Since the financial crisis of 2007-8, one suggested target reform has been the monetary system itself. This reform is based on the recognition that money in the modern economy is a rather peculiar phenomenon.
There are two popular conceptions of the nature of money, both of them incorrect. (Note that when we talk about money, it is entirely artificial to separate cash, in the form of bank notes and coin, from what we hold in bank accounts. To all effects and purposes, for the vast majority of us, they are the same and completely interchangeable.)
The first conception is that money is a fixed quantity determined by the government, which is either accepted by convention or because you can go to your bank and get a certain quantity of gold for it. (Presumably not many people have actually tried this!) The second is that banks can issue new money to lenders as a multiple of pre-existing deposits, depending on how often depositors demand cash. This is frequently referred to as ‘fractional reserve banking’. Continue reading A Banking Debate→
The authors of this report claim that ‘there has been a failure of government policy to decide the role banks should play, and therefore what sort of institutions they should be.’ and that ‘we have ended up with a banking system dominated by a small number of giant banks…’ These institutions are only able to survive because they are ‘too big to fail’, yet they offer poor customer choice and service, have acted illegally in rigging markets and indulge in ‘socially useless’ activities.
A Review of ‘Chasing Goldman Sachs: How the Masters of the Universe Melted Wall Street Down…and Why They’ll Take Us to the Brink Again’ by Suzanne McGee (2010, Crown Business)
This book is an excellent complement to the academic stuff I’ve read on the causes of the financial crisis. These latter accounts are very detailed in terms of ‘what’ happened but tend to be light on the ‘why’. ‘Chasing Goldman Sachs’ goes a long way to filling that gap.
The academic consensus view seems to be that driven by an increase in demand for safe places to save there was a huge increase in deposits held by financial institutions and collateralised by Asset-Backed Commercial Paper (ABCP). A significant proportion of this paper was comprised of securitised mortgages – many packaged in such a way that their quality was opaque. The toxicity of these was enhanced by dodgy ratings and shuffling to off-balance-sheet vehicles. When problems with some of these mortgages arose it took a while for holders of these ‘shadow-banking’ deposits to sort out whether or not their deposits were collateralised by bad assets or good ones. There was a panic and large-scale dumping of these deposits which led to loss of liquidity in the market for short-term interbank loans. Without these loans banks find it very difficult to balance their books at the end of each day as they are obliged to. (A good guide to all this from the academic point of view and to further more technical reading is at http://www.nber.org/papers/w17778.) Continue reading ‘Chasing Goldman Sachs’ by Suzanne McGee – A Review→
Understanding Money – a non-technical account of the essential role money and its creation plays in a modern economy. This article was previously available as a pdf, but I have now posted it as a blog in its own right. Since it was originally written in 2010, I have made a few revisions and additions.
Most of us have little idea of what money is and where it comes from. When we think of money, we think of bank-notes and coins. We know that most money is held in bank accounts, but even then we have an image (although most of us are probably aware that it isn’t quite an accurate image) of these notes and coins being held for us by the bank or lent out by the bank to make money for them (and hopefully us, if the money is held in an interest-bearing account). In fact the reality is about as far away from this as it is possible to imagine.
Of the total amount of money (adding together bank-notes and coin held by the general public and the value of all bank accounts in the UK), the bank-notes and coin make up only around 3% ! The reality is that the vast majority of all money exists only as a record held in someone’s name by some bank or other. How can this be? Where does this money come from? Where does it go? In this article I will attempt to answer these questions, and in doing so explain the benefits and the potential downside to our monetary system. Continue reading Understanding Money→
‘Aggregate Demand, Idle Time, and Unemployment’ – A Critique of Michaillat and Saez
Like all neoclassical models, that of Michaillat and Saez (2014) referred to in Simon Wren-Lewis’s Mainly Macro blog on 16th August fails to model money realistically. This renders their model incoherent and in any case incapable of encompassing one of the most important causes of unemployment: inadequate aggregate demand due to monetary factors.
The chief feature of their model is a product market in which matching is the mode of exchange. This produces costly frictions that lead output to apparently run ahead of consumption. To make sense of demand that does not automatically follow from income Michaillat and Saez introduce a ‘non-produced good’ which is endowed to every household. When households meet to exchange goods there is mutual trade of this non-produced good and households’ individually produced goods so as to optimise each household’s joint holding in utility terms. Michaillat and Saez ascribe a relative price p to the production good, which apparently becomes the absolute price when they determine the price of the non-produced good as 1. Since it is determined in equilibrium it is important that p is an absolute price, otherwise quantities of exchanges, production and labour demanded would be indeterminate in the model as they would also depend on the rate of exchange between the produced and non-produced goods. In fact it turns out that claiming p to be an absolute price is untenable. Continue reading Money and the Neo-classics… Again→
The causes of unemployment make it a moral issue. Radical solutions are required.
