Random charts - 40.

Large pink text on the charts below was added by me.

Sheffield University authors’ strange ideas on bank and monetary reform.

 
Three Sheffield University department of economics authors, Sheila Dow, Guðrún Johnsen and Alberto Montagnoli, published a paper a year or two ago entitled “A Critique of Full Reserve Banking.”

The first seven pages simply describe full reserve are perfectly OK. However, the authors’ criticisms of full reserve start in their section 3.1 (p.8) and the mistakes from that point onwards come thick and fast.

For example the authors say at the end of the first para of section 3.1, that bank crises tend to destroy trust in commercial banks, but, apparently unbeknown to advocates of full reserve, trust can actually be maintained via taxpayer backed deposit insurance.

Well I have news for the Sheffield authors: advocates of full reserve and indeed everyone else has actually tumbled to the fact that the trillions dished out or loaned by central banks during the 2008/9 crisis did actually save the system. Plus the entire country, is aware that governments (i.e. taxpayers) stand behind private bank accounts.

But the Sheffield authors miss the crucial point here, namely what are taxpayers doing backing a commercial operation: money lending etc? Taxpayers do not back money lending when it’s done in a slightly different form, namely lending to friends and relatives or the purchase of corporate bonds by unit trusts / mutual funds.


The history of money.

Then at the start of the next para, the authors say “…money in  practice has always been created by private sector institutions and has involved a token of credit extended by some and received by others…”

If the authors studied the history of money they’d discover that money in most civilisations stems from a desire by kings and rulers to make tax collection more efficient. So the King or ruler pays for what he wants using his home made money, while at the same time demanding that taxes be paid in that form of money – else you’re in trouble. That threat gives the ruler’s money plenty of clout.

Thus it is quite untrue to say that “money has always been created by private sector institutions..”.


Safe assets.

Later in the same para, the Sheffield authors say that “the availability of safe assets would be reduced” as a result of implementing full reserve.

Well simply saying that the supply of something is reduced is not a brilliant criticism. The crucial question is whether the supply is reduced to (or increased to) some sort of GDP maximising amount. If the supply of apples is not at its GDP maximising amount, e.g. because apple growers have formed a cartel, then the supply and GDP can potentially be increased by breaking up the cartel.

In the case of full reserve, the supply of totally safe and very liquid assets, i.e. money, would very definitely at its optimum level, at least in the following sense.

Given an inadequate stock of money, the population would tend to try to save with a view to acquiring its desired stock. That would cause Keynes’s “paradox of thrift” unemployment, which in turn would induce government to print and spend extra money into the economy, thus bringing the stock up to its “GDP maximising” or optimum level.


Risky savings.

Next, the Sheffield authors say in relation to implementing full reserve, “Savings accounts would now carry risk about which the general population would need to take an informed position. But  even  financial  experts  in  the  run-up  to  the  crisis  failed  to  price  in  risk  adequately –   the effect  of  unreasonable  conventional  judgements  arrived  at  under  uncertainty.  It  is  totally unreasonable  to  expect  the  general  public  to  undertake  this  kind  of  assessment  and  bear  the  consequences  of  a  financial  failure  without  deposit  insurance.”

The answer to that is first that the majority of the savings of the average household are ALREADY difficult to “price” in the sense that it is not clear what they will fetch when they are eventually turned into cash. The biggest chunk of saving for the average household is their house, and given that house prices in Britain have doubled in real terms over the last twenty years (compared to Germany where they have remained constant in real terms), there is plenty of scope for that big chunk of household savings to fall dramatically in value.

Another big chunk of saving comes in the form of private pension schemes. But they are normally related to stock market performance, and it’s impossible to say where the stock market will be in ten or twenty years time.

Third, under full reserve, and as explained just above, people are free to stock up on whatever amount of base money (i.e. totally safe money) they want if they are keen to have a stock of savings the value of which is totally clear.


Subsidized bank accounts.

Then at the end of the same paragraph, the authors object to the fact that if depositors’ money is not loaned out (thus earning interest), banks might have to charge for transaction accounts.

Well one answer to that is that banks ALREADY charge for transaction accounts. I pay about £12 a month for my high street bank current account and get next to nothing by way of interest.

But doubtless if depositors’ money is not loaned out, banks would charge MORE FOR current / checking accounts. But charging the full cost of supplying goods and services is hardly unusual. When you buy baked beans, cabbages or a car you pay the full cost of acquiring those items.

A system under which the income from money lending is used to defray the cost of running a current / checking account is simply a form of cross subsidisation, and subsidies are frowned on in economics: they reduce GDP unless there is a good social justification for the subsidy.


The precautionary motive.

Next (para starting “It seems to be assumed…”), the Sheffield authors say there is demand for money not just for transaction purposes, but also for the well-known “precautionary” motive, and that under full reserve, the authorities would need to take that into account in deciding how much  money to create.

Well as just explained, any tendency to increased saving by households and businesses, with a view to increasing their stock of safe money would tend to cause paradox of thrift unemployment, and the authorities would need to react to that by increasing the amount of money created and spent. But the authorities need to do that ANYWAY!!! That is, it is not just under full reserve, that gyrations in the private sector’s desire to save money is a source of instability!


Safe assets.

Later in the same paragraph, the Sheffield authors say “But the build-up to the crisis demonstrated the widespread capacity for conventional expectations to be unreasonable and, in particular, to underestimate risk. As a result high expected returns on market assets could entice society into treating assets as safe which are in fact much less safe than current bank assets.”

