Tag: finance is fraud

The European Crisis in Sixteen Tweets

Much confusion comes from the idea that “a single currency” is a straightforward, normal state and “exit” from it a dramatic rupture.

Ensuring that claims on all banks are treated as equivalent is a utopian dream even in a single political unit; it requires constant intervention to even approximate.

“Greece” is simply the label currently put on the underlying contradictions of euro project.

Whether Greece” exits” or not, that project remains allowing unlimited financial flows based on the unanchored expectations of financial markets…

… and then demanding that real productive activity and standards of living adjust to accommodate them.

Since this would destroy society if really adhered to, the system is buffered with offsetting public flows, on conditions set by unaccountable authorities.

 

 

There is no sense in which default “leads to” exit. Creditors will attempt to force exit, as punishment for default.

Greek default will stress banks throughout Europe. In response ECB says it will increase liquidity for non-Greek banks, cut off liquidity for Greek banks.

Recall that in 2011-2012, sovereign debt yields reached 7% in Spain and Italy, 12% in Ireland, 14% in Portugal. Certain default if they had stayed there.

Rates fell only after ECB intervened in markets & explicitly promised to prevent defaults. ECB commitment convinced private holders to accept lower yields.

ECB continues to support markets for sovereign debt of countries other than Greece, in order to keep them at small premium to German debt.

Recall that after 2011, Spain and Italy both accumulated Target balances that dwarfed official aid to Greece…

… in part because ECB loosened collateral requirements for banks there. Meanwhile, collateral requirements for Greek banks have been tightened.

If ECB treated Greece the same as Spain, Italy etc, there would be no crisis. With “whatever it takes” guarantee, markets would be happy to hold Greek debt.

If ECB treated Spain, Italy, Portugal, Ireland as they’ve treated Greece, those countries would have crises like Greece, including defaults.

There is a crisis in Greece and not the other deficit countries because the authorities have chosen for the crisis to be in Greece.

 

 

What If the ECB Pulls the Trigger?

Over the past week, it’s become clear that the real leverage the European authorities have over Greece is via the banking system. What does Greek need continued loans for? Not to pay for public expenditures, thanks to the primary surplus. Not to pay for imports — Greece has a (small) trade surplus. Not to service current debt, if it defaults. What does need to be financed, is the flow of deposits out of Greek banks to the rest of Europe.

So what happens if that financing is cut off, as the ECB is threatening? The usual answer is collapse of the Greek banking system, followed immediately by a forced exit of Greece.  But the other night I was talking to some friends about the situation, and we found ourselves wondering: What concretely are the mechanics of this? What is the exact chain of events from an end to ECB financing to Greek exit from the euro? I don’t know the answer to this, but the more I think about it, the less confident I am in the conventional wisdom.

What concretely does it mean that the ECB is providing liquidity support to Greek banks? As far as I can tell, it is this. When a holder of a deposit in a Greek bank wants to make a payment elsewhere, either to purchase a good or asset outside Greece or to move the deposit elsewhere, the Greek bank must transfer an equal quantity of settlement assets to the bank receiving the deposits. These settlement assets are normally acquired on the fly, by issuing a new liability in the interbank market, but if other banks are unwilling to accept the liabilities of Geek banks, they can be borrowed directly from the ECB, against suitable collateral. This is the lending that the ECB is threatening to cut off.

What if the Greek banks can’t acquire settlement assets? Then other banks will not accept the deposits, and it will be impossible to use deposits in Greek banks to make payments. Depositors will find their accounts frozen and, in the normal course of events, the banks would be shut down by regulators.

But Greece still does have a central bank. My understanding is that much of the day to day business of central banking in Europe is carried out by the national central banks. In principle, even if Greek banks can’t acquire settlement assets by borrowing from the ECB, they can still borrow from the Greek central bank. This doesn’t help with payments to the rest of Europe, since reserve balances at the Greek central bank won’t be accepted elsewhere. But I don’t see why the Greek central bank can’t keep the payments system working within Greece itself. If the Greek central bank is willing to provide liquidity on the same terms as the ECB, what’s going to force the Greek banks to shut down? It’s not as though there’s any Europe-wide bank regulator that can do it.

In a sense, this is a kind of soft exit, since there will now be a Greek euro that is not freely convertible into a non-Greek euro. But I don’t see why it has to be catastrophic or irreversible. Transactions within Greece can continue as before. And for routine trade it might not make much difference either, since the majority of Greek imports come from outside the EU. Where it would make a difference is precisely that it would prevent Greek depositors from moving their funds out of the country. [1] In effect, by cutting Greece off from the European interbank payment system, the ECB will be imposing capital controls on Greece’s behalf. You could even say that, if the threat of cutting off liquidity support can trigger a run on Greek banks, actually doing so will ensure that there isn’t one.

Now maybe I’m wrong about this. Maybe there is a good reason why the Greek central bank can’t maintain the payment system within Greece. But I also think there’s a larger point here. I’m thinking about the end of the gold standard in the 1930s, when breaking the link with gold was considered an unthinkable catastrophe. And yet the objective basis of the money system in gold turned out to be irrelevant. I think, in the same way, the current crisis may be revealing the reflexive, self-referential nature of money. On a certain level, the threat against Greece comes down to: “You must make your money payments, or we will deprive you of the means to make your money payments.”

