finance – Page 3 – J. W. Mason

Is Capital Being Reallocated to High-Tech Industries?

Readers of this blog are familiar with the “short-termism” position: Because of the rise in shareholder power, the marginal use of funds for many corporations is no longer fixed investment, but increased payouts in the form of dividends and sharebuybacks. We’re already seeing some backlash against this view; I expect we’ll be seeing lots more.

The claim on the other side is that increased payouts from established corporations are nothing to worry about, because they increase the funds available to newer firms and sectors. We are trying to explore the evidence on this empirically. In a previous post, I asked if the shareholder revolution had been followed by an increase in the share of smaller, newer firms. I concluded that it didn’t look like it. Now, in this post and the following one, we’ll look at things by industry.

In that earlier post, I focused on publicly traded corporations. I know some people don’t like this — new companies, after all, aren’t going to be publicly traded. Of course in an ideal world we would not limit this kind of analysis to public traded firms. But for the moment, this is where the data is; by their nature, publicly traded corporations are much more transparent than other kinds of businesses, so for a lot of questions that’s where you have to go. (Maybe one day I’ll get funding to purchase access to firm-level financial data for nontraded firms; but even then I doubt it would be possible to do the sort of historical analysis I’m interested in.) Anyway, it seems unlikely that the behavior of privately held corporations is radically different from publicly traded one; I have a hard time imagining a set of institutions that reliably channel funds to smaller, newer firms but stop working entirely as soon as they are listed on a stock market. And I’m getting a bit impatient with people who seem to use the possibility that things might look totally different in the part of the economy that’s hard to see, as an excuse for ignoring what’s happening in the parts we do see.

Besides, the magnitudes don’t work. Publicly traded corporations continue to account for the bulk of economic activity in the US. For example, we can compare the total assets of the nonfinancial corporate sector, including closely held corporations, with the total assets of publicly traded firms listed in the Compustat database. Over the past decade, the latter number is consistently around 90 percent of the former. Other comparisons will give somewhat different values, but no matter how you measure, the majority of corporations in the US are going to be publicly traded. Anyway, for better or worse, I’m again looking at publicly-traded firms here.

In the simplest version of the capital-reallocation story, payouts from old, declining industries are, thanks to the magic of the capital markets, used to fund investment in new, technology-intensive industries. So the obvious question is, has there in fact been a shift in investment from the old smokestack industries to the newer high-tech ones?

One problem is defining investment. The accounting rules followed by American businesses generally allow an expense to be capitalized only when it is associated with a tangible asset. R&D spending, in particular, must be treated as a current cost. The BEA, however, has since 2013 treated R&D spending, along with other forms of intellectual property production, as a form of investment. R&D does have investment-like properties; arguably it’s the most relevant form of investment for some technology-intensive sectors. But the problem with redefining investment this way is that it creates inconsistencies with the data reported by individual companies, and with other aggregate data. For one thing, if R&D is capitalized rather than expensed, then profits have to be increased by the same amount. And then some assumptions have to be made about the depreciation rate of intellectual property, resulting in a pseudo asset in the aggregate statistics that is not reported on any company’s books. I’m not sure what the best solution is. [1]

Fortunately, companies do report R&D as a separate component of expenses, so it is possible to use either definition of investment with firm-level data from Compustat. The following figure shows the share of total corporate investment, under each definition, of a group of six high-tech industries: drugs; computers; communications equipment; medical equipment; scientific equipment other electronic goods; and software and data processing. [2]

As you can see, R&D spending is very important for these industries; for the past 20 years, it has consistently exceed investment spending as traditionally defined. Using the older, narrow definition, these industries account for no greater share of investment in the US than they did 50 years ago; with R&D included, their share of total investment has more than doubled. But both measures show the high-tech share of investment peaking in the late 1990s; for the past 15 years, it has steadily declined.

Obviously, this doesn’t tell us anything about why investment has stalled in these industries since the end of the tech boom. But it does at least suggest some problems with a simple story in which financial markets reallocate capital from old industries to newer ones.

The next figure breaks out the industries within the high-tech group. Here we’re looking at the broad measure of investment, which incudes R&D.

As you can see, the decline in high-tech investment is consistent across the high-tech sectors. While the exact timing varies, in the 1980s and 1990s all of these sectors saw a rising share of investment; in the past 15 years, none have. [3] So we can safely say: In the universe of publicly traded corporations, the sectors we think would benefit from reallocation of capital were indeed investing heavily in the decades before 2000; but since then, they have not been. The decline in investment spending in the pharmaceutical industry — which, again, includes R&D spending on new drugs — is especially striking.

Where has investment been growing, then? Here:

The red lines show broad and narrow investment for oil and gas and related industries — SICs 101-138, 291-299, and 492. Either way you measure investment, the increase over the past 15 years has dwarfed that in any other industry. Note that oil and gas, unlike the high-tech industries, is less R&D-intensive than the corporate sector as a whole. Looking only at plant and equipment, fossil fuels account for 40 percent of total corporate investment; by this measure, in some recent years, investment here has exceeded that of all manufacturing together. With R&D included, by contrast, fossil fuels account for “only” a third of US investment.

In the next post, I’ll look at the other key financial flows — cashflow from operations, shareholder payouts, and borrowing — for the tech industries, compared with corporations in general. As we’ll see, while at one point payouts were lower in these industries than elsewhere, over the past 15 years they have increased even faster than for publicly traded corporations as a whole. In the meantime:

Very few of the people talking about the dynamic way American financial markets reallocate capital have, I suspect, a clear idea of the actual reallocation that is taking place. Save for another time the question of whether this huge growth in fossil fuel extraction is a good thing for the United States or the world. (Spoiler: It’s very bad.) I think it’s hard to argue with a straight face that shareholder payouts at Apple or GE are what’s funding fracking in North Dakota.

[1] This seems to be part of a larger phenomenon of the official statistical agencies being pulled into the orbit of economic theory and away from business accounting practices. It seems to me that allowing the official statistics to drift away from the statistics actually used by households and businesses creates all kinds of problems.

[2] Specifically, it is SICs 83, 357, 366, 367, 382, 384, and 737. I took this specific definition from Brown, Fazzari and Petersen. It seems to be standard in the literature.

[3] Since you are probably wondering: About two-thirds of that spike in software investment around 1970 is IBM, with Xerox and Unisys accounting for most of the rest.

