit / raising the surplus or by raising interest rates. In short, private money printing is subsidised by taxpayers, and subsidies reduce GDP, unless there is a good reason for a subsidy.

The net result of letting private money displace base money is an artificially low rate of interest and an artificially high level of debt, plus GDP is reduced. So if you wondered why interest rates are now at very low levels, and why debts are arguably too high, you now have part of the answer.

GDP would thus be increased if privately issued money was banned, though its complete elimination is not necessary. For example local currencies are a form of privately issued money. They do little harm and they’re a bit of fun.

Also shadow banks, particularly the smaller ones, would doubtless try to circumvent attempts to ban private money. That is, they’d try to issue money-like liabilities. However, while those liabilities may be readily accepted in the World’s financial centres, they are not much use for 99% of other transactions: buying a house or car or doing the weekly shop for groceries.

Bearing in mind that the normal definition of money is something like, “anything widely accepted in payment for goods and services”, it’s debatable as to how money-like the liabilities of small shadow banks can ever be.

Tuesday, 15 March 2016

Wiping out the national debt is easy.

Step 1: Have the central bank print loads of money and buy back all the debt. That is, in effect, do a massive QE operation. Of course doing all that in one year would be disruptive (though not impossible). But doing it over five years wouldn’t be difficult.

Step 2: That amount of money printing would probably be too inflationary, though given the muted effect of QE, it wouldn’t be AS INFLATIONARY as some might claim.

Step 3: Thus some sort of deflationary measure would be needed to counteract the above inflation. Probably the best would be to raise taxes and extinguish the money collected.

Step 4: As long as the above inflationary and deflationary effects exactly cancel each other out, there’d be no effect on aggregate demand or numbers employed.

QED. Problem solved.

Monday, 14 March 2016


Someone keeps trying to put a comment on this site with links to various delights like “hard anal porn”, “wife sex”, “fat fuck movies” and so on. Tempted as I am to have a peep, I’m very busy at the moment. But next weekend….

Apologies in advance if I fail to block this comment. Or alternatively you may be into this sort of thing and will thus be more than pleased with this new addition to this blog.

If you want links to the various delights on offer, please contact me. I’m very broad minded....:-)

Saturday, 12 March 2016

Mervy King’s bizarre arguments against very high bank capital ratios.

Mervyn King, former governor of the Bank of England, has just published a book entitled “The End of Alchemy…”.

In Ch 7 of the book he argues against the idea that the bank industry should be split in two, one half (funded just by shares) doing lending, and the other half of which accepts deposits, but which cannot lend (except to government or the central bank). Under that arrangement the first half cannot go insolvent (though King doesn’t seem to have worked that out, as is shown below). As to the second half, that’s as safe as it is possible to get in this world. (Incidentally, King sometimes refers to the lending half as “wide banks”).

That arrangement obviously involves a capital ratio of 100% for the lending half. But some of the arguments for and against that arrangement also apply to capital ratios that are high, but not up to the 100% level. For example Martin Wolf and Anat Admati advocate a 25% or so ratio, while Miles Kimball (economics professor at the University of Michigan) advocates 50%

King’s first objection to very high capital ratios comes in the paragraph starting “So why hasn’t the idea been implemented?” That first objection actually comes in two parts. First King says “Banks will lobby hard against such a reform.”

Yes I bet they will. Doubtless they also lobby against controls on laundering Mexican drug money. But any such lobbying is a total and complete irrelevance: the only important question is whether much higher bank capital ratios (or curtailing the laundering of Mexican drug money) is in the best interests of the country as a whole.

Second, and also part of his first objection, King says the transition to very high capital ratios “…could be disruptive, forcing a costly reorganisation of the structure and balance sheet of existing institutions.” Well the simple answer to that is that the existence of high upfront costs is not an argument against ANYTHING, whether it’s demolishing an office block and re-building it, or anything else. The only important question is whether benefits outweigh costs in the long run, a point which I’d imagine 95% of taxi drivers understand.

