Tuesday, 27 January 2015
Private banks create money when they lend, as pointed out in this recent Bank of England work. That point was actually being made decades ago in some economics text books, e.g. R.G.Lipsey’s “Principles of Economics”.
To be more accurate, if loans are being REPAID to a bank at the same rate as new loans are granted, the bank does not on balance create money. On the other hand, the TOTAL STOCK of private bank created money tends to rise, year after year, so as distinct from the latter “repayments equals new loans” scenario, private banks ARE INTO THE BUSINESS of creating entirely new money in that the total stock of privately created money expands most years.
An alternative and perfectly valid way of looking at this process is to say that money is destroyed when a loan is repaid and created when loans are granted. The difference between those two ways of looking at the process is not important.
Money creation brings benefits.
In favor of private money creation, there is the point that money is useful stuff, ergo creating it brings benefits. And certainly if there were no central bank, then private banks would be performing a useful service in creating money. Indeed, that’s exactly what those proverbial goldsmiths did when they first issued paper receipts for non-existent gold a few hundred years ago.
However, we have central banks nowadays, thus the question arises as to whether money is best produced by 1, private banks, 2, central banks or 3, both types of banks (as is currently the case).
Privately created money involves big risks.
Privately created money has several serious problems. It gives rise to bank runs and credit crunches plus private money creation is a form of fraud and theft. We’ll start with bank runs and credit crunches.
Money is a liability of a bank: in the case of a loan, it’s an entirely artificial debt owed by a bank to a borrower which the bank undertakes to transfer to anyone else when instructed to do so by the borrower using the borrower’s cheque book, debit card or similar. Moreover, the debt is advertised by the bank as being money and a characteristic of money is that it is FIXED IN VALUE (inflation apart).
That is, we expect for example a $100 bill to be worth very nearly $100 in a months time, as distinct from for example shares which can fall or rise dramatically in value in 24 hours.
The net result is as follows. After a borrower has spent what they’ve borrowed and the relevant money has been deposited in some private bank, the private bank system then has a liability that is fixed in value and an asset (the loan the borrower) which can fall in value. That is, some borrowers fail to repay their debt.
The latter scenario (having a liability that is fixed in value and an asset that can fall in value) is clearly risky. That risk works out OK roughly nine years out of ten. But the inescapable reality is that in the tenth year it all goes wrong: the brute fact is that private banks have gone bust by their hundreds over the centuries.
In short, risk is an inherent characteristic of private money creation. Or as “Douglas Diamond and Raghuram Rajan say in the abstract of this paper, and in reference to the liquidity / money creation that private banks offer: “We show the bank has to have a fragile capital structure, subject to bank runs, in order to perform these functions.”
Private money creation is fraudulent.
Not only does private money creation involve the near inevitability of 1929 crashes and credit crunches, it can also be argued to be fraudulent. That is, for a bank to promise its creditors they’ll be able to get $X back for every $X deposited when in fact the money concerned has been put at risk is either totally fraudulent or at least semi-fraudulent. It’s little different from borrowing money from a friend, promising to repay it, and then putting the money on a horse or a roulette table. As Martin Wolf, chief economics commentator at the Financial Times put it, “If we were not so familiar with banking, we would surely regard it as fraudulent”.
(Incidentally I’m not arguing that banning private money creation would bring a total end to bouts of irrational exuberance or the opposite, i.e. recessions. But the ban would certainly help.)
Private money creation is theft.
Money printing is profitable, as counterfeitors will attest. And what private banks do is essentially the same, but private bankers wear smart suits, drive smart cars and they take great care to befriend top politicians. That makes bankers immune from prosecution.
To explain why private money creation equals theft, let’s concentrate on the process whereby private banks EXPAND the money supply as distinct from RECYCLING existing money.
When a private bank grants a loan, the borrower spends the money and gets themselves a car or whatever. So as a result of a few book-keeping entries, the borrower manages to acquire a real and valuable assets. Nice work if you can get it! And at the same time, the rest of the community loses a real and valuable asset and in exchange gets some book-keeping entries (or numbers in a computer, which is the form that book-keeping entries take nowadays).