The rule of the money system requires that real productive activity be organized around the need for money. This in turn requires that money not be too freely available, but also that it not be too scarce. Think of Aunt Agatha in Daniel Davies’ parable. Suppose her real goal is to run her nephew’s life — to boss him around, have him at her beck and call, to know that he won’t make any choices without asking if she approves. In that case she always has to be threatening to cut him off, but she can’t ever really do it. If he knows he’s getting money from her he won’t care what she thinks — but if he knows he isn’t, he won’t care either. He has to be perpetually unsure. And in keeping with Davies’ story, the only thing Jim actually needs the money for, is to continue servicing his debt to Aunt Agatha. The only real power she has is a superstitious horror at the idea of unpaid debts.

In this way I’ve tentatively convinced myself that all Syriza needs to do is hold firm. The only way they can lose is if they lose their nerve. Conversely, the worst outcome for the ECB and its allies would be if they force Greece into default — and everyone watches as the vengeful money-gods fail to appear.

UPDATE: It turns out that Daniel Davies is making a similar argument:

Capital controls are arguably what Greece needs right now – they have
balanced the primary budget, and they need to stop capital flight.
From the ECB’s point of view, I’d agree that the move is political, but
it also means that they are no longer financing capital flight.

There’s
a sensible negotiated solution here – with a lower primary surplus than
the program (in which context I think Varoufakis’ suggestion of 1.5% is
not nearly ambitious enough), a return to the structural programs (the
Port of Piraeus really does need to be taken out of the political
sphere), and an agreement to kick the headline debt amount into the far
future (in service of which aim I don’t think all the funny financial
engineering is helping).

The fall-back is a kind of soft exit,
with capital controls. But the massive, massive advantage of capital
controls over drachmaisation is that they  preserve foreign exchange.
Greece imports fuel and food. With capital controls, it can be sure of
financing vital imports.

The fact that Davies is thinking the same way makes me a lot more confident about the argument in this post.

[1] Greek banks would also presumably be limited in their ability provide physical cash to depositors, but I don’t think this is important.

Why Not Just Mail Out Checks?

A friend writes:

Let’s suppose that the United States could get a Universal Basic Income, but it had to trade a bunch of stuff for it. What would be important to keep after a UBI?

Obviously, various income support could right out the door (food stamps, unemployment insurance). But would we be willing to trade labor regulations (minimum wage, union laws)? Public schools? Medicare? Curious as to your thoughts.

This sort of choice comes up all the time these days. Of course in practice it’s a false choice: They take our parks and public insurance, and never send out those UBI checks. Or occasionally, as in New York, they give us our universal pre-K and parks and bike lanes, and we don’t have to give up our meager income-support checks to get them.

Still, it’s an interesting question. How should we answer it?

1. At least for an important current on the left, the goal isn’t to distribute commodities more equally, but to liberate human life from the logic of the market. Or, a society that maximizes positive freedom and the development of people’s capacities, as opposed to one that maximizes consumption of goods. From that point of view, diminishing the scope of the market — incremental decommodification, as Naomi Klein used to say — is the important thing, so we’d always reject this kind of trade. (Assuming it’s on more or less “even” terms.)

2. Setting that aside. Shouldn’t we have a presumption that the goods that are currently publicly supplied are subject to some kind of market failure? Presumably there’s some reason why many governments provide insurance against old age and health costs, housing, education, police and fire services, and very few governments provide clothing or restaurant meals. Of course one wouldn’t want to say the current mix of public-private provision is ideal. But one wouldn’t want to say it carries no information, either.

3. There’s a genuine value in institutions that pursue a public purpose, rather than profit. We can debate whether hospitals should be public, nonprofit or even private at the level of management, but presumably in the operating room we want our doctor thinking about what’s most likely to make this surgery successful and not what’s most likely to make him money. (And we don’t think reputation costs are enough to guarantee those motives coincide — so back to market failures as above.) In the same category, and close to many of our hearts, are professors and other teachers, who teach better when they’re focused on just that, and not worrying about their paycheck.

4. Related to (3), how do we manage a system in which the public sector is disappearing? Seems to me the logical outcome of the UBI-and-let-markets-do-the-rest approach is stuff like this. Either you agree that intrinsic motivation is important, in which case you have to honestly ask in each particular case whether self-interest adds more than it detracts. Or you deny it, but then you’re left with the problem of how to you assure the honesty of the people sending out the checks. (Not to mention all the zillion commercial transactions that happen every day.) DeLong somewhere calls neoliberalism a counsel of despair, which makes sense only once you’ve given up on the capacity of the state. But without minimal state capacity even neoliberalism doesn’t work. If the nightwatchman won’t do what’s right because it is right, you can’t have markets either. Better pledge yourself to a feudal lord. And if the nightwatchman will, then why not the doctor, teacher, etc.?

5. How confident are we that unfettered markets plus UBI is politically sustainable? Being a worker expecting a certain wage gives you some social power. Being a participant in a public institution gives you, arguably, some social power, an identity, it helps solve the collective action problem of the poor. (Which is the big problem in all of this.) But receiving your UBI check doesn’t give you any power, any capacity to disrupt, it doesn’t give you a sense of collective identity, it doesn’t form a basis of collective action. My hypothesis is that the parents at the local public school are more able to act together — they have the PTA, to begin with — than the same number of voucher recipients are.

Did We Have a Crisis Because Deficits Were Too Small?

In comments to the previous post on fiscal policy, Steve Roth points to a couple posts from his own (excellent) blog pointing to a similar argument by Randy Wray, that falling federal debt-GDP ratios nominal volumes of government debt have consistently preceded financial crises historically.