Mixed Messages from The Fed and the Bond Markets

It’s conventional opinion that the Fed will begin to raise its policy rate by the end of 2015, and continue raising rates for the next couple years. In the FT, Larry Summers argues that this will be a mistake. And he observes that bond markets don’t seem to share the conventional wisdom: “Long term bond markets are telling us that real interest rates are expected to be close to zero in the industrialised world over the next decade.”

The Summers column inspired me to take a look at bond prices and flesh out this observation. It is straightforward to calculate how much the value of a bond change in response to a change in interest rates. So by looking at the current yields on bonds of different maturities, we can see what expectations of future rate changes are consistent with profit-maximizing behavior in bond markets. [1]

The following changes shows the yields of Treasury bonds of various maturities, and the capital loss for each bond from a one-point rise in yield over the next year. (All values are in percentage points.)

Maturity	Yield as of July 2015	Value Change from 1-Point Rise
30 year	3.07	-17.1
20 year	2.77	-13.9
10 year	2.32	-8.4
5 year	1.63	-4.6
1 year	0.30	-0.0

So if the 30-year rate rises by one point over the next year, someone who just bought a 30-year bond will suffer a 17 percent capital loss.

It’s clear from these numbers that Summers is right. If, over the next couple of years, interest rates were to “normalize” to their mid-90s levels (about 3 points higher than today), long bonds would lose half their value. Obviously, no one would hold bonds at today’s yields if they thought there was an appreciable chance of that happening.

We can be more precise. For any pair of bonds, the ratio of the difference in yields to the difference in capital losses from a rate increase, is a measure of the probability assigned by market participants to that increase. For example, purchasing a 20-year bond rather than a 30-year bond means giving up 0.3 percentage points of yield over the next year, in return for losing only 14 percent rather than 17 percent if there’s a general 1-point increase in rates. Whether that looks like a good or bad tradeoff will depend on how you think rates are likely to change.

For any pair of bonds, we can calculate the change in interest rates (across the whole yield curve) that would keep the overall return just equal between them. Using the average yields for July, we get:

30-year vs 20-year: +0.094%

30-year vs. 10-year: +0.086%

30-year vs. 5-year: +0.115%

20-year vs. 10-year +0.082%

20-year vs. 5 year: + 0.082%

Treasury bonds seem to be priced consistent with an expected tenth of a percent or so increase in interest rates over the next year.

In other words: If you buy a 30 year bond rather than a 20-year one, or a 20-year rather than 10-year, you will get a higher interest rate. But if it turns out that market rates rise by about 0.1 percentage points (10 basis points) over the next year, the greater capital losses on longer bonds will just balance their higher yields. So if you believe that interest rates in general will be about 10 basis points higher a year from now than they are now, you should be just indifferent between purchasing Treasuries of different maturities. If you expect a larger increase in rates, long bonds will look overpriced and you’ll want to sell them; if you expect a smaller increase in rates than this, or a decrease, then long bonds will look cheap to you and you’ll want to buy them. [2]

A couple of things to take from this.

First, there is the familiar Keynesian point about the liquidity trap. When long rates are low, even a modest increase implies very large capital losses for holders of long bonds. Fear of these losses can set a floor on long rates well above prevailing short rates. This, and not the zero lower bound per se, is the “liquidity trap” described in The General Theory.

Second, compare the implied forecast of a tenth of a point increase in rates implied by today’s bond prices, to the forecasts in the FOMC dot plot. The median member of the FOMC expects an increase of more than half a point this year, 2 points by the end of 2016, and 3 points by the end of 2017. So policymakers at the Fed are predicting a pace of rate increases more than ten times faster than what seems to be incorporated into bond prices.

If the whole rate structure moves in line with the FOMC forecasts, the next few years will see the biggest losses in bond markets since the 1970s. Yet investors are still holding bonds at what are historically very low yields. Evidently either bond market participants do not believe that Fed will do what it says it will, or they don’t believe that changes in policy rate will have any noticeable effect on longer rates.

And note: The belief that long rates unlikely to change much, may itself prevent them from changing much. Remember, for a 30-year bond currently yielding 3 percent, a one point change in the prevailing interest rate leads to a 17 point capital loss (or gain, in the case of a fall in rates). So if you have even a moderately strong belief that 3 percent is the most likely or “normal” yield for this bond, you will sell or buy quickly when rates depart much from this. Which will prevent such departures from happening, and validate beliefs about the normal rate. So we shouldn’t necessarily expect to see the whole rate structure moving up and down together. Rather, long rates will stay near a conventional level (or at least above a conventional floor) regardless of what happens to short rates.

This suggests that we shouldn’t really be thinking about a uniform shift in the rate structure. (Though it’s still worth analyzing that case as a baseline.) Rather, an increase in rates, if it happens, will most likely be confined to the short end. The structure of bond yields seems to fit this prediction. As noted above, the yield curve at longer maturities implies an expected rate increase on the order of 10 basis points (a tenth of a percentage point), the 10-year vs 5 year, 10 year vs 1 year, and 5 year vs 1 year bonds imply epected increases of 18, 24 and 29 basis points respectively. This is still much less than dot plot, but it is consistent with idea that bond markets expect any rate increase to be limited to shorter maturities.

In short: Current prices of long bonds imply that market participants are confident that rates will not rise substantially over the next few years. Conventional wisdom, shared by policymakers at the Fed, says that they will. The Fed is looking at a two point increase over the next year and half, while bond rates imply that it will take twenty years. So either Fed won’t do what it says it will, or it won’t affect long rates, or bondholders will get a very unpleasant surprise. The only way everyone can be right is if trnasmission from policy rate to long rates is very slow — which would make the policy rate an unsuitable tool for countercyclical policy.

This last point is something that has always puzzled me about standard accounts of monetary policy. The central bank is supposed to be offsetting cyclical fluctuations by altering the terms of loan contracts whose maturities are much longer than typical business cycle frequencies. Corporate bonds average about 10 years, home mortgages, home mortgages of course close to 30. (And housing seems to be the sector most sensitive to policy changes.) So either policy depends on systematically misleading market participants, to convince them that cyclical rate changes are permanent; or else monetary policy must work in some completely different way than the familiar interest rate channel.

[1] In the real world things are more complicated, both because the structure of expectations is more complex than a scalar expected rate change over the next period, and because bonds are priced for their liquidity as well as for their return.

[2] I should insist in passing, for my brothers and sisters in heterodoxy, that this sort of analysis does not depend in any way on “consumers” or “households” optimizing anything, or on rational expectations. We are talking about real markets composed of profit-seeking investors, who certainly hold some expectations about the future even if they are mistaken.