Moreover, it’s debatable as to whether the latter transition really would be costly. Milton Friedman’s view was that it WOULDN’T. As he put it in his book A Program for Monetary Stability, “There is no technical problem in achieving a transition from our present system to 100% reserves easily, fairly speedily and without any serious repercussions on financial or economic markets.”

Well the above pair of objections to higher capital ratios aren’t too clever are they? I’d expect an intelligent school leaver to see the flaw in King’s arguments there.


King’s second objection to narrow banking has to do with intermediation, and answering it would take too long. So I’ll skip that in this article. I’ve actually dealt with all relevant points in earlier articles.

Bank insolvency.

King’s third objection does not consist of one single clear point. Rather it’s a collection of different points.

The opening sentences of this third objection are just below. But first I’d better explain that King’s phrase “radical uncertainty” which appears in the passage below refers to big problems that suddenly appear from nowhere, like the 2007/8 bank crisis: so called “black swan” events.

Anyway, his third objection starts…

“Third, and most important of all, radical uncertainty means that it is impossible for the market to provide insurance against all possible contingencies, and one role of governments is to provide catastrophic insurance when something wholly unexpected happens. Ending alchemy does not in itself eliminate large fluctuations in spending and production.”

(By “alchemy”, King means (roughly speaking) “borrow short and lend long”. I’ve put his definition of the word at the end below. As you’ll see, his “alchemy” is a strange concept. But “borrow short and lend long” is the best translation into normal English I can think of.)

Well it’s true, as King says, that curtailing borrow short and lend long, or implementing very high capital ratios will not of itself eliminate “fluctuations in spending and production”.  The advocates of very high capital ratios have never claimed they do. But the latter changes do make banks more stable.

King’s criticism is like criticising cars because while they transport people in comfort and at quite a speed, they only carry about four people and don’t go as fast as airliners. Cars (and this may be news to King) are a big improvement on horses and carriages. That’s an achievement.

Moving on, King then makes various points which I could criticise, but I’ll concentrate on his worst mistake which is that he quite clearly does not understand that wide banks cannot go insolvent, nor does he understand the basic money creation process which private banks engage in.

He says, “Ensuring that money creation is restored to government through the requirement for narrow banks to back all deposits with government securities does stop the possibility that runs on the banking and shadow banking sectors will transmit shocks at rapid speed right across the financial sector, as happened to such devastating effect in 2008. But the risk from unexpected events is then focused on the prices of assets held directly by households and businesses and on the solvency of wide banks.”

Now hang on. As King himself rightly points out, wide banks (the half of the industry which lends to mortgagors, businesses, etc) are funded just by equity. That being the case, how is it possible for them to go insolvent? Insolvency means not being able to pay creditors when debts are due for settlement. But a bank funded just by equity doesn’t owe anything to anyone!

Of course it’s theoretically possible that a bank becomes indebted to TRADE CREDITORS (e.g. those who supply it with electricity, paper, computers etc) and that the loans the bank has made are so hopeless that there is no cash available from those loans when they’re due for repayment. But nothing like that has ever happened in the banking world far as I know. That degree of failure would be far worse than occurred with Lehmans or Northern Rock.

The next passage which indicates that King basically does not understand wide banks reads, “Although wide banks cannot create money in the form of deposits, they can still borrow short and lend long.”

Complete nonsense. It’s the very fact of a bank borrowing short and lending (long or short) that results in money creation. That is, if a bank accepts a deposits totaling £X and lends that on, then borrowers have £X to play around with, and depositors still see a total of £X (credit balance) on their bank statements. £X has been turned into £2X. In contrast, if a bank borrows long (e.g. depositors cannot get access to their money without say 3 or 6 months notice) that so called money is not counted as money in most jurisdictions. So no money multiplication takes place.

As King himself correctly pointed out a few paragraphs earlier, a wide bank is one funded just by equity, i.e. not funded by short term debt. As he put it…

“If deposits must be backed with safe government securities, then it follows logically that all other assets, essentially risky loans to the private sector, must be financed by issuing equity or long-term debt, which would absorb any losses arising from those risky assets.”