In an earlier post I noted some features of unemployment from a UK perspective. The main thrust was that a fairly constant proportion of the population in employment (around 72% of those of working-age) hides a serious decline in the availability of adequate work, due mainly to the increase in women in the workforce and the fall in the ratio of full-time to part-time work. In a paper I wrote and referenced here on welfare I hinted at a moral dimension to the issue of unemployment in a capitalist economy (by which I simply mean an economy where physical means of production tend to belong in more or less concentrated hands).
I have now written a rather more formal paper (pdf 198kb) which I presented to the Post-Keynesian Study Group annual workshop in May this year in which I expanded on why we have a persistent problem with unemployment, and why this has a significant moral implications in our attitude to the unemployed. In this light of this I review the inadequacy of current policy and look at some of the more radical solutions proffered. The following is a non-technical summary of the paper. Continue reading Unemployment – Morality, Money and Increasing Returns→
I note an interesting little discussion between Tim Worstall and Ralph Musgrave on money creation in the context of the Northern Rock bank crisis of 2007. Essentially Tim was claiming, against the PositiveMoney view, that the failure of the bank was evidence that it was not possible for banks to create money. Ralph’s point was that it is possible for banks to create money if they move ‘in step’, but since Northern Rock was creating money (by lending) faster than other banks this led to its problems.
In fact both Tim and Ralph are ignoring the role a crucial player here: the Central Bank – in this context the Bank of England (BofE).
The basis of our monetary system is money created by the BofE in the form of notes, coins and accounts held by commercial banks with the Bank of England. Let’s imagine a single commercial bank operating in the UK that holds a certain amount of this BofE money. This bank could certainly create additional money by lending up to the point that it could still cope with demands of depositors for banknotes and coin, or to pay taxes etc. to the government. Most transactions, however, would be between account-holders. All the bank need do for these is adjust its deposit records; no reserves would be required.
I’ve got involved with one or two on-line debates recently in which the issue of money in commercial banking is seen as a fraudulent process by which value is stolen from citizens. Usually the central bank is seen as the government’s enabler in this process, and so to blame for the resultant misallocation of credit or ‘malinvestment’. This is a view to be found among adherents of the ‘Austrian’ school of economics, and ties in nicely with their extreme views of the efficacy of markets and the villainy of governments. Even if they do not believe the only money used should be gold, they believe that its value should be tied to gold and that central banks consistently devalue the currency by setting too low the interest rates at which commercial banks borrow from them.
While the Austrians’ views are so dogmatic as to be fairly easily ignored, there has also been a recent tendency among some campaigners, such as Positive Money or GolemXIV, to blame the current discrepancy between rewards to the rich and punishment for nearly everyone else on the banking’s ability to ‘create money out of thin air’. According to this view the banks then profit from this costless activity by lending it to us at interest, either directly or indirectly via government. Continue reading Is Banking Government-sponsored Counterfeiting?→
Long piece today by the Guardian’s economics leader writer, Aditya Chakrabortty, on the cost of the banking crisis, bank misconduct and what should be done about it. I agree wholeheartedly with the thrust of this piece, and indeed said much the same two and half years ago in my piece on the Guardian Cif site. Aditya’s piece concludes that
any investigation needs to understand how to reform the finance sector so that crises like these don’t recur; and so that banks actually work in the public interest rather than hire propagandists to pretend they do. Because in the end, financial reform is not about technicalities, but about politics: deciding what role banks should play in an economy, and what kind of economy we want.
However, he says also that:
According to the IMF, the British stuck £1.2 trillion behind the finance sector. Read that again: well over a trillion pounds in bailouts, and loans and state guarantees on bankers’ trading. In just a few months, and with barely any public debate, every household subbed £46,774 to the City. A sliver of that money eventually went unused; as for the remaining hundreds of billions, we have no idea just how much we’ll get back – or when.
David Malone, a documentary film maker, perhaps better known these days as blogger on the financial crisis and its causes – operating under the name GolemXIV – gave a talk in Edinburgh on the 6th of December.
He’s quite a charismatic guy and gave an effective talk in a church with no aids other than a radio microphone. I hope that he will continue to campaign against the current acceptance of continuing economic policies that will undoubtedly make the majority of us worse off. I have offered him this commentary in the hope of improving our mutual understanding of the problems faced and how we might deal with them.
I was at your talk in St John’s in Edinburgh last Tuesday night and was impressed by the eloquence and passion with which you make the case that the current economic situation is a travesty of democracy and fairness. With that view I am in complete agreement, and I think you have the qualities needed to get the required message across. Continue reading Commentary on GolemXIV in Edinburgh→