Mistakes by the St Louis Fed.

This article by Michael Pakko of the St Louis Fed makes two mistakes. The first is a biggish mistake: a $340bn mistake, or thereabouts. But it’s a common mistake. It is as follows.

He claims two justifications for a deficit, i.e. a rise in the national debt. The first is that “ . . . deficits can be justifiable if they finance long-term expenditures (as with an individual who finances the purchase of a home)”.

The second is borrowing so as to fund Keynsian stimulus.

There is actually a third, which is the need to keep the monetary base expanding. The need for this constant expansion is down to two factors. First it is reasonable to assume the monetary base will expand in line with real economic growth, say 2% a year for the sake of argument.

Second, there is inflation to take into account. Unless the monetary base is constantly topped up, inflation will erode real value of the base (let’s say, again, at 2% a year).

An identical point applies to the national debt. To be more accurate, there is no “need” to keep the national debt at a constant level relative to GDP. But the reality is that while this debt is on the high side at the moment, it is unlikely to vanish altogether in the next ten years.

So let’s make the crude assumption that the national debt stays at a constant level, and equal to the average level over the last decade or so: roughly 50% of GDP.

Let’s also take the U.S. monetary base as $1trillion (about 7% of GDP): that’s where it was roughly 18 months ago before the very large spike caused by bank bailouts, quantitative easing, etc. Let’s say GDP is $15trillion.

Taking the above back of the envelope figures, the deficit required to keep the monetary base and national debt expanding along with real GDP will be:

(2% + 2%) x (50% + 7%) x $15trillion = $340bn (unless I’ve made a mistake!)

The second mistake in the Fed article is the claim, mentioned above, that “ . . . deficits can be justifiable if they finance long-term expenditures (as with an individual who finances the purchase of a home)”.

Not true. Indeed, “individuals who finance a home” and businesses who borrow to invest seem to have got their heads screwed on tighter than governments in this area, and for the following reasons.

The REAL purpose of a loan is to cover expenditure which the borrower cannot possibly meet from their own resources. E.g. if you’ve got at least $30,000 in the bank and want to buy a $30,000 car, there is no obvious reason to borrow the $30,000.

Now governments make investments every year which are of monumental proportions compared to investments made by the average firm or household. But then government INCOME is monumental as well.

In other words governments can perfectly well fund ALL their investments out of income. Indeed, taking the simple example of where a government invests exactly the same amount each year, and funds this out of borrowing which it gradually pays back, this government will end up paying out EXACTLY THE SAME AMOUNT of money each year as if it had funded investments out of income. The only difference is that under the borrowing scenario, interest has to paid.

To summarise, the fact that $X of a deficit is spent on investment does not justify that portion of the deficit, at least not on the basis of Pakko's argument. There may of course be justifications for government borrowing so as to fund investments, but if they exist, they are more abstruse and complicated than the above one.

The Telegraph does the banksters’ bidding.

Having made fools of themselves in the credit crunch, and lost some influence with governments, banks are now trying to re-capture governments. And it looks like banks have got the Telegraph on side, at least in relation to the latest Bank of England Quarterly Credit Conditions Survey – to judge by a totally distorted bit of reporting in The Telegraph.

The Telegraph Business section had a front page report (7th Jan) on the latest edition of the above survey. The article was entitled “Basel III squeezes bank loans”. And the thrust of the article was, as the title implies, that the BoE’s survey had found that Basel III was restricting bank loans.

Problem is that is not what the BoE’s survey says at all.

The reality is that Basel III was scarcely mentioned in the BoE survey. Most the survey was pretty boring: it claims there are no dramatic changes happening as regards credit conditions right now.

The only mention of Basel III was that “A couple of lenders commented that . . .the amount of capital available for lending had been somewhat tighter and more uncertain following the Basel III announcement in September. Though it was difficult to assess the prospective impact of Basel III, lenders commented that capital would constrain net new lending to some extent going forward.”

That’s about 60 words devoted to Basle III in a report consisting of about 3,000 words. And that’s not counting several pages of tables, charts, etc.

Moreover, it seems that only “a couple of lenders commented” on Basel III (though the wording of the BoE survey is not 100% clear here). I have not yet discovered exactly how many lenders took part in this particular survey, but it seems that the intention when this quarterly survey was first set up was to involve between 10 and 30 lenders. (See p.3 of the “Consultation Document” here (scroll to bottom of page).

Now 2 out of 10 or 20 is not what you might call an overwhelming majority!

How much did the banks pay the Telegraph for that article? Sorry, I better put that more politely – how much advertising did banks offer to place on the pages of the Telegraph in exchange for the article?

Or I could put it even more politely: how many weekends for Telegraph journalists on yachts owned by senior bank officials were offered in exchange for the article? There are numerous ways of putting it.

