Whoopee: CUSP publishes long inconclusive article on MMT, the debt and deficit.

 

CUSP (Centre for the Understanding of Sustainable Prosperity) describes itself at the start of the article as “an internationally leading research organisation funded by the UK’s Economic and Social Research Council (ESRC)”. Well, they WOULD give a flattering description of themselves, wouldn't they? The authors are Tim Jackson and Andrew Jackson.

I'm amazed to see Andrew Jackson, who co-authored what is sometimes called “Positive Money's Bible” (the book “Modernising Money”), which was a brilliant bit of work, if rather long, now authoring this boring article by CUSP.

The article – tediously long at 4,500 words - does get some things right. E.g. it draws attention to the incompetence of the IMF on the subject of debts and deficits. To be exact, the authors say, “The International Monetary Fund (IMF) initially appeared to support Reinhart and Rogoff, suggesting in 2013 that the most ‘critical fiscal policy requirements’ are a ‘persistent but gradual consolidation and, for the United States and Japan, the design and implementation of comprehensive medium-term deficit-reduction plans’.”

Unfortunately the conclusion of the CUSP article is so vague and inclusive, that it's not clear what the point of the article is. The conclusion reads...

“Our principal call here is for a greater degree of flexibility in the use of both monetary and fiscal policy and for better coordination between them. That flexibility should extend not only to the appropriate allocation of the respective targets of price stability and debt sustainability, but also to the precise mandates of the institutions involved in delivering those targets and the mechanisms through which they are achieved.”

The REAL OBJECTIVE of this CUSP article should be obvious: it's to make it look like the highly qualified bores associated with CUSP are doing something, which justifies their salaries.

As for the article's “call for greater flexibility”,that clashes with the call for “precise mandates of the institutions involved in delivering those targets and the mechanisms through which they are achieved.”

If the “mandates” are “precise”, that implies less flexibility than would otherwise be the case.

But not to worry: MMT has set out the “mandates” over and over, and I have added to that numerous times on this blog.

The first basic principle is that, as MMT says, the size of the deficit and debt are irrelevant: the only important consideration is minimising unemployment in as far as that is compatible with keeping to the inflation target. Second, there two obvious problems with the latter policy. The CUSP authors rightly draw attention to one, but appear to be oblivious of the second.

The first is: what happens, given a large debt, if interest rates rise? Government does not really want to had out large sums by way of interest payments to the cash rich. Plus any such interest payments will increase the deficit for reasons that have nothing to do with the JUSTIFIED reason for increasing it, namely dealing with excess unemployment.

Well there's a simple solution to that problem, namely to simply refuse to roll over debt at the new higher interest rate as it becomes due for rollover. I.e. just print money, hand it to previous debt holders and tell them to go away.

Of course that would result in the private sector holding too much cash, which would probably cause excess demand. But that's easily dealt with via higher tax, particularly on the wealthy.

The second problem, which is very similar to the first, is this. The need for a larger than usual deficit probably arises from, or at least is contributed to by an increased desire by the private sector to hoard cash rather than spend it.

But what happens if that desire reverses itself? Well, we're back with the situation where the private sector has an excess stock of cash, and the solution is the same: rob the private sector of that stock via extra tax!

Problems solved!!!!!!

As MMT has claimed for a long time, the best rate of interest on government debt is zero. Doubtless it can't be held at EXACTLY zero all the time. But at least, given the latter “solutions”, it can be held NEAR ZERO for much of the time.

 Crowding out: a slight mistake by Stephanie Kelton and Bill Mitchell.

One of MMT's main objections to the conventional wisdom involves so called “crowding out”: that's the idea that if government spends more, it will have to borrow more, which will raise interest rates, which in turn will cut private sector investment, i.e. “crowd out” the latter investment. Alternatively government will have to raise taxes, which will crowd out a broader range of spending by the private sector.

The response by leading MMTers like Kelton and Mitchell to that is that more government spending will not necessitate a rise in interest rates or increased taxes if the economy has spare capacity, i.e. where we are not at full employment. In other words in the latter scenario, the extra government spending can go ahead, and the only net effect will be reduced unemployment, an obviously desirable outcome.

