Start your own bank !

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Adam Posen, new member of the Bank of England monetary policy committee, has written a paper claiming that the UK stimulus cannot be withdrawn till UK banks are fixed. He also claims the UK relies too heavily on a small number of large banks and that the latter do not serve small and medium enterprises well when these banks are in trouble.

This is a thoughtful, “plain English” and easy to read paper. But I disagree on two points.

One point missing, as far as I can see, from his paper is that the dominant position of large banks will be reduced automatically, as long as government abstains from giving these banks more than the bare minimum needed to prevent them collapsing: no special intervention from the authorities is required to bring into existence an increased number of small quasi-banks.

There has been evidence over the last year of an increase in the extent to which non bank firms have been lending direct to each other, rather than using banks as middle men. If the middle men are incompetent, why bother with them?

Also there is evidence of more wealthy individuals taking an interest in firms in their immediate neighbourhood, rather than putting money into City of London or Wall Street institutions possibly hundreds of miles where these individuals live. Some point applies: if those working on Wall Street and in the City are Madoffs, “inside traders” and sharks - why bother with them?

Private individuals and non bank firms cannot create money in the same way as the commercial banking system does. If more financing is to be done by the former, rather than by the latter, a bigger monetary base is required, which is what quantitative easing has produced. Thus Posen’s claim that the stimulus will be withdrawn at some point could be wrong: possibly the increased monetary base, or some of it, should remain.

Taxpayer support given to banks should NOT be whatever is required to get them back to where they were pre-crunch. It should be just enough to make sure the country’s money transfer system does not collapse. Having done that, the question as to whether banking activity is conducted by large banks or, at the other extreme, by butchers, bakers and candlestick makers should be left to market forces. Unfortunately this is not what seems to happening in the US: that is, the large institutions seem to be getting preferential treatment.

As to Europe: much the same story.

Obama and David Cameron are clueless.

“Obama wrestling with jobs outlook” is a headline in the Wall Street Journal, 23rd October 2009. The article below starts, “....the Obama administration is searching for ways to boost job growth without adding to the federal budget deficit.”

God give me strength. How’s he going to do that? It would be easier to make pigs fly.

And David Cameron, leader of the Tory Party and the UK’s chief economic illiterate, claims that the value added tax cut earlier this year was a bad idea because it added to the deficit! Well running a deficit in a recession is the right thing to do. Cameron has learned nothing from Keynes or the 1930s.

This is very elementary, but a “job” is an activity that involves person X producing something because person Y is prepared to pay for the “something”. If all the “Y” people are saving, rather than spending (which they are at the moment) that means no jobs (or at least a shortage of jobs). Solution: print money and give it to “Y” people – well, every household to be more realistic.
Yes, I know there is an inflationary danger. But the world economy has been blown off course.

When you’ve been blown off course you have to make a correction. You may undercorrect or overcorrect. It would have been far better not to have had to make any correction, but we are where we are. We have to attempt a correction. Doing nothing, or doing far too little is fatuous.

One problem is that the deficit so far, roughly $1.4trillion for the year ended 30th Sept 09 in the US, pales into significance compared to the loss of worth in household balance sheets over the last two years, roughly $10trillion. In short, if another $1trillion was printed and handed to US households, they would still be feeling poor compared to two years ago. But this trillion might improve their cash positions enough to induce the required reduction saving and increased spending. (That’s saving of money, as distinct from saving physical goods or similar assets – two very different things).

On the other hand Janet Tavakoli spells out some good reasons for thinking a further two or three trillion are needed (number of households under water, etc) Bizarrely she claims this cannot be done because the US got cannot borrow this much more. Janet: it doesn’t have to: it can just print the stuff!!!!! Yes, that could be inflationary: every six year old knows that. And its very difficult to know how much to print. But the point is that “borrowing” is not a constraint.

And finally, if there is one thing a government ought to be able to do in a recession it is to maintain employment in areas where it has direct control, e.g. in central and local government. But the US government (doubtless like many other governments) hasn’t even managed that!

As I said: God give me strength. Now I’m off to tear my hair out.

£200bn off the National Debt at a stroke!!!

Gordon Brown recently announced a £16bn sale of public assets to reduce the National Debt. Pathetic !! It would be easy to wipe ten times that much (or even more) off the ND at a stroke. Here's how.

The total amount that has been quantitatively eased in 2009 is about £200bn (a bit under that figure, actually). And 99% of what has been quantitatively eased is government debt, i.e. gilts rather than private sector bonds.

We are thus now in the strange position where the “government” (an entity owned by the people) owes the Bank of England (another entity owned by the people) around £200bn. This is as nonsensical as saying I am in debt because my right hand pocket owes my left hand pocket some money.

