Sunday, 13 August 2017

A not very clever article on banking by Tim Congdon.

It’s this recent article in the Telegraph entitled “Our zeal to punish the bankers only stoked the Great Recession”.

Tim Congdon has the impressive sounding title of: “Chairman of the Institute of International Monetary Research at the University of Buckingham”. Unfortunately his ideas have never been equally impressive, as I’ve explain in earlier articles on this blog.

The basic point he has banged on about for many years (and in his Telegraph article) is that GDP is related to the money supply, ergo (so his argument goes) if the money supply is expanded, GDP rises. Ergo it is essential for commercial banks to be encouraged to lend more (as the title of the above article implies).

The flaws in that idea should be obvious enough to anyone with a decent grasp of economics, but for the benefit of readers not sure what the flaw is, I’ll run through it.

Two sorts of money.

The problem with Congdon’s argument is that there are two very different forms of money: central bank issued money and private bank issued money. The former is a net asset as far as the private sector is concerned. To illustrate, one way of expanding the private sector’s stock of CB money would be for the CB to print dollar bills or pound notes and to have government hand them out in the form of extra unemployment benefit or increased state pensions.

That would induce pensioners etc to spend more.

In contrast, there is commercial bank issued money. That money comes into being when a commercial bank grants a loan. But note that while it’s nice for the borrower to have $X at their disposal as a result of the loan, the borrower is of course indebted to the bank. So on balance the borrower is no better off (unlike the above mentioned pensioners.) Or to quote a commonly used phrase (which Congdon has presumably not caught up with), commercial bank issued money “nets to nothing”. Certainly there is no mention of the two basic forms of money in Congdon’s article.

Congdon is correct to suggest that increasing either form will increase demand. The reason why pensioners etc spend more when they find more pound notes in their wallets is obvious enough. As to how and why increased loans by commercial banks raises demand, that should be equally obvious: if I borrow $Y with a view to having a house built, that will increase demand for bricks, timber, bricklayers, plumbers and so on.

For more details on how, why and the extent to which increased bank loans increases demand, Steve Keen’s short and very readable book “Can we avoid another financial crisis” is a good source.

To summarise so far, if we want to increase demand, that is easily done EITHER by expanding the stock of central bank money or the stock of commercial bank money. And the way governments normally induce commercial banks to lend more to their customers is to cut interest rates.

Why expand the amount of dodgy private money?

There is however a glaring problem with privately issued money: the private banks which issue it, not to put too fine a point on it, are big time criminals. To be more exact, total fines and out of court settlements paid by US banks in recent years in the US comes to a staggering $200bn or so. And then there’s the small matter of the risky practices they indulged in which caused the worst recession since World War II.

So, contrary to Congdon’s suggestions, there are EXTREMELY GOOD reasons for clamping down on various commercial bank practices. And as for Congdon’s complaint that that exacerbates recessions, the simple answer to that is to expand the private sector’s stock of CENTRAL bank money: exactly what various governments have actually done in recent years.

It could be argued that the WAY in which the private sector’s stock of central bank money has been expanded, namely QE, has not been very effective because QE is just an asset swap. That is, the central bank prints $Z worth money and buys up $Z of government debt. And from that you might concluded that private sector net assets have remained about constant.

Actually that’s a bit misleading. Reason is that prior to QE and during the initial stages of QE there was a much larger than normal government deficit. And a deficit consists of: “government borrows $A and gives lenders $A of government bonds and spends $A back into the private sector. Lo and behold the private sector’s stock of paper assets rises by $A! Then comes QE, which consists of “central bank prints $A and buys back $A of bonds. Net result: the private sector has $A more cash (just like the above mentioned pensioners).

And finally, for anyone interested in delving a bit further into Congdon’s ideas, there is a transcript of a discussion between him and Prof Robert Skidelsky here in which Skidelsky tries to explain to Congdon the error of his ways.


  1. Anything that demands more bank lending to get us out of here is doomed to fail with no other actions.See Japan for instance and relying on bank lending to do anything other than cause the next crash is foolhardy.
    Interesting points on what should governments spend.If Keynes was advocating no more than 25% of GDP he would be incredulous as to what the modern states now spend.Anyhwere between 40 -55% of GDP I believe.This is another issue which I seldom see discussed,what is that opitimim level?And it is surely dependent on the state of the nations economy.

    1. The % of GDP going to public spending is an essentially POLITICAL question isn't it? That's the standard "left versus right" argument that takes place before every general election.

  2. It's took me while to grasp this,but it is crucial to everything as I see it.I have enjoyed the journey to get here.But now I am here what is the elusive answer?

    1. Answer to what? If your question is "what's the optimum amount of public spending" my answer is: "darned if I know"! Shouldn't think that helps, but it's still a bit early in the morning and my brain doesn't normally get going till the 2nd cup of morning coffee...:-)

  3. Kind of a rhetorical question,I don' either.It depends on your political standpoint as you say.
    If we have a PM style Monetary Authority they would in effect decide on that ,so politicians are out of that loop.MMTers see this as the big problem with PM.

    1. No: under the PM system (as they make clear), POLITICIANS decide the PROPORTION of GDP that goes to public spending (and quite right, as that's a political decision). Meanwhile the monetary authority decides how much stimulus we have, i.e. the excess of government spending over government income.

      E.g. monetary authority says "government spending shall exceed government income by 2% of GDP this year". Politicians then decide where that's done via say spending equal to 30% of GDP and income equal to 28%, or spending equal to 52% and income equal to 50%.

  4. Ok thanks I will check that out in more
    detail,my misunderstanding.


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