The Slough of Despond
I'm bored.
Bored with this crisis. Bored with endless calls for bank reforms. Bored with never-ending stories of inadequate bank resolution and legal battles which benefit no-one but lawyers. Bored with ineffectual monetary policy and fiscal gridlock. Bored with seeing the same things proposed over and over again, even things we know don't work and will never happen.
Today, Mike Konczal wrote a piece on why restoring Glass-Steagall wouldn't solve anything. He's right, of course. But it is now seven years since the crisis, and we have known for most of that time that restoring Glass-Steagall wasn't going to happen and wouldn't solve anything anyway.Why are we still discussing it now? Why can't we just accept that Glass-Steagall is dead, and move on?
Today, I had to explain YET again that although banks create money when they lend, that does not mean lending doesn't need funding. Payments are deposit outflows. That applies whether the deposits concerned are created by the bank through lending or placed in the bank by customers. So no, banks can't "just lend" without any form of funding. Banks have to fund deposit outflows. If they don't, they can't allow money to be removed from deposit accounts. Look what happened in Greece when the ECB limited the funds available to Greek banks.
Today, I read yet another piece proposing that the UK should have a system of small savings banks "just like Germany's". Because, you know, banks aren't lending to SMEs. Laudable, but creating a UK Sparkassen network isn't by itself going to solve the problem. There are very significant differences between Germany and the UK. In the UK, most lending goes towards house purchase. In Germany, much less of it does, because fewer people own their own homes. Because of this, German households hold far more of their savings in the form of bank deposits than UK households do. UK households' savings are mostly in the form of property and pensions. So where are the deposits going to come from to fund a new network of Sparkassen focused on SME lending? And what would the consequences be for the funding of existing banks and building societies? It's blindingly obvious that 250 new deposit-funded banks are simply going to take deposits from mortgage lenders, forcing them to make greater use of bond issuance and wholesale funding. Like that worked so well for Northern Rock. Why don't researchers think things through?
Today, I was sent a copy of a proposal to the Dutch parliament to "replace bank-created money with Government-created". That old chestnut, again. Yet another version of the Chicago plan. I've lost count now of the number of full reserve banking proposals I've seen. I've yet to see one that actually succeeded in eliminating bank money. And I've also yet to meet an advocate of full reserve banking who understood that it is to all intents and purposes a strict gold standard, with alchemists replacing miners. I keep saying it is a really bad idea because central banks get their forecasts wrong ALL the time and anyway economies work better if demand for money leads supply. But the idea keeps coming back to haunt me. I worry that some lunatic government will actually try out one of these idiot schemes one of these days.
Today, I heard that Barclays is to appoint an investment banker as CEO. Thank goodness. The vilification of investment banking and reification of retail banking in recent years has been poisonous. It has caused the near-destruction of an industry that is vital for business investment. No wonder business investment has been so poor.
In September, the Bank of England's Andy Haldane discussed negative rates and the end of cash as if these ideas are new. As if they have never been discussed before. But we've been discussing negative rates and their effects for years, and we've been discussing eliminating physical cash, or at least finding ways of discouraging people from hoarding it, for even longer. Has no-one heard of Silvio Gesell?
We now have empirical evidence that banks may raise interest rates to borrowers when they are charged for depositing money at the central bank. The G30 report released last week observed that Credit Suisse raised mortgage rates in January 2015 because of the ECB's slightly negative interest rate on reserves. If interest rates were significantly more negative, what do you suppose banks would do? Yet we are still talking about negative interest rates as if they are expansionary monetary policy. They aren't. They are direct taxation of bank deposits, which is financial repression. And financial repression is contractionary, especially in the absence of a trade surplus. We KNOW this. It is not rocket science. Why are we still considering negative rates?
We seem to be completely stuck. Unable to escape from the Slough of Despond, we flail around in circles.
But why are we stuck? Why have we been unable to find our way out of the mire? John Bunyan has the answer:
Central banks are terrified of raising interest rates, because it might cause bankruptcies on Main Street and crashes on Wall Street. They look at below-target inflation, flat wage growth and awful productivity, and think "there is no reason whatsoever for raising interest rates". I never thought I would find myself writing this, but - yes, there is. Purchasing power in today's fiat money economies is created by bank lending, and very low interest rates are deadly for banks. They can't make money when yield curves are flat and the slightly-below-zero bound is binding. The longer very low interest rates remain, the more difficult it is for banks to survive. They could improve their profitability by doing riskier things, but we don't like that either: prudential regulation is making it ever more expensive to take risk. Then we wonder why M4 lending growth is persistently negative (see table A2.2.3). Meh.
But even worse is the fiscal terror that prevents governments acting to restore their economies, or even forces them to do lasting damage in the name of "setting fiscal finances on a sustainable path". We know that trying to eliminate a fiscal deficit when the private sector is highly indebted and the external sector is in deficit depresses growth. We know that fiscal surpluses are contractionary. We know that spending cuts hurt the poorest most, and tax cuts all too often benefit the well-off most. We know that high unemployment among the young scars them for life. We know that high adult unemployment is associated with increased suicide risk, particularly among men.
We know that programmes of public works restore depressed economies, fast and effectively. Dammit, even Hitler knew this. Why don't we do them? Because we are scared.
We won't let our governments borrow for long-term public investment because "OMG Greece!", even though interest rates are on the floor and investors are crying out for safe long-duration assets. We won't let our governments print money for long-term public investment either, because "OMG Weimar!", even though public investment would raise production whereas Weimar's problem was that production had been trashed. We talk about the "burden of debt service for the next generation", while refusing to invest in the tangible and intangible assets that would help ensure the next generation actually has a future.
I fear for my children. But not because of public debt. No, I fear for them because of unemployment, underemployment, low wages, debt, poverty. And war. OMG, war. Can't we see that the path we are on now has in the past always led to war?
There is no justification for this. The obstacles are entirely political. We need Help.
So, here are my Helpful suggestions:
UPDATE: I have reluctantly decided to close comments on this post. As Niels said, "which bit of ' bored with seeing the same proposals over and over again' gave you the impression that it was time to offer the same proposals again?" It's been an interesting discussion, but it's time to move on. I want to enjoy life. I hope you do too.
Bored with this crisis. Bored with endless calls for bank reforms. Bored with never-ending stories of inadequate bank resolution and legal battles which benefit no-one but lawyers. Bored with ineffectual monetary policy and fiscal gridlock. Bored with seeing the same things proposed over and over again, even things we know don't work and will never happen.
Today, Mike Konczal wrote a piece on why restoring Glass-Steagall wouldn't solve anything. He's right, of course. But it is now seven years since the crisis, and we have known for most of that time that restoring Glass-Steagall wasn't going to happen and wouldn't solve anything anyway.Why are we still discussing it now? Why can't we just accept that Glass-Steagall is dead, and move on?
Today, I had to explain YET again that although banks create money when they lend, that does not mean lending doesn't need funding. Payments are deposit outflows. That applies whether the deposits concerned are created by the bank through lending or placed in the bank by customers. So no, banks can't "just lend" without any form of funding. Banks have to fund deposit outflows. If they don't, they can't allow money to be removed from deposit accounts. Look what happened in Greece when the ECB limited the funds available to Greek banks.
Today, I read yet another piece proposing that the UK should have a system of small savings banks "just like Germany's". Because, you know, banks aren't lending to SMEs. Laudable, but creating a UK Sparkassen network isn't by itself going to solve the problem. There are very significant differences between Germany and the UK. In the UK, most lending goes towards house purchase. In Germany, much less of it does, because fewer people own their own homes. Because of this, German households hold far more of their savings in the form of bank deposits than UK households do. UK households' savings are mostly in the form of property and pensions. So where are the deposits going to come from to fund a new network of Sparkassen focused on SME lending? And what would the consequences be for the funding of existing banks and building societies? It's blindingly obvious that 250 new deposit-funded banks are simply going to take deposits from mortgage lenders, forcing them to make greater use of bond issuance and wholesale funding. Like that worked so well for Northern Rock. Why don't researchers think things through?
Today, I was sent a copy of a proposal to the Dutch parliament to "replace bank-created money with Government-created". That old chestnut, again. Yet another version of the Chicago plan. I've lost count now of the number of full reserve banking proposals I've seen. I've yet to see one that actually succeeded in eliminating bank money. And I've also yet to meet an advocate of full reserve banking who understood that it is to all intents and purposes a strict gold standard, with alchemists replacing miners. I keep saying it is a really bad idea because central banks get their forecasts wrong ALL the time and anyway economies work better if demand for money leads supply. But the idea keeps coming back to haunt me. I worry that some lunatic government will actually try out one of these idiot schemes one of these days.