Well frankly it’s a bit odd to claim that if the supply of stuff with characteristic X is reduced, people will make believe that other commodities normally regarded as NOT POSSESSING characteristic X will all of a sudden acquire characteristic X. Does his strange new theory apply anywhere else?

If the supply of alcoholic drinks is reduced, would people start trying to make believe that milk or orange squash contained alcohol? Or if the supply of petrol was reduced, would people trying filling up the tanks of their vehicles with water?


The shadow banking sector.

Next in the same paragraph, the authors trott out the old criticism that if money creation is suppressed in the regular bank sector, then money creation will just migrate to the shadow sector. Well clearly that will happen to some extent. But there are several answers to that problem.

First, illicit money creation has been going on since the dawn of time in the form of counterfeiting central bank notes. The fact that counterfeiting has never been TOTALLY suppressed and never will be as long as we have physical money, is not a reason for not suppressing counterfeiting.

Second, there is a simple way of dealing with shadow banks: regulate them the same was a regular banks. As Adair Turner, former head of the UK’s Financial Services Authority put it, “If it looks like a bank and quacks like a bank, it has got to be subject to bank-like safeguards.”

Of course it will never be possible to regulate every single small shadow bank. Indeed most of us are a bank in the sense that most of us have loaned money to friends or relatives at some time. However, that does not matter. Reason is that money is defined as anything WIDELY ACCEPTED in payment for goods and services. And while I can write out IOUs on the back of envelopes and while those IOUs might be accepted by a very small number of people, my “envelope money” clearly does not constitute money as per the above definition.

Same goes for small shadow banks: their liabilities scarcely qualify as money.

Third, the private sector only produces its own money where government fail to produce an adequate supply, as indeed the Sheffield authors themselves say. But if government / the state issues enough to give us full employment, it is hard to see why private sector entities would want a further supply of money, at least for transaction purposes: at full employment, further transactions just ain’t possible.

Of course there may well be a desire by some people to have government (i.e. taxpayers) provide some sort of guarantee that sundry assets will never lose value. But if taxpayers are going to do that in the case of bank liabilities, why not also in the case of non bank corporation liabilities, e.g. bog standard stock exchange shares or bonds?

The latter is clearly not a justifiable use of taxpayers’ money: there are whole string of more pressing uses for taxpayers’ money, like spending more on health and education.


Section 3.2.

The first paragraph of this section tries to cast doubt on the idea that stimulus can be effected by having central bank and government vary the amount of money created and spent. The authors say:

“But even if these judgements about the feasibility and merits of central bank independence are accepted, it is much more problematic to judge the work of a central banker or a committee whose job would be to inject money into the banking system and to place a limit on the amount. The performance would have to be based on a counterfactual, but it is difficult to envisage how this would be chosen and estimated.”

“Problematic to judge the work..”? What on Earth does that mean?

Moreover, having government and central bank create money and spend it amounts to exactly the same thing as traditional fiscal stimulus followed by QE, which is what we’ve done and big time over the last five years or so. (Traditional fiscal stimulus equals “government borrows £X, spends it and gives bonds worth £X to lenders”. While QE equals “central bank prints £X and buys back those bonds”. That all boils down to “the state (i.e. government and central bank) prints £X and spends it (and/or cuts taxes)”.


Lending.

The Sheffield authors next para (starting “These issues..”) casts doubt on the Positive Money claim that in addition to the state effecting stimulus by creating money and spending it, the state should also keep an eye on whether enough is being loaned to allegedly “productive” activities.

I agree with the Sheffield authors there: the decision by households and firms as to how they allocate additional money that comes their way strikes me as being their business, not the business of bureaucrats in London who think they have better ideas on how resources should be allocated.


The authorities need the “correct” economic model?

In the next para (starting “Even if we accept…”), the authors argue that if the central bank is to inject the right amount of money into the economy, the CB needs the “correct” economic model of the economy in order to get that decision right.

Basically that’s nonsense, though obviously it would be nice to have some sort of model which is a perfect replica of the real world economy. The reason that idea is nonsense is that all the CB needs to do when determining the suitable amount of stimulus is very much what CBs and fiscal authorities do at the moment: make a guess at how much stimulus is needed and see if the guess works out.

In other words what monetary and fiscal authorities do at the moment is “suck it and see”. And under the slightly different way of imparting stimulus advocated by Positive Money and the New Economics Foundation, they’d adopt the same “suck it and see” ploy.

“Suck it and see” is not ideal of course, but at least the PM/NEF system is no worse in that respect than the existing system.


Conclusion.

Well I’m now half way through the Sheffield paper and I think I’ve established that the authors are not too clued up. I do not have time to deal with the rest of their paper, and I imagine readers will not be too interested either.



   

The basic principles that support full reserve banking.

Principle No.1.    Everyone has a right to a totally safe bank account in the same way as everyone has a right to enough food, a roof over their head and so on. Plus many employers find a totally safe bank account useful.

Principle No.2.     The fact that everyone has a right to something is not necessarily an argument for supplying the item to them for free. For example the way food is delivered to everyone is normally to ensure everyone has sufficient cash income; then people are free to choose the food they want and they pay for it, using that cash.

