The fantasy world of George Selgin.

George Selgin is a US economist who has written several books and articles on banking.

In a couple of recent Financial Times articles, Martin Wolf referred to what he called “libertarian fantasists”. (Article titles: “Time to embrace central bank digital currencies is now” and “The libertarian fantasies of cryptocurrencies”.)

The fantasy that Wolf refers to is the idea that Selgin has advocated for decades, namely that we would benefit from a system where government plays almost no role in the production of and organisation of money. As Wolf rightly says, “Money is a public good par excellence. That is why dispensing with the role of governments in money is a fantasy.

Selgin recently objected on social media to Wolf's “libertarian fantasy” remark.

Selgin advocates so called “free banking” which is a set up where banks can do anything they like as long as they obey to laws that other corporations have to obey, like the law of contract.

The latter idea is indeed fantasy. The first problem with it is thus. The brute reality is that banks throughout history have failed left right and centre. So what happens, you might ask, when a bank under free banking does a Northern Rock, i.e. c*cks it up and depositors flee? Well according to Selgin, all they have to do is quit the particular “Northern Rock” concerned and take their savings elsewhere.

Well the blindingly obvious flaw in that is that the FIRST PEOPLE who suspect there is something wrong at the failing bank manage to escape. But well before they've all escaped, the bank closes its doors: the remaining depositors (the less financially astute) get shafted!

Selgin's views on banking are also EXTREMELY US-centric: that is, he concentrates almost exclusively on banking in the US over the last two hundred years, while totally ignorning what banks were doing in other countries or more than two hundred years.

And indeed in the US between roughly a hundred and two hundred years ago there were hundreds of bank failures. But Selgin blames that on government: in particular the refusal of the US government to allow so called “branch banking”. Branch banking is where a bank sets up branches all over the US or at least over a relatively wide area, rather than being confined to just one state. And the problem with being confined to just one state is that a bank's fortunes are tied very much to the fortunes of that state, which necessarily means greater fluctuations in the fortunes of the bank's customers. For example, the fortunes of a bank in an agricultural state are very much tied to the fortunes of agriculture. So Selgin blames the above hundreds of bank failures on banks' inability to spread more widely over the entire country.

Well there's a simple flaw in that argument, which is that any competent banker ought to be able to gauge the risks his bank faces. For example, if the fortunes of a state are very much tied to the fortunes of just one industry, bankers in that state ought to be able to take precautionary measures, like having a relatively high capital ratio. But they failed to do that, which indicates (as Martin Wolf suggests) that if banks are left entirely to their own devices, they tend to end up being run by incompetent cowboys.

Indeed, there are enough cowboys even in a relatively well run bank system, like the UK right now. For example there were the cowboys running Northern Rock and then there's Fred Goodwin who messed things up at the Royal Bank of Scotland.

Scotland and Canada.

By way of trying to bolster the case for free banking Selgin, time and again, refers to a relatively short period (about seventy years) where free banking or something very like it did appear to work in two or three countries, Scotland and Canada being two.

That of course is an entirely specious argument: it ignores the other hundred or so countries in the World and second, it ignores periods in Scottish and Canadian history other than the period Selgin chooses to boost his arguments. Moreover, every Tom, Dick and Harry is well aware that DECADES can go by without there being any big problems in a country's bank industry, then all of a sudden, disaster strikes. The absence of any bank failures in the UK between WWII and the failure of Norther Rock is an example. Thus Selgin's seventy year period proves nothing.

Selgin's “seventy year period” argument is much the same as me arguing that because I have not had a car accident for forty years that therefore I am a 100% safe driver, and thus that there is no chance of me being responsible for a car accident in the next ten years.

Conclusion.

George Selgin, as Martin Wolf suggests, is indeed a fantasist.

Fractional reserve banking: the fraud which banksters fooled politicians into supporting.

 

Fractional reserve banking is fraudulent because it involves banks, 1, accepting deposits, 2, lending out money, and 3, telling or suggesting to depositors that their money is safe, which it clearly isn't because if a bank makes enough silly loans (which any bank is likely to do at some point in its history) it is then unable to repay depositors their money. Or to be more accurate, fractional reserve has certainly been fraudulent for a large majority of its history, i.e. up to the introduction of government run deposit insurance schemes (early 1930s in the US and a few decades later elsewhere).

Of course, given deposit insurance (and bank bail outs) fractional reserve is no longer fraudulent because the promise by banks that depositors' money is safe is an accurate and honest promise since the promise is backed by the full weight of the state and the near infinite amounts of money the state can grab off taxpayers to make good that promise.

But that's simply a way of saying that banksters got politicians to support the fraud in which they specialise.

