Monday, 25 July 2016
The first two are light hearted but quality stuff all the same. Prof Anat Admati, who specialises in banking, makes an appearance. These five videos were brought to my attention by Jack Haze, who works for a bank in the US.
I couldn’t fault the first video (the pair are actually a two part series). The second half of the second one made claims which I thought were true, but were not actually substantiated in the video. But that’s a minor blemish.
The third video is high quality stuff - apart from the poor sound quality for the first minute or so. It’s a presentation done for the Swiss CFA Society, by Prof Dirk Niepelt (University of Bern). It examines the Swiss Vollgeld initiative, i.e. the idea being pushed in Switzerland (and indeed in many other countries) that commercial banks should not be allowed to print or create money: “full reserve banking” (FR) as it is normally called. Niepelt concludes that FR could work, but he claims it would have significant problems.
However, he ends by making an odd claim, as follows.
He says he doesn’t like the idea of FORCING those with bank accounts to make the stark choice that FR forces bank account holders to make. That’s the choice between putting money into, first, a totally safe but zero interest earning account, and second, an account where interest IS EARNED, but account holders have to bear the costs if things go wrong with the bank (or where the particular type of loan chosen by the account holder (e.g. mortgages) goes wrong.
Instead, so he says, central banks should offer totally safe accounts for those who want them (perhaps managed by commercial banks). That’s actually something the Bank of England is contemplating and which Positive Money backs. And indeed those accounts would be just the same as the safe accounts contemplated by advocates of FR.
As to those who want a decent rate of interest, so Niepelt says, they could have accounts like existing bank accounts (where money is loaned on to mortgagors, small businesses, etc), but those account holders would bear the cost if things go wrong.
Now hang on: a system where account holders bear the costs when things go wrong is exactly what the advocates of FR argue for!!!!! In short, I’m puzzled as to what the difference is between Niepelt’s system and FR.
The final two videos are also produced by the CFA, but I’ll deal with those in a day or two. Relevant links:
Sunday, 24 July 2016
Our response to critics in the Cambridge Journal of Economics https://t.co/UxXcrltKGG— Positive Money (@PositiveMoneyUK) July 24, 2016
Ever read something by a professional economist, full of the usual impressive jargon, then your jaw drops: you suddenly realise they have no grasp of the BASICS? Here’s an example.
In the Cambridge Journal of Economics paper by Malcolm Sawyer and Giuseppe Fontana referred to above, the authors (S&F) don’t appear to understand that when a central bank creates money and government spends it, that that money ends up in private sector bank accounts. You’d think that was a simple enough point, wouldn’t you? But S&F say:
“…it is not clear where the prior savings alluded to by Daly and other advocates of full reserve banking have come from. It is technically impossible for banks as a whole to collect deposits without at the same time granting loans for the same amount. Therefore, at least initially there must have been a process of credit creation in the economy, which was completely unconstrained and unrelated to pre-existing resources.”
Technically impossible for banks to collect deposits without at the same time granting loans??? Whaat?? Let’s run thru this V-E-R-Y S-L-O-W-L-Y.
In the case of a helicopter drop (to take just one example), that involves the central bank creating new money out of thin air, which money is then spent in some way or other. For example the CB could just send a cheque to every household in the country, which, contrary to the “technical impossibility” referred to by S&F, results in households’ bank accounts being boosted.
Another alternative is for the CB to give the money to government / the treasury, which then spends the money (and/or cuts taxes). In that case, as well, new money boosts private sector bank accounts.
Standard fiscal stimulus.
In contrast to helicopter drops, there is standard fiscal stimulus. That consists of government borrowing $X, spending $X (and / or cutting taxes), and giving $X worth of bonds to those it has borrowed from. However, that on its own is likely to raise interest rates, which the CB is unlikely to allow assuming there really is a recession which justifies the fiscal stimulus. Thus the CB is likely to print a fair amount of money and buy back some of the latter bonds. Indeed, over the last five years or so, and as a result of QE, the Bank of England bought back ALMOST ALL the new bonds issued by government.
