Lawrence Summers is clueless.

Reason is that he keeps contradicting himself on the subject fiscal stimulus. For example…..

He co-authored an articlewith Brad De Long in 2012 advocating fiscal stimulus. Then at the end of last year he made his now famous speech at the IMF introducing his “secular stagnation” idea: which was that we’re in a hole and there’s nothing we can do about it: i.e. not even fiscal stimulus can get us out of the hole.

Then early this year he made an amazing discovery, namely that it is actually possible to raise demand via fiscal stimulus.

Only problem was that he advocated doing it via investment in “high return” infrastructure investment. Now there are two flaws in that idea.

First, it can take years to get those sort of investment projects going and complete them by which time the current recession will probably have finished. Second, if an investment is “high return” then that investment should be made ANYWAY: i.e. regardless of whether we are in a recession or not.

Incidentally you won’t be surprised to learn that another not too clued up economist from Harvard (forgive the tautology) also promotes the “high return” investment idea: that’s Kenneth Rogoff.

Then in this Financial Times articlea few days ago, he shied away from fiscal stimulus but produced a new and unbelievably stupid idea namely that “Creative consideration should also be given to ways of mobilising the trillions of dollars in public assets held by central banks and sovereign wealth funds largely in the form of safe liquid assets to promote growth.”

So what exactly are those mysterious “public assets”? Given their astronomic size (trillions of dollars) all Summers can be referring to is government debt held by central banks. But since central banks are part of the government machine, those “assets” are nothing more than a book-keeping entry!!! They aren’t any form of REAL WEALTH like an empty office block which can be potentially be put to use.

Moreover, are they an “asset”? Well as just intimated, they are an asset as viewed by central banks and a LIABILITY as viewed by governments. That is, they are essentially a debt owed by department of government to another. This is all gobbledegook!!!!

As I pointed out in a letter in the Financial Times, and as others have pointed out, those government debts might as well be torn up: they’re meaningless.

But that’s not to say there isn't a grain of truth in what Summers says. If he is trying to say that governments and central banks can simply create – er – “assets” out of thin air (i.e. money) and spend it (and/or cut taxes) so as to boost economic activity, the he is right. But then that’s no more than Keynes pointed out nearly a century ago, as as MMTers and Positive Money keep pointing out. And that’s fiscal stimulus.

But of course there is a big problem in suggesting that we print money and net spend it, namely that whenever the words “print” and “money” appear in the same sentence, hoards of idiots come out of the woodwork screaming “inflation”.

And in a world ruled by idiots, you have to be careful what you say, as Krugmanpointed out recently. Likewise in a conversation between Keynes and Abba Lerner, Keynes told Lerner to be careful what he said in reference to money and printing.

So it’s just possible that Summers is fiendishly clever, and is trying to send a message to economic illiterates that make up Congress: that is, trying to instil in them that come a recession, it’s up to them to do something. But I doubt it. I think he’s cluless.

But never mind: once you’re an established emperor, the fact that you’re naked matters not one iota. Everyone will see you as being dressed in the finest clothes – apart from a few naughty boys like me.

Bank balance sheets and full reserve. Part II.

In reaction to my recent post on this topic (Monday, 7^th April) it’s been pointed out to me that when loans by private banks (PBs) are handed over to the central bank (CB), it would actually be PBs who continued to collect interest and repayment of capital on those loans, since CBs don’t have the resources to do the job. And that’s a good point. But that point can be taking into account without significantly changing the balance sheets set out in the above post. The changes needed are as follows.

 It would be necessary to debit commercial banks (in the books of the CB) with a sum equal to the capital value of those loans (maybe in a special “capital repayment” ledger). So the only change to the balance sheets is the DESCRIPTION of the £0.6X at the extreme bottom left of the balance sheets. (That’s the asset side of the CB’s balance sheet immediately after conversion to full reserve)

That is, “Loans (formerly owned by commercial banks)” becomes something like “debt owed by PBs to CB and equal to the capital value of loans which former bank depositors do not want to fund” – bit of a mouthful, but hopefully not totally incomprehensible.

The result would be that PBs would collect repayment of capital on those loans and hand the money over to the CB, and the interest on those loans would cover the cost of that collection work.

Shareholders.

I glossed over treatment of existing bank shareholders in the above mentioned post. The best way to treat them is perhaps as follows (and I’ll assume Lawrence Kotlikoff’s system rather than Positive Money’s).

First, set up a mutual fund specially for former bank shareholders, where the assets of the fund consists of loans equal in value to the above shares.

To that extent shareholders are treated much the same way as former depositors who want to fund loans (“investment accounts” in the case of Positive Money’s system).

However, the above “special mutual fund” would contain an additional characteristic, namely that those investing in the mutual fund have a right to the profits or losses that arise from the repayment (or non-repayment) of loans mentioned above.

And that would be entirely reasonable because shareholders would have benefited from the latter profit or born the latter loss had PBs never converted to full reserve.

As to how those shareholders are treated in the balance sheets, they’d appear in the “commercial banks after conversion to full reserve” balance sheet (3^rd one down). And the way they are treated is so similar to the way depositors who want their money lending on or investing are treated that the only change needed is a few additional words on the liability side. That is “Deposits in PM’s investment accounts or Kotlikoff’s mutual funds” becomes something like “Deposits in PM’s investment accounts or Kotlikoff’s mutual funds plus shareholders’ stakes in the mutual fund specially set up for shareholders”.

Where do PBs get base money?