And if you still aren't persuaded that fractional reserve (absent government support) is fraudulent, consider the fact that mutual funds, unit trusts, private pension funds etc must inform investor / savers loud and clear that their money is at risk, else those responsible for failing to make that clear will be in court accused of fraud. At least that's certainly the law in the UK, and doubtless several other countries.

To summarise, the idea that government should support a type of fraud is just laughable.

 

Ban the fraud or just curtail it a bit?

And that of course raises an obvious question, namely should that fraud perpetrated by private banks be banned outright, or should the fraud to turned into a non-fraudulent activity by the simple expedient of making banks abide by the same rules as mutual funds, pension funds etc. In other words should a bank be allowed to tell depositors that the bank will make every effort to repay a depositor $X for every $X deposited, but that there is no absolute guarantee it will be able to do that (rather than suggest depositors' money is safe)?

Well that all depends on whether there are significant systemic risks stemming from the latter hypothetical arrangement, doesn't it? Indeed, the latter is very much an example of the principle widely accepted in economics, namely that harmful externalities (e.g. pollution) should not be allowed.

I'm fairly sure that if banks were required to publicise the latter “we'll make every effort but can't guarantee anything” point, then the so called money they create would be reduced to the status of Bitcoin, namely that it would certainly become a TYPE OF money, but only chancers, gamblers and criminals would be interested in it.

In contrast, the bulk of the population and small / medium size firms understand money to be composed of units which are ABSOLUTELY GUARANTEED not to lose value (inflation apart). And what do you know? There's already billions of dollars worth of that sort of money in circulation! That's central bank (CB) issued money (often referred to as “base money”). Thus any deficiency in the amount of money that would result from openly declaring private bank issued money to be only a form of quasi money could easily be made good by expanding the stock of base money.

Does base money circulate?

Now some readers may object to the latter paragraph on the grounds that base money does not get into circulation. Well firstly, PHYSICAL money ($100 bills etc) is a form of base money, and that's very much in circulation.

As to the bulk of base money, which comes in digital form, it certainly might seem it only exists in the accounts of a few privileged private banks – accounts held at the CB. However, that's actually misleading, and for the following reason.

Central banks often have reason to pay money to non bank private sector entities: e.g. if you sell some government debt to the central bank as part of the QE operation, you'll get a cheque from the CB, which you'll deposit with your private / commercial bank, which in turn deposits the money at the CB. But you have complete control over that money! E.g. you can turn it into physical money whenever you want. Thus in effect, your commercial bank simply acts as agent for you when you want to withdraw or transfer some of your stock of base money. Ergo that base money is effectively in general circulation.

Indeed, under full reserve banking as proposed by Positive Money and others, that “agent” arrangement is formalised in the sense that under Positive Money's system, anyone can hold an account at a private bank which is totally safe, NOT BECAUSE government has backed private bank created money, but because money in those accounts is 100% backed by base money held by their commercial bank at the CB.

 

Conclusion.

So to summarise, we need to ban the age old fraud perpetrated by private banks, namely telling depositors their money is safe when it quite clearly isn't. Plus government support for that fraud (in the form of deposit insurance and bank bailouts) should cease.

Instead, private banks (as long as systemic risks do not ensue) should be allowed to revert to SOMETHING LIKE their age old fraud, i.e. telling depositors their money is safe, but with the difference that they make it clear that depositors' money is not in fact totally safe.

That would reduce privately issued money to something like the status of Bitcoin, i.e. it would reduce it to quasi money, which would be of little interest to about 90% of households and small/medium sized firms. And that in turn would require a big expansion in the stock of base money.

And what do you know? The latter arrangement equals full reserve banking, or at least something close to full reserve.

 

The tired old “privately issued money is stimulatory” canard.

A final and feeble excuse for privately issued and government backed money is that it is stimulatory. Well the simple answer to that is that absent that form of money, stimulus can perfectly well be implemented by issuing more base money: exactly what governments have done over the last ten years on an unprecedented scale in reaction to the GFC and Covid.

Interest rates have been artificially high for centuries.

 

David Hume in his essay “Of Money” (written almost three hundred years ago) said “It is very tempting to a minister to employ such an expedient, as enables him to make a great figure during his administration, without overburdening the people with taxes, or exciting any immediate clamors against himself. The practice, therefore, of contracting debt, will almost infallibly be abused in every government. It would scarcely be more imprudent to give a prodigal son a credit in every banker’s shop in London, than to empower a statesman to draw bills, in this manner, upon posterity.”

In other words politicians are always tempted to pay for public spending via borrowing rather than taxes because voters are keenly aware of tax increases, but tend not to attribute any rise in interest rates that might derive from more government borrowing to government or politicians.

Simon Wren-Lewis (former Oxford economics prof) refers to this phenomenon as the “deficit bias”.