An entirely different explanation is that the Telegraph is for the most part a newspaper for fuddy duddies who cannot imagine anything much apart from the status quo. It is a newspaper devoid of IDEAS. And the status quo just prior to the credit crunch involved banks ruling the roost, so according to Telegraph logic, banks must go back to ruling the roost.

The reality is that the role banks play in an economy is very variable. For example, bank assets and liabilities in the UK have expanded a whapping ten fold in the last 30 years or so. To what benefit? Economic growth is no better now than in the 1960s.

Channel stimulus to the Main Streets of this world rather than the Wall Streets, and that puts cash into the pockets of ordinary households, plus banks are cut down to size.

This is better than Dennis Kucinich’s bill.

Positive Money’s ideas on bank reform are better than Dennis Kucinich’s.

Positive Money’s only mistake is that they make a concession to their opponents they don’t need to make. That is, they suggest their proposals will lead to a reduced bank lending – and the suggestion (implicit rather than explicit) seems to be that this is a weakness in their proposals. I beg to differ for the following reasons.

1. Bank assets and liabilities have increased by a staggering amount in the last 30 years (by a factor of around ten, relative to GDP, I seem to remember). This has brought with it some lending which is clearly on a massive and irresponsible scale, e.g. NINJA mortgages. Thus any idea that a reduction in bank lending is necessarily harmful is positively hilarious.

Put another way, the size of the role that banks play in an economy is very variable for given GDP.

One knee jerk reaction to the idea that we have higher interest rates and less lending is the fewer poor people will be able to buy their own houses. My answer to that is that while having a roof over one’s head is a basic human right, actually owning a house is not. Indeed, the WEALTHIEST country in Europe (Germany) has the LOWEST rate of owner occupation!!!!

2. Positive Money’s suggestion that all bank accounts be split into two two types, “transaction” and “savings” is good, but the idea that 20% of savings accounts can then be withdraw more or less instantaneously is a mess. That 20% effectively then becomes “transaction money”. So I suggest just keep clean and simple: transaction accounts and savings accounts, and leave it at that.

Are we influenced by the future?

Professor Daryl Bem of Cornell University says we are, and has done experiments which claim to prove it. Weird.

Hat tip to Mark Wadsworth.

The great crowding out argument is a waste of time, ink and paper.

Hundreds of thousands of hours have been expended in academia over the last century over the argument as to whether government borrowing “crowds out” private sector employment. The alleged problem is that when government borrows, this raises interest rates, which in turn stifles private sector economic activity.

There is one awkward fact which is actually a big hint that the whole argument is a waste of time, namely that sometimes governments actually WANT crowding out to take place. This occurs where government borrows AS A SUBSTITUTE for tax.

Half the purpose of tax is to rein in private sector activity or private sector demand so as to make room to the relevant public sector activity (e.g. make labour available for such public sector activity).*

Now this makes a bit of a nonsense of the “crowding out doesn’t occur” argument, doesn’t it?

To put that in more general terms, where government WANTS crowding out to take place, it will LET interest rates rise, or deliberately raise them, or impose some other deflationary measure.

In contrast, where government borrows with a view to stimulus, it JUST WON’T LET interest rates rise in consequence. Indeed, the chances are that the relevant government will be LOWERING interest rates!

To that extent, the whole question as to whether government borrowing crowds out is a waste of time.

A possible answer to the above argument is that it would nevertheless be nice to know the EXACT EXTENT of crowding out. Well, sorry, but not even this excuse for the argument stands inspection, and for the following reasons.

Where government borrows with a view to stimulus, it won’t let interest rates rise, and indeed, will probably lower them. And this is done by creating money ex nihilo and buying government bonds. But wait a moment: when government borrows, it CREATES government bonds!

Now what is the point of this exercise? That is, what is the point of creating and distributing something, only to buy it back a few weeks later? There is no point!

Put that another way, where governments go through the motions of borrowing with a view to stimulus, they actually end up effecting the stimulus by plain old money printing. Thus we don’t even need to know the extent to which crowding out takes place!


Abba Lerner.

And wouldn’t you know it: Abba Lerner advocated effecting stimulus by plain old money printing rather than by having government borrow and spend.

Abba Lerner and Modern Monetary Theory win again.

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*To be more accurate, the CONVENTIONAL WISDOM is that the purpose of tax is obtain money for government spending. In contrast, as the advocates of Modern Monetary Theory correctly point out, collecting money cannot possibly be the purpose of taxation because governments can produce any amount of money any time from the printing press. Thus the REAL purpose of tax is to rein in private sector demand to a level at which the additional demand coming from the public sector won’t be inflationary.

Moreover, it is highly unlikely that the amount of money that needs to be collected in tax so as to rein in private sector demand by a given amount will exactly equal the amount of demand stemming from spending that amount of money on public sector projects. That is, the idea that one needs to collect exactly £X in tax to cover £X of government spending is actually nonsense: the final nail in the coffin of the above mentioned conventional wisdom.

