Summary. If you lend money to a corporation which itself specialises in lending money, i.e. if you make a deposit at a bank, most governments protect you. But loans to other corporations are not protected. There is no logic in that pro money lender discrimination.
The most common excuse for that discrimination is that the “protection” encourages saving at banks which in turn encourages investment and economic growth. Unfortunately exactly the same argument applies to non-bank corporations. Thus the logical course of action is to abolish taxpayer funded backing for deposits at commercial banks. Of course everyone is entitled to a totally secure way of lodging and transferring money, but that can be done with accounts where relevant monies are simply lodged at the central bank, and perhaps also put into short term government debt, but nothing else. Indeed those sort of accounts already exist the state run savings banks in several countries.
Ending state protection for conventional depositors would mean the end of privately created money, but that wouldn’t matter.
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If you lend to a corporation that specialises in money lending (i.e. make a deposit at a bank) most governments protect you against loss. E.g. in the European Union, deposits up to 100,000 Euros are protected. That protection extends to term accounts, which in effect are little different to bonds.
In contrast, if you lend to, or buy bonds in a corporation that does NOT SPECIALISE in money lending (e.g. corporations that make cars or computers) then there is no government protection. You’re also on your own with some bonds issued by local government, cities, etc.
That’s clearly an anomaly. So what’s the excuse for that pro-bank and pro-depositor discrimination? Well the most common excuse seems to be that if government insures those who lend to banks, then banks will lend more which allegedly promotes investment and economic growth.
Certainly that “growth” argument is the one put by the UK’s Vickers commission. (See sections 3.20 to 3.24 of their report) And that commission consisted of some economics heavyweights. For example John Vickers himself (chairman of the commission) was formerly chief economist at the Bank of England. And Martin Wolf, chief economics commentator at the Financial Times, was also on the commission.
But there’s a glaring flaw in that “growth” argument, namely that if protecting those who lend to banks results in more investment and growth, the so too would protecting those who lend to other corporations or to cities. Moreover, defenders of the existing bank system cannot claim that protecting allegedly responsible banks is OK, but protecting any old fly-by-night corporation is not OK: reason is that almost every corporation is MORE RESPONSIBLE than banks! Banks are arguably the world’s biggest criminal organisations if one goes by the size of fines they’ve had to pay recently – over $100billion.
I.e. if the argument is that government should insure only loans to RESPONSIBLE organisations, then insuring loans to banks should be outlawed!
Protection for depositors has been provided for free in the UK for decades, a blatant subsidy of banks and depositors. In contrast in the US, depositor protection in the case of small banks is provided by the self-funding FDIC, while depositors at large banks in the US rely on the too big to fail implicit guarantee of banks provided by Uncle Sam.
But even if depositor protection is done on an FDIC style “self-funding” basis, why is there no equivalent for those who lend to non-bank corporations and cities (NBCCs)?
Of course those who buy NBCC bonds can arrange insurance with privately insurance companies rather than with government, and indeed there’s no reason bank depositors shouldn’t do that. Cars, houses, ships and NBCC bonds are privately insured. Why not term accounts and current / checking accounts at banks?
Safety.
Another argument that defenders of the existing bank system put is that everyone has a right to a totally safe method of lodging money, thus government backing for bank deposits is justified.
Well that argument confuses two issues: first, the lodging of money in a totally safe manner, and second, lending money – in some cases to quite risky borrowers.
Certainly everyone has a right to a totally safe method of lodging and transferring money. In contrast, borrowers do not have a right to be able to borrow on any sort of subsidised basis.
In fact many governments ALREADY PROVIDE total safety in the form of state run savings banks (e.g. National Savings and Investments in the UK). And as is entirely logical in view of the complete safety offered, depositors’ money in those savings banks is normally invested in a near totally safe manner, i.e. the money is simply lodged at the central bank and/or put into short term government debt and nothing else.
As to whether PRIVATE banks should be allowed to run totally safe accounts of that sort (i.e. where money is simply lodged at the central bank and/or put into short term government debt), perhaps they should. I won’t go into that question here. But in the US, that sort of arrangement will soon be in effect. That is, money market mutual funds (MMMFs) in the US will shortly be divided into those which invest just in government debt and which will be allowed to portray their liabilities as genuine money, and in contrast MMMFs which can invest in a broader range of assets, but which as a result will have to let the value of their liabilities float in value, which will mean those liabilities are no longer a form of money: they’re more in the nature of shares.
Bankers manipulate politicians.