Of course the rise in interest rates attributable to government borrowing couldn't be described as “artificial” if that borrowing made sense. For example, it's possible that government borrowing which was confined to funding public sector CAPITAL spending might make sense, though even that is debatable.

One reason for doubting the validity of the “borrow for capital spending” idea is that when any private sector entity, e.g. household or firm, wants to make a capital investment, e.g. buy a new car, and happens to have enough cash to pay for the investment, it won't, quite righly, borrow. Why pay interest when you don't need to?

In other words, the REASON for borrowing to fund capital spending is SHORTAGE OF CASH. But governments are never short of cash in the sense that there is no limit to the amount of cash they can grab off taxpayers, never mind that in most years there is scope for simply printing more money. In short, the “borrow to fund capital spending” idea looks flimsy.

But in any case, the reality is that governments just don't borrow purely for capital spending: they borrow to fund CURRENT spending as well.

So to summarise, a significant proportion of government borrowing, if not most of it, is not justified. Ergo government borrowing results in a artificially high interest rates and has done so for a very long time. Of course the low rates of interest we've seen over the last ten years or so since the GFC and the onset of Covid are an exception, but this article is concerned about the very long term: the last three hundred years or so.

Robert Skidelsky's strange ideas on QE.

He penned an article recently entitled “Where has all the money gone?” and makes the bizarre claim in his first para that “...one question is almost never discussed: Why have central banks’ massive doses of bond purchases in Europe and the United States since 2009 had so little effect on the general price level?”
 

Well I've seen that question discussed at least once a week for the ten years or so since QE started! How about you? And if you and/or Skidelsky HAVEN'T seen that question discussed, then I don't know what planet you and he live on...:-) I discussed that question on this blog just over ten years ago!
 

Google “QE” and “asset swap” (which is all that QE amounts to) and you'll find about SEVEN THOUSAND articles and similar making that point.

Second, Skidelsky (like most allegedly “professional” economists) appears to be unaware that far from it necessarily being desirable to reverse QE, there's a good case for continuing it till the ENTIRE GOVERNMENT DEBT is QE'd. Reason is that, as Milton Friedman and MMTers claim, the best rate of interest on government liabilities is zero percent. If that's correct, then the entire stock of government debt might as well be turned into zero interest yielding cash!!

Next, Skikelsky tackles the question as to EXACTLY WHY QE has not boosted demand all that much. Well I suggest the answer to that has been obvious for a long time to anyone who has got past the first chapter of an economics text book. It's that QE consists of the central bank creating new money and buying up bonds, mainly government bonds, thus that process involves giving savers a slightly different asset to the asset they currently hold! That process is hardly likely to result in a splurge of consumer spending and for the blindingly obvious reason that savings are by definition assets which the owner has no intention of spending. Doh!!

But that's too simple for Skidelsky. Instead he invokes an arcane reason put by Keynes namely that that during recessions money flows to what Keynes called “financial circulation” rather than “industrial circulation”. As Skidelsky puts it, “During a sharp economic downturn, he (Keynes) argued, money is not necessarily hoarded, but flows from “industrial” to “financial” circulation. Money in industrial circulation supports the normal processes of producing output, but in financial circulation it is used for “the business of holding and exchanging existing titles to wealth, including stock exchange and money market transactions.”

But wait..... That idea of Keynes's has NOTHING specifically to do with QE!! It's simply what might be called a “general all purpose” idea as to what happens in recessions!!

But Skidelsky's article then goes from bad to worse. He says “But the antidote is staring us in the face. First, governments must abandon the fiction that central banks create money independently from government. Second, they must themselves spend the money created at their behest. For example, governments should not hoard the furlough funds that are set to be withdrawn as economic activity picks up, but instead use them to create public-sector jobs.”

Re the “fiction that central banks create money independently from government”, central banks actually do that when they create new money and do QE in the form of buying up COMMERCIAL as opposed to government bonds!!

Of course it is true (as Skidelsky has himself pointed out elsewhere) that the large majority of bonds “QE'd” have been GOVERNMENT bonds. But it is wholly untrue to say central banks can't create money independently of government.

Next in the above quote comes Skidelsky's claim that when governments cut a particular form of spending (furlough spending in this case), that the relevant money is likely to be hoarded by government. Well that's not true.

Governments, as far as they can, first decide whether to go for a deficit and also decide how large that deficit should be, or they may decide that a “no deficit” scenario is best for the time being, i.e. they may decide to “balance the books” for a while.

Whichever of those options government goes for, it will then try to stick to that option (surprise surprise). And that means that if a particular form of spending is cut (e.g. furlough) government will AUTOMATICALLY raise some other form of spending or cut taxes. If it doesn't, it won't ipso facto stick to its own deficit target!!!