Also in comments, Chris Mealy asks,

Isn’t the idea that sufficient government debts will prevent phony safe assets and the financial crises they lead to?

Right, exactly!
A couple years ago, VoxEU ran several good pieces making exactly this argument — that it was the lack of sufficient government debt that spurred the growth of mortgage securitization. Here is one:

The increased demand for US government debt by emerging economy central banks led to lower yields, thus forcing those savers in the OECD countries who would normally have held government assets to frantically “search for returns”. … The AAA tranches on securitised US mortgages … seemed to provide the safety plus a “yield pick up” without any risk… 

The key technology that permitted the transformation of US mortgages into safe liquid assets was securitisation. … The massive buying of US government paper by emerging market central banks had displaced other investors whose preference previously had been for safe, short-term, liquid assets.  … The excess demand for short-term, safe, liquid assets created by emerging economies’ accumulation of reserves could not have been satisfied by the securitisation of US mortgages (and consumer credit) without massive credit and liquidity “enhancements” by the banking system. … 

Looking forward, this analysis implies that the current (smaller but still sizeable) US current account deficit should not lead to similar asset supply and demand mismatches since US households are now starting to save and it is the US government which is running the deficit, thus supplying exactly the kind of assets needed…

And here is another, from an impeccably mainstream author:

The entire world had an insatiable demand for safe debt instruments – including foreign central banks and investors, but also many US financial institutions. This put enormous pressure on the US financial system… The financial sector was able to create micro-AAA assets from the securitisation of lower quality ones, but at the cost of exposing the system to a panic… In this view, the surge of safe-asset demand was a key factor behind the rise in leverage and macroeconomic risk concentration in financial institutions… These institutions sought the profits generated from bridging the gap between this rise in demand and the expansion of its natural supply. … 

[Once the crisis began], the underlying structural deficit of safe assets worsened as the … triple-A assets from the securitisation industry dried up and the spike in perceived uncertainty further increased demand for these assets. Safe interest rates plummeted to record low levels. … Global imbalances and their feared sudden reversal never played a significant role for the US during this deep crisis. In fact, the worse things became, the more domestic and foreign investors ran to US Treasuries for cover and treasury rates plummeted (and the dollar appreciated). … 

One approach to addressing these issues prospectively would be for governments to explicitly bear a greater share of the systemic risk. … If the governments in asset-producing countries were to do it directly, then they would have to issue bonds beyond their fiscal needs.

The logic is very clear and, to me at least, compelling: For a variety of reasons (including but not limited to reserve accumulation by developing-country central banks) there was an increase in demand for safe, liquid assets, the private supply of which is generally inelastic. The excess demand pushed up the price of the existing stock of safe assets (especially Treasuries), and increased pressure to develop substitutes. (This went beyond the usual pressure to develop new methods of producing any good with a rising price, since a number of financial actors have some minimum yield — i.e. maximum price — of safe assets as a condition of their continued existence.) Mortgage-backed securities were thought to be such substitutes. Once the technology of securitization was developed, you also had a rise in mortgage lending and the supply of MBSs continued growing under its own momentum; but in this story, the original impetus came unequivocally from the demand for substitutes for scarce government debt. It’s very hard to avoid the conclusion that if the US government had only issued more debt in the decade before the crisis, the housing bubble and subsequent crash would have been much milder.
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While we’re at it, I can resist reposting the old post where I first mentioned this stuff:
A focus on cyclical stabilization assumes that there is no systematic long-term divergence between aggregate supply and aggregate demand. But Keynes believed that there was a secular tendency toward stagnation in advanced capitalist economies, so that maintaining full employment meant not just using public expenditure to stabilize private investment demand, but to incrementally replace it.
Another way of looking at this is that the steady shift from small-scale to industrial production implies a growing weight of illiquid assets in the form of fixed capital. There is not, however, any corresponding long-term increase in the demand for illiquid liabilities. If anything, the sociological patterns of capitalism point the other way, as industrial dynasties whose social existence was linked to particular enterprises have been steadily replaced by rentiers. The whole line of financial innovations from the first joint-stock companies to the recent securitization boom have been attempts to bridge this gap. But this requires ever-deepening financialization, with all the social waste and instability that implies.
It’s the government’s ability to issue liabilities backed by the whole economic output that makes it uniquely able to satisfy the demands of wealth-holders for liquid assets. In the functional finance tradition going back to Lerner, modern states do not possess a budget constraint in the same way households or firms do. Public borrowing has nothing to do with “funding” spending, it’s all about how much government debt the authorities want the banking system to hold. If the demand for safe, liquid assets rises secularly over time, so should government borrowing.
From this point of view, one important source of the recent financial crisis was the surpluses of the 1990s, and insufficient borrowing by the US government in general. By restricting the supply of Treasuries, this excessive fiscal restraint spurred the creation of private sector substitutes purporting to offer similar liquidity properties, in the form of various asset-backed securities. But these new financial assets remained at bottom claims on specific illiquid real assets and their liquidity remained vulnerable to shifts in (expectations of) the value of those assets.
The response to the crisis in 2008 then consists of the Fed retroactively correcting the undersupply of government liabilities by engaging in a wholesale swap of public for private liabilities, leaving banks (and liquidity-demanding wealth owners) holding government liabilities instead of private financial assets. The increase in public debt wasn’t an unfortunate side-effect of the solution to the financial crisis, it was the solution.
Along the same lines, I sometimes wonder how much the huge proportion of government debt on bank balance sheets — 75 percent of assets in 1945 vs. 1.5 percent in 2005 — contributed to the financial stability of the immediate postwar era. With that many safe assets sloshing around, it didn’t take financial engineering or speculative bubbles to convince banks to hold claims on fixed capital and housing. But as the supply of government debt has dwindled the inducements to hold other assets have had to grow increasingly garish.
From which I conclude that ever-increasing government deficits may in fact be better Keynesianism – theoretically, historically and pragmatically – than countercyclical demand management.
(What’s striking to me, rereading this now, is that when I wrote it I had not read any Leijonhufvud. Yet the argument that capitalism suffers from a chronic oversupply of long, illiquid assets is one of the central messages of Keynesian Economics and the Economics of Keynes — “no mortal being can hold land to maturity,” etc. I got the idea from Minsky, I suppose, or maybe from Michael Perelman, who are both very clear that the specific institutions of capitalism are in many ways in deep tension with the development of long-lived capital goods.)