Another problem with GOVERNMENT provided insurance for conventional bank accounts is that bankers are experts at manipulating politicians. To illustrate, the UK finance industry spends £90million a year on lobbying. As for the US, as Senator Dick Durbin said, "And the banks -- are still the most powerful lobby on Capitol Hill. And they frankly own the place." In short, bankers will never stop trying to persuade politicians to insure risky deposits and loans at subsidised rate.
Bankers and terrorists.
In fact there’s a similarity between bankers and terrorists, as follows. It’s widely accepted that terrorists do not need to succeed every time. That is, they only need to bring down airliners once in every ten attempts, and they’ve made their point: they get their way.
Same goes for bankers. That is, if politicians currently in power actually know something about banking and economics (no, don’t laugh) and are able to resist bankers’ blandishments, no problem: banks only have to wait two or three years, and there’ll be some politician in power who falls for the nonsense that banks trott out over and over. That’s nonsense of the sort alluded to by Paul Volker when he said "Just about whatever anyone proposes, no matter what it is, the banks will come out and claim that it will restrict credit and harm the economy....It's all bullshit".
What banks have very cleverly done over the decades and centuries is to combine two activities, namely accepting deposits which are supposedly safe and which make up the vast bulk of the nation’s money supply, and second, money lending. That means that if they make a mess of money lending, the nation’s money supply and money transfer system may be trashed. It is then easy for bankers to persuade politicians to give or lend banks a few billion or trillion of taxpayers’ money at favourable rates.
The solution is to undo that mixing of deposit taking and lending. Expect howls of protest from bankers whenever that’s proposed, and Volker type sob stories about “economic growth” being hit.
Unused money.
Another argument that defenders of the existing system often put is that if money which is supposed to be totally safe is simply lodged at the central bank, i.e. not used, that will cut aggregate demand.
Well the answer to that is that if that money IS USED, the effect is to raise demand, and assuming demand is already at the maximum level that is feasible without exacerbating inflation too much, then some of that money would have to be withdrawn from the private sector, else inflation would become excessive. Put another way, if everyone wanted to keep $10,000 dollars under their mattress against a rainy day and scarcely ever used that money, it would be easy and it would cost nothing in real terms to crank up the printing presses and proved everyone with what they wanted.
In short, the REAL COST of providing everyone with rainy day money 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.”
The end of privately created money.
Assuming debts owed by money lenders (i.e. deposits at banks) are not insured at all, or if they are insured, are insured by PRIVATE insurers rather than by government, then those deposits are not entirely safe because it’s always possible that private insurers fail.
Thus assuming that what is meant by “money” is a debt owed to the “money owner” or depositor which is totally safe, then those non-insured deposits or bonds do not constitute money. I.e. “real / genuine” money would only be in the form of debts owed to “money owners” which are backed by government, like the above money in state run savings banks.
Of course if the latter idea were implemented, private banks would try every trick in the trade to PASS OFF their risky liabilities as totally safe money, just as they did in the 1930s before the days of deposit insurance. That trickery would need to be countered with a requirement that private banks made it abundantly clear that those liabilities were NOT government backed, and thus that those liabilities were more in the nature of standard commercial loans than money.
Positive Money, the New Economics Foundation and Richard Werner in their submission to Vickers argued that interest rate adjustments were a defective method of regulating demand.
Support for that idea comes from a recent Financial Times article which suggests the UK is not actually able to alter interest rates because UK rates are tied to US rates. The chart below is from the FT article. (The article is by Martin Sandbu and is entitled “Free lunch: is the Bank of England a slave of the Fed?”)
In contrast, fiscal stimulus in the UK (e.g. having the state spend more on health and education, or cut taxes ) results in demand rising in the UK, and not to too great an extent elsewhere. I.e. when spending on health and education rises, the extra pay that teachers, nurses etc get does leak out of the UK and boost demand elsewhere in the World to SOME EXTENT. For example teachers and nurses spend more on foreign holidays and imported cars. But plenty of that extra spending is confined to the UK.
Moreover, in that demand does leak out to elsewhere in the world, that means the pound falls on foreign exchange markets, which in turn discourages imports to the UK and encourages exports from the UK. Thus you could say that in effect, increased demand in the UK boosts employment in the UK and does not leak to imports.
Mike King makes ten criticisms of PM here. I’ve copied them below and after each one have put my answer (in green). I agree with some of King’s criticisms, but not others. Mike King starts....
1. Positive Money says that profit (seigniorage) accrues to commercial banks on a large scale resulting from money-creation via lending. I say: Lending which results in new money creation is through increased economic activity, and the owners of the new money in the first instance are profitable depositors, not the banks. There is no seigniorage.