Conclusion. Skidelsky's claim that recessions should be solved mainly by FISCAL means is certainly correct, or to be more accurate, I'd suggest (along with most MMTers) that ABOVE the zero bound the first resort should be to cut interest rates, with fiscal means then being employed at or near the zero bound. But most of the rest of Skidelsky's article, shall we say, leaves room for improvement.

Good news: Richard Murphy says the recent £10bn tax increase is not needed!

Normally I agree with Richard Murphy, but he rather went off the rails in this recent article where he claimed that since the UK govt has had to borrow and spend £26bn less than was forecast in March, that therefore the recently announced £10bn tax increase to fund more spending on social care is not needed. Article title: “The government has borrowed £26bn less....”.

Spotted the flaw in that argument? If not, it's as follows.

The fact that govt has had to print and spend £26bn less than expected (which is what “borrow and spend” actually means given that the Bank of England simply prints money and buys back govt debt as Murphy rightly says) means the economy has performed better than expected. i.e. govt thinks the amount of stimulus needed to keep the economy as near capacity as possible is £26bn less than expected. Indeed, given the shortages appearing left, right and centre (in the US and Europe IN ADDITION to the UK), it looks like Sunak's “£26bn less” strategy is not unreasonable.

But that comes to the same thing as saying the UK finance minister thinks (rightly or wrongly) that had that £26bn been printed spent, the result would have been excess inflation. Same goes for printing and spending £10bn without covering that with £10bn of extra tax.

Note: the question as to whether the economy REALLY IS near capacity and thus the latter excess inflation would transpire is an important question, but it's WHOLLY IRRELEVANT to this £26bn/£10bn argument. Murphy assumes government is CORRECT to cut stimulus by £26bn, which is a fair enough assumption to make for the sake of argument.
I.e. his claim is that £26bn less is needed for stimulus, ergo there is £26bn, £10bn or whatever of lovely free money just waiting to be printed and spent. False logic.

More nonsense from Mariana Mazzucato & Co.

 

That's in an article by her and co authors published by the Boston Review and entitled “Industrial Policy's Come Back”.

This article simply repeats a message she has made at least TWENTY TIMES before and I'm getting tired of it.

She and co-authors say in connection with Regan / Thatcher “neoliberal market fundamentalism” that “Under this regime, modern capitalist markets have proven themselves unable to create an even distribution of wealth and income, ecological sustainability, affordable shelter and health care..”.

Well no one ever said Regan / Thatcher style “fundamentalism” or free markets WOULD DEAL with inequality or “ecological sustainability”!!! Economics text books have always made it clear that there are some things the market does not deal well with, if at all: e.g. “externalities” like pollution, and inequality. Certainly in the UK, spending on social security did not plummet when Thatcher came to power: i.e. she was perfectly well aware that the market would not deal with poverty. (Incidentally, be nice if those who teach economics in universities got to grips with introductory economics text books, wouldn't it!!)

Ergo what is needed to deal with the latter problems is a social security system, anti pollution laws and measures like subsidies for wind & solar power etc. But we've been doing all that for YEARS and in some cases DECADES!! and no thanks to Mazzucato.

While one COULD CLASSIFY subsidies for wind and solar power as a FORM OF industrial policy, that on it's own is not what is normally meant by “industrial policy”. The phrase “industrial policy” (and this is the way in which the authors use the phrase in he second half of the article) means something like “a move towards a Soviet style central planning system” or an “industrial strategy” as the authors call it.

So while the authors claim the above points which have long been made in economics text books are an argument for an industrial stratety (in the latter broad sense) they are actually nothing of the sort.
 

Oooh. Gosh. Let's stimulate demand.

Next, the authors say “Any industrial strategy should therefore aim to stimulate demand...”. Well who ever said government and central bank SHOULD NOT stimulate demand when necessary? Why do Mazzucato & Co think governments and central banks have created and spent billions if not trillions into their economies since the GFC?

Doh!!

Next, the authors claim “We need a different approach to policy making: a mission-oriented framework that focuses government action on solving fundamental challenges rather than waiting for the solution to trickle down through competitive market forces.”

Now what ACTUAL EVIDENCE is there that a “mission-oriented framework” (whatever that is) would do better than competititve market forces? The authors offer no evidence!

This article is just a series of important sounding pseudo technical words and phrases which boil down to nothing.

Anyway, the authors then give four instances of “mission oriented frameworks” or if you like, for reasons for industrial policy. The first is that the state “should play an active role in creating and shaping markets in the direction of well-defined missions, using the full arsenal of policy instruments at its disposal—including public investment, regulation, demand-stimulating procurement, macroeconomic policy, and education and skills training.”

Well that's a bit like saying that in deciding what to do next week, you should have “well defined missions”. If that isn't as good as meaningless I don't know what is.