UPDATE: Hey look, The Economist agrees. I think that means it’s time to move on.

UPDATE 2: So does Joe Weisenthal at the The Business Insider. His argument (and Stephanie Kelton’s) is different from the one here — it focuses on the fact that net savings across sectors have to sum to zero, as opposed to the government’s advantage in providing liquidity. But the fundamental point is the same, that the important thing about the government fiscal position is the implications it has for private balance sheets.

UPDATE 3: Steve R. points out that I misread his posts — Wray’s argument is about the nominal volume of federal debt outstanding, not the debt-GDP ratio. Hmm. I’m not sure I buy that relationship as evidence of anything … but it’s still good to see that Wray is asking this question. Steve also points to this paper, which looks very interesting.

IMF: Abolish the Debt!

Not exactly; you have to read between the lines a little.

People are talking about this new thing from the IMF, reviving the 1930s-era “Chicago plan” for 100% reserve banking. Red meat for the end-the-Fed crowd. The paper shares a coauthor, Michael Kumhof, with that other notable recent piece of IMF rabble-rousing, on how inequality is responsible for financial crises. Anyway, the Chicago plan. It was the brainchild of Herbert Simon Henry Simons and Irving Fisher:

The key feature of this plan was that it called for the separation of the monetary and credit functions of the banking system, first by requiring 100% backing of deposits by government-issued money, and second by ensuring that the financing of new bank credit can only take place through earnings that have been retained in the form of government-issued money, or through the borrowing of existing government-issued money from non-banks, but not through the creation of new deposits, ex nihilo, by banks.  

Fisher (1936) claimed four major advantages for this plan. First, preventing banks from creating their own funds during credit booms, and then destroying these funds during subsequent contractions, would allow for a much better control of credit cycles, which were perceived to be the major source of business cycle fluctuations. Second, 100% reserve backing would completely eliminate bank runs. Third, allowing the government to issue money directly at zero interest, rather than borrowing that same money from banks at interest, would lead to a reduction in the interest burden on government finances and to a dramatic reduction of (net) government debt, given that irredeemable government-issued money represents equity in the commonwealth rather than debt. Fourth, given that money creation would no longer require the simultaneous creation of mostly private debts on bank balance sheets, the economy could see a dramatic reduction not only of government debt but also of private debt levels.

Kumhof and his coauthor Jaromir Benes run through how such a thing would be implemented today, and then estimate its effects on output and prices in a DSGE model. (I don’t care about that second part.) My opinion: I don’t think this makes sense practically as a practical policy proposal or strategically as a political focal point. But it’s not crazy. I think it’s a useful thought experiment to clarify what we do and don’t need banks for, and I’m glad that some people around Occupy seem to be noticing and talking about it.

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Though Kumhof and Benes don’t quite say so, this proposal should really be understood as addressing two distinct and separate problems:

1. Stabilization via monetary policy is constrained by the fact that its traditional tools have less purchase on private credit creation than they are imagined to or they used to, and not just at the ZLB. (As discussed repeatedly on this blog, e.g. these posts and this one.) So if the state wants to continue relying on monetary policy as its main countercyclical tool, we need to think about institutional changes that would strengthen the transmission mechanism.

2. If government liabilities are more liquid than the liabilities of even the biggest banks, as they certainly seem to be, then the banking system plays no function with respect to federal borrowing. The banks that hold federal debt are providing “anti-intermediation” — they are replacing more liquid assets with less liquid ones. In this sense, whatever income banks get from holding federal debt and providing means of payment are pure rents – it would be more efficient for federal liabilities to serve as means of payment directly.

The Chicago plan is the stone that is supposed to kill both these birds. I think it misses both, but in an intellectually productive way. In other words, it’s fun to think about.

The goal of the plan is to, in effect, collapse the categories of inside money, outside money and government debt by eliminating the first and turning the third into the second. Equivalently, it’s an attempt to legislate the economy into functioning the way monetarists (and some MMTers) say it already does, with a fixed money supply set by policy. You could think of it as another intervention in the centuries-old Currency School vs. Banking School debate — except that unlike most Currency School advocates over the past two centuries, Kumhof and Benes acknowledge that the Banking School is right about how existing financial systems operate, and that 100% reserves is not a return to some “natural” arrangement but a radical and far-reaching reform.

Why wouldn’t it work?