Principle No.3.     Various basic essentials are supplied to everyone for free in many countries, e.g. health care and education for kids. The argument for that, rather than having people to pay cash for those items is that some people would choose not to purchase those items, and instead would spend the relevant cash on luxuries. That would impose costs on the community at large, for example the failure by some to purchase health care could promote the spread of contagious diseases, and the costs of not teaching kids the three Rs are heavy for society at large later in those kids’ lives: they are unlikely to find jobs, which means society as a whole has to support them.

Principle No 4.     There are no particularly heavy costs for society at large that derive from someone NOT HAVING a bank account (i.e. letting them deal just in cash). Therefor there is nothing wrong with requiring people to PAY FOR the privilege of having a bank account.

To that extent, the argument that it is important to let banks lend on depositors’ money so as to earn interest and thus defray the cost of administering bank accounts is not valid. Moreover, cross subsidization (e.g. having money lending subsidise the cost of administering a bank account) is generally frowned on in economics. Indeed, subsidies in general are frowned on unless there is a good social case for subsidies.

Of course the possible withdrawal of physical cash in the next few years might seem to weaken the latter argument. However, even if physical cash is withdrawn, there would still be a few people happy to go without a bank account: for example one member of a husband and wife couple who was happy for their partner to do all the financial transactions for the family. Same applies to children not considered by their parents to be responsible enough to have a bank account.

Principle No.5.     Where anyone wants interest on the money they’ve deposited at a bank, there is only one way the bank can supply that interest, which is to lend on relevant monies. I.e. anyone who wants interest in effect is a lender. That is, they are into commerce, and it is a widely accepted principle that it is not the job of governments or taxpayers to stand behind commercial transactions. Thus there should be no taxpayer deposit insurance where a depositor wants their money loaned on, any more than there is taxpayer backed insurance for people who deposit money at a mutual fund / unit trust, or who deposit money with their stock broker with a view to that money being invested or loaned on.

Principle No.6.     The argument that if deposits ARE INSURED BY TAXPAYERS, that banks will lend more and thus boost GDP does not stand inspection. Clearly if deposits where relevant monies are loaned on ARE INSURED by taxpayers, there would SEEM TO BE a rise in GDP. However, governments (assisted by their central banks) have complete control of aggregate demand, and can thus raise demand and GDP any time they want. To that extent, the additional above mentioned demand stemming from extra private bank lending is irrelevant: i.e. given inadequate demand stemming from deposits no longer being insured by taxpayers, government can easily make good that deficient demand with conventional stimulus, fiscal or monetary.

Thus given that keeping demand at the full employment level is not difficult in principle, the question than arises as to what the GDP maximising banking set up is.

Well it’s widely accepted in economics that GDP is not maximised where anything is subsidised for no good reason. And taxpayer backed insurance for money which is deposited at banks and loaned on is an unjustified subsidy for reasons given above.

Ergo taxpayer backed deposit insurance reduces GDP. Put another way, bank loans should be funded via equity. Or put another way, where X lends to Y and Y does not repay the money, X should foot the bill, not the taxpayer.

A second weakness in the argument that taxpayer backed insurance for lenders increases lending and thus GDP and/or investment is that exactly the same argument applies to lending in the form of the purchase of corporate bonds and even corporate shares. For some strange reason, advocates of the above “taxpayer backing for lenders increases GDP” argument apply that argument to bank deposits, but never to corporate bonds or shares. That is a clear inconsistency.

Principle No.7.     Taxpayer backed insurance is subsidised insurance because everyone knows the “insurance company” cannot possibly fail, unlike private sector insurance companies. Of course taxpayer backed insurance could take account of the artificial privilege that taxpayer backing brings by making an extra charge for its insurance. However the reality is that over the last hundred years or more, bankers have regular as clockwork bribed or persuaded politicians into doing the exact opposite: i.e. bankers have induced politicians to grant private banks special privileges rather than make sure banks and their customers PAY FOR special privileges, like taxpayer backed insurance. Thus the idea that an extra charge for the privilege of taxpayer backing would ever be made, or the idea that if it were made, the extra charge would last any length of time, is a joke.

Principle No.8.      Funding bank loans via equity rather than deposits might seem to raise the cost of loans because equity holders demand a higher return than depositors. That apparent difference is largely or  entirely an illusion: reason is that once the cost of deposit insurance is taken into account, the total cost of funding via deposits is in theory no different to the cost of funding via equity. Reason is that the risks of bank funders losing a given proportion of their money is determined by the nature of the bank’s ASSETS (e.g. NINJA mortgages versus safer mortgages) not by the nature of its funding.

Put another way, the extra return demanded by equity holders as a percentage of their total stake in a bank should be equal to or related to the risk they run. But the risk run by depositors is the same. Ergo the insurance premium, as a percentage of the sum insured for depositors, ought to be the same or at least very close to the latter percentage in the case of equity holders (i.e. the amount equity holders charge for “self-insuring”).

Moreover, the return on bonds (which are similar in nature to deposits) in the US is currently HIGHER than the return on equity!


Conclusion.

The best bank system is one where people can have totally safe accounts if they want, but those accounts are inherently safe because relevant money is not loaned on. Alternatively, if they want interest, they themselves carry the risk of having their money loaned out, not the taxpayer. Under such a system it is plain impossible for banks to fail: to illustrate, if a bank’s assets (i.e. the loans it has made) turn out to be worth only 75% of book value, then the stake in the bank held by those who have chosen to have their money loaned on drops to about 75% of book value. The bank as such does not go bust.