Mervyn King was head of one of the world’s leading central banks for a decade or so. You have to wonder whether he was up to the job to judge by his book. If you want to know why the 2007/8 bank crisis erupted, perhaps you now have part of the answer.

King’s definition of “alchemy”.

His definition runs as follows (and if you find it a mouthful, so do I).

“By alchemy I mean the belief that all paper money can be turned into an intrinsically valuable commodity, such as gold, on demand and that money kept in banks can be taken out whenever depositors ask for it. The truth is that money, in all forms, depends on trust in its issuer. Confidence in paper money rests on the ability and willingness of governments not to abuse their power to print money. Bank deposits are backed by long-term risky loans that cannot quickly be converted into money. For centuries, alchemy has been the basis of our system of money and banking. As this book shows, we can end the alchemy without losing the enormous benefits that money and banking contribute to a capitalist economy.”

Were you somewhat bamboozled by that definition? I was.

For example, where are these people who apparently think that “all paper money can be turned into an intrinsically valuable commodity, such as gold, on demand and that money kept in banks can be taken out whenever depositors ask for it”?

Anyone with a grain of common sense knows that if the entire population tried to withdraw their stock of money from banks and turn it into gold or anything else “intrinsically valuable”, the result would be chaos. For a start, every bank would immediately go insolvent and we’d have rampant inflation!


P.S. 19th March 2016.   There is another none too flattering review of Mervy King’s book (by Joseph Huber) here.
P.S. 29th March 2016.  As distinct from my above article which deals with just one chapter of King's book, there was a long letter in the Financial Times recently which criticised the BASIC IDEA in King's book. (Letter title: "Banking system sometimes needs a does of radical uncertainty.")

Friday, 11 March 2016

Full reserve banking is almost a panacea.

According to the Modigliani Miller theory, raising a bank’s capital ratio – even to 100% - should have no effect on the cost of funding the bank. MM has been criticised, but far as I can see, the criticisms don’t amount to much. See under “Flawed Criticisms of Modigliani Miller” here.

However, one possible reason why bank capital might be expensive is that banks allow clever clever traders (often as not in their twenties) to risk the bank’s solvency by using shareholders’ money to make silly derivative bets. That is, bank shareholders never quite know when the value of their shares will suddenly halve in value or even become worthless. That being the case, potential shareholders will want a significant return for the risk they run.

That problem is automatically solved by full reserve banking, because under FR banking, or at least most versions of it, bank shareholders have a CHOICE as to how their money is used. That is, those who simply want to fund conservative mortgages and have nothing to do with derivatives can do so, while those who want to fund clever clever stuff like NINJA mortgages (with derivatives mixed in for good measure perhaps) can do so. And if they lose their money, why should we care?

The net result would probably be lower mortgage costs for responsible mortgagors, and higher mortgage costs for risk takers, and quite right.

But of course that’s not what banks want at all: what they want (to repeat) is the freedom to use grandma’s savings and taxpayers’ money to gamble in casinos; and keep the profit when that works and send the bill to the taxpayer when it doesn’t.

Thursday, 10 March 2016

Two sorts of money: public and private.

There’s two sorts of money: state issued money and private bank issued money.

It costs nothing to issue state money. In contrast, private banks have to check on the credit-worthiness of customers before giving them money. And that involves significant costs: in fact the only reason private banks charge more interest to borrowers than they themselves pay bondholders, depositors etc is to cover those costs (plus something for profit, i.e. for shareholders). So state issued money is better. But if state issued money is cheaper to produce than private money, why does private money predominate?

Reason is that private banks can lend without having to endure the full costs of lending, so they can undercut the going rate of interest.  In particular they don’t have to ABSTAIN FROM consumption in order for borrowers to consume more. Of course it can be argued that where private bank lending rises and the economy is at capacity, the central bank will raise interest rates so as to forestall inflation. And that encourages saving or “abstinence”. True, but by that time private money has got into the economy. Put another way: how do central banks raise interest rates? They do it by withdrawing base money from the private sector (selling government debt).

