Saturday, 30 July 2016

Do private banks make seignorage profits?

The word seignorage is not defined in exactly the same way in every dictionary. But the word will be used here to refer to the profit that is made by a money issuer or money printer .

The simplest and crudest example is the profit that a backstreet counterfeiter makes: counterfeiters print bits of paper and use them to buy goods and services of real value. Nice work if you can get it.

Governments (and/or their central banks) do much the same: they create new money and use that to buy infrastructure investments, schools, war ships and so on. Of course no one objects to the seignorage there because the latter assets are shared by the community at large.

Certainly where recipients of that money are prepared to hold the money without demanding interest (and holders of £10 notes, $100 bills don’t get interest), government makes a seignorage profit. As to where government has to pay interest to recipients of that money, then essentially government funds its spending by borrowing, and there is no real seignorage profit.

Fontana and Sawyer.

Commercial banks certainly create money, but are they also into seignorage?

Messers Fontana and Sawyer claim in a recent paper entitled “Full Reserve Banking: More ‘Cranks’ Than Brave Heretics” that commercial banks do not enjoy seignorage.  As they put it, “Graziani (2003, pp. 58–66), among others, has explained that no agent involved in the loans supply process has a seigniorage privilege: not businesses, not households, and certainly not commercial banks.”

Fontana and Sawyer do not actually produce any detailed reasons as to why commercial banks do not enjoy seignorage. Instead, as the above passage implies, they rely on a long passage in a book by Augusto Graziani – “The Monetary Theory of Production”. So let’s consider Graziani’s arguments.

The first glaring weakness in Graziani’s argument is that he DEFINES money, or at least his ideal form of money as something that does not involve seignorage!

Well I can prove that boats don’t float using my own special definition of the word boat which is something like “anything that sinks”!

The relevant words of Graziani’s are (his p.60), “A real money should satisfy three main characteristics . . .”. And one of these is that “the use of money must be so regulated as to give no privilege of seigniorage to any agent.”

Moreover, since governments clearly enjoy seignorage, it would seem that Graziani does not regard base money as money, which is strange idea. Last time I tried buying stuff with £10 notes, the shop accepted by £10 notes!

Graziani’s basic argument is that the simple / basic / obvious activity of banks involves no seignorage, which is correct. That basic activity is that a bank creates and lends money to person X as needed so that X can pay Y for goods or services supplied. Y then deposits the money at Y’s bank, which in turn demands payment (in the form of base money) from X’s bank. Clearly there is no seignorage profit there for either bank.

In the case of private banks, it is much less clear whether and if so how they make seignorage profits. However, Huber (2000) explains pretty clearly how they do it in this simple illustration.

“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. So their profit on this part of their business is not, say, 9% credit-interest less 4% debit-interest = 5% normal profit; it is 9% credit-interest less 0% debit-interest = 9% profit = 5% normal profit plus 4% additional special profit. This additional special profit is hidden from bank customers and the public, partly because most people do not know how the system works, and partly because bank balance sheets do not show that some of their loan funding comes from money the banks have created for the purpose and some from already existing money which they have had to borrow at interest.”

Of course private banks do not lend to one lot of borrowers at the free market rate and to another lot at the artificially low rate that comes from lending out freshly printed money, as is rather suggested in Huber’s simple illustration. Rather, private banks use the freedom to print money to lend at a lower rate than would otherwise obtain, and that expands the total amount of lending they do. The profit derived from that extra business is certainly seignorage profit of a sort: i.e. it is profit derived from money printing.

Friday, 29 July 2016

Interest rate adjustments are absurd. Negative rates just compound the absurdity.

Whence the assumption that given inadequate demand, the cause is inadequate demand for investment goods? I.e. whence the assumption that demand should be increased by encouraging more lending and investment?

I mean before cutting interest rates, do central banks do detailed surveys of employers’ current use of capital equipment and actually PROVE that not enough of such equipment is being used? Of course not.

Moreover, the idea that central bank staff know more about the optimum amount of capital equipment to use in for example the chemical industry than qualified chemical engineers with twenty years experience is absurd.

Of course if demand falls to inadequate levels, employers will cut back on investment spending, plus interest rates will fall. But whence the assumption that employers have not cut back on investment spending to an extent that is entirely rational in view of those two factors? The most reasonable assumption is that employers, including chemical engineers, have got their sums right, and hence that no additional and artificial cut in interest rates is needed.

I.e. the most reasonable assumption is that given an increase in demand for ALL goods and services, employers will increase investment spending as appropriate.

Provisional conclusion: in case you didn’t already know it, you’re living in la-la land. Or put another way, the emperor has not clothes.

The free market.

With a view to seeing what WOULD BE the best way to increase demand, let’s consider what a perfectly functioning free market would do about inadequate demand, i.e. excess unemployment. Obviously the free market is not always a perfect system: there are certainly specific areas where it goes wrong. But I do have some faith in it. Indeed the economists and politicians who think they know better than free markets turn out to be wrong half the time.

In a totally free market, given excess unemployment, wages and prices would fall. That raises the real value of money (base money in particular). That increased stock of money in real terms encourages more spending. That effect is known as the “Pigou effect” (after the economist Arthur Pigou).

 Of course the Pigou effect does not work too well in the real world because (as Keynes righly pointed out) wages are “sticky downwards”. Thus as an alternative (and as I think Keynes pointed out), why not increase the stock of MONEY UNITS (pounds, dollars, etc), rather than try to get the increased stock by increasing the value of each unit?

Increasing the number of units equals helicopter money, which in turn comes to very nearly the same thing as fiscal stimulus funded by new money rather than by government debt - or if you like, the same thing as fiscal stimulus plus QE.

Incidentally, where the monetary base takes the form of gold or some other rare metal, a fall in demand to inadequate levels would cause the price of gold to rise relative to other other goods, which in turn would induce gold miners to produce more of the stuff. Thus in that scenario, the free market’s response to inadequate demand is to increase the total value of the monetary base BOTH via increasing the number of units (ounces of gold or whatever) and via increasing the value of each unit.

The above argument is very near to saying that inadequate demand should be tackled by fiscal stimulus funded by new money, which would be a bit of a change from current arrangements. But don’t worry about that. The best way implement that “fiscal stimulus funded by new money” was set out in the submission to the UK’s Vickers Commission authored by Positive Money, the New Economics Foundation and Prof Richard Werner.

The DIFFERENCE BETWEEN “fiscal stimulus funded by new money” and simply increasing the value of the monetary base (a la free market) is that in the latter case no stimulatory effect comes from extra spending INITIALLY: that is, the extra spending is a SECONDARY effect of increasing the total value of the stock of money. Still, there isn't a huge difference between those two ways of increasing demand, and they both make more sense than interest rate adjustments, as indeed is argued in the latter submission.


PS. (31st July 2016).  Recent evidence that interest rate adjustments don’t have much effect:

Plus (14th August 2016), see this "anti monetary policy" letter by several economists in The Guardian: .

Monday, 25 July 2016

Five videos on banking.

The first two are light hearted but quality stuff all the same. Prof Anat Admati, who specialises in banking, makes an appearance. These five videos were brought to my attention by Jack Haze, who works for a bank in the US. 

I couldn’t fault the first video (the pair are actually a two part series). The second half of the second one made claims which I thought were true, but were not actually substantiated in the video. But that’s a minor blemish.

The third video is high quality stuff - apart from the poor sound quality for the first minute or so. It’s a presentation done for the Swiss CFA Society, by Prof Dirk Niepelt (University of Bern). It examines the Swiss Vollgeld initiative, i.e. the idea being pushed in Switzerland (and indeed in many other countries) that commercial banks should not be allowed to print or create money: “full reserve banking” (FR) as it is normally called. Niepelt concludes that FR could work, but he claims it would have significant problems.

However, he ends by making an odd claim, as follows.

