Saturday, 19 December 2020

Credit guidance nonsense

Summary.          Credit guidance is the idea (promoted by Positive Money and others) that government should induce banks to lend less to various sectors of the economy which are allegedly unproductive, e.g. property based loans like mortgages, and more to sectors which are allegedly productive, like SMEs and green investments. The first problem there is that banks already lend to SMEs up to the point where the marginal or least viable SME borrower is only just worthwhile. Thus quite how further SME loans can be described as “productive” is a mystery. Second, as regards green investments, there’s nothing wrong with promoting economic activity which cuts CO2 emissions, but the bias towards investment at the expense of more labour intensive forms of activity does not make sense particularly since advocates of credit guidance say they want to maximise job creation. Third if loans for mortgages are constrained, that will cut the number of houses built, which a strange objective, given the housing shortage. Fourth, increased lending for house purchases is largely just a series of book-keeping entries: i.e. it does not involve the consumption of real resources. To that extent, there are no real resources there that can be re-allocated for example to green investments.


Positive Money (PoMo) have recently put much effort into advocating the idea that the Bank of England should do more so called “credit guidance”: in particular, induce private banks to lend more to allegedly “productive” borrowers, e.g. small and medium size firms (SMEs), and less to allegedly unproductive loans, e.g. property related loans, like mortgages.

To quote the relevant PoMo article (I’ve put the quote in green italics):

“For too long the UK economy has been held back by the majority of bank lending going towards property and financial markets rather than the productive investment in the real economy desperately needed to level up regions and boost incomes.

Now more than ever we need concrete action to guide lending towards productive investment to support a sustainable recovery and a fair green transition. Policymakers should look to introduce modern forms of so-called ‘credit guidance’, which were effective in steering lending towards more productive ends for much of the twentieth century.”

Unfortunately there are four big problems there.

First, commercial banks (henceforth just “banks”) are only too happy to lend to ABSOLUTELY ANY borrower who seems credit worthy and viable. It makes no difference whether the borrower is an SME or someone wanting a mortgage or any other sort of borrower. Thus banks WILL ALREADY be lending to SMEs up to the point where the marginal or least viable SME borrower is only just viable, in the view of banks.

Moreover, banks are not even constrained in their lending activities nowadays by a shortage of reserves: unlike prior to the 2007/8 bank crisis. Banks are now AWASH with reserves.

And they’re not constrained by lack of capital either: if banks spot an increase in the number of genuinely viable SME borrowers, or any other type of viable borrower, they’ll have no difficulty acquiring extra capital so as to help fund relevant loans.

So to summarise, PoMo and others want banks to make extra loans to borrowers who appear not be viable. But in that case, how can those borrowers be described as “productive”? It’s all nonsense!

Moreover, if extra loans are to be given to unviable SMEs, banks will want a subsidy for doing that. But PoMo and other authors cited in the above PoMo article don’t seem to be aware of that. Certainly they don’t tell us where any subsidy comes from.


The second problem: matters green.

The idea that banks should be induced to lend to fund investments which cut CO2 emissions sounds wonderful. Environmentally concerned folk with a poor grasp of economics will love that.

Global warming is arguably the most important problem the human race has ever faced, and certainly that problem needs to be solved. But introducing any sort of assistance for loans which fund green investments rather than assistance for non investment type costs (e.g. labour) needed by green projects does not make sense. Moreover, the latter concentration on capital equipment clashes with the claim by PoMo that job creation is an important element of their proposals.  

Put another way, taxes on CO2 emitting activities or materials, like petrol or diesel make sense. And subsidies for generating electricity from wind and solar make sense. But a bias towards capital intensivity where those activities are concerned does not make sense.  

The third problem: less house building.  

The above PoMo article (and the works cited in it) make much of the fact that a large proportion of lending is property based (e.g. mortgages). And that, so the argument goes, means there is loads of money currently devoted to property purchase which COULD BE diverted to allegedly “productive” SMEs and so on.

Well apart from the above mentioned “marginal” problem, there’s another problem there, as follows. What induces house builders to build more houses is (unsurprisingly) house price increases. In fact there’s plenty of evidence that housebuilders are brutally commercial in that respect, i.e. they often obtain land with planning permission but do not build on it immediately. Instead, they wait till house prices in relevant areas have risen to the point where they can be sure that the millions spent erecting a new estate bring them a profit. Can you blame them?

