Robert Skidelsky: arbitrary deficit reduction targets are a farce.

Robert Skidelsky made a good five minute speech recently in which he criticised the UK finance minister’s (Osborne’s) arbitrary deficit reduction targets, which Osborne (as is entirely predictable) has completely failed to meet. (H/t to Mike Norman)

One reason that arbitrary deficit reduction targets will almost never be met is that, as Skidelsky correctly points out, the appropriate size of the deficit is largely dependent on factors which are unpredictable. E.g. private sector confidence and hence spending is not predictable: the less that confidence, the bigger the deficit needs to be. And conversely, if the private sector goes into a fit of irrational exuberance, not only will the deficit need to be smaller: a surplus might even be in order.

So what’s the optimum size for the deficit? Very simple: it needs to be whatever gives us full employment. Or as Keynes put it, “Look after unemployment and the budget will look after itself”.

And as for the idea we constantly get from the massed ranks of loudmouthed economic illiterates, namely that excessive deficits lead to the debt rising and we can’t let the debt rise too far, I’ve given the answer to that a hundred times on this blog (as have others).

The first answer is that the debt can always be wiped out by QEing it (which incidentally cuts interest paid on the debt).  Second, the debt (or more accurately the debt and monetary base) are ASSETS as viewed by the private sector. Thus the bigger those assets, the more the private sector will spend, all else equal. Thus the debt is self-limiting.

That “self limit” may be much bigger than in previous decades, or it might be much smaller. Who cares? What’s the problem if it’s bigger than in the recent past?

Lenders should not be funded by depositors.

Or put another way, lending entities (e.g. banks, money market mutual funds, etc) should be funded just by capital, not by depositors or other types of debt.

Banks engage in two activities: accepting deposits and lending. Those two activities do not need to be conducted by the same organisations or entities. Or as James Tobin put it, “The linking of deposit money and commercial banking is an accident of history..”.

Having the same entity accept deposits and make loans is certainly PROFITABLE amongst other reasons because it enables the entity to engage in a fraud, which is thus. A deposit by definition is a promise to return to the depositor sums deposited (maybe plus some interest and maybe less some bank charges). But lending is inherently risky: it is indisputable that banks have gone bust regular as  clockwork for centuries because of bad luck or incompetence. Thus lending out depositors’ money is  inherently fraudulent. Indeed, it is widely accepted that what is sometimes called “fractional reserve” banking is fraudulent. Or as Martin Wolf put it, “If we were not so familiar with banking, we would surely regard it as fraudulent”.

The attraction of this fraud is that it enables banks to fund themselves more cheaply. That is, if you tell depositors their money is totally safe, most of them will believe you, thus they lodge their money with you at a lower rate of interest than if you tell depositors they may lose their money.

The latter fraudulent element in traditonal banking can be removed if the agreement between bank and depositor, instead of promising to return money deposited, says something like, “we, the bank, will return your money only if all goes well.” But in that case, depositors effectively become a type of shareholder. That’s shareholder as in “someone who shares in profits and losses”. 

Insurance.

An alternative is for depositors to be backed by taxpayers, as is currently the case in the UK. But that amounts to a subsidy of banking, so that makes no sense.

Another alternative is for depositors to be protected by some sort of self-funding insurance (like FDIC in the US). But the costs of that insurance will be passed on to borrowers, so lenders do not get funded any more cheaply that way. (I’ll use the word “lender” to refer to any bank-like entity that lends to mortgagors, businesses, etc)

To expand on that, if the chance of those who fund a lender losing all their money is 1:30 and that’s the only risk, then the logical insurance premium is 1/30^th of sums deposited, which gets passed on to borrowers. But if as an alternative a lender is funded just by shareholders (that’s people who ACCEPT risk, or if you like, “self-insure”), the charge made to mortgagors and other borrowers will be exactly the same.

Insolvency.

A further weakness in having lenders funded by depositors or other types of debt, is that insolvency is possible. Or as George Selgin put it in his book “The Theory of Free Banking”, “For a balance sheet without debt liabilities, insolvency is ruled out…”.