Someone has been diddled, haven’t they?
And do the bank and borrower ever need to repay the loan? Well not if that new money becomes a PERMANENT ADDITION to the money supply. Let’s illustrate that point by reference to paper money as distinct from the above digital or book-keeping money.
Suppose everyone decides they want to carry an additional £10 around with them, the central bank / government would need to create an extra £10 per person, and spend that money into the private sector (in the form of extra spending on roads, law and order, education or whatever).
In a sense then, government “profits” in that it manages to acquire real goods and services (roads etc) in exchange for silly bits of paper which cost next to nothing to print.
But of course we don’t object to that profit because government is owned by the people: put another way, when a new road is built, we all benefit. In contrast, and in the case of a private bank and borrower, it’s the private bank and borrower who make the profit, not the community. Why do we let them get away with it?
Also, note that where a loan brings about a permanent increase in the money supply, the borrower DOES NOT (contrary to popular perception) borrow from the bank. At least no REAL GOODS OR RESOURCES are transferred from the bank to the borrower. Put another way, bank staff do not sweat their guts out making the new car or whatever the borrower acquires.
The only job performed by the bank is an administrative one: e.g. checking up on the value of the collateral supplied by the borrower. Thus the bank, strictly speaking, has no reason to charge interest: it DOES HAVE a reason to charge for the above ADMINISTRATION COSTS, and will almost certainly CALL THAT interest. But it’s not actually interest.
In contrast, in the case of RECYCLING (in the above sense), a private bank obviously gets the money it lends out from somewhere: it gets the money from depositors, bond-holders or shareholders. And the latter three will want interest or some sort of return on their money. And clearly the bank has to pass on that interest to borrowers. So in that case, borrowers pay BOTH the above administration costs and what might be called “genuine interest”.
To summarise, private money creation involves bank runs, credit crunches, fraud and theft! How low can you get?
So is there an alternative way of supplying the economy with the money it needs? Well yes: have the CENTRAL BANK supply as much money as we need. And money creation is a job that central banks already perform: indeed they’ve been performing that task on a unprecedented scale in recent years in the form of QE.
Banning private money inhibits lending?
There might seem to be a problem in banning private money creation and having the central bank supply our money needs instead, and that’s that as pointed out above, lending by private banks seems to be inextricably tied to money creation. And if that were the case, then obviously banning private money creation would inhibit or bar lending by private banks.
However, as already intimated, it is legitimate to say that no money creation in fact takes place when most loans are granted in that ROUGHLY SPEAKING, loans repaid to a private bank each month equal new loans granted. Put another way, in that private banks just re-cycle EXISTING MONEY, they don’t create new money.
And if all money were CENTRAL BANK CREATED, the granting of loans would not be inhibited in that private banks just engage in the latter recycling process. Put another way, if there were a FIXED STOCK of central bank money, and private bank money were banned, then obviously expanding the money supply would not be possible.
But of course the latter is a total and complete non-problem because central banks and governments can and do expand the stock of central bank created money any time they want. QE is just one method.
Conclusion: privately created money has nothing going for it. It involves fraud and theft. It’s a left-over from those goldsmiths who issued paper receipts for non-existent gold, and made a fortune doing so. Private money creation only continues because of general ignorance about money: in particular the fact that private bankers run rings round economically illiterate regulators and politicians.
Saturday, 24 January 2015
At least that’s what Carney (governor of the Bank of England) suggested recently in Davos. According to this article, “Mr. Carney said that making banks maintain even higher levels of equity could increase their costs, and those costs would probably get passed on to the banks’ customers.” That “expensive capital” story is often spun by commercial banks when trying to avoid better capital ratios, and it looks like Carney may have fallen for it.
So let’s go through this from the beginning. It’s not difficult: in fact it’s desperately simple.
It might seem that bank capital is expensive compared to debt (e.g. bonds or deposits) because the return demanded by shareholders is higher than that demanded by debt holders. Well that difference in return is explained by the very simple fact that shareholders are first in line for a hair-cut when the bank is in trouble. Obviously shareholders want a bigger return!
