Keynes was a racist – shock horror.

Keynes once said, "We should encourage small political and cultural units. It would be a fine thing to have thirty or forty capital cities in Europe, each the center of a self-governing country entirely free from national minorities (who would be dealt with my migrations where necessary).”

Well that’s a bit un-PC, to put it mildly. In fact if you expressed the above sentiment nowadays, the politically correct would explode with contrived righteous indignation.

Of course it could be argued that Europeans are so similar racially, that the above idea of Keynes’s is not racist. However, anyone repeating the above sentiments nowadays would most certainly be accused of racism, not to mention xenophobia, Nazism, and every other expletive imaginable.

Incidentally I got the above quote from "Where Keynes Went Wrong" by Hunter Lewis, p.316. And he got it from "John Maynard Keynes" by Robert Skidelsky (vol3) p.218.


It get’s worse, or funnier (take your pick).

Another interesting bit of historical “shock horror” is that for several years after WWII, the British political left favoured Eugenics: that is denying those with defects the right to reproduce, or even disposing of them. And Eugenics is of course traditionally associated with Nazism.

Indeed The Guardian (Britain’s leading left of centre broadsheet newspaper) had doubts about the National Health Service when it was first set up, and on the grounds that the NHS would make it easier the feckless and defective to survive and reproduce.

Now this will of course have the sanctimonious section of Britain’s political left baffled. That is, they’ll be baffled as to how intelligent people, particularly left of centre intelligent people can accept the above sort of views. But that just illustrates the ignorance of the sanctimonious section of the political left in 2012.

The explanation is that the views adhered to by both political left and political right have nothing to do with REASON, as Simon Jenkins recently pointed out.

In other words if you try arguing in favour of Eugenics or preserving European sub-cultures (as per Keynes), you’d get nowhere. And it wouldn’t matter how good your arguments were, because REASON does not determine political views. What DOES DETERMINE political views is fashion, propaganda, the conventional wisdom, and so on.

Put another way, 90% of the human race (the intelligentsia included) are robots: they’ll think what they are told to think, and do what they’re told to do. The current deficit hysteria in the U.S., brought about in part by the hundreds of millions of dollars’ worth of propaganda funded by Pete Peterson is an example.

Or put it yet another way, if you are born into a society where a popular form of entertainment consists watching lions eat Christians in your local Colosseum then there is a 90% chance you’ll be happy watching lions eat Christians.

Or as Edmund Burke put it, “Custom reconciles us everything.”

As to Eugenics, there is a perfectly good argument in favour of Eugenics, namely that what with modern medicine and comfortable 21st century lifestyles, the genetic quality of the human race will be deteriorating, because survival of the fittest no longer operates to any great extent. That deterioration may in the future be countered by gene therapy of some sort. But if not, and if you want the human race to survive, then Eugenics is the only way forward.

Of course the latter argument could be flawed. I’m happy to listen to geneticists or similarly well qualified persons who think there is indeed a flaw there.

But don’t expect a reasoned response to the latter argument from the politically correct.

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Steve Keen’s debt jubilee idea.

Summary: I have plenty of respect for Steve Keen, but don’t agree with his debt jubilee idea. He argues that the process of paying off debts is deflationary, and that if we want to get the debt reduction process over quickly and return to normal levels of aggregate demand, we need stimulus, with debtors being made to use the stimulus money they receive to pay down their debts.

Strikes me the bureaucracy involved there is a problem. But more fundamentally, it’s the PROCESS OF PAYING OFF DEBTS that is deflationary. Thus if debtors who seriously want to remain indebted are allowed to do so, there is no deflationary effect. As to debtors who WANT TO reduce their debts, they will do so AUTOMATICALLY given stimulus. Thus there is no need for any sort of special “debt forgiveness” scheme.

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There has been a big rise in private sector debt over the last decade or so. Paying off this debt will have a similarly big and long lasting deflationary effect. So Keen wants the “paying off” to be speeded up with a “debt forgiveness” program or “debt jubilee”.

The essence of his argument is under the heading “A Modern Jubilee”. In contrast, the paragraphs PRIOR to that heading contain the technicalities and evidence to back his argument. His argument, as I understand it, is essentially as follows.

The accumulation of private debts is an important contributor to aggregate demand (AD), and in particular the ACCELERATION in the growth of this debt is the vital factor.

I have no quarrel with that.

He then claims that the LEVEL of private debt accumulation over the last ten years or is unprecedented, and that paying it off will involve such a degree of AD reduction that the only solution is a debt jubilee.

Now that argument would be valid if the only source of AD or potential AD was debt accumulation. But it’s not: government and central bank can perfectly well make up for any lack of AD by boosting private and/or public spending.

Indeed, Keen’s proposal is to do EXACTLY the latter, but channel a portion of the extra money towards debt reduction. He says:

“A Modern Jubilee would create fiat money in the same way as with Quantitative Easing, but would direct that money to the bank accounts of the public with the requirement that the first use of this money would be to reduce debt. Debtors whose debt exceeded their injection would have their debt reduced but not eliminated, while at the other extreme, recipients with no debt would receive a cash injection into their deposit accounts.”

First, I’m not sure that QE alone would have the required stimulatory effect, because QE has a negligible effect on private sector net financial assets. But that is a minor quibble: it’s not of crucial relevance to the basic argument here.

So let’s just assume that stimulus is implemented, and the net effect is to channel money into everyone’s pockets (debtors, creditors, you name it).


Bureaucracy.

The first problem with requiring debtors to use their newly acquired stock of money (stimulus money) to pay off their debts is the ENORMOUS amount of bureaucracy involved.

For example, just assuming debtors are induced to write out checks to their creditors, what’s to stop those debtors (where they want to maintain their level of debt) quietly incurring a similar amount of debt from other creditors (or even re-financing via the SAME ORIGINAL CREDITOR/S a few months later)?


Stimulus plus jubilee equals stimulus.

The second problem is this. As far as ultimate effects go, there is very little difference between Keen’s idea and a straightforward dose of stimulus (SDS) WITHOUT any specific attempts to have debtors pay off their debts.

To illustrate this point, I’ve listed below the six changes that Keen claims would result from his jubilee idea. Plus I’ve put comments in orange below after each.

1. Debtors would have their debt level reduced;

Same applies to SDS to the extent that debtors think the best use they can make of a cash windfall is to pay off their debts. In contrast, to the extent that they see fit to MAINTAIN their level of debts (and assuming their creditors are happy with that) I see no good reason to pay off the debts.) Moreover, simply MAINTAINING a debt at a constant level does not have a deflationary effect: it’s the PAYING OFF of debts that has the deflationary effect. So if a set of debtors want to maintain their indebtedness, where is the harm?

2. Non-debtors would receive a cash injection.

Same goes for SDS.

3. The value of bank assets would remain constant, but the distribution would alter with debt-instruments declining in value and cash assets rising;

To the extent that debtors see fit to pay off their debts, exactly the same applies to SDS.

4. Bank income would fall, since debt is an income-earning asset for a bank while cash reserves are not;

Same again: to the extent that debtors see fit to pay off their debts, exactly the same applies to SDS.

5. The income flows to asset-backed securities would fall, since a substantial proportion of the debt backing such securities would be paid off;

Same again: to the extent that debtors see fit to pay off their debts, exactly the same applies to SDS.

6. Members of the public (both individuals and corporations) who owned asset-backed-securities would have increased cash holdings out of which they could spend in lieu of the income stream from ABS’s on which they were previously dependent.

