The words of Prof. Bryan Caplan:
"I've been in school for the last 35 years - 21 years as a student, the rest as a professor. As a result, the Real World is almost completely foreign to me. I don't know how to do much of anything. While I had a few menial jobs in my teens, my first-hand knowledge of the world of work beyond the ivory tower is roughly zero.
I'm not alone. Most professors' experience is almost as narrow as mine. If you want to succeed in academia, the Real World is a distraction. I have a dream job for life because I excelled in my coursework year after year, won admission to prestigious schools, and published a couple dozen articles for other professors to read. That's what it takes - and that's all it takes."
Words of Dean Baker (director of the Centre for Economic Policy Research):
“If we ask why economists would believe something about the world that seems to fly in the face of evidence, my answer would be that it is the easiest path for them. The vast majority of economists have no interest in upsetting the apple cart. They wanted to be economists because it is a relatively well-paying and prestigious profession. The way you move ahead in the profession is you repeat what the people who are more prominent than you are saying. This carries no risk. If they are right you can share in the glory. If they end up being wrong, then you have the “who could have known?” excuse.”
Dean Baker again:
“In elite Washington circles, ignorance is a credential.”
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Positive Money advocates full reserve banking. So do I. So I support Pos Mon both financially and with my time. But I disagree with them on a couple of points.
What proportion of money is created by commercial banks?
Pos Mon (and the New Economics Foundation) claim that 97% of money is created by private banks rather than the Bank of England. This figure is based on the fact that 3% of money is physical cash (£20 notes etc).
If monetary base came only in the form of the above cash, then the argument would be valid. But the reality is that a significant portion comes in the form of book keeping entries, or (as is the case nowadays) entries in computers. As far as I can see this amounts to about another 3% during normal times. In contrast, during the current recession, the monetary base in the UK and elsewhere has been significantly expanded.
For example, in the US the base as a proportion of M2 rose from about 12% at the end of 2000 to 27% in Oct 2011. For the figures, see here and here.
The “book keeping entry” portion of the monetary base is not of course strictly speaking in circulation. But nor can it be said to be private bank created.
The process by which this portion of the monetary base comes into existence (using QE for the purposes of illustration) is thus. The Bank of England (BoE) creates money and buys Gilts from X – (person or institution). The latter gets a cheque for the value of the bonds sold. The cheque is deposited at X’s commercial bank and X’s account at the commercial bank is credited. And the commercial bank presents the cheque to the BoE, who credit the commercial bank’s account in the BoE’s books.
The net result is that the money supply is expanded, NOT as a result of any private bank’s money creation activities, but as a result of the BoE’s money creation activities. And the only reason X is not a direct holder of monetary base is that the BoE does not create accounts in its books for anyone apart from very large institutions, like commercial banks. But in effect, X holds monetary base: it’s just that a commercial bank acts as agent for X at the BoE.
Are we reliant on debt for our money supply?
Another claim made by Pos Mon is that we are reliant on debt (owed to banks) for our money supply. The above 97% figure would certainly seem to support this view.
On the other hand, given a about of deleveraging, such as we have had recently, and a consequent contraction of privately created money, it is clear that central banks step in and make up for the contraction of privately created money with an expansion of central bank money (monetary base).
This phenomenon is nicely illustrated by the 2nd chart on page 2 of this Credit Suisse paper.
So are we really “reliant” on privately created money for our money supply? I suggest not. I suggest that what is going on is as follows.
The typical household with a mortgage will be in debt to the mortgage provider to the tune of very roughly £20,000 to £60,000 with only perhaps £1,000 or so in the bank. In other words the average household with a mortgage sees fit to have an amount of debt which is large compared to the amount of debt free money it chooses to hold.
Those households with £20 – 60,000 of debt will of course be balanced by other households or institutions with equally large amounts of cash to spare.
Incurring debt so as to get a roof over one’s head is largely a VOLUNTARY choice, since the alternative and debt free method of getting a roof over one’s head is to rent. Indeed, this ties up with law of reflux and the real bills doctrine which state that each private sector entity incurs the amount of debt it WANTS, or regards as appropriate, or regards as best suiting its needs.
To summarise, commercial banks provide what might be called a “debt transfer” service. Those debts are widely regarded as “good” because they are backed by respected institutions: large banks. Thus these debts are a form of money.
AS IT HAPPENS, these debts provide the economy with nearly as much money as it wants or needs. But if the population were particularly keen on incurring NO DEBT, the money supply would not shrivel up: the central bank would just step in and issue the amount of money required to keep the economy ticking over.
Do we “rent” our money supply?
Pos Mon, or at least a proportion of Pos Mon minded folk, promote the idea that because people pay interest on debt, and because that debt is a form of money, that therefor we “rent” our medium of exchange. I disagree.
The rent paid here is the rent paid by debtors to creditors. If the creditor is NOT A BANK, chances are that the debt does NOT become a form of money. Money is anything widely accepted in payment for goods and services. For example, where firm A supplies firm B with goods, a debt is than owed by B to A. And part of the agreement between the two may involve interest to be paid by B to A if B is late in paying for the goods. But this debt is not a form of money because it is not easily transferable: it is not widely accepted in payment for goods and services.
And borrowing, lending, debts, etc would continue after the introduction of full reserve, as Pos Mon admits. Put another way, if you have money in your bank account, you are, to that extent, a creditor. But you don’t pay “rent” for the privilege of possessing this money do you? Quite the reverse: other than during the very low interest rates that currently obtain as a result of the credit crunch, you probably get some interest. I.e. the bank PAYS YOU!!!!
Conclusion: debtors normally pay interest to creditors, but posessors of the money created by commercial banks do not pay rent to such banks for the privilege of being supplied with a medium of exchange.
