The purpose of the ring-fence is to separate retail banking from the riskier investment banking activities: i.e. to separate the essential money transfer functions which cannot be allowed to fail from the risky, clever clever stuff. (Of course there are still systemic risks from the clever clever instiutions, (e.g. Long Term Capital Management), but the basic money transfer system is more important.)
The basic problem with the ICB proposal is that they’ve put BOTH risky AND stuff which is supposed to be safe (i.e. not to be contaminated by risky stuff) inside the ring fence! It’s a bit like putting foxes inside the chicken coop.
Paragraph 2.27 says that deposits from and loans to individuals and firms or corporations should be inside the fence. But this involves significant risk. How in God’s name does one stop banks lending to firms, particularly large ones, which turn out to be thoroughly dodgy and high risk?
Still on para 2.27, the ICB says that loans to “non financial companies” should be inside the fence. That’s just asking for squabbles over exactly what constitutes a “financial company”. I can see lawyers earning big fees there. Or as Martin Jacomb put it in the Financial Times, “The fingfencing proposal involves much detailed regulation.”
Some small retail depositors actually WANT risk.
The next problem is that some small depositors actually WANT to expose themselves to risk, and why not? There is nothing wrong with the basic idea behind capitalism, namely that people can take a risk and possibly make money or lose money.
As pointed out above, the ICB ring fencing does not guard small retail depositors against risk, but just supposing it DID guard those depositors against risk, that is a nonsense in that some small retail depositors actually WANT to have a flutter or take a risk. They are not catered for under the ICB regime.
So what is the solution to all this? Well the solution was given very eloquently by Mervyn King, governor of the Bank of England. As he said, “If there is a need for genuinely safe deposits, the only way they can be provided, while ensuring costs and benefits are fully aligned is to insist such deposits do no coexist with risky assets”.
In other words why not give depositors a choice. Choice No 1 is to have an account which is 100% safe and taxpayer backed. But in keeping with Mervyn King’s principle outlined above, the money in such accounts cannot be invested in commerce or exposed to any kind of risk. The money can only be deposited at the central bank or perhaps invested in government securities.
On the other side of the fence so to speak is choice No 2. This is for customers to let banks invest their money any way the bank sees fit. Alternatively banks could offer a range of accounts with different levels of risk, or other characteristics, like “money will only be invested in the UK”. But that is a minor detail. The important point is that the money is used for commercial purposes, and it is NOT the job of taxpayers to subsidise commerce. Thus there would be no taxpayer funded rescue if it all goes wrong.
The latter “two choice” system involves minimal regulation. For example there is no need to distinguish between financial and non financial firms. Investing in ANY firm is commerce. The investment will thus earn more interest than the safe No 1 choice above. But there is no taxpayer funded guarantee.
Likewise there is no need for regulators to look in detail at what loans banks are making and try to decide whether individual loans are too risky to be acceptable. Indeed the very idea that regulators are able to make this judgement is laughable. Banks themselves are scarcely able to quantify the riskiness of those they lend to: look at the disastrous loans they made prior to the crunch.
As to what to do with the commercial or risky activities or divisions of banks, those can only be made less of a systemic risk by reducing leverege, enlarging capital requirements, insisting on bail-ins and so on.
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Afterthought (26th Oct 2011): I just noticed that the Guardian’s City editor, Jill Treanor, is also critical of the commission’s hazy ideas as to what does and does not go inside the fence. She says, “The commission is vague about whether banking to large companies should be in or outside the ringfence.”
Dani Rodrik trotts out, and goes along with the alleged dilemma that 99% of the elite in the US and Europe think they face. This is that stimulus is needed, but governments are already heavily in debt and can thus allegedly cannot afford much more stimulus.
The latter so called dilemma is a complete non-problem for those of us who understand Modern Monetary Theory (MMT). Rodrik’s solution to the problem is to have what he calls an “independent board” solve the problem. Well that was easy, wasn’t it? Let’s solve the world hunger problem and global warming by appointing committees to solve those two problems. Put another way, the $64k question which Rodrik doesn’t answer is exactly what ideas and principles does his “board” use to solve the problem. The principles / ideas should be as follows.
The structural debt and deficit.
Re the structural part of the debt, reducing it is child’s play: just print money and buy back the debt (i.e. Q.E. it). To the extent that that is too stimulatory or inflationary, just raise taxes and use the money collected to buy back more debt. The money printing element is stimulatory/inflationary, while the tax element is deflationary. Mix the two in the right proportion, and the net effect is neutral. I.e. GDP remains unaltered, as does the total number employed, etc etc. Meanwhile big chunks of debt disappear.