And that all nets out the same thing as a helicopter drop, i.e. “the state prints money and spends it and/or cuts taxes”.
So, as in the case of a helicopter drop, new money is created by the state and fed into the private sector, which (gasps of amazement) boosts private sector bank balances.
As for S&F’s point that “. Therefore, at least initially there must have been a process of credit creation in the economy, which was completely unconstrained and unrelated to pre-existing resources”, well yes: S&F are right there. There is indeed a “process of credit creation” which is “unrelated to pre-existing resources”. It’s the CB and its money printing operations!! Doh!
Hope that’s clear, children. Hope it’s also clear that Sawyer and Fontana don’t have much of grasp of the basic book-keeping entries done by central and commercial banks – not that S&F are the only so called “economists” who don’t have a grasp of the basics.
(P.S. The inclusion of the tweet above by Positive Money should not be taken as a suggestion that PM agrees with the above article.
Thursday, 21 July 2016
Ricks is an associate law professor at Vanderbilt Law School who specialises in financial regulation. A recent paper entitled “Safety First? The Deceptive Allure of Full Reserve Banking” claims to set out a fatal flaw in full reserve (FR).
On the plus side, the paper is short and clearly written, and Ricks has a good grasp of the potential problems with FR.
However, the alleged fatal flaw is easily dealt with in principle: indeed the flaw was clearly recognised and fully dealt with in the submission to the UK’s Vickers Commission by Positive Money, the New Economics Foundation and Prof Richard Werner five years ago. The alleged flaw is also fully dealt with in other literature by the latter three authors. (I’ll refer to the latter three authors, and the latter submission and other relevant literature produced by those three authors simply as the “Vickers authors”.)
The layout of Ricks’s paper.
Ricks claims there are two basic flaws in FR, the first of which is non-fatal, while the second is allegedly fatal. The first or “non-fatal” flaw is thus.
Under FR, the private sector, banks in particular, are banned from issuing or “printing” money: an activity they engage in under the existing bank system (sometimes called “fractional reserve banking”). Instead, all money is issued by the state. But as Ricks rightly explains, financial institutions would try to circumvent that ban. However, since, as he says, that problem can be dealt with (a point I agree with), I won’t consider that point further here.
As to the second and allegedly fatal flaw, Ricks calls that “fiscal-monetary entanglement”, and it consists of the fact that under FR, when it is necessary to increase the economy’s stock of money, that money must first be created and spent into the economy (and/or taxes must be cut).
But as Ricks rightly points out, there is an obvious problem there, namely that the need for stimulus is then dependent on the whims of a bunch of people known as “politicians” whose knowledge of economics is hopeless. And that’s doubtless putting it too politely. Plus even in that politicians ARE economically literate, they sometimes devote more effort to squabbling with each other than making sure there’s enough demand to keep as many people employed as possible (particularly in the US).
Well there’s a simple solution to that problem, at least it’s simple in principle, and the solution (to repeat) was set out by the three Vickers authors. The solution is to have the central bank, or some independent committee of economists responsible for the AMOUNT of stimulus (i.e. the AMOUNT of new money created and spent (net of taxes) into the economy, while politicians retain control of obviously POLITICAL decisions like what proportion of GDP is allocated to public spending and how that spending is split between law enforcement, education, defence and the various other items that governments spend money on.
To illustrate, where there is no government borrowing, politicians would decide the proportion of GDP to allocate to public spending and would collect tax to cover that spending, while the latter committee if it though $Xbn of new money should be created and spent net of tax would tell politicians as much, and politicians would get on with spending that extra money, or cutting taxes by that amount, or would go for some mixture of spend and tax cut.
And that of course is a large and fundamental change to the split of responsibilities as between central banks on the one hand and politicians / treasuries on the other. But there is nothing the least undemocratic about it. I.e. the change is (to repeat) simple in principle, though actually getting that change in place might involve political problems (more so in the US than Europe, at a guess).