Do Shareholder Payouts Fund Investment at New Firms?

Are shareholder payouts a tool for reallocating capital from large, established corporations to the newer, smaller firms with better prospects for growth? If so, we should see this reflected in the investment figures — the shareholder revolution of the 1980s, and the more recent growth of activist investors, should be associated with a shift of investment away from big incumbent firms. Do we see this?

As a simple test, we can look at the share of corporate investment accounted for by smaller and younger firms. And the answer this exercise suggests is, No. Within the corporate sector, there is also no sign of capital being allocated to new sectors and smaller firms. The following figures show the share of total corporate investment accounted for by young firms, defined as those listed for less than five years; and by small firms, defined as those with sales below the median sales for listed corporations in that year. [1]

The share of investment accounted for newer firms fluctuates between 5 and 20 percent of the total, peaking periodically when large numbers of new firms enter the markets. [2] The most recent such peak came in tech boom period of the late 1990s, as one might expect. But the young-firm investment share shows no upward trend, and since the recession has been stuck at its lowest level of the postwar period. As for the the share of investment accounted for small firms, it has steadily declined since the 1950s — apart from, again, a temporary spike during the tech-boom period. Like the investment share of newer firms, the investment share of small firms is now at its lowest level ever.

We come to a similar conclusion if we look at the share of investment accounted for by noncorporate businesses. Partnerships, sole proprietorships and other noncorporate businesses accounted for close to 20 percent of US fixed investment in the 1960s and 1970s, but have accounted for a steady 12 percent of fixed investment over the past 25 years. So the funds flowing out of large corporations sector are not financing increased investment in smaller, younger corporations, or in the noncorporate sector either.

This is not really surprising. Smaller and younger businesses are mainly dependent on bank loans, and shareholder payouts don’t increase bank lending capacity in any direct way. More broadly, it’s hard to see evidence that potential funders of new businesses are liquidity-constrained. Higher payouts presumably do contribute to higher stock prices, and perhaps marginally to lower bond yields, but any connection with financing for new businesses seems tenuous at best.

In any case, whatever the shareholder revolution has accomplished, there does no seem to have been any reallocation of capital to smaller, growing firms. Capital accumulation in the United States is more concentrated in large established corporations than ever.

[1] Data is from Compustat, a database that assembles all the income, cashflow and balance sheet statements published since 1950 by corporations listed on US markets. I’ve excluded the financial sector, defined as 2-digit NAICS 52 and 53 and SIC 60-69. Investment is capital expenditure plus R&D.

[2] I suspect the late-80s peak is an artifact of the many changes of ownership in that period, which are hard to distinguish from new listings.

Do Shareholder Payouts “Allocate Capital”?

With my colleagues at the Roosevelt Institute, I’m working on a long-delayed followup to the Disgorge the Cash paper.

One of the issues we are addressing is this: Aren’t higher shareholder payouts just a way of channeling funds from mature, slow-growing firms to fast-growing sectors that need capital? This has always been one of the main arguments in support of the shareholder revolution. Michael Jensen:

With all its vast increases in data, talent, and technology, Wall Street can allocate capital among competing businesses and monitor and discipline management more effectively than the CEO and headquarters staff of the typical diversified company. KKR’s New York offices and Irwin Jacobs’ Minneapolis base are direct substitutes for corporate headquarters in Akron and Peoria.

Can the data shed light on the claim that high shareholder payouts are just a way that capital markets reallocate scarce funds from stagnant established firms to up-and-coming innovators?

One line of evidence against this claim is presented in my original Disgorge paper, though not explained as clearly as it could have been. As the table below — reproduced from the paper — shows, the correlations of investment with profits and borrowing have weakened not just at the level of the individual firm, but for the corporate sector as a whole. If markets were mainly reallocating capital from the industries of yesterday to the industries of tomorrow, we would expect an inflow of funds into the corporate sector to be associated with a rise in investment somewhere, even if not in the firms that initially received them. But this is not the case — or at least, it is less the case than it used to be. The weakening of the aggregate relationship between cashflow from operations and borrowing, on the one hand, and investment, on the other, suggests that higher payouts from one business are not translated into more investment funding for another.

Now I want to present two more lines of evidence that point in the same direction.

First, we can compare sources and uses of funds for corporations in general with the same sources and uses for corporations in high-technology industries. Second, we can look at smaller and younger firms specifically, and ask if they account for a higher share of investment than in the old days of managerialism, when investment was more internally financed. In the next two posts that’s what I’ll do.

The Greek Crisis and Monetary Sovereignty

Note: This post only really makes sense as a continuation of the argument in this one.

It’s a general rule that the internal logic of a system only becomes visible when it breaks down. A system that is smoothly reproducing itself provides no variation to show what forces it responds to. Constraints are invisible if they don’t bind. You don’t know where power lies until a decision is actively contested.

In that sense, the crises of the past seven years — and the responses to them — should have been very illuminating, at least if we can figure out what to learn from them. The current crisis in Greece is an ideal opportunity to learn where power is exercised in the union, and how tightly the single currency really binds national governments. Of course, we will learn more about the contours of the constraints if the Syriza government is more willing to push against them.

The particular case I’m thinking of right now is our conventional language about central banks “printing money,” and the related concept of monetary sovereignty. In periods of smooth reproduction we can think of this as a convenient metaphor without worrying too much about what exactly it is a metaphor for. But if Greece refuses to accept the ECB’s conditions for continued support for its banks, the question will become unavoidable.

We talk about governments “printing money” as if “money” always meant physical currency and banks were just safe-deposit boxes. Even Post Keynesian and MMT people use this language, even as they insist in the next breath that money is endogenously created by the banking system. But to understand concretely what power the ECB does or does not have over Greece, we need to take the idea of credit money seriously.

Money in modern economies means bank liabilities. [1] Bank liabilities constitute money insofar as a claim against one bank can be freely transferred to other units, and freely converted to a claim against another bank; and insofar as final settlement of claims between nonfinancial units normally takes the form of a transfer of bank liabilities.