However, it’s false logic to conclude that if bank capital ratios are increased that the TOTAL return demanded by all bank funders at a particular bank (shareholders, depositors etc) will rise. Reason is that the total risks involved in running a bank are determined SOLELY by the nature of the bank’s assets (its loans and investments). E.g. a bank that specialises in NINJA mortgages obviously runs a bigger risk than one specialising in conventional mortgages.
In contrast, whether those funding the bank are composed mainly of shareholders, bond-holders or depositors HAS ABSOLUTLY NO INFLUENCE on the above “total risk”. Ergo changing the composition of funders (e.g. increasing shares at the expense of bonds or deposits) has no effect on the total return demanded by bank funders.
Indeed, the latter very simple point was the point made by Messers Modigliani and Miller, a point for which helped them get a Nobel Prize.
The messy real world.
Unfortunately in the real world, the Modigliani Miller theory (MM) doesn’t work out quite as simply as the above simple bit of theory suggests. That is, there are host of complexities (half of them unnecessary) that muddy the picture in the real world. And that is music to the ears of banksters and academics in the pay of banksters: those complexities enable them to churn out thousands of words of waffle which actually boil down to nothing, and which don’t basically rebut the above simple theory. And that, combined with bribes paid to politicians by bankers enables bankers to avoid better capital ratios, often as not.
The tax treatment of debt.
For example, there’s the point that the tax treatment of debt is different to the treatment of shares: interest on debt can be debited to profit and loss accounts. But dividends can’t. Well that “tax” point is wholly irrelevant because tax is an ENTIRELY ARTIFICIAL imposition: it doesn’t reflect underlying economic realities.
But that’s not how some academics see it: they seem to think that because debt is good value for money on account of those tax advantages, that therefor the REAL COST of debt is lower than the REAL COST of capital.
Anat Admati touched on the latter point in a recent tweet:
If banks aren't as attractive to equity investors, maybe too much of their current value is due to debt subsidies. http://t.co/D6xGHjiTQ0
— Anat Admati (@anatadmati) January 23, 2015
Admati is professor of economics at Stanford.
Another flawed “bank capital is expensive” argument is thus.
Given inadequate capital ratios of the sort of that prevailed before the crunch, clearly the chance of bank insolvency is too high. And we all know who carries much of the cost stemming from bank insolvency in the case of large banks: the taxpayer.
It follows that as bank capital ratios are raised, significant costs are removed from taxpayers and loaded onto shareholders. So as capital ratios rise, the TOTAL COST of funding banks does rise. But of course that rise is due to the removal of a subsidy: an entirely justifiable removal. MM remains unscathed!
Another popular argument against better capital ratios is that the effect will just be to drive business towards the unregulated sector: shadow banks. Well the answer to that is to regulate shadow banks the same was as regular banks are regulated. Or as Adair Turner (former head of the UK’s Financial Services Authority) put it, “If it looks like a bank and quacks like a bank, it has got to be subject to bank-like safeguards..”
Of course it will never be possible to regulate every single shadow bank including the very smallest. But that doesn’t matter. As long as every institution that behaves like a bank and which has a turnover of more than roughly $10m a year is regulated, that cracks the problem.
If someone lends $100 to their next door neighbour, they’re acting as a bank strictly speeking. Clearly it would be absurd to regulate that sort of lending.
Friday, 23 January 2015
I normally agree with Turner, but not with this article of his entitled “Have we become too flexible?”
His basic point (set out essentially in his final four paragraphs) is that labor market flexibility depresses wages, and lower wages is the last thing we need right now, what with inadequate aggregate demand. OK, let’s think about this.
First, let’s assume that when the labor market becomes more flexible, it also becomes more efficient: that is, output per head rises. Obviously there are possible circumstances where the latter does not obtain: for example if the rules governing the labour market were changed to those that govern a slave labor market – i.e. employers could order employees to do absolutely anything on pain of being flogged – then that would improve flexibility. However, a slave labor market would doubtless not bring all round benefits and probably wouldn’t raise output per head.