But it follows from the above that if the economy IS IN FACT at full employment, then extra public spending WILL CROWD OUT private sector spending (investment spending or other spending). But strange to relate neither Kelton nor Mitchell actually mention that!!

At least I can't find anything to that effect in Kelton's book “The Deficit Myth” nor in Bill Mitchell's articles. But of course it's always possible Kelton or Mitchell do actually that point and it's just that I failed to find it! But certainly a good 99% of their material on crowding out is devoted to debunking the above mentioned conventional wisdom, rather than admitting that the crowding out idea is valid where the economy is at capacity.

My above “crowding out is sometimes needed” point may be IMPLICIT in Kelton and Mitchell's arguments in that they say deficits are limited by inflation, i.e. if government were to spend more when the economy is at capacity WITHOUT raising interest rates or taxes, the effect would be excess inflation. Still, they really ought to have made that point EXPLICITELY in the passages of their works which deal with crowding out.

If you don't make everything 100% clear, your opponents will get the wrong end of the stick or jump on it and claim they've spotted a flaw in MMT, as Ann Pettifor does in relation to the above crowding out point and MMT. See just under her heading “Mainstream economic theory and deficit financing” in her article entitled “‘Deficit Financing’ or Deficit-Reduction Financing?”

Waffle and hot air from Grace Blakeley on central banks.

That's a recent article of hers in Tribune entitled “Democratise Central Banks.”

“Democratise” is of course a favourite word with think-tank wonks and other PC air-heads. It sounds soooo loving and caring doesn't it? But normally those using the word have no idea EXACTLY WHAT form their “democratisation” should take. And Blakeley is equally vague on that point.

But presumably she means putting CB decisions into the hands of democratically elected politicians. But therein lies a HUGE problem, which is that one of the main purposes of CB independence (as indeed she herself rightly says) is to keep politicians AWAY FROM the printing press!!! Blakeley totally fails, in fact doesn't even TRY to square that circle.

But never mind: if you aim to be an economics commentator, spewing out lots of meaningful sounding words which don't actually mean anything won't harm your career.

The natural rate of interest.

Next, she claims one of the main objectives of central bank is to get CB interest rates to keep close to the “natural rate of interest”. As she puts it, “ The idea behind central bank independence is that there exists a natural long-term rate of interest—the rate at which supply and demand for money are in equilibrium, prices are stable, and full employment is maintained—and the job of central bankers is to ensure that short-term interest rates in the real economy hover around this natural interest rate.”

Well Google something like “central banks” and “objectives” and you'll find no references to “the natural rate of interest”, though obviously if you read an entire book on the subject, doubtless you'll find references to “the natural rate of interest”.

But in the next para, she says “there is no natural’ long-term rate of interest.”

Well, seems central banks are making an almighty c*ck up there. Or is it Grace Blakely that has no idea what she's talking about? I think I know the answer to that.

Then in the same passage, she says “When central banks started to buy long-dated government bonds, they revealed their intention to influence long-term interest rates, turning the long-term rate into a policy variable rather than a macroeconomic constant. “ Well quite: as MMTers have repeated till they are blue in the face, the rate of interest (certainly on government liabilities) is a “policy variable”.

Next in the three or four paras starting “In other words, quantitative easing has proven that the decisions central banks make about monetary policy are political choices”. Well clearly there are important political implications involved in QE, e.g. (as she says) the rise in asset prices, and hence rise in inequality it causes. But what else are Cbs supposed to do given near zero rates of interest and failure of “democratically elected governments” to implement enough fiscal stimulus? She doesn't tell us.

Instead, her conclusion, as mentioned above, is the fatuous claim that CBs need to be “democratised”.

 

Conclusion.

Looking for a job as an economics commentator? Well all you need do (especially if you're female and have a pretty face) is spew out meaningful sounding, but essentially meaning less hot air: especially when it comes to impressing the editors of left wing publications like Tribune. As Frances Coppola said about Blakeley, “If you don’t understand banks, you shouldn’t write about them.”

Economists overlook the obvious flaw in maturity transformation.

