Barclays Bank’s fake capital.

In 2008, Barclays came up with a great idea for improving its capital ratio: create a few billion pounds out of thin air and lend it to an Arab sheikh (Sheikh Mansour) on condition he used the money to buy newly issued shares in the bank.

According to a Science Direct paper by Prof Richard Werner entitled “How do banks create money…”, that trick was illegal, “But regulators were willing to overlook this”, as Werner put it. And apparently the justification for that illegality was (to quote Werner again) that “This certainly was cheaper for the UK tax payer than using tax money.”  OK, let’s run thru this.

In the recent recession, stimulus was needed, plus it was clear that banks needed to be made safer, e.g. by increasing their capital ratios. But there is a possible conflict there.

If increasing bank capital ratios (as per the Modigliani Miller theory) has no effect on the cost of funding banks, then there isn't too much of a problem. That is, banks can simply be ordered to raise their capital ratios, plus stimulus can be implemented.

That stimulus does not cost taxpayers anything. Reason is, to over simplify a bit, that in the case of helicopter drops (one form of stimulus), the state simply prints money and spends it (and/or cuts taxes). There is no need to rob taxpayers of a single penny. Or as Milton Friedman put it, “It need cost society essentially nothing in real resources to provide the individual with the current services of an additional dollar in cash balances.”

Of course stimulus can take various forms other than helicopter money (HM), but actually fiscal and monetary stimulus combined come to much the same thing as HM, as others have pointed out. That is, under traditional fiscal stimulus, government borrows £X and spends it and/or cuts taxes, and it gives £X of bonds to those it has borrowed from. The central bank then prints money and buys back at least some of those bonds so as to make sure interest rates don’t rise. Or maybe the central bank prints money and buys back ALL OF those bonds, which is pretty much what has happened under QE in recent years. The latter scenario nets out to the same thing as HM.

So let’s assume that stimulus takes the form of HM (a policy which is actually advocated by some, e.g. this lot)


What if Modigliani Miller is not valid?

An alternative possibility is that MM is NOT VALID, i.e. that increased bank capital ratios do in fact raise bank funding costs. In that case, raising those ratios will indeed cut lending which will be deflationary, but that deflationary effect is easily countered with more HM. So again, there is no cost to the taxpayer, and thus no excuse for dodgy loans to sheiks.

Yet another possibility is that MM is not valid, but government is determined not to let lending by banks decline. That of course is a totally illogical stance: after all if the cost of funding banks (or growing apples) rises, then it’s reasonable to expect a fall in bank lending (or apple sales). Indeed, it was blindingly obvious in 2008 that banks had over-extended themselves, i.e. loaned out too much, thus a CONTRACTION in total bank lending would have made very good sense.

As to what REASON government might have for insisting that bank lending should not fall, the possibilities aren’t too hard to fathom. One is that politicians are beholden to bankster / criminals for funding political parties. Another is that because bankers wear smart suits, drive smart cars and have nice houses in the country, politicians conclude that bankers must know what they’re talking about. Thus when bankers say banks cannot be allowed to shrink, else civilisation as we know it will come to an end, politicians jump to attention and do what bankers want.


Taxpayers subsidize banks.

Yet another possibility is that MM is not valid, government is determined not to let the size of the bank industry shrink, and decides to deal with that by some sort of taxpayer funded subsidy for the process of increasing bank capital. That’s the ONLY circumstance in which the “Sheikh Mansour” trick would save taxpayers’ money. But for reasons given above, refusing to let the size of the bank industry shrink makes no sense whatever.


Conclusion.

This is nonsense from start to finish, unless I’ve missed something.

Silly attack on NAIRU by Lars Syll.

I nearly always agree with Lars, but not with this criticism he makes of NAIRU. Basically he just plays the old straw man trick: he attributes a characteristic to NAIRU which just isn’t there in dictionary or text book definitions of the concept.

To be more exact he claims NAIRU is a “timeless long-run equilibrium”. Well NO IT’S NOT!!  That is, advocates of the NAIRU concept make it perfectly clear that the level of unemployment at which inflation rises too much or “accelerates” can vary with a whole host of factors: changing skill levels of the workforce, changing patterns of supply and demand which will make some skills obsolete, and so on.