That system is full reserve banking.

Nonsensical conventional wisdom on banking.

Sir John Vickers on the left  (I think) sits under a slide, the heading of which is complete nonsense: that’s the idea that there is a trade-off between growth and risk when it comes to bank regulation.

That trade off APPEARS TO BE the case for an apparently very plausible reason, namely that the lighter is regulation, the more banks will lend and at a lower rate of interest. And of course more bank lending means more demand, all else equal.

The flaw in that argument is that governments have complete control of aggregate demand via stimulus (monetary and or fiscal), thus any fall in demand stemming from less commercial bank activity is easily compensated for via stimulus. Ergo there is no reason for tighter bank regulation to have any effect on demand or numbers employed.

Thus the KEY question is: what’s the OPTIMUM or GDP maximising amount of bank regulation. As I’ve pointed out time and again on this blog, the concept “optimum” seems to be beyond the comprehension of the simple folk who make up much of the economics profession. Certainly a failure to understand that concept would explain falling for the above “trade-off” fallacy.

Well there is a simple and widely accepted principle in economics namely that subsidies do not result in GDP being maximised, and that applies to banks. Thus there is a big problem with the idea that lighter bank regulation raises GDP which is that the lighter the regulation, the more the banking industry has to be backed by, i.e. subsidised by taxpayers. For example, the riskier banks are, the more expensive will deposit insurance be – never mind the half dozen other subsidies that banks get, like the TBTF subsidy.

So…how do we bring about a entirely subsidy free bank industry? Well it’s quite easy: just make sure that banks and those who have any sort of relationship with banks carry the full costs of bank failures when they occur, rather than have taxpayers foot the bill.

And that’s easily done by stipulating that anyone who wants to have a bank lend on their money with a view to earning interest carries the cost when those loans go wrong. After all, anyone who wants their money lending out is into commerce, and IT IS A WIDELY ACCEPTED PRINCIPLE THAT IS IS NOT THE JOB OF TAXPAYERS TO STAND BEHIND COMMERCIAL TRANSACTIONS.

In short, having banks fund loans via deposits is plain straightforward fraud. It involves telling depositors their money is totally safe, when the mere fact of lending it on by its very nature means that money IS NOT SAFE.

Ergo loans should be funded via equity or similar. And having done that, there is no need for deposit insurance because banks do not promise equity holders they’ll get $X back for every $X placed with the bank.

Taxpayers do not stand behind people who start up a small business or who invest in the stock exchange. There is no reason for taxpayers to stand behind a slightly different form of commercial activity: having a bank lend on your money.

The Wolf, Balls, Boait debate at the Royal Society of Arts on bank reform, London, 18th Sept 2017.

 

Martin Wolf is the chief economics commentator at the Financial Times. Ed Balls is a former UK politician who worked under Martin Wolf at the FT for a few years. Fran Boait is director of Positive Money.

The latter three gave speeches in the order in order given above, i.e. Martin Wolf went first. Wolf’s speech was much the most technically competent, as might be expected. I didn’t disagree with anything he said.

I’ve set out a summary of their speeches below. I’m not guaranteeing my summary is accurate or fair. Listen to the debate if you want a total accuracy and fairness.

Times given are APPROXIMATE: certainly not accurate to the nearest second or even the nearest 30 seconds.


Martin Wolf.

7.30 Martin Wolf started with the interesting point that money can be defined (to paraphrase him) as the stuff you hold which is supposed to be totally safe and which you can use in times of trouble. Yet it is precisely privately issued money which has a habit of disappearing into thin air in times of trouble.

The crisis was not just a shadow banking crisis: virtually all banks were involved.

UK banks’ capital ratio HAS BEEN improved, but not by nearly enough. In fact ratios have simply been returned to where they were around 1970.

17.00  Quote: “a bank is about as unsound a financial structure as you can imagine” (produced laughter)

Ring fencing will help, but it’s not the basic solution.

Risk weighting doesn’t work: banks claimed their assets were totally risk free just before the 2007 crisis.

20.0 Banks have a big incentive so subvert the regulations, and essentially they will succeed in demolishing all the new regulations passed since the crisis.

Wolf likes Mervy King’s “pre-positioned collateral” idea.

21.00  Wolf likes Positive Money’s “Sovereign Money” proposal.

Quote: “Money consists of the liabilities of unsound financial institutions”.

25.0  Wolf’s ends by saying that the existing bank system is a huge nonsense. That reminds me of Mervyn King’s famous quip: “Of all the many ways of organising banking the worst is the one we have today”

Wolf says there will be another bank crisis. It’s not a question of if: it’s a question of when.


Ed Balls starts at 25.0.

In his first ten minutes he explains how he, and the then governor of the Bank of England and others in early 2007 had a “war game” to mimick a bank crisis. The war game was accurate for the UK in that it envisaged a crisis sparked off by a building society / bank in the North of England in trouble – that was good foresight given the Norther Rock fiasco that happened a few months later. But the war game did not forsee the extent to which the real crisis was international.

35.0  Claims Friedman’s monetarism was an example of Chicago School thinking. Strange claim. Balls gets Keynsianism, Chicago School, monetarism and other stuff very muddled.

Balls claims there are three question marks to be put over full reserve banking. The first is whether we can pin down what is used as money?