Money is created by loan transactions, which create two pairs of balance-sheet entries — an asset for the borrowing unit and a liability for the bank (the deposit) and a liability for the borrowing unit and an asset for the bank (the loan). Money is destroyed by loan repayment, and also when the liabilities of a bank cease to be usable to settle claims between third parties. In familiar modern settings this lack of acceptability will be simultaneous with the bank being closed down by a regulatory authority, but historically things are not always so black and white. In the 19th century, it was common for a bank that ran out of reserves to suspend convertibility but continue operating. Deposits in such banks could not be withdrawn in the form of gold or equivalent, but could still be used to make payments, albeit not to all counterparties, and usually at a discount to other means of payment. [2]

To say, therefore, that a government controls the money supply or “prints money” is simply to say that it can control the pace of credit creation by banks, and that it can can maintain the acceptability of bank liabilities by third parties — which in practice means, by other banks. It follows that our conventional division of central bank functions between monetary policy proper (or setting the money supply), on the one hand, and bank regulation, operation of the interbank payments system, and lender of last resort operations, on the other, is meaningless. There is no distinct function of monetary policy, of setting the interest rate, or the money supply. “Monetary policy” simply describes one of the objectives toward which the central bank’s supervisory and lender-of-last-resort functions can be exercised. It appears as a distinct function only when, over an extended period, the central bank is able to achieve its goals for macroeconomic aggregates using only a narrow subset of the regulatory tools available to it.

In short: The ability to conduct monetary policy means the ability to set the pace of new bank lending, ex ante, and to guarantee the transferability of the balances thus created, ex post.

It follows that no country with a private banking system has full monetary sovereignty. The central bank will never be able to exactly control the pace of private credit creation, and to do so even approximately except by committing regulatory tools which then are unavailable to meet other objectives. In particular, it is impossible to shift the overall yield structure without affecting yield spreads between different assets, and it is impossible to change the overall pace of credit creation without also influencing the disposition of credit between different borrowers. In a system of credit money, full monetary sovereignty requires the monetary authority to act as the monopoly lender, with banks in effect serving as just its retail outlets. [3]

Now, some capitalist economies actually approximate to this pretty closely. For example the postwar Japanese system of “window guidance” or similar systems in other Asian developmental states. [4] Something along the same lines is possible with binding reserve requirements, where the central bank has tight operational control over lending volumes. (But this requires strict limits on all kinds of credit transactions, or else financial innovation will soon bypass the requirements.) Short of this, central banks have only indirect, limited influence over the pace of money and credit creation. Such control as they do have is necessarily exercised through specific regulatory authority, and involves choices about the direction as well as the volume of lending. And it is further limited by the existence of quasi-bank substitutes that allow payments to be made outside of the formal banking system, and by capital mobility, which allows loans to be incurred, and payments made, from foreign banks.

On the other hand, a country that does not have its “own” currency still will have some tools to influence the pace of credit creation and to guarantee interbank payments, as long as there is some set of banks over which it has regulatory authority.

My conclusion is that the question of whether a country does or does not have its own currency is not a binary one, as it’s almost always imagined to be. Wealth takes to form of a variety of assets, whose prospective exchange value can be more or less reliably stated in terms of some standard unit; transactions can be settled with a variety of balance-sheet changes, which interchange more or closely to par, and which are more or less responsive to the decisions of various authorities. We all know that there are some payments you can make using physical currency but not a credit or debit card, and other payments you can make with the card but not with currency. And we all know that you cannot always convert $1,000 in a bank account to exactly $1,000 in cash, or to a payment of exactly $1,000 – the various fees within the payment system means that one unit of “money” is not actually always worth one unit. [5]

In normal times, the various forms of payment used within one country are sufficiently close substitutes with each other, exchange sufficiently close to par, and are sufficiently responsive to the national monetary authority, relative to forms of payment used elsewhere, that, for most purposes, we can safely speak of a single imaginary asset “money.” But in the Greek case, it seems to me, this fiction obscures essential features of the situation. In particular, it makes the question of being “in” or “out of” the euro look like a hard binary, when, in my opinion, there are many intermediate cases and no need for a sharp transiton between them.

[1] Lance Taylor, for instance, flatly defines money as bank liabilities in his superb discussion of the history of monetary thought in Reconstructing Macroeconomics.

[2] Friedman and Schwartz discuss this in their Monetary History of the United States, and suggest that if banks had been able to suspend withdrawals when their reserves ran out, rather than closed down by the authorities, that would have been an effective buffer against against the deflationary forces of the Depression.

[3] Woodford’s Interest and Prices explicitly assumes this.

[4] Window guidance is described by Richard Werner in Masters of the Yen. The importance of centralized credit allocation in Korea is discussed by the late Alice Amsden in Asia’s Next Giant.

[5] Goodhart’s fascinating but idiosyncratic History of Central Banking ends with a proposal for money that does not seek to maintain a constant unit value – in effect, using something like mutual fund shares for payment.

“Disgorge the Cash” at the Roosevelt Institute

I have a working paper up at the Roosevelt Institute, as part of their new Financialization Project. Much of the content will be familiar to readers of this blog, but I think the argument is clearer and, I hope, more convincing in the paper.

The paper has gotten a nice writeup at the Washington Post, and at the Washington Center for Equitable Growth.

UPDATE. And in the International Business Times.

Where Do Interest Rates Come From?

What determines the level of interest rates? It seems like a simple question, but I don’t think economics — orthodox or heterodox — has an adequate answer.

One problem is that there are many different interest rates. So we have two questions: What determines the overall level of interest rates, and what determines the spreads between different interest rates? The latter in turn we can divide into the question of differences in rates between otherwise similar loans of different lengths (term spreads), differences in rates between otherwise similar loans denominated in different currencies, and all the remaining differences, grouped together under the possibly misleading name risk spreads.

In any case, economic theory offers various answers:

1. The orthodox answer, going back to the 18th century, is that the interest rate is a price that equates the desire to save with the desire to borrow. As reformulated in the later 19th century by Bohm-Bawerk, Cassel, etc., that means: The interest rate is the price of goods today relative to goods tomorrow. The interest rate is the price that balances the gains from deferring consumption with our willingness to do so. People generally prefer consumption today to consumption in the future, and because it will be possible to produce more in the future than today, so the interest rate is (normally) positive. This is a theory of all transactions that exchange spending in one period for spending (or income) in another, not specifically a theory of the interest rate on loans.

The Wicksell variant of this, which is today’s central-bank orthodoxy, is that there is a well-defined natural interest rate in this sense but that for some reason markets get this one price wrong.

