Ann Pettifor has just published a book “The Production of Money”.
To help launch the book she did a talk at the LSE recently which contained a fair amount of nonsense, and which I reviewed recently here and here. Now for the book.
I’ll concentrate on chapter 6, which deals with bank and monetary reform, since that is what interests me. However, there are a couple of passages from earlier in the book which are a laugh and are as follows.
Under the heading “The good news: savings are not needed for investments” (Ch 2) the first sentence reads “The miracle of a developed monetary economy is this: savings are not necessary to fund purchases or investment.”
Well that’s good news. So if the country wants £10bn of new infrastructure or housing there is no need for anyone to cut back on cars, booze, holidays etc? As Pettifor rightly says this is indeed a “miracle” (ho ho).
And under the heading “The value of a sound banking system” she says that thanks to private banks, “…there need never be insufficient money to tackle, for example, energy insecurity and climate change. There need never be a shortage of money to solve the great scourges of humanity: poverty, disease and inequality..”.
What – so private banks are great philanthropic organisations devoted to cutting inequality and curing disease. Well silly me: I thought it was mainly the social security system (nothing to do with private banks) that dealt with inequality. And my silliness goes even further: I always thought that in the UK it was primarily the National Health Service that dealt with “disease”. But clearly I’m wrong: apparently it’s those criminal bankers on Wall Street and the City of London who we have to thank. This is just hilarious.
On p.95 she says, “Monetary reform campaigners advocate adoption of a particular variety of ‘neoclassical economics’ that proved backward looking in the 1930s and disastrous in the 1970s and 1980s.”
Well it’s hard to define “neoclassical economics” in one sentence. Look up various explanations of the term in the internet if you’re interested. But roughly speaking it consists of a belief in free markets. But monetary reformers advocate a much bigger role for money creation by the state (as indeed Pettifor herself explains) and a suppression of what private banks, left to their own devices, would do in a totally free market. So Pettifor is out by a hundred and eighty degrees there!
Moreover Takahashi Korekiyo, Japan’s finance minister in the early 1930s used sovereign money type stimulus very successfully to help get Japan out of the 1930s recession. What’s “backward looking” about that?
The campaign’s aims.
Under the above heading, Pettifor then explains (correctly) that one of the basic objective of what she calls “monetary reformers” is to ban private money creation and instead have just the state issue money. There are (unfortunately) several names for state or central bank issued money. Economists normally refer to “base money”. I’ll use the phrase “sovereign money” since Pettifor uses that phrase (as does Positive Money).
One of the first objections she makes to banning privately created money is to argue that the creation of and distribution of, and/or spending of sovereign money has no effect on demand!
So if the UK government printed and dished out £10,000 worth of £10 notes to every household in the country there’d be no effect? You really have to be barking mad to believe that. Indeed there is plenty of empirical evidence supporting the idea that given a windfall in the form of dollops of sovereign money (e.g. in the form of tax cuts) or in any other form, people spend a significant proportion of that money fairly quickly (see endnote for two bits of evidence).
But that’s not to say that controlling the quantity of money should be the ONLY WAY of controlling demand, or that it’s a very precise method of doing so. However monetary reformers do not (contrary to the claims of Pettifor) say that controlling the quantity of money SHOULD BE the only way of controlling demand.
As Adair Turner (a supporter of monetary reform) explained in a very good talk in Dublin a year ago, which I reviewed here, the INITIAL effect of the state creating new money and spending it (and/or cutting taxes) is a FISCAL EFFECT. E.g. if new money is spent on schools, the immediate effect is that more teachers are employed, and more is spent on school books and so on.
Thus if there were NO MONETARY EFFECT AT ALL, monetary reformers’ preferred method of controlling demand would still work!
What did Keynes mean?
Having criticised Pettifor’s claim that printing and spending extra sovereign money has no effect, it should be said that she quotes a passage from Keynes which seems to support her case. I’ll actually deal with that quote at the end below because she repeats the quote at the end of her Chapter 6.
Loans create deposits.
Next, Pettifor accuses Henry Simons and Irving Fisher (two economists who were active mainly in the 1920s and 30s) of being unaware of the fact that loans create deposits. As she puts it (p.100), “Second, Simons and Fisher assumed that banks singlehandedly created their own funds. In this view, there is no room for borrowers…”.