There’s a somewhat incidental point that Ricks considers and doesn’t get quite right. It’s thus.
As he rightly says, one way to feed extra money into the economy (indeed a commonly used way under the EXISTING system) is to have the central bank buy government debt. But what if there is no government debt – a possibility considered by Irving Fisher and Milton Friedman who were both advocates of FR? Well there’s a very simple solution to that problem, a solution which has been widely discussed in the last year or two: helicopter drops!
Of course helicopter drops are not democratic in that they give an unelected body, the central bank, the right to take a POLITICAL decision, i.e. whether to spend freshly created money on handouts to taxpayers or handouts to the less well off, or whatever. In short, if we’re going to have anything resembling a helicopter drop, it should take the form advocated by above Vickers authors, namely (to repeat): the central bank or some committee of economists decides on the AMOUNT of new money to be created and spend net of tax, while politicians decide the exact nature of that spending.
Thus the Vickers authors’ solution works both where there is government debt and where there isn't.
Milton Friedman and Hyman Minsky.
Not only does Ricks go off the rails in connection with government debt, but Friedman and Minsky did as well! At least according to Ricks, both Friedman and Minsky thought that government debt was essential or at least desirable in order for FR to work, because (allegedly) extra money is fed into the economy by having the central bank buy that debt.
Well that’s an odd claim for Friedman to make, given that it was Friedman who was one of the first to advocate helicopter drops – a system which (to repeat) requires no government debt!
And a final reason for attaching little importance to government debt is that (as pointed out by advocates of Modern Monetary Theory and Martin Wolf (chief economics commentator at the Financial Times)) government debt and base money are almost the same thing. Thus swapping one for the other has almost no effect. Indeed, QE consists precisely of the latter “swap”, and as we’ve discovered, QE does not have a huge effect (something predicted before QE was implemented by a few clued up individuals, including yours truly).
Thus government debt will be ignored for the rest of this article.
Is a big change in central bank / treasury responsibilities needed?
Given that FR requires the above big change in the responsibilities of central banks, treasuries and politicians, it’s reasonable to ask whether in that case the change to FR is worth it.
Well the answer to that is that those changes have big merits even if we do not convert to FR, and the rest of this article explains why. I’ll run thru various problems with the existing system which need dealing with quite apart from FR.
1. Under the existing system, we have TWO entities that are able to implement stimulus: the central bank and treasuries. That makes as much sense as a car with two steering wheels controlled by a husband and wife having a row. In contrast, under FR (to repeat) just ONE entity decides the AMOUNT of stimulus, while the other, treasuries plus politicians, decides on the NATURE of any extra spending net of tax.
That system would hopefully put an end to the absurdity we have seen in recent years where Congress refuses to implement enough fiscal stimulus because a bunch of economic illiterates (politicians) are too busy squabbling amongst themselves on the question as to whether to raise or cut taxes and public spending.
The Nobel laureate economist Jan Tinbergen framed a principle on the subject of just one entity or system dealing with each problem. His principle was roughly to the effect that for each policy objective, one policy instrument is needed and one only.
2. To repeat, as Ricks rightly points out, to get more money into the economy under FR, there has to be fiscal stimulus first. That rather implies a downgrading of the main alternative form of stimulus, namely interest rate adjustments (though it wouldn’t rule out such adjustments, far as I can see).
Well that point is fully dealt with by the three Vickers authors. As they show, interest rate adjustments are a very defective tool. We can well live without them. Moreover, I suggest the optimum or GDP maximising rate of interest is the free market rate: i.e. what’s the state doing interfering with that rate?
3. Another popular objection to the change in responsibilities needed to facilitate FR is that the central bank (or the above mentioned independent committee) then has the power to over-rule stimulus decisions taken by democratically elected politicians, and that’s allegedly not democratic.