Answer. This is complicated, but hopefully the two paragraphs below clarify the issue a bit.
“Lending which results in new money creation is through increased economic activity..” Nope. If I get a loan for £X, money is created as soon as the £X is credited to my account. No increased economic activity takes place till I spend it, and it’s possible I don’t spend it and indeed quite likely I don’t spend ALL OF IT: people normally borrow MORE THAN they need so that they don’t have to go back to the bank a second time when they find they haven’t borrowed enough.
Seigniorage is the profit that comes from issuing money in exchange for real goods and services. It would be a gross over-simplification to say that every time a loan of £X is granted that the relevant bank makes a seigniorage profit of £X. However, assuming the expansion in the stock of privately created money is £Y in a given year, then that’s pure profit for banks and those they’ve loaned to, IF THAT NEWLY ISSUED MONEY is used as genuine money: i.e. passed from hand to hand fairly quickly. Alternatively, if the so called new money is put into an account where the depositor demands interest, then no money creation has taken place, and there is no seigniorage profit. All that’s happened is that the new depositor has made a loan to the borrower via a bank.
2. Further to this Positive Money says that increased public debt and taxes, and decreased public services, arise from commercial bank lending through seigniorage foregone. I say: there is no seigniorage foregone.
Answer. See above.
3. Positive Money insists that debt has to be created in order to facilitate economic transactions. I say: this confuses the netting (payment) system and the pooling (savings-loans) system. Only reserves (or cash, which is interchangeable with reserves) are needed for the payment system, a tiny sum in comparison to the total annual transactions in the economy (reserves are ~1/3000 – 1/7000 of broad money).
Answer. PM doesn’t say that, far as I know. But they do subscribe to the view that “without debt there’d be no money”, which I don’t agree with. My reasons are here.
Incidentally, on the subject of “debt has to be created in order to facilitate economic transactions..” that’s true and on a massive scale in that economic activity seems to involve a HUGE amount of trade debt. The total of trade debts for SMEs in the UK is a massive three times GDP.
4. Further to this Positive Money claims that increased savings reduces the percentage of money available as transactions. I say: reserves and transactions cannot diminish because of increased saving, but where reserves do become a smaller percentage of M4 over time it is because of increased efficiency in clearing.
Answer. “…that increased savings reduces the percentage of money available as transactions.”. Not sure exactly what Mike King means by that, but I certainly agree with Keynes’s “paradox of thrift” point: i.e. that increased saving (of money) reduces aggregate demand.
“…where reserves do become a smaller percentage of M4 over time it is because of increased efficiency in clearing”. Strikes me the stock of reserves has nothing to do with “clearing efficiency”. Reserves (and I assume we’re referring to bank reserves, i.e. base money) have increased DRAMATICALLY over the last three years as a result of QE. That has nothing to do with clearing efficiency.
5. Positive Money claims that money, i.e. broad money or M4, is ‘rented’ from the banking system. I say: this confuses deposits which pay interest with loans that charge interest.
Answer. As I explain in the article linked to under “3” above, where banks are into the business of creating money and NOT GRANTING long term loans, THERE ARE costs involved in doing that, i.e. administration costs. And banks would charge for that. However, as pointed out in that article, there is no reason for banks to charge INTEREST. Thus I’d say PM is correct if their “rent” refers just to administration costs, but wrong if they’re claiming anyone has to pay INTEREST on money created by private banks.
Incidentally, the above administration cost involved where private banks create money is in contrast to the creation of central bank money (aka sovereign money), the creation of which is near costless (as pointed out by Milton Friedman). That’s one argument in favour of banning privately created money.
6. Positive Money claims that commercial bank money ‘creation’ is responsible for house price rises. I say: the market has marked up house prices for many reasons, the most significant being the housing shortage.
Answer. PM actually say there are several explanations for high house prices. But I agree: commercial bank money creation doesn’t have much to do with it. Witness the fact that house prices in the UK have doubled in REAL TERMS over the last 30 years, whereas in Germany, Switzerland and Japan, house prices have remained constant. And that’s despite the latter 3 countries having the same bank system as the UK.
7. Positive Money believes that attempts to pay down debt lead to recessions. I say: causality runs the other way.
Answer. Most economists agree with PM there. That’s an example of Keynes paradox of thrift. I believe Steve Keen actually claims that it’s not increased debt that is stimulatory (and debt reduction that is deflationary): it’s the 2nd power that is important, i.e. the ACCELERATION in levels of debt (or debt reduction) that’s important.