He says he doesn’t like the idea of FORCING those with bank accounts to make the stark choice that FR forces bank account holders to make. That’s the choice between putting money into, first, a totally safe but zero interest earning account, and second, an account where interest IS EARNED, but account holders have to bear the costs if things go wrong with the bank (or where the particular type of loan chosen by the account holder (e.g. mortgages) goes wrong.

Instead, so he says, central banks should offer totally safe accounts for those who want them (perhaps managed by commercial banks). That’s actually something the Bank of England is contemplating and which Positive Money backs. And indeed those accounts would be just the same as the safe accounts contemplated by advocates of FR.

As to those who want a decent rate of interest, so Niepelt says, they could have accounts like existing bank accounts (where money is loaned on to mortgagors, small businesses, etc), but those account holders would bear the cost if things go wrong.

Now hang on: a system where account holders bear the costs when things go wrong is exactly what the advocates of FR argue for!!!!! In short, I’m puzzled as to what the difference is between Niepelt’s system and FR.

The final two videos are also produced by the CFA, but I’ll deal with those in a day or two. Relevant links:

Sunday, 24 July 2016

A blunder by “professional” economists.

Ever read something by a professional economist, full of the usual impressive jargon, then your jaw drops: you suddenly realise they have no grasp of the BASICS? Here’s an example.

In the Cambridge Journal of Economics paper by Malcolm Sawyer and Giuseppe Fontana referred to above, the authors (S&F) don’t appear to understand that when a central bank creates money and government spends it, that that money ends up in private sector bank accounts. You’d think that was a simple enough point, wouldn’t you? But S&F say:

“…it is not clear where the prior savings alluded to by Daly and other advocates of full reserve banking have come from. It is technically impossible for banks as a whole to collect deposits without at the same time granting loans for the same amount. Therefore, at least initially there must have been a process of credit creation in the economy, which was completely unconstrained and unrelated to pre-existing resources.”

Technically impossible for banks to collect deposits without at the same time granting loans???  Whaat?? Let’s run thru this V-E-R-Y S-L-O-W-L-Y.

Helicopter drops.

In the case of a helicopter drop (to take just one example), that involves the central bank creating new money out of thin air, which money is then spent in some way or other. For example the CB could just send a cheque to every household in the country, which, contrary to the “technical impossibility” referred to by S&F, results in households’ bank accounts being boosted.

Another alternative is for the CB to give the money to government / the treasury, which then spends the money (and/or cuts taxes). In that case, as well, new money boosts private sector bank accounts.

Standard fiscal stimulus.

In contrast to helicopter drops, there is standard fiscal stimulus. That consists of government borrowing $X, spending $X (and / or cutting taxes), and giving $X worth of bonds to those it has borrowed from. However, that on its own is likely to raise interest rates, which the CB is unlikely to allow assuming there really is a recession which justifies the fiscal stimulus. Thus the CB is likely to print a fair amount of money and buy back some of the latter bonds. Indeed, over the last five years or so, and as a result of QE, the Bank of England bought back ALMOST ALL the new bonds issued by government.

And that all nets out the same thing as a helicopter drop, i.e. “the state prints money and spends it and/or cuts taxes”.

So, as in the case of a helicopter drop, new money is created by the state and fed into the private sector, which (gasps of amazement) boosts private sector bank balances.

As for S&F’s point that “. Therefore, at least initially there must have been a process of credit creation in the economy, which was completely unconstrained and unrelated to pre-existing resources”, well yes: S&F are right there. There is indeed a “process of credit creation” which is “unrelated to pre-existing resources”. It’s the CB and its money printing operations!! Doh!

Hope that’s clear, children. Hope it’s also clear that Sawyer and Fontana don’t have much of grasp of the basic book-keeping entries done by central and commercial banks – not that S&F are the only so called “economists” who don’t have a grasp of the basics.


(P.S. The inclusion of the tweet above by Positive Money should not be taken as a suggestion that PM agrees with the above article.


Thursday, 21 July 2016

Morgan Ricks’s criticism of full reserve banking.

Ricks is an associate law professor at Vanderbilt Law School who specialises in financial regulation. A recent paper entitled “Safety First? The Deceptive Allure of Full Reserve Banking” claims to set out a fatal flaw in full reserve (FR).

On the plus side, the paper is short and clearly written, and Ricks has a good grasp of the potential problems with FR.

However, the alleged fatal flaw is easily dealt with in principle: indeed the flaw was clearly recognised and fully dealt with in the submission to the UK’s Vickers Commission by Positive Money, the New Economics Foundation and Prof Richard Werner five years ago. The alleged flaw is also fully dealt with in other literature by the latter three authors. (I’ll refer to the latter three authors, and the latter submission and other relevant literature produced by those three authors simply as the “Vickers authors”.)

The layout of Ricks’s paper.

Ricks claims there are two basic flaws in FR, the first of which is non-fatal, while the second is allegedly fatal. The first or “non-fatal” flaw is thus.

Under FR, the private sector, banks in particular, are banned from issuing or “printing” money: an activity they engage in under the existing bank system (sometimes called “fractional reserve banking”). Instead, all money is issued by the state. But as Ricks rightly explains, financial institutions would try to circumvent that ban. However, since, as he says, that problem can be dealt with (a point I agree with), I won’t consider that point further here.

As to the second and allegedly fatal flaw, Ricks calls that “fiscal-monetary entanglement”, and it consists of the fact that under FR, when it is necessary to increase the economy’s stock of money, that money must first be created and spent into the economy (and/or taxes must be cut).

But as Ricks rightly points out, there is an obvious problem there, namely that the need for stimulus is then dependent on the whims of a bunch of people known as “politicians” whose knowledge of economics is hopeless. And that’s doubtless putting it too politely. Plus even in that politicians ARE economically literate, they sometimes devote more effort to squabbling with each other than making sure there’s enough demand to keep as many people employed as possible (particularly in the US).

Well there’s a simple solution to that problem, at least it’s simple in principle, and the solution (to repeat) was set out by the three Vickers authors. The solution is to have the central bank, or some independent committee of economists responsible for the AMOUNT of stimulus (i.e. the AMOUNT of new money created and spent (net of taxes) into the economy, while politicians retain control of obviously POLITICAL decisions like what proportion of GDP is allocated to public spending and how that spending is split between law enforcement, education, defence and the various other items that governments spend money on.

To illustrate, where there is no government borrowing, politicians would decide the proportion of GDP to allocate to public spending and would collect tax to cover that spending, while the latter committee if it though $Xbn of new money should be created and spent net of tax would tell politicians as much, and politicians would get on with spending that extra money, or cutting taxes by that amount, or would go for some mixture of spend and tax cut.

And that of course is a large and fundamental change to the split of responsibilities as between central banks on the one hand and politicians / treasuries on the other. But there is nothing the least undemocratic about it. I.e. the change is (to repeat) simple in principle, though actually getting that change in place might involve political problems (more so in the US than Europe, at a guess).

Government debt.

There’s a somewhat incidental point that Ricks considers and doesn’t get quite right. It’s thus.

As he rightly says, one way to feed extra money into the economy (indeed a commonly used way under the EXISTING system) is to have the central bank buy government debt. But what if there is no government debt – a possibility considered by Irving Fisher and Milton Friedman who were both advocates of FR? Well there’s a very simple solution to that problem, a solution which has been widely discussed in the last year or two: helicopter drops!

Of course helicopter drops are not democratic in that they give an unelected body, the central bank, the right to take a POLITICAL decision, i.e. whether to spend freshly created money on handouts to taxpayers or handouts to the less well off, or whatever. In short, if we’re going to have anything resembling a helicopter drop, it should take the form advocated by above Vickers authors, namely (to repeat): the central bank or some committee of economists decides on the AMOUNT of new money to be created and spend net of tax, while politicians decide the exact nature of that spending.

Thus the Vickers authors’ solution works both where there is government debt and where there isn't.