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Youtube clip of Ron Paul interviewing Bernanke.
Ron Paul asks whether money for capital investment can come from the printing press – see 1min 30 secs into the interview. Bernanke does not give a straight answer. The answer is thus.
If an economy is at capacity, and the government / central bank machine (GCBM) prints money and distributes it to commercial banks, who then lend it to firms doing capital investment, that investment expenditure will raise demand, which in turn will raise inflation. That effectively robs those who are not in receipt of GCBM largess, and those robbed are forced to forgo consumption.
Thus the REAL RESOURCES for the capital investment come from those robbed. And that is a pretty random selection of the population, and an illogical way of organising the reduction of consumption needed to fund capital investment.
If the economy is below capacity.
In contrast, if the economy is BELOW capacity, the additional demand may well not exacerbate inflation too much. But robbery still takes place. That is GCBM allocates the “right to control resources” (i.e. money) to a few chosen institutions (i.e. banks). That is money that could have been simply spent into the economy, and/or used to cut taxes (as advocated by Modern Monetary Theory and by this lot.
If GCBM can show that the amount of investment is sub-optimum, i.e. that there has been market failure, then artificial assistance for investment could be justified. But of course GCBMs have never demonstrated this: that would be too much like hard work.
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Hat tip to Dr Mike Heywood. I got the link to the above Youtube clip from an email that Dr Heywood distributes about once a week. This email contains what he thinks are interesting economics articles, and a selection of economics / politics related cartoons. Contact: mike@mikehaywoodart.co.uk.
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It’s been announced in the last 48 hours that the UK government intends underwriting a few billion of loans by banks to businesses, which to the innocent will sound a good idea.
But why should government subsidise bank loans to businesses? There are alternative sources of funding for businesses: issuing shares or obtaining loans from non-bank institutions (or in the case of small businesses, loans from family members or friends).
Siemens in Germany are very much into the “firm to firm” lending business. Are they entitled to a subsidy, and if not, why not?
Moreover, the whole bank lending business already receives an ASTRONOMIC subsidy: that’s the too big to fail subsidy plus the £85,000 per account guarantee provided by government (i.e. taxpayers). The too big to fail subsidy alone was estimated by the Independent Banking Commission as being worth well over £10bn a year (about £150 per UK resident per year). See p.130 here.
As the ICB righly say (p. 8) “The risks inevitably associated with banking have to sit somewhere, and it should not be with taxpayers.”
Government should stop tinkering with the dozens of levers that they think control the economy and concentrate on approximately one lever. As advocated by Prof Werner, Positive Money, the New Economics Foundation, government should just create new money and spend it into the economy when needed (and/or cut taxes). Modern Monetary Theory advocates the same.
Or as Simon Jenkins put it, “Governments can worry about borrowing, lending, inflation, fiscal rectitude, whatever until the cows come home – but without demand there is recession.”
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The recent failure of Deutschland to sell its debt stems does not stem the market thinking Deutschland is not credit-worthy. The very idea is absurd. The problem derives from suspicious as to whether the Euro will survive. Who wants to own bonds denominated in a currency that might cease to exist in a few months?
The solution is for the ECB to act a bit more like a normal central bank / government and create and spend money into the Euro economy. This comes to much the same thing as the Euro distribution long advocated by Warren Mosler (see para starting “The ECB would create…”).
Or have I missed something?
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The article starts:
It is now clear that curbing Britain’s public debt is going to be much harder than the coalition government originally predicted. While David Cameron admitted as much earlier this week, official confirmation will come next week with the publication of the Office of Budget Responsibility’s report on the state of the UK’s public finances. While disappointing, this does not undermine what still appears to be a sensible plan. The problem for the government is that weaker actual and potential growth has made the task of reining in the deficit much harder than forecast.
Now why would “weaker growth” result in “reining in the deficit” being “much harder”? Reason is that weak growth necessitates a bigger deficit, or to be more exact, weaker growth requires more stimulus, which itself requires a bigger deficit.
But what’s wrong with such a deficit? If the private sector fails to spend, the remedy is to have government spend more (and/or cut taxes so that the private sector is encouraged to spend more). So what’s wrong with such a deficit – the fact that it results in more debt?
POPPYCOCK! As both Keynes and Milton Friedman pointed out, a “stimulus deficit” can be funded EITHER by borrowed money OR printed money. If interest rates are round about zero, there is no harm in borrowing more. But if interest rates become significantly positive, then all government needs do is to go for the print option. So there is no problem there.
But the next sentence of the FT article is bizarre. It says,
Chancellor George Osborne’s hopes of eliminating the current structural deficit by 2014-5 now look impossible.
Well as made clear above, the part of the deficit that may have to expand if weak growth persists is NOT THE STRUCTURAL DEFICIT. It’s the stimulus part of the deficit.
Put another way, the structural deficit is the part of the total deficit which has no influence on growth.
Or as the Reuters definition puts it “The portion of a country's budget deficit that is not the result of changes in the economic cycle. The structural deficit will exist even when the economy is at the peak of the cycle.”
Wiki says much the same: “a structural deficit exists even when the economy is at its potential”
(There are actually a number of other and silly definitions of the phrase “structural deficit” out there. I may do a post on this, as well as contacting the authors of those definitions.)
Now if the structural deficit has no influence of growth, it follows (by definition) that removing this part of the total deficit will have no “anti-growth” effect, i.e. no “anti-stimulatory” effect!
So if it’s the structural deficit and debt that the FT is talking about, it is untrue to say that, “curbing Britain’s public debt is going to be much harder” because of poor growth figures.
As to the actual mechanics of reducing the structural deficit without harming growth, see here.
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John Redwood says 87 countries have left currency unions since 1945.
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