Well my answer to that is we do not need to “pin down” in order to reap the benefits of full reserve. Indeed, after the introduction of full reserve, people will certainly continue to use a variety of forms of money other than that nation’s official currency. Plus many advocates of full reserve don’t even object to some of those alternative forms of money (e.g. local currencies like the Lewis pound in the UK or Ithaca dollars in the US).

The important point is that full reserve makes available to everyone a form of money which is totally safe. If people want to take risks and stock up on strange forms of money like Bitcoins or Krugerands, that’s their business.

38.0. Balls says (rightly) that under a sovereign money / full reserve system there is some sort of committee of economists that decides how much money to create per month (a point which Positive Money would not disagree with) but that the job of that committee is incredibly hard. Reason is that the committee has to foresee crises. That’s his second point.

Well the simple answer to that is that crises would not occur at all because it’s impossible for banks to go bust under full reserve!!!!! Of course that’s not to say economies would be 100% stable under full reserve, but advocates of full reserve never claimed they would be 100% stable. But the solution to a downturn under full reserve is much the same as under the existing system: stimulus. The main difference is that the FORM OF stimulus advocated by Positive Money amounts to a merge of monetary and fiscal policy: that is, given a need for stimulus, the state simply creates money and spends it (and/or cuts taxes).

His third point is that full reserve is much better introduced world-wide than being introduced by just one country. True. But then there are numerous organisations around the world pushing for full reserve.

Balls is a bit clueless. He claims that the above mentioned money creation committee has to take all sorts of decisions, like what constitutes worthwhile investments!!! Total nonsense.

Balls claims that avoiding bank crisis is not the most important issue we face.

Well I dare say it isn’t, but that’s not an argument for not tackling the issue. Sprained ankles or flue may not be the most important issues facing the National Health Service, but if we can find a way of halving the time taken to cure sprained ankles or flue, why not go for it? False logic there by Balls.


Fran Boait starts around 42.0.

She says she won’t talk much about stripping private banks of their powers to create money. And launches forth about inequalities, climate change, and other issues. She attacks “neoliberalism”.

Well neoliberalism is a favourite gripe of lefties. Be nice if they defined it!!!! Also it should be remembered that neoliberalism, at least in the UK, was a reaction to what preceded it, namely the Labour government throwing taxpayers’ money at clapped out loss making industries so as to “save jobs”. At least that was the excuse. “So as to buy votes” might be nearer the mark.

Many reacted to that episode with something like, “S*d taxpayer funded subsidies: let’s just have the free market rip.” Can’t say I totally disagreed with the latter “let market forces rip” philosophy.

47.0 She disagrees with Carney’s claim that the UK needs a much bigger financial sector.

She claims lots of people think markets are perfect!! Well about 95% of economists realize (apparently unbeknown to Fran Boait) that markets are highly IMPERFECT. She claims “markets are people” – meaningless phrase, but the phrase will go down well with lefties.

51.0  Complains that QE and interest rate cuts (almost the same thing) makes the rich richer by increasing asset prices. Problem with that is that as Positive Money itself has said, INTEREST RATE INCREASES can also be argued to increase inequalities in that debtors have to pay more interest to the rich (i.e. creditors).

She wants the Treasury committee inquiry into monetary policy to be re-opened.

52.0 She ends by saying she wants to “democratize” the Bank of England and the financial system. What does that mean? Democratize is one of those words like “neoliberal”, “radical” or “progressive”: fashionable at the moment, but their exact meaning is not clear.

Random charts - 39.

Text in pink on the charts below was added by me.

Random charts - 38.

Text in pink on the charts below was added by me.

Taxpayer backed deposit insurance is a nonsense.

If bank deposits are not insured, as was the case in several countries prior to WWII, then so called deposits are not actually deposits: that’s “deposit” in the sense of “a totally secure holding of $X”. Those so called deposits are more akin to shares or bonds, i.e. so called depositors are not guaranteed to get their money back.

So that system, it can be argued, amounts to full reserve banking: a system where bank loans are funded by equity, not deposits.

Alternatively, if deposits are insured by taxpayer backed deposit insurance, that amounts to a subsidy of banks and depositors. Reason is that taxpayer backed insurance is artificially cheap or “good value for money” because everyone knows the state has limitless powers to grab money off taxpayers to rescue depositors should there be a series of large bank failures.

That’s similar to the “too big to fail” phenomenon: that is, if everyone knows taxpayers will come to the rescue of a large bank when it gets into trouble, that knowledge in itself means the relevant bank can borrow at an artificially low rate of interest, even if the bank never actually gets into trouble and taxpayers never actually need come to the rescue of said bank.

But subsidies for banks or indeed any other type of corporation are not justified, unless it can be shown there are overwhelming social considerations involved.

Ergo taxpayer backed deposit insurance for fractional reserve banks is not justified. Accounts at banks should be split into two basic types: first, accounts where deposited money is not loaned on. Those accounts are totally safe because they are INHERENTLY totally safe and do not need any significant amount of insurance.

The second type of account is where deposited money IS LOANED ON, but it’s made abundantly clear to depositors that they may not get all their money back.

And apart from the latter arrangement making sense logically, an additional bonus is that it’s plain impossible for banks to fail: for example if it turns out that the loans made by a bank are worth only half of their book value, the bank does not go bust. All that happens is that depositors will get only around half their money back if they want to cash in their deposits immediately. Alternatively they can hold on in the hopes that things improve.