Milton Friedman and Hyman Minsky.

Not only does Ricks go off the rails in connection with government debt, but Friedman and Minsky did as well! At least according to Ricks, both Friedman and Minsky thought that government debt was essential or at least desirable in order for FR to work, because (allegedly) extra money is fed into the  economy by having the central bank buy that debt.

Well that’s an odd claim for Friedman to make, given that it was Friedman who was one of the first to advocate helicopter drops – a system which (to repeat) requires no government debt!

And a final reason for attaching little importance to government debt is that (as pointed out by advocates of Modern Monetary Theory and Martin Wolf (chief economics commentator at the Financial Times)) government debt and base money are almost the same thing. Thus swapping one for the other has almost no effect. Indeed, QE consists precisely of the latter “swap”, and as we’ve discovered, QE does not have a huge effect (something predicted before QE was implemented by a few clued up individuals, including yours truly).

Thus government debt will be ignored for the rest of this article.

Is a big change in central bank / treasury responsibilities needed?

Given that FR requires the above big change in the responsibilities of central banks, treasuries and politicians, it’s reasonable to ask whether in that case the change to FR is worth it.

Well the answer to that is that those changes have big merits even if we do not convert to FR, and the rest of this article explains why. I’ll run thru various problems with the existing system which need dealing with quite apart from FR.

1. Under the existing system, we have TWO entities that are able to implement stimulus: the central bank and treasuries. That makes as much sense as a car with two steering wheels controlled by a husband and wife having a row. In contrast, under FR (to repeat) just ONE entity decides the AMOUNT of stimulus, while the other, treasuries plus politicians, decides on the NATURE of any extra spending net of tax.

That system would hopefully put an end to the absurdity we have seen in recent years where Congress refuses to implement enough fiscal stimulus because a bunch of economic illiterates (politicians) are too busy squabbling amongst themselves on the question as to whether to raise or cut taxes and public spending.

The Nobel laureate economist Jan Tinbergen framed a principle on the subject of just one entity or system dealing with each problem. His principle was roughly to the effect that for each policy objective, one policy instrument is needed and one only.

2. To repeat, as Ricks rightly points out, to get more money into the economy under FR, there has to be fiscal stimulus first. That rather implies a downgrading of the main alternative form of stimulus, namely interest rate adjustments (though it wouldn’t rule out such adjustments, far as I can see).

Well that point is fully dealt with by the three Vickers authors. As they show, interest rate adjustments are a very defective tool. We can well live without them. Moreover, I suggest the optimum or GDP maximising rate of interest is the free market rate: i.e. what’s the state doing interfering with that rate?

3. Another popular objection to the change in responsibilities needed to facilitate FR is that the central bank (or the above mentioned independent committee) then has the power to over-rule stimulus decisions taken by democratically elected politicians, and that’s allegedly not democratic.

Well the simple answer to that is that an independent central bank ALREADY HAS that power: that is, an independent central bank can implement interest rate changes which negate fiscal stimulus (or lack of) which the central does not approve of. Indeed, Scott Sumner has made much of that point, for example in an article entitled “Why the fiscal multiplier is roughly zero”. He claims (if I’ve got him right) that fiscal stimulus is near useless because the central bank will simply overrule any fiscal stimulus it thinks inappropriate.

I think that’s taking the point too far, but certainly there’s no doubt that under the EXISTING SYSTEM, an independent central bank can negate fiscal stimulus.

P.S. (22nd July, 2016)  There is more discussion of Rick’s ideas in this Seeking Alpha article authored by Martin Lowy.

Tuesday, 19 July 2016

The existing bank system pushes up house prices?

Positive Money keeps claiming that the existing bank system (sometimes called “fractional reserve banking”) pushes up house prices. E.g. see this video

The basic argument is that private banks create money out of thin air and lend it to whoever (mainly mortgagors) and that “freedom to print” pushes up house prices.

Well the first flaw in that argument is that our bank system has remained unchanged for about two hundred years – at least in the sense that private banks can print money. Thus that right to print does not explain the recent and very steep rise in UK house prices. (House prices in the UK have approximately DOUBLED IN REAL TERMS over the last twenty years).

Moreover, other countries around the world have the same bank system, yet in some of them (e.g. Germany and Switzerland), house prices have remained STABLE in real terms over the last twenty years. (See The Economist house price index for figures on house price increases in different countries).

And that rather makes it look like SOMETHING ELSE is behind house price increases in the UK. I suggest immigration plus a reluctance by local authorities to release enough land for house building are two important factors, but I won’t go into detail on that point.

House price volatility.

Note that house price VOLATILITY is not the same thing as long term house price increases. That is, there is no question but that private banks act in a pro-cyclical manner: i.e. they print and lend out money like there’s no tomorrow in a boom and thus exacerbate the boom. And come a recession, they do the opposite, namely call in loans, which exacerbates the recession.

Indeed, it strikes me that banks DO exacerbate house price volatility, but they DO NOT boost house prices in the long term.

Elasticity of supply and demand.

Another point which casts doubt on the whole idea that lending by private banks exacerbates house price increases is that the price of a commodity WILL NOT rise, give increased demand, if supply is elastic. In the case of housing, that means that if the price of timber, bricks, concrete etc and the wage demanded by bricklayers, plumbers etc does not rise in the long term given increased demand for housing, then the price of houses WILL NOT rise even if there is increased demand for housing.

The input involved in house construction which MIGHT RISE given increased demand for housing is LAND. A semi-plausible reason for saying that is the supply of land is limited, thus increased demand might raise the price of land. And indeed the price of land with permission for use for housing has rocketed in the UK in recent decades relative to the price of agricultural land.

But in fact even in the UK, one of the most heavily populated countries in the World, there’s no basic shortage of land. That is, the explanation for the steep rise in the price of land with permission to build on is (to repeat) reluctance by local authorities to grant that permission (partly down to the activities of so called “NIMBIES”, i.e. people nice houses in the country who understandably do not want large housing developments near where they live – “Not In My Back Yardies”)

As for bricks and concrete, the UK is not about to run out of clay for making bricks, not is it about to run out of gravel for making concrete, far as I know.

So the conclusion is that the supply of housing in the long term is pretty elastic, thus even if our bank system DOES INCREASE demand for housing, that shouldn’t raise house prices all that much.

Malcolm Sawyer discovers that bank loans create money and repayments destroy it.

Congratulations to Malcolm Sawyer (former professor of economics at Leeds in the UK) for his “discovery” that money is created when a bank grants a loan, and that money is destroyed when a loan is repaid.

That’s the gist of this recent paper of his. The “gist” is of course hidden underneath a pile of the sort of pseudo technical verbiage that academics usually deploy to hide the fact that they aren’t saying much.

The above point about money creation and destruction is second nature to the more clued up supporters of Positive Money and advocates of Modern Monetary Theory.

Friday, 15 July 2016

“Job Guarantee” nonsense.

Job Guarantee (JG) is a popular idea: it’s been around for centuries. Basically it’s the idea that there are numerous jobs or tasks that need doing, thus government can put the unemployed to work doing those tasks. The Work Project Administration (WPA) in the US in the 1930s was just one example of JG. And certainly JG could be used to totally abolish unemployment if we’re prepared to see the unemployed doing very menial jobs.

To illustrate with an extreme example, we could just tell the unemployed their unemployment benefit is henceforth conditional on their walking up and down their street keeping it free of litter. Anyone refusing would be deemed not to be unemployed on the grounds that they had refused work. Hey presto: unemployment vanishes.

The idea actually goes back to Pericles in ancient Athens around 2,500 years ago: he put unemployed Athenians to work on public construction projects.

Unfortunately most of the advocates of JG are a bit naïve: they’re oblivious of the basic problems involved. And that helps explain why most JG type schemes end up as an expensive mess and get abandoned a year or two after being set up: those organising them have little idea what they are doing  - which is not to say JG has no future at all.