8. Positive Money believes that an independent committee could better set the rate of money ‘creation’ than the commercial bank system. I say: the rate of money creation, or destruction, is not dictated by the commercial banks at all, but by the rate of growth or shrinkage of the economy.
Answer. There certainly isn't a CLOSE relationship between the expansion of M4 and growth. E.g. prior to the 2007/8 crisis M4 was expanding much faster than the economy.
I don’t think there are strong reasons for saying causation runs one way rather than the other. My hunch is that if there’s a fit of irrational exuberance amongst the general population and among businesses, private banks just join in the frenzy.
Also note there is very little difference between PM’s independent committee and the BoE MPC. That is, under the existing system, the latter committee manipulates the money supply when it adjusts interest rates and/or implements QE.
9. Further to this Positive Money believes that money ‘creation’ by commercial banks is undemocratic. I say: new money arises through increased economic activity and its level cannot be set by a committee, democratically accountable or otherwise.
Answer. The very word “democratic” makes my toes curl. The existing BoE MPC is not democratically elected. But that’s not a problem for me: that committee is a committee of supposed experts. It’s quite right that they aren’t democratically elected. I wouldn’t like to see a democratically elected committee design a nuclear power station, because that’s a job for experts.
I suspect PM is throwing the word “democratic” around for effect – so as to make their ideas appealing for the more naïve section of the population. In which case, well done PM. I’m a great believer in manipulating the naïve section of the population – I mean we don’t want them having real power do we (just to be thoroughly cynical).
10. Positive Money believes in a concept called ‘debt-money’ as opposed to ‘debt-free money.’ I say: this distinction is vacuous. Money, whether held directly, or borrowed, is an obligation on the market to provide goods, services or labour. Unless that money is created ex nihilo by the state or a counterfeiter, it has arisen through prior provision of goods, services or labour.
Answer. Agreed in that for reasons I gave under No.3 above, I don’t think that money creation by private banks requires anyone to go into debt long term (e.g. take out a mortgage). However, to the extent that private banks are into the business of just creating money, then for everyone with a short term positive balance on their bank account of £Z, there is someone with a short term negative balance of the same amount. MMTers agree with that. To use MMT parlance, “horizontal money nets to nothing”.
As to the idea that base money (aka sovereign money) is “debt free”, I agree: such money is an asset as viewed by the private sector, but there’s no corresponding private sector debt. THERE IS a public sector debt OF A SORT. That is, base money appears as a liability on the BoE’s balance sheet. But it’s a strange sort of liability. For example the state can grab any amount of base money off the private sector any time it likes via tax. If you were able to grab money off the bank that supplied your mortgage, would you be in debt to the bank?
I normally agree with Krugman, but not with this article. He’s joined the chorus of voices pushing for a higher inflation target, the idea being that come the next recession, central banks have more room for manoeuvre. That is, given inflation of say 4% instead of 2%, and assuming a central bank cuts interest rates to say 1%, that means the real rate of interest is minus 3% instead of minus 1%. And that minus 3% real rate supposedly gives the economy more of a boost than the minus 1% real rate .
But how do we actually get inflation up to 4%? Well Robert Mugabe knows how to do that, though half the world’s so called “professional” economists seem to think that raising inflation is difficult. The answer is a nice big dose of fiscal stimulus, perhaps assisted by QE. And those two in combination come to the same thing as “the state prints money and spends it, and/ or cuts taxes”.
But hang on: the BASIC object of the exercise is to get the economy up to the capacity or “full employment” level. Once you’ve done that, it’s a case of “problem solved”.
What then is the point of boosting demand even more (which may bring no additional real output) with a view to boosting inflation from 2% up to 4%?
Put another way, what’s the point of giving the economy EXCESS stimulus via fiscal means, and then partially negating that with raised interest rates? As I pointed out here, that’s very similar to controlling a car’s speed by having the accelerator permanently on the floor, and controlling the speed by apply varying amounts of pressure to the brake pedal.
The only excuse for that “accelerator and brake” policy would be if interest rate adjustments worked quicker and more predictably that fiscal stimulus. But there seems little evidence to support that.
Two of the main activities performed by banks are deposit taking and lending. Arguably those two activities are irreconcilable. As Adam Levitin put it in the abstract of this paper, “Banking is based on two fundamentally irreconcilable functions: safekeeping of deposits and re-lending of deposits. Safekeeping is meant to be a risk-free function, but using deposits to fund loans inevitably poses risk to deposits, thereby undermining the safekeeping function.”
In contrast to that, Anil Kashyap and co-authors in a paper entitled “Bankers as Liquidity Providers…” argue that there are synergies to be gained from combining deposit taking and lending.