Today, I heard that Barclays is to appoint an investment banker as CEO. Thank goodness. The vilification of investment banking and reification of retail banking in recent years has been poisonous. It has caused the near-destruction of an industry that is vital for business investment. No wonder business investment has been so poor.
In September, the Bank of England's Andy Haldane discussed negative rates and the end of cash as if these ideas are new. As if they have never been discussed before. But we've been discussing negative rates and their effects for years, and we've been discussing eliminating physical cash, or at least finding ways of discouraging people from hoarding it, for even longer. Has no-one heard of Silvio Gesell?
We now have empirical evidence that banks may raise interest rates to borrowers when they are charged for depositing money at the central bank. The G30 report released last week observed that Credit Suisse raised mortgage rates in January 2015 because of the ECB's slightly negative interest rate on reserves. If interest rates were significantly more negative, what do you suppose banks would do? Yet we are still talking about negative interest rates as if they are expansionary monetary policy. They aren't. They are direct taxation of bank deposits, which is financial repression. And financial repression is contractionary, especially in the absence of a trade surplus. We KNOW this. It is not rocket science. Why are we still considering negative rates?
We seem to be completely stuck. Unable to escape from the Slough of Despond, we flail around in circles.
But why are we stuck? Why have we been unable to find our way out of the mire? John Bunyan has the answer:
Wherefore CHRISTIAN was left to tumble in the Slough of Despond alone; but still he endeavoured to struggle to that side of the slough that was farthest from his own house, and next to the wicket gate: which he did, but could not get out, because of the burden that was upon his back. But I beheld, in my dream, that a man came to him whose name was HELP, and asked him what he did there?
Chr. "Sir," said CHRISTIAN, "I was bidden to go this way by a man called EVANGELIST, who directed me also to yonder gate, that I might escape the wrath to come; and as I was going thither, I fell in here."
Help. But why did you not look for the steps?
Chr. Fear followed me so hard, that I fled the next way and fell in.Fear. Yes. All-pervasive, paralysing fear holds us in a depression from which we cannot escape.
Central banks are terrified of raising interest rates, because it might cause bankruptcies on Main Street and crashes on Wall Street. They look at below-target inflation, flat wage growth and awful productivity, and think "there is no reason whatsoever for raising interest rates". I never thought I would find myself writing this, but - yes, there is. Purchasing power in today's fiat money economies is created by bank lending, and very low interest rates are deadly for banks. They can't make money when yield curves are flat and the slightly-below-zero bound is binding. The longer very low interest rates remain, the more difficult it is for banks to survive. They could improve their profitability by doing riskier things, but we don't like that either: prudential regulation is making it ever more expensive to take risk. Then we wonder why M4 lending growth is persistently negative (see table A2.2.3). Meh.
But even worse is the fiscal terror that prevents governments acting to restore their economies, or even forces them to do lasting damage in the name of "setting fiscal finances on a sustainable path". We know that trying to eliminate a fiscal deficit when the private sector is highly indebted and the external sector is in deficit depresses growth. We know that fiscal surpluses are contractionary. We know that spending cuts hurt the poorest most, and tax cuts all too often benefit the well-off most. We know that high unemployment among the young scars them for life. We know that high adult unemployment is associated with increased suicide risk, particularly among men.
We know that programmes of public works restore depressed economies, fast and effectively. Dammit, even Hitler knew this. Why don't we do them? Because we are scared.
We won't let our governments borrow for long-term public investment because "OMG Greece!", even though interest rates are on the floor and investors are crying out for safe long-duration assets. We won't let our governments print money for long-term public investment either, because "OMG Weimar!", even though public investment would raise production whereas Weimar's problem was that production had been trashed. We talk about the "burden of debt service for the next generation", while refusing to invest in the tangible and intangible assets that would help ensure the next generation actually has a future.
I fear for my children. But not because of public debt. No, I fear for them because of unemployment, underemployment, low wages, debt, poverty. And war. OMG, war. Can't we see that the path we are on now has in the past always led to war?
There is no justification for this. The obstacles are entirely political. We need Help.
So, here are my Helpful suggestions:
- Stop proposing new bank reforms. We've heard it all before. Get capital buffers up to 20%, then leave banks alone. Particularly, stop attacking investment banks. They have a job to do.
- Stop trying to restrict what central banks can do. Liquidity is lifeblood to the financial system. Trying to restrict it causes gangrene. Let central banks provide it freely.
- Stop expecting central banks to restore growth. They can't.
- Stop worrying about public debt. Borrow to invest for the future. Then central banks will be able to raise interest rates, since increased borrowing would tend to push them upwards anyway.
- Stop trying to balance budgets. They will balance themselves in due course.
- Stop worrying about inflation. There isn't any. If it appears, cheer.
UPDATE: I have reluctantly decided to close comments on this post. As Niels said, "which bit of ' bored with seeing the same proposals over and over again' gave you the impression that it was time to offer the same proposals again?" It's been an interesting discussion, but it's time to move on. I want to enjoy life. I hope you do too.
Related reading:
Pilgrim's Progress - John Bunyan
"And on a personal level - stop worrying and enjoy life. Even if you are flat broke and out of a job. Like me."
ReplyDeleteNothing wrong with that. If that works, all my blessings.
One alternative, though, is to stop worrying, and get constructively angry...
Great post. Agree with your frustration: everybody has been and is still only looking at Central Banks and their interest rates to save the economy, not seeing the core problem: not enough investment and spending.
ReplyDeleteOne question though: you say low interest rates are deadly for banks, but in the article you link to that mechanism is not explained. For a bank to make a profit it wouldn't make a difference if they lend out for 4% and borrow/fund with 1% (spread 2%) or on the other hand if they lend out for 6% and borrow/fund with 4%: the difference is the same?
I can see the point about the spread being the same, but.
DeleteIf Savers were to get 3.5% instead of 1.5% that they are getting now they might just start spending this interest. They are too frightened to spend too much capitol.
So interest rates to borrowers start to rise back to historical norms.
If it was signalled well in advance that interest that this was going to happen over the next two years, people could plan, plus it might give confidence that the system is returning to normal?? Then we might start to believe what the politicians/economists are saying.
We need to be better at defining exactly what the problem is...
ReplyDeleteMight I suggest high quality puerh tea? An excellent time-consuming habit of refinement that entertains and smartens up the unemployed. Or so I think.
ReplyDeleteThe issue is pretty simple. Game of Monopoly has been won. The winners don't want to restart a new game, both because that's costly for them and because they might not become winners again. For as long as they can spin the consequences of not restarting the game, they'll lead everyone on a glorious hunting of the snark (of course, they'll sneak off as soon as polite).
At the end of the day, war is the corrective. Humanity depends on war for resets every bit as much as lodgepole pines depend on fire to create the next generation.
You have to be joking, Frances.
ReplyDeleteYou might be bored with it, but I am glad we are not listening to you. ;-)
20% equity base for banks - that is a great suggestion, but we are at the moment at 3% (US and Switzerland 5%) and that has taken 7 years since 2008 to get to that point. So you might as well wish for £1m of helicopter money for each of us, that is just as likely to get enacted.
Now, investment banks have an important job to do. Do they? What exactly is that, and how much of their business is actually funding new ventures with equity stakes, for example, and how much is just rent extraction? Or faked trading in derivatives, foreign exchange, futures, and i-shares (excahnge traded funds). Trading in hot air, in other words, which does not help the economy one iota.
Further, the "Glass Steagall Act" is of course just being enacted in some limited form in the UK,. by ringfencing investement banking from retail banking. Good, that is how it has to be. It would be better if retail and investment banking would be split completely, (Glass Steagall pure) but this ring-fencing already is a good step in the right direction.
Why do Central Banks need to provide liquidity? They do not provide liquidity to me, but provided £375bn liquidity to banks to enable them to sell bonds at a profit from a QE programme. That obviously has to stop, as it only helps the rich. PQE is the obvious solution to a economic downturn problem. Now obviously, should there be a major problem, say a big bank going bust, because it cannot meet its derivative positions, there should be ABSOLUTELY NO PROVISION OF LIQUIDITY to save that speculation nonsense. These banks need to be able to go bust. THe provision of central bank liquidity willy-nilly has to stop.
Now, public debt is a problem. Not because of the debt itself, but the interest on it. 50bn of the current interest bill per year on public debt, 60bn projected from 2020 onwards, and going up steeply. Clearly PQE would help there, too.
Balanced budgets will not happen unless taxation and expenditure is in line, that is not automatic. That needs rises in taxes which should come from wealth, as that would have the least impact on the economy. It should not be done by taxing away the previously granted tax-credits, as this will take around £10bn out of UK consumptyion figure ((£4.4bn + muiltiplier)
Matt, which bit of ' bored of seeing the same proposals over and over' gave you the impression that it was time to offer the same proposals again?
DeleteSame proposals?