On the first goal, improving the reliability of stabilization policy, it’s important to recognize that deposits are not where the action is, and haven’t been for a long time. So 100% reserve backing of deposits is really the smallest piece of this thing. In effect, it’s a proposal to tighten the Fed’s handle on the narrow money supply — M1, in the jargon. but most means of payment in the economy aren’t captured by M1 — they don’t take the form of deposits, and haven’t for a long time. (In this respect things have really changed since 1936.) So it wouldn’t be enough to tighten the rules on deposit creation; you’d have to abolish (or impose the same reserve requirements on) all the other assets that serve as means of payment (and are more or less captured in M2 and formerly in M3), and prevent the financial system from developing new ones.

The proposal does do this, but it’s pretty draconian — under Kumhof and Benes’ plan “there is no lending at all between private agents.” As soon as you relax that restriction, the plan’s advantages in terms of stabilization go away. An absolute legal prohibition on IOUs might please Ezra Pound, but it’s hard to see it playing well among any of the IMF’s other constituencies. And the reality is if anything worse than that, because, as the Islamic world has been finding for 1,400 years now, it is very hard to legally distinguish debt contracts from other kinds of private contracts. So in practice you’d need an almost Soviet level of control over economic activity to realize something like this.

Perhaps I’m exaggerating the practical difficulties faced by the plan, but even if you could overcome them, it would only solve half the problem. The proposal only strengthens contractionary policy, not expansionary policy. It might have prevented the acceleration in credit creation in the 1980s and 1990s, but wouldn’t have done anything to boost credit creation and real activity in the past few years. It’s true that it would prevent the specific dynamic that Fisher (and later Friedman) blamed for the Depression, a positive feedback in a downturn between bank failures and a falling money supply. But that dynamic no longer exists, given deposit insurance and active countercyclical monetary policy, altho I suppose one could imagine it reappearing again in the future…

Part of the issue is whether you think lack of effective demand = lack of nominal effective demand = excess demand for money, by definition. This is the standard New Keynesian view, borrowed from monetarism. In this view a recession necessarily involves an insufficient money supply. But I don’t accept this. And once you accept that recessions involve multiple equilibria or coordination failures, there is no reason to think that increasing the supply of money must logically be a reliable way to get out of one, and lots of empirical evidence that it isn’t.

But even if the “Chicago plan” is not a workable solution to the breakdown of the monetary policy transmission mechanism, it’s a useful exercise. At the least, it calls attention to the fact that there is a breakdown — in a monetarist world, reforming the financial system to allow the central bank to control the money supply would be like legislating the law of gravity. Kumhof and Benes are clear that this proposal is only meaningful because under current arrangements, money is fully endogenous:

The critical feature of our theoretical model is that it exhibits the key function of banks in modern economies, which is not their largely incidental function as financial intermediaries between depositors and borrowers, but rather their central function as creators and destroyers of money. A realistic model needs to reflect the fact that under the present system banks do not have to wait for depositors to appear and make funds available before they can on-lend, or intermediate, those funds. Rather, they create their own funds, deposits, in the act of lending. This fact can be verified in the description of the money creation system in many central bank statements, and it is obvious to anybody who has ever lent money and created the resulting book entries.

(As a footnote tartly notes, that includes Kumhof, a former banker.)

So while the proposal doesn’t describe something you could actually do, it does help illuminate the current system of credit creation, via a sharply contrasting ideal alternative.

How about the second goal, eliminating the value-subtracting activity of banks “financing” government debt? Here I think they are onto something important. Interest is a payment for liquidity, as we’ve known since Keynes. So there is no economic reason for the government to pay interest to financial intermediaries when its own liabilities are the most liquid there are.

The problem here is, it’s not clear why, once you recognize this, you would stop at splitting of the payment system from credit creation. Why doesn’t the state provide means of payment directly? Whatever arguments there were for a state monopoly on money issue presumably don’t go away when money becomes electronic, so why isn’t there a public debit card just like there is federal currency? (This becomes really obvious when you look at the outright scams that happen when private businesses manage EBT cards, etc.) Of course there are people who want private currencies, but they are crazy libertarians. And yet without anyone accepting their arguments, we’ve implicitly gone along with them as the economy has moved toward electronic means of payment — every time you pay with a debit or credit card, some financial parasite takes their cut. The obvious solution is to end the private monopoly on means of payment. (What do want? Postal savings and a public payment system! When do we want them? Now!) Benes and Kumhof don’t go all the way there, but their plan is at least a step in that direction.

There’s a broader point here. Axel Leijonhufvud (among others) suggests that the fundamental reason there is a term premium (and at least part of the reason there is a liquidity premium) is that there is a chronic excess of long-term, illiquid assets in the form of physical capital, because of the technical superiority of roundabout production processes. That is, the time to maturity of the representative asset is longer than the horizon of the typical asset-holder. Thus the “constitutional weakness” (Hicks) at the long end of the credit market.

But if a larger proportion of the private economy’s outside assets are made up of government debt rather than physical capital, (and if a larger proportion of saving is done by institutions rather than households, tho that’s iffier) then this constitutional weakness goes away, and there’s no reason to have anyone collecting a fee for maturity transformation. Ashwin at Macroeconomic Resilience has written some very smart stuff about this.

Banks came into existence, in other words, in a world where most savers had a very high demand for liquidity, and most liabilities were risky and illiquid. So you needed someone to stand between, to intermediate. But today most saving is via institutional investors with long horizons — pensions etc. — or internal to the firm, while a very large proportion of borrowing is by sovereign governments, and so less risky/more liquid than anything banks can issue. In this world there’s no need for intermediaries in the old sense; they’re just rent-collecting parasites. This is not the way the “Chicago plan” is motivated but it seems like a not-bad way of making the point.