This means there is a very simple way of knocking £200bn off the National Debt: tell the Bank of England to shred all the gilts in its possession. Yep, it’s that easy. It’s a bit like saying “I’m abandoning this silly business of right hand pocket owing money to right hand pocket, and instead I’ll go for a more rational book keeping system”.

Once the governor of the Bank of England has been forced (at gunpoint if necessary) to shred his gilts, there remains the £200bn or so of monetary base added to the economy in 2009 which of course is potentially inflationary. It would certainly be wise to rein in this money by means of increased taxation (and/or other deflationary measures). But there is yet more good news to come on this tax front. Indeed, this news is as miraculous as the £200bn wiped off the national debt, and it is thus.

There is no point in reining in the above money until it looks like causing inflation. Thus the tax needed to do this is not a tax in the normal sense of the word, i.e. something that makes one worse off. The “reining in tax” simply takes money away from people which, were they to keep it, would actually make them WORSE OFF because it would cause inflation.

So there you have it. £200bn wiped off the national debt with the outstanding problems solved by means of a tax which isn’t really a tax.

I could patent this idea and demand a 1% commission from government for using the idea, which would make me £2bn better off. But I haven’t got time to get down to the patent office.

Was Abraham Lincoln right about money?

Abraham Lincoln said, “"The government should create, issue and circulate all the currency and credits needed to satisfy the spending power of the government and the buying power of consumers. By adoption of these principles, the taxpayers will be saved immense sums of interest. Money will cease to be master and become the servant of humanity."

Many economists have expressed similar sentiments (see “References” below). The sentiment, to put in economics jargon, is that fractional reserve banking should not be allowed, or at least that the “fraction” should be much more tightly controlled. That is, the monetary base (i.e. central bank created money) should make up a much larger proportion of the money supply, with commercial bank created money playing a smaller role.

The main advantage to this change is that it would ameliorate the extent to which the money supply varies in a pro-cyclical manner. That is, during booms, commercial banks create more money – just what is not needed. And during recessions, they extinguish money - again, just what is not needed.

This is not to say that this change would do away with economic cycles. The velocity of circulation of money can vary dramatically, thus even where one had for the sake of argument, an absolutely constant money supply, cycles could and probably would still occur. But at least the above system would help iron out the cycles.

Would this change do away with bank failures? No. There is nothing to stop a bank making silly loans under this different regime. But this regime would at least reduce the incidence of bank failures. Bank failures occur to a significant extent because of bubbles: i.e. commercial banks make loans, which boosts asset prices, which makes hitherto apparently risky loans look less risky, thus banks make further loans and create even more money, etc.


References.

Henry Simons, Irving Fisher, and Frank Knight in the 1930s: (See p. 9)

Milton Friedman (See 4th para)

American Monetary Institute.

Stabilising Aggregate Demand.

Booms and recessions have followed one another for thousands of years. Certainly ancient Rome had a nasty credit crunch.

There shouldn’t be a problem with organising a constant level of demand from the public sector. Any competent government ought to be able to spend almost exactly the same amount, in real terms or money terms, year after year. Indeed any competent government ought to be able to do vastly better than this and have public spending vary at least to some extent in a counter cyclical manner.

Unfortunately during the 2007-9 recession governments have proved somewhat incompetent in this regard. That is, some governments seem to be under the illusion that just because their income from tax has declined, that therefore they need to cut their own spending. These governments need to go back and re-study basic economics. US government employees (federal, state and local) declined by 130,000 between September 08 and September 09.

In contrast to the public sector, organising a constant level of demand from the private sector is much more difficult: for example consumers have a habit of suddenly going wild with their credit cards for no obvious reason. Alternatively, (as in 2009) they suddenly do the opposite: start saving as never before. Or it’s South Sea Bubbles or tulip mania.

And then there are stock market and house price changes. When these rise, household balance sheets improve, which induces households to spend.

So how do we organise a more constant level of demand from the private sector? Well, we need a tax (or subsidy, come to that) which can be altered relatively quickly. The UK government did this in 2009 when it reduced Value Added Tax. An alternative, suggested by Winterspeak is to vary payroll taxes. (See Winterspeak's 15th and 16th Sept 09 posts.)

A problem with the two latter is that what economists call the “incidence” of the tax falls partially on employers. For example, reduce VAT, and while employers will to some extent pass on the reduction in the form of lower prices, that is not where all the reduction goes: that is, employers will to some extent pocket the reduction. And the problem with this is that employers are not the ultimate source of all demand. The ultimate source of all demand is the consumer. That is, ideally, all stimulus money needs to go directly to the consumer’s pocket.