DeleteWhere are these proposals (a) not to provide liquidity in the next bank crash, (b) restrict gov. borrowing to reduce the interest burden of the state, (c) a wealth tax, or (d) abolishing trading in hot air?
They are not, as far as I know, part of the public discourse.
If you think that they are the same proposals currently on the table, please show me where they are?
Matt,
DeleteIt's not me who is not being listened to. It's you. Fortunately, since you haven't the faintest idea what you are talking about.
Not providing liquidity to the banks in a crisis is an unbelievably dangerous proposal. That is why it is not part of the public discourse.
I've tried to explain to you many times why these ideas are wrong and some of them dangerous. I know that others have tried too. But it seems you don't want to listen, because you are convinced you are right even though you know very little about how the monetary system works. I think that is known as arrogance.
"Now, investment banks have an important job to do. Do they? What exactly is that, and how much of their business is actually funding new ventures with equity stakes"
DeleteI kind of think not knowing this disqualifies you from opining on these subjects. Why don't you go away and find out what investment banks do.
Matt, which bit of ' bored of seeing the same proposals over and over' gave you the impression that it was time to offer the same proposals again?
DeleteMatt, which bit of ' bored of seeing the same proposals over and over' gave you the impression that it was time to offer the same proposals again?
Deletehttp://sites.google.com/site/elreductordegrasaresena/
ReplyDeletehttp://nomorefakereviews.ning.com/articles/el-reductor-de-grasa-guia-resena
Frances,
ReplyDeleteI'm out of job, too. It's because I've chosen to pursue something the pay from which lies in the future (I hope). That something is increased understanding of our monetary system (and thus of our economy). The reason I pursue this is because I was tired and angry already four years ago! Tired and angry of all this madness going on around us. Tired of no one (and that includes me) seeming to understand what is going on in our economies. It seemed to me that we have a "debt addiction", and many wise people agreed, but some wise people didn't agree. That was killing me. #uck. (Did you know that Aldous Huxley was depressed by the Depression and that's where "Brave New World" came?)
For the last 18 months I've been working alone, trying to figure out how the monetary system works. During my waking hours and in my dreams. I've read stuff written by you, by all our great economists and less great economists, but most important of all, I've been thinking and writing notes.
What makes me pissed today? That you, whom I consider an expert on the monetary system and have enjoyed listening to, express yourself in this blurry way:
"Today, I had to explain YET again that although banks create money when they lend, that does not mean lending doesn't need funding. Payments are deposit outflows. That applies whether the deposits concerned are created by the bank through lending or placed in the bank by customers. So no, banks can't "just lend" without any form of funding. Banks have to fund deposit outflows. If they don't, they can't allow money to be removed from deposit accounts."
There is no "money" to be removed from anywhere. And if all the banks increase their lending, individual banks need to "fund" (your term, not mine) only tiny outflows, as large gross outflows are matched against large gross inflows. Don't mistake this for "funding of lending". At best, this is "funding of net deposit outflows".
Listen to John Hicks ("A Market Theory of Money"):
"We are on the way to a credit economy... Money remains of course a standard of value, in terms of which people do their calculations, and in terms of which debts are expressed. But money as a means of payment is just a debt. The payment of a debt is an exchange of debts."
Read it twice. Hicks didn't realize -- none of us did -- that this "credit economy" is the world we have been living in all along. A payment of a debt cannot really be "an exchange of debts", or at least it doesn't make sense to talk about a "means of payment" being a debt. We need to finally make the link to real economy, where these debts are paid by sales (but only when the seller had a debit balance from before) and incurred by purchases (but only when new debit balances are created), much like Alfred Mitchell-Innes suggested already in 1913.
All this applies to central bank credit balances ("currency in circulation" + reserves) as well. There are differences between CB credit balances and commercial bank credit balances, but the mechanism is the same. Both are part of our "bookkeeping system", the purpose of which is to track credit/debt relationships, not to settle debts. I, like anyone else, used to think that the central bank doesn't really owe a "depositor" anything, but that the commercial bank does (it owes "money"). The truth is that no bank owes anything to its "creditors" (who, thus, are not really creditors of the bank -- a point which was noticed by the questioning mind of J. Schumpeter --, but creditors of someone else). Banks are bookkeepers. The ones who owe, and the ones who are owed to, we find on the opposite sides of the bank balance sheet.
Here I'm suggesting a new way to view the system. And right now I see adopting this viewpoint as the best chance for us to get out of this misery. (I'm not bored. I'm just angry.)
Peter,
DeleteI don't think it is any more accurate to explain what banks due purely in terms of changes in stocks. A change of stock level is a flow. You are essentially saying that flows of funds are an unhelpful illusion. I'm afraid I must, respectfully, disagree. Both stocks and flows are important.
Really when we are talking about "funding", we are discussing changes in the composition of the asset side of a bank's balance sheet. What I was pushing back against in my comment was the notion that a bank can create its own liquid assets. It can't.
We can look at it like this (with a nod to Eric Lonergan, since I am defining money narrowly in this example). When banks lend, they add to the stocks of illiquid loans AND illiquid deposits on their balance sheets. We call a demand deposit "money" because the central bank guarantees the drawing down of credit balances (and debit, within limits imposed by the bank). But really, a demand deposit is illiquid. It's only liquid if the bank can exchange it for central bank money, which is the universal medium of exchange in that currency (reserves are accepted by all banks, currency is accepted by all non-banks).
When a depositor makes a payment or withdraws funds, he converts some of his stock of illiquid assets to central bank money. The bank has to have that money on the asset side of its balance sheet. It can't create it itself - after all, it's not the central bank. So it has to exchange some of its illiquid assets for money. It does this using third parties, to whom it pledges illiquid assets. If it can't do this, then eventually the composition of the asset side of its balance sheet becomes entirely illiquid. When that happens, depositors can't convert their deposits into money, because the bank hasn't got any and can't obtain any. This is why the central bank lender-of-last-resort function is so crucial. Without it, a bank really can run out of money, not for lending but for payments. That is what happened in Greece.
Frances,
DeleteI think you don't address what I said, or tried to say. It's no suprise, though: as I said, I'm suggesting a new way to view the system.
I'm not saying that flows are unimportant. I'm only saying that flows can be viewed as credit and debit entries (entries affect balances, always) in a ledger. This viewpoint stresses the fact that there really isn't any "funds" or "money" flowing between accounts. To say there is, is to adopt a different viewpoint -- the conventional one -- which I have found lacking in many respects. We are used to think as if there was something ("money") flowing between accounts, but you will have hard time proving that there is.
To me it's bookkeeping, and nothing but bookkeeping. Balances and entries, instead of "stocks" and "flows". I don't care what you call these balances and entries, as long as your thinking is clear. But I found my thinking to be not-too-clear before I adopted this new language. Language and thinking go together, right?
So, all that you say in your reply, I can express in another language: traditional bookkeeping language. (Of course, "cash flow statements" are part of accounting, and they work for individual firms, but are problematic when dealing with banks. But I'm talking about thinking in terms of "T-accounts", that's the bookkeeping I refer to.) I'm not really in disagreement with what you say. But I do believe that it would be very helpful to avoid talking about "money".
In my world, you can go to your bank where you hold a credit balance (a "deposit"; another word I don't like to use) and ask them to give you a credit balance at the central bank instead (in form of "physical currency", a bearer note which refers directly to a credit balance in the CB ledger). I try to abstract from this "physical currency" as often as possible and view it as a credit balance in the CB ledger (which it is). The difference between physical currency and bank reserves (both are credit balances) is that changes in the ownership/holdership of the former are not recorded in the CB ledger, unlike changes in the ownership of the latter.
I could continue, but you might get the point. As I said, yours is a different viewpoint. Seen from my viewpoint, a bank never runs out of "money", but out of its counterparties' trust (the CB included). It is not anymore able to debit its account at the central bank. In general, as creditworthiness/trust disappears, so goes the ability to debit one's account.
Like I said, adopting this viewpoint (and language) has clarified my thinking. It also leads to some interesting implications. For instance, we cannot anymore talk about -- nor think in terms of -- "money" as a "means of payment". This is what I tried to tell you in my first comment. If these credit and debit balances and entries are just a part of a complicated system to keep track of credit/debt relationships, then all payments have to (in order for us to have a meaningful definition of a 'payment') happen outside this bookkeeping system. Payments are made by selling something (i.e. payments turn out to be made only "in kind"). Those payments are only recorded in this bookkeeping system. This definition of 'payment' seems to be consistent, because debts are incurred (i.e. debit balances created) when someone buys something and the purchase sum is not covered by credit balances held by the buyer prior to the purchase ("buys with credit").
Is this rocket science or finance for dummies?
It is sadly an incomplete view. It's like saying that when I go to work, my house has one less person in it and my office one more person in it. It's correct, but it's not complete. The complete picture is that the change in level of population in both my house and my office occurs because I have travelled from my house to my office.