Same again: to the extent that debtors see fit to pay off their debts, exactly the same applies to SDS.

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Muddled thinking on ELR.

The idea that government should act as employer of last resort (ELR) is as old as the stars. And one of the main groups pushing ELR is based at the University of Missouri-Kansas City (UMKC). Unfortunately there is a large amount of muddled thinking on this subject, for example in this paper by Pavlina Tcherneva of the above university.

I’m frustrated at this because the UMKC lot favour Modern Monetary Theory (as do I), plus they favour ELR, and I favour ELR – thought I don’t agree with them on exactly what form it should take.

The flawed arguments Pavlina puts for ELR are as follows.


1. Trickle up and down.

ELR is desirable in that it involves trickle up whereas, traditional demand management involves trickle down, (p. 2 & 3).

The flaw in that argument is that while traditional demand management often involves trickle down (which I deplore), it does not HAVE TO. For example, the VAT reduction earlier in the recession in Britain is an example of traditional demand management done in a trickle up manner.

Thus trickle down is not an INHERENT CHARACTERISTIC of traditional demand management. Ergo the trickle-up characteristics of ELR are not an argument for ELR.


2. Poverty.

Traditional demand management does not deal well with poverty (p.3). True. However – and this is a bit of a statement of the obvious – countries in the West typically spend about 10% of their entire GDP on anti-poverty measures even in the middle of economic booms. For example in Britain, about HALF THE WORKFORCE get some sort of in-work benefit regardless of whether the economy is at capacity or in a recession. Raising aggregate demand (AD) raises AD. That’s it. That solves some problems, not others.

Blaming AD increases for not dealing adequately with poverty is like blaming internal combustion engine carburettors for not cleaning your clothes. Carburettors perform a specific and very limited role. Same goes for adjusting AD. Neither AD increases nor carburettors solve every problem under the sun, nor do they even solve a particularly large range of problems.

Moreover, the relatively low wages normally paid on ELR type schemes mean that ELR does not deal too well with poverty either.


3. Raising AD can exacerbate inflation.

Pavlina claims that traditional methods of boosting AD tend to be inflationary. Well, sure. So what do we conclude? That all jobs dependent on demand should be destroyed and replaced with ELR jobs – jobs which by their very nature are never going to be fantastically productive?

A better and more precise statement of the above “inflation” point is that raising AD where the economy is nowhere near capacity will not exacerbate inflation too much, whereas once the economy reaches capacity (or NAURU to put it another way), the inflationary effects of any further rise in demand are serious.

Thus there is no harm at all in using a straight rise in AD to deal with unemployment given spare capacity. Indeed, this is a FAR BETTER way of reducing unemployment than ELR because regular jobs (public or private sector) are more efficient than ELR jobs.

Of course it is extremely difficult to know exactly when the economy is at capacity or what level of unemployment corresponds to NAIRU. Nevertheless, it is a good idea to get the theory behind ELR right, and in particular to understand the very different role that ELR plays as between where the economy is above and below capacity.


4. ELR as an automatic stabiliser.

Pavlina claims (p.5) that ELR is a good automatic stabiliser.

The answer to that is that in as far as the wage paid for ELR work is no different to unemployment benefit, and in that that is the ONLY cost of ELR schemes, ELR is no better as a stabiliser than unemployment benefit.
On the other hand if ELR pays a wage HIGHER than benefits, that reduces the incentive to seek regular work, which gives rise to problems dealt with below. Plus if ELR schemes involve costs other than the cost of ELR labour, that also gives rise to problems dealt with below.


5. ELR promotes growth?

Pavlina claims that ELR work promotes growth.

She says, “Growth, in other words, is a by-product of strong employment, not the other way round. How do we launch a virtuous cycle? One of the most effective ways is through direct job creation in the public sector…..One modern proposal inspired by Keynes and Minsky is the job guarantee (ELR), in which the public sector provides a voluntary job opportunity, in a community project that serves a public purpose, to anyone willing and able to work but unable to find private sector employment.”

So hundreds of thousands of people engaged in not desperately productive public sector type work will boost growth? I think not. Of course there will be a finite effect on growth, but it won’t be spectacular.

I use the phrase “not desperately productive” because that is often the REALITY of ELR type employment. In the 1930s, the WPA was commonly said to stand for “we piddle around”.

Alternatively, if ELR jobs REALLY ARE productive, why would the regular public sector not already be doing the work concerned? Put another way, if ELR jobs really are about as productive as regular jobs, why bother with ELR - why not just expand the regular public sector? Looks like ELR is in check mate there.

Anyway, let’s look at the ways in which ELR might promote growth a bit more closely.

Let’s concentrate first on the wage paid for ELR work, and let’s assume the wage is the same as benefits. In this case, no extra aggregate demand (AD) ensues. So to that extent, “strong employment” will do precisely nothing to bring an economy “out of recession”.

The only exception to the latter point would come where ELR jobs improved the EMPLOYABILITY of ELR people. Unfortunately the empirical evidence is that employability is not improved very much on these schemes which are concerned with public sector type work: PRIVATE SECTOR type subsidised employment is a different matter – employability does seem to improve. Which is one reason I favour extending ELR to the private sector.


ELR pays a regular wage.

In contrast to the above “wage equal to benefits” scenario, let’s consider the other extreme: where the wage paid is the same as in the regular economy for given skills and experience. In this case those doing ELR work have NO MOTIVE to find regular jobs. So ELR reduces aggregate labour supply, which means AD has to be reduced. In fact it will have to be reduced so much the ELR scheme is no longer a net creator of jobs.

And for evidence to back the latter point, consider the fact that we’ve had a VAST EXPANSION in public sector spending relative to GDP over the last century, plus these jobs pay the standard rate for given skills etc. The result has had no discernible overall effect on unemployment.

Pay on ELR schemes could of course be somewhere between the above two hopeless extremes. But any such compromise would probably just combine the hopelessness of both extremes, the net result being a hopeless compromise.


Other factors of production.

As distinct from pay, let’s now concentrate on the skilled permanent labour, capital equipment and materials required for ELR schemes (i.e. “other factors of production” (OFP)).

If ELR schemes employ no OFP at all, then no extra AD ensues. So there again, “strong employment” has no effect on AD: it won’t bring an economy “out of recession”.

On the other hand if such schemes DO EMPLOY significant amounts of OFP, there is a problem, as follows.

If the economy is working at below capacity, the best cure for unemployment is a straight rise in AD, not ELR. So let’s assume the economy is working at or near capacity.

In this scenario, ordering up extra OFP for use on ELR schemes cannot be done because the economy is at or near capacity: the result will be excess inflation. I.e. to make OFP available for ELR means reducing the OFP available for the regular economy, which destroys jobs in the regular economy. ELR is in check mate again.

Conclusion so far: the idea that extra AD can or should come via ELR schemes is badly flawed. And that is NOT TO SAY that ELR does not FACILITATE a rise in AD. Indeed, as I argue here, ELR in the form of subsidised temporary jobs with existing employers should improve the inflation / unemployment relationship, which in turn makes possible a rise in AD.


6. Can ELR jobs be made voluntary?

Pavlina claims that ELR jobs should be voluntary. Now there is a problem there, which is that anyone who voluntarily moves from unemployment to a ELR job ipso fact believes they have moved to a more attractive situation or scenario. That means that the RELATIVE ATTRACTIONS for them of regular employment must have declined. I.e. aggregate labour supply is reduced. And that in turn means that ELR jobs will at least to some extent be at the expense of regular jobs.