And as for the idea that funding loans via equity will be much more expensive than funding them via deposits, that’s rather contradicted by the fact that at the time of writing the return on equity in general is (bizarrely) less than the return on bonds, and bonds are of course nothing more than long term deposits.

But even if funding via equity does turn out to be more expensive, the important point is that that system is subsidy free. Ergo it approximates a genuine free market better than funding via deposits. Ergo GDP ought to be higher under that subsidy free system.

How to deal with debt ceiling numpties.

First, the Fed carries on doing QE: i.e. printing money and buying up government debt (Treasuries).

That will probably raise inflation too much, so the Fed announces that taxes need to be raised or public spending cut so as to deal with that inflation. That would be music to the ears of right wingers (Republicans) seeing as they’re always keen to cut the deficit.

If that process goes on for long enough, there’d be little or no debt left: it will be turned into base money paying a zero rate of interest.

Debt ceiling numpties (Republicans) would then be hit in the face with the realization that the debt had been replaced with base money: i.e. that debt and money are virtually the same thing. That would be a big improvement in Republican’s grasp of economics.

A further benefit would be that the US would no longer be paying interest to China, Japan and other foreign countries.

What’s not to like?

As for how to regulate demand, just continue with the above idea: i.e. the Fed suggests to numpties (I mean “Congress”) that the deficit needs raising or reducing a bit – and possibly, given a serious outbreak of irrational exuberance, that a surplus is in order.

The only slight drawback with that idea is that the reduction in interest yielding investments in the US would induce some investor / savers to take their money elsewhere in the world, and that would cause the dollar to decline relative to other currencies, which in turn would reduce US living standards for a while. But that’s a purely temporary effect.

I really deserve a nobel prize for that idea, but I’m far too modest to nominate myself.

Green new deal BS.

Large numbers of well meaning numpties in recent years have advocated the idea that we should print money and spend it on the sort of stuff popular with left of centre environmentally concerned folk. I.e. the green new dealers advocate that the money be spent on windfarms, solar energy, insulating homes and so on.

Richard Murphy seems to advocate the idea: title of his article is "Time for a Green New Deal."

The flaw in the idea is that it confuses two entirely separate issues. That is, (and first), we don’t need to print money in order to devote a larger proportion  of GDP to green stuff: we’re free to do that ANYWAY. In case you’re not clear on how to do it, this is how: raise taxes and spend more on green stuff! There: that wasn’t difficult was it?

An alternative is to spend less on existing forms of public spending (health, education, law enforcement, etc) and spend more on green stuff. That wasn’t a big intellectual challenge was it?

Second, printing money is a form of STIMULUS, and that’s necessary when the economy is operating at less than capacity, i.e. when unemployment could be lowered without exacerbating inflation too much.

But that has precisely and exactly nothing to do with the decision as to whether to spend more on green stuff!

Hope that’s cleared that up. Probably not.

Fontana and Sawyer’s incompetent criticisms of Positive Money on full reserve banking.

Summary.   A debate has taken place in the Cambridge Journal of Economics over the last year or so between on the one hand Giuseppe Fontana and Malcolm Sawyer (F&S) and on the other hand, sundry Positive Money authors. This present article of mine is a response to the latest F&S paper in that journal.

To summarise, a few of F&S’s criticisms of the Positive Money authors are valid, but basically F&S’s paper is a litany of nonsense. Among other things, F&S attribute ideas to PM without saying whereabouts in the PM paper those ideas appear. Moreover, far as I can see, some of those ideas don’t actually appear in the PM paper at all.


Details on this series of papers.

F&S published a paper in the above journal in 2016 entitled “Full reserve banking: more ‘cranks’ than ‘brave heretics’”. I actually reviewed that paper here just over a year ago.

Messers Dyson, Hodgson & Van Lerven of Positive Money responded to that with a paper in the same journal entitled “A response to critiques of “full reserve banking”. I’ll refer to that as “the PM paper” or “the PM authors” or similar.

F&S have recently responded to that PM paper with a paper entitled “A rejoinder to “A response to critiques of ‘full reserve banking’”.

This present article of mine examines the latter F&S paper.


The details.

F&S start by saying that while the PM authors claim their proposals are different from full reserve banking, in fact PM proposals and full reserve are to all intents and purposes the same. I agree with F&S there.


Seigniorage.

F&S then claim on their p.2 that contrary to the claims of the PM authors, “No agents involved in the loans supply process, including commercial banks, have a seigniorage privilege.”

Well the first problem there is that the word “seigniorage” does not appear in the PM paper. Second, F&S do not say where the “seigniorage claim” is in the PM paper.

The first sentence of the Oxford Dictionary of Economics (2009) definition of seigniorage is “The profits made by a ruler from issuing money”. Obviously “rulers” are irrelevant here, in that we are considering the possibility that a “non-ruler” i.e. a commercial bank can make seigniorage profits.

Clearly a private / commercial bank cannot do exactly what a back-street counterfeiter or legitimate state / “ruler” can do, namely print money and buy whatever the printer wants with the freshly issued money. In the case of back-street counterfeiters, that’s bog standard consumer goods: booze, food, holidays, etc. And in the case of governments (aka “rulers”) it’s the various items that states or governments normally buy: roads, military equipment, hospitals, schools, etc. However, what commercial banks can do is to create and lend out their liabilities, which are treated as money.