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Third piece, the transition. How do you go to a 100%-reserve world without a huge contraction of credit and activity? Here their solution is kind of clever. If you look at US nonfinancial debt, they observe, total business and home mortgage debt together come to about $20 trillion, and total government and non-mortgage household debt also come to about $20 trillion. Only the former, which finances investment, is socially productive, they figure. Under the Chicago Plan, banks would need $20 trillion in new reserves to avoid reducing the investment-financing part of their lending. Where do those new reserves come from? By the central bank buying up and extinguishing the other, non-productive half of the debt. It’s the best-credentialed jubilee proposal you’re likely to see.

Of course banks are worse off because half their interest-earning assets are replaced with sterile reserves. But in the logic of the proposal, there’s no social cost to that, since the lost interest income was for value-substracting “anti-intermediation” (my phrase, not theirs) activity; it was the banks’ fee for substituting less liquid for more liquid assets. Strictly speaking,though, this only applies to government debt. It’s not clear what’s supposed to happen with the stuff the non-mortgage household debt was paying for. Some of it, like credit card debt, was incurred just incidentally to making payments, and would no longer be needed in a world with separate payment and credit systems. As for the rest, they don’t say. It would be logical to see it as mostly for essentials that are better provide publicly, financed by continued reserve issuance. But that would be, as somebody said, not just reading between the lines, but off the edge of the page.

Overall, I like it. A lot. Not because I think it’s a good policy proposal or even (probably) a useful focal point for political mobilization. In general, I think that one should avoid, even for rhetorical purposes, the presumption that economic policy is set by a benevolent philosopher-king (an assumption baked into standard macro models). Agreeing on how the banking system “should” function under some more or less implicit set of constraints will not get us a bit closer to a society fit for human beings. But politically, having paper from the IMF suggesting, even in this rather artificial way, that the simplest solution to excessive debt is just to abolish it, has got to be useful in the coming rising of the debtors. Intellectually, meanwhile, what I like about this is that it puts in sharp relief how little the existing financial system can be explained, as it usually is, as the solution to the economic problems of intermediation and liquidity provision. If the functions banks are supposedly performing could be performed much more efficiently and easily without them, then banks must really be for something else.

EDIT: Oh and also, I’ve got to quote this bit:

Any debate on the origins of money is not of merely academic interest, because it leads directly to a debate on the nature of money, which in turn has a critical bearing on arguments as to who should control the issuance of money. … Since the thirteenth century [the] precious-metals-based system has, in Europe, been accompanied, and increasingly supplanted, by the private issuance of bank money, more properly called credit. On the other hand, the historically and anthropologically correct state/institutional story for the origins of money is one of the arguments supporting the government issuance and control of money under the rule of law. In practice this has mainly taken the form of interest-free issuance of notes or coins, although it could equally take the form of electronic deposits. 

There is another issue that tends to get confused with the much more fundamental debate concerning the control over the issuance of money, namely the debate over “real” precious-metals-backed money versus fiat money. … this debate is mostly a diversion, because even during historical regimes based on precious metals the main reason for the high relative value of precious metals was … government fiat and not the intrinsic qualities of the metals.These matters are especially confused in Smith (1776), who takes a primitive commodity view of money… 

The historical debate concerning the nature and control of money is the subject of Zarlenga (2002), a masterful work that traces this debate back to ancient Mesopotamia, Greece and Rome. Like Graeber (2011), he shows that private issuance of money has repeatedly led to major societal problems throughout recorded history, due to usury associated with private debts. Zarlenga does not adopt the common but simplistic definition of usury as the charging of “excessive interest”, but rather as “taking something for nothing” through the calculated misuse of a nation’s money system for private gain.

This is a really smart passage for a bunch of reasons. But what I really like about it is that it vindicates my position in the great Graeber debate on about three different levels. Take that, Mike Beggs!

Adventures in Cognitive Dissonance

Brad DeLong, May 25:

WHAT ARE THE CORE COMPETENCES OF HIGH FINANCE? 

The core competences of high finance are supposed to be (a) assessing risk, and (b) matching people with risks to be carried with people with the risk-bearing capacity to carry them. Robert Waldmann has a different view:

I think their core competencies are (a) finding fools for counterparties and (b) evading regulations/disguising gambling as hedging.

Regulatory arbitrage, and persuading those who do not understand risks that they should bear them–those are not socially-valuable activities.

Brad DeLong, yesterday:

NEXT YEAR’S EXPECTED EQUITY RETURN PREMIUM IS 9% 

If you have any risk-bearing capacity at all, now is the time to use it.

So I guess last week’s doubts have been assuaged. Or did he really mean to write “If you have any capacity for being fooled into being a swindler’s counterparty, now is the time to use it”?

EDIT: Oh and then, the post just after that one argued — well, really, assumed — that the current value of Facebook shares gives an unbiased estimate of future Facebook earnings, and therefore of the net wealth that Facebook has created. (I guess not a single dollar of FB revenue comes at the expense of other firms, which must be a first in the history of capitalism.) Is there some way of consistently believing both that current stock values give an unbiased estimate of the present value of future earnings, and that stock values a year from now will be much higher than they are today? I can’t see one. But then I’ve never had the brain for theodicy.