In other words Pavlina has not cottoned onto Calmfors Iron Law of Active Labour Market Policy which states that if ALMP type employment is not to be at least partially at the expense of regular employment, there has to be an element of compulsion. (Lars Calmfors is a Swedish economist.)

There is absolutely no question but that people who want ELR to be voluntary have their hearts in the right place. I’m sure they are all socially concerned, kindly people. Unfortunately to do good in this world, TWO CHARACTERISTICS are required. First, generosity, and second, having your head screwed on.

 
7. The purpose of economic activity.

Pavlina claims, “The difference between the non-profit JG model and conventional fiscal policies is that the former is a long-run program that has an explicit objective to deal with the problem of unemployment directly, rather than treating it as a by-product of growth.”

The problem with that statement is that employment creation is not the basic economic objective. The basic objective is to maximise wealth creation WHILE MINIMISING the amount of work or “employment” needed to create that wealth.

Indeed, economic nirvana would consist of robots doing all the work, while human beings did whatever they pleased all day long: socialising, reading books, playing or listening to music. I know several people who have spent decades living on social security benefit for fraudulent reasons. They lead a very pleasant, easy going life-style. They could doubtless give lessons on how to lead a life of leisure to the “everyone must work” brigade.


Conclusion.

There is not a cat in Hell’s chance of the human race ever understanding labour markets (to be cynical or realistic – take your pick).

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Prof. Raghuram Rajan is clueless.

Rajan had an article in the Financial Times earlier this week entitled “Sensible Keynsians know there is no easy option.” The first paragraph reads:

“In the long run we are not dead, we will still be recovering from the Great Recession. We should therefor weigh stimulus policies not just their immediate effect but on their consequences over time. Sensible Keynesians recognise this. They bet that reviving growth through government spending today outweighs the future loss of growth as the debt taken on to fund current spending is paid back.”

Readers with a grasp of Modern Monetary Theory should immediately see the flaws there. They don’t really need to read any further.


Borrowing OR printing money brings stimulus.

The above suggestion that stimulus necessarily means more debt is nonsense. As Keynes, Milton Friedman and others pointed out, stimulus does not need to be funded by extra debt. It can perfectly well be funded simply by printing money. You’d think a self-styled “Professor” writing an article about Keynes would be acquainted with Keynes’s ideas.

Indeed, where a monetarily sovereign government borrows and spends, and then does QE, the end result comes to the same as the government / central bank machine printing money and spending it. Perhaps Rajan hasn’t heard of QE. (Incidentally, I’ll use the word government here in the sense “government and central bank combined”.)

In that a government goes for the “print” option, there is no “loss of growth” (as Rajan claims) when the debt / money is paid back. Reasons are as follows.


Two senses of the word “debt”.

There are actually two senses in which the word “debt” as used above can be taken. First, the result of QE is that the central bank is left holding government debt. And this is essentially a nonsense: it just amounts to one part of the “government machine” owing money to another part of the machine. Those so called debts can be torn up any time. They are to all intents and purposes meaningless bits of paper or meaningless book keeping entries.

The second sense is thus. In a fiat money system, money is a debt. And money created by the central bank is supposedly a debt owed by the central bank to holders of such money.

However, the word debt does not really apply here. As Willem Buiter put it, “These monetary (base money) ‘liabilities’ of the central bank are not in any meaningful sense liabilities, because they are irredeemable…”

But that does not alter the fact that the money printed during a recession may prove a source of inflation come the recovery. If so, some sort of deflationary measure will be required: like raising taxes and reining in and “unprinting” some of the money.

However, and contrary to Rajan’s suggestions, that does not involve a “loss of growth”: it simply prevents excess inflation. Indeed, excess inflation probably results in a lower GDP all else equal than obtains where the 2% or so inflation target that most countries aim for is achieved.


The “real debt” option.

To repeat, Keynes, Milton Friedman etc, pointed out that governments aiming for stimulus have two options: borrow money or print it. Let’s now consider the borrow option.

According to Rajan, paying back this debt involves a “loss of growth”.

Of course it is true that ALL ELSE EQUAL paying back debt is deflationary. But no government with its head screwed on would impose unnecessary deflation. Put another way, paying back debt (as in the above first “money” option) makes sense if the economy is overheating and inflation looms. And as in the case of the above “print money” option, the only net effect is to keep inflation under control: there is no “loss of growth”.

But if the debt IS NOT paid off, is that a problem? Certainly the word “debt” has nasty connotations or overtones. And for simpletons (i.e. Republicans, followers of Rogoff and Reinhart, and the Peterson Institute, etc) connotations and overtones are all they understand.

The REALITY is that if the real or “inflation adjusted” interest paid on debt is negligible (as for example it is in Japan, the US, and UK and various other countries), then such debt comes to much the same thing as money (or monetary base to be exact). That is, monetary base is in theory a debt owed by the central bank on which the CB normally pays no interest.

In contrast, if a significant real rate of interest IS BEING PAID on a country’s debt, that’s more of a problem. But escaping this situation is child’s play. Such a country just needs to print money and buy back the debt. Of course the effect of that could easily be too inflationary. But if inflation IS INDEED a problem, all such a country needs to do is get some of the money for the “buy back” from raised taxes. And as long as the inflationary effect of the money printing equals the deflationary effect of the extra tax, then there is no net effect inflation-deflation-wise.


Closed versus open economies.

In that our hypothetical country is a closed economy, the latter buy-back would result in no “loss of growth” or loss of living standards: all that takes place is a re-shuffling of assets and liabilities between different citizens of the country concerned.

In contrast, where a significant portion of the debt is held by foreigners AND in as far as foreigners take their money out of the country concerned, then then the country’s currency loses value on the forex market. And that certainly results in a standard of living hit for the country’s citizens for a while. But any such hit will be minimal and temporary.

I expanded on the latter point, see here.

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P.S. (25th May 2012). Chris Giles (economics editor of the Financial Times) makes the same mistake as Rajan. That is, he claims that the money or debt used to fund stimulus necessarily needs to be repaid and that this is some sort of problem. See his final sentence here.

P.P.S. (2nd June). Just noticed this blog post which also casts doubt on Rajan’s abilities.




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Hogwash from the Bank of England on QE.

I’ve just been through a BoE attempt to justify QE. It’s drivel.

After a few hundred words explaining what QE is, their first suggestion as to why QE might actually stimulate economic activity is that, “Direct injections of money into the economy, primarily by buying gilts, can have a number of effects. The sellers of the assets have more money so may go out and spend it.” (p.9).

“Can have”… “sellers of the assets… may spend it”??? What are they on about? The people running the economy ought to have a good idea as to whether “sellers of assets ACTUALLY WILL go out and spend”. Phrases like “May spend” and “can have” just aren’t good enough.

Plus I can think of a very good reason why “sellers of assets” WILL NOT “go out and spend”.

People hold Gilts (directly or indirectly as part of their pension fund) because that is a chunk of their wealth that they regard as their SAVINGS!!!!! Yes: S-A-V-I-N-G-S. If that chunk is converted to cash, the most reasonable assumption is that they will still regard said chunk of their wealth as savings. I.e. the WON’T go out and spend it. Doh!!!


The stock market.

The BoE continues, “Or they may buy other assets instead, such as shares or company bonds. That will push up the prices of those assets, making the people who own them, either directly or through their pension funds, better off. So they may go out and spend more.”