Well if Simons and Fisher were that pig ignorant on the basics of money and banks I doubt they’d ever have achieved the fame they did. In fact after five minutes of rummaging around on the internet I found two quotes from Fisher which clearly indicate he was well aware that loans create deposits. In his book “100% Money and the Public Debt” he says “The essence of the 100% plan is to make money independent of loans; that is, to divorce the process of creating and destroying money from the business of banking.”
Well that pretty obviously implies that in Fisher’s view, under the existing system, money IS DEPENDENT on loans, doesn’t it? And again, Fisher says, “Thus our national circulating medium is now at the mercy of loan transactions of banks.”
No doubt I could spend another five or ten minutes digging up further quotes.
Next, under the heading “Usurious rates” Pettifor accuses monetary reformers of being indifferent to interest rates and not being concerned about the high rates paid by some borrowers.
Well there’s a very good reason for leaving interest rates (i.e. the price of borrowed money) to market forces. It’s the same as the reason why leaving the price of steel, brass bolts and ten million other products to market forces is not a bad idea (unless it can be specifically shown that the market gets something badly wrong). The reason is that, as explained in the economics text books, there are good reasons for thinking GDP is maximised where prices are set by the market.
Pettifor then points to current low central bank base rates and claims that other rates are “very high”. High compared to what? She doesn’t explain.
Mortgages account for a substantial proportion of all loans, and the rate for 15 year mortgages in the UK is now around 3% as compared to about 8% in the early 1990s. (See the chart half way down here.) On that basis, the rate of interest on mortgages is currently “low” rather than “high”.
Moreover, if Pettifor has some magic way of slashing the rate paid by those with mortgages and by other borrowers (apart from letting private banks print and lend out counterfeit money, which is effectively what they do) then I’m sure we’re all ears. Unfortunately she is silent on that point, apart from making the decidedly uninspiring claim that “the system” should be “reformed and managed to keep interest rates across the spectrum of lending low” (p.105).
The reality, of course, is that running a bank does involve costs, like bad debts, staff salaries, purchasing computers and other equipment. Thus if banks are to be commercially viable, they have to charge more to borrowers then they themselves pay to depositors, shareholders, etc. Of course some banks make big profits. But then some make losses: e.g. Northern Rock. And last time I looked, J.P.Morgan’s return on capital, was pathetic.
Next, the first sentence under the heading “Private deficits cannot finance economic activity” reads, “The system of fractional reserve banking so enamoured of monetary reformers, implies that bankers would only be allowed to lend the savings or deposits lodged in their vaults by savers or depositors.”
Fractional reserve enamoured of monetary reformers? What on Earth is Pettifor on about? The existing or “fractional reserve” bank system is exactly what monetary reformers oppose!!!!!!!
Later, under the same heading, she says, “However, the principle of full-reserve banking would prevail on the whole with very little certainty as to whether members of the Money Creation Committee (MCC) would be willing to “create new money” for the banking system.
Well quite right: why should the MCC have any special regard for those poor downtrodden criminal organisations commonly known as “banks”? Indeed, why should it have any special regard for any particular industry?
The job of the MCC under full reserve banking is to make sure the ECONOMY AS A WHOLE has enough money to give us full employment. Whether there is an expansion or contraction in bank activity (lending and borrowing) over a particular year or decade is unimportant.
Moreover, UK bank assets and liabilities have expanded TEN FOLD relative to GDP since the 1970s. How much of that extra activity is of any real use? Adair Turner made a good point when he said that a significant proportion of bank activity is “socially useless”.
Pettifor then says, “The Independent Commission on Banking (ICB) argued that this (i.e. full reserve banking) would undoubtedly increase rates of interest on loans, but would also curtail the lending capacity of the UK banking system. It would result in unprecedented contraction of economic activity – employment, investment and spending – to levels of existing, and invariably scarce, savings….”.
Well it’s blindingly obvious that ALL ELSE EQUAL full reserve would “contract economic activity”. Full reserve restricts what banks can do, relative to what they are allowed to do under the existing system (sometimes called “fractional reserve”). All else equal, a contraction of the illegal drugs industry or the prostitution industry would contract economic activity. Is that an argument against tighter regulation of the drug trade or prostitution?