Well the simple answer to that is that an independent central bank ALREADY HAS that power: that is, an independent central bank can implement interest rate changes which negate fiscal stimulus (or lack of) which the central does not approve of. Indeed, Scott Sumner has made much of that point, for example in an article entitled “Why the fiscal multiplier is roughly zero”. He claims (if I’ve got him right) that fiscal stimulus is near useless because the central bank will simply overrule any fiscal stimulus it thinks inappropriate.
I think that’s taking the point too far, but certainly there’s no doubt that under the EXISTING SYSTEM, an independent central bank can negate fiscal stimulus.
P.S. (22nd July, 2016) There is more discussion of Rick’s ideas in this Seeking Alpha article authored by Martin Lowy.
Tuesday, 19 July 2016
Positive Money keeps claiming that the existing bank system (sometimes called “fractional reserve banking”) pushes up house prices. E.g. see this video.
The basic argument is that private banks create money out of thin air and lend it to whoever (mainly mortgagors) and that “freedom to print” pushes up house prices.
Well the first flaw in that argument is that our bank system has remained unchanged for about two hundred years – at least in the sense that private banks can print money. Thus that right to print does not explain the recent and very steep rise in UK house prices. (House prices in the UK have approximately DOUBLED IN REAL TERMS over the last twenty years).
Moreover, other countries around the world have the same bank system, yet in some of them (e.g. Germany and Switzerland), house prices have remained STABLE in real terms over the last twenty years. (See The Economist house price index for figures on house price increases in different countries).
And that rather makes it look like SOMETHING ELSE is behind house price increases in the UK. I suggest immigration plus a reluctance by local authorities to release enough land for house building are two important factors, but I won’t go into detail on that point.
House price volatility.
Note that house price VOLATILITY is not the same thing as long term house price increases. That is, there is no question but that private banks act in a pro-cyclical manner: i.e. they print and lend out money like there’s no tomorrow in a boom and thus exacerbate the boom. And come a recession, they do the opposite, namely call in loans, which exacerbates the recession.
Indeed, it strikes me that banks DO exacerbate house price volatility, but they DO NOT boost house prices in the long term.
Elasticity of supply and demand.
Another point which casts doubt on the whole idea that lending by private banks exacerbates house price increases is that the price of a commodity WILL NOT rise, give increased demand, if supply is elastic. In the case of housing, that means that if the price of timber, bricks, concrete etc and the wage demanded by bricklayers, plumbers etc does not rise in the long term given increased demand for housing, then the price of houses WILL NOT rise even if there is increased demand for housing.
The input involved in house construction which MIGHT RISE given increased demand for housing is LAND. A semi-plausible reason for saying that is the supply of land is limited, thus increased demand might raise the price of land. And indeed the price of land with permission for use for housing has rocketed in the UK in recent decades relative to the price of agricultural land.
But in fact even in the UK, one of the most heavily populated countries in the World, there’s no basic shortage of land. That is, the explanation for the steep rise in the price of land with permission to build on is (to repeat) reluctance by local authorities to grant that permission (partly down to the activities of so called “NIMBIES”, i.e. people nice houses in the country who understandably do not want large housing developments near where they live – “Not In My Back Yardies”)
As for bricks and concrete, the UK is not about to run out of clay for making bricks, not is it about to run out of gravel for making concrete, far as I know.
So the conclusion is that the supply of housing in the long term is pretty elastic, thus even if our bank system DOES INCREASE demand for housing, that shouldn’t raise house prices all that much.
Congratulations to Malcolm Sawyer (former professor of economics at Leeds in the UK) for his “discovery” that money is created when a bank grants a loan, and that money is destroyed when a loan is repaid.
That’s the gist of this recent paper of his. The “gist” is of course hidden underneath a pile of the sort of pseudo technical verbiage that academics usually deploy to hide the fact that they aren’t saying much.
The above point about money creation and destruction is second nature to the more clued up supporters of Positive Money and advocates of Modern Monetary Theory.