Plus money lenders who can simply print the money they lend out, are clearly in a different and better position to a money lender who has to come by money in the way the large majority of households and employers do, namely earn it or borrow it.

Of course, private banks do not charge what might be called a “normal” rate of interest  on the money they have to borrow BEFORE lending it out, and a lower rate on the money they themselves print or create (at no cost to themselves). What they do, as explained by Joseph Huber in his work “Creating New Money” is to use the cost savings derived from money printing to charge less interest than they otherwise would, and hence expand the overall size of their business and the overall size of their profits. As Huber 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.”

So to summarise, it is true that private banks to not earn seigniorage profits on a narrow definition of the word “seigniorage”, but it’s pretty obvious they earn an unjustifiable profit which amounts to “seigniorage profit” on a broader definition.


Inflation.

Next, and still on their p.2, F&S criticise a claim allegedly made by the PM authors namely that the money supply can be used to control inflation. F&S say the PM authors claim “Inflation can be controlled by the rate of increase of the money supply, as in the standard though now discredited monetarist theory.”

Well the answer to that is that the PM authors and PM literature in general certainly do not go along with the Milton Friedman idea that we should have the same annual increase in the money supply (if that’s what F&S mean by “the standard though now discredited monetarist theory”).  Indeed PM literature in general is perfectly clear that there will always be unforeseen fluctuations in economic activity, and that those fluctuations will need to be counteracted by varying  the amount of stimulus.

Moreover, PM literature in general makes the very obvious point that where the state creates and spends money, there is a fiscal as well as a monetary effect. That is, to illustrate, if the state creates $X and spends it on roads and education say, the fact of that extra means more jobs for contractors and teachers, plus there is the purely monetary effect (i.e. the increase in the money supply) which comes a bit later and which also has a stimulatory effect.

In fact F&S themselves actually quote a passage by the PM authors which makes just that point. The quote is on p.5, where F&S quote the PM authors as saying “Consequently, in a sovereign money system, monetary policy would work by financing a fiscal stimulus…”.

It’s a trifle incompetent to accuse someone of saying X when you yourself specifically quote them as contradicting X!!!

But if F&S are claiming that there is no monetary effect at all, then in effect they’re saying that when people come by a windfall, e.g. win a lottery or come by a tax rebate, their weekly spending does not rise at all. Well first that is obvious nonsense on common sense grounds. Second, it is clear from the empirical evidence that (amazing as it might seem) when households come by windfalls, their weekly spending rises!


Demand for loans.

Next (item No.3, p.2) F&S attribute a truly extraordinary idea to the PM authors namely that “The demand for loans is of little or no consequence for the determination of the quantity of money in the economy.”

Well, first, F&S do not say where the PM authors make that claim, and I can’t see where they do make that claim. Moreover, the PM authors say on their page 2: “a bank cannot make a loan unless it can find a willing borrower”.

Well that’s clear enough isn't it? The PM authors are saying the amount of bank loans made is determine much like the way the number of apples sold is determined: an interplay between supply and demand.


Bank loans create debts.

Next (item No.4, p.2) F&S say the following claim by the PM authors is false: “The new supply of bank loans produces an equivalent increase in the amount of outstanding debt in the economy.”

Well frankly that’s bizarre. So when I borrow £Y from a bank I’m not £Y in debt to the bank???  This is good news. Perhaps F&S can tell us where these amazing banks are where one can borrow money, yet not become indebted!!

By way of justifying the above, F&S say (same page) “The reflux principle operates in modern economies such that much or all of newly created money is extinguished by the reimbursement of previously accumulated debt.”

Well quite. In other words if someone borrows £A from a bank, £A of money and £A of debt is created. And when the debt is repaid to the bank, the money vanishes, and that’s very conventional thinking. I.e. there’s nothing controversial there.

PM’s work “Sovereign Money”, is perfectly clear on the latter point. It says for example on page 9, “As bank balance sheets contracted, broad money was destroyed.”

And on page 15 they say  “First, following the crisis households lowered their consumption spending in order to focus on repaying debt. Deleveraging requires loan repayments to be made at a faster rate than new loans are taken out. Because loan repayments are the reverse process of money creation, money is being destroyed at a faster rate than new money is being created, lowering spending, nominal demand and income.”


Matters green.

Next, (top of page 3), F&S criticise the PM authors for getting environmental and equality matters mixed up with the decision as to whether we have full or fractional reserve banking. I agree with F&S there.

The truth is that even under the existing (i.e. fractional reserve) system, we can be as green as we like, plus we can have any level of equality we like. Thus green and equality matters have little to do with the decision as to whether to adopt full reserve banking.


House prices.

Next, F&S claim that full reserve would not tame rising house prices. Well there is a very simple and obvious reason why it WOULD, at least to some extent. It’s that full reserve makes lending and borrowing more difficult which is bound to mean a finite rise in interest rates. Indeed, that’s one of the most popular criticisms made of full reserve.

And higher interest rates means it costs more to buy houses. In fact the big rise in house prices in REAL TERMS in the UK over the last twenty years or so is clearly related to some extent to the steady and large decline in interest rates over that period. (To be more accurate, the rise in house prices probably has much to do with increased demand for housing as a result of lower interest rates, COMBINED WITH the suppression of additional supply thanks to local authorities failure to make enough land available: witness the HUNDRED FOLD increase in the price of land once it gets planning permission.)