However other things are not equal (gasps of amazement). That is, the tightening up on bank activities that takes place under full reserve is compensated for by creating and printing whatever amount of sovereign money is needed to keep the economy at capacity. In short, there is less lending and borrowing based activity (i.e. debts decline) while there is a rise in non-borrowing based activity.
The crucial question.
Thus the CRUCIAL QUESTION, which seems to be beyond the grasp of Pettifor and the ICB, is this: what’s the optimum or GDP maximising mix of borrowing based and non-borrowing based activity? Or put another way, what rate of interest gives us that optimum?
Well as Pettifor rightly says, under full reserve, interest rates are left to market forces. And as already pointed out, unless there is what economists call “market failure” (i.e. unless it can be shown that supply and demand are not working properly) then the normal assumption in economics is that GDP is maximised where market forces prevail.
Thus the conclusion is that far from GDP contracting under full reserve, as suggested by Pettifor (and the ICB), it would actually expand.
First time buyers.
One obvious and naïve criticism of the argument just above is that is that higher interest rates would hit less well off first time house buyers and other low income house buyers. Well the answer to that is “Pareto”. For the benefit of non-economists (and Ann Pettifor) I’ll explain.
Pareto was an Italian philosopher and economist who made the following point. To simplify at bit, he said the important objective in economics is to maximise GDP (within environmental constraints of course). But if any specific groups are adversely affected by the attempt to maximise GDP, they can always be compensated by taxing those who GAIN from the process, and giving the proceeds to the former group. As a result, everyone is better off.
In fact we actually already have a host of measures for helping those who are less well off housing wise. Thus any interest rate rises stemming from full reserve would probably not even require the implementation of any new measures: i.e. it would simply be a case of enhancing existing measures.
Should or can money be debt free?
Under the above heading, Pettifor rightly points out that Positive Money makes much of the difference between private bank created money, which can correctly be described as “debt encumbered” and central bank created money can be described as “debt free”. Other advocates of full reserve tend not to make so much of that “debt” distinction.
The question as to whether sovereign money really is debt free has been extensively debated in the literature. What is clear is that while sovereign money can be said to be a debt owed by the state to individuals holding that money, at the same time the state has the right to confiscate any amount of that money that it chooses from holders of that money via taxation. So it’s a strange sort of debt, isn't it?
It’s like me getting a mortgage from my bank, but at the same time having the right to raid the bank and grab wads of £10 notes with a view to paying off the mortgage! In that scenario, the so called debt I owe to the bank is clearly not a debt in the normal sense of the word debt.
And not only that, but the only thing the state undertakes to give its creditors when it’s time to “pay its debts” is sovereign money, which the state can print in any quantity it likes whenever it likes. Again, that’s a bit like me being able to pay off my mortgage with £10 notes printed on my desktop printer.
To summarise, there is certainly a difference in the extent to which privately created money and sovereign money really are debts. To that extent, Positive Money is right. But on the other the other hand THE EXACT EXTENT to which sovereign money is debt free is very debatable and semantic.
But Pettifor’s take on all this is plain bizarre. She says, “There is no such thing as debt-free money, or if there is, it is very likely something quite different – a grant or a gift. Now there is no real reason why society should not aspire to building a gift-based economy.”
Well what’s all this about a “gift based economy”? None of the advocates or sympathisers with full reserve (Milton Friedman, Lawrence Kotlikoff, Merton Miller, etc) are aware that any sort of “gift based economy” is involved as a result of full reserve. Far as they’re concerned, industry and commerce carry on much as before: on a COMMERCIAL basis, not on any sort of altruistic or “gift” basis.
If Pettifor wants to get her bizarre “gift” idea across, she needs to do vastly more explaining that appears in her book far as I can see, though admittedly I haven’t read every page. However, when the Kindle version comes out I’ll do a quick spot of word searching for “gift” to see if she does indeed provide a decent explanation, and if she does, I’ll humbly withdraw the above criticism.
The ‘People’s QE’ proposals weaken democratic authority.
Under the above heading, Pettifor then claims that having a committee of economists (e.g. at the central bank) determine how much money is created “weakens democratic authority”: that is, if such a committee not only decides how much money to create, BUT ALSO decides HOW it is spent (a job for democratically elected politicians) then clearly she has a point. “Democratic authority” is indeed “weakened”.