Net result: private banks have managed to have their money displace base money.

Moreover, government will not necessarily counter the above inflation with interest rate increases: it may go for fiscal tightening, e.g. raising taxes. In that case, again, the state is simply WITHDRAWING its money from the economy in order to make room for privately printed money. 

The net result of letting private money displace public money (aka base money) is an artificially low rate of interest and an artificially high level of debt.

Tuesday, 8 March 2016

The bank subsidy no one has spotted.


Private banks create money. That activity is subsidized by taxpayers. Reason is as follows. Assume an economy where the only form of money is base money and assume there’s enough of that money to bring full employment. If private banks then start creating and lending out their own money, government would have to confiscate base money off taxpayers so as to forestall inflation. Ergo taxpayers subsidize the creation / printing of money by private banks. Ergo privately issued money printing mis-allocates resources and reduces GDP.

At about 3,000 words, this article is much longer than most articles I produce. However, the basic ideas are set out in the first third of the article. The rest considers possible weaknesses in the arguments in that first third.


 Private banks enjoy at least three different subsidies, as follows.

1. The too big to fail subsidy which enables large banks to borrow at preferential rates of interest.

2. What might be called the “bail out” subsidy: the fact that the Fed for example loaned private banks around $600bn for about 18 months at the height of the crisis at a derisory rate of interest.

3. Governments in some countries have provided deposit insurance for private banks (and depositors) for free for decades. (In contrast, in the US, the FDIC actually charges banks for deposit insurance, and quite right).

However, there’s a fourth subsidy. I’ll explain it by reference to a very simple economy where the only form of money, at least initially, is base money. Let’s assume that that base money comes in fiat form (as it does throughout the World nowadays) rather than in the form of gold.

Assume that the quantity of money is enough to bring full employment: that is, the stock of money held by households and firms is enough to induce them to spend at a rate that keeps as many people employed as is possible without causing excess inflation. Also, assume that initially commercial banks are confined to lending money which depositors, bond-holders etc have deposited: i.e. banks don’t CREATE and lend out money as happens at the moment. (I.e. "deposits" would have to be in the form of bonds or at least long term deposits, or something that didn't count as money.)

There is no obvious reason why in that scenario interest rates would not settle down to some sort of genuine free market rate. In particular, a free market is one where the producers of each commodity bear the full cost of production, and in the case of loans, that means (first) that lenders take a hit when loans go wrong. Though let’s assume lenders are free to insure against those losses. Second, it means that lenders forego consumption in order to enable borrowers to consume.

Commercial banks create money.

Then one day, commercial banks (just like goldsmiths in London 300 years ago) realize that where they wish to lend, but don’t have the necessary funds, that’s no problem. Like the goldsmiths in London 300 years ago who loaned out receipts for gold that didn’t exist, commercial banks can simply print their own money, or issue IOUs. Whether those IOUs come in physical paper form (e.g. £10 notes) or whether commercial banks are confined to issuing IOUs in book-keeping form (as has been the case in Britain since 1844) doesn’t matter.

Now there are a couple of problems with lending out privately created money. The first is that on the above assumptions (full employment equilibrium, etc) all those who want to borrow at the prevailing rate of interest will already have done so. Thus there would seem to be no market for commercial banks’ funny money.

Well there’s a simple solution to that problem. The solution stems from the fact that it costs nothing for private banks to create money – just as it costs counterfeiters almost nothing to print money. That is, a money printing private bank does not need to endure one of the above mentioned costs that lenders normally endure, namely foregoing consumption. I.e. if you can, in effect, print $100 bills and lend them out, well that’s nice work if you can get it. And private banks can indeed “get it”. (For more on that, see 2nd para of Ch 4 (p.31) here).