Now what exactly is achieved by insolvency? The answer is: precious little. To illustrate, if a lender is funded just by capital and its assets fall to say 90% of book value, then its shares will fall to about 90% of initial value. But if the lender is funded entirely or almost entirely by debt, and assets fall to 90% of book value, and the lender is made insolvent, then depositors and other debt holders will get about 90 cents in the dollar.

And what’s the big difference between those two scenarios? The only real difference is that in the first case the lender does not go out of business, while in the second, the lender DOES GO out of business. Now if there’s some big merit in having firms go out of business, I long to know what it is.

Money market mutual funds.

Now what do you know? The above suggestion or rule, namely that lenders should be funded just by shareholders is actually being imposed on money market mutual funds in the US. (See Forbes article entitled “Will New Money Market Rules Break Money Markets?”

That is, MMFs which invest money in anything more risky that base money or government debt will not be allowed to promise not to break the buck. That is, the wont be allowed to promise depositors $X back for every $X depositors. That means those depositors effectively become shareholders.

A final and obvious question arising from all the above is: if would be depositors can’t place their money with a lenders, where do they place it? Well the answer is in the above couple of paragraphs. That is, they place it with entities that invest ONLY in ultra-safe stuff, i.e. base money and/or government debt (preferably short term government debt). And that all equals full reserve banking!

Macromedia.

The term “macromedia” is a recent addition to the English language, and I like it. It refers to the nonsense, bullshit, clap-trap, rubbish, etc that we get from respectable news outlets on economics in general, but particularly on the subject of the national debt and deficit. At least, I’m fairly sure that’s what’s meant by the word.

And rest assured that that 90% of what you read in so called “quality” newspapers about the deficit is nonsense.

This new word is used for example by Chris Dillow here, and by Simon Wren-Lewis here.  

Huffington highlights important parts of the Autumn Statement.

Huffington has done a good summary of the main points in George Osborne's Autumn Statement:

Randy Wray thinks “decent wages” can be paid for JG work.

Randall Wray is an enthusiastic supporter of what can loosely be described as make work / job creation / workfare schemes. Along with other supporters of the latter he refers to that sort of subsidised work as “Job Guarantee” (JG). That’s in an article of his entitled “The Answer to the Unemployment Problem is More Jobs”.

Unfortunately he seems to  think that what he calls “decent wages” can be paid for that sort of work. As he puts it, “So here’s my puzzlement. Why won’t progressives try to help develop the moral framing to support jobs-for-all? At decent wages.”

The answer to his “puzzlement” is that “progressives”, or at least the economically literate ones have tumbled to a bit of macroeconomics as follows.

If those on JG work are paid “decent wages”, then their incentive to seek regular or non-subsidised work is destroyed. That in turn reduces aggregate labour supply, which is inflationary, which in turn necessisates a cut to demand, which in turn means unemployment returns to approximately its original level. In short, JG has not created any additional work.

Worse still, it has replaced regular or viable work with less viable or subsidised JG work.

But that’s not to rule out JG schemes. It’s just that “decent wages” are pie in the sky. Or put another way, there is method in the UK’s current JG scheme, the Work Programme, which involves those concerned being paid whatever they’d have got on benefits.

Put another way, for JG to work, there has to be what might be alled a “workfare element”: i.e. “do this job else your benefit gets cut”. The inevitability of that workfare element was pointed out by the Swedish labour market economist, Lars Calmfors, and myself twenty years ago.

The only way round the latter problem is to make up for the above reduced job search efforts by having the state do more job searching, i.e. spending more on state run employment agencies. However that costs. And given the less then brilliant output from JG jobs, it is questionable as to whether the combination of well paid JG work and spending millions on state employment agencies would give us a net increase in GDP. After all, the purpose of work is to PRODUCE, isn't it? That is, the purpose is to increase GDP.

The UK pays interest on its debt?

Given that the rate of interest the UK pays on its debt is very near the rate of inflation, it is very debatable as to whether the UK (and indeed some other countries) actually pay any interest on their debt. Certainly from 2011 to 2013 the REAL or inflation adjusted rate of interest paid by the UK was negative.

1948 "Loans create deposits" video.

 Here's a short video (5 minutes about) on the "loans create deposits" phenomenon from 1948.



H/T to Stephanie Kelton and Mike Norman.