Rediscovering Minsky's wheel, one pundit at a time | 77 comments (77 topical, editorial, 0 hidden)

Re: But isn't that (none / 0)

No, I think we're talking about exactly the same thing. And you're also right that the theory is that raising the reserve requirement shrinks the money supply.

Wikipedia claims in the US the reserve requirement is 10% for demand deposits and zero for time deposits. Now, how is the theory

The reserve requirement can affect monetary policy, because the higher the reserve requirement is set, the less money banks will have to loan out, leading to lower money creation, and maintaining the purchasing power of the currency previously in use. The effect is exponential, because money that is loaned out can be re-deposited; a portion of that money may again be re-loaned, and so on.

compatible with my argument above that

in order to cover 100 worth of deposits you have to repo 105 worth of eligible assets.
The bank balance sheet could well consist of an additional 100 worth of debt on the liability side, 20 worth of equity, and 115 worth of other assets, which may or may not be eligible collateral for repos. To wit:
Assets			| Liabilities
======================================
eligible assets 105 + x | debt	   100
other assets	115 - x | deposits 100
			| equity    20
I fail to see why requiring that 105 worth of eligible assets be pledged at the discount window in exchange for 100 in cash would collapse the money supply.

Maybe it's that the standard theory is bunk, but I'm reluctant to claim that just yet. The wikipedia article has interesting cross-country and historical data on reserve requirements...

Economics is politics by other means

by Carrie (migeru at eurotrib dot com) on Wed May 11th, 2011 at 02:05:05 AM EST
[ Parent ]

Re: But isn't that (none / 1)

Maybe it's that the standard theory is bunk

There's no "maybe" about that. The "money multiplier" (which is simply the inverse of the reserve requirement) is a completely ex post construct which offers no constraint on private bank lending.

As long as the central bank is targeting an overnight interbank rate via open market operations, reserve requirements (if remunerated at the policy rate) can be set to as high a number as the fraction of (current reserves + acceptable paper for open market operations) to total insured deposits on the private banks' balance sheet. Beyond this point it would lose the ability to conduct open market operations, because the central bank would run out of valid paper to buy, but that is the only reason you can't set reserve requirements to ten million per cent if you wanted to.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Wed May 11th, 2011 at 03:07:09 AM EST
[ Parent ]

Re: But isn't that (none / 0)

(Well, you might get some Funny effects if you jack reserve requirements higher than 100 % while remunerating reserves, unless you take care to ensure that banks cannot exploit the reserve remuneration with bogus loans.)

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Wed May 11th, 2011 at 03:11:02 AM EST
[ Parent ]

Re: But isn't that (none / 1)

Currently the ECB's reserves are remunerated at the repo rate. Which means that, apart from the haircut, it's free for eligible banks holding eligible assets to satisfy reserve requirements. Which is why tapping the marginal lending facility should be a sign of distress (why pay 2% overnight when you can do a free weekly repo?). By the way, the ECB's reserve requirement is 2% of deposits.

Economics is politics by other means

by Carrie (migeru at eurotrib dot com) on Wed May 11th, 2011 at 03:54:43 AM EST
[ Parent ]

Re: But isn't that (none / 0)

The wiki article is quite informative. But I suspect that the effects on the money supply of the monetary multiplier depends on market psychology -- whether the market is dominated by greed or fear -- as, even with zero reserve requirement, the bank still has to find customers who want to take out loans.

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Wed May 11th, 2011 at 09:33:14 AM EST
[ Parent ]

Re: But isn't that (none / 1)

But I suspect that the effects on the money supply of the monetary multiplier depends on market psychology

There is no money multiplier. There is only interest rate, margin requirement and the volume of creditworthy customers. Those are the operational constraints - the "money multiplier" is an ex post accounting construct that only appears to be stable because financial regulators impose a stable liquidity requirement. In the zero lower bound to the interest rate, the "money multiplier" looks like it drops, because liquidity requirements cease to have meaning when liquidity is free. The second you raise interest rates materially above zero, the "money multiplier" will, in an open market operation regime, go back to being the inverse of the liquidity requirement, because the central bank is forced to drain all reserves that are surplus to requirement via open market operations before the interbank rate goes up.

Alternatively, the central bank can obtain precisely the same effect by remunerating excess reserves at the policy rate, but this will lead to much pundit bullshitting about "inflation just around the corner" due to "excess reserves just waiting to be lent out." And since modern central bankers seem to pay more attention to pundits' inflationary expectations than to the state of the real economy, they'd likely chicken out and go back to open market operations, despite this being a materially worse option in terms of performing useful macroeconomic planning.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Thu May 12th, 2011 at 04:24:50 AM EST
[ Parent ]

Re: But isn't that (4.00 / 3)

There is no money multiplier because the mainstream-economics modelled process by which banks successively loan out deposits thereby multiplying them does not actually happen in that way, ever, anywhere.