But that in turn gives rise to a problem, namely that people borrow money to SPEND IT, and that additional spending will be inflationary (given the above starting assumptions). Moreover, whoever receives that money will then have an excess stock of money and will try to spend it away, which adds to the inflationary pressure. Thus government has to implement some sort of compensating DEFLATIONARY measure. For example it could raise taxes and rather than spend the money it collects, and simply extinguish that money. (That’s actually the opposite of what governments have done in recent years, namely implement fiscal stimulus followed by QE – see the end of this article under the heading “Grab and extinguish” for more details on that)

An alternative deflationary measure would be for government to remove base money from circulation by borrowing money off the private sector. But to pay interest, government would have to grab money off the private sector via tax, and tax is not a free market phenomenon (which is not to suggest that tax is never justified). Either way, to counteract the inflationary effect of the money created by private banks, government has to rob taxpayers.

Let inflation rip?

Re dealing with the above mentioned inflationary effect of private money printing, there is actually an alternative to grabbing money off taxpayers, and that is simply to let inflation rip until the real value of base money has been reduced to near nothing and is almost totally replaced with privately issued money. George Selgin actually describes that process.

In that case it is existing holders of base money who are robbed or who subsidise private money creation, rather than taxpayers. But that robbery / subsidy is of course equally unjustified.

So the net effect is that taxpayers or savers subsidise private banks’ “print and lend out money” activity. And subsidies misallocate resources: they reduce GDP. So the conclusion is that we’d be better off if private money printing / creation was outlawed.

And that’s it. The rest of this article deals with possible weaknesses in the above argument plus there’s the “Grab and extinguish” section mentioned above and set out below.

An alternative free market scenario.

It could be argued that there’s a flaw in the initial assumptions above. That is, it was assumed that our hypothetical economy has a fiat style monetary base and that in turn assumes the existence of some sort of government and central bank to organise the monetary base, and governments and central banks are arguably not free market phenomena. OK, let’s consider what happens where there is no government apart from just enough “government” to maintain law and order.

In that scenario if private banks are free to print money units and lend them out, there’d be no constraint on inflation. Banks would just print away and when anyone entered a bank demanding something (like base money) in exchange for the bank’s “100 unit” notes, the bank would simply say: “There’s no base money. Go away.”

So that scenario is just chaos.

A gold monetary base.

Another and more realistic scenario is an economy where the accepted form of money is gold or some other rare metal. That was situation in Britain about 300 years ago when goldsmiths started hiring out gold receipts for non-existent gold.

To explain what’s wrong with those receipts, I’ll make some simplifying assumptions. First, assume no economic growth. Also most of the costs involved in running a business (cost of labour, fuel etc) are irrelevant to the argument here. I.e. the RELEVANT items are, 1, the sum borrowed, 2, the interest paid and 3, the asset bought with that borrowed money.

So let’s assume a private bank prints money and lends it to a business which simply buys an asset, say a house, and sits on that asset: it doesn’t even rent out the house.

The effect of that additional money (given the same starting assumptions as at the start of this article above) is inflation: i.e. the price of gold rises in terms of other goods.

Next, the holder of the bank’s funny money (probably the person who sold the house to our entrepreneur) turns up at the bank and asks for gold in exchange. But there’s a problem: the price of gold has risen in terms of other goods. Thus the bank has a problem: the value of its liability (gold) has risen in terms of the ultimate asset which underpins that liability, namely the house. Too much of that sort of thing would lead to the bank going insolvent. So I suggest that under a gold standard regime, commercial banks just wouldn’t go in for money creation. And certainly banks in the 1700s and 1800s when the gold standard prevailed, didn’t deliberately print money and lend it to borrowers to fund projects that produced a ludicrously low return on capital.

So under our “gold standard free market” scenario, private money printing just won’t take place.

The actual history.

However, in the 1700s and 1800s, the amount of privately issued money expanded by leaps and bounds. So how come?
Well I suggest the explanation is that the 1700s and 1800s were periods of unprecedented economic growth – at least in Europe and North America. And growing economies need a growing money supply. Enter private banks with their money printing activities stage left.

The alternative would have been to bar privately created money, which in turn would have meant deflation and falling prices, which in turn would have made it economic to expand the monetary base by digging up more gold.