2. An equally old idea is that the interest rate is the price of money. In Hume’s writings on money and interest, for instance, he vacillates between this and the previous story. It’s not a popular view in the economics profession but it’s well-represented in the business world and among populists and monetary reformers,. In this view, money is just another input to the production process, and the interest rate is its price. A creditor, in this view, isn’t someone deferring consumption to the future, but someone who — like a landlord — receives an income thanks to control of a necessary component of the production process. A business, let’s say, that needs to maintain a certain amount of working capital in the form of money or similarly liquid assets, may need to finance it with a loan on which it pays interest. Interest payments are in effect the rental price of money, set by supply and demand like anything else. As I say, this has never been a respectable view in economic theory, but you can find it in more empirical work, like this paper by Gabriel Chodorow-Reich, where credit is described in exactly these terms as an input to current production.

3. Keynes’ liquidity-preference story in The General Theory. Here again the interest rate is the price of money. But now instead of asking how much the marginal business borrower will pay for the use of money, we ask how much the marginal wealth owner needs to be compensated to give up the liquidity of money for a less-liquid bond. The other side of the market is given by a fixed stock of bonds; evidently we are dealing with a short enough period that the flow of new borrowing can be ignored, and the bond stock treated as exogenously fixed. With no new borrowing, the link from the interest rate is liked to the real economy because it is used to discount the expected flow of profits from new investment — not by business owners themselves, but by the stock market. It’s an oddly convoluted story.

4. A more general liquidity-preference story. Jorg Bibow, in a couple of his essential articles on the Keynesian theory of liquidity preference, suggests that many of the odd features of the theory are due to Keynes’ decision to drop the sophisticated analysis of the financial system from The Treatise on Money and replace it with an assumption of an exogenously fixed money stock. (It’s striking that banks play no role in in the General Theory.) But I’m not sure how much simpler this “simplification” actually makes the story, or whether it is even logically coherent; and in any case it’s clearly inapplicable to our modern world of bank-created credit money. In principle, it should be possible to tell a more general version of the liquidity preference story, where, instead of wealth holders balancing the income from holding a bond against the liquidity from holding “money,” you have banks balancing net income against incremental illiquidity from simultaneously extending a loan and creating a deposit. I’m afraid to say I haven’t read the Treatise, so I don’t know how much you can find that story there. In any case it doesn’t seem to have been developed systematically in later theories of endogenous money, which typically assume that the supply of credit is infinitely elastic except insofar as it’s limited by regulation.

5. The interest rate is set by the central bank. This is the orthodox story when we turn to the macro textbook. It’s also the story in most heterodox writers. From Wicksell onward, the whole discussion about interest rates in a macroeconomic context is about how the central bank can keep the interest rate at the level that keeps current expenditure at the appropriate level, and what happens if it fails to do so. It is sometimes suggested that the optimal or “natural” interest rate chosen by the central bank should be the the Walrasian intertemporal exchange rate — explicitly by Hayek, Friedman and sometimes by New Keynesians like Michael Woodford, and more cautiously by Wicksell. But the question of how the central bank sets the interest rate tends to drop out of view. Formally, Woodford has the central bank set the interest rate by giving it a monopoly on lending and borrowing. This hardly describes real economies, of course, but Woodford insists that it doesn’t matter since central banks could control the interest rate by standing ready to lend or borrow unlimited amounts at thresholds just above and below their target. The quite different procedures followed by real central banks are irrelevant. [1]

A variation of this (call it 5a) is where reserve requirements bind and the central bank sets the total quantity of bank credit or money. (In a world of bind reserve requirements, these will be equivalent.) In this case, the long rate is set by the demand for credit, given the policy-determined quantity. The interbank rate is then presumably bid up to the minimum spread banks are willing to lend at. In this setting causality runs from long rates to short rates, and short rates don’t really matter.

6. The interest rate is set by convention. This is Keynes’ other theory of the interest rate, also introduced in the General Theory but more fully developed in his 1937 article “Alternative Theories of the Rate of Interest.” The idea here is that changes in interest rates imply inverse changes in the price of outstanding bonds. So from the lenders’ point of view, the expected return on a loan includes not only the yield (as adjusted for default risk), but also the capital gain or loss that will result if interest rates change while the loan is still on their books. The longer the term of the loan, the larger these capital gains or losses will be. I’ve discussed this on the blog before and may come back to it in the future, but the essential point is that if people are very confident about the future value of long rates (or at least that they will not fall below some floor) then the current rate cannot get very far from that future expected rate, no matter what short rates are doing, because as the current long rate moves away from the expected long rate expected capital gains come to dominate the current yield. Take the extreme case of a perpetuity where market participants are sure that the rate will be 5% a year from now. Suppose the short rate is initially 5% also, and falls to 0. Then the rate on the perpetuity will fall to just under 4.8% and no lower, because at that rate the nearly 5% spread over the short rate just compensates market participants for the capital loss they expect when long rates return to their normal level. (Obviously, this is not consistent with rational expectations.) These kinds of self-stabilizing conventional expectations are the reason why, as Bibow puts it, “a liquidity trap … may arise at any level of interest.” A liquidity trap is an anti-bubble, if you like.

What do we think about these different stories?

I’m confident that the first story is wrong. There is no useful sense in which the interest rate on debt contracts — either as set by markets or as target by the central bank — is the price of goods today in terms of goods tomorrow. The attempt to understand interest rates in terms of the allocation across time of scarce means to alternative ends is a dead end. Some other intellectual baggage that should overboard with the “natural” rate of interest are the “real”rate of interest, the idea of consumption loans, and the intertemporal budget constraint.

But negative criticism of orthodoxy is too easy. The real work is to make a positive case for an alternative. I don’t see a satisfactory one here.

The second and third stories depend on the existence of “money” as a distinct asset with a measurable, exogenously fixed quantity. This might be a usable assumption in some historical contexts — or it might not — but it clearly does not describe modern financial systems. Woodford is right about that.

The fifth story is clearly right with respect short rates, or at least it was until recently. But it’s incomplete. As an empirical matter, it is true that interbank rates and similar short market rates closely follow the policy rate. The question is, why? The usual answer is that the central bank is the monopoly supplier of base money, and base money is used for settlement between banks. This may be so, but it doesn’t have to be. Plenty of financial systems have existed without central banks, and banks still managed to make payments to each other somehow. And where central banks exist, they don’t always have a monopoly on interbank settlement. During the 19th century, the primary tool of monetary policy at the Bank of England was the discount rate — the discount off of face value that the bank would pay for eligible securities (usually trade credit). But if the discount rate was too high — if the bank offered too little cash for securities — private banks would stop discounting securities at the central bank, and instead find some other bank that was willing to give them cash on more favorable terms. This was the problem of “making bank rate effective,” and it was a serious concern for 19th century central banks. If they tried to raise interest rates too high, they would “lose contact with the market” as banks simply went elsewhere for liquidity.