“May go out??” Why not look at the actual evidence here? This study found that in recent years consumer spending rises by one HUNDREDTH of a dollar for every dollar increase in a consumer’s stock market assets. So boosting stock market prices is an absolutely brilliant way of boosting consumer spending, isn’t it?

Moreover, even if boosting stock markets DOES significantly boost consumer spending, where is the justice in largess towards the wealthy, while the less well-off don’t get to increase their consumption of consumer goodies? Oh I forgot: politicians, central bankers and the wealthy are all in cahoots. Silly me.

The BoE continues, “And higher asset prices mean lower yields, which brings down the cost of borrowing for businesses and households. That should provide a further boost to spending.”

We’re suffering from the aftermath of a credit crunch caused by excessive and irresponsible borrowing, and all that central banks can come up with is trying to encourage more borrowing. Central bank staff clearly need psychiatric help.

Presumably central bank’s suggested treatment for someone just involved in a car crash would be to put them into another car and have them drive at 60mph into a concrete wall.


Reserves.

Next comes a real peach. The BoE claims “In addition, banks will find themselves holding more reserves. That might lead them to boost their lending to consumers and businesses.”

First, there goes that word “might” again: i.e. “we haven’t a clue”.

Second, anyone with a grasp of how the banking system works (and that evidently does not include central bank staff) knows that reserves are near irrelevant to commercial banks’ decision to lend. Or as Don Kohn (Former FRB Vice Chair) put it:”I know of no model that shows a transmission from bank reserves to inflation”.

Or as Vitor Constancio (ECB Vice President) put it: “The level of bank reserves hardly figures in banks’ lending decisions; the supply of credit outstanding is determined by banks’ perceptions of risk/reward trade-offs and demand for credit”.

As to the actual evidence, we’ve had an ASTRONOMIC and UNPRECEDENTED increase in bank reserve over the last two years. And the effect? Banks are more reluctant to lend then they were in the good old days when we had Captain Mainwaring type bank managers. What can you do in response to all this, but laugh?

Next, the BoE claims, “More generally, the Bank of England’s purchases of both government and corporate bonds also increase the total demand for those types of assets, pushing up their prices. This is another way in which the Bank’s actions will make it cheaper for companies to raise finance.”

No doubt QE does “make it cheaper for companies to raise finance”. But what in Heaven’s name is the point of boosting an economy purely via one particular form of economic activity, that is lending to companies? You might as well boost an economy just by boosting sales of cars, baked beans, central heating systems and massage parlours.

Central banks staff (and other smartly dressed economic illiterates mingling around the centres of power in the world’s capital cities) need to be reminded that the basic purpose of economic activity is the produce what the CONSUMER WANTS. That’s “what the consumer wants” either as expressed by consumers with their credit cards etc, and as expressed by consumer / voters at election time when they vote for a significant proportion of GDP to be allocated to public spending.

I.e. given a recession, what needs boosting is consumer spending and public spending. And the empirical evidence is that when consumers come by a windfall or their income increases, the do actually spend a significant proportion of the money concerned. See here, here, here or here.

Note that I didn’t use words like “may” or “might” or “can”. I cited EMPIRICAL EVIDENCE as to what consumers ACTUALLY DO.

As to public spending, if this cannot be increased quickly come a recession, then bureaucrats running government departments and local governments need to be given lessons on how to expand or contract their spending and the numbers they employ within a month or two. The actual SIZE of the increased spending does not need to be huge. 5% would do the job. 

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 P.S. (same day). Error. When first putting the above post online, I said that the above mentioned study into the effect of a stock market rise on consumer spending found a one dollar rise in share prices gave rise to a thousandth of a dollar of extra consumer spending. The figure is actually a hundredth.

P.P.S. (25th May 2012). The above post is not supposed to imply that QE is useless: it’s just some of the BoE arguments for QE that I object to. The basic argument for QE is that it negates a weakness in fiscal policy: crowding out. That is, if government borrows and spends, the borrowing will tend to raise interest rates, which to some extent thwarts the desired effect of the spending. QE (or simply having the central bank keep interest rates constant when a fiscal boost is implemented) helps ensure that crowding out does not occur. Least that’s how I see it.

Prof. Mariana Mazzucato makes amazing discovery.

Mariana Mazzucato (professor of economics and other stuff) has made an amazing discovery, namely that investment is needed for economic growth.

At least that is the basic and only message in a recent Guardian article of hers.

She says “Growth requires investment”. You could have knocked me down with a feather.

And her final paragraph reads, “So if growth is really on the agenda, the focus should be on the productive investments needed to rebalance Europe, and mechanisms that allow that to happen.”

I have news for Prof. Mazzucato.

Investment is NOT NECESSARILY REQUIRED for growth: not where a firm already has enough invested. As to which firms do need to invest, and which don’t, we don’t need professors of economics to sort that one out. If we just increase demand, businesses which benefit from investment will do so automatically – else they’ll get driven out of business by their competitors.

As to what the mysterious “mechanisms” are that would “allow that (investment) to happen”, I’m mystified and Mazzucato doesn’t tell us. Though I do have one suggestion: if economics professors did more thinking before speaking on this subject, that would be helpful.


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The difference between MMT and Keynes.

Dean Baker said recently that he couldn’t see the difference between Modern Monetary Theory (MMT) and Keynes. Which is fair enough because the differences are not great. So I’ll try to set out some differences.

Failure to understand MMT, far as I can see, is actually a failure to fully grasp two points: first, the difference between macro and micro, and second, the difference between a monetarily sovereign country and a non-monetarily sovereign country. (A monetarily sovereign country is one that issues its own currency.)

And the list of household name economists who do not fully understand the latter two points is truly amazing. The list includees Brad De Long, Lawrence Summers, and Martin Wolf, as I’ll show below.

The above claim that failure to fully understand the significance of monetary sovereignty is an important element in failure to understand MMT is supported by the fact that MMTer Rodger Mitchell constantly bangs on about monetary sovereignty and constantly finds examples of economists who trip up because they don’t fully get the significance of it.

To say there are differences between MMT and present day Keynsians (or at least people who are not strongly opposed to Keynes’s ideas) is not the same as saying there is a difference between MMT and the actual ideas put by Keynes himself. I won’t dwell much on the latter, as I’m not a Keynes expert.


1. Micro and macroeconomic entities are different.

Re the difference between macro and micro, DeLong and Summers are concerned here about whether a government deficit will in the long run be self-financing.

That concern makes no sense. MICROECONOMIC entities must in the long run be self-financing. For example, a household’s outgoings cannot in the long run exceed its income, else it goes bust.

In contrast, GOVERNMENT’S outgoings can exceed its income till the end of time. (Incidentally I’ll use the word government in the sense “government and central bank combined”).

Indeed, the US and UK’s government’s outgoings ACTUALLY HAVE exceeded income decade after decade for the last seventy years at least.

And the reason government can do this that it can print and spend money. Of course there are limits to how far government can indulge in this practice if excess inflation is to be avoided. But there is no question but that governments of monetarily sovereign countries can do this.


2. Government borrowing is pointless.

A microeconomic entity, if it wants to spend more money than it actually has, must borrow (as indeed must non-monetarily sovereign countries, like Eurozone countries).

In contrast, a monetarily sovereign country does not need to borrow: it can simply print money and spend it.

Keynes said that in a recession, government should either borrow extra money and spend it, or print extra money and spend it. Personally I doubt that Keynes actually meant what he said when suggesting that government should borrow. He was politically very astute, and knew what the reaction of economically illiterate politicians would be to anything they didn’t like the sound of. I suspect Keynes knew what the reaction of politicians would be had he put too much emphasis on the “print and spend” option. He thus tended to advocate “borrow and spend”.