The table below displays the mainstream economics relending model of how loans are funded and how the money supply is affected. It also shows how central bank money is used to create commercial bank money from an initial deposit of $100 of central bank money. In the example, the initial deposit is lent out 10 times with a fractional-reserve rate of 20% to ultimately create $400 of commercial bank money. Each successive bank involved in this process creates new commercial bank money on a diminishing portion of the original deposit of central bank money. This is because banks only lend out a portion of the central bank money deposited, in order to fulfill reserve requirements and to ensure that they always have enough reserves on hand to meet normal transaction demands.

That's what

There is no money multiplier. There is only interest rate, margin requirement and the volume of creditworthy customers. Those are the operational constraints - the "money multiplier" is an ex post accounting construct

means.

Economics is politics by other means

by Carrie (migeru at eurotrib dot com) on Thu May 12th, 2011 at 06:10:36 AM EST
[ Parent ]

Re: But isn't that (none / 0)

So then what does happen in terms of interest rate, margin requirement and the volume of creditworthy customers?

Sweden's finest (and perhaps only) collaborative, leftist e-newspaper Synapze.se

by A swedish kind of death on Thu May 12th, 2011 at 07:06:53 AM EST
[ Parent ]

Re: But isn't that (4.00 / 2)

You have a bunch of borrowers.
Some of those borrowers are not creditworthy on the basis of their expected future cash flow. Banks are not supposed to lend them money.
Some of the otherwise creditworthy borrowers are unable to put up sufficient margin to cover the requirement. Banks are not supposed to lend to those, because the bank might be wrong about their future cash flow and needs an equity cushion to protect itself from that risk.
Some of the otherwise well-capitalised and creditworthy borrowers will be unwilling to pay the rediscount rate plus the markup to cover the bank's costs (and dividends). They will not borrow.

Monetary policy, as traditionally practised, pretends that #1 works perfectly. Since #1 works perfectly by assumption, #2 is unnecessary (so we can allow no-money-down adjustable-rate mortgages without a hitch). It then focuses all of its efforts on #3, and attempts to control inflation by jacking up the rate so high that people refuse to borrow.

I argue, first, that the central bank should be spending more effort on safeguarding financial stability by making sure you don't get runs on certain asset classes (including the country's ForEx reserves), and much less on safeguarding the return on lazy money by keeping inflation low. And, second, that financial instability arises when borrowers are not creditworthy (regardless of whether that money is cheap or expensive), and not when borrowers are creditworthy (again, regardless of whether the money is cheap or expensive). It is therefore much more sensible to focus on making sure the financial sector can't lend to people who are not creditworthy than it is to fiddle with the interest rate at which lending takes place.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Thu May 12th, 2011 at 01:28:15 PM EST
[ Parent ]

Re: But isn't that (none / 0)

M'kay, that is understandable and sounds sensible.

But how is this related to the story of the wheel of loans and deposits that Migeru quoted? Is the premise of that story that the volume can be regulated by setting the interest rate?

Sweden's finest (and perhaps only) collaborative, leftist e-newspaper Synapze.se

by A swedish kind of death on Thu May 12th, 2011 at 03:18:11 PM EST
[ Parent ]

Re: But isn't that (4.00 / 7)

M'kay, that is understandable and sounds sensible.
But how is this related to the story of the wheel of loans and deposits that Migeru quoted?

Tangentially, I'm afraid.

The problem is that we have at least three main narratives of what banking is.

The Conventional Wisdom:

Alice goes up to a bank and gives it one hundred gold coins, and the bank gives her a note saying she owns 100 gold coins in its vaults.
Bob goes up and asks the bank to borrow fifty gold coins. The bank looks at Bob's business plan and decides to give him fifty gold coins. In return, Bob gives the bank a note saying that he will pay it back, with interest.
Charles goes up to the bank and asks for thirty gold coins. The bank looks at Charles' business plan, decides that it wants nothing to do with it and tells him to sod off.

You can add various complications, such as fractional reserve banking, checking accounts where the gold never leaves the vault once deposited, except during bank runs) and such. But the basic narrative is that Alice deposits money, which the bank then uses to make loans.

Paper money, it is imagined, works the same basic way. Except that instead of digging it out of a mine you print it at a central bank, a notion which is slightly ominous and invokes images of wheelbarrows and invading Poland.

The orthodox liturgy

The central bank prints money, and sells it to private banks, in exchange for securities of unimpeachable value (such as gold or government bonds).
Private banks use fractional reserve banking to create new money. The ratio between bank money and central bank money is the "money multiplier."
Alice, Bob and Charles go up to the bank and ask for loans. The bank looks at how much money it can create from the reserves it has, realises that it can only lend to one of them
The bank asks the prospective borrowers what interest rate they are prepared to pay. Alice says 4 %, Bob says 5 % and Charlie says 12 %.
The bank looks at Charlie's business plan, and tells him to sod off.
The bank looks at Bob's business plan. Since it looks OK, and Bob offered a better return than Alice, the bank lends to Bob.
By adjusting the supply of central bank money, the central bank can determine how many of the three the private bank is able to lend to. Allow it to lend to too many, and you get inflation. Allow it to lend to too few, and you get economic paralysis due to lack of investment.
If the central bank overshoots the money supply enough to enable the private bank to lend to all three, the bank will have an incentive to lend to Charles even though he has a dodgy business plan, because it has free money lying around.