Anyway, the only actual EXAMPLE of the latter “market shaping” approach given is Germany's policies on combating climate change. But we already know (to repeat) that that's a problem that needs to be addressed and urgently!! We've all known that for YEARS!! Plus that (to repeat) is not any sort of new idea in that (to repeat) the economics text books have explained for DECADES, that the market does not deal well with externalities like excess CO2 emissions.

Looks like there is nothing in Mazzucato & Co's article that is original or new. It's just hot air, waffle and important sounding words of phrases, and I can't be bothered with any more of it.

But the authors should be congratulated in one respect: a torrent of waffle and important sounding pseudo technical words and phrases will fool a large majority of the public and perhaps about half of academia plus editors of publications like the Boston Review. If you can churn out hot air, waffle and important sounding phrases and a litany of false logic, you'll go far.

Strange ideas on NAIRU from Roger Farmer.

 

Farmer claims in this NIESR publication entitled “Coordinating monetary, fiscal and financial policy” that “There is no NAIRU” and that NAIRU “is a religion, not a science”. MMTers incidentally often claim likewise.

His main reason for that claim seems to be that “Because the NAIRU and r-star are unobservable and time-varying, the dominant paradigm is irrefutable.” Presumably “dominant paridigm” refers to NAIRU. (Academics always like using six syllables where two will do because that makes them look important.)

Well there's an obvious flaw in that argument, which is at we human beings use HUNDREDS of concepts every day which are “unobservable and time-varying”. Love is not “observable”, at least in the sense that it cannot be actually measured, which I assume is what Farmer means here. Clearly every romantic novel should be burned as they are all talking nonsense.

And for another example there is “power” in the sense of the power of the Roman Empire or the US military machine in 2021. How exactly do you measure those? You can't, at least not with anything remotely like accuracy that is normally implied when the word measurement is used in physics, astronomy etc.

Incidentally, while on the subject of physics, there are sub-atomic particles whose existence was inferred before they were actually “observed”. Obviously physicists need to pay attention to Farmer and the NIESR (ho ho).

Clearly all books on the history of the Roman Empire and indeed all other books which refer to the “power” of some country or empire should be re-written.

I could cite a hundred other examples of commonly used ideas and concepts which are not “observable”, but hopefully you've got the point.

The moral is that if you're looking for nonsense on stilts, then something written by a leading economist published by a respectable, taxpayer funded organisation like the NIESR might be a good place to look.

The futility of interest on government debt – and other anomalies

 .

Paying interest on reserves and government debt really is a genius idea. It amounts to rewarding those who hoard cash by paying them interest. That interest has to be paid for somehow: in effect it's paid for by taxes on the section of the population which DOES NOT have cash to hoard. At least that's true assuming the economy is at capacity and the interest cannot be funded simply by printing money. And if THERE IS scope for money printing, then donating that money to money hoarders is not number one priority for about 99% of the population, I'd guess.

It might seem tempting to claim that interest on reserves is paid to banks, not depositors. The answer to that is that ANY INCREASED INCOME enjoyed by banks inevitably trickles down to bank shareholders, depositors, those who borrow from banks and anyone who has anything to do with banks. i.e. that increased income absolutely must end up on SOMEONE'S pocket, including the pockets of depositors. And the fact is that cuts in bank costs over the decades and centuries (e.g. thanks to computers) have not benefited JUST shareholders: proof of that lies in the fact that the return on capital that banks manage has always been comparable to that obtained in other industries, over the medium and long term.

And the idea that government liabilities should pay no interest is not some sort of new crank idea: Milton Friedman (and MMTers) claim/ed there should be a zero rate on government debt. Like Milton Friedman, I wouldn't TOTALLY RULE OUT interest rate hikes in emergencies.  But the above daft aspect of interest on government liabilities (subsidising the rich) does support the claim by Friedman and MMTers that the best rate of interest on state liabilities is zero. (For Friedman, see his para starting “Under the proposal..” in his 1948 AER paper.)

Of course it might be argued that interest on government debt would be justified where relevant sums fund public INVESTMENTS like infrastructure. But government debt in most countries just isn't limited to funding those investments. So that point is irrelevant for the moment.

 

That strange deposit insurance limit.

Another anomaly here is as follows. Most countries limit the amount per person deposited at banks which is covered by deposit insurance (€100,000 in the EU and £85,000 in the UK). But in the UK, and maybe other countries, you can deposit up to £2million at the state run savings bank National Savings and Investments. And your money will be totally safe because NSI invests only in base money (i.e. reserves) and government debt.

Moreover, even if institutions like NSI didn't exist, anyone is free to buy as much government debt as they like. Of course if you buy debt which still has several years to run before maturity it's possible to lose money. But if you buy SHORT TERM debt, it's near impossible to lose out.