But a gold monetary base suffers from a defect: the high real costs of producing gold. Thus private money printers in the 1700s and 1800s did perform a useful service: they obviated those “high costs”.

But that doesn’t mean that the best way of increasing the country’s money supply, given economic growth, is to have private banks print and lend out money. Reason is as follows.

The purpose of economic activity is to produce what people want, both by way of publicly produced items (roads, education, etc) and items people buy out of their disposable income (beer, cars, clothes, etc).

Thus when more money is required, there is no obvious reason to feed that extra money into the economy exclusively via more borrowing to fund investment than there is to feed it in via subsidies for cars, ice cream or lollipops, or just via spending more on education. Given that the basic purpose of the economy is to produce what people want (to repeat) and assuming there is scope for letting them have more of what they want, the logical course of action is give people more of what they want (in the case of publicaly produced items) or plain old cash (e.g. tax cuts) when it comes it items purchased out of disposable income. Moreover, employers will AUTOMATICALLY invest more when they see the additional demand stemming from tax cuts and more public spending. There’s no need for any artificial encouragement to invest.  As Jamie Galbraith put it, “Firms invest when they can make money, not when interest rates are low.”

To summarise and recap, while the private money printing that took place in the 1700s and 1800s did serve a purpose (obviating the cost of digging up gold), that doesn’t justify the printing of money by private banks.

Private money costs more to produce than public money.

A further weakness in the idea that an economy with a powerful government and central bank is not a free market economy is thus.

A free market is one in which the most efficient producers remain in business, while the less efficient go out of business. And private money creation is inherently costly compared to publicly created money. That’s because if a private bank is going to supply a customer with a stock of money, the bank has to check up on the credit-worthiness of the customer and quite probably take collateral off the customer. Then it has to check up on the value of the collateral.

And there are significant costs there. In fact the only reason banks charge borrowers more interest than the interest that banks pay those who fund them (depositors, bond-holders etc) is precisely those costs – plus something for profit. Those costs come to very roughly 2% pa of the relevant capital sum.

In contrast, the real costs involved in having the state print money are near zero. That is, if it is decided that stimulus is needed say in the form of QE, then creating the money to do that simply involves pressing a few buttons on a computer keyboard at the central bank. There’s no need to check up on anyone’s credit-worthiness.

To repeat, a free market is one in which the most efficient producers win, and the least efficient are driven out of business. Whether those producers are public sector or private sector is irrelevant. And it’s clear that money creation can be done more cheaply by the public sector than the private sector.

And if you want to know why, in that case, there is so much privately created money in circulation, the answer is that as soon as commercial banks have more base money than they need to settle up with each other they are then in a position to print and lend out money at below the going or free market rate of interest, as explained above. Indeed that’s exactly how central banks cut interest rates: by increasing the stock of base money.

Alternatively, if the economy is at capacity and private banks create and lend out money, that (to repeat) causes excess inflation, which forces the state to grab base money off the private sector. Indeed that’s exactly what happens when counterfeiters produce money: if there were no counterfeit money and counterfeiters managed to print and put their own money into circulation to the tune of X% of the money supply, then government would have to grab money off the private sector to the tune of roughly X% of the money supply to forestall inflation.

Private money as a by-product of lending.

Another potential flaw in the first third of this article is that money creation by private banks is arguably a free by-product of lending. Indeed there’s that popular phrase: “loans create deposits”. Put another way, it could be argued that the costs of private money creation (checking up on credit-worthiness etc) are costs involved in making a loan, not costs involved in creating money.

The answer to that is that’s impossible to say (without some detailed research) exactly how far borrowers are simply after a stock of money with which to do day to day business, and in contrast, how far they are after long term loans, e.g. mortgages. Certainly a significant proportion of the population has no desire to borrow, but obviously DOES WANT a stock of money. Thus attributing the costs of money creation JUST TO lending is not realistic.

For more details on the point that no long term debt to a bank is involved where the bank simply supplies a customer with money for day to day transactions, see here.

A low interest rate scenario.