DeleteChanges in credit and debit balances don't happen by magic. They happen because the holders of those balances instruct banks to change them, and banks instruct each other to change them. An electronic payment actually consists of two messages: one form the customer to the bank instructing it to reduce his deposit balance by the amount of the payment, and one from the customer's bank to the payee's bank instructing it to increase the payee's deposit balance by the amount of the payment. Both banks make bookkeeping entries in response to these instructions. You are only looking at the bookkeeping entries and not at the instructions. The instructions physically move. It is those, not the bookkeeping entries, that represent the movement of money. Money is a flow, not a stock.
Well, you tried to adopt my view and what you saw was sadly incomplete :-) That doesn't make my view incomplete. It's actually not missing anything of what you refer to when you talk about "instructions". Why do we give these instructions? Usually the need to do it arises from real transactions (sales and purchases). It might also arise from our need to have a credit balance in another bank's ledger and so we instruct both banks (the banking system) to arrange it. My view covers all this and, oh, so much more.
DeleteMy point, which still seems to escape you is this: We can explain the monetary system in terms of credit and debit balances, and entries that change those balances (your "flows"), and thus get entirely rid of the mental picture of "money" moving between accounts. The instructions you refer to are us asking the "bookkeepers" (banks) to make changes in their ledgers which track the credit/debt relationships in the economy. We don't ask them to "move funds" or to "make payments" -- no matter if this is how it seems to be (the Sun seemed to revolve around the Earth).
By the way, think about what a rise in a credit balance (as a consequence of a credit entry that was made on the account) means. It means that the holder of the balance has extended credit. And this change in a credit balance we are used to call, following the prevailing view, a "payment"! It just doesn't make sense. Seen from my viewpoint, everything looks more coherent.
DeleteI hope you can stay constructive. I'm not here to show that you are wrong. We have all been looking at the system from an incomplete viewpoint. That's my message.
Your point doesn't escape me at all. Rather, mine seems to escape you. The bookkeeping entries that change the balances are not the flows. They merely document the effect of the flows. The flow itself is the movement of instructions between the banks.
DeleteOr rather, the flow is the interaction between people that results in banks being instructed to make bookkeeping entries to change their respective deposit balances.
DeleteWhat kind of interaction between people you refer to? I wrote: "Why do we give these instructions? Usually the need to do it arises from real transactions (sales and purchases)." There is a flow of real goods and services between people, and this flow results in banks being instructed to adjust their ledgers. This adjustment doesn't lead to "money" being transferred to the seller, but to the seller ending up with a higher credit balance (she is owed more).
DeleteHere is R.G. Hawtrey ("Currency and Credit", 1919) arguing, mor or less, for my point (although to him this was an imaginary world, not the one we actually live in):
ReplyDelete"Suppose then that society is civilised, and that money does not exist. Goods are brought to market and exchanged. But even though there is no medium of exchange, it does not follow that they must be bartered directly for one another. If a man sells a ton of coals to another, this will create a debt from the buyer to the seller. But the buyer will have been himself a seller to someone else, and the seller will have been himself also a buyer. The dealers in the market can meet together and set off their debts and credits. But for this purpose the debts and credits, which represent the purchase and sale of a variety of goods, must be reduced to some common measure. In fact a unit for the measurement of debts is indispensable. Where a commodity is used as money, it naturally supplies the unit for the measurement of debts. Where there is no money, the unit must be something wholly conventional and arbitrary. This is what is technically called a ''money of account". Even when money is used, it may occasionally happen that the unit for the calculation of debts diverges in some degree from exact correspondence with the money in circulation. In that case the distinction between money and money of account immediately becomes a practical one. The value of the standard coin will be quoted in terms of the money of account, and varying amounts of the standard coin will be needed to pay a given debt. This is an approximation to the state of affairs which we are assuming. But however conventional and arbitrary the unit may be, once it is established as the basis of the debts and prices and values of a market, it is bound to assume a certain continuity.
[…]
Each dealer in the market calculates his own command of wealth in the same unit; it affords the basis for his valuation both of what he wants to buy and of what he wants to sell, and he looks for only such divergence from the previous prices as variations of supply and demand will justify. The total effective demand for commodities in the market is limited to the number of units of the money of account that dealers are prepared to offer, and the number that they are prepared to offer over any period of time is limited according to the number that they hope to receive. Therefore, arbitrary as the unit is, capricious variations in its purchasing power will not occur."
Your quote from Hawtrey defines the nature of the disagreement between us. You are regarding money solely as a medium of account - an abacus, if you like. Clearly, viewed in this way, money is simply a tally and cannot be said to "move" anywhere.
DeleteBut I'm afraid I regard this as an inadequate view of money. Hawtrey specifically excludes money's other purpose, which is as a medium of exchange. He is discussing a pure barter economy. They do not exist. In our real world, transactions occur using money not just as a tally but as a means of communication - a common language, if you like.
Frances, now you're spot on! I do regard money solely as an abstract unit of account.
DeleteWhereas these previous writers (Hawtrey and Hicks are perhaps best examples) have been talking about a "pure credit economy" which they don't consider reality -- although Hicks said we are moving towards it --, I am arguing that we live, indeed, in a pure credit economy. Previous writers haven't got over "fiat money", but I define that, too, as a credit balance (and I'm able to show how that credit balance is a real liability).
It's interesting that you call it a "pure barter economy". So did Jevons ("a complicated and perfected system of barter"). Adam Smith, on the other hand, said that if money didn't exists, then we would need to turn to "barter and credit".
I might sound crazy, but I'm serious in arguing that money-as-a-medium-of-exchange doesn't exist. Was I not sure that it existed? Of course I was. For 35 years. But when the facts change... :-)
Below is an interesting quote from Willem Buiter (http://willembuiter.com/numerairology.pdf). He defines your "abacus" thus: "What serves as unit of account in private transactions and private contracts and in the mental arithmetic involved in economic calculation and computation"
DeleteFull quote:
"The determination of the numéraire and its significance is a much-neglected issue in monetary economics. The great monetary economists of previous generations distinguished carefully between what one of them, Patinkin, called “the abstract unit of account” and the actual, physical (and today also digital), medium of exchange. The abstract unit of account “...serves only for purposes of computation and record keeping. This unit has no physical existence;” (Patinkin 1965, p. 15). Patinkin refers to prices in terms of the abstract unit of account as accounting prices and prices in terms of the medium of exchange, as money prices. In what follows, accounting prices will also be identified with contracting prices and invoicing prices. (p. 131)
What serves as unit of account in private transactions and private contracts and in the mental arithmetic involved in economic calculation and computation is determined by individual choice conditioned by social convention, rooted in culture and history, not by government decree. (p. 147)"
I am a little surprised, a little sympathetic, and a little discouraged. You lament our current systems, and yet you tell us to stop trying to change them. They are all man-made systems and therefore can be replaced by new man-made systems. Furthermore, our money and banking systems are based on the gold standard even though we are no longer on the gold standard. Furthermore the current timing relationships between loans and repayments of those loans are ridiculous. The whole system must be replaced and because the current banking system depends on these timing relationships then they must also be replaced.
ReplyDeleteI am not bored so much as I am weary. I read every day people complain about how our systems don't work, and I agree, they don't work and they, in the US at least, have never worked. Our systems have seemed to change through history, but they haven't. We act as if we are still on the gold standard.
Our banking systems are not worth the powder it would take to blow them to pieces.
Dear Frances, I am merely a layman when it comes to economic issues, so I feel reluctant to leave this question. I fully agree that governments must intervene courageously through public investment programmes. But I've found a particular paragraph of your article perplexing:
ReplyDelete«Purchasing power in today's fiat money economies is created by bank lending, and very low interest rates are deadly for banks. They can't make money when yield curves are flat and the slightly-below-zero bound is binding. The longer very low interest rates remain, the more difficult it is for banks to survive. They could improve their profitability by doing riskier things, but we don't like that either: prudential regulation is making it ever more expensive to take risk.»
Aren't you basically saying we need to overcome the effects of a terrible debt-based monetary bubble by creating another one?
Respectfully.
“I've lost count now of the number of full reserve banking proposals I've seen. I've yet to see one that actually succeeded in eliminating bank money.” So where’s the flaw in Milton Friedman’s and Lawrence Kotlikoff’s claim that full reserve would eliminate “bank money”? And ditto for other advocates of full reserve, e.g. Positive Money, the New Economics Foundation and Richard Werner.