Certainly most members of the general public who opine on this subject are clueless. Unfortunately most of the academics who write on the subject aren’t much better. There’s a collection of academics who advocate JG at the University of Missouri  - Kansas City. No names mentioned!!! But if you Google UKMC and JG you’ll find loads of material.

Rate of pay for JG work.

Most advocates of JG gayly advocate generous rates of pay for JG without any apparent awareness of the fact that generous pay destroys the incentive for JG employees to seek normal jobs. That means labour supply to the existing labour market is reduced. That’s inflationary, so demand has to be cut (e.g. via increased interest rates), which raises unemployment! Hardly the object of the exercise!!!

Hire out JG people to existing employers?

Another basic question JG advocates fail to address in any detailed way is whether JG employees should be employed in specially set up. projects (a la WPA), or whether those employees should be hired out to existing employers. Well there’s a big problem with the former option, namely that skilled permanent labour has to be hired to actually run such projects – unless those employed on those projects are to consist just of the recently unemployed (who tend to be relatively unskilled). That’s just a recipe for grossly inefficient forms of employment.

The above naïve advocates of JG might answer the latter point by claiming that some WPA work was relatively efficient (which it was). The answer to that is that the WPA was implemented at a time of catastrophically high unemployment: a scenario where there is a decent availability of skilled labour from the ranks of the unemployed. But the solution to very high unemployment is a straight rise in demand, not JG. I.e. JG comes into its own precisely where there is a shortage of skilled labour amongst the unemployed.

But if skilled labour is taken from the existing workforce, then relatively productive jobs are destroyed, and replaced with the relatively unproductive jobs that inevitably make up JG schemes. Thus “specially set up” projects as per the WPA are a nonsense.

In contrast, if JG people are subsidised into jobs with existing employers, a better mix of skilled and unskilled labour is obtained. But the majority of the advocates of JG haven’t the faintest inkling of the latter problem.

Public or private sector jobs?

Another basic question normally ignored by JG advocates is whether JG schemes should consist just of public sector type jobs (as per the WPA and as per Pericles’s JG scheme), or whether JG people should be hired out to private sector employers as well.

Well suppose there were two schools that were identical in every respect, except that one was private and one public. If JG was confined to the latter, the reason for doing so absolutely has to be POLITICAL rather than economic. I.e. there is no economic reason for not allowing private employers to take on JG employees. And in fact the UK’s JG scheme (or at least the nearest thing to JG currently operating in the UK) hires out the unemployed to private sector employers). That’s the so called “Work Programme” – which incidentally seems to be horribly expensive to administer (perhaps because too many go-gooders have had a hand in its design).


Another problem with JG is this: to what extent do JG people simply displace normal employees? Well there’s guaranteed to be SOME displacement: i.e. employers are bound to some extent to use temporary, JG, i.e. not desperately skilled employees as substitutes for normal or fully viable employees. However, if employers know they can only have any given JG employee for a limited period, the displacement shouldn’t be too bad: employers will tend not to classify genuinely productive employees as temporary JG people because employers like to hang on to productive employees. In contrast, they don’t mind relatively UNPRODUCTIVE employees disappearing to another employer or to unemployment.


My cynical conclusion is that JG might be worthwhile if the existing and very naïve advocates of the idea have nothing to do with it!

Tuesday, 12 July 2016

Seigniorage profits made by private banks.

Seigniorage is defined in the Oxford Dictionary of Economics (2009) as “The profits made by a ruler from issuing money”. I suggest the word “ruler” is superfluous there. I.e. seigniorage is the profit made by ANYONE who issues or prints money, including for example, a backstreet counterfeiter. At any rate, I’ll use the word in the latter sense.

As to how backstreet or traditional counterfeiters make a profit, that’s obvious enough: they print $100 bills for example and buy consumer goodies with those bills. I.e. they get $100 worth of real goods in exchange for a piece paper. Nice work if you can get it.

But private banks also issue a form of money. As the opening sentence of a Bank of England article entitled “Money creation in the modern economy” puts it, “This article explains how the majority of money in the modern economy is created by commercial banks making loans.”

However, private banks clearly do not do the same thing as traditional counterfeiters: use the money they create to buy consumer goodies. Instead, they lend out that money at interest.

So is there any sort of seigniorage profit there? Well the answer is: yes. The way that profit comes about was explained in a rather stylized way by Messers Huber and Robertson 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. So their profit on this part of their business is not, say, 9% credit-interest less 4% debit-interest = 5% normal profit; it is 9% credit-interest less 0%debit-interest = 9% profit = 5% normal profit plus 4% additional special profit. This additional special profit is hidden from bank customers and the public, partly because most people do not know how the system works, and partly because bank balance sheets do not show that some of their loan funding comes from money the banks have created for the purpose and some from already existing money which they have had to borrow at interest.”

That explanation by Huber and Robertson is unrealistic, and doubtless deliberately so. Banks do not of course lend to the majority of borrowers at the normal rate, and lend to another lot at 4% less than the normal rate. Rather, the ability of private banks to create a certain amount of new money almost every year enables them to lend at a lower rate than if they had to obtain money the way most of us do: doing some sort of work and saving up.

And no doubt competition between banks means that lower rate is enjoyed to some extent by borrowers rather than all of it going straight to banks’ bottom line.

But the fact remains, that private banks’ freedom to print money benefits those banks, and those they lend to.

So who loses out?

There are no free lunches in this world. I.e. the latter extra profit for banks and borrowers must come from somewhere. And where it comes from is not too difficult to work out.

Assume, just to keep things simple, that the economy is at capacity (i.e. full employment) prior to private banks being granted the right to create money. Assume that banks are then granted the latter right. The extra lending will boost demand. But that’s not permissible without inflation rising too much, given the above assumption that the economy is already at capacity.

So to counteract the inflationary effect of that new borrowing, government would have to implement some sort of DEFLATIONARY measure, like raising taxes or cutting public spending. In that case, those paying for the above increased bank profits and reduced interest for borrowers would be taxpayers or the recipients of public spending.

An alternative would be for the central bank to raise interest rates. But to do that, taxes would have to be raised there as well - to pay for the interest going to those with cash to spare who decided to buy the new state issued high interest bonds. So again, taxpayers pay a price.


Private banks do actually make seigniorage profits but no quite in the same way as traditional counterfeiters. In the case of private banks, the profit is earned in much more circuitous way.

I’ll leave the last word to the French economics Nobel laureate, Maurice Allais:

“In reality, the ‘miracles’ performed by credit are fundamentally comparable to the ‘miracles’ an association of counterfeiters could perform for its benefit by lending its forged banknotes in return for interest. In both cases, the stimulus to the economy would be the same, and the only difference is who benefits."

Wednesday, 6 July 2016

The “Loanable funds” idea is partially valid.

It has become fashionable in the last few years to claim that banks do not intermediate between lenders and borrowers (as per the traditional view of banks) and that instead, banks simply print and lend out money whenever they spot viable borrowers. That traditional view is sometimes call the “loanable funds” idea or theory.

The idea that loanable funds is totally obsolete was repeated in an article by Michael Kumhof and Zoltán Jakab, published by the IMF in March 2016. The article was entitled “The Truth About Banks”. Presumably the article represents the views of K&J rather than being official IMF policy.

Incidentally, for verification of the idea that private banks create or print new money, see the opening sentences of a Bank of England article entitled “Money Creation in the Modern Economy” by Michael McLeay and co-authors.

The economy is at capacity.

In fact where, or to the extent that an economy is at capacity, the loanable funds view is valid. Here’s why.

Assume an economy is at capacity: i.e. further demand is not possible without causing an unacceptable rise in inflation. Also assume banks spot new and viable borrowers. What happens if banks do create money out of thin air and lend? Well that money will be spent, which will raise demand which is not acceptable. So the central bank will raise interest rates so as to choke off the extra borrowing!