And in case you’re wondering why I haven’t left the above two paragraphs on his blog in the form of a comment, reason is that his blog is powered by Wordpress which I’ve found over the last few years to be a constant pain in whatsit. Leaving comments on his blog seems to be impossible.

What’s best: 0% inflation or 2% inflation?

Narayana Kocherlakota, a professor of economics at the University of Rochester and he served as president of the Federal Reserve Bank of Minneapolis from 2009 through 2015.

In this Bloomberg article he argues for 2% inflation because 2% has always been the target, and we should stick to it so as to provide PREDICTABILITY for everyone: investors, savers and so on. However, that predictability point doesn’t tell us what the FUNDAMENTAL arguments for 2% are (as opposed to 0%, minus 3% or any other figure).

One fundamental argument for a small positive rate stems from the “wages are sticky downwards” point. That is, it’s desirable for wages in different professions to change relative to each other in line with supply and demand. But it’s difficult and sometimes impossible to actually cut wages in some sectors, else you get strikes. Ergo to some extent RELATIVE wage changes have to come about raising the wage in some sectors, rather than by cutting them in others.

Also inflation is a tax on people and firms with piles of cash and no idea what to do with it. Taxes have to be collected, and that tax on hoarders isn't a bad tax.

Spanish banks’ fake capital.

I argued yesterday that it’s OK for a bank to lend to someone on condition they purchase shares in the bank.

Having slept on the problem (which included a nightmare involving me buying favors off politicians on behalf of Goldman Sachs, ha ha) I’ve changed my mind.  It now strikes that fake capital is not actually acceptable. Moreover, what’s wrong with it is the same as what’s wrong with the ENTIRE commercial bank system, namely that commercial / private banks have the right to print some of the money they lend out. That right amounts to a subsidy of private banks in exactly the same way as backstreet counterfeiters are effectively subsidised by the community at large. Indeed that’s what I argue in this paper (which with a few modifications is appearing in an economics journal shortly).

The standard bank “loans create deposits” trick, which is how banks create or print money is obviously not EXACTLY the same as the fake capital trick, but the flaw in both those tricks is the same. I’ll explain.

If a bank out-competes non-bank entities for shareholder funds, e.g. by offering a better return on capital, that’s a fair free market contest which the bank wins. But if the bank obtains funds by simply printing money and lending it to someone at an artificially low rate of interest, and that someone buys shares in the bank, that is not a genuine free market contest between the bank and non-bank firms: the bank obtains shareholder funds on a subsidised basis. Ergo the fake bank capital trick is unacceptable. But so too is the entire private bank system in its present form (sometimes referred to as “fractional reserve” banking).

Incidentally, the sort of people who are going to borrow from a bank with a view to buying the bank’s shares will tend to be people who don’t have much to lose should they go bankrupt: they will tend to be people with no net assets, far as I can see. I.e. if person X initially has no net assets and they borrow $Y and buy $Y of shares and the shares become worthless, then X is bust. But X had no net assets to start with, so X doesn’t lose much. On the other hand, there’s a chance the bank shares do well, in which case X cleans up. So for the Xs of this world, it’s a “heads I win, tails I don’t lose” bet. X might as well go for it.

Having said that, when Barclays printed a few billion and loaned it to Sheikh Mansour on condition he bought shares in Barclays, I assume Mansour WOULD HAVE lost out, had Barclays’s shares declined, because presumably Mansour had ample net assets. As it turned out, Mansour subsequently sold the shares and made £2.25bn profit.

But to reflect that risk, Mansour would have demanded some sort of perk from Barclays, and seems he did, and got it, to judge by Vincent Richardson’s comment after yesterday’s post on this blog. (BTW Vincent, like me, is an active Positive Money supporter in the North East of England).

And finally, assuming my above argument is correct, then defenders of the existing private bank system are in a bit of a jam: if they want to object to fake bank capital, they’ll have to admit that the entire private bank system is flawed.




 

Does Barclays style fake bank capital matter?

Spanish banks have started copying the Barclays fake bank capital trick, i.e. creating money out of thin air and lending it to whoever on condition they buy shares in the bank.