 

Short abstract.    Maturity transformation has the alleged advantage that it enables money / liquidity creation by private banks. It also has a big drawback, namely that's it leads to bank fragility, and hence to bank failures and disasters like the 2008 bank crisis. But central banks and governments can create any amount of money anytime. So why court disasters like the 2008 bank crisis. i.e. why not ban maturity transformation and just have central banks and governments do the money creation?

Longer abstract.   The “borrow short and lend long” practice that banks engage in (aka maturity transformation (MT)) has an alleged advantage namely that it enables money / liquidity creation by private banks (thus it's the basis of fractional reserve banking). The big DISADVANTAGE is that it renders banks vulnerable: it largely explains bank failures and was a big contributor to the 2008 bank crisis, which cost about thirty million people their jobs worldwide. So economists, regulators and politicians devote tens of thousands of hours and millions of dollars trying to work out the best compromise between the latter advantage and disadvantage.

Now the obvious point they overlook here is that governments and CENTRAL BANKS can very easily create and spend into the economy whatever amount of money is needed to bring about full employment, and all WITHOUT the latter risk! Indeed, governments and central banks have been doing just that on an unprecedented scale since the latter crisis. So why do we expose ourselves to the latter risk? There's no point. At least I've read more about banks, MT etc than 99.99% of the population, and don't remember seeing the latter obvious point being made.

Of course the above arguments against MT is not a comprehensive argument against MT. The purpose of this article was just to point out an example of failure to see the obvious.

___________

Overlooking the obvious is a well-known human failing, but it’s worse with economists because they spend a fair amount of time trying to impress everyone with their amazingly sophisticated and complicated solutions to sundry problems – which almost ipso facto means overlooking the obvious.

Second, when anyone produces a simple solution to an economics problem, that tends to get rejected because it’s embarrassing to have to admit that the profession overlooked a simple solution for an extended period.

Anyway, moving on to maturity transformation (MT), MT is a phrase often used to describe what banks do, namely “borrow short and lend long”. While an alleged merit of MT is that it creates money/liquidity, a claim made here for example. In contrast, the big problem with MT is that it renders banks vulnerable. (as pointed out by Messers Diamond and Rajan in the abstract of their NBER working paper 7430.

To illustrate MT, the typical retail bank accepts deposits which are essentially short term loans to a bank, and lends to mortgagors and others.

The former loans / deposits are short term because the loan can be withdrawn by the lender / depositor instantaneously (or after two or three months in the case of a term account) . In contrast, mortgages typically last several years. And that makes banks vulnerable: if depositors withdraw their depositors faster than the bank can turn its loans and investments into cash, the bank is bust.

But there's a blindingly obvious way to create liquidity / money WITHOUT the above risk of bank failures and recessions which result in 30 million losing their jobs: have the government and central bank (“the state”) create money and spend it into the economy! Economists apparently haven't noticed that very obvious point.

Incidentally, some readers may be wondering whether the above conflation of “money” and “liquidity” is justified.

Well the third edition of the Oxford Dictionary of Economics starts its definition of liquidity thus.

“The property of assets of being easily turned into money rapidly and at a fairly predictable price....short dated securities such as Treasury bills are the main asset of this form.”

Indeed Treasury bills and government debt generally are actually used as money in the World's financial centres! Thus whether a very liquid asset is officially classified as money is near irrelevant: the reality is that it is actually likely to be used as money.

Of course the initial recipents of the new money under a “have the state” do the money creation would be a bit different to where private banks do the job. But the differences are less than might seem: where the state does the job, those who receive the money are free to lend it out, or use the extra money to pay interest on additional loans. So lending and borrowing, via banks and in other ways, do in fact rise where the state creates extra money.

Second, to the extent that “the state” system puts more money into the hands of a wide cross section of the population, its hard to see what's wrong with that.

Third, any democratically elected government has the right to concentrate a particular bout of stimulus on SPECIFIC items, say health and education. But what of it? Does any great harm come from that?

In that barring or curtailing the amount of money creation done by private banks DOES cut the amount of money creation by private banks, less private bank related activity there means less debt. In view of the moaning and groaning we get from the great and good about the allegedly excessive amount of debt, no great harm is done there either!

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.