To be more exact, the rise in interest rates will encourage more saving (i.e. abstaining from spending), which will make room for at least SOME extra borrowing and spending.

In short, in that scenario, it just isn't possible for one set of people or other entities to lend, unless another set save more. So in that scenario, the loanable funds idea is valid.

The economy is not at capacity.

In contrast, where or to the extent that an economy is NOT AT capacity, things are a bit different. It’s true that in that scenario commercial banks can print new money and lend it out. But assuming that prior to that hypothetical new lending the maximum possible amount of lending had already been done at the prevailing rate of interest, then private banks just won’t lend more unless the central bank cuts interest rates.

But cutting interest rates is not the only way of implementing stimulus: the alternative is more public spending (funded for example with STATE issued money) and/or using that extra money to fund tax cuts.

So even where the economy is NOT AT capacity, if extra lending and investment is to take place, saving has to be done in the sense that if all the necessary stimulus comes from more lending, then none can come from extra public or consumer spending (else inflation would take off). Thus even where the economy is not at capacity, the loanable funds idea is not totally invalid.

And that all raises a question which is a bit incidental to the above points, but I’ll deal with it briefly anyway. That’s the question as to which is the best form of stimulus: interest rate cuts or extra public and/or private spending? Well I suggest the latter extra spending is better, with interest rates being left to find their free market level.

After all, the basic purpose of the economy is to produce what people want (in the form of both public and private spending). Thus given scope for producing more, it is not unreasonable to assume that expanding ALL FORMS of spending by the same percentage will maximise utility. In contrast, I just don’t see the case for concentrating stimulus on a relatively NARROW set of products, whether that’s “lending and investment”, or “education, whiskey and chocolate cake.”

Saturday, 2 July 2016

Giuseppe Fontana and Malcolm Sawyer’s defective criticisms of full reserve banking.

Giuseppe Fontana and Malcolm Sawyer (F&S) wrote a paper recently criticising full reserve banking (FR). At the time of writing, the paper is due for publication in the Cambridge Journal of Economics. Pre-publication copies are available from the publishers. The paper is entitled “Full Reserve Banking: More ‘Cranks’ Than Brave Heretics”.

F&S actually published a paper making similar points about a year ago which I dealt with here. However, their more recent paper is substantially different, hence the review of it in the paragraphs below.

The review of F&S’s paper in the paragraphs below is unusually long (by the standards of this blog). I’ve done a summary (in green) which is correspondingly long.


Section 1 (Introduction)
.   A flaw which underlies the whole paper and which first becomes evident in the introduction is that the paper purports to be a criticism of FR, whereas in fact it is primarily a criticism of Positive Money (PM), or of the works of PM’s founder, Ben Dyson. F&S do cite other advocates of FR, but they cite a strange collection, which includes two groups whose main concern is matters green or environmental. In contrast, there is no mention of the more heavyweight or authoritative advocates of FR, like the clutch of economics Nobel laurate economists who support FR (or supported it during their lifetimes).

Section 2.1.   This section aims to rebut the claim by PM that the creation of money by private banks yields seigniorage profits for those banks. This is actually a complicated issue. The space devoted to it by F&S is wholly inadequate, as indeed is my rebuttal of F&S’s arguments.

Section 2.2.   F&S claim that PM’s system aims to control inflation by controlling the money supply (as per some versions of monetarism). In fact, when creating and spending new base money (e.g. on infrastructure) there is an INEVITABLE element of FISCAL stimulus. Thus PM’s system is not the same as the latter over-simple forms of monetarism.

Also, in this section, it looks as though F&S haven’t grasped the point that FR involves the abolition of privately issued money.

Section 2.3.    F&S claim that PM think the volume of loans made by banks is determined ONLY by the SUPPLY of same, and not by DEMAND. The idea that the volume of ANYTHING produced is determined just by supply and not demand is very strange idea, and is certainly not one adhered to by the advocates of FR.

Sections 2.4 and 2.5.    2.4 is very unclear, so I have ignored it. As to 2.5, F&S criticise the idea put by PM that there is a distinction between base money which PM claim to be “debt free”, and privately issued money, which PM claim to be debt encumbered. In fact it’s not just PM that make that claim: for example it is generally accepted in Modern Monetary Theory circles that privately issued money nets to nothing in the sense that for each dollar of such money, there is a dollar of debt.

However it CAN BE argued that in a limited sense, base money is a liability of the state, and hence that such money is debt encumbered. Conclusion: when it comes to the “debt based versus debt free” characteristics of different types of money, the distinction between base and privately issued money is not TOTALLY clear. However PM and MMTers are quite right to say that there is a fundamental difference between base money and privately issued money in that connection.

F&S also make the point in this section that base money (e.g. $100 bills) is not REAL WEALTH. I.e. paper money is just bits of paper. That point is so obvious that it goes without saying.

Section 3.    F&S criticise PM for claiming that FR brings financial stability. In fact PM merely claims (as do other advocates of FR) that FR would IMPROVE financial stability.

F&S also claim that FR is deflationary. Well it’s pretty obvious that if privately printed money is banned, that is deflationary. The solution is STIMULUS: in the form of creating and spending an alternative form of money (base money) into the economy.

Next, F&S make an absolutely fundamental mistake which indicates they do not have a basic grasp of FR, or indeed of the existing monetary system. They argue that since it is loans that create deposits under the existing system, it is not clear where deposits come from under a system where loans can no longer create deposits. Well the simple answer is that they come from the base money which is created and spent into the economy under FR. (Indeed, the latter form of deposit creation operates to a limited extent even under the existing system.)

Cheating.   F&S then claim it would be easy for banks to cheat by quickly switching depositors’ money from investment accounts to current / checking accounts (i.e. accounts that are supposed to be totally safe). Well that would be a flagrant breach of the basic rules of FR, and that sort of breach ought to be very easy for any auditor to spot: certainly vastly easier that dealing with one of the alternative forms of bank regulation, Dodd-Frank, which consists of 22,000 pages (fifteen times the length of War and Peace).

Section 5.    F&S claim that under FR, the deficit equals the increase in the private sector’s stock of money, which is correct. They then argue that pitching the deficit at a level that gives the private sector its desired stock of money will not necessarily bring full employment. Well of course! Given excess unemployment, the authorities under FR pitch the deficit a “bit too high” so to speak: they pitch it at a level which gives the private sector a slightly EXCESSIVE stock of money, which in turn induces the private sector to spend more. And something of very much that sort applies both under FR and under the existing system.

Section 6 (Conclusion).   Here, F&S claim that FR would nullify the automatic stabilisers. In fact the automatic stabilisers are not quite all they are cracked up to be. But if it really is thought they are desirable, it would be easy to build them into FR.

Section 1: Introduction.

The first main error in this paper, which underlies the entire paper is that the paper is essentially a criticism of Positive Money (PM), or if you like, a criticism of PM authors: Ben Dyson in particular (who founded PM) and other PM related authors. Just to illustrate that, the majority of passages from other authors’ works quoted by F&S are from Dyson’s works (six out of eleven).

F&S ARE CLEARLY AWARE of other advocates of full reserve banking (FR) and cite a number of these, but the collection they cite in the first section of their paper is a bit odd. In contrast, there is no mention of the more heavyweight or authoritative FR advocates, at least if one judges “authoritativeness” on the basis of Nobel prizes. Economics Nobel laureate backers of FR include:

1. Milton Friedman (1960 & 1948). See list of references at the end below.

2. Merton Miller.

3. Maurice Allais – see Phillips (1992).

4. James Tobin. See Tobin (1987) and Musgrave (2015).

Plus there are various people currently working as professors of economics who also back FR: John Cochrane, Lawrence Kotlikoff and Richard Werner. They aren’t mentioned either. And another household name economist who supported FR was David Hume (see Paganelli (2014)).