Obviously, this isn’t a problem today — when the Fed last raised policy rates in the mid-2000s, short market rates rose right along with it. Or more dramatically, Brazil’s central bank held nominal interest rates around 20 percent for nearly a decade, while inflation averaged around 8 percent. [2] In cases like these, the central bank evidently is able to keep short rates high by limiting the supply of reserves. But why in that case doesn’t the financial system develop private substitutes for reserves? Mervyn King blandly dismisses this question by saying that “it does not matter in principle whether the disequilibrium in the money market is an aggregate net shortage or a net surplus of funds—control of prices or quantities carries across irrespective of whether the central bank is the monopoly supplier or demander of its own liabilities.” [3] Clearly, the central bank cannot be both the monopoly supplier and the monopoly demander of reserves, at least not if it wants to have any effect on the rest of the world. The relevant question — to which King offers no answer — is why there are no private substitutes for central bank reserves. Is it simply a matter of legal restrictions on interbank settlements using any other asset? But then why has this one regulatory barrier remained impassable while banks have tunneled through so many others? Anyway, going forward the question may be moot if reserves remain abundant, as they will if the Fed does not shrink its balance sheet back to pre-crisis levels. In that case, new tools will be required to make the policy rate effective.

The sixth story is the one I’m most certain of. First, because it can be stated precisely in terms of asset market equilibrium. Second, because it is consistent with what we see historically. Long term interest rates are quite stable over very long periods. Third, it’s consistent with what market participants say: It’s easy to find bond market participants saying that some rate is “too low” and won’t continue, regardless of what the Fed might think. Last, but not least from my point of view, this view is clearly articulated by Keynes and by Post Keynesians like Bibow. But while I feel sure this is part of the story, it can’t be the whole story. First, because even if a conventional level of interest rates is self-stabilizing in the long run, there are clearly forces of supply and demand in credit markets that push long rates away from this level in the short run. This is even more true if what convention sets is less a level of interest rates, than a floor. And second, because Keynes also says clearly that conventions can change, and in particular that a central bank that holds short rates outside the range bond markets consider reasonable for long enough, will be able to change the definition of reasonable. So that brings us back to the question of how it is that central banks are able to set short rates.

I think the fundamental answer lies behind door number 4. I think there should be a way of describing interest rates as the price of liquidity, where liquidity refers to the capacity to honor one’s promises, and not just to some particular asset. In this sense, the scarce resource that interest is pricing is trust. And monetary policy then is at root indistinguishable from the lender of last resort function — both are aspects of the central bank’s role of standing in as guarantor for commitments within the financial system. You can find elements of this view in the Keynesian literature, and in earlier writers going back to Thornton 200-plus years ago. But I haven’t seen it stated systematically in way that I find satisfactory.

UPDATE: For some reason I brought up the idea of the interest rate as the price of money without mentioning the classic statement of this view by Walter Bagehot. Bagehot uses the term “price of money” or “value of money” interchangeably with “discount rate” as synonyms for the interest rate. The discussion in chapter 5 of Lombard Street is worth quoting at length:

Many persons believe that the Bank of England has some peculiar power of fixing the value of money. They see that the Bank of England varies its minimum rate of discount from time to time, and that, more or less, all other banks follow its lead, and charge much as it charges; and they are puzzled why this should be. ‘Money,’ as economists teach, ‘is a commodity, and only a commodity;’ why then, it is asked, is its value fixed in so odd a way, and not the way in which the value of all other commodities is fixed?

There is at bottom, however, no difficulty in the matter. The value of money is settled, like that of all other commodities, by supply and demand… A very considerable holder of an article may, for a time, vitally affect its value if he lay down the minimum price which he will take, and obstinately adhere to it. This is the way in which the value of money in Lombard Street is settled. The Bank of England used to be a predominant, and is still a most important, dealer in money. It lays down the least price at which alone it will dispose of its stock, and this, for the most part, enables other dealers to obtain that price, or something near it. …

There is, therefore, no ground for believing, as is so common, that the value of money is settled by different causes than those which affect the value of other commodities, or that the Bank of England has any despotism in that matter. It has the power of a large holder of money, and no more. Even formerly, when its monetary powers were greater and its rivals weaker, it had no absolute control. It was simply a large corporate dealer, making bids and much influencing—though in no sense compelling—other dealers thereby.

But though the value of money is not settled in an exceptional way, there is nevertheless a peculiarity about it, as there is about many articles. It is a commodity subject to great fluctuations of value, and those fluctuations are easily produced by a slight excess or a slight deficiency of quantity. Up to a certain point money is a necessity. If a merchant has acceptances to meet to-morrow, money he must and will find today at some price or other. And it is this urgent need of the whole body of merchants which runs up the value of money so wildly and to such a height in a great panic….

If money were all held by the owners of it, or by banks which did not pay an interest for it, the value of money might not fall so fast. … The possessors would be under no necessity to employ it all; they might employ part at a high rate rather than all at a low rate. But in Lombard Street money is very largely held by those who do pay an interest for it, and such persons must employ it all, or almost all, for they have much to pay out with one hand, and unless they receive much with the other they will be ruined. Such persons do not so much care what is the rate of interest at which they employ their money: they can reduce the interest they pay in proportion to that which they can make. The vital point to them is to employ it at some rate…

The fluctuations in the value of money are therefore greater than those on the value of most other commodities. At times there is an excessive pressure to borrow it, and at times an excessive pressure to lend it, and so the price is forced up and down.

The relevant point in this context is the explicit statement that the interest, or discount, rate is set by the supply and demand for money. But there are a couple other noteworthy things. First, the concept of supply and demand is one of monopolistic competition, in which lenders are not price takers, but actively trade off markup against market share. And second, that the demand for money (i.e. credit) is highly inelastic because money is needed not only or mainly to purchase goods and services, but first and foremost to meet contractual money commitments.

[1] See Perry Mehrling’s useful review. Most of the text of Woodford’s textbook can be downloaded for free here. The introduction is nontechnical and is fascinating reading if you’re interested in this stuff.

[2] Which is sort of a problem for Noah Smith’s neo-Fisherite view.