Having said above that private money creation enables private banks to make loans by undercutting the going rate of interest, an exception to that comes where the free market rate of interest has dropped to very low levels, as seems to have happened recently. Indeed, interest rates have been falling for twenty years or so. In that case the scope that private banks have for undercutting the going rate of interest is much diminished. And that helps explain why in recent years there has been a huge increase in the amount of base money, but very little inflation as a result.

“Grab and extinguish”.

I claimed above that where the state grabs money off the private sector via tax and extinguishes that money, that’s the opposite of the fiscal stimulus combined with QE that has been implemented in recent years. The reason for that is quite simple and is thus.

Fiscal stimulus consists of government borrowing $X, spending that back into the economy and giving $X of bonds to those it has borrowed from. QE consists of the state printing money and buying back those bonds. So the net effect is: “the state prints money and spends it”.

“Grab and extinguish” is the opposite of that. I.e. the state, instead of spending money into the economy, takes money AWAY FROM the economy and “unprints” it, i.e. extinguishes it.


Letting any private sector entity print or create money is a subsidy of that entity because taxpayers have to be robbed to prevent the inflation that would otherwise occur. That point applies both to respectable private banks and backstreet counterfeiters.  In other words it doesn’t matter whether the private sector money creator LENDS OUT the money created or whether it simply spends it (which is what counterfeiters do): in both cases taxpayers subsidise the private money creator.

Subsidies mis-allocate resources and thus reduce GDP. Ergo private money creation / printing should be abolished.

Monday, 7 March 2016

Genius idea from Wolfgang Munchau in the FT.

His idea is for the ECB to buy up non-performing Eurozone bank loans: i.e. have taxpayers bail out incompetent banks. Pure genius.

I’ve got a better idea: have taxpayers bail out EVERY loss making firm. Think of the number of jobs saved! Europe’s unemployment problem would vanish in no time.

Why did no one think of this before?

Saturday, 5 March 2016

What’s Mervyn King on about?

Meryn King, former governor of the Bank of England, has just published a book, entitled “The End of Alchemy….”. And one of the central objectives of the book, as the title implies, is to end alchemy. So what does he mean by “alchemy”? Well this is his (rather long complicated) definition:

“By alchemy I mean the belief that all paper money can be turned into an intrinsically valuable commodity, such as gold, on demand and that money kept in banks can be taken out whenever depositors ask for it. The truth is that money, in all forms, depends on trust in its issuer. Confidence in paper money rests on the ability and willingness of governments not to abuse their power to print money. Bank deposits are backed by long-term risky loans that cannot quickly be converted into money. For centuries, alchemy has been the basis of our system of money and banking. As this book shows, we can end the alchemy without losing the enormous benefits that money and banking contribute to a capitalist economy.”

Notice that phrase “As this book shows, we can end the alchemy…”. It certainly seems that one of the central objectives of the book is to end alchemy. Indeed that point is repeated elsewhere in the book.

Well now, I’d imagine that the more astute half of the population are already aware that if everyone with money in their bank tried to withdraw it all at once, the first problem is that banks just wouldn’t be able to supply that money: banks would immediately go insolvent. And the more astute half of the population is also aware that that’s not too much of a problem because the chance of everyone or even a largish proportion of depositors trying to withdraw all their savings at once is so remote that we can forget about it. Plus that half of the population will also be aware that it would be impossible to turn “all paper money” into gold or anything else of real value at the drop of a hat.

So as far as that half of the population goes, alchemy doesn’t exist. That is, there just isn't a “belief” to use King’s phraseology, that all paper money can be turned into gold at the drop of a hat or that everyone can withdraw all their savings at once from every bank in the country.

As for the less astute half or so of the population, if they think everyone really can withdraw all or most of the money they’ve deposited at banks without there being a problem, what of it? Unless there’s some sort of major loss in confidence in ALL BANKS, that mass withdrawal just won’t happen. So as far as that less astute half of the population goes, what’s the big problem with alchemy? The truth is that there just isn't a problem.