In view of large amount of brainpower behind FR, F&S’s description of FR supporters as “cranks” is questionable. Perhaps F&S can at some future date let us know which of the above Nobel laureates and economics professors are “cranks” – I assume it’s all of them.

As to the list of FR supporters that F&S DO CITE, they include two organisations or groups whose main concern is matters GREEN OR ENVIRONMENTAL. That’s the UK’s Green Party and a paper by Farley and co-authors. F&S also cite the prime minister of Iceland, whose FR policies are a straight copy of PM’s ideas. That’s a strange assortment. But of course if you’re trying to rubbish an idea, it pays to keep quiet about the more authoritative advocates of the idea, while drawing attention to the less well qualified advocates.

The abbreviation “PM”.

To repeat, while F&S’s paper claims to be a criticism of FR, it is more a criticism of PM and it’s founder, Ben Dyson. For the sake of brevity below, I won’t distinguish between cases where that is literally the case, and cases where other authors ought to be mentioned. I.e. I’ll cut a corner and say “PM” where I really ought to spell out exactly which authors, including PM authors, are involved.  Readers are of course free to look an F&S’s paper with a view to seeing EXACTLY who advocates which idea. Also, please note that I am NOT an official spokesperson for PM.

Incidentally, PM have given their own answer to F&S which is due to appear alongside F&S’s article, though far as I know, pre-publication versions of THAT are not available.

Section 2 – FRB and endogenous money.

F&S’s second section, entitled “FRB and endogenous money” has five sub-sections, and in the first (2.1) the authors criticise the idea that private banks which create or print money make seigniorage profits. (“FRB” is F&S’s abbreviation for “full reserve banking”).

Unfortunately F&S’s actual REASONS for thinking banks don’t make seigniorage profits are thin on the ground to put it politely. According to F&S, “Graziani (2003, pp. 58–66), among others, has explained that no agent involved in the loans supply process has a seigniorage privilege: not businesses, not households, and certainly not commercial banks.”

As for GRAZINI’S alleged “explanations” they are minimal. In fact  Graziani’s paper mentions the word seigniorage just once. That’s in  this very odd passage (p.3):

“In order for money to exist, three basic conditions must be met….money must not grant privileges of seigniorage to any agent making a payment.”

Well as PM and many others have explained, where the state creates and spends base money it most certainly DOES MAKE seigniorage profits. But that doesn’t matter because the profit is effectively shared by the country as a whole. As for the implication behind the latter passage of Grazini’s namely that base money is not money because it earns seigniorage profits, that is just nonsense. For example the money produced by back-street counterfeiters is money within the dictionary or text book definition of the word money, and that certainly earns seigniorage profits for counterfeiters. Other examples of where private money issuers earn seigniorage profits are given below.

And one of the few other sentences in Grazini’s paper on seigniorage (p.7) reads “A bank cannot buy commodities by means of its own credit (if it did so, it would acquire the market commodities without giving anything in return).”

Well that rather amounts to saying that because obtaining something for nothing (i.e. seigniorage) is undesirable, ergo that cannot happen. I.e. that sentence begs the question as to whether private banks actually do or don’t reap seigniorage profits. As to FULLY EXPLAINING why private banks do enjoy seigniorage profits, that would take far more space that would be suitable here. But here’s a BRIEF explanation.

Seigniorage profit is earned where any entity (e.g. the state, a back-street counterfeiter, or bank) issues an IOU in paper or book-keeping form, buys something with it and the IOU then goes into circulation: i.e. the original issuer is never asked to produce anything of real value in exchange for the inherently worthless bit of paper / IOU. Clearly that is profitable for the IOU issuer.

In the case of private banks, they hire out IOUs (commonly known as “money”) to borrowers. Those borrowers they buy something with the IOUs, and to the extent that (and only to the extent that) that IOU / money stays in circulation, that means profits for banks and borrowers.

As to what constitutes “staying in circulation”, the stock of private bank created money is constantly rising, so in that sense the money stays in circulation. Also in that the money ends up on current or “checking” accounts where no interest is paid, that can legitimately be said to be “in circulation”. In contrast, where the money ends up in term accounts (where account holders demand a decent rate of interest) then effectively those account holders have loaned money to the above borrowers. Clearly that does not involve seigniorage profits.  (And to complicate things still further, there is of course no sharp dividing line between current and term accounts).

Interest rate spreads.

F&S then say, “The profits of commercial banks come from the difference between the rate of interest on loans, with allowance for default, and the costs of deposits, including operating costs and any interest rate payments.”

In the context in which that sentence appears, that sentence is clearly meant to suggest that bank profits come from that interest rate difference RATHER THAN from seigniorage. Well banks clearly do aim to cover their costs and make a profit from that interest rate spread. But that doesn’t prove they don’t ALSO profit from seigniorage.

As Maurice Allais put it, “In reality, the ‘miracles’ performed by credit are fundamentally comparable to the ‘miracles’ an association of counterfeiters could perform for its benefit by lending its forged banknotes in return for interest. In both cases, the stimulus to the economy would be the same, and the only difference is who benefits.”

To summarise, whether and to what extent banks and their customers earn seigniorage profits is complicated. F&S certainly don’t give the subject adequate treatment. In fact I sometimes wonder whether ANYONE has a full grasp of this subject.

Section 2.2 - base and privately created money.

Here, F&S challenge PM’s alleged claim that inflation can be controlled just by controlling the stock of BASE MONEY (i.e. CENTRAL BANK created money). F&S claim that would make that PM claim similar to the more naïve versions of monetarism.

F&S do cite just one sentence by Dyson which suggests that Dyson does support that “naïve” view. However, it’s obvious from a fuller reading of PM’s literature (e.g. Positive Money (2011) that given the WAY extra money is fed into the economy under PM’s proposals there is a FISCAL as well as a purely monetary effect.

That is, under PM’s system, when stimulus is needed, the state creates new money and SPENDS IT (and/or cuts taxes). Indeed, it is widely recognised nowadays that helicopter drops contain an inevitable fiscal element. If you Google “helicopter” and “fiscal” you’ll find enough reading material to keep you occupied for a full month.

To illustrate (and this is a bit of a statement of the obvious), if government decides the create and spend enough new money into the economy to employ one thousand extra bureaucrats, employment will rise by one thousand (all else equal) AS SOON AS job applicants have been interviewed and allotted to their jobs. I.e. the increased employment comes BEFORE the money supply has increased.  As for the strictly MONETARY effect (the increased money supply) that comes later and might be relatively feeble. And if it WAS relatively feeble, that wouldn’t matter one iota.

Incidentally Keynes (1933) also advocated the creation and spending of new base money in a recession. See his para 5, phrase starting “or public authority”. Seems like PM has quite a few “friends in high places” apart from the above mentioned Nobel laureates!

Boyancy and exuberance.

Then in the final paragraph section 2.2, F&S claim, the amount of money is a RESULT of the buoyancy of the economy (or “exuberance” to use a word popularised by Greenspan), rather than the CAUSE of anything.

That claim is a major blunder which indicates F&S don’t basically understand the bank and monetary system.

PM (and other FR advocates, far as I know) do not deny that given “exuberance” the amount of private bank created money will rise. Indeed, that’s one of PM’s main CRITICISMS of the existing bank system: i.e. that given exuberance or extra confidence, private banks create and lend out money like there’s no tomorrow, which is exactly what happened prior to the 2007/8 crisis. Or put another way, as is widely accepted in economics, private banks act in a PRO-CYCLICAL manner. ( Incidentally, that “pro-cyclical” point was spelled out in the first sentence of a recent IMF article (Kumhoff (2016) )

Moreover, PM’s system does not aim to control the amount of private bank created money: indeed, PM advocates the abolition of that type of money! It’s BASE MONEY (aka central bank created money, aka “high powered money”) that PM aims to control or adjust.

Thus F&S’s “buoyancy” or “exuberance” point is flawed.