In contrast, MMTers are not bothered about the reaction of economic illiterates. MMTers tend to blurt out the truth, as they see it: namely that it is pointless for a government that can print infinite quantities of currency whenever it wants to borrow the stuff. Certainly Abba Lerner (often said to be the founding father of MMT) did not advocate that government should borrow and spend in a recession. He favoured the print and spend option. (He did advocate government borrowing, but only as means of controlling interest rates – not a policy I personally approve of.)


3. Effect is all that matters.

As Lerner stressed, the important consideration in connection with a change to government spending is not the numbers involved but the ACTUAL EFFECT of that change. That might sound like a statement of the obvious, but plenty of present day Keynsians (never mind Austrians and others) don’t get it.

A classic example concerns the multiplier. Plenty of present day Keynsians (e.g. Alberto Alesina and Francesco Giavazzi) think there is merit in a recession in channelling government spending towards areas which have a decent multiplier. Reason being that one gets a bigger effect employment-wise than from low multiplier type spending.

The thinking behind this is of course that “money is saved” in the process. And the flaw in that argument is that printing and spending more money costs nothing in real terms. Or as Milton Friedman put it, “It need cost society essentially nothing in real resources to provide the individual with the current services of an additional dollar in cash balances.” (That’s from Ch 3 of Friedman’s book, “A Program for Monetary Stability”.

In other words, there is no point distorting the economy towards high multiplier areas, because there are no REAL COSTS involved in ignoring the multiplier.

The above “multiplier myth” is another example of failure to see the difference between macro and micro.


4. “Fiscal space” is hogwash.

A popular idea currently doing the rounds and adhered to by many self-styled Keynesians (particularly in the IMF and OECD) is that when a country borrows too much it runs out of “fiscal space”. That is, such a country loses the ability to effect stimulus because it cannot borrow any more.

Well the answer to that is, as pointed out above, a monetarily sovereign country does not need to borrow in order to effect stimulus – a point that MMTers have grasped, but which others apparently have not.

Martin Wolf and Jonathan Portes (head of Britain’s National Institute of Economic and Social Research) are examples of economists who adhere to the idea that high interest rates demanded by potential creditors limits and country’s ability to effect stimulus.

For more on the nonsensical “fiscal space” idea, see here.


5. The purpose of tax is to counteract inflation, not to collect revenue for government.

The above is a point often made by MMTers. It’s a bit of a semantic point. But the point certainly contains an underlying truth. It derives, logically, from the statement that inflation is the only constraint on the deficit or on government spending.

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David Cameron’s deficit fixation.

Congratulations to Martin Wolf for attacking David Cameron’s fixation with the deficit in today’s Financial Times.

It would be nice if the so called economists advising Cameron had studied economics – Keynes in particular. Keynes said (quite rightly) “Look after unemployment, and the budget will look after itself”.

However, Martin Wolf is wrong to argue that “With long term government borrowing as cheap as in living memory….now is the time for government to borrow.” (Actually those are the words of Jonathan Portes, director of the National Institute of Economic and Social Research, who Martin Wolf quotes.)

The reason Wolf and Portes are wrong is thus. Even if interest rates were relatively high (because say of a reluctance by creditors to lend to government), that would be no reason to hold back on stimulus assuming stimulus was clearly justified (i.e. because the economy was obviously working at below capacity).

Given relatively high interest rates and a need for stimulus, the government / central bank of any monetarily sovereign country can simply print and spend money instead of borrow and spend money, as both Keynes and Milton Friedman pointed out.

I’ve already referred about fifty times on this blog to the latter point made by Keynes and Friedman. Clearly I’ll just have to go on repeating it till I’m blue in the face.

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Some money is BOTH base AND broad.

Most people who have worked thru a basic introductory economics text book know that a nation’s stock of money can be split into an infinite number of categories. But one common categorisation involves splitting money supply into just two categories: base and broad.

Base money is central bank created money. Other names include “the monetary base” or “high powered money”. In contrast, there is broad money, i.e. commercial bank created money.

However, there is a small portion of the total money supply which is both base AND broad. This arises where a private sector non-bank entity purchases government debt. And this small portion of the money supply seems to give rise to a large amount of confusion: hence this post.

When a non-bank entity buys government debt, the central bank then owes the entity a debt. But non-bank entities cannot deal direct with central banks. So when the above purchase occurs, the arrangement the relevant parties end up with is: central bank owes a commercial bank a debt, and the commercial bank owes the above entity a debt.

Or as the Bank of England puts it, “When assets are purchased from non-banks . . . the banking sector gains both new reserves at the Bank of England and a corresponding increase in customer deposits.”

And in a different document, and in different words, the BoE says, “If the Bank of England purchases an asset from a non-bank company, it pays for the asset via the seller’s bank. It credits the reserve account of the seller’s bank with the funds, and the bank credits the account of the seller with a deposit. (Hat tip to Gillian Swanson for directing me to the above BoE articles.)

Money is of course a form of debt: a creditor / debtor relationship. And the creditor in that relationship can make someone else the creditor (for some or all of the debt). “Making someone else a creditor” is commonly known as “making a payment”.

The actual size of the above tranche of money that is both base and broad is normally insignificant. But it will have risen substantially as a result of QE. As far as I can see from U.S. figures, the size of this tranche is currently about the same as the total amount of physical cash in circulation ($100 bills, coins, etc).

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Banks are inherently fraudulent institutions.

A bank, by definition, is an institution which undertakes to return $100 to depositors for every $100 deposited. Or to be strictly accurate, it undertakes to return $100 possibly plus some interest and possibly less some expenses. However the two latter are small compared to the capital sum: about 5% of the capital sum per year at most.

In contrast to guaranteeing to return $100 for every $100 deposited, investment and lending are risky activities. If you “invest” in the stock exchange, or in your own business or the business of a friend or relative, you might double your money or lose the lot.

Thus the phrase “investment banking” is blatant self-contradiction: it’s fraudulent. Or rather it’s an attempt to fool depositors: it’s an attempt to persuade them they can be guaranteed to have their $100 back, at the same time as reaping the rewards of engaging in commerce: making an investment that might involve the $100 disappearing. And normal banking or retail banking isn’t much better.

And who pays for the above fraud or charade? Well, it’s the taxpayer.

Unit trusts and mutual funds don’t make the above absurd promise about returning $100 per $100 deposited, so why should banks be allowed to make this promise?


Fooling politicians and everyone else.

The word bank, and in particular the phrase “investment bank”, are also attempts to fool politicians. Those are the folk who are supposedly the guardians of taxpayers’ money, but who in fact are easily fooled into parting with taxpayers’ money.

That is, ever since banks first appeared on planet Earth, bankers have persuaded politicians that the banking system cannot be allowed to fail, thus taxpayers’ money must stand behind banks, including investment banks.


Ban bank lending?

So the logical course of action would seem to be to certainly ban banks from investing, but also to ban them from lending. However there is an apparent problem there, or rather there is an alleged problem which most bankers know perfectly well is not a problem at all. It’s a pseudo problem which politicians can easily be made to fall for. And it’s the alleged fact that if banks don’t lend, that constrains economic activity. Or it constrains growth. And banks are very concerned about growth: you can tell that from the fact that they’ve done about as much for growth over the last five years as was done for the economic growth of Hiroshima and Nagasaki by the atomic weapons dropped there.

