Sunday, June 30, 2013
Friday, June 28, 2013
Interesting stuff here on Roger Mitchell's blog.
Looks like it was the biggest 100 banks that started offering “liar loans” willy nilly before the crunch. Vertical axis is delinquency rates, the red line is the 100 largest banks, and the blue line other banks.
One of the main excuses for QE is that things would have been worse without it, which is a bit like saying that on a cold day it’s an idea to burn your furniture on your log fire. After all, the house would be “colder without” burning your furniture.
The latter furniture burning policy of course begs the question as to whether there isn’t a better way warming your house. Likewise, the above QE argument begs the question as to whether fiscal stimulus ins’t better than QE.
Amazing the daft logic employed by Bank of England officials and other members of our elite, ins’t it?
Anyway, QE has been widely ridiculed elsewhere so I won’t say any more about it. Instead, let’s consider the other main element in monetary policy, namely interest rate adjustments.
Recessions have several different possible causes. Let’s take each in turn and see if an interest rate cut makes sense.
A recession could be caused by employers deciding that less investment will be needed in future. I.e. a recession can be caused by a fall in investment spending. If there really is a drop in the total amount of investment needed, then an interest rate cut is not appropriate. I.e. what’s the point in encouraging investment, when less investment is needed?
The best policy is simply to boost consumer spending.
Alternatively, employers might cut investment spending because they think consumer demand in on the wane. In that case the best solution is to make sure consumer demand does not wane!!!
Also, if interest rates are cut in either of the above scenarios, that will boost consumer spending, but it will skew the spending towards durables - a “skew” that will have to be unwound later. So that doesn’t make much sense. And the “skew” is substantial: that is, interest rate cuts have a big effect on demand for durables compared to other forms of consumer goods: see here.
A possible argument for monetary policy is the lags are shorter than in the case of fiscal policy, but there does not seem to be much evidence in support of that idea.
A rise in consumer caution.
Another possible cause of recessions is consumers abandoning “irrational exuberance” mode, and moving towards “savings” mode.An interest rate cut would help there, but it involves the above mentioned “skew”.
And if the root cause of the problem is people’s decision spend less: i.e. their decision to build up their cash holdings (Keynes’s paradox of thrift unemployment) why not supply them with more cash? In MMT parlance, if people’s “savings desires” are not being met, supply them with savings.
If government goes for the “create money and spend more” option, that has an instant fiscal effect: jobs are created. If government goes for the “tax less” option, that also increases household’s stocks of cash. Plus if households see their cash holdings rising towards their desired level, they’ll probably increase their spending immediately to some extent: i.e. they won’t wait till their “net financial assets” have reached the desired level before increasing their spending.
Creating new money and spending it into the economy is really a mix of monetary and fiscal policy. And it’s a policy often promoted by advocates of full reserve banking, e.g. this lot. But it’s certainly not an interest rate cut – though doubtless there will be a finite effect on interest rates.
Conclusion: monetary policy is largely nonsense.
P.S. (5th July 2013). For another argument against interest rate adjustments, see article entitled “Interest rate cuts versus stimulus…..” here.
Thursday, June 27, 2013
In this Financial Times article, Martin Wolf describes bank leverage of 33:1 which existed prior to the crunch as “frighteningly high”. But then says “I cannot see why the right answer should be no leverage at all. An intermediary that can never fail is surely also far too safe.”
The answer to Wolf’s question is as follows.
Reducing the 33:1 to for example the 4:1 suggested by Wolf in a later FT article would certainly reduce the chance of bank failure to a very low level. And if all we were concerned with was bank safety, then 4:1 would probably suffice. But there is another point to consider, which Wolf spelled out in very eloquent form here.
In answer to the question as to how the credit crunch possible, Wolf says “The answer is that we have entrusted a private industry with the provision of ….the supply of money..” To be exact, when a commercial bank lends, it creates money.
Or in the words of Mervyn King, “When banks extend loans to their customers, they create money by crediting their customers’ accounts.”
In other words there are good arguments for a system under which only the government / central bank machine creates money – sometimes known as “full reserve banking”.
And full reserve is a system that necessarily involves 1:1 leverage. Reasons are thus.
If £X of money freshly created by government is deposited at a commercial bank, and the bank lends it on, then the commercial bank is creating money, for reasons spelled out by Mervyn King above. To be exact, once the loan has been made, both the depositor and borrower consider themselves to be in possession of £X. So £X has been turned into £2X.
In contrast (and taking Laurence Kotlikoff’s full reserve system), if the depositor wants their bank to lend on or invest their money, then under LK’s system, the money is put into a mutual fund (unit trust in the UK) of the depositor’s choosing. The depositor then no long holds money: they hold a stake in a mutual fund. And the value of that fund rises or falls in line with the performance of the underlying loans or investments.
And those depositor / mutual fund stake holders are effectively shareholders. Thus the bank’s leverage is effectively 1:1.
As distinct from money that depositors want to have loaned on, there is money to which depositors want instant access, and which they want to be near 100% safe and backed by taxpayers. If that money is simply lodged at the central bank (as it would be under the full reserve system advocated by for example Positive Money), then no money creation takes place, plus there is very little risk involved.
Another problem with private money creation is that it is pro-cyclical: exactly what we don’t want.
All in all, there are good arguments for banning private money creation.
Tuesday, June 25, 2013
This article in the Wall Street Journal yesterday by Prof. John Cochrane advocated the sort of banking system which tends to be advocated by full reserve enthusiasts, like me, Laurence Kotlikoff, etc. That’s a system under which it is plain impossible for a bank to SUDDENLY fail. Though a slow decline is perfectly possible.
The system also involves no bank subsidies (though Cochrane didn’t mention that, far as I can see).
As Cochrane says, “At its core, the recent financial crisis was a run. . . . In the 2000 tech bust, people lost a lot of money, but there was no crisis. Why not? Because tech firms were funded by stock.”
Later he says, “Runs are a pathology of financial contracts, such as bank deposits, that promise investors a fixed amount of money and the right to withdraw that amount at any time.” Spot on.
And: “Institutions that want to take deposits, borrow overnight, issue fixed-value money-market shares or any similar runnable contract must back those liabilities 100% by short-term Treasurys or reserves at the Fed. Institutions that want to invest in risky or illiquid assets, like loans or mortgage-backed securities, have to fund those investments with equity and long-term debt. Then they can invest as they please, as their problems cannot start a crisis.”
Couldn’t have put it better myself.
Or in the words of Mervyn King, “…we saw in 1987 and again in the early 2000s, that a sharp fall in equity values did not cause the same damage as did the banking crisis. Equity markets provide a natural safety valve, and when they suffer sharp falls, economic policy can respond. But when the banking system failed in September 2008, not even massive injections of both liquidity and capital by the state could prevent a devastating collapse of confidence and output around the world.”
Or in the words of George Selgin, “For a balance sheet without debt liabilities, insolvency is ruled out…”. (That’s from his book “The Theory of Free Banking” which is available for free online, though I couldn’t find the URL while writing this post. Doh!)