Thus the effect of constraining loans to house buyers would be less house construction: not a brilliant idea, given the housing shortage.

Fourth: book-keeping.

Much of the increased lending that accompanies house price increases does not involve the consumption of real resources. To illustrate, if saver / lenders increase their willingness to lend at lowish rates of interest (which is what has happened over the last twenty years or so), and/or if borrowers increase their willingness to borrow more money to buy more expensive houses, the initial effect (ironically) is not that a significant number of people move into larger or better houses.

Reason is that the stock of houses in the short term is fixed. Thus all that happens is that debts in the form of mortgagers rise, and that increased debt must of course be owed to someone: it’s owed to saver / lenders who find their stock of money has risen. But that’s all nothing more than a glorified series of book-keeping entries.

In contrast to the latter INITIAL effect, there is of course another effect (alluded to above) namely that the increased price of houses induces builders to erect more houses. That DOES INVOLVE the consumption of real resources.
So to summarise, and contrary to the claims of credit guidance advocates, a million Euros or dollars less lending to mortgagors does not mean there is then a million Euros or dollars that can be spent on green projects or loaned to SMEs to enable them buy new machinery.  

Friday, 18 December 2020

Mervyn King’s poor criticisms of MMT.

In this Spectator article, he tries to criticise MMT. Article title: "The Ideological Bankruptcy of Modern Monetary Theory."

His second paragraph contains the revelation that while there’s something to be said for money printing a la MMT, money printing is not a new idea and we need to be careful with money printing.

Well I think the average ten year old knows that money printing is not a new idea, plus the average ten year old knows there are dangers associated with money printing. That’s why MMTers have repeated till they are blue in the face that inflation places a limit to the amount that can be printed. Evidently Mervy King is not aware of the latter point.

Next, King trotts out the fiendishly clever play on words which hundreds of others have trotted out, namely that Modern Monetary Theory is neither modern, nor monetary, nor a theory.

There again, and as regards "modern", MMTers are streets ahead of Mervy King: they have always made it clear that their ideas owe a lot to economists from long ago: in particular Abba Lerner and Keynes.

Next, comes this para (which I’ve put in green italics):

“It is not monetary because the relevant questions concern fiscal policy: how should governments finance their deficits and what are the limits to those deficits? If deficits can always be financed by the printing of money by a compliant central bank, then we are in a world of ‘fiscal dominance’, to use the modern jargon. Inflation is then determined by government spending decisions. It was precisely to convince financial markets of the opposite that led to the independence of the Bank of England.”

Well now if it’s so fantastically important that a central bank be independent, how come the UK managed OK in the years PRIOR to when the BoE was made independent (in 1997)? I’m not saying I OPPOSE central bank independence. I actually BACK the idea. My point is simply that the difference between an independent and non independent bank is not Earth shattering.
However, the above quoted para from King’s article does contain a valid criticism of MMT, and it’s one that I’ve highlighted myself over the years. It’s that while there’s nothing wrong with MMT theory, MMTers have not thought through the practicalities. In particular, as King says, MMT seems to assume that politicians control the amount of money that is created and spent, and in view of Mugabe, the Weimar republic etc, that may not be desperately clever.
So, is there a way of implementing MMT while keeping politicians away from the printing press? Well yes there is. As pointed out by Positive Money and Ben Bernanke, it would be perfectly feasible to have the central bank (or some other independent committee of economists) decide how much money to print each year, while politicians retain the right to decide the NATURE of deficit spending, e.g. whether it goes towards education, health, tax cuts, etc etc.

But Mervyn King is evidently not aware of the latter Positive Money / Bernanke point, so he’s clearly is not up to speed on this subject.

Sunday, 13 December 2020

Fractional reserve banking is as clever as legalising drunk driving and making it compulsory to insure against resulting injuries.



Prior to the introduction of deposit insurance, our bank system (fractional reserve banking) was essentially fraudulent. Reason is that banks told depositors or at least suggested to them that their money was safe, while at the same time, granting loans. Those two activities are plain incompatible because if a bank makes enough silly loans, and banks do just that far too frequently, then they are not able to repay depositors their money.