The above anomaly is not easy for governments to resolve: to resolve it, i.e. ensure that no one holds more than a limited amount of government liability, they'd have to check up on how much each person has in state run savings banks AND how much government debt they hold DIRECTLY. And to add to the complexity, they'd need to check up on how much each person had in mutual funds which specialise in holding government debt.

But at least a near permanent zero rate of interest on government liabilities would HELP cut down on all the above anomalies.

___________

P.S. 16th Sept 2021. I'm please to see Warren Mosler (founder of MMT) agrees with the point made in the above first paragraph. Warren has actually made the above point about money put into government debt amounting to placing money in a term account at a bank called "government": he's made the point several times in his books and articles far as I remember.

Whoopee: Bank of England has a new and sub-standard chief economist, Huw Pill.

 

 If you want an example of beautifully crafted English which boils down to saying nothing much, (one of the main skills possessed by those, like Sir Humphrey Appleby, at the top of the British establishment), I recommend Huw Pill's chapter (Ch3) in this NIESR publication. It's entitled “Renewing our monetary vows.” 

Incidentally, the NIESR at the moment seem to be the World's experts at churning out content free, sleep inducing hot air. It's an organisation which specialises in consuming taxpayers' money, not so as to promulgate knowledge or ideas on economics, but rather to do what a significant proportion of academics do: publishing content free waffle so as to further their careers.

Anyway, QE is one of the main topics of Pill's above mentioned chapter, if not THE MAIN topic, and his conclusion (his last para) is that “defensible limits” on “central bank financing of government deficits” are needed. But what makes him think that a central bank which has an inflation targeting mandate would let CB financing of govt deficits get excessive? Given too much inflation, any such CB would do one or more of several things: e.g. 1, stop any more QE, 2, put QE into reverse, 3, raise interest rates which comes to much the same as reversing QE: i.e. a central bank which aims to raise interest rates will (inter alia) sell govt debt into the market. 

So why the need for “defensible limits”?

Pill's point is a bit like saying we need “defensible limits” to the amount of water the fire brigade pour on burning houses, else the excessive amount of water poured on the house would do more harm than good. The answer to that is that every fire-fighter knows (as indeed does every ten year old) that once a fire is obviously out, no more water needs to be poured on it.


 

Richard Murphy is not up to speed on banking.

 

Abstract. The main nonsensical claims made by Richard Murphy in his article are first that Positive Money wants a ban on all further increases in the money supply. Second he claims that neither Positive Money nor the Bank of England are aware the loans by commercial banks create money. Third, he objects to the fact that nothing is done with reserves at the BoE, i.e. he objects to the fact that those reserves are not for example loaned out by the BoE.

 __________

This article of his contains blunder after blunder.  It’s entitled “Positive Money and the Bank of England are completely wrong….”.  Apologies for the length of this article, but the sheer number of blunders will take time to address.

In reference to Bank of England proposals on Central Bank Digital Currency (CBDC) he says in his second para: “Quite staggeringly they (Positive Money) are using this proposal to demand the end to the right of private banks to create money, and as I note below the Bank of England will not want to take on that role.” 

Actually the Positive Money article to which Murphy links in his 3rd para does not “demand” an end to privately created money (although PM do advocate such a ban). The PM article simply refers to the claim by a senior BoE official, Andy Haldane, that CBDC may herald the end of private money issuance, which is a fair enough point.

Next, Murphy seems totally unaware of the fact that PM is nowhere near the only lot to advocate the latter ban. That ban has been or is supported by a good sixty economists (including a clutch of Nobels). There's a list of those sixty here. The proposal to ban privately created money goes by various names: “full reserve banking”, “100% reserves”, “narrow banking”, etc.

Having said that numerous economists and groups advocate banning privately issued money, I should qualify that by saying the objective is actually to ban “privately issued and state backed” money (backed via deposit insurance, bank bail outs, etc). In contrast, there is privately issued money which is NOT state backed and which is thus clearly not entirely safe: e.g. Bitcoin. Indeed, there are any number of not entirely safe forms of privately issued money. At a stretch, you can use a bottle of whiskey as money, or at least you can try. Banning ALL FORMS of obviously dodgy money would be near impossible. But as long as everyone knows the risks (which in the case of Bitcoin they do), I don't see the much harm in those strange privately issued forms of money, though things are moving fast in this area and need watching.
 

PM advocates a ban on all new money?

Next, there's Murphy's claim that “ what Positive Money are proposing is that we crash the economy by denying it access to any new money.” Total nonsense. Under full reserve, as proposed by PM and dozens of others, the economy is not denied access to new money. The proposal is (to repeat) that the only form of totally safe money should be state issued money (which can be increased annually, as clearly explained by PM, by whatever amount government and central bank think appropriate.) There is no plan to ban all increases in the supply of money!!

