Yet another sucker falls for the multiplier myth.

This article claims that $5 spent on food stamps brings $9 of extra economic activity. Which kind of sounds like value for money doesn’t it? But there’s a flaw in that argument, namely that the "extra economic activity" created by a particular type of spending (i.e. the multiplier effect) is actually irrelevant. I set out the reasons here and here.

And that (to repeat) is not to argue against more money being spent on food stamps. The point is that in determining the merits of spending $X on Y or Z, the costs and benefits of Y and Z are the crucial factors: the multiplier effect is irrelevant.

A solution to the Euroshambles.

The Euro periphery's problems would be solved if it cut its costs, i.e. if it became more competitive vis a vis Germany. That could be achieved by a few years of excess inflation in Germany. 

It can be argued Germnay is MORALLY obliged to endure years of uber inflation so as to help the periphery. But that wasn’t down in black and white when the Eurozone was first set up. Quite the reverse: it was obvious from the way the system was set up that it was the less competitive countries that would face elevated rates of interest for money they wanted to borrow if they lost competitiveness. I.e. the burden of adjustment was placed on countries that lose competitiveness.

What Germany could do is approach periphery countries and say “We’re happy to change the rules of the game and endure a few years of excess inflation as long as you pay us something for the inconvenience.” That way, everyone (hoffentlich) would then be happy. Germany wouldn’t lose, because the payment they get from the periphery counterbalances the costs of excess inflation in Germany. While periphery GDP rises and hopefully by more than the fee paid to Germany.

Alles would then be in ordnung.

Letting a bank go bust when all its creditors are shareholders or loss absorbers is pointless.

I support Positive Money, while not agreeing with every single one of their policies. One of their policies that doesn’t stand inspection is the idea that depositors should take a hair-cut when a bank fails. (Section 6.9 of their book “Modernising Money”).

They advocate that shareholder should be first in line for haircuts in the event of failure, and no one can quarrel with that: that’s common practice with a corporation that fails – bank or any other corporation.

Next in line are bond holders, and finally depositors. And that all sounds reasonable, doesn’t it?

However, there’s a kind of self-contradiction there, and as follows.

Suppose that in the event of insolvency it turns out that depositors’ stake in a bank turns out to be worth 80p in the £. Instead of closing down the bank, which causes a lot of disruption, why not just say to depositors “sorry, but your stake is now worth 80p in the pound. You can cash that in now, or keep hold of your stake in the hopes that things improve.”
Depositors would be no worse off: either way they get 80p, or thereabouts.

Now that’s exactly what happens in the case of a shareholding in any firm or indeed a stake in a unit trust (“mutual fund” in the US). That is you buy your stake for £X a unit on 1^st Jan, knowing full well that next day, or at any point in the future, the stake may be worth more than or less than £X.

And indeed the latter sort of model is the one advocated by Laurence Kotlikoff for banking: that is, anyone who wants their bank to lend on their money so that interest is earned has to face the value of their stake varying in line with the value of those loans. In effect, under Kotlikoff’s system, depositing a FIXED SUM of money in a bank and getting interest on it comes to an end. That is no longer allowed. Instead, and to repeat, those who want interest have to take a stake in the underlying loans or investments.

It could be argued that the Positive Money system, depositors have the advantage of being able to get £Y back for every £Y they deposit at a bank, unless the bank goes bust. But that’s a bit of a self-contradiction: it’s a bit like saying that a boat floats unless it sinks. I.e. under the PM system, depositors just DON’T HAVE 100% security.

Moreover, a system in which a bank claims that depositors have Z million worth of deposits when the assets to back that Z million are worth less than Z million is a bank that creates money out of thin air. And that’s exactly what PM opposes.

And finally, when a bank DOES FAIL under PM’s system, the failure is SUDDEN. In contrast, under Kotlikoff, when a bank performs badly, all that happens is that the value of the stakes held by all creditors (shareholders, bondholders, and depositors) drifts downwards. (Actually in the case of Kotlikoff’s system there aren’t any shareholders or bondholders, as I understand it.).

Former governor of the Bank of England, Mervyn King referred to the advantages of that GRADUAL collapse. He said:

“And we saw in 1987 and again in the early 2000s, that a sharp fall in equity values did not cause the same damage as did the banking crisis. Equity markets provide a natural safety valve..”

Everyone complains about debt while advocating policies that increase the total amount of debt.

The great, the good, quangocrats, politicians of every political persuasion, and every sort of worthy windbag you can imagine complains about the levels of household or private debts.

But at the same time they advocate policies that increase the total amount of private debt: that is, they advocate a system under which government (i.e. taxpayers) stand behind (i.e. subsidise) private banks. And private banks are in the business of debt creation or lending.

Subsidise an industry, and the total size of the industry will be bigger, all else equal.

There is a better alternative: withdraw all taxpayer support for the bank industry. That is, force lending institutions (or the lending departments of banks) to be funded ENTIRELY by share holders or quasi shareholders or loss absorbers of some sort.

That way, if a lending institution makes silly loans, the institution itself doesn’t fail: all that happens is that the shareholders and loss absorbers take a hit.

Of course people or depositors will want a bigger return for taking a stake in an institution where they stand to take a hit. But that just reflects the absence of the taxpayer funded support: it reflects the removal of a subsidy.

And clearly, the reduced amount of lending that results from that withdrawal of taxpayer funded support would be deflationary. But that’s not a problem: that deflationary effect can be countered by having the government / central bank machine create new money (“debt free money”) and spend it into the economy.

Net result is that the average firm and household would have more money, and thus wouldn’t need to borrow so much. So while interest rates would rise, TOTAL INDEBTEDNESS would decline. So at a wild guess, the total amount paid by way of interest might stay about the same.

Financial Times Watch. No.1.

This is a new feature of this inspiring (?) blog: comments on FT articles.

Oct 30: Martin Wolf has doubts about Mark Carney’s new fit of generosity towards commercial banks. Nice to see Wolf agreeing with my take on the subject.

There’s just one sentence in Wolf’s article that might be been phrased better. In reference to commercial banks in trouble, said, “The Victorian commentator Walter Bagehot thought central bank lending at a penalty rate would curb the danger.”

Actually Walter Bagehot didn’t think much of central banks lending to commercial banks in trouble. That is, he thought it better for commercial banks to have decent reserves and capital, and then being allowed to fail once those reserves and capital were exhausted. But by the time Bagehot wrote his book “Lombard Street”, the above bailouts or loans by the Bank of England was so well established, that Bagehot didn’t think it worth the effort to try to abolish that system. (See first few paragraphs of the conclusion of “Lombard Street”).

So if you see Carney trying to justify his policy by reference to Bagehot, take that with a pinch of salt.

Samuel Brittan, the closet MMTer?

Brittan is spot on when he argues in this article that the reason governments have implemented quantitative easing, is that QE is allegedly or hopefully a way of effecting stimulus that doesn’t involve increasing the dreaded deficit and national debt (as I pointed out in July.)

In his final paragraph, he argues for a combination of fiscal and monetary stimulus and then says the reason that has not been implemented is because of the “mistaken analogy between household and government budgets”.

Spot on: George Osborne, the UK’s finance minister, like the economic illiterates in Treasuries round the world (and in the IMF and OECD) think that national debts (macroeconomics) can be likened to household debts (microeconomics).