Anyway, governments eventually decided to do something about that. But instead of simply banning the above practice, they decided, if anything, to encourage it by introducing deposit insurance (in the early 1930s in the US, for example). That is, banks could continue to engage in the above fraud, but depositors were shielded against loss when the fraud resulted in disaster.

Unfortunately, though, that did not deal with all the fallout from the above mentioned “disaster”: i.e. banks going bust. That is, deposit insurance, while it protected depositors from loss, did not stop banks going bust.

So in 2007/8 for example we had a major bank crisis, as a result of which various banks faced going bust, though of course the majority were saved thanks to taxpayer funded largesse. But even that taxpayer funded largesse did not prevent the bank crisis causing a ten year long recession and tens of millions worldwide losing their jobs, and hundreds of thousands losing their homes.

In other words, to repeat, deposit insurance does not deal with all the fallout from bank crises.
The alternative to deposit insurance would have been to ban the above mentioned fraud. And doing that would have involved forcing banks to abstain from putting depositors’ money at any risk whatever: in other words banks would have been forced to keep money which depositors wanted to be totally safe in a totally safe manner (shock horror). That is banks would have been banned from lending out depositors’ money, or even from having the same entity or bank subsidiary engage in both accepting deposits and making loans.

As for loans, banks would have been forced to fund those via equity, not deposits. And what d’yer know? That’s what full reserve banking consists of.

So deposit insurance has distinct similarities to legalising drunk driving while making up for that sloppy attitude by forcing all car  drivers to be insured for medical expenses and loss of earnings if they crash their cars while under the influence of alcohol. That is, that insurance deals with SOME OF the problems of drunk driving, but it does not cover all the fallout from that anti-social activity.

And just to repeat, deposit insurance deals with SOME OF the consequences of the above fraud, but it does not deal with all the fallout from that activity.

In particular, bank failures under full reserve banking are plain impossible: as for safe money, that’s safe. And as to banks which lend, or the subsidiaries of banks which lend, they’re funded via equity, thus if they make silly loans, all that happens is that the value of that equity falls. The bank or subsidiary does not go bust.

Of course that is not to argue that full reserve puts an end to all booms and busts. But it does remove or at least ameliorate one cause of boom and bust.

And as for any idea that any cut in lending and indebtedness caused by full reserve is a problem, that is hard to reconcile with never ending complaints we get from a long list of worthies to the effect that there is too much private sector debt.

Plus the fact that more lending increases GDP all else equal DOES NOT prove that more lending is desirable. One reason is that increasing GDP, i.e. imparting stimulus when unemployment is higher than it need be, can very easily be done WITHOUT any specific attempt to increase lending and debt. For example a helicopter drop basically just increases consumer spending, though doubtless a finite amount of extra lending will accompany that.

Moreover, the conventional assumption in economics is that externalities should not be allowed. And a bank system which imposes ten year long recessions on an economy is clearly a system which is guilty of imposing an externality. 


P.S. (14th Dec). I’ve just realised there’s a bit of a mistake / omission from the above article, as follows. Supporters of the existing / fractional reserve bank system would argue in response to the above points that bank problems NOT DEALT WITH by deposit insurance are dealt with via bank regulation, e.g. imposing minimum capital requirements.

My answer to that is that the latter idea is fine in theory, but the problem is that bankers always find it easy to get their way with politicians and roll back bank regulations. Witness the claim by Sir John Vickers (chairman of the main UK government inquiry into banks in the wake of the 2007/8 bank crisis) that bank regulations are still not adequate.

And it’s not just POLITICIANS who do banksters’ bidding: Mervyn King, former governor of the Bank of England, appears to be just as willing to do banksters’ bidding. In Ch7 of his book “The End of Alchemy” he argues against full reserve banking on the grounds that “banks would lobby hard against such a reform”. Perhaps he also thinks theft should be legalised because thieves are not too keen on anti-theft legislation.

Conclusion: in practice, it is very debatable as to whether bank regulation actually solves the problem, though clearly there is more to this argument than appears in the above article and this “P.S.”.



Saturday, 12 December 2020

An absurdity at the heart of interest rate adjustments.


Assuming negative interest rates are ruled out, clearly interest on government debt and/or interest on reserves has to be ABOVE zero if interest rate cuts are to be used to impart stimulus. But why ARE interest rates on government debt and reserves ever above zero?