Friday, 15 July 2016
Job Guarantee (JG) is a popular idea: it’s been around for centuries. Basically it’s the idea that there are numerous jobs or tasks that need doing, thus government can put the unemployed to work doing those tasks. The Work Project Administration (WPA) in the US in the 1930s was just one example of JG. And certainly JG could be used to totally abolish unemployment if we’re prepared to see the unemployed doing very menial jobs.
To illustrate with an extreme example, we could just tell the unemployed their unemployment benefit is henceforth conditional on their walking up and down their street keeping it free of litter. Anyone refusing would be deemed not to be unemployed on the grounds that they had refused work. Hey presto: unemployment vanishes.
The idea actually goes back to Pericles in ancient Athens around 2,500 years ago: he put unemployed Athenians to work on public construction projects.
Unfortunately most of the advocates of JG are a bit naïve: they’re oblivious of the basic problems involved. And that helps explain why most JG type schemes end up as an expensive mess and get abandoned a year or two after being set up: those organising them have little idea what they are doing - which is not to say JG has no future at all.
Certainly most members of the general public who opine on this subject are clueless. Unfortunately most of the academics who write on the subject aren’t much better. There’s a collection of academics who advocate JG at the University of Missouri - Kansas City. No names mentioned!!! But if you Google UKMC and JG you’ll find loads of material.
Rate of pay for JG work.
Most advocates of JG gayly advocate generous rates of pay for JG without any apparent awareness of the fact that generous pay destroys the incentive for JG employees to seek normal jobs. That means labour supply to the existing labour market is reduced. That’s inflationary, so demand has to be cut (e.g. via increased interest rates), which raises unemployment! Hardly the object of the exercise!!!
Hire out JG people to existing employers?
Another basic question JG advocates fail to address in any detailed way is whether JG employees should be employed in specially set up. projects (a la WPA), or whether those employees should be hired out to existing employers. Well there’s a big problem with the former option, namely that skilled permanent labour has to be hired to actually run such projects – unless those employed on those projects are to consist just of the recently unemployed (who tend to be relatively unskilled). That’s just a recipe for grossly inefficient forms of employment.
The above naïve advocates of JG might answer the latter point by claiming that some WPA work was relatively efficient (which it was). The answer to that is that the WPA was implemented at a time of catastrophically high unemployment: a scenario where there is a decent availability of skilled labour from the ranks of the unemployed. But the solution to very high unemployment is a straight rise in demand, not JG. I.e. JG comes into its own precisely where there is a shortage of skilled labour amongst the unemployed.
But if skilled labour is taken from the existing workforce, then relatively productive jobs are destroyed, and replaced with the relatively unproductive jobs that inevitably make up JG schemes. Thus “specially set up” projects as per the WPA are a nonsense.
In contrast, if JG people are subsidised into jobs with existing employers, a better mix of skilled and unskilled labour is obtained. But the majority of the advocates of JG haven’t the faintest inkling of the latter problem.
Public or private sector jobs?
Another basic question normally ignored by JG advocates is whether JG schemes should consist just of public sector type jobs (as per the WPA and as per Pericles’s JG scheme), or whether JG people should be hired out to private sector employers as well.
Well suppose there were two schools that were identical in every respect, except that one was private and one public. If JG was confined to the latter, the reason for doing so absolutely has to be POLITICAL rather than economic. I.e. there is no economic reason for not allowing private employers to take on JG employees. And in fact the UK’s JG scheme (or at least the nearest thing to JG currently operating in the UK) hires out the unemployed to private sector employers). That’s the so called “Work Programme” – which incidentally seems to be horribly expensive to administer (perhaps because too many go-gooders have had a hand in its design).
Another problem with JG is this: to what extent do JG people simply displace normal employees? Well there’s guaranteed to be SOME displacement: i.e. employers are bound to some extent to use temporary, JG, i.e. not desperately skilled employees as substitutes for normal or fully viable employees. However, if employers know they can only have any given JG employee for a limited period, the displacement shouldn’t be too bad: employers will tend not to classify genuinely productive employees as temporary JG people because employers like to hang on to productive employees. In contrast, they don’t mind relatively UNPRODUCTIVE employees disappearing to another employer or to unemployment.