Far as I can see (which may not be very far), this doesn’t matter too much. To illustrate…

Say a bank has the sort of capital ratio advocated by Martin Wolf and Anat Admati, i.e. say 25%, and say that’s all “fake” capital – in the Barclays / Spanish sense. Say the value of the bank’s assets fall by 25%. The bank won’t be insolvent. That’s an improvement on the situation where the bank has a capital ratio of say 5% all of which is “genuine capital”, and assets fall in value by 25%. In the latter scenario, the bank IS INSOLVENT.


(If the above link doesn't work, Google title of the article, i.e. "Next Banking Scandal Explodes in Spain" published by "Wolf Street".)

__________

P.S. (10th June 2016).  I’ve changed my mind on this issue. See next day’s post.
 

Skidelsky opposes helicoptering… then supports it.

I normally agree with Robert Skidelsky, but he goes a bit off the rails in this article where he initially attacks helicoptering, before concluding that it’s not such a bad idea.

By way of attacking helicoptering he quotes a not too brilliant passage from Keynes, as follows.

“For whilst an increase in the quantity of money may be expected…to reduce the rate of interest, this will not happen if the liquidity-preferences of the public are increasing more than the quantity of money.”

Now that’s like saying that turning up the central heating won’t make the house warmer if at the same time someone opens all the windows and doors. Or to put it in more general terms, when it’s claimed that A and B are positively related and that cause / effect runs from A to B, the normal or common sense assumption is that increasing A will increase B. Of course, implicit in that common sense argument is the very reasonable “all else equal” assumption.

To put it less politely, if I said that turning up the central heating makes the house warmer, and someone responded by saying “not if someone opens all the doors and windows”, I’d tell that someone exactly what to do with himself.

Moreover, even if someone DOES open all the doors and windows, if the central heating emits ENOUGH HEAT, the house will get warmer DESPITE the doors and windows being open.

Likewise, even if the public’s liquidity preference DOES INCREASE a bit, a big enough money supply increase will outweigh the latter effect.

Next comes this passage in Skidelsky’s article:

“Economists are now busy devising new feats of monetary wizardry for when the latest policy fails: taxing cash holdings, or even abolishing cash altogether; or, at the other extreme, showering the population with “helicopter drops” of freshly printed money.

The truth, however, is that the only way to ensure that “new money” is put into circulation is to have the government spend it. The government would borrow the money directly from the central bank and use it to build houses, renew transport systems, invest in energy-saving technologies, and so forth.”

Now there are a few problems with that passage. First, whence the assumption that the only way to “ensure that new money is put into circulation is to have government spend it”? That is, if government does “shower the population” with “freshly printed money”, why would that money not then be “in circulation”? I mean does the average lottery winner on receipt of their new found pile of cash bury it underground or just leave it all in a bank term account?

Clearly not! They SPEND a significant proportion of that cash: i.e. put it into “circulation”.

Second, the passage from Skidelsky’s article quoted above actually contains an element of POLITICAL bias, which is not something a professional economist ought to do. That is, in advocating more public spending, Skidelsky is adopting a left of centre stance. But the government of the day might be right of centre and might be aiming to CUT public spending, in which case, given a need for stimulus, that government would aim to increase PRIVATE spending rather than PUBLIC spending. Such a government could get more money into “circulation” by cutting taxes or raising social security benefits (the former being more right of centre than the latter of course).

In short, instead of advocating more public spending, Skidelsky ought to have used a politically neutral phrase like “raise the deficit” or similar.

Of course it may be that we get a better so called “bang per buck” from public spending as compared to tax cuts, but that is irrelevant, and for two reasons. First, the democratic choice of the population takes precedence over minor technical matters like bang per buck: that is if voters want more (or less) public spending, government should comply with voters’ wishes.

Second, the entire bang per buck concept  is irrelevant. Reason is thus. Advocates of the bang per buck idea view money at government’s disposal as some sort of REAL COST. It isn't: government (assisted by the central bank) can create infinite amounts of new money at the press of a computer mouse, and at NO COST.

Thus if the average household has to be supplied with rather a large amount of cash to induce it to up its weekly spending, what of it? The cost of supplying that cash is zero. Or as Milton Friedman put it, “It need cost society essentially nothing in real resources to provide the individual with the current services of an additional dollar in cash balances.” (Ch3 of his book “A Program for Monetary Stability”).

(BTW: hat tip to Mike Norman for drawing my attention to the Skidelsky article.)

Odd ideas from Andrea Terzi on helicoptering.