Well the reason is that the authorities are trying to damp down demand: i.e. people can be induced to hold a larger stock of cash than they would normally do if they are offered interest on cash which is locked away for a while (e.g. locked away in the form of interest yielding government debt).  

But demand inevitably varies in some way with the private sector’s stock of cash (aka base money). Thus in order to get interest on state liabilities (government debt / reserves) anything above zero, it is  first necessary for government to issue too large a stock of debt / reserves!

Now what exactly is the point of creating and spending such a large amount of cash / reserves into the economy that it is then necessary to bribe holders of that cash not to spend it by offering them interest on their pile of cash? Or to put it more brutally, what is the point of creating and spending so much cash / base money that it becomes necessary to spend taxpayers’ money bribing the rich (i.e. holders of that money) into not spending it?

Or to put it even more brutally, if you want to impart stimulus by cutting interest rates, it is first necessary to spend taxpayers’ money bribing the rich to hoard money.
And that, folks, is part of the logic behind the MMT “permanent zero rate of interest” idea – at least I think it is.  

Saturday, 5 December 2020

The Resolution Foundation falls for the nonsensical “fiscal space” idea.



The Resolution Foundation is a UK economics think tank, and the their ideas on “fiscal space” are set out in recently published work entitled “Unhealthy Finances”, which at about 70,000 words is about the length of an average book.

I demolished the whole fiscal space idea in an MPRA article about ten years ago, and another MMTer, Bill Mitchell, took the idea apart in an article entitled “The ‘Fiscal Space’ Charade” in 2015.  

Plus I explained the flaw in an article on this blog in 2012.

Anyway, there’s nothing like repetition for getting ideas across. So I’ll briefly explain the flaw in the fiscal space idea yet again in the paragraphs below.

Fiscal space is the idea that if a country’s debt/GDP ratio is on the high side, relative to where it’s been in recent decades, it will have to pay a relatively high rate of interest on that debt and/or if it wishes to implement more stimulus, it will have to borrow yet more and pay an even higher rate of interest on its debt, thus in that situation, it does not allegedly have “space” for implementing stimulus.

And if you want an alternative definition, the IMF definition is set out near the start of the above mentioned article by Bill Mitchell.

The first and very obvious flaw in that FS idea is that any country which issues its own currency does not need to borrow in order to fund stimulus: it can fund stimulus by simply printing money, which in effect is what most of the World’s larger countries have done over the last five years or so. You have to wonder what planet Resolution Foundation authors live on.

The second flaw in the fiscal space idea is the assumption that because the debt has been at let’s say 50% of GDP for the last two decades, that therefor it is not sustainable for it to remain at 100% for the next one or two decades. That assumption is particularly questionable given that the Japanese debt/GDP ratio is around 250% with few obvious problems, and given that the UK ratio was at a similar level just after WWII.

Moreover, it is plain impossible to predict where we will be in three or five years’ time. For example it could be that in five years’ time, the big increase in the desire to save that happened over the last twenty years or so goes into reverse. That is, the private sector could go into “spendthrift mode”, or if you like, Alan Greenspan irrational exuberance mode. In that case it would certainly be desirable to raise taxes so as to rein in the additional demand that stemmed from the latter exuberance, and hence cut the debt, as suggested by the Resolution Foundation.  

But equally, it could be that the private sector’s desire to save CONTINUES to increase, and we become another Japan.  In that case government HAS ABSOLUTELY NO OPTION but to meet those “savings desires” (to use an MMT phrase). If government DOES NOT supply the private sector with the savings it desires, the private sector will try to save so as to acquire those savings, and Keynesian “paradox of thrift” unemployment will ensue. In that case (unless government wants to see unemployment rise to unnecessarily high levels) government and central bank will just have to let the debt (and/or the stock of base money) rise even further.

The moral is: “play it by ear”. In other words the basic MMT idea is quite right: that’s the idea that the deficit (or surplus) simply need to be whatever results in unemployment being as low as is consistent with hitting the inflation target while keeping interest on the debt at or near zero.  In contrast, all attempts to PREDICT (a la Resolution Foundation) what tax rises will be needed in three or five years’ time are futile.