Now obviously, all else equal, if banks stop lending, that constrains economic activity. That is, if those with money to spare cannot invest their money via one of those fraudulent institutions we call “banks”, then less investment or lending takes place. (Those with money to spare can still of course invest via other entities: the stock exchange, unit trusts, mutual funds, etc).

But the above assumption that all else needs to be equal is of course total nonsense. That is, the deflationary effect of preventing banks from investing or lending can easily be compensated for by increasing the money supply.


Those Austrians, yawn, yawn.

Now the knee jerk reaction of Austrians and other simpletons to the phrase “increase the money supply” is entirely predictable: they’ll start chanting “Weimar”, “Mugabwe”, “inflation”, etc. However (to repeat the point for the benefit of simpletons) the above money supply increase won’t be inflationary as along as the stimulatory / inflationary effect equals the DEFLATIONARY effect of stopping banks engaging in investing or lending.

Another factor that contributes to the reluctance to constrain, if not ban bank lending is the popular perception that money in a bank somehow represents real wealth; and that failure to invest this money means real wealth lying idle. Most politicians suffer from this delusion, and even those sitting on Britain’s recent investigation into banking, the Vickers commission, suffered from the delusion.

The truth is that money in banks is nothing more than a series of book keeping entries (or if you like, numbers in computers). Money is nothing more than a claim to resources. It is not “resources” as such. It does not equal real investment in the same sense as a house or factory is a real investment.


Back where we started?

Now it might seem that if we ban investment and/or lending by banks and compensate for that by increasing the money supply, that we’re back where we started.

Well we certainly OUGHT to be back where we started in that GDP would be back to where it started. But we wouldn’t be back where we started in a very important sense: taxpayers would no longer be underwriting commercial activity. That is, taxpayers would no longer stand behind investments or loans made by banks.

In fact, if the cross subsidisation of banks and depositors by taxpayers is banned, then GDP ought to RISE, all else equal.


Taxpayers SHOULD stand behind genuine savings accounts.

In contrast to investing, having access to an account which is 100% safe is arguably a basic human right. Possibly this sort of account should be run by the state. Or possibly banks should be allowed to run this type of account, with state backing, but with very strict limits on what can be done with the money.

Even investing in government stock is questionable because such stock can rise or fall in value. Personally I’d allow nothing to be done with the money other than lodging it at the central bank.


Basle plonkers.

Of course an alternative way to ensure bank safety is to ensure adequate bank capital. That supposedly means that when a bank has an unusual run of bad luck or incompetence with its investments or loans, depositors’ money is still safe.
But the problem there is the people framing rules on capital adequacy are manifestly incompetent, plus they are wide open to regulatory capture. According to Mervyn King, the best capitalised bank in the UK according to Basle II rules three months before the collapse of Northern Rock was . . . . have a guess . . . . wait for it . . . Northern Rock.


Conclusion.

The best solution is just to ban institutions which promise to repay $100 for every $100 deposited from investing or lending.


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Banks aren’t lending to SMEs – boo hoo.

British politicians have over the last year or so been worrying about the reluctance of banks to lend to small and medium size enterprises (SMEs). I criticised politicians for this concern about a year ago here. It’s time to make some additional points on this topic.

In addition to politicians, Positive Money makes much of the fact that banks lend primarily to those purchasing property while failing to fund SMEs and socially desirable stuff like infrastructure. (Incidentally, I support Positive Money, but disagree with them on a few points.)

Investments made primarily or partially because of their social desirability are dead loss from the strictly commercial point of view (at least that’s certainly the case with the National Health Service and state education). Given that banks undertake to repay depositors about £100 for every £100 deposited, it is a BLATANT SELF-CONTRADICTION to expect banks to invest in loss makers. (To be more accurate, banks undertake to repay the original £100 possibly plus interest and possibly less expenses.)

As regards SMEs, much the same point applies: it is a SELF-CONTRADICTION to ask an institution to guarantee to return £100 per £100 deposited AND take significant risks.
In contrast, for those who want to take a risk, there are plenty of options: i) the stock exchange, ii) start your own business, iii) help a friend or relative with their business, iv) bet on a horse.

Banks INEVITABLY go for safe investments, like property. And even property has not proved safe enough over the last five years.

Frances Coppola makes a good job of attacking the “banks must lend more to SMEs” argument.

As pointed out above, it is fundamentally silly to expect an institution which guarantees to return money to depositors to take risks. But of course the way we’ve solved this problem so far is to have government guarantee banks. And for the naïve, that seems to solve the problem: banks can take risks while depositors’ money is safe. Problem is that that just means taxpayers are subsidising commerce. And it’s not the taxpayer’s job to do this.

A vastly more intelligent and logical solution to the above safety / risk conundrum is to make depositors come clean: that is, force them to decide between safety and risk taking. Put another way, depositors need to be prevented from having their cake and eating it (enjoying the rewards of risk without actually taking any risk).

And that can be done via the “two account” system advocated by Positive Money and others in their joint submission to the Vickers commission. (See “Step 1”, p.7, here.)

The two account system enables a depositor to EXPLICITLY allow the depositor’s bank to take a risk with their money. The benefit for the depositor is a better rate of interest. The drawback is that this is COMMERCE, and there is no obligation on taxpayers to rescue those who take commercial risks if everything goes belly up. That is, under the two account system, depositors who explicitly let their bank take a risk with their money do not get their money back, or don’t get all of it back, if everything goes belly up.

That two account system might result in far more money being allocated to SMEs than politicians wittering on about the subject.


Is more alcohol the solution to alcoholism?

Another fundamental absurdity in politicians’ concern about bank lending to SMEs is that we’ve just had a credit crunch caused by excessive and irresponsible borrowing (in case you hadn’t noticed). And the solution adopted by the authorities? Well it’s to cut interest rates so as to encourage more lending and borrowing. You just couldn’t make it up.

In particular, having lent irresponsibly, banks have learned their lesson. They’re more cautious about lending. Politicians, it seems, have not learned any lessons. Politicians think the solution for excessive lending and borrowing is yet more lending (to SMEs in particular).

Presumably politicians think the cure for alcoholism is to supply alcoholics with yet more alcohol. And the cure for someone with a broken leg? Presumably it’s to break the other leg.


Lenders need specialist knowledge.

Lending to an SME ideally involves a detailed knowledge of the particular business the SME is in. And the average British bank manager just does not have that knowledge. Thus loans to, or investments to SMEs will inevitably tend to come from specialist lenders: not bog standard high street banks.

For example, Siemens has set up a bank. Siemens clearly has a detailed knowledge of the business it is in.

As this Financial Times article put it, “Siemens often acts an anchor lender, prompting other banks to participate as they presume that the engineering group is better placed to judge the technological risks of a project.”


Less lending constrains economic growth?

A popular argument put by economic illiterates (aka politicians) is that less lending means less economic growth. This is also an argument put by banks when lobbying for less bank regulation. And politicians fall for the argument every time.

Well is blindingly obvious that less lending means less growth ALL ELSE EQUAL. But of course there is no need for all else to be equal. That is, given less lending, demand and growth can perfectly well be boosted by boosting plain simple old consumer spending and/or increased public spending.

That boosts firms’ order books, and for what it is worth, there is nothing that potential lenders like more than a firm with a full order book.

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If the market can’t allocate the unemployed to jobs, why not have the bureaucracy do it?

In a perfect market, a surplus of people with a given set of skills and experience (i.e. a particular “type” of labour) would cause a drop in the wage for that type of labour. The market would clear, and all members of that type of labour would find employment. So given a perfect market, there’d be no unemployment.