A possible objection to the above is that CBs deal only in base money. And since PBs in the decade or so immediately after the switch to full reserve are paying the CB fairly large amounts of base money every year (in respect of the repayment of loans where PBs collect those repayments), then the question arises as to where the base money comes from.

Well the answer is that government and CB would be spending base money into the economy to make up for the deflationary effect of the latter repayments. Problem solved!

Bank balance sheet changes caused by the switch from fractional to full reserve.

Two attempts have been made to show the central bank and commercial bank balance sheet changes that would result from a switch from fractional to full reserve banking. They are both far too complicated. One is by Messers Benes and Kumhoff and set out in their IMF paper. (See page 64 onwards). The other is by the two Positive Money (PM) authors Ben Dyson and Andrew Jackson in Ch.8 of their book “Modernising Money”.

The IMF paper is about 36,000 words. I did a 2,000 word summary of it here.

Also, the IMF system for converting to full reserve involves a debt jubilee of truly astronomic proportions, the reasons for which are a puzzle. There may be merits in debt jubilees, but that’s an entirely separate issue from switching from fractional to full reserve banking.

I’ve set out a much simplified set of balance sheets below. But first, the arguments leading to the latter balance sheets.

First, you will see no reserves on the balance sheets prior to the switch. That is because in normal times (e.g. prior to the crunch) reserves form a very small proportion of commercial bank’s assets. Indeed in many countries, commercial banks can have that proportion as small as they like. For example in Canada  just prior to the crunch, bank reserves were around 0.3% of bank assets. So let’s just ignore reserves prior to the switch.

I’ve also ignored bondholders and shareholders. As to bonds, they are essentially just a form of long term deposit, ownership of which is frequently traded, so I’ve merged them with depositors. Thus the balance sheets below are applicable both to high street banks which obtain a lot of money from retail depositors and investment banks which obtain no money from the latter source, relying instead on bonds or quasi-bonds.

As to shareholders, they formed a very small proportion of banks’ liabilities (if indeed you can call shares a liability).

Of course that proportion will rise A BIT as a result of recent attempts to raise capital ratios. But the regulators are having a hard job raising those ratios by any significant amount.

The switch.

Come the switch, let’s say depositors want 60% their money to be completely safe, i.e. have 60% of their money lodged “full reserve fashion”. That would mean commercial banks just open safe accounts for those depositors, and shift £0.6X from depositors’ existing accounts to the newly created safe or “full reserve” accounts.  At the same time, the central bank credits the account of the commercial bank with £0.6X (created out of thin air).

At that stage, there has been a large gift (worth £0.6X) made by the central bank to commercial banks, which of course cannot be allowed. And “X” of course amounts to BILLIONS. And a further anomaly is that there are £X of loans (e.g. mortgages) supported by only £0.4X  of deposits, which is a nonsense.  In the case of PM’s system, the latter £0.4X would be made up of depositors willing to put their money in to investment accounts. Under Lawrence Kotlikoff’s system which in principle is the same as PM’s, PM’s “investment accounts” take the form of mutual funds (“unit trusts” in the UK).

So, £(X – 0.4X) i.e. £0.6X of loans needs to be given by commercial banks to the central bank. And the result is that the central bank has then not made any sort of net gift to commercial banks. The central bank would collect interest and repayment of capital on those loans and mortgages, or it could sell on the latter to any willing buyers.

In the balance sheets below, the initial assets and liabilities of the central bank are shown as zero, which is obviously unrealistic in a sense. However, given that it’s just the CHANGES to bank balance sheets that of relevance here, ignoring the EXISTING assets and liabilities of the central bank is a justifiable simplification.

Another simplification is that under Kotlikoff’s full reserve system, depositors who want their money investing or lending on put their money into mutual funds (“unit trusts” in the UK). And mutual funds are separate legal entities to the banks (or other entities) that run those funds, thus those mutual funds SHOULD HAVE their own balance sheet below. However, I’ve merged those mutual fund balance sheets with commercial banks’ consolidated balance sheet.

Initial balance sheets.

Commercial
banks.

Assets.	Liabilities
Loans.       £X	Deposits.   £X

Central bank

Assets.	Liabilities.
Zero	Zero.

Balance
sheets after conversion to full reserve.

Commercial banks.

Assets.	Liabilities.
Loans. £0.4X	Deposits in PM’s investment accounts or Kotlikoff’s mutual funds.             £0.4X
Reserves.£0.6X	Safe or full reserve deposits.     £0.6X

Central banks.

Assets.	Liabilities.
Loans (formerly owned by commercial  banks)    £0.6X	Commercial banks’ Reserves.     £0.6X

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Paul Krugman is brilliant.

This recent article by Krugman is short and brilliant. First, though, the background.

As Bill Mitchell, me and numerous others have pointed out for a long time, some of the literature emanating from the IMF (and the OECD) is nonsense. But as Krugman points out, IMF employees are not totally stupid. So why the nonsense?

According to Krugman, the explanation is that the IMF has to keep in sweet with rich and/or powerful idiots: the real source of nonsensical ideas.

I’m sure there's plenty of truth there. I.e. if Stalin, Hitler, or the Taliban ruled the world, the IMF would have to make complimentary remarks about, respectively, Gulag Archipeligos, gas chambers, and stopping women learning to read and write.

Having said that, my hunch is that "it's a bit of both": i.e. there are some genuine incompetents in the IMF, while competent IMF staff know they cannot say exactly what they think.