Kashyap & Co’s argument runs off the rails in their first paragraph where they say “More precisely, deposit-taking involves issuing claims that are riskless and demandable, that is, claims that can be redeemed for a fixed value at any time.”
The problem there is that those “claims” are very definitely not riskless. As Levitin put it in the above quote, “…using deposits to fund loans inevitably poses risk to deposits…”. That is banks thru history have gone bust with monotonous regularity, which means that (absent banks being backed by taxpayers) depositors face a risk. Plus of course bank shareholders face a risk.
On the other hand if banks ARE BACKED by taxpayers so as to dispose of the above risk, then that’s a subsidy of banks, and subsidies do not make economic sense.
At the very least, if Kashyap & Co need to be more precise about their above “riskless” claim.
However Kashyap & Co’s main point (and this is a clever and plausible point I haven’t come across before) is as follows. Where a bank undertakes to let depositors have their money back on demand, banks obviously have to have a stock of money to actually meet those demands. Also, banks having promised sundry borrowers they can withdraw money on demand up to the maximum amount of agreed loans, have to have another stock of cash to actually meet those “demands to withdraw”. So in a sense, depositors and borrowers are both depositors.
Now the larger the number of deposits at a bank, the smaller the stock of cash the bank needs (relative to total deposits) in order to be 99.9% sure of being able to meet demands to withdraw every day. To illustrate, if a bank had just one deposit of $1000, the bank would definitely need to keep $1000 in cash in order to be able to deal with the far from remote possibility that the depositor wants all his or her money back. In contrast, if the bank has ten thousand depositors, than at a very rough guess it would only need to keep a hundredth that amount in the form of ready cash in order to be 99.9% sure of being able to meet demands to withdraw.
Ergo, there are economies of scale or synergies to be had from combining deposit taking and lending.
However, there’s a flaw in that argument commonly known as the “fallacy of composition”. The fallacy of composition is the assumption (which often doesn’t work out) that one can extrapolate from the microeconomic to the macroeconomic. Put another way it’s the assumption that what benefits some microeconomic entity like a household or bank will also benefit the economy as a whole.
In the case of a bank calculating the minimum stock of cash it needs in order to meet withdrawals, obviously anything that reduces that stock is beneficial to the bank. However, viewed from the perspective of the economy as a whole, i.e. the macroeconomic perspective, supplying the economy with more cash costs nothing. To take an extreme example, if everyone wanted to keep an extra £1,000 under their mattress or in some state run savings bank, the state can meet that demand at almost no cost. That is, printing a ton of £50 notes costs almost nothing, compared to the face value of the notes. And as to non-physical money, the central bank can create limitless amounts of money at the click of a computer mouse.
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.”
In response to David Graeber’s recent article on sectoral balances, Ann Pettifor seems to be worried that people will take sectoral balance analysis as being the EXPLANATION for changes in flows of money between different sectors, as distinct from being simply a statement or quantification of those flows.
I agree with Scott Fulwiller's response to Pettifor, namely that I’ve never actually known anyone make that mistake.
The balance sheet of a firm or corporation doesn’t EXPLAIN anything. But balance sheets are nevertheless useful snapshots of the total assets and liabilities of a firm or corporation at a given moment in time.
According to Steve Keen there is no such thing as the natural rate of interest. As he puts it “it is a fantasy: there is no such thing.”
What: so if I shop around for a loan I’ll find the rates offered jump around all over the place between plus 50% pa and minus 20% - or something?
My guess is that I’ll find every bank I apply to will make a roughly similar offer, and far as I’m concerned, that’s the natural rate as of 2015, or at least something quite close to the natural rate.
To be more accurate, my definition of the natural rate of interest on a near zero risk loan (or any other level of risk you care to choose) is the rate that prevails at a particular point in time assuming government is not artificially interfering with the rate.
Of course what constitutes “artificial interference” is a tricky question. Certainly I’d classify borrowing so as to fund CURRENT spending as opposed to capital spending as a form of artificial interference.
As to whether governments ought to borrow so as to fund CAPITAL spending, that’s more debatable. But assuming it can be demonstrated that GDP is maximised by having government borrow so as to fund capital spending (or not), and assuming government complies with that “demonstration”, then the prevailing rate of interest for a loan of any given level of risk is the “natural rate”.
Can’t see the problem IN PRINCIPLE with that “natural rate” idea. As to actually quantifying it, that's tricky because of the above difficult argument about whether and how much government ought to borrow, plus of course government is a very large borrower.