ReplyDelete“And I've also yet to meet an advocate of full reserve banking who understood that it is to all intents and purposes a strict gold standard…” What? FR is a hundred miles from the gold standard. E.g., first, the monetary base is flexible under FR (as it is under the existing bank system), whereas under the gold standard, the base is limited to how quickly gold can be got out of the ground. Second, under the gold standard, inflation is near impossible since gold over the very long term doesn’t lose its value. (The price of bread in 1900 was the same as it was in 1800). In contrast, under an incompetently run FR system (as with incompetence under the existing bank system), excess inflation is all too easy.
“I keep saying it is a really bad idea because central banks get their forecasts wrong ALL the time..” My answer: CBs “get their forcasts wrong all the time under the EXISTING system”.
I've explained the flaw here: http://www.coppolacomment.com/2012/10/the-imf-proposes-death-of-banking.html
DeleteRichard Werner does not advocate full reserve banking. He advocates small banks and SME lending.
Full reserve banking is very like a gold standard. It just replaces miners with alchemists (central bankers). I pointed this out in the post. You must have missed it.
Inflation is absolutely possible with the gold standard. Read this from Giles Wilkes on the inflationary consequences of a sudden influx of gold: https://freethinkecon.wordpress.com/2014/06/20/smaug-and-the-questionable-relevance-of-transmission-mechanisms/
There is no reason to suppose that CB forecasts would be any better under a different system.
Frances,
DeleteRe the article of yours you refer to above, you concentrate on the IMF Benes & Kumhoff paper. I also don’t have much time for that work. As you rightly say, the authors conflate two items which are entirely different animals: full reserve and debt jubilees.
Returning to your original suggestion, i.e. that it’s not possible to stop banks issuing DIY money, one answer to that is that it’s not the ambition of most advocates of FR to totally abolish DIY money: e.g. most Positive Money supporters have no objections to local currencies, like the Bristol pound.
In contrast, stopping large banks issuing money, that’s easy. You advocate a 20% capital ratio (which I agree would be an improvement on the existing system), thus you presumably think that 20% can be enforced. Thus presumably 30%, 50% or 100% can be enforced. And at 100%, a bank by definition is not issuing money because everything on the liability side of its balance sheet is equity, rather than money.
Re Richard Werner, he advocated FR in a joint submission to Vickers with Pos Money and the NEF (link below). Re his small banks, that doesn’t conflict with FR: i.e. one can have big FR banks or small FR banks.
http://b.3cdn.net/nefoundation/3a4f0c195967cb202b_p2m6beqpy.pdf
Re the gold standard, clearly when there is a sudden influx of gold, the price of gold falls (aka inflation rises). But in the real world, that just doesn’t happen all that often. (The import by Spaniards of gold from central / South America in the middle ages is an obvious exception).
Re your point that “There is no reason to suppose that CB forecasts would be any better under a different system”, I agree. My point was that they wouldn’t be any worse either.
“Get capital buffers up to 20%, then leave banks alone.”
ReplyDeleteWell raising buffers to 20% is a significant move in the direction of full reserve (which involves a 100% ratio). If the remaining 80% is bonds (to take a simple case), those bonds are essentially shares in that bond holders stand to lose everything. So that’s full reserve in all but name.
Alternatively, if the 80% is composed to a significant extent of deposits which are supposedly totally safe, someone has to ensure that safety, and we all know who that is: the taxpayer. So that system involves taxpayer subsidies of banks, and subsidies misallocate resources, i.e. reduce GDP.
Another alternative: have deposits insured by some sort of FDIC system (or Osborne’s bank profit surcharge). The flaw there is that assuming everyone gauges the insurance premium correctly, then the amount shareholders charge for self-insuring (which is what shareholders do) will be the same as the FDIC system charges. Ergo the latter is no cheaper.
However, there’s a big flaw with FDIC: the temptation to cheat the insurer. I.e. take excessive risks, keep the profit when that works, and send the bill to the insurer when it doesn’t. That’s largely what was behind the 2007 crisis and the costs of that were horrendous. In contrast, "shareholder / self-insurers" don't cheat themselves. Ergo full reserve is the best system.
Sheesh. Are you aware of the difference between debt and equity? Bonds are in no way "essentially shares" unless their terms & conditions specifically make provision for their conversion. The obligation may be wiped in bankruptcy, but not if the bank remains as a going concern. This hasn't changed even though the EU is doing its best to change the rules. So far , every attempt to wipe bondholders has been met with lawsuits.
DeleteIf I eat one-fifth of a cake, is that a "significant move" in the direction of eating the whole cake?
Frances,
DeleteI didn’t say that shares and bonds are the same thing. I said they were the same IN THAT in both cases, relevant savers / investors stand to lose everything if the worst comes to the worst. (That’s in contrast to depositors, who have a cast iron guarantee that they’ll get their money back - at least £75k of it).
Moreover, much of the “existing system versus FR” debate revolves around the cost of funding banks under the two systems. In that both shareholders and bond holders stand to lose everything, they’ll charge the same for funding a bank. Plus in that shareholders demand and get a bigger return than bondholders, that’s only because shareholders get wiped out before bondholders when a bank is in trouble. Thus expanding the proportion of funding that comes from shareholders shouldn’t have any effect on the TOTAL COST of funding a bank because all that “expansion” does is to shift risk between shareholders and bondholders.
Ergo the cost of funding a bank just via equity is much the same as funding it 20% via equity and 80% via bonds.
1. Stop proposing new bank reforms. We've heard it all before.
ReplyDeleteMaybe you have heard it before and maybe you haven’t. Your 20% recommendation is itself a “reform.”
Banks, under the system you seem to favor, depend on a few human beings to make loans. So, human nature enters into the picture and liquidity then becomes a function of the education, attitude, and personal goals and beliefs of these human beings. Human nature is the biggest problem we have to deal with. So, banks have to be reformed so that loans do not depend on human nature. Money cannot be created. It already exists in an infinite amount. It can only be activated or deactivated. It is not a thing, it is a form of mathematics that describes a certain part of the natural world.
The managers of our corporations manage money within the time limits of their bonus programs. Again human nature enters into the picture. This means that loans have to be repaid on some time schedule that fits into the compensation structure of the bankers and the corporatists. This is good for them and bad for the rest of us.
Taxes and interest make no sense. They reduce productivity thereby seriously weakening growth. Because money already exists we do not need to collect taxes or charge interest.
Perhaps, all of this would be more easily understood if one just imagines that we are still on the gold standard, which our governments seem to think we still are, and we find that the Rocky Mountains are made of pure gold, they sit atop a limitless, accessible pile of gold—endless trillions of dollars of pure gold. What happens then?
2. Particularly, stop attacking investment banks. They have a job to do.
Then why aren’t they doing it?
3. Stop trying to restrict what central banks can do. Liquidity is lifeblood to the financial system. Trying to restrict it causes gangrene. Let central banks provide it freely.
Yes, liquidity is the lifeblood of the financial system, but the way liquidity is provided to the financial system today is not working. If it were working then our economies would moving at full speed. So, the whole liquidity system must be replaced, and it must be coordinated with the stages of modern human life, not lagging behind the business cycle.
4. Stop expecting central banks to restore growth.
Yes, central banks, as they are now structured and as they now operate cannot restore growth, so they must be changed.
5. Stop worrying about public debt. Borrow to invest for the future. Then central banks will be able to raise interest rates, since increased borrowing would tend to push them upwards anyway.
Borrow? From whom? What nonsense. There is no need to borrow, in fact there is no possibility of ever borrowing money at all. One can borrow a tool, or a car, or a cup of sugar, because they are all physical things, but one can never borrow money. It can only be activated or deactivated. It is not a thing. Interest rates? Again, nonsense. This concept has been one of the most insidious frauds ever perpetrated by the wealthy on the poor. What a ghastly, repugnant idea.
6. Stop trying to balance budgets. They will balance themselves in due course.
Another outmoded concept. Budgets are either on track or off track. They are merely management tools.
7. Stop worrying about inflation. There isn't any. If it appears, cheer.
At last, something we agree on.
"Banks, under the system you seem to favor, depend on a few human beings to make loans. So, human nature enters into the picture and liquidity then becomes a function of the education, attitude, and personal goals and beliefs of these human beings."
DeleteMost lending decisions now are not made by human beings. They are made by algorithms. This eliminates human nature from the decision making process. Presumably you think this is a good thing?
Yes, let's just create a completely mechanised, automated monetary system with no human intervention. Then it can never go wrong, can it? Trouble is, the people it serves - you know, the millions who use financial services every day - can and do "go wrong". As you say, the problem is human nature.
I have hurt your feelings, I am sorry. But...
DeleteI made my living designing systems for all kinds of large enterprises, including banks, saving and loan companies, national health care (Medicare and Medicaid, HMO's, trucking companies, airlines, large bottling companies, telephone companies, and more. My generation was the one that computerized the world. You are welcome.