[3] in the same speech, King observes that “During the 19th century, the Bank of England devoted considerable attention to making bank rate ‘effective’.” His implication is that central banks have always been able to control interest rates. But this is somewhat misleading, from my point of view: the Bank devoted so much attention to making its rate “effective” precisely because of the occasions when it failed to do so.

Mehrling on Black on Capital

In a post last week, I suggested that an alternative to thinking of capital as quantity of means of production accumulated through past investment, is to think of it as the capitalized value of expected future profit flows. Instead of writing

α = r k

where α is the profit share of national income, r is the profit rate, and k is the capital-income ratio, we should write

k = α / r

where r is now understood as the discount rate applied to future capital income.

Are the two rs the same? Piketty says no: the discount rate is presumably (some) risk-free interest rate, while the return on capital is typically higher. But I’m not sure this position is logically sustainable. If there are no barriers to entry, why isn’t investment carried to the point where the return on capital falls to the interest rate? On the other hand, if there are barriers to entry, so that capital can continue to earn a return above the interest rate without being flooded by new investment with borrowed funds, then profits cannot all be attributed to measured capital; some is due to whatever privilege creates the barriers. Furthermore, in that case there will not be, even tendentially, a uniform economywide rate of profit.

In any case, whether or not we have a coherent story of how there can be a profit rate distinct from the discount rate, it’s clearly the latter that matters for corporate equity, which is the main form of capital Piketty observes in modern economies. Verizon, to take an example at random, has current annual earnings of around $20 billion and is valued by the stock market at around $200 billion. Nobody, I hope, would interpret these numbers as meaning that Verizon has $200 billion of capital and, since the economy-wide profit rate is 10%, that capital generates $20 billion in profits. Rather, Verizon — the enterprise as a whole, its physical capital, its organization and corporate culture, its brand, its relationships with regulators, the skills and compliance (or not) of its workers — currently generates $20 billion a year of profits. And the markets — applying the economy-wide discount factor embodied in the interest rate, plus a judgement about the likely change in share of the social surplus Verizon will be able to claim in the future — assess the present value of that stream of profits from now til doomsday at $200 billion.

Now it might so happen that the stock market capitalization of a corporation is close to the reported value of assets less liabilities — this corresponds to a Tobin’s q of 1. Verizon, with total assets of $225 billion and total liabilities of $50 billion, happens to fit this case fairly well. It might also be the case that a firm’s reported net assets, deflated by some appropriate price index, correspond to its accumulated investment; it might even also be the case that there is a stable relationship between reported net capital and earnings. But as far as market capitalization goes, it makes no difference if any of those things is true. All that matters is market expectations of future earnings, and the interest rate used to discount them.

I was thinking about this in relation to Piketty’s Capital in the 21st Century. But of course the point is hardly original. Fischer Black (of the Black-Scholes option-pricing formula) made a similar argument decades ago for thinking of capital as a claim on a discounted stream of future earnings, rather than as an accumulation of past investments.

Here’s Perry Mehrling on Black’s view of capital:

As in Fisher, Black’s emphasis is on the market value of wealth calculated as the expected present value of future income flows, rather than on the quantity of wealth calculated as the historical accumulation of savings minus depreciation. This allows Black to treat knowledge and technology as forms of capital, since their expected effects are included when we measure capital at market value. As he says: “more effective capital is more capital” (1995a, 35). Also as in Fisher, capital grows over time without any restriction from fixed factors.

…

For Black, the standard aggregative neoclassical production function is inadequate because it obscures sectoral and temporal detail by attributing current output to current inputs of capital and labor, but he tries anyway to express his views in that framework in order to reach his intended audience. Most important, he accommodates the central idea of mismatch to the production function framework by introducing the idea that the “utilization” of physical capital and the “effort” of human capital can vary over time. This accommodation makes it possible to express his theory in the familiar Cobb-Douglas production function form: y = A(eh)^α(fk)^(1-α), where y is output, h and k are human and physical capital, e and f are effort and utilization, and A is a temporary shock (1995, eq. 5.3).

It’s familiar math, but the meaning it expresses remains very far from familiar to the trained economist. For one, the labor input has been replaced by human capital so there is no fixed factor. For another, both physical and human capital are measured at market values, and so are supposed to include technological change. This means that the A coefficient is not the usual technology shift factor (the familiar “Solow residual”) but only a multiplier, indeed a kind of inverse price earnings ratio, that converts the stock of effective composite capital into a flow of composite output. In effect, and as he recognizes, Black’s production function is a reduced form, not a production function at all in the usual sense of a technical relation between inputs and outputs. What Black is after comes clearer when he groups terms and summarizes as Y=AEK (eq. 5.7), where Y is output, E is composite utilization, and K is composite capital. Here the effective capital stock is just a constant multiple of output, and vice versa. It’s just an aggregate version of Black’s conception of ideal accounting practice (1993c) wherein accountants at the level of the firm seek to report a measure of earnings that can be multiplied by a constant price- earnings ratio to get the value of the firm.

…

In retrospect, the most fundamental source of misunderstanding came (and comes still) from the difference between an economics and a finance vision of the nature of the economy. The classical economists habitually thought of the present as determined by the past. In Adam Smith, capital is an accumulation from the careful saving of past generations, and much of modern economics still retains this old idea of the essential scarcity of capital, and of the consequent virtue attached to parsimony. The financial point of view, by contrast, sees the present as determined by the future, or rather by our ideas about the future. Capital is less a thing than an idea about future income flows discounted back to the present, and the quantity of capital can therefore change without prior saving.

In comments, A H mentioned that Post Keynesian or structuralist economics seem much closer to the kind of analysis used by finance professionals than orthodox economics does. I think one reason is that we share what Mehrling calls the “money view” or, here, the “finance vision” of the economy. Orthodoxy sees the economy as a set of exchanges of goods; the finance vision sees a set of contractual money payments.

Mehrling continues:

In The Nature of Capital and Income, Irving Fisher (1906) straddled the older world view of economics and the emerging world view of finance by distinguishing physical capital goods (for which the past-determines-present view makes sense) from the value of those goods (for which the future-determines-present view makes sense). By following Fisher, Black wound up employing the same straddle.

Piketty may be in a similarly awkward position.

How Not to Think about Negative Rates

Last week’s big monetary-policy news was the ECB’s decision to target a negative interest rate, in the form of an 0.25 percent tax on bank reserves. This is the first time a major central bank has announced a negative policy rate, though some smaller ones (like the Bank of Sweden) have done so in the past few years.