Now the INITIAL EFFECT of improved flexibility can easily be that employers pay less to employees for a given type of work. E.g. trade unions have often tried to insist that particular types of work be carried out only by fully qualified employees – union members to boot and at the union wage. And if employers can scrub that union imposed rule and employ unskilled employees instead, then the wage paid for the type of work concerned will fall. And it’s doubtless that point that induces Turner to think that more flexibility equals falling wages.
But that’s actually nonsense and for the following reasons. Suppose EVERYONE’S wage (including the “wage” of employers) is halved. Does that mean anyone is worse off? Clearly not: there’s no affect whatever on the REAL WAGE. The fall in money wages is exactly compensated for by a doubling in the value of money. Everyone is back where they started.
And the same point applies to a cut in money wages for a specific group or groups of employees: the net result is a decline in the AVERAGE money wage paid to everyone. But there’s no reason to assume a change in the AVERAGE REAL WAGE.
So, more flexibility improves output per head. And that output will clearly be shared between employers and employees.
Now let’s make the very reasonable assumption that the EXACT WAY that additional output is split between employers and employees does not change just because a group of employers manage to impose greater flexibility. For an example of a “way” in that additional output is split, the labor market might work in some sort of optimal way: i.e. additional output might be split in a way that maximises GDP. Alternatively employers might have some sort of market power and might be able to grab the lion’s share of that increased output.
Whichever of the latter two scenarios obtains, there is no reason to think that WAY additional output is split is going to change just because there’s an improvement in labor market flexibility.
In short, improved labor market flexibility brings increased output (despite the fact that the INITIAL effect can be a drop in money wages for SPECIFIC groups of employees). And that increased output will inevitably be shared somehow or other between employers and employees.
And there’s nothing inherently wrong with that. To repeat, there may be SPECIFIC CASES where employers (or employees) grab more than their fair share of increased output. But that’s a separate point. It doesn’t alter the fact that increased output stemming from increased flexibility is basically desirable.
Thursday, 22 January 2015
Wednesday, 21 January 2015
Dirk Neipelt (professor at Bern University) tentatively advocates the above, (which amounts to full reserve banking (FR)) in this recent Vox article entitled “Reserves for everyone…”. But I’m not sure how far he realizes he’s advocating FR. Certainly he doesn’t cite any of the well-known advocates of FR stretching back to the 1930s, e.g. Irving Fisher (1930s), Milton Friedman (1960s), etc. On the other hand he does make one reference to “narrow banking”, which on some definitions is the same as FR.
What Neipelt does advocate is letting everyone have an account at the central bank (CB): i.e. let everyone have a stock of base money.
Of course, many central banks would not want the hassle involved in opening accounts for every other household and firm. But that problem is easily solved: have commercial banks act as AGENTS FOR the central bank. Another solution (already up and running in the UK) is to have some sort of separate government run bank organise the relevant accounts. And in the UK that is currently done by “National Savings and Investments”.
NSI currently doesn’t offer ALL THE services you’d expect of a deposit accepting entity / bank, e.g. it doesn’t offer cheque books or debit cards. But letting it do so wouldn’t be difficult.
As Neipelt rightly says, CB money is as near totally safe as it’s possible to get. That’s in contrast to commercial bank created money, billions of dollars of which vanished into thin air in the 1930s.
Re Neipelt ‘s claim that a “reserve only” system “could undermine deposit-financed credit creation..” that’s a popular and flawed objection to FR. Under FR, anyone is free to have their money loaned on to whoever they wish (NINJA mortgagors, safe mortgagors, or whatever). The big difference as compared to the existing system is that those making the latter choice carry ALL THE RISKS, as opposed to the existing system where the taxpayer carries some of the risk (e.g. via TBTF).
So FR does “undermine deposit financed credit creation” in that it increases costs for borrowers: but only because the latter (TBTF etc) subsidy of lenders is removed. What’s wrong with that? Subsidies misallocate resources.