So, I understand how algorithms work, They are controlled by parameters (if yours is not so controlled then you need to move your money) which are set by human beings. And when those humans make their decisions they are always going to consider their own personal circumstances first, last and always. James Madison discussed this point in Federalist 10 and he said that this human problem was the Achilles' heel of our constitutional system. He said that it was impossible for one representative to reflect the needs and desires of 30,000 citizens, and he said further that over time the representative would begin to look to his own interests and to the interests of his friends thereby sacrificing the interests of his constituents.
So, I stand by my argument. Human nature is the biggest problem we have. Of course it is impossible to eliminate any human input, but it is entirely possible and wise to focus it on the common good. The common good is a stranger to our banking systems--everywhere on earth.
I favor a system wherein banking decisions are made by a great number of people who represent a cross-section of the population that depends on the services of the banks. This will serve to dampen the selfish effects of a few bank executives. The model of the chief executive in business and in government is one of the greatest failings of our systems.
I, too, designed systems for banks and financial institutions. I'm well aware of how parameters are set. They are the framework within which decisions are made by the algorithms. If you think parameters are set by bank executives, you don't understand banks. Parameters are set by ordinary people doing ordinary jobs for ordinary money, who understand very well the concerns of other ordinary people.
DeleteForgive me, but that does not make sense.
DeleteI cannot see how bank executives would turn over policy decisions to "ordinary people doing ordinary jobs for ordinary money, who understand very well the concerns of other ordinary people."
This process would mean that bank loan policy would be established without input from the bank's managers. But, if what you say is so, then those ordinary people have not been successful in meeting the needs of their customers, else more enterprises would be started, more people would be hired, more money would be injected into the system, prosperity would break out.
I am pretty sure that ordinary people are very concerned about the lack of hiring, about the low level of economic activity, about their inability to get a raise, and all the rest.
And if you are right then my design for a Universal Bank of the United States will not work.
Well, back to the drawing board. Thanks for the education.
"...those ordinary people have not been successful in meeting the needs of their customers, else more enterprises would be started, more people would be hired, more money would be injected into the system, prosperity would break out."
DeleteNo. The primary purpose of banks has changed from supporting businesses to providing ordinary people with the means to buy a house. We could say that the fact that ordinary people are setting the parameters itself tends to skew bank lending in that direction, since buying houses is of much more importance to bank staff than supporting businesses that they don't work for.
I did not know that was how banks worked. Wow!
DeleteSo if an ordinary person wants to start a business, where does he go for capital?
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DeleteHe remortgages his house to provide startup capital for his business.
DeleteThanks for the education. It appears that your nation's financial systems need an overhaul just as much as ours.
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DeleteI know I am being a pest, but there is another problem that I am having difficulty with and that is about the supply of money.
ReplyDeleteI am of the opinion that money exists in an infinite amount, that the supply is unlimited, it is inexhaustible. Therefore all we have to do, in the US, is devise a way to distribute it, devise a way to control inflation, and step aside--poverty will be washed away and prosperity will break out.
In this way we can finance all worthwhile, non-inflationary projects. Our only limitations will be materials, machines, and people to put them to good use. In this way we will have our best chance of mitigating the adverse effects of global warming.
But whenever I talk about these things, people flatly tell me three things: there is a limit to the supply of money, Weimar--Weimar--Weimar, and whatever you spend must be paid for by collecting taxes. All of these, in my view, are nonsensical. But you already can see how wrong I can be. Where am I going wrong?
I know it sounds like I am being a wise-guy, and I probably am, a little, but I sincerely need to be taught. Where am I going wrong?
The folks at New Economic Perspectives have, just like you, told me politely that I don't know what I am talking about. They told me to leave them alone. They haven't banned me, but they just ignore me. This is particularly mystifying because they also claim that the money supply is inexhaustible. When they say it it okay, but when I say it, not so much.
I read, and read, and read, books, blogs, pdfs, I watch videos all the time--I spent an hour this morning watching a video by a NEP top gun who is an adviser to one of our presidential candidates in which she explains the problems with the economic system we now have. At one point she says that we can't run out of money. She said that the US can never go bankrupt.
So, what is going on here? Is the money supply inexhaustible? If so, why haven't we changed our systems to take notice of that fact? Can we design systems that take notice of that fact? I know I have tried, and up until the morning I was convinced they will work. But not anymore.
Part of my problem is that I grew up with the understanding that there is an unlimited supply of money. In the summer of 1949 my father and his friends, all WWII vets, were holding one of their regular bull sessions when my father introduced the idea of Rocky Mountains made of gold into the conversation. Those men worked with that idea for years, but by the time I went away to college in 1957 they had become comfortable with it. They concluded that inflation was the only worry and they concocted a system for dealing with that abd I have adapted to modern times. In effect they... well I have gone on too long.
If you can help me I would be grateful.
Thanks
Hestal,
DeletePlease look at my comments above. I don't know if they help, but I've been struggling with the same problem you seem to be struggling with (and yes, I, too, have been reading and thinking about this a lot --pretty much 24/7 for the last 18 months). I know it's a lot to ask, but I would suggest you consider getting rid of "money" all together in your thinking and replace it with "credit balances". That helped me.
Thanks, Peter, for the suggestion. I have read the discussion above and it is above my head. But perhaps you could help me out. As you see above Frances told me that banks don't support businesses anymore. Instead they focus on home loans. I asked her where a person would go for capital if she wanted to start a business? Can you answer this question? I would appreciate it if you would. Thanks.
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DeleteOn the "banks create deposits" thing, I'm always left thinking about Tobin and his idea that there'll always be a "reflux" (not sure if he uses this world) if banks try to lend beyond private sector credit demand, due to the portfolio preferences of the public.
ReplyDeleteThat would imply a sort of reverse causality loanable funds, wouldn't it? There is certainly some truth to that, it seems to me, but at the same time it's obviously not what actually happens. The portfolio rebalancing seems to instead happen through capital assets appreciating (leading to a Minksy Moment and so on).
What are your thoughts on this, Frances?
I'm not Frances, but I'd like to hear what you mean with "private sector credit demand"? Demand for "deposits" or demand for "loans"? If I take it to mean the former, I would suggest that banks can sell/securitize these loans and thus convert deposits into other kind of financial assets. And it seems to me that there is usually demand for this kind of assets when banks are increasing lending.
ReplyDeleteIntrigued by your throw away reference to Gesell. Because he is one way out of the impasse for the UK.
ReplyDeleteYou comment that German savers do not build up asset value in landed property like the British. The whole Gesellian system depended on not being able to hoard money in banks or in landed property: in these its value would deteriorate as fast as labour loses its utility (through starving) .Gesell spent half of his magnum opus discussing the land as a residuum of hoarded money problem. (This bit Keynes ignored while plagiarising the velocity money -Aberhart's term).So Step One: institute a stiff Land Value Tax to block money disappearing into land; Step Two increase the money supply. (No need to stop banks creating money because their main British vice , of pumping up land price inflation, will be cured and they'll have to " lend" virtuously ie' anywhere but land which is always inflationary because you cannot increase the supply. ( I was publishing this idea thirty five years ago, so no hope there then)
Sorry, didn't mean "credit" there but "money". That is, demand for deposits.
ReplyDeleteBanks definitely can do what you suggest. It seems to me they don't need to securitize anything, they can just offer their clients another kind of financial product (ie: a bond) and thus change their liability structure accordingly. If they didn't, so the Tobin point (as I understand it) goes, people would just repay loans and reduce the money supply to where it was before banks created the new money.
But then several questions spring to mind:
1) This doesn't seem to be what we have seen. Rather, capital assets have risen in value and new "money like products" (ie: shares in money market mutual funds) have been created.
2) Otherwise, if Tobin's point is correct, why wouldn't a loanable funds model apply?
Yes, you're right about the possibility of just selling bonds to "deposit holders".
DeleteAnd yes, Tobin's point doesn't seem to be correct. If you think of it, what happens when someone doesn't want to hold a deposit? This someone buys something (a house or a bond, for instance). What did the seller of that something desire? To sell it and hold a deposit instead! How long does he want to hold the deposit? I don't know. What I know is that once he proceeds to buy something, there is a seller willing to hold the deposit -- if only for a while.
How does this sound?
In other words, I don't see any clear connection between banks increasing lending and people being willing to repay loans. And if you think of what happens during a credit crunch: banks decrease lending and people become more willing to repay loans. When banks increase lending, it means people are more willing to incur debt, not the opposite?
DeleteAh, but the seller willing to hold the deposit could want to do so to pay down debt. I'm not saying I agree with Tobin, I just find there is some powerful logic behind his assertion that if banks force money upon a private sector with a certain portfolio preference, these have equal power to destroy it.
DeleteIntuitively, this is my solution to the conundrum:
Yes, if there was an equal probability for any actor in the economy to receive the deposit (that is, the person selling the asset, not the one who borrows from the bank to then pay this person) then Tobin would be right: the natural way to rebalance the portfolio would be to deleverage in the proportion in which there is more money than real growth being created.