Next, Murphy says “That is to say that we already have a digital currency in the UK. Your bank account is already part of a wholly digital currency system. So, there is no obvious need for a CBDC unless it does something better than your existing bank account or existing money can do.”

Well as anyone who has been more than half awake for the last year or so knows, the Chinese have actually implemented CBDC on a small trial basis. Plus central banks the World over are actively considering the idea. For example the Bank of England's latest proposals are here.


Plus Martin Wolf, chief economics commentor at the Financial Times says the Bank of England needs to get a move on with this. But no doubt Murphy thinks he knows better.

Wolf's reason (if I've got him right) is that numerous private operaters are forging ahead with CBDC like bank accounts: so called “stablecoins”. Thus central banks need to get a move on and set up their own stablecoin type accounts (i.e. CBDC) for those who want that. Plus central banks need to get a move on with regulating stablecoins, which is one of the main issues addressed in the latter BoE work.

Moreover, the brute fact of the matter is that people and money are moving into stablecoins in large amounts. If that's what the customer wants, then who is Murphy to deny them what they want?

Next, Murphy says “Then let me as clear as it is possible to be: no one, anywhere, has yet found any evidence that a so called digital currency of any form can do that.” (He's referring to CBDC “doing better” than existing bank accounts.

The answer to that is that the above mentioned Bank of England discussion paper cites at least a dozen ways in which CBDC might (at least in the eyes of some account holders) be better than existing bank accounts.

 

Seven arguments against CBDC.

Next, Murphy lists a number of reasons why he thinks CBDC would actually make people worse off.

The first is that he doubts BoE CBDC accounts would offer overdrafts. Well what of it? Some people don't want overdrafts. I haven't had one for twenty years!!

Plus the UK's government run savings bank, National Savings and Investments does not offer overdrafts. But millions of people have accounts there!! If that's what people want, why shouldn't the “consumer be sovereign”? Why not let people have what they want?

Murphy's second reason is that BoE CBDC will not offer credit cards. That's really the same as his point No.1 just above, and my answer is the same.

Murphy's third reason is just more of the same: he says BoE CBDC will not suit those with “chaotic financial affairs”. Well probably not: in other words BoE CBDC will probably not give overdrafts to those who cannot organise their affairs. But that's not a brilliant reason for denying the bulk of the population whose affairs ARE ORGANISED the type of bank account they want.

Murphy's fourth point is yet more of the same. This is getting tedious. He points out yet again that BoE CBDC won't offer overdrafts.

His fifth point is that what BoE CBDC offers essentially is a savings account on which customers can draw the digital equivalent of a cheque, making those accounts a form of current account (“checking account” in US parlance).

Well true. But that's what a significant proportion of the population want!! That's why billions have been deposited at National Savings and Investments.

In his sixth point, Murphy says “Nor is anyone discussing what the Bank of England might do with the funds deposited with it. That is the most massive going flaw in their whole paper - and in Positive Money's response to it.”

That point nicely illustrates Murphy's non grasp of how banks, commercial and central, work. The quickest answer to his “do with the funds” point is that central banks AT THE MOMENT do not do anything with the funds deposited with them. That is, reserves (i.e. base money) held by private / commercial banks are AT THE MOMENT deposited at the central bank - where (Murphy will be horrified to learn) those funds do not do anything – apart from earning interest for commercial banks. But the latter point is not of great relevance here.

 

Why central bank created money does nothing.

The actual reason central banks do not “do anything” with reserves, i.e. state created money, lodged at central banks is that central banks and governments have decided that central banks should play a SOCIAL role in the form of trying to create the optimum amount of a country's basic form of money, i.e. base money / central bank created money. And they have deliberately decided to abstain (rightly or wrongly) from COMMERCE, i.e. lending out money to mortgagors, corporations etc except in that they can play a social role by buying corporate bonds with a view to enhancing QE and raising demand.

I.e. obtaining a stock of that basic form of money and levering it up into a larger amount of money is a job governments wish to leave basically to COMMERCIAL banks. 

 

The BoE doesn't know private banks create money??

In his seventh point, Murphy puts his foot right in it when he says “neither Positive Money or the Bank of England (based on some of their comments on their website in this proposal) seem to be aware that savings are not what creates the UK money supply. The UK’s money supply is created by lending.”


Er – actually one of the main points in a BoE article “Money creation in the modern economy” published a few years ago was PRECISLY that commercial banks create money when they lend (a point that Positive Money had been making for YEARS beforehand.) Indeed Keynes made that point in 1920s/30s in his book “Treatise on Money” as did Josiah Stamp, governor of the BoE in the 1920s. Plus David Hume made the point 300 years earlier.
 

