Stein of the Fed advocates high unemployment so as to save Wall Street.

Jeremy C Stein in this recently published articleadvocates a relatively high level of unemployment because full employment and a booming economy tempts Wall Street into taking risks. His opening paragraph says:

“…should financial stability concerns, in principle, influence monetary policy decisions? To be specific, are there cases in which one might tolerate a larger forecast shortfall of the path of the unemployment rate from its full-employment level than one would otherwise, because of a concern that a more accommodative policy might entail a heightened risk of some sort of adverse financial market outcome? This question is about theory, not empirical magnitudes, and, in my view, the theoretical answer is a clear "yes."”

High unemployment so as to stop banksters behaving irresponsibly? Now if that’s not a damning indictment of the existing banking system, then I don’t know what is.

Of course you don’t have to accept my interpretation of what Stein is saying. You’re free to read his article and then leave a comment below telling me I’ve got it all wrong.

The false logic at the heart of fractional reserve banking.

There is a whapping great bit of false logic at the heart of fractional reserve banking, as follows.

Under full reserve, depositors can place their money in a bank which simply warehouses or lodges the money at the central bank. Or they can invest their money elsewhere e.g. on the stock exchange, mutual funds (in the US) or unit trusts (in the UK) and so on.

Unfortunately, as is blindingly obvious from the history of banks ever since Roman times, fractional reserve banks are prone to collapse when they make poor loans or investments. Thus governments (aka taxpayers) underwrite fractional reserve banks, i.e. subsidise those banks. The subsidies take various forms. First, deposits are guaranteed, at least up to some maximum (£85,000 in the UK at the moment.) And second, in the case of large banks, governments are just not prepared to let them fail normally, thus those with more than £85,000 in a large bank in the UK are being subsidised by taxpayers.

And third there are the lender of last resort facilities offered to banks by central banks: not a luxury available to other industries normally.

But subsidising banks does not make sense any more than does subsidising restaurants or garages.

As an alternative, governments can stipulate that fractional reserve banks have enough capital to ensure that they're so called “unlikely” to go bust. What “unlikely” actually means is about a one if fifty or one in a hundred chance of a given bank going bust in a given year. So in that scenario governments still stand behind depositors. So the subsidy is still there.

A solution to that is to make capital requirements so large, e.g. say 50% (which was common in the 19^thcentury), that the chance of a bank going bust is then vanishingly small, and then remove the guarantee that governments give to depositors.

But in that case, depositors then in effect become shareholders, because if their bank DOES GO BUST, they bear some of the loss. After all, a shareholder is one who by definition shares in profits and losses. Thus the bank becomes a sort of mutual fund: one of the alternatives offered to depositors under full reserve.

QED. Fractional reserve is in check mate. It's a glorified piece of false logic.

And that's why Dodd-Frank and others trying to improve bank regulation simply end up producing rules and regulations of byzantine complexity which don't even solve the problem. They're trying to make sense out of something which is fundamentally senseless, which is a glorified bit of false logic. They're on a hiding to nothing. They should pack it it. Give up.

 

Bernanke says the Fed didn’t do enough. Scott Sumner is thrilled.

Scott Sumner, the world’s most ardent anti-Keynsian and ardent opponent of fiscal stimulus, is thrilled that Bernanke says the Fed didn’t do enough monetary stimulus during the recent recession. That, so Sumner claims, is support for his Market Monetarism.

Just one problem there: Bernanke also said there wasn’t enough fiscal stimulus. See here, and here, and here, and here, and here.

But if you want more, then Google “Bernanke fiscal congress” or something like that.

Loans create deposits? Not in one sense of the word “loan”.

The Bank of England staff recently published an article supporting the heterodox view that loans by commercial banks create deposits. That sparked a HUGE reaction round the world. There is however a sense in which loans do NOT CREATE deposits. It all hinges on what you mean by the word “loan”: a word that actually has two meanings.

First, there is something like “the transfer of real wealth by a lender to a borrower for a significant length of time with the borrower normally paying interest to the lender”.