Terzi sets out some ideas on helicoptering in this article. I’ve reproduced the article below with my comments interspersed (in green italics).






In his piece on helicopter money, Lord Adair Turner seemed to argue that:

1) The money multiplier provides the needed boost to expansionary fiscal policy, yet this boost could generate inflation.

2) The risk of inflation could be managed by raising reserve requirements as needed.

Both statements are incorrect.

So why exactly would raising reserve requirements not succeed in raising interest rates? An explanation is needed. After all, it’s widely accepted that central banks can keep interest rates up PRECISELY by keeping commercial banks short of reserves.

And this is the slightly expanded version of my Letter to the Financial Times (FT.COM published an abridged version)

In ‘The helicopter money drop demands balance’ (May 22), Lord Adair Turner defends the notion that bigger fiscal deficits are needed to end the current stagnation, but leaves one question unanswered: Why should a money-financed deficit be more powerful than a traditional debt-financed deficit?

...Because money (base money to be exact) is a bit more liquid than government debt!

Money-financed fiscal deficit is one particular form of government spending (in excess of taxes) that is funded by the central bank directly crediting the recipient banks with central bank money. In a traditional debt-financed fiscal deficit, banks are ultimately credited with government securities.

No. In a “traditional debt-financed fiscal deficit”, the entities “credited with government securities” are (surprise, surprise) those which buy those securities, which for the most part are not commercial banks. In fact commercial banks in the US and UK hold only 5% (very roughly) of government debt. The vast majority is held by pension funds, insurance companies, foreigners, you name it.

The expansionary effect of the two options must then be equivalent, as private sector’s disposable income increases by precisely the same amount, the only difference being that banks hold a bigger balance with the central bank in one case and a bigger credit balance with the government in the other case.

Yes, obviously the INITIAL expansionary effect is the same, but there are SECONDARY effects, like the above mentioned liquidity difference.

Indeed, large-scale purchases of government debt by central banks (a.k.a. QE) are a form of ‘helicopter money’ for a given fiscal stance, as they substitute central bank money for government debt, and their dismal results are evidence that funding public debt with central bank money provides no special boost.

To say there is “no special boost” is going too far. QE does have a FINITE effect, but clearly not a big one.

The belief that an increase in bank reserves would boost an expansion of bank credit has been convincingly refuted by all central banks’ experts on monetary operations. The money multiplier is inapplicable to a floating currency, and the only reason for having reserve requirements is to limit the volatility of money market rates under current liquidity management arrangements.

Turner recommends helicopter money as a way to manage fiscal deficits without creating more public debt. However, central bank money is another form of debt, and any narrative that begins by assuming that government debt is bad won’t go very far by proposing an increase of debt in a different form.

“Central bank money is another form of debt”? Well it’s a strange form of debt. Reason is that government has the right to grab any amount of money it wants off the private sector via taxation. That’s the equivalent of me having the right to break into the bank that granted me my mortgage and grab wads of £10 notes with a view to paying down my debt to the bank. You can call that a debt owed by me to the bank, but like I say, it would a strange sort of debt.

Also, who says “government debt is bad”? One of the basic bits of logic behind money financed deficits is that the lower is interest on government debt, the nearer do base money and government debt become the same thing (as pointed out by Martin Wolf). Thus if an economy in need of stimulus continues to refuse to react to interest rate cuts, there must come a point at which debt financed deficits become pointless and one is FORCED to switch to money financed deficits. Strictly speaking that point is when interest on government debt is zero, but clearly when interest on the debt is say 0.1% there probably won’t be any takers. So one might as well make the switch when the rate is 0.5% or so.

A better version of Turner’s important point that fiscal deficits are needed is to question current debt limits. Designed to check governments’ spending power, they have caused collateral damage by leaving the support of growth entirely to private debt. And private debt is critically pro-cyclical.

And finally there is something fundamentally illogical about debt financed deficits, which is that the basic objective is STIMULUS, but borrowing is “anti-stimulatory”: that is, it has a DEFLATIONARY effect. So debt financed deficits are a bit like chucking dirt over your car before washing it.

Moreover, debt is attractive to foreigners, for example China, Japan, etc hold a large stock of US government debt. I don’t see anything desperately clever about getting into debt to foreigners, not that doing so is necessarily a disaster.