Another problem with the above two measures is that consumers probably notice a change to their monthly income more quickly than they notice a change to the price of goods resulting from a VAT change. Thus ideally it is consumers’ income that needs to be changed.
In the UK there are three levers government could pull that would immediately change consumers’ income. 1, the state pension. 2. Pay As You Earn income tax deduction that is made from most wage earners’ wage packets. 3. Employee National Insurance contributions.

A fourth possibility is the vast array of other state benefits (e.g. for the unemployed, the temporarily sick and injured, etc). The problem here is the temporary nature of these benefits. That is, sorting out any mistakes or problems in respect of changes to someone’s state pension is probably easier than doing the same in respect of someone’s unemployment benefit. This is because a pensioner is, as it were, constantly in touch with the state via the pension system. In contrast, an unemployed individual is in contact with the relevant part of the state for a limited period. Any mistakes would involve re-contacting the individual, which could be administratively expensive for the state compared to sorting out a problem with a pensioner.

Banks aren't lending - so what?

Why on earth do governments, having prevented a total collapse of the bank system, want to rely on bank lending to stimulate our economies?

The basic purpose of preventing a collapse of the commercial bank system was to prevent a collapse of the money transmission system (an essential “utility” service, much like electricity or water distribution). That is, the basic purpose was to make sure wage and salary payments, for example, continued to be made, and to make sure household savings accounts did not disappear into thin air.

But there is no need to give the idiots and fraudsters running large banks more than is needed to enable them to continue this basic service. Give them more than this, and they’ll probably just revert to what they’ve been doing for several decades: throwing billions down the drain, if no trillions. The “Savings and Loan” fiasco of the 1980s and 90s cost the US taxpayer over $100bn. The large US banks were essentially bankrupted by the 1980s Latin American debt crisis (see 5th October post at "Washington's Blog"). And now the 2007-9 credit crunch has knocked how much of world economic output: 5%? That is more trillions gone west.

Having given the above bare essential stimulus to banks, all further stimulus should be channelled to the source of all demand. Which is? . . . . .the consumer! Some of us were saying this a year ago: e.g. me, Winterspeak, the IMF (p.6, section 16), Simon Jenkins, James Surowiki, etc.

But senior politicians in charge of large government departments probably think that no one can do anything unless they are (like themselves) in charge of something big (like a government department or a large bank). Well senior politicians need to understand that the average convenience store owner has just as much business sense than the average finance minister.

And the evidence supports this, in a way. That is, small banks have done relatively well during the credit crunch. And in Europe, some firms (with no experience whatsoever of banking, but with cash to spare) have in 2009 increased the extent to which they play the part of banks, for example lending to other firms which they know to be sound businesses.

In a free market, the most efficient should be allowed to expand and on occasions drive the less efficient out of business. If an engineering firm in Detroit is a better judge of the creditworthiness of other engineering firms in Detroit than banks, then banks should under no circumstances get preferential access to taxpayers’ money designed to encourage loans to firms in Detroit.

Another reason politicians may have preferred to give money to millionaire bankers rather than to the peasantry is that what might be called the “informal” banking system that “peasants” would come up with, given half a chance, would probably require a bigger monetary base than the existing “big commercial bank” system. This is because the large commercial bank system can effectively print money. That is, it can build a very large “pyramid of credit” or “pyramid of printed money” on a relatively small monetary base.

Engineering firms in Detroit cannot do this. But this is no reason not to allow engineering firms in Detroit to play the part of banks. Creating monetary base does not cost anything in real terms. Also, while increasing the monetary base may be inflationary OTHER THINGS BEING EQUAL, the effect will not be inflationary where the monetary base is increased because engineering firms in Detroit genuinely NEED that monetary base to engage in banking activities. In short, politicians may be reluctant to allow engineering firms to play the part of banks because politicians fear that the increased monetary base needed will be inflationary. These politicians are wrong.

Recessions get rid of lame ducks?

Those opposed to the measures being taken to deal with the 2008-9 recession sometimes claim that recessions are desirable in that they get rid of uneconomic firms, or “lame ducks”. An example of this flawed idea appears in a blog by Dr Madsen Pirie of the Adam Smith Institute.

There are two reasons for discounting this idea: one theoretical and one empirical. Taking the former first, if a firm has gradually declining profits or mounting losses, closure or bankruptcy is inevitable at some point, even given no recession. As to empirical evidence, this very much backs up the theoretical point. That is, during recessions, bankruptcies do rise, as would be expected. But they don’t multiply by ten or a hundred. They rise by fifty percent or in relatively bad recessions double or treble. But that’s it.