Second, there is something like “a bank credits the account of a customer with $X so as to provide the customer with liquid working capital, or “day to day transaction money”, with the AVERAGE balance on the account remaining around $X.”

That distinction can be illustrated by reference to a barter economy in which a bank sets up in business. Citizens in that economy would deposit collateral at the bank and have their accounts credited so as to enable them to trade with each other using money instead of barter. But if that was their ONLY INTENTION, then the AVERAGE BALANCE on each person's account would remain at its initial level. That is, no one would have obtained a loan from anyone else in the transfer of real wealth sense of the word.

So in the latter scenario, the bank creates money, but not as a result of making a loan in the “transfer of real wealth” sense.

In contrast, where a citizen in the formerly barter economy wanted a loan in the transfer of real wealth sense, that wealth cannot come from the bank, because a bank is just a collection of office blocks full of employees, computers etc. The wealth can only come from other citizens who have decided to forgo the consumption of REAL WEALTH for an extended period and deposit the money they've earned at the bank. So in the latter scenario, deposits come before loans (contrary to the claims of the more naïve heterodox economists).

Moreover, in the latter scenario, no money has been created: that is, as long as those long term depositors have no intention of spending their money, what they've done in effect is to transfer their money to the borrower. That is, the bank acts as an intermediary between borrower and lender.

Indeed, the latter point is reflected in the way the money supply is measured in most countries: that is, so called money in term or deposit accounts to which the account holder does not have access for several months is often not counted as money.

Conclusion.

Where a bank makes a loan in the “transfer of real wealth” sense, it can well be argued that no money is created. In contrast, where it makes a so called loan that simply consists of providing customers with day to day transaction money or liquid working capital, then money IS CREATED. But that's not a loan in the transfer of wealth sense.

British Treasury has plan to reduce the debt by 2035. LOL.

This article by Martin Wolf in yesterday’s Financial Times has a great little chart showing the Treasury and Office for Budgetary Responsibility’s projections for how the debt relative to GDP might fall in the years up to 2035. Plus there are of course related passages in the article. (The chart appears in the hard copy edition but not the internet edition).

Advocates of Modern Monetary Theory, and others with a grasp of economics will be laughing in the aisles because deficits and hence debts are HIGHLY UNPREDICTABLE.

It seems to have escaped the notice of the Treasury and OBR that we experienced a dramatic rise in the deficit and debt over the last four years a so, and that no one in the five years or so before the crunch would have predicted this rise.

And quite apart from the fact that Treasury and OBR don’t seem to be aware of what’s going on right under their noses as pointed out in the paragraph just above, there is a very simple theoretical point about deficits and debts which the latter two illustrious (?) bodies don’t seem to have grasped. It’s a point made by Keynes and which is not much more than common sense.

It’s the point that given the gyrations in private sector spending, the public sector has to counteract those gyrations by running a deficit in a recession and cutting the deficit, or even running a surplus in a boom.

And booms, or outbreaks of Alan Greenspan’s “irrational exuberance” are as unpredictable as recessions. Thus it’s quite on the cards that the debt, far from gradually declining in the years up to 2035 as per Treasury and OBR predictions, will suddenly decline in three years’ time. Or it could be seven years’ time. Or thirteen or fifteen. And I’ll bet that before 2035, we have another recession, so the debt will shoot up again, and then down again. All of which will make the Treasury and OBR ideas about a slow gradual decline up to 2035 look very silly.

Or as Keynes put it, “Look after unemployment, and the budget looks after itself”.

And at this point in the argument any economic Neanderthals will chirp with something like, “But we can’t just leave the debt at it’s currently elevated level. Creditors might start demanding higher rates of interest. Then we’re scuppered.”

Well I’ve been thru that argument a dozen times before on this blog, so I’d ask the Neanderthals to do a bit of Googling (if they know how) if they want the latter question answered.

And now I’m off to do something more intellectually stimulating than dealing with debt-phobes: talking to the hibernating snails in my garden, to be exact.