But that is not a mistake Positive Money makes! Though there may well be others who make that mistake.
If Ann Pettifor had actually read and understood PM’s proposals she’d discover that there is a 100% clear distinction between the decision as to how much money to create (done by a committee of economists) and in contrast, strictly political decisions, like what proportion of GDP is allocated to public spending, and how that is split between health, education and so on: those decisions being taken by democratically elected politicians.
Indeed, it is not just Positive Money who make that distinction. The joint submission to the ICB made by PM, the New Economics Foundation and Prof Richard Werner makes the latter distinction as well. (The title of that work is “Towards a twenty-first century century banking and monetary system”)
I know for a fact that the latter point has been explained to Pettifor in comments after her various articles. Presumably she is too arrogant or stupid to absorb said explanations.
Donald Trump and helicopter money…
Under the above heading, Pettifor claims a weakness of full reserve is that it involves inflation targeting. Complete nonsense!
If the money creation committee, or indeed the economics profession as a whole decide to target the unemployment rate or thought that astrology should be used to determine the amount of money created or stimulus in general, there’d be nothing to stop the money creation committee going for astrology (or tea leaf reading or crystal ball gazing or anything else you care to mention).
Moreover, it’s a bit strange to say that inflation targeting is a weakness in full reserve when inflation targeting is used under the existing system! I.e. if inflation targeting is a weakness in full reserve, then by the same token, it is a weakness in the existing system!
The Keynes quote.
As mentioned above, Pettifor does quote a passage from Keynes which seems to support her idea that the creation and spending of sovereign money is useless.
The passage is actually from a letter from Keynes to Roosevelt in 1933, and it is as follows.
“The other set of fallacies, of which I fear the influence , arises out of a crude economic doctrine commonly known as the Quantity Theory of Money. Rising output and rising incomes will suffer a set-back sooner or later if the quantity of money is rigidly fixed. Some people seem to infer from this that output and income can be raised by increasing the quantity of money. But this is like trying to get fat by buying a large belt. In the US today your belt is plenty big enough for your belly. It is a most misleading thing to stress the quantity of money, which is only a limiting factor, rather than the volume of expenditure, which is the operative factor”.
Now there is a big problem for Pettifor with that quote, namely that earlier in the letter (para 5), Keynes advocates amongt other things, public money creation! He actually says “public authority must be called in aid to create additional current incomes through the expenditure of borrowed or printed money.”
So is Keynes contradicting himself? Well it’s not entirely clear: he could certainly have worded his letter much better. The best explanation I can think of is that there is certainly one type of money, the expansion of which will not have any effect, and that’s commercial bank created money – very different stuff to CENTRAL bank created money. (The latter is a net asset as viewed by the private sector. The former is not.)
That is, commercial bank created money (i.e. the type of money which results from a commercial bank extending a loan) RESULTS FROM a desire to do business: it is not the CAUSE OF extra business or extra sales.
To illustrate, if someone gets a loan for £X to buy new car, the bank credits £X to the account of the borrower, and hey presto, £X of new money comes into existence. But it’s not the simple fact of creating that money that boosts car sales, or more generally, economic activity as a whole: it’s the fact of SPENDING the money that does the trick (as Keynes rightly says).
To summarise, it is clearly nonsense to claim that increasing the private sector’s stock of sovereign money (e.g. £10 notes) has no effect. Give anyone a wheelbarrow full of £10 notes, and they’re liable to spend some of it. In contrast, if a commercial bank were to grant millions of pounds worth of loans to a selection of people who had no desire for a bank loan, there’d be no effect on the real economy. The latter “borrowers” would simply contact their bank and tell it to stop being silly.
I assume that’s the explanation for Keynes’s apparent self-contradiction.
It would seem from Chapter 6 of Pettifor’s book that she has an exceptionally poor grasp of money and banking. Her book will do far more harm than good. However, she is a good public speaker, and that fools 90% of the plebs and the sheeple, as an successful politician will confirm.
Two of the studies which confirm that when households receive windfalls, they spend a significant proportion fairly quickly:
1. “Did the 2008 Tax Rebates Stimulate Spending?”. NBER.
2. “Allocation of Windfall Income: A Case Study of a Retroactive Pay Increase to University Employees.” Margaret Rucker. Journal of Consumer Affairs.