Even more hilarious is that that BoE paper has been cited three hundred and seventy times. See here. In short, the entire World seems to be aware of that BoE paper apart from Murphy.

What's wrong with “debt based” money?

 
 

 When a private / commercial bank grants a loan, it credits the account of the borrower with the bank's home made money, and at the same time, the borrower is in debt to the bank in that the borrower must repay the debt at some stage. The borrower of course then spends that money, so that money ends up with a variety of other people and firms. It would therefore seem that someone has to go into debt in order for people to have a stock of money.
 

That idea is promoted in this Positive Money article for example.

Only problem with that idea is that the total amount of debt that the population wants to incur vastly exceeds the amount of money it needs for day to day transactions. Thus money is in effect a free by-product of lending and debt. 

In contrast, if no one in the country, or at least very few wanted to incur debt, then debt based money would certainly be inferior to “non debt based” money, i.e. base money (central bank issued money). But that's not what obtains in the real world.  

To illustrate with some figures, the average mortgage in the UK is just under £140,000 and there are around 11 million mortgages and 30 million households. Average household income is around £30,000 pa, i.e. £2500 a month. So the average household needs a minimum of about £2,500 to tide it over from one salary cheque to the next. Say £4,000 for comfort.
 

So total amount of money needed for day to day transactions and a bit for rainy days is 30million x £4,000 equals £120bn. In contrast, the total amount of mortgage debt is 11million x £140,000 equals £1.54tr. So the total of all mortgages is a bit over ten times the amount of money needed.

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P.S. 3rd Sept 2021.  I omitted the REASON debt based money would be inferior to base money where there was very little desire to incur debt in the above paragraphs. Reason is that (assuming the stock of money people want for day to day purchases is the same) then the only way they'd be able to acquire that money would be to borrow it from a commercial bank. But that involves those banks in checking up on the credit worthiness of borrowers, getting security / collateral off them as necesssary, and those are very real costs. In contrast, if the relevant economy relies just on base money, there are no such costs. As Milton Friedman put it (using rather convoluted language), "It need cost society essentially nothing in real resources to provide the individual with the current services of an additional dollar in cash balances."  .

Regulating stablecoins – the rules of full reserve banking proved right yet again.

 


This is an odd article by Frances Coppola on regulating stablecoins. The title of the article is “Regulating stablecoins for what they are.”

She claims in her second para that “....a stablecoin regulated like a bank or a money market fund (MMF) would not be able to do its job.” But in her last para, she says “….regulators should concentrate on ensuring that stablecoins . . . have 100% reserves and/or are licensed banks.” Slight inconsistency there, I think.

Another inconsistency is that in the past she has opposed 100% reserves / full reserve, e.g. in this article of hers. And while that article was published several years ago, far as I know she has not retracted any of it.

Martin Wolf also has an article on this subject in the Financial Times entitled “Time to embrace...”. The article doesn't seem to be behind a paywall.

His concluding sentence is virtually the same, word for word as Frances Coppola's.

I agree with both conclusions. Or to be more accurate, I'd advocate applying the basic rule of full reserve banking (aka “100% reserves”) to stablecoins, banks and MMFs (Money Market Mutual funds). That basic rule is that any bank or bank like entity including MMFs and stablecoins where it claims that investor / depositors' money is safe must back all deposits with reserves (though possibly short term government debt should be allowed as “backing” as well). And as for entities where there is less than 100% backing, they should be allowed to do anything they like, as long as they do not break the laws that other corporations and firms have to obey. Plus they must make it clear, if it's not already obvious to everyone, that depositor / investors face risks. i.e. if anything goes wrong with the entity and depositor / investors lose out, there is no government rescue available for them.

Indeed, MMFs in the US were made to obey the latter basic rule in the aftermath of the 2008 bank crisis.

And the beauty of the latter rule is that it complies with a principle widely accepted in science, namely that science awards top marks to simple rules that explain a lot, e.g. Einstein's theory of relatively or Newton's laws of motion. In contrast, science is skeptical of complicated laws which do not explain very much.

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P.S. 8th Sept 2021.    Another reason for imposing the rules of full reserve on stablecoins, i.e. insisting they are 100% backed by central bank reserves is thus. As I explain in more detail in MPRA paper No.108488, having a stablecoin backed by something more risky than central bank reserves has superficial attractions. Indeed that's an idea that the Bank of England toys with in its recent discussion paper on CBDC and stablecoins. One attraction is that stablecoins (or any entity that resembles a bank or mutual fund) backed by more risky assets is then into money creation, which is stimulatory. But absent that stimulus, it is the easiest thing in the World to implement stimulus simply by having the central bank create money instead, and spend it into the economy (and/or cut taxes). Ergo the the above mentioned risks are entirely pointless!