UPDATE: Anyone reading this should immediately go and read rsj’s much better take on the same DeLong post over at Windyanabasis. He explains exactly why DeLong is confused here.

Doug Henwood on Our Current Disorders

Blogging’s been light here lately. Sorry. In the meantime, you should read this:

if you combine net equity offerings—which, given the heavy schedule of buybacks over the last quarter century, have been negative most of the time since 1982—takeovers (which involve the distribution of corporate cash to shareholders of the target firm), and traditional dividends into a concept I call transfers to shareholders, you see that corporations have been shoveling cash into Wall Street’s pockets at a furious pace. Back in the 1950s and 1960s, nonfinancial corporations distributed about 20% of their profits to shareholders…. After 1982, though, the shareholders’ share rose steadily. It came close to 100% in 1998, fell back to a mere 25% in 2002, and then soared to 126% in 2007. That means that corporations were actually borrowing to fund these transfers. …

So what exactly does Wall Street do? Let’s be generous and concede that it does provide some financing for investment. But an enormous apparatus of trading has grown up around it—not merely trading in certificates, but in control over entire corporations. I think it’s less fruitful to think of Wall Street as a financial intermediary than it is to think of it as an instrument for the establishment and exercise of class power. It’s the means by which an owning class forms itself, particularly the stock market. It allows the rich to own pieces of the productive assets of an entire economy. So, while at first glance, the tangential relation of Wall Street, especially the stock market, to financing real investment might make the sector seem ripe for tight regulation and heavy taxation, its centrality to the formation of ruling class power makes it a very difficult target.

For a long while [after 1929], shareholder ownership was more notional than active. … But when the Golden Age was replaced by Bronze Age of rising inflation and falling profits, Wall Street … unleashed what has been dubbed the shareholder revolution, demanding not only higher profits but a larger share of them. The first means by which they exercised this control was through the takeover and leveraged buyout movements of the 1980s. By loading up companies with debt, they forced managers to cut costs radically, and ship larger shares of the corporate surplus to outside investors rather than investing in the business or hiring workers. … [In the 1990s,] the shareholder revolution recast itself as a movement of activist pension funds… the idea was to get managers to think and act like shareholders, since they were materially that under the new regime.

But pension fund activism sort of petered out as the decade wore on. Managers still ran companies with the stock price in mind, but the limits to shareholder influence have come very clear since the financial crisis began. Managers have been paying themselves enormously while stock prices languished. … The problem was especially acute in the financial sector: Bank of America, for example, bought Merrill Lynch because its former CEO, Ken Lewis, coveted the firm, and if the shareholders had any objections, he could just lie to them… It was as if the shareholder revolution hardly happened, at least in this sense. But all that money flowing from corporate treasuries into money managers’ pockets has quieted any discontent.

I do have some doubts about that last paragraph, tho — I suspect that “especially acute” should really be “limited to.” I don’t think it’s as if the shareholder revolution never happened — there still is, you know, all that money flowing into money managers’ pockets — but more a matter of quis custodiet ipsos custodes. If the function of finance is as overseers for the capitalist class — and I think Doug is absolutely right about this — then, well, who’s going to oversee them. Intrinsic motivation, norms and conventions, is really the only viable solution to this sort of principal-agent problem, and the culture of finance doesn’t do it.

Jim Crotty is also very worth reading on this. And I think he’s clearer that this kind of predatory management is mostly specific to Wall Street.

A History of Catastrophes

Schumpeter says:

Even if he confines himself to the most regular of commodity bills and looks with aversion on any paper that displays a suspiciously round figure,the banker must not only know what the transaction is which he is asked to finance and how it is likely to turn out, but he must also know the customer, his business, and even his private habits, and get, by frequently “talking things over with him,” a clear picture of his situation. … However, this is not only highly skilled work, proficiency in which cannot be acquired in any school except that of experience, but also work which requires intellectual and moral qualities not present in all people who take to the banking profession. 

… In the case of bankers, however, failure to be up to what is a very high mark interferes with the working of the system as a whole. Moreover, bankers may, at some times and in some countries, fail to be up to the mark corporatively: that is to say, tradition and standards may be absent to such a degree that practically anyone, however lacking in aptitude and training, can drift into the banking business, find customers, and deal with them according to his own ideas. In such countries or times, wildcat banking develops. This in itself is sufficient to turn the history of capitalist evolution into a history of catastrophes.

From Business Cycles: A Theoretical, Historical and Statistical Analysis of the Capitalist Process.

What a magnificent book! Leaving my heavily-annotated copy on the NYC subway is one of my great regrets in life, bookwise. It doesn’t seem to be in print now. Does anybody still read it?

Political Economy 101

When he’s right, he’s right:

everything we’re seeing makes sense if you think of the Right as representing the interests of rentiers, of creditors who have claims from the past — bonds, loans, cash — as opposed to people actually trying to make a living through producing stuff. Deflation is hell for workers and business owners, but it’s heaven for creditors. … thinking of what’s happening as the rule of rentiers, who are getting their interests served at the expense of the real economy, helps make sense of the situation.

Or, almost right. Because it isn’t just the Right…

EDIT: It’s interesting to note how reflexively DeLong shied away from this thought when it occurred to him a while back, with the ludicrous-on-its-face argument that only “coupon-clippers with their portfolios 100% in government bonds” could have an interest in deflation. The existence of rentiers as a distinct social class is an unthought in respectable circles. Which shows how impressively disrespectable Krugman is becoming.