Of course the latter wheeze COULD to some extent result in debt being replaced with monetary base, which might seem a bit of a cheat. Explaining the reasons why this is not a cheat leads us nicely into the question as to how to deal with the “non-structural” part of the debt and deficit, i.e. the stimulus element. After that it will hopefully be apparent why no “cheat” is involved.
The stimulus element.
Rodrik makes a big mistake when he says that “Everyone agrees that the country’s public debt is too high and needs to be reduced over the longer term.” Well MMTers don’t agree it is too high. In the view of MMTers, private net financial assets (of which the debt is an important part) need to be whatever induces or “stimulates” the private sector into spending at a rate that brings full employment.
If that level of assets happens to be larger than ever before, so be it. If it happens to be smaller than ever before, so be it.
A predictable response to the latter point is that debt involves paying interest, and there must be some limit to the interest rate burden that governments can carry.
Well at the moment, the REAL rate of interest on US debt is NEGATIVE!!!!! So there is not much of a problem there. However, if rates turn significantly positive in the future, then obviously there is a problem: a problem which calls for a solution.
And the solution is simply to have the above mentioned government issue net financial assets consisting of NON INTEREST PAYING debt: i.e. cash, or monetary base. Put another way, if a government wants to spend more, what on earth is the point of it borrowing something (i.e. money) which it can produce in infinite quantities itself? Paying someone else to borrow something which you produce yourself for free is RAVING BONKERS!!!
Milton Friedman in 1948 advocated a monetary / economic system which incorporated the latter idea: i.e. a system under which governments issue no interest paying debt. (See page 250).
It would be nice of today’s so called economists had actually studied economics and knew about ideas which are now over sixty years old.
Readers will hopefully have tumbled to why the above “cheat” in connection with the structural debt and deficit is no cheat at all. Assuming the interest paying debt is reduced (or, a la Friedman, abolished), then the monetary base needs to be whatever “stimulates” the private sector into spending at a rate that brings full employment without too much inflation. If that level of monetary base is $1 per person, so be it. If it happens to be $10,000 per person, who cares? The IMPORTANT point is to bring about full employment.
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Anti-Keynsians have been putting their foot in it big time recently by taking Keynes’s parable about pointless hole digging seriously.
Keynes made the point that the multiplier works even if the form of spending that sparks of a “mulitiplier episode” is pointless, like having people dig holes and fill them up again all day. At the same time he made it perfectly clear (for the benefit of the humourless) that he did not actully favour pointless hole digging.
Krugman, making the same point, gave as an example, spending money on defending the world from an invasion by aliens from outer space: an invasion which in the even turns out to be a false alarm.
Unfortunately a number of less than sophisticated folk have taken Keynes’s hole digging and Krugman’s hypothetical alien invasion seriously.
Two examples of these humourless economists are thus.
1. Wall Street Journal Op Ed article (para starting “The authors are careful….”).
2. The Cobden Centre
The moral is: keep humour, irony and words with more than two syllables out of debates on economics, else those simpletons will get the wrong end of the stick.
Actually economics is so complicated that it’s VERY GOOD IDEA to keep humour and all unnecessary words and syllables out of it..
The main headline in today’s Financial Times is that Geithner is calling for stimulus. Would this by any chance the same Tim Geithner who earlier on in the recession was a staunch OPPONENT of stimulus? The same Tim Geithner who is part responsible for the unemployment and poverty being experienced by millions of Americans?
If I was Tim Geithner I’d have died of shame by now. But then in the West’s elite don’t know the meaning of the word shame. .
The idea that employers should be rewarded in proportion to the number of new or additional employees they take on is as old as the stars. The idea is a waste of time given very high levels of unemployment because a straight rise in demand is simpler and just as effective.
As to lower or “NAIRU” unemployment levels, the idea works for a short time. That is, it reduces NAIRU for a short while, perhaps up to a year or so, but loses its effect thereafter.
Conclusion: the idea is not much use. For a detailed analysis of the idea, see here.
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Faced with a sharply appreciating Swiss Franc, the Swiss are at last reacting in a logical way: printing Swiss Francs in whatever volume is required for those who want to hold them. This will NOT be inflationary because the demand for these additional Francs is a demand to HOLD Francs, not spend them. As David Hume pointed out in his essay “On Money” two hundred years ago, additions to the money supply are not inflationary until and to the extent that the additional money is actually spent.
Hopefully the rest of the world will tumble to the latter point before we get too far into a Japanese lost decade. That is, weak demand in the US stems from a desire by the private sector to hoard or hold more money than is usual (in addition to the effect of deleveraging).
The solution to the latter problem is to print money and spend it (and/or cut taxes). And if inflation looks like getting excessive, do the opposite: raise taxes and rein in money and “unprint” this money..