My cynical conclusion is that JG might be worthwhile if the existing and very naïve advocates of the idea have nothing to do with it!
Tuesday, 12 July 2016
Seigniorage is defined in the Oxford Dictionary of Economics (2009) as “The profits made by a ruler from issuing money”. I suggest the word “ruler” is superfluous there. I.e. seigniorage is the profit made by ANYONE who issues or prints money, including for example, a backstreet counterfeiter. At any rate, I’ll use the word in the latter sense.
As to how backstreet or traditional counterfeiters make a profit, that’s obvious enough: they print $100 bills for example and buy consumer goodies with those bills. I.e. they get $100 worth of real goods in exchange for a piece paper. Nice work if you can get it.
But private banks also issue a form of money. As the opening sentence of a Bank of England article entitled “Money creation in the modern economy” puts it, “This article explains how the majority of money in the modern economy is created by commercial banks making loans.”
However, private banks clearly do not do the same thing as traditional counterfeiters: use the money they create to buy consumer goodies. Instead, they lend out that money at interest.
So is there any sort of seigniorage profit there? Well the answer is: yes. The way that profit comes about was explained in a rather stylized way by Messers Huber and Robertson in their work “Creating New Money”.
As they put it, “Allowing banks to create new money out of nothing enables them to cream off a special profit. They lend the money to their customers at the full rate of interest, without having to pay any interest on it themselves. So their profit on this part of their business is not, say, 9% credit-interest less 4% debit-interest = 5% normal profit; it is 9% credit-interest less 0%debit-interest = 9% profit = 5% normal profit plus 4% additional special profit. This additional special profit is hidden from bank customers and the public, partly because most people do not know how the system works, and partly because bank balance sheets do not show that some of their loan funding comes from money the banks have created for the purpose and some from already existing money which they have had to borrow at interest.”
That explanation by Huber and Robertson is unrealistic, and doubtless deliberately so. Banks do not of course lend to the majority of borrowers at the normal rate, and lend to another lot at 4% less than the normal rate. Rather, the ability of private banks to create a certain amount of new money almost every year enables them to lend at a lower rate than if they had to obtain money the way most of us do: doing some sort of work and saving up.
And no doubt competition between banks means that lower rate is enjoyed to some extent by borrowers rather than all of it going straight to banks’ bottom line.
But the fact remains, that private banks’ freedom to print money benefits those banks, and those they lend to.
So who loses out?
There are no free lunches in this world. I.e. the latter extra profit for banks and borrowers must come from somewhere. And where it comes from is not too difficult to work out.
Assume, just to keep things simple, that the economy is at capacity (i.e. full employment) prior to private banks being granted the right to create money. Assume that banks are then granted the latter right. The extra lending will boost demand. But that’s not permissible without inflation rising too much, given the above assumption that the economy is already at capacity.
So to counteract the inflationary effect of that new borrowing, government would have to implement some sort of DEFLATIONARY measure, like raising taxes or cutting public spending. In that case, those paying for the above increased bank profits and reduced interest for borrowers would be taxpayers or the recipients of public spending.
An alternative would be for the central bank to raise interest rates. But to do that, taxes would have to be raised there as well - to pay for the interest going to those with cash to spare who decided to buy the new state issued high interest bonds. So again, taxpayers pay a price.
Private banks do actually make seigniorage profits but no quite in the same way as traditional counterfeiters. In the case of private banks, the profit is earned in much more circuitous way.
I’ll leave the last word to the French economics Nobel laureate, Maurice Allais:
“In reality, the ‘miracles’ performed by credit are fundamentally comparable to the ‘miracles’ an association of counterfeiters could perform for its benefit by lending its forged banknotes in return for interest. In both cases, the stimulus to the economy would be the same, and the only difference is who benefits."