The Financial Crisis and the Recession: Two Datapoints for the Skeptics

One of the most dramatic features of the financial crisis, for those who were following it obsessively in the autumn of 2008, was the near-freezing up of the commercial paper market. Commercial paper is short-term debt sold in markets rather than advanced by banks. It’s mostly very short maturity — days, weeks or months, not years. It’s generally cheaper than other forms of financing, but firms that rely on it need to be able to borrow more or less continuously. Doubts about their financial condition, or even the suspicion that other lenders might have doubts, can quickly push them up against their survival constraint. This is what happened to a number of financial institutions — most spectacularly Lehman Brothers — in the third quarter of 2008. The breakdown in the commercial paper market was one of the things that convinced people the financial universe was imploding, and taking the real economy down with it.
The story, implicit or explicit, was that the suddenly reduced or uncertain value of financial assets, and the seizing-up of the interbank markets, left banks unable or unwilling to hold the liabilities of nonfinancial businesses, i.e., to lend. These businesses found themselves unable to finance new investment or even routine operations, leading to the Great Recession. This is essentially the same story that Milton Friedman told (and Peter Temin, among others, criticized), about the Great Depression, but it’s also more or less the consensus view of the 2008-09 crisis among New Keynesian economists. For example:
A large decrease in the value of asset holdings of financial institutions resulted in dramatic intensification of the agency problems in those institutions … Credit spreads widened and credit rationing became widespread. The diminished ability to finance the acquisition of capital goods resulted in huge cutbacks of all types of investment.

The same story was widespread in the business journalism world, with people like Andrew Ross Sorkin writing, “Commercial paper, the workaday stuff that lets companies make payroll, was suddenly viewed as radioactive — and business activity almost stopped in its tracks.” Most importantly, this was the view of the crisis that motivated — or at least justified — the choice of both the Bush and Obama administrations to make strengthening bank balance sheets their number one priority in the crisis. But is it right? There are reasons for doubt.

Data from FRED. 

See, here’s a funny thing. I haven’t seen it discussed anywhere, but it’s very interesting. The commercial paper of financial and nonfinancial firms, normally interchangeable, fared quite differently in the crisis. Up til then, both had tracked the federal funds rate closely, except in the early 90s (the last by-general-agreement credit crisis) when both had risen above it. But as the figure above shows, in the fall of 2008, right around the Lehmann failure (the arrow on the graph), an unprecedented gap opened up between the interest lenders demanded on commercial paper from financial versus nonfinancial companies.

The implication: The state of the interbank lending market isn’t necessarily informative about the availability of credit to nonfinancial firms. It’s perfectly possible that lots of big banks had made lots of stupid bets in the real estate market, and once this became known other banks were unwilling to lend to them. But they remained perfectly willing to lend to everyone else — perhaps even on more favorable terms, since those funds had to go somewhere. The divergence in commercial paper rates is hardly dispositive, of course, but it at least suggests that the acute phase of the financial crisis was more of a problem for the financial sector specifically than for the economy as a whole

Second. Sorkin calls commercial paper “the workaday stuff that lets companies meet payroll.” This kind of language was everywhere for a while — that the financial crisis threatened to stop the flow of short-term credit from banks, and that without that even the most routine business functions would be impossible.

One of the central political-economic facts of our time is that public discussion of the economy is entirely dominated by finance. The interests of banks differ from those of other businesses on many dimensions; one of them is banks’ dependence on short-term financing. Financial firms are defined by the combination of short-term liabilities and long-term assets; they need to borrow every day; that’s why they’re subject to runs. The fear of not being able to make payroll if you’re cut off, even briefly, from financial markets, is perfectly reasonable, if you’re a bank.
But if you’re not?
In fact, short-term debt is large relative to cashflow only for financial firms. Nonfinancial firms don’t finance operating expenses through debt, only investment. (And inventories and goods-in-progress, which are largely financed by credit from customers and suppliers, rather than from banks.) From Compustat:
Short-term debt as a fraction of total debt

Sector Median Mean
FIRE 0.56 0.55
Non-FIRE 0.16 0.23

Short-term debt as a fraction of cashflow
Sector Median Mean
FIRE 7.53 15.1
Non-FIRE 0.35 0.71

Short-term debt as a fraction of revenue
Sector Median Mean
FIRE 0.78 1.64
Non-FIRE 0.04 0.08

(FIRE is finance, insurance and real estate. Short-term here means maturities of less than a year. Cashflow is defined as profits plus depreciation.)
This isn’t a secret; but it’s striking how different are the financing structures of financial and nonfinancial firms, and how little that difference has penetrated into public debate or much of the economics profession. For the median financial firm, losing access to short-term finance would be equivalent to a 70 percent fall in revenues; few could survive. For the median nonfinancial firm, by contrast, loss of access to short-term finance would be equivalent to a fall in revenues of just 4 percent. Short-term finance is just not that important to nonfinancial firms.
So, the breakdown in short-term credit markets was largely limited to financial firms, and financial firms are anyway the only ones that really depend on short-term credit. I don’t claim these two pieces of evidence are in any way definitive — I’ve got a long paper on this question in the works, which, well, won’t be definitive either — but they are at least consistent with the story that the financial crisis, on the one hand, and the fall of employment and output, on the other, were more or less independent outcomes of the collapse of the housing bubble, and that the state of the banks was not the major problem for the real economy.

EDIT: For the life of me, I can’t get either graphs or tables to look good in Blogger.