However, this is not how real life works. In fact, the flow of money is more likely to be from the cash strapped who borrow at the bank to those selling assets that have no need to deleverage. These people are then likely to either hold the money or purchase longer term assets (or financial products) with it. Either way, the price of capital assets is pushed up.
Yes, eventually the money will reach somebody who would in the initial state have paid back debt, but on average by the time this happens capital assets will have already appreciated (so the portfolio rebalancing has already happened through a different way). This is especially true in the boom, of course.
In the bust, however, the end receivers of money are indeed likely to use it to deleverage and destroy these deposits. Thus, the effect is the opposite.
The bottom line of this idea would be that the money creation power of banks is actually asimetrical during the economic cycle. In the boom, there'll be little reflux, in the bust there'll be too much.
But that's just an intuition, that's why I was searching for input.
Sounds all plausible to me!
DeleteI think this portfolio approach is what causes the problem (which is not real). No one ends up with a deposit unwillingly. If you want to pay back a loan, then you have decided so before you sell and acquire the deposit. People don't survey the monetary aggregates and base their decisions to pay back loans on the amount of M2. In the economy seen as a whole, there exists no optimal portfolio balance (should I say 'equilibrium'...) that will suddenly be disturbed by a forced injection of new deposits.
You write: "that have no need to deleverage". If you think of it, who has a need to deleverage in a boom? Usually not even the "cash strapped", and surely not more than they have to according to the pre-set repayment schedule (which doesn't take into account increase in deposits).
You appear to be under the impression that one can just start 'Public works' today in the way they did in 1935. Construction is not the same any more. Its a highly skilled job now, even the 'labourers' are machine operatives or technicians these days. You can't just take random people who have zero skills, or the mental capacity to achieve them (a considerable % of the underclass these days) or people with other skills and let them loose on a building site. It would be chaos and a death trap.
ReplyDeleteAll a large program of public works would achieve is a massive influx of trained immigrants, and a massive flood of imported raw materials to use in the construction process. The UK does not have the reserve skilled labour, or the manufacturing capacity to sustain such a program of public works. And if you create such skilled labour through training programmes and massive investment in manufacturing capacity, what happens when the works are finished? All those workers are suddenly out of a job, and the factories making building materials without orders.
As always, when the State directs investment to places that the market does not voluntarily do so, whether its wind turbines, or hundreds of thousands of trained bricklayers, unless it can keep that investment going forever, at some point the money runs out and you're back to square one.
I quite agree that skills are not available for a rapid and big rise in infrastructure projects. See:
Deletehttp://www.theguardian.com/business/2015/feb/10/uk-plumbers-builders-engineers-skill-crisis-economy
Mind, if you make that point on Richard Murphy's blog, you're likely to be banned from his site. (He's one of the main advocates of a sudden and big rise in infrastructure spending under the guise of his so called "peoples' QE).
Frances,
ReplyDeleteA good post but, respectfully, the biggest threat to your children's future (and mine I suspect) is more likely to be climate change than economic incompetence. There is some degree of natural selection in terms of economic policy, and over time it tends to grope along in roughly the right direction. We don't have the luxury of such forgiving circumstances when it comes to the makeup of the planetary atmosphere. Indeed, regaining the rapid growth of past years would probably make things worse in this regard. Bit of a double edged sword really.
Excellent article. I think you touch upon a wider problem - a sort of mid-life crisis for Western society. We are comfy, well fed etc but our major industry seems to be 'getting in each others way'. We lack any idea where to go next and would argue interminably about it.
ReplyDelete"Hasn't Haldane heard of Silvio Gesell?"
ReplyDeleteYes, he has, Frances - if you read it, you'll see that he explicitly mentioned Gesell in that speech, along with some of the more recent discussion on negative interest rates. One reason the same arguments keep coming up (apart from the fact that many people are unaware of them) is that intelligent people often don't take the trouble to understand them.
You, for example, say that 'We now have empirical evidence that banks may raise interest rates to borrowers when they are charged for depositing money at the central bank'. Well, yes, in a monetary system in which savers have the power to take the medium of exchange out of circulation, that is indeed likely to happen - but that doesn't tell us anything about what would happen in a system where savers didn't have that power. That's why Haldane speculated on 'breaking the constraint physical currency imposes on setting such a rate', because he recognises that there isn't any practical way of introducing effective negative rates in the current monetary system.
You call negative rates 'direct taxation of bank deposits', but this misses the point. There's a fundamental question to be asked: does the state have an obligation to provide the public with some form of liquid savings and, if it does, what terms should that be on? Given that all forms of real wealth have a carrying cost of some kind, it's debatable whether such an obligation exists at all but, even if we accept that it is desirable, there's no reason why it should be provided at no cost - and it is utter folly to allow the medium of exchange to be hostage to it. The negative interest debate is not about taking something from the public which is naturally theirs, it's about the wisdom of giving them something (security of savings) which does not exist in nature and which imposes a burden on society at large.
Malcolm,
DeleteIt is actually because savers DON'T have the power to take money out of circulation that banks are likely to raise interest rates to borrowers if they are taxed for holding money on deposit at the central bank.
ALL money except physical cash is held in the banking system. A negative interest rate achieved by eliminating physical cash is thus a universal tax on money. It is not clear to me why people should pay additional taxes on their earnings - on which they have already paid income tax - purely in pursuit of a monetary policy objective. It is also not clear to me in what way this could possibly be considered expansionary policy.
I have given considerable thought to the effects of negative rates and the problem of cash, actually. Links to some, though not all, of my work on this are in the post.
"It is actually because savers DON'T have the power to take money out of circulation that banks are likely to raise interest rates to borrowers if they are taxed for holding money on deposit at the central bank."
DeleteYou've lost me there, Frances; I can't see the logic in that at all.
As you say yourself in one of those articles you linked to "Realistically [banks] cannot cut their deposit rates to savers to below zero (savers would stuff mattresses instead)". Stuffing cash under the mattress is taking it out of circulation and, as long as savers have the right to withdraw their savings in a physical form which maintains its nominal value, there is no practical way to charge people for holding excessive liquidity. And if banks can't pass the cost of negative rates on to savers then of course they pass them on to borrowers.
However, if we had a system in which the physical medium of exchange lost value if it ceased to circulate (which wasn't technologically feasible in Gesell's day but would be today) then banks would be able to charge for holding money at sight. In that situation they would be able to lower lending rates, which would widen the pool of creditworthy borrowers.
If, when you characterise negative rates as a tax, you mean that people would perceive it that way then yes, if it was introduced clumsily, that's exactly how most people would see it - because most people don't distinguish between money and what it represents. But, as you know, they're not the same. When you're given a banknote, the value it represents becomes yours but the note itself does not; it remains the property of the issuer. Money is a vehicle which carries value, and the provider of that vehicle is providing a service. Traditionally that service has been provided free of charge, without any limits to how long money can be held, but that's largely the result of historical happenstance, and there's no necessity for that to continue for ever more.
We don't regard it as a tax when we are charged for using a phone, so why would it be a tax if we were charged for the use of money? We'd simply be paying for a service (and the charge would only be applied if we used it in a way which adversely affected others ability to use it).
If we want a healthy economy the monetary system needs to properly represent the real world and, in the real world, storing wealth generally imposes costs; it is absurd that storing money not only carries no cost but actually imposes costs on others. Introducing such a radical change won't be straightforward but we'll never have a stable monetary system until we do.
Two points.
Delete1) How long do you suppose it would take for the private sector (non-banks) to devise methods of storing money without incurring the tax? And what do you suppose would happen to banks that could not avoid the tax? They would be forced to absorb it in order to compete for deposits. That would involve raising rates to borrowers. I'd suggest you have a look at the effect of Regulation Q in the USA.
2) It is not clear to me why it is morally justifiable to force people to hold their earnings in only one form (bank deposits) while charging them to do so. It is also not clear to me how it is possible to do so. One of the immediate effects of the ECB's negative rate in reserves was to trigger mass purchases of government debt by banks, as they rushed to unload the reserves that they were now being taxed to hold. What makes you think that households and businesses would behave differently? And what makes you think that private sector providers would not help them to do do? If central banks abolish cash to enable negative rates, I'm buying shares in Bitcoin.
Malcolm, could you explain what you mean by circulation in "Stuffing cash under the mattress is taking it out of circulation"? Is a deposit I "sit on" in circulation? I don't think so.
DeleteFrances:
I think your two points are very good. One sentence makes me think, though:
"morally justifiable to force people to hold their earnings in only one form (bank deposits) while charging them to do so"
Are people forced to hold their "earnings" in only one form? Behind this thought lurks "the money earned", a way of thinking which I'm trying to challenge. All these people have earned so far are credit balances, which means that they are owed something (by the society). We will find out what this something is when they make purchases of goods and services (that is, only ex-post). (They always have the alternative to hold their earnings in real assets.)