And as for any idea that a rise in interest rates would be a catastrophe, people with mortgages in the UK in the 1980s were paying almost THREE TIMES the rate of interest they do nowadays. For some strange reason the sky did not fall in, nor were the streets lined with homeless beggars. If anything, the number of beggars has RISEN over the last twenty years, though admittedly I’m not the World’s expert on begging.

And finally, low interest rates are not an unmixed blessing: they encourage asset price bubbles plus they hit savers and pensioners.


So what’s the optimum rate of interest?

Since there are clearly advantages and disadvantages in both high and low interest rates, an obvious question arises, namely what’s the optimum or GDP maximising rate? My answer to that is “the free market” rate. And that’s pretty much PM’s answer in that PM advocates leaving interest rates largely to their own devices.


Financial stability.

Next (still on the same page and paragraph) F&S claim full reserve would not bring improved financial stability. Well that is a truly hilarious claim: reason is that under full reserve it is plain impossible for a bank to go bust. Reason is that under FR, loans are funded by equity. Thus if the value of loans made by a bank turn out to be worth only half their face value (which has never happened in the case of a large bank) all that happens is that the value of the shares / equity approximately halves. The bank as such does not go bust.

Also in the same paragraph, F&S make the bizarre claim that investment grinds to a halt entirely under FR. They say “When investments are halted…”. That is such obvious nonsense that I can’t even be bothered dealing with it.


Alternative forms of money.

Next  (bottom a p.3) F&S repeat a popular claim made by critics of full reserve, namely that if conventional forms of privately issued money are banned (that’s money issued by high street banks), then alternative forms of private money will arise.

The first answer to that is that opponents of fractional reserve banking have never advocated a TOTAL BAN on privately issued money. For example many advocates of full reserve are happy with local currencies, e.g. the Lewis pound or the Ithaca dollar.

Second, there always have been and probably always will be strange bits of paper which serve as money in the world’s financial centers, e.g. London and New York. For example short term government debt is often accepted in lieu of money in those centers.

Third, whatever bank regulations we have, banks will always make big efforts to circumvent the regulations. In that connection, the fact that the rules of full reserve can be written on the back of an envelope, compared to Dodd-Frank which occupies well over ten thousand pages, is a big plus for full reserve: simple rules are relatively easy to enforce.

Fourth, F&S cite PayPal as an alternative form of money. Well it just isn't: PayPal is simply an alternative way of TRANSFERRING existing sums of money between different peoples’ and firm’s bank accounts. As Wikipedia puts it, “PayPal . . . . supports online money transfers and serves as an electronic alternative to traditional paper methods like checks and money orders.”


The cost of current accounts.

Next, (p.4) F&S trott out the ever popular criticism of full reserve, namely that it would result in those with current accounts (checking accounts in the US) having to pay more for their accounts because account holders would no longer be helped by the interest that comes from lending out some of their money.

The answer to that is that cross subsidisation is generally frowned on in economics and quite right. To be more exact, under the existing or fractional reserve system, the lodging and transfer of money is subsidised by another activity, namely the lending out of money. There is no particular merit there, any more than there are merits in having baked beans subsidised by a tax on rice pudding.


Matters fiscal.

Next, on their page 5, section 4, F&S set out a totally bizarre and nonsensical argument relating to fiscal stimulus.

F&S point out that the government of a country which issues its own currency can simply print money (in physical or electronic form) and spend that into the economy. Indeed, governments (in the sense: “government plus central bank”) already do that: witness the fact that the stock of base money in private hands has steadily risen since WWII and before, with a particularly sharp rise as a result of QE.

F&S then point out that governments clearly do not fund their spending PURELY via new money: they also fund it via tax and borrowing.

So far so good. Those are widely accepted common sense points.

But F&S also accuse the PM authors of being confused over the latter points. Well I’m darned if I can see why. To repeat, the above points are very simple and straightforward. But F&S end with what they clearly think is some sort of punch line or crucial flaw in PM thinking, namely: “A legitimate question then arises: if the government has the power to create money once, in order to promote—in their words—the central bank money monetary circuit, why then could the government not use the same power in the future?”

Well if you can work out the relevance of the latter question, you’re smarter than me. Elucidation will be welcomed in the comment section below.

Anyway, my answer the latter “why could the government not use the same power in the future?” question is: “IT CAN!!!”.

Indeed PM has devoted tens of thousands of words to setting out the exact circumstances in which government SHOULD create and spend new money (and/or cut taxes). Plus PM has devoted thousands of words to explaining how to avoid an excessive and irresponsible use of that source of funds.

F&S’s argument is a bit like explaining that a baby can suck milk from its mother’s breast and then asking, “what’s to stop it sucking more milk?” The answer is . . . wait for it . . . “nothing”….it CAN suck more milk.  Babies can suck as much milk as they want, assuming an adequate supply is there.

Put another way, if someone is able to drive a car a hundred miles, what’s to stop them driving another ten miles? My answer is: “probably nothing”!

Hope that’s cleared that one up!


Conclusion.

I’ve had enough of this nonsense. I can’t be bothered with the final couple of pages of the F&S paper. I’ve got better things to do than parley with self-styled professors of economics who are a long way from being totally clued up.

Random charts - 37.

Large text in pink on charts below was added by me.