At least that would be the case assuming there is nothing of a macro-economic nature preventing full employment. E.g. let’s assume the above wage cuts result in instantaneous price cuts, which increases the value of the monetary base and national debt. That in turn means a rise in value of private sector net financial assets, which in turn raises aggregate demand. (That’s the “Pigou” effect.)

So perfect market = full employment. Imperfect market = unemployment. That’s the problem. Now for the solution – well, an improvement on the current situation anyway.


The market and the bureaucracy.

There are two ways of allocating economic resources: allocation by the market and allocation by the bureaucracy. Since the market can’t allocate the unemployed, what system should the bureaucracy adopt in order to do the allocation? How about this.

Assume that given a decline in unemployment, every employer would expand numbers employed in the same proportion. That is a crude assumption. But it’s very roughly correct.

So assuming the objective is to expand numbers employed by each employer in the same proportion, employers need to be told, “You can expand your payroll by X%, and the additional employers will be free. Moreover, this is something you really ought to do because your competitors will probably be doing it, which will cut their unit costs. I.e. if you don’t do likewise, your competitiveness will decline.”

Hey presto: unemployment falls.

Well that’s the theory. Now for the possible problems.


Would the free employees displace regular employees?

Obviously it’s impossible to guarantee that out of the millions of employers in the country there would never be an instance of regular employees being displaced.

But the more important point is to consider the main “overall” or macroeconomic effects. And the important point here is that the above mentioned rise in aggregate demand would mean that OVERALL, there’d be no net displacement. That is, on balance, there’d be a net rise in numbers employed. (Incidentally, in the real world, there’d be no need to rely on the Pigou effect: governments can of course raise aggregate demand whenever they want).

Moreover, there are several measures that can be taken to dissuade employers from using free employees as substitutes for fully viable employees. For example if the time that a given free employee stays with a given employer is limited to a few months, that induces employers to claim the subsidy only in respect of their LEAST PRODUCTIVE employees: no employer wants to lose their MORE PRODUCTIVE employees.


And finally.

And finally, smart readers will have noticed that the above system comes to the same thing as a “Government as Employer of Last Resort” system, of a particular type. It’s an ELR system under which the unemployed are allocated to EXISTING employers, public and private, rather than allocating them to SPECIALLY SET UP EMPLOYERS doing just public sector type work (which is what the WPA and numerous other ELR systems have consisted of).

In other words, the above is a piece of theory which underpins the idea: “allocate ELR employees to existing employers, public and private.”

Obama boasts about having cut government spending during the recession.

I realised long ago that governments are economically illiterate. But it’s worse than that: seems they’re actually economically mad.

According to TPM Livewire, the transcript of one of Obama’s speeches reads, “It’s worth noting, by the way – this is just a little aside – after there was a recession under Ronald Reagan, government employment went way up. It went up after the recessions under the first George Bush and the second George Bush. So each time there was a recession with a Republican president, we compensated by making sure that government didn’t see a drastic reduction in employment. The only time government employment has gone down during a recession has been under me. So I make that point just so you don’t buy into this whole bloated government argument that you’re hearing.”

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Mervyn King and the economics profession need to study the Tinbergen principle.

Mervyn King said in a recent speech that inflation was well under control prior to the crunch. See paragraph beginning “Let me start…”. That is pretty much correct. It is true that in the early 2000s inflation was definitely below the 2% target, while just before the crunch it was a bit over the target (3% at most). But certainly, King is more or less right: inflation was under control.

But that raises a dilemma. Had the excessive borrowing taking place prior to the crunch been reined in with higher interest rates, that would arguably have brought an unnecessary dose of deflation.

At least for those not acquainted with the ideas put by the economics Nobel laureate, Jan Tinbergen, there seems to be a dilemma.


The Tinbergen principle comes to the rescue.

The Tinbergen principle states that for each policy objective, at least one policy instrument is needed. Personally I don’t like that formulation. I’d re-phrase the Tinbergen principle thus: for each policy objective, there is a policy instrument best suited to meeting each objective.

Anyway, the obvious way to deal with excessive borrowing is to raise the price of borrowing, i.e. raise interest rates. And assuming that is correct, it follows from the Tinbergen principle that the best way of adjusting demand must be SOMETHING ELSE.

And indeed, there is very simple and different way of adjusting demand: have government create new money and spend it (and/or cut taxes). Or conversely, given a need to rein in demand, government can do the opposite: raise taxes and “unprint” the money collected.

Had interest rates been raised prior to the crunch, at the same time as implementing the right amount of “print and spend”, borrowing would have been reduced, while overall demand would have remained constant. That is, demand would have shifted FROM attempts to purchase more and bigger houses TOWARDS other consumer items (and/or increased public spending).

Indeed, under a full reserve banking system where demand is adjusted JUST BY the above “print/unprint” policy, interest rates would rise AUTOMATICALLY given a surge in attempts by households (or anyone else) to borrow more.


Objections.

The reaction of some of those who accept the conventional text book description as to how the banking system works will be to claim that the above “print and spend” policy would raise bank reserves, which in turn would reduce interest rates and ENCOURAGE lending.

The answer to that is that the above conventional text book description is wrong (as is now widely accepted). That is, banks and their lending activities are capital constrained, not reserved constrained.

For some literature on the latter point, Google something like “banks capital constrained reserve”.

I listed a good ten or so reasons here as to why using interest rates to control demand is not a brilliant idea here. The above “dilemma” is yet another reason to add to the list.

Another possible objection to the above “raise rates and print” policy is thus. Central banks cut interest rates by buying government debt. That puts cash or monetary base into the hands of the private sector, which in turn reduces rates. However, the above “raise rates and print” policy WOULD ALSO put cash into the hands of the private sector – which would on the face of it reduce rates.

The answer to that is that there is big difference between putting monetary base into the hands of would be lenders (former Gilt holders), and putting monetary base into the hands of the average household. In the latter instance, a smaller proportion of the new money will be lent.

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P.S. (same day). Hat tip: I learned about Mervyn King’s speech from Frances Coppola’s blog. She also comments on his speech.



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Benjamin Franklin’s arguments for increasing America’s money supply.

In 1729 Benjamin Franklin wrote a 6,500 word article advocating an increase in America’s money supply. I’ve done a 700 word summary below. (I learned about Franklin’s article from Mike Norman’s blog.)


Ultra brief summary.

Basically, Franklin argues that a shortage of money leads to a semi-barter economy, which is inefficient. And he argues for money to be created in the form of bills of exchange with land being the collateral that backs such bills. Interestingly, he is aware of the Real Bills doctrine (or the idea behind it) namely that banks will only issue an amount of money or bills that the rest of the private sector actually wants or needs to do business, etc.


This summary is not 100% accurate.

I don’t guarantee the summary is entirely accurate, particularly as there are some convoluted passages I don’t understand. But hopefully the summary will give a flavour of Franklin’s arguments. In fact Franklin himself pleads for similar indulgence. He says, “As this Essay is wrote and published in Haste, and the Subject in itself intricate, I hope I shall be censured with Candour, if, for want of Time carefully to revise what I have written, in some Places I should appear to have expressed myself too obscurely, and in others am liable to Objections I did not foresee.”


700 word summary.

Franklin starts with four points, after which he lists another four points relating the SORT OF PEOPLE likely to favour and oppose a money supply increase. I’ll take all his points in turn including the above eight. I’ve put MY COMMENTS on Franklin’s ideas in brackets.