Section 2.3.

Here, F&S claim FRB advocates think loans are determined SOLELY by the SUPPLY of loans offered by banks rather than DEMAND for loans. And to back this claim, Sawyer quotes a passage of Dyson’s that could be interpreted as saying that.

Well the idea that the amount of anything produced is determined SOLELY by supply rather than demand is clearly absurd. Indeed, F&S would have discovered from a wider reading of PM literature that PM do not claim the DEMAND for loans is totally irrelevant. Moreover, it’s unlikely in the extreme that the numerous other advocates of FRB over the last two hundred years make that “demand is irrelevant” claim.

Section 2.4

I find this section near incomprehensible. I could try to guess what F&S are trying to say, but that would not be a productive use of time.

Section 2.5

F&S start with the claim made by PM that privately created money is “debt based” (i.e. that for every dollar of that sort of money there is a dollar of debt), whereas base money is debt free.

F&S’s first problem here is that it’s not just PM that make that claim: advocates of Modern Monetary Theory often make the same point. For example, as Mitchell (2009) puts it “All financial transactions between non-government players basically net to zero because for every asset created in the currency there is a corresponding and equal liability. Only the government can create deposits in the private banking system without any formal liability being incurred.”

As MMTers often put it, base money (and government debt) are “Private Sector Net Financial Assets” – PSNFA being a specifically MMT phrase. Thus F&S’s opponents are more formidable than they like to think.

Re F&S’s claim that base money is a liability of the central bank or “the state”, there is no 100% clear answer to that question. Certainly PM is right to say that although Bank of England £10 notes say the BoE will pay the holder of the note £10 (in gold presumably), anyone turning up at the BoE and demanding something in exchange for their £10 notes will simply be told to go away.

To that extent, BoE money is clearly not a liability of the BoE.

On the other hand Wray (2014) argues that since base money is used to pay taxes, that constitutes an example of one liability cancelling out another. Ergo, so Wray argues, base money is a liability of the state.

But against that, the state is free to grab any amount of base money off the private sector whenever it wants via tax. That’s like me having the right to raid the bank that granted me a mortgage and grab bundles of $100 bills to help pay off my mortgage. In that scenario, my debt to the bank or “liability” is a strange sort of debt / liability.

To summarise, there are no simple answers to the question as to whether base money is a liability of the state or the central bank. But there is absolutely no doubt that PM (and MMTers) are right to say there is a fundamental difference between privately issued money and state issued money (base money).

Fiat money does not equal wealth.

Next, Sawyer says “It is also readily apparent that a higher amount of (base) money does not constitute a higher level of wealth. There is no increase in the capacity of the economy to produce..”.

Well I think we’ve all gathered that under a fiat money system, money is not real wealth in the same sense as a gold coin is real wealth: $100 bills are just bits of paper. The average teenager has worked that out.

The important point is that base money (e.g. $100 bills) ARE REGARDED as a form of wealth. Thus increasing the private sector’s stock of base money increases its inducement to spend (a point also supported by most MMTers far as I can see).

Section 3 – The FRB goal of financial stability.

Here, the authors accuse PM of claiming that FRB brings financial stability. In fact PM simply claims that FR IMPROVES financial stability.

F&S then trott out the claim (which has been made by many others) that FRB would not improve financial stability because it’s only regular banks rather than shadow banks that would be regulated. Well the simple answer to that is to regulate ANYTHING (larger than some minimum size) which behaves in a bank-like manner, regardless of whether it calls itself a bank or not, as pointed out by Adair Turner: former head of the UK’s Financial Services Authority (see Masters (2012). As Turner put it, “If it looks like a bank and quacks like a bank, it has got to be subject to bank-like safeguards.”

Many of the laws that govern garages take no account of the SIZE OF the garage, and quite right. It would be nice if bank regulators had as much brain as garage regulators!


Next, F&S claim “A second problem with the claimed goal of financial stability is that FRB has an inherent though often ignored deflationary bias…”

Well obviously if lending and borrowing are made more difficult, as indeed they are under FR, then there’ll be a deflationary effect. But that’s easily dealt with via stimulus. Problem solved! Put another way, if privately printed money is to be more or less abolished, it’s pretty obvious that some alternative money has to take its place, and there’s only one alternative: base money. And printing and spending base money into the economy equals stimulus.

Next, F&S claim (para starting “Notwithstanding..”, p.7) that while banning private money printing might reduce instability somewhat, “..herding behaviour could still produce sectoral overinvestment and financial instability.”

Well of course! No doubt F&S are right there. But there is no question but that stopping private banks printing and lending out money like there’s no tomorrow in a boom ought to reduce instability SOMEWHAT. As I said just above, PM does not claim FR abolishes instability: the claim is simply that it improves things a bit.

Loans do not create deposits under full reserve.

Next comes this passage (in the same paragraph): “The second inconsistency is that it is not clear where the prior savings alluded to by Daly and other advocates of FRB have come from. It is technically impossible for banks as a whole to collect deposits without at the same time granting loans for the same amount. Therefore, at least initially there must have been a process of credit creation in the economy, which was completely unconstrained and unrelated to pre-existing resources.”

That passage indicates a complete failure to understand how the monetary system works. Contrary to F&S’s claim, it is not (under FR) “technically impossible for banks as a whole to collect deposits without at the same time granting loans..”. That’s true (or to be accurate, largely true) under the EXISTING BANK SYSTEM. In contrast, under FR, there is almost no money apart from money issued by the central bank.

So how do private banks “collect deposits” under FR? Well they collect them from people or firms which by one means or another have obtained some of the money created and spent into the private sector by the state (e.g. firms who build roads for government, bureaucrats working for government, recipients of state funded social security payments, etc.)

Indeed, the latter point is PARTIALLY true at the moment, particularly since QE. QE has meant that roughly 10% of the money supply is now base money (central bank created money). That contrasts with the 3% (or thereabouts) which used to obtain.  That is, at the time of writing, commercial banks are actually able to “to collect deposits without at the same time granting loans” to quite a significant extent.

(Incidentally, and to be accurate (again), it’s not strictly true to say that under FR every single pound in the UK for example would be state issued money. Reason is that advocates of FR don’t have big objections to various MINOR forms of privately issued money, like local currencies. Plus there might be a small amount of money creation under FR by SMALL shadow banks. But the BASIC aim of FR is to have the LARGE MAJORITY of money in the form of state issued money).

Section 4 – How long would FRB arrangements last?

F&S claim that private banks could easily circumvent the rules of FR. One way banks could do this apparently is:

“For instance, investment accounts with a short notice period for withdrawals could be used as means of payment, i.e. near-money: in the existing electronic age, funds could be switched from an investment account into a transaction account, and then used for the payment of goods and services by two mouse clicks.”

Well that would be a flagrant breach of the basic rules of FR. It should be easy for an auditor to spot that sort of dishonesty. All auditors have to do is look at promotional literature issued by banks for depositors. If it says anything like “We offer you the combined advantages of instant access to your money while you get the decent rate of interest that comes from having your money is loaned out to mortgagors, SMEs etc”, then it’s hefty fines (and even better, prison sentences) for relevant banks or bank staff.

F&S also claim that UK banks could circumvent the rules by denominating bank accounts in dollars rather than pounds. I’m baffled. Again, the important point is to look at the small print as per the paragraph just above. The actual currency in which accounts are denominated is irrelevant.

As to the costs of enforcing the rules of FR, they would not be negligible. But compare that to the costs of enforcing the alternatives, e.g. the Frank-Dodd rules, FR is a walk in the park. Frank-Dodd regulations currently stand at 22,000 pages, fifteen times the length of War and Peace (Grind (2016).

Moreover, FR makes it plain impossible for a bank to go insolvent, a point which F&S do not mention (though a large drop in bank shares are perfectly possible.) In contrast Dodd-Frank which simply makes failure less likely. Given that we had a catastrophic bank crisis in 2007/8, followed by a recession lasting about seven years, you’d think that a paper on FR would mention that FR makes bank failure impossible!!