Modern Monetary Theory beats Tim Congdon.

Tim Congdon is one of the UK’s leading economists. For example he served on the Treasury's panel of independent economic forecasters in the l990s.

For some time he has argued that the money supply declines during recessions, thus artificially maintaining the money supply will help in a recession. E.g. see here and here. This is a crude argument. It overlooks various subtleties.

The first of the above links is concerned with QE, and Congdon argues that since QE maintains the money supply, this alleviates the recession. Well certainly QE boosts asset prices: nice for the asset rich. That in turn induces the wealthy to spend more (not MUCH more, though). But getting out of recessions by inducing the rich spend more is not a measure that has “social justice” written all over it. Moreover, why try to escape a recession by having ANY particular group spend more? Would it make sense to induce men to spend more but not women?

Private bank created money comes into existence as a RESULT of the private sector’s desire to do business and borrow for the latter purpose. Conversely, this stock of money declines in recessions, as a result of a REDUCED desire to do business. That is, deleveraging takes place. (Nothing new there: Walter Bagehot described this process a hundred and fifty years ago.)

Or as Robert Skidelsky put it in the second of the above links “….the basic cause of the collapse of the money supply was a collapse in the demand for loans…” Congdon, it seems, still does not understand this point.

The next “subtlety” is that boosting the money supply has no effect whatever till that money is SPENT – as David Hume pointed out in his essay “Of Money” 250 years ago.

To illustrate with a silly example, if government (as per Congdon’s advice) were to “borrow from the banking system” and withdraw all the new money in cash and store it in the vaults of the Treasury, there would be precisely no anti-recessionary effect – no effect on demand.

Or as David Hume put it in connection with money supply increases, “If the coin be locked up in chests, it is the same thing with regard to prices, as if it were annihilated…”

In short, simply maintaining the money supply achieves nothing. The fundamental anti-recessionary factor is SPENDING.

The next question mark over Congdon’s idea is thus. What is the point of a government borrowing from the “banking system” when the government has its OWN bank: the central bank? That why let private banks take a cut out of what is really taxpayers’ or citizens’ money?

Presumably Congdon wants to expand private bank created money rather than central bank created money, as it is the former which collapses in a recession.

However, and first, he obviously does not regard this as too important because he is happy enough with QE which expands central bank created money, as pointed out above.

Second, a possible argument for expanding commercial bank created money is that expanding the monetary base expands banks’ reserves, which in turn enables them to lend more which could at some stage be inflationary. This idea is now generally regarded as obsolete. For example some countries (e.g. Canada) have NO reserve requirement. Second, the reality is that banking system lends when it sees viable lending opportunities. If adequate reserves are not there, the central bank just has to provide reserves, else the central bank loses control of interest rates.


Modern Monetary Theory is better.

One of the basic ideas in Modern Monetary Theory (MMT) is that in a recession, the government / central bank machine should simply create and spend more money (and/or lower taxes and leave more money in taxpayers’ pockets). And conversely, when inflation looms, the process should be put into reverse. The above anti-recessionary idea is pretty much what Keynes advocated, though a contemporary of Keynes’s, namely Abba Lerner, made the above point in a more open and blunt fashion than Keynes. Plus I think Lerner added the bit about “putting the process into reverse” (though I might be wrong there). Thus Lerner is often regarded as the founding father of MMT.

Now creating AND SPENDING extra money in a recession makes more sense than just creating money, for reasons given above. So MMT beats Congdon there.

Second, MMT advocates having the government / central bank machine do the money creation, not commercial banks. As pointed out above, there is not much sense in letting commercial banks charge millions to do something that the central bank can do with a click on a PC mouse. So MMT beats Congdon there as well.

Game, set and match to MMT.

UK banks try to re-capture government.

Having been on the receiving end of a fair amount of bank bashing, banks in the UK are fighting back.

As is entirely predictable, they are fighting to do what banks always try to do: capture government. The propaganda effort seems to have been stepped up in recent days. There is a “don’t be nasty to banks” article in some newspaper every, written by members of the establishment, who no doubt mix socially with senior bankers.

1. 29th December, 2010: article by former deputy prime minister, Lord Heseltine.

2. Article by Boris Johnson, mayor of London.

This is actually a volte face by Boris: he used to be a champion bank basher. Plus more stuff by Boris here:

3. Ruth Lea article in The Times “Be kind to bankers - or get shopping."

Ruth Lea was chief UK economist at Lehman Brothers, and currently Non-Executive Director and Economic Advisor to the Arbuthnot Banking Group.

All three of the above articles are based very much on the argument that banks earn lots of money for the UK so they need featherbedding. Much the same argument applies to supplying third world dictators, like Saddam Hussein, with armaments.

In huge contrast to the above, the UK is lucky to have Mervyn King as head of its central bank. Mervyn King is actually prepared to THINK about what the best banking set up is, and to think some very unconventional thoughts on the subject.