First, he claims that a shortage of money results in a high interest rate. And trade is discouraged because those with money will tend to lend it out at interest rather than invest in a business. As distinct from businesses in general, Franklin is particularly concerned about the price of land, and thinks that a high price for land is desirable because it encourages husbandry.

(Strikes me that a shortage of money will result in people paying a high price to borrow MONEY, but I see no reason it would result in a high price (in terms of person hours) to borrow anything else. A country that is short of money is a semi-barter economy. Trade is discouraged in that barter is inefficient, but not because of the “high price” of business assets.)

Second, Franklin claims an increase in the money supply has encouraged ship building.
(I expect he is right: I would expect more money to encourage specialisation, e.g. in shipbuilding.)

Third, a lack of money induces would be immigrants to migrate to countries with more money. This is a problem when those potential immigrants are what Franklin calls “Labouring and Handicrafts Men, which are the chief Strength and Support of a People”.

Fourth, lack of money encourages the consumption of European goods. Plus it encourages employers to pay their employees partially in kind rather than in cash (which is what you’d expect in a semi-barter economy).


The sort of people likely to favour and oppose a money supply increase.

1, Those currently engaged in money lending.
2. Those currently in possession of plenty of money, even if they don’t engage in money lending.
3. “Lawyers, and others concerned in Court Business.” The reason Franklin gives is that the legal business results in people going into debt (presumably to pay fines, etc).
4. Dependents on and friends of the above three.
In contrast, traders and manufacturers will favour a money supply increase.
Franklin then considers whether a money supply increase will debase the value of money, and he starts by pointing out that barter is inefficient. He then points out that gold and silver have often been used as money. But the value of precious metals varies. Franklin claims the value of silver in terms of person-hours shrank to a sixth is former value after large quantities of gold and silver were transported to Europe by Spaniards from mines in central America.

He then considers bills of exchange and points out their convenience.

Then he argues for bills based on land. He says, “For as Bills issued upon Money Security are Money, so Bills issued upon Land, are in Effect Coined Land.” Plus he points out that with America’s population rising, the value of land should continue to rise so there is minimal danger of the value of the collateral declining.

He gets the point that more than one factor gives money its value. He says, “Money as Bullion, or as Land, is valuable by so much Labour as it costs to procure that Bullion or Land. Money, as a Currency, has an Additional Value by so much Time and Labour as it saves in the Exchange of Commodities.”

In the paragraph starting “From these considerations” he doesn’t seem to think that an excess money supply leads to inflation. He does not give any good reasons in this paragraph. The really good reason comes in the next paragraph…..

In the paragraph starting “If it should be objected…” he gets the point that the population will only “coin land” (i.e. demand money) to the extent that money is needed in order to do business. This is essentially the “Real Bills Doctrine”.

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The U.S. public sector CUT employment during the recession!!!!!

This is my chart of the week – copied from Warren Mosler’s site. The contents should be broadcast from the rooftops. I actually drew attention a few weeks ago to research indicating that U.S. states failed to spend stimulus money. But a picture or chart is worth a thousand words.

Of course the chart is misleading in that a more realistic chart would have a horizontal axis representing zero public sector employees. Put another way, the coloured lines in the chart shown here should really be more or less horizontal. Nevertheless, the chart makes its point.


Public versus private sectors.

The private sector cannot be blamed for cutting jobs in a recession: the private sector reacts to demand, and if demand declines, then the number of private sector jobs declines. That is unavoidable.

In contrast, it is precisely the PUBLIC SECTOR that is in a position to maintain, or even expand employment in a recession.

Excuses for not re-allocating surplus labour.

Some parts of the public sector are similar to the private, in that they also depend on demand. But that is not a good excuse for failing to re-allocate labour within the public sector in a recession.

Another possible excuse for the public sector failing to re-allocate labour in a recession is that the public sector is not as good at employing relatively unskilled labour as the private sector. While the people being re-allocated may well be skilled, the point is that the mere fact of their jobs becoming superfluous is an indication that there is an over-supply of their skills. Thus they are likely to have to work in a relatively unskilled capacity for a while.

But if the public sector CAN’T re-allocate these people, then I don’t see much hope for a large scale WPA, or “make work” or “job guarantee” scheme (as advocates of Modern Monetary Theory call it), because that would involve vastly more relatively unskilled people doing public sector type work.


The lesson to be learned.

The moral is that public sector managers need to be made to think up and have a list of peripheral or less important jobs or projects that need doing: jobs and projects that come into existence given a recession. And I’m not claiming the latter is an original idea: I seem to remember reading something about local governments in Sweden being made to have a list of peripheral jobs and projects that can be implemented, in a recession.

The phrase “jobs and projects” might sound like a tautology. However jobs can be increased without increasing the number of projects: by employing more people on existing projects. Those existing projects would not necessarily be finished more quickly – the additional labour could enable value to be added to the final output of those projects.

How to slash unemployment.

The unemployed are unsold labour. If something is unsold, it can normally be sold by reducing its price.

But reducing the price (in money terms) of ALL LABOUR is fatuous because that just reduces demand. And in any case, most labour is not unsold: it is employed even in a recession. I.e. there is no need to reduce the price of “sold” labour.

So how about reducing the price of UNSOLD labour, i.e. make the unemployed available to employers at a price well below the going rate / union rate / minimum wage, etc? That would cut employers’ marginal costs.

Assuming demand is raised by the requisite amount, employment would rise, on the courageous assumption that employers don’t replace too many EXISTING employees with the newly available subsidised employees.

But hang on. Why not just raise demand and not bother with the subsidy? The reason lies in a labour market characteristic that was highlighted by some recent research, namely that the unemployed are relatively UNSUITABLE potential employees. This point has always been intuitively obvious to those with an understanding of labour markets (0.001% of the population). But the latter research showed that employers in the U.S. say they have about as much difficulty now obtaining suitable labour from the ranks of the unemployed as before the recession.

In short, the above proposed subsidy would make up for UNSUITABILITY.

Put another way, the subsidy would counteract the fact that when demand is raised, the effect is simply to bid up the price of suitable labour, rather than result in more jobs for the unemployed.


Unsuitability of specific individuals changes.

To over-simplify the issue a bit, let’s divide the workforce into two groups: the suitable and the unsuitable. And let’s assume the suitable are employed and the unsuitable are unemployed.

If the stock of individuals making up the unemployed never changed (i.e. a given stock of individuals was permanently unemployed) then implementing the above subsidy would be easy enough: just attach the subsidy to all those individuals currently unemployed.

But it’s more complicated than that: someone can be unsuitable / unemployed because there is a temporary surplus of their skills in their travel to work area, and then find a few months later that there is demand for those skills.

So how do we stop employers claiming the subsidy in respect of individuals who are in fact suitable? Well it’s not too difficult in principle.

Just limit the time for which a specific individual can stay with a given employer on a subsidised basis. Perhaps limit the time to three months or so.

That way, if at the end of the three months the employer GENUINELY thinks some individual is unsuitable, the employer will be happy to let the individual go: so the subsidy will have served a purpose: it will have facilitated the employment of an unsuitable individual for three months.

In contrast, if the employer thinks the individual is SUITABLE, the employer will want to keep the employee. In which case the subsidy comes to an end.

The latter arrangement could be refined. For example the fact that an employer keeps an employee AFTER the subsidy expires indicates the employee was suitable BEFORE the subsidy expired. Thus it could make sense to charge such an employer for part or all of the three months worth of subsidy.

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