Again, you can add various embellishments to this (such as the interbank market), but this is the core narrative.

What actually happens

Alice, Bob, Charlie and Dennis go up to a bank and ask for loans.
The bank looks at the borrowers' business plans. It then tells Charlie to sod off.
The bank asks how much margin the remaining three candidates are prepared to put down. Alice says 20 %, Bob says 20 % and Dennis says 15 %. Charlie doesn't say anything, because he isn't there anymore, but if he had been there he would have said 10 %. (Margin is the "money down" that you pay for out of your own pocket. So if you post a € 100.000 house as collateral for a mortgage at 20 % margin [or "20 % down"] then it means that you only want to borrow € 80.000.)
The bank wants 20 % down, so it tells Dennis that it must regretfully decline his application.
The bank asks what they are willing to pay. Alice says 4 % and Bob says 5 %. Charlie and Dennis aren't there, but if they had been they would have said 12 % and 5 %, respectively.
The bank looks up the central bank's policy rate, which turns out to be 2 %. The bank knows that its overhead amounts to 1½ % of its portfolio, and estimates that Alice and Bob both have a 1 % risk of going bust. So it adds that as well, for a total interest rate of 4½ %.
Since Alice can pay less than that, the bank must respectfully decline her application. Since Bob can pay more than that (and still have a viable business model), he gets to borrow.
Having lent Bob money, the bank now has more liabilities that it needs to provide regulatory liquidity reserves for. It therefore goes to the interbank market to borrow the money at the central bank's policy rate.
If the central bank discovers that banks can borrow in the interbank market for less than the policy rate, it sells some bonds. Since bonds are not valid for covering liquidity requirements, this removes liquidity from the interbank market, forcing the interbank market to ration liquidity by price. Conversely, if the central bank finds that banks must pay more than the policy rate to borrow in the interbank market, it buys some sovereign bonds, to depress the interbank rate.

The most important difference to notice is that the marginalist narrative pretends that the central bank prints money first, and then the private banks lend it out. Whereas in the real world, private banks lend out money, subject to the constraint that the loan must be remunerative given the interest rate target defined by the central bank. And only after the fact does the central bank prints money in order to defend its interest rate target.

So the central bank can't cause bubbles by "printing too much money" in an effort to keep interest rates low. What happens instead is that private banks fail to perform due diligence in steps 2 and 4. If the private bank allows Charlie and Dennis to slip past steps 2 and 4, then the central bank can't do anything about that. If the central bank wanted to crowd out Charlie and Dennis - who are bad risks - by raising interest rates, it would have to raise interest rates above 12 %, which would kill Bob's application stone cold dead as well.

Further, you will notice that Alice was actually a good risk (same margin and default risk as Bob), and was able to pay more than the bank needed in and of itself (the bank needs 2½ %, she could pay 4 %). So why did the central bank kill her investment by imposing a further 2 % return requirement? Because the central bank wants to suppress investments that would be profitable on their merits, in order to create enough spare capacity (read: Unemployment) in the economy to prevent inflation.

What Mig was proposing is that instead of steps 8 and 9 above, the central bank should offer to lend the bank money directly to cover its liquidity requirements. Because that way, the central bank can get to take a look at the bank's balance sheet (since the bank has to post collateral).

What I did was take it a step further, and argue that the central bank should demand that private banks put up the whole loan amount, but then offer to lend the bank the money that it needs to post, up to a certain margin requirement. Because then, if the private bank allows Charles and Dennis to slip through bullets 2 and 4, the central bank can say "look, Charlie is a bad risk - we won't lend you any money with his note as collateral," and then the private bank will have to go gamble with its own money (as opposed to being able to gamble with money it borrows, in effect, indirectly from the central bank through the interbank market).

Moreover, the central bank can also say "look, Dennis may be a good risk, but we're only lending you 72 % of the value of his house (and only 90 % of the value of his mortgage), because you need to put up ten percent margin on your loan, and someone - you or Dennis or someone else, we don't care - has to put up twenty percent margin on Dennis' loan." So the bank is allowed to lend to Dennis, but it has to find the proper margin somewhere.

As an aside, the Austrians are conceptually stuck in the Conventional Wisdom "commonsense" view of money. Which is why they seem to be superficially in agreement with people who actually understand money: Both groups criticise the orthodox liturgy, from a perspective that focuses on the interaction of debt with financial stability.

The difference is that the Austrians (a) are actually a step further removed from understanding money than the marginalists. And (b) have taken leave of their sanity.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Thu May 12th, 2011 at 06:08:28 PM EST
[ Parent ]

Re: But isn't that (none / 1)

So to answer your original question, Mig and I were discussing steps 8 and 9 of the third narrative. ARG asked a question about how my recommended policy would influence step 2 of the second narrative. Which is an unanswerable question, because step 2 of the second narrative is arrant nonsense.

So the discussion switched from Mig and I geeking