So the real question is: Is it morally justifiable to charge people for holding credit balances in our common bookkeeping system? My answer: It depends. We must differentiate between a "nominal charge" and "a real charge". If you're charged 1 % p.a. nominally while deflation runs at 2 %, then there is no real charge, and I would be tempted to conclude that the nominal charge is a fair one. But, there will always be the question of "implicit agreement". Did these creditors have a good reason to expect that they would never be charged even nominally, so that one should be able to make a speculative profit during deflation by holding zero-interest credit balances? Or was that just a rule we all had thought existed, but it didn't?
Once more: There is no "money".
To answer Peter's question first: I agree, excessive amounts held in sight deposits can't really be regarded as being in circulation.
DeleteFrances, the underlying problem is an incompatibility between the different functions of money; its value as a medium of exchange depends on it circulating freely but its value as a store of wealth depends on it being taken out of circulation. But the more that is used as a store of wealth, the less is available to facilitate economic activity – and its importance as unit of account constrains the monetary authorities' power to manage that conflict. In my view, a healthy society can't have a monetary system which allows the official medium of exchange to be hoarded. (By official medium of exchange I mean whatever the government expects in payment of taxes.)
From that perspective, it doesn't matter if people choose to store their wealth in other forms because doing so involves spending the hoarded medium of exchange, thereby releasing it back into circulation. Nor does it matter what people use as a medium of exchange in private transactions which they can choose not to engage in. But if people are required to pay taxes in a form which can be held hostage by the rich, that is pernicious. It creates subservience because it obliges the poor to obtain money on whatever terms the rich set. To my mind that is one of the two principal causes of inequality (the other being derelict laws of land ownership) because it underpins a steady flow of wealth from the poor to the rich. Indirectly it is also a root cause of instability, because hoarded money can come flooding back into circulation unpredictably, making proper management of the monetary system next to impossible.
The answer to your second point is implicit in your first: nobody will be forced to hold their earnings in the form of bank deposits. Employers and employees have a mutual contract to provide each other with value. If they regard the official medium of exchange as an unsatisfactory vehicle for that exchange they can choose to use something else. Why should their contract be regarded as imposing an obligation on the state to issue money in a form which favours the rich?
You say "... banks [...] rushed to unload the reserves that they were now being taxed to hold. What makes you think that households and businesses would behave differently?"
They wouldn't behave differently, Frances - they would spend their excess savings, releasing the hoarded medium of exchange back into circulation. That's the purpose of negative rates, to ensure that the medium of exchange circulates at a healthy rate.
It seems to me that you're judging different options by different standards. In your post on The problem of cash you say 'it would be better to allow inflation to be higher so negative rates were not necessary'. Presumably you're assuming, there, that monetary authorities will behave responsibly and not create double-digit inflation. But your arguments on negative rates seem to assume that they will behave irresponsibly.
The ability to charge people for holding excessive liquidity is not the same as an obligation to do so, it's merely an additional lever for managing the monetary system. It doesn't preclude allowing positive rates on savings, it merely removes savers' power to demand them. Responsible authorities would set a rate which balanced the need to keep the medium of exchange circulating with the need to keep the banks supplied with funds for investment. I don't know what rates would be, on average, over the long term, but my guess is that, most of the time, they would hover close to zero. At that level, I would expect most savers to be content with the security of government-backed money and not bother seeking riskier savings vehicles.
Malcolm,
DeleteI'm afraid I fundamentally disagree. Sight deposits are "in circulation". This is for two reasons:
- the majority of sight deposits are transaction accounts, on which the balance constantly changes as people buy and sell goods and services. Transaction accounts reflect the activity in the economy. Taxing transaction accounts is thus taxing productive activity.
- they form part of the liability side of bank balance sheets that are mainly made up of risky loans. I'm not going to get into another argument about what is meant by "funding", but it is a fact that sight deposits form a large part of the funding for bank lending.
Thus, sight deposits are not in any sense "hoarded" money. Hoarding would be buying gold then burying it under the floorboards, or withdrawing physical cash and stuffing mattresses with it.
If you want to tax people for hoarding, you should tax time deposits, not sight. Though even those form part of stable funding for lending, including lending to enterprises. Taxing them would therefore seem to be unproductive.
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ReplyDeletedamn good post
ReplyDelete"I fear for my children. But not because of public debt. No, I fear for them because of unemployment, underemployment, low wages, debt, poverty. And war. OMG, war. Can't we see that the path we are on now has in the past always led to war?"
ReplyDeleteWell yes.
I'm not qualified to comment on the different forms of banking, or money creation, discussed above. I follow you Frances and others discussing this because the questions around who (or what) controls the creation and distribution of money are obviously at the heart of the apocalypse we are making for ourselves.
It often strikes me though that this is all *just* about paper, or its electronic substitute. An entirely human creation not subject to any physical forces but laws we make up. That's what really comes out of 'thin air'. Blindingly obvious perhaps, but worth remembering sometimes.
It puts me in the slough of despair often but it also gives me hope - people can decide to change this, there's no god involved, and no escape velocity. If we survive this current nonsense I'm sure we'll look back in wonder at how self-inflicted this all is, and laugh at the absurdity.
Anyway thank you for a good post.
Frances:
ReplyDelete"Not providing liquidity to the banks in a crisis is an unbelievably dangerous proposal. That is why it is not part of the public discourse."
It is only dangerous if you do not have any other resolution regime to hand.
It is absolutely ludicrous to suggest, as you seem to be doing, we should again pay billions to the likes of Goldman Sachs (as the public did last time) to bail them out for some dodgy derivatives trades.
You are suggesting we do the same thing again. Clearly, the next time a crisis comes along, all these banks should allowed to go bust. In a nice orderly manner, taken over by the government, which would ensure that bad banks would be set up, which would take all the dodgy assets over, and return the remainder of the banks to the private sector, if that is what is wanted.
The cry "liquidity for everything" in a crash situation, brought about by the failure of one or more major banks in the world, should certainly be avoided.
Matt,
DeleteI'm very sorry, but your comment just displays how little you know. Liquidity doesn't "bail out banks". It keeps the payment system going, enabling ordinary people to pay their bills and receive their wages, businesses to pay their suppliers and their employees. Without that support, interruption in the flow of funds around the economy such as happened after the failure of Lehman would have been catastrophic. No "resolution regime" can ever be an adequate substitute for liquidity provision in a crisis.
Do not believe everything the banking industry will tell you. It is pretty clear that Goldman Sachs, together with many other investment banks would have gone under, if they had not had billions of $ pumped into them, to provide liquidity. Their was also no liquidity provision for Lehman, for example, but for other investment banks there was.
ReplyDeleteIn fact, their insurer of CDS on their dodgy mortgage securitisation, AIG, went bust, and so would they have, had the Fed not insured that they were bailed out, by providing liquidity.
The payment system should be a worry, but that of course can be decoupled much quicker and easier, and especially cheaper, if there is a crisis. If we do some contingency planning.
To just proclaim there should be unlimited liquidty in a crisis, as you do, when it is clear that the crisis is caused by some doubt about the solvency of market participants (otherwise we would not have a crisis) is just making the same mistakes again we were made in 2008.
So contingency planning has to be different, than throwing buckets of liquidity at the problem. But is is not. Which just shows that we have not learned anything.
No, Matt. This is just wrong.
DeleteLehman was allowed to fail for political reasons. The Fed was then forced to provide liquidity TO THE SYSTEM to keep funds flowing round the economy. The BoE had to follow suit when RBS failed: we were within half an hour of the payments system collapsing.
You cannot "decouple" the payments system from the banking system. You may be able to isolate individual failing banks, but what happened in 2008 was a systemic failure.
In a systemic crisis, it is not possible to distinguish clearly between solvent and insolvent banks, and it is dangerous to try to do so. It is also dangerous to cherry-pick which institutions qualify for liquidity support, because ALL money runs through banks. All of it. You can't decide to provide liquidity support for retail transactions, but not for wholesale ones, for example. When an investment bank fails, it puts at risk its settlement bank, and through that, the payments system.
I don't support bailing out insolvent banks. Indeed, I was one of the early voices calling for banks to be allowed to fail. But they have to be allowed to fail in a managed and orderly way. Disorderly collapses are disastrous.
It was the belief that banks shouldn't be bailed out that led to the disastrous decision to allow Lehman to fail. You would not only have allowed Lehman to fail, but then refused to allow the Fed to provide liquidity to the financial system after its collapse. That is insanity, pure and simple.
Please, please do some proper research. Your beliefs are not only wrong, they are very, very dangerous.