And the above material all appears in the opening pages of the book. Well that’s not a good start to the book!

But that’s not to say the bank system is totally without problems – to suggest that would be obviously absurd. Moreover, there certainly is a problem which is roughly speaking related to King’s non-existent alchemy problem. That is, banks are in the business of “borrow short and lend long” and with a view to maximising profits, they tend to borrow as short as possible and lend as long as possible. When that process is taken too far, some banks can’t meet their liabilities as they fall due. They are then insolvent.

So the problem is not, as King suggests, that banks are unable to turn ALL THEIR liabilities into gold or something of real value at the drop of a hat. The problem is that some banks get into the position where they can’t turn QUITE ENOUGH of their liabilities into something of real value, or something that their creditors regard as being of real value.

Lehmans was a classic example. As I understand it, Lehman’s liabilities did not exceed its assets when it went under. It’s problem was that it couldn’t turn the assets into cash fast enough to satisfy its creditors.

Wednesday, 2 March 2016

The Independent spouts nonsense on house building.

Their article argues that because house builders keep a stock of land with planning permission over and above what they need immediately, that therefor they are artificially raising house prices. Two flaws in that argument.

First, it is perfectly normal in most industries to keep a bigger stock of raw materials and other inputs than is needed in the immediate future. Reason is that it makes sense to have that stock available to meet sudden increases in demand or failures by raw material suppliers to supply on time.

Second, in a genuinely competitive market, it just ain’t possible to artificially raise prices with a view to earning above normal profits. One producer can cut output with a view to raising prices if they like, but other producers are likely to immediately cash in on any rise in prices and profits. And given the number of different house builders, I’d guess the house building industry is reasonably competitive.

Tuesday, 1 March 2016

Five arguments against negative interest rates.

First, they induce the cash rich to buy stuff they don’t really want with the sole objective of disposing of cash. A minor example of that is the rise in demand by households for safes in Japan: bought with a view to storing physical cash. That’s similar to Keynes’s tongue in cheek idea for creating employment, namely putting cash in bottles and burying them underground, and then paying people to dig them up again.

In contrast, helicopter drops, assuming they’re distributed fairly widely among the population enable the less well-off to buy stuff they DO WANT OR NEED.

Second, the idea that heavy reliance should be put on interest rate adjustments is debatable because there is no prima facie reason for thinking that given a recession, it’s primarily a shortage of INVESTMENT spending that’s to blame, rather than a shortage of household or CURRENT spending or government spending.

And even if it’s determined that a drop in investment spending IS TO BLAME, there is then the question as to whether that drop is justified or not: corporations may have cut their investment spending for perfectly good reasons. Thus ideally the authorities need to do a lot of research to determine whether that drop is justified. Of course the authorities never do that research. And if they did, it might not be possible to come up with a definitive answer.

So why not just boost demand for ALL GOODS AND SERVICES (public and private), and leave it to employers to decide for themselves whether that increased demand warrants more investment? Or do we take it that bureaucrats working in central banks and treasuries know more about the optimum amount to invest in the chemical industry than chemical engineers with twenty years’ experience?

Third, adjusting interest rates with a view to adjusting demand might make sense if the desired effect (i.e. change in spending) was much quicker in the case of interest rate adjustments than in the case of tax cuts or increases in public spending. However the lags seem to be about the same in both cases.

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

Fifth, there is empirical evidence that the effect of interest rate adjustments is not impressive. See here and here. In particular, the second of those backs Galbraith’s point.


P.S. (an hour after publishing the above). The above mentioned increase in demand in Japan for safes is not of course PRIMARILY motivated by the desire to turn cash into physical assets (i.e. safes). The main motive is to dispose of money held in digital form in banks and turn that into physical cash.

Also: a sixth flaw in negative interest rates is thus. As interest rates fall, it obviously becomes viable to make investments that produce lower and lower returns on capital. This process (at least in theory) becomes absurd when rates go negative. Reason is that it is then possible to make investments which produce a NEGATIVE return on capital: that's investments which actually destroy wealth rather than produce wealth.