Re his claim that “As a by-product, public ‘insurance’ of bank deposits could be scaled down..”, actually “public insurance” of banks can be removed altogether. At least if lending entities are funded just by shares rather than by money, then it’s impossible for lending entities / banks to go insolvent. Though the value of their shares can decline to the point where they become takeover targets. (Entities funded just by shares cannot go insolvent because they owe nothing to anyone - certainly not to shareholders. In contrast, money is liability of a bank which is more or less fixed in value.)
Loans granted by CBs.
Neipelt also raises this question: “Would central banks lend funds only to financial institutions or also to the broader public, and at the same policy rates?”
My answer that is that there’s no excuse for central banks to lend to anyone. Certainly CBs shouldn’t get involved in COMMERCIAL loans of any sort, i.e. loans to “the broader public”.
As to CB loans to commercial banks, the only generally accepted excuse for those sort of loans arises where commercial banks are in trouble, and CBs lend according to Walter Bagehot’s criteria, namely at penalty rates and in exchange for decent collateral. But the latter policy involves problems.
First, once you allow “Bagehot” type lending, political pressures ensure that the lending is at rates well below the “penalty” rate. And second, the collateral can be nearer junk than first class. That’s exactly what happened in the recent crisis. And that amounts to a subsidy of commercial banks.
Second, if lending entities / banks are funded just by shares rather than deposits, it’s impossible for those lenders to go insolvent. So the need for Bagehot type lending just doesn’t arise!
Funding for lending.
Having said just above that the “only generally accepted” excuse for CB lending is the Bagehot excuse, there have of course been various exceptions, e.g. the UK’s so called “Funding for Lending” scheme. However, for most of the last century, the only widely accepted excuse for CB lending has been the Bagehot excuse, while schemes like Funding for Lending have been small scale and temporary.
Completely ban private money creation?
Neipelt seems to envisage letting everyone have an account at the CB, while letting commercial banks continue with private money creation. So should we do that, or aim for a straight ban on privately created money?
Certainly the bulk of the advantages in cutting down on private money and boosting CB money come with doing just that (i.e. insisting on a big rise in commercial bank capital ratios). I.e. raising lending entities’ capital ratios from roughly 30% to 100% (which equals a total ban on private money) does not bring huge benefits. However, I favour the 100% figure, and for several reasons, as follows.
1. 100%, to repeat, does bring finite benefits.
2. 100% is a nice clear line in the sand. Anything less, and the banking lobby will just bribe and cajole regulators and politicians into a gradual relaxation of capital ratios, till we’re back with the ridiculously risky ratios that existed prior to the crunch. Indeed, the bank lobby in the US is currently proving highly adept at dismembering Dodd-Frank.
3. Resources are optimally allocated where there are no subsidies. A total removal of bank subsidies means that depositors are in line for hair-cuts when things go seriously wrong (as in Cyprus recently). But a stake in a bank which involves sharing in profits and losses is what’s known as a “share”. Or at least it’s getting near to being a share.
So to that extent and by definition, a total removal of bank subsidies (aka optimally allocating resources) means a total ban on private money.
(H/t to Mike Norman.)
PS ( 22nd Jan 2015). Also (No.4), anything less than 100% means banks can engage in a trick allegedly employed by Barclays during the crisis, which is to lend large sums to a borrower on condition the latter use some of the money to buy shares in the bank. To the extent that that trick works, a hefty capital ratio (say 30 to 50%) means that sub 100% capital ratios are no sort of constraint on bank expansion.
Tuesday, 20 January 2015
Mark Carney, governor of the Bank of England thinks so. At least in this speech of his (p.3), he says, “Success would be a global financial system that maximises its full potential to ensure that….. liquid savings are transformed into long-term loans…”
The UK’s so called “Vickers commission” report on banking makes the same claim (sections 3.20 and 3.21).
Well now, the most “liquid” of all assets or savings is money, so I assume that’s what Carney is referring to, or at least I assume it’s ONE OF the types of saving he is referring to. As to Vickers, money is quite clearly what is being referred to.
So, does it matter whether as much “saved money” as possible is transformed into loans?
Well as viewed from a micro economic perspective, i.e. as viewed by an individual household or firm, there’s much to be said for maximising the proportion of savings that are loaned out rather than taking the form of pound notes or dollar bills stuffed under the proverbial mattress.