Whether a tax on reserves is really equivalent to a negative interest rate, and whether this change should be expected to pass through to interest rates or credit availability for private borrowers, are not easy questions. I’m not going to try to answer them now. I just want to call attention to this rather extraordinary Neil Irwin column, as an example of how unsuited mainstream discussion is to addressing these questions.

Here’s Irwin’s explanation of what a negative interest rate means:

When a bank pays a 1 percent interest rate, it’s clear what happens: If you deposit your money at the bank, it will pay you a penny each year for every dollar you deposited. When the interest rate is negative, the money goes the other direction. … Put bluntly: Normally the banks pay you to keep your money there. Under negative rates, you pay them for the privilege.

Not mentioned here, or anywhere else in the article, is that people pay interest to banks, as well as receiving interest from them. In Irwin’s world, “you” are always a creditor, never a borrower.

Irwin continues:

The theory is that when it becomes more costly for European banks to keep money in the E.C.B., they will have incentive to do something else with it: Lend it out to consumers or businesses, for example.

Here’s the loanable funds theory in all its stupid glory. People put their “money” into a bank, which then either holds it or lends it out. Evidently it is not a requirement to be a finance columnist for the New York Times to know anything about how bank loans actually work.

Irwin:

Banks will most likely pass these negative interest rates on to consumers, or at least try to. They may try to do so not by explicitly charging a negative interest rate, but by paying no interest and charging a fee for account maintenance.

Note that “consumers” here means depositors. The fact that banks also make loans has escaped Irwin’s attention entirely.

Of course, most of us are already in this situation: We don’t receive any interest rate on our transaction balances, and pay are willing to pay various charges and fees for the liquidity benefits of holding them.

The danger of negative rates, per Irwin, is that

It is possible that, assuming banks pass along the negative rates through either fees or explicitly charging negative interest, people will withdraw their money as cash rather than keeping it on deposit at banks. … That is one big reason that the E.C.B. and other central banks are going to be reluctant to make rates highly negative; it could result in people pulling cash out of the banking system.

Again the quantity theory in its most naive and stupid form: there is a fixed quantity of “money” out there, which is either being kept in banks — which function, in Irwin’s world, as glorified safe deposit boxes — or under mattresses.

Evidently he’s never thought about why the majority of us who already face negative rates on our checking accounts continue to hold them. More fundamentally, there’s no explanation of what makes negative rates special. Bank deposits don’t, in general, finance holdings of reserves, they finance bank loans. Any kind of expansionary policy must reduce the yield on bank loans and also — if margins are constant — on deposits and other bank liabilities. Making returns to creditors the acid test of policy, as Irwin does, would seem to be an argument against expansionary monetary policy in general — which of course it is.

What’s amazing to me in this piece is that here we have an article about monetary policy that literally makes no mention of loans or borrowers. In Irwin’s world, “you” are, by definition, an owner of financial assets; no other entities exist. It’s the 180-proof distillation of the bondholder’s view of the world.

Heterodox criticism of the loanable-funds theory of interest and insistence that loans create deposits, can sometimes come across as theological, almost ritual. Articles like this are a reminder of why we can’t let these issues slide, if we want to make any sense of the financial universe in which we live.

Gurley and Shaw on Banking

Gurley and Shaw (1956), “Financial Intermediaries in the Saving-Investment Process”:

As intermediaries, banks buy primary securities and issue, in payment for them, deposits and currency. As the payments mechanism, banks transfer title to means of payment on demand by customers. It has been pointed out before, especially by Henry Simons, that these two banking functions are at least incompatible. As managers of the payments mechanism, the banks cannot afford a shadow of insolvency. As intermediaries in a growing economy, the banks may rightly be tempted to wildcat. They must be solvent or the community will suffer; they must dare insolvency or the community will fail to realize its potentialities for growth.

All too often in American history energetic intermediation by banks has culminated in collapse of the payments mechanism. During some periods, especially cautious regard for solvency has resulted in collapse of bank intermediation. Each occasion that has demonstrated the incompatibility of the two principal banking functions has touched off a flood of financial reform. These reforms on balance have tended to emphasize bank solvency and the viability of the payments mechanism at the expense of bank participation in financial growth. They have by no means gone to the extreme that Simons proposed, of divorcing the two functions altogether, but they have tended in that direction rather than toward endorsement of wildcat banking. This bias in financial reform has improved the opportunities for non-monetary intermediaries. The relative retrogression in American banking seems to have resulted in part from regulatory suppression of the intermediary function.

Turning to another matter, it has seemed to be a distinctive, even magic, characteristic of the monetary system that it can create money, erecting a “multiple expansion”of debt in the form of deposits and currency on a limited base of reserves. Other financial institutions, conventional doctrine tells us, are denied this creative or multiplicative faculty. They are merely middlemen or brokers, not manufacturers of credit. Our own view is different. There is no denying, of course, that the monetary system creates debt in the special form of money: the monetary system can borrow by issue of instruments that are means of payment. There is no denying, either, that non-monetary intermediaries cannot create this same form of debt. …

However, each kind of non-monetary intermediary can borrow, go into debt, issue its own characteristic obligations – in short, it can create credit, though not in monetary form. Moreover, the non-monetaryintermediaries are less inhibited in their own style of credit creation than are the banks in creating money. Credit creation by non-monetary intermediaries is restricted by various qualitative rules. Aside from these, the main factor that limits credit creation is the profit calculus. Credit creation by banks also is subject to the profit condition. But the monetary system is subject not only to this restraint and to a complex of qualitative rules. It is committed to a policy restraint, of avoiding excessive expansion or contraction of credit for the community’s welfare, that is not imposed explicitly on non-monetary intermediaries. It is also held in check by a system of reserve requirements. … The [money multiplier] is a remarkable phenomenon not because of its inflationary implications but because it means that bank expansion is anchored, as other financial expansion is not, to a regulated base. If credit creation by banks is miraculous, creation of credit by other financial institutions is still more a cause for exclamation.

The first paragraph of this long footnote is a succinct statement of a basic tension in bank regulation that remains unresolved. (Recall that Simons’ proposal to eliminate the intermediation function of banks was recently revived by Michel Kumhof at the IMF.) The other two paragraphs are a good clear statement of the argument I’ve been trying to develop on this blog, that there is no fundamental difference between money and other forms of financial claims, and a macroeconomically meaningful “quantity of money” was an artifact of mid-20th century regulatory arrangements.