In contrast to the above 22,000 pages, the rules of FR can basically be written on the back of an envelope. Rule number one is “Deposits which purport to be totally safe must be just that”. Rules number two is: “Where anyone wants their money loaned out, they carry the risk of doing so.”

But that’s not to say auditors would be able to prevent every single instance of liquidity or money creation by the smaller shadow banks. But then auditors are clearly unable to regulate banks under the EXISTING SYSTEM with anything near perfection.

Section 5 – Government budget and the monetary creation process.

The first few paragraphs of this section try to argue that FR would constrain public spending. As F&S put it, “In contrast to present arrangements, under FRB government expenditure would be constrained by a lack of availability of finance.”

On the contrary: as PM literature (and the literature produced by other advocates of FR) makes perfectly clear, there is no constraint WHATEVER on government’s freedom to increase public spending and pay for that with extra tax. Indeed any such constraint would be a totally unacceptable intrusion into an obviously POLITICAL matter, namely the proportion of GDP allocated to public spending.

However, what government CANNOT do under FR (or at least some versions of FR) is to BORROW so as to fund extra spending. Reason is that that would be stimulatory, and under FR, stimulus is under the control of the central bank, or some independent committee of economists. Just to illustrate the latter point that different advocates of FR adopt slightly different policies here, PM's proposals still allow government borrowing under discretion of the Treasury, so would not affect the automatic stabilisers, while Friedman's 1948 proposal would prohibit all government borrowing."

Section 5.1.

This starts by pointing out that that public sector’s deficit ends up as increasing the private sector’s stock of base money (“public sector” equals government and central bank). But apparently there is a problem there: as F&S put it, “Thus, the private sector would have to be willing to absorb any increase in central bank money into their savings but may be (since central bank money and transaction accounts are barren assets yielding zero interest) reluctant to do so over and above any increase in the transactions demand.”

Well the first mistake there is that, as explained in the introductory economics text books, people do not hold money just for the well- known “transaction” motive: there is the equally well known “precautionary” motive. That is most people like having a stock of money against a rainy day.

Next, according to F&S there is a problem here which they explain in this sentence: “The first of the problems comes from asking the question as to what reason there is to think that the pre-specified budget position target is compatible with a high level of employment.”

Well the very simple answer to that is that the authorities under FR pitch the “budget position” (normally a deficit) at whatever level they think will bring “a high level of employment” in exactly the same way as they do under the existing system!!

Next, F&S claim to have spotted another problem, which to quote, is that “the case has not yet been made that a budget deficit equal to the growth of the transactions demand for money (and as indicated above, broadly in line with the nominal growth of the economy) would be compatible with a high level of employment.”

Well the answer to that is that under PM’s system (and the similar systems promoted by other FR advocates) the authorities WOULD NOT aim to pitch the deficit at a level which equaled the change in the demand for money. At least they certainly wouldn’t do that given excess unemployment.

Of course the authorities do not do detailed estimates as to what the transaction and precautionary demand for money is, but IN PRINCIPLE at least, and given excess unemployment, they pitch the deficit at a level they think is likely to result in the private sector having an excess stock of money, which results in the private sector spending more. Indeed (and to repeat) that’s little different to the existing system, under which the authorities increase the deficit given excess unemployment.

As distinct from “in principle”, in practice it would not be easy to pitch the deficit at exactly the right level under FR any more than that is an easy task under the existing system.

Section 6  - Concluding comments.

Here, F&S claim, “Finally, FRB will nullify the automatic stabilisers of fiscal policy and lead to a de facto dominance of monetary policy and un-elected central bankers over fiscal policy and democratic decision making.”

The reason F&S THINK that PM’s proposals lead to a degradation of “democratic decision making” is obvious. Under those proposals, the amount of stimulus is determined by the central bank, or some independent committee of economists. And that induces F&S (and indeed many others) to jump to the conclusion that the latter technicians determine the nature of, and/or total amount of public spending. I fact it does neither.

The basic idea in the PM proposal (supported incidentally by the New Economics Foundation and Prof Richard Werner) is that stimulus comes in the form of having the central bank create new money and then having government / politicians spend it in whatever way they choose (and perhaps also cut taxes). In short, while the AMOUNT of stimulus is decided by the above central bank or other committee, the NATURE of stimulus spending remains entirely under the control of democratically elected politicians – contrary to F&S’s claim.

Moreover, under PM’s system, politicians still have complete control over another obviously political decision, namely what proportion of GDP is allocated to public spending. That is, if politicians want to increase that proportion, there is nothing to stop them increasing public spending and raising taxes so as to pay for it. But what they CANNOT do is raise spending WITHOUT raising taxes. That would be stimulatory, and under PM’s system, stimulus is under the control of the central bank or some committee of economists.

And to add insult to injury, for countries which have independent central banks (that’s the majority of countries nowadays), central banks ALREADY HAVE the last say in how much stimulus there should be because an independent central bank can override fiscal stimulus decisions taken by politicians, and by using interest rate adjustments. Indeed the fact that an independent central bank has the last word when it comes to determining the AMOUNT of stimulus is the basis of the “monetary offset” idea advocated by Sumner (2013).

Another mistake made by F&S make in relation to the “democratic decision making” point is F&S’s assumption that PM’s idea about implementing stimulus via having the state create money and spend it, is an idea shared by most advocates of FR. It just isn't!

In other words, as I pointed out at the outset above, F&S more or less equate PM with FR: that is, F&S are apparently unaware of the fact (to repeat) that a clutch of Nobel laureate economists and other household name economists ALSO support FRB, but those economists DON’T specifically support PM’s “committee of economists” idea (not that they’d necessarily DISAGREE with the idea).

Incidentally, the above “degradation of democratic decision making” mistake was also made by Pettifor (2014) in an article of hers entitled “Why I disagree with Martin Wolf”.

Automatic stabilisers.

F&S also claim that the PM system scuppers automatic stabilisers. Now that’s a better criticism than most of the above criticisms F&S make of PM. But it’s not a brilliant criticism, and that automatic stabiliser problem is easily dealt with.

F&S are right to say that under the existing system, when unemployment rises, government does not need to go running cap in hand to anyone for funds to pay for the increased unemployment benefit burden: government just funds the extra spending via extra borrowing.

However, it really doesn’t take a genius to set up a rule under which government under a PM/NEF system AUTOMATICALLY gets funds from the central bank to pay for a rise in the unemployment benefit bill (or at least a proportion of it). But there’s another problem with the above automatic stabiliser alleged problem which F&S propose, as follows.

As explained above, even under the EXISTING SYSTEM, assuming an independent central bank, the central bank has the final say on the amount of stimulus. Now suppose there’s a rise in the unemployment benefit bill, the CHANCES ARE that that means demand is too low which means the central bank will not raise interest rates, and indeed may even cut them.

On the other hand, it’s always possible that notwithstanding a rise in unemployment, the central bank still thinks demand is too high (or inflation is too high). In that case the central bank is likely to COUNTERACT a rise in demand stemming from the automatic stabilisers kicking in (Sumner’s point, sort of). So even under the EXISTING SYSTEM, central banks can scupper the automatic stabilisers. And a central bank may in fact be right to do that: for example a rise in unemployment in ONE MONTH is not a brilliant reason for thinking a recession is on the way.

So…. the automatic stabilisers only work under the existing system gratis the central bank! And that set up really isn't much different to what would obtain under the PM system where (as F&S suggest) PM’s system scuppers the automatic stabilisers. But if you don’t like that, i.e. if you’re an “automatic stabiliser” enthusiast, then it’s not difficult to incorporate an automatic stabiliser element in the PM system.


P.S. (30th  July 2016).  Re the above inadequate treatment of seignorage, I’ve done a fuller treatment here:


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