But as anyone who has got half way through an introductory economics text book knows, it is very dangerous to extrapolate from the microeconomic to the macroeconomic. More often than not, that doesn’t work. The currently fashionable tendency by twits in high places to treat government, and in particular government debt, in the same way as a household’s debt is a classic example of this mistake.
In contrast to savings as viewed by households (microeconomics), there are savings as viewed by the country as a whole (macroeconomics). Here, “liquid savings”, are not (as Carney and Vickers seem to think) some sort of valuable asset which must if possible be used. Money is simply a book-keeping entry, and banks (both commercial banks and central banks) can create such “entries” in infinitely large amounts any time. I.e. those “entries” are as inherently worthless as $100 bills and £10 notes.
Far from straining ourselves to ensure that every unit of money saved is loaned on, there are some very good reasons for NOT LENDING MONEY ON. E.g. throughout history, banks have gone bust precisely because they have loaned out too much, with the result that when depositors’ form queues outside such banks wanting their money back, the money isn't there: a “bank run”.
So how do we ensure bank runs don’t take place? Well it’s easy: forbid banks from lending out money unless relevant depositors have specifically given permission for their money to be loaned out, and for a longish period. Or alternatively, have lending funded just by shares in the lending entity. That’s different from the existing system under which banks can lend out the large majority of the contents of depositors’ checking or current accounts without permission from depositors.
Of course requiring the above “permission” would reduce the proportion of deposits that were loaned on, which might cause grief for Carney and Vickers. But actually things are not that simple.
The latter reduced amount of lending would certainly cause a decline in total amounts loaned – at least initially. But that would cause a decline in aggregate demand, and government and/or central bank would have to react to that. And a very good way of returning demand to its initial level would be exactly what we have in practice done over the last three years or so. That’s fiscal stimulus followed by QE. And the latter amounts to printing new base money and spending it into the economy (and/or cutting taxes).
(By “fiscal stimulus”, I mean having government borrow and spend, and/or cut taxes. Then comes QE, which consists of the central bank printing money and buying back those government bonds. Net effect comes to the same thing as the government / central bank machine simply printing money and spending it, and/or cutting taxes.)
So, the latter money creation would result in everyone having a larger stock of money, some of which they’d let their bank lend on. Thus the above INITIAL reduction in amounts loaned out would be partially reversed by the latter money creation.
But it probably wouldn’t be TOTALLY reversed. I.e. the net effect would be (assuming the economy remains at capacity) less lending based activity and more non-lending based activity. That is, a proportion of households and firms would be able to do whatever they wanted to do (e.g. buy property) WITHOUT borrowing rather than WITH THE ASSISTANCE of borrowing. Now is that some sort of disaster?
To summarise, trying to maximise the proportion of “liquid savings” loaned on is a badly flawed objective. A better objective is to treat lending just like any other commodity: maximise output (without output being subsidised) and to the point where the marginal unit sold is only just profitable.
And what do you know? That’s what full reserve banking consists of. That is, under full reserve, there is no sort of subsidy or rescue available to lenders (unlike the existing system where we have a host of subsidies for banks, TBTF, etc).
As to the total amount of money saved, that needs to be whatever induces the private sector to spend at a rate that brings full employment, i.e. keeps the economy at capacity. If that results in everyone having $10,000 in savings which is not loaned or (or which is stuffed under mattresses) what’s the problem? Printing that $10,000 costs nothing. 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.”
Monday, 19 January 2015
George Osborne (the UK’s economically illiterate finance minister) wants government to run a surplus – more or less permanently. I’ve explained why that makes no sense in theory more than once on this blog.
But it’s nice to see the theory confirmed by a nice simple chart (see below). The chart shows US deficits (in orange) and surpluses (in blue) over the last 30 years or so. As you’ll see, surpluses are a rarity. And in total over that 30 years, they’re pretty much irrelevant compared to the total size of deficits.
Far as I know the sky isn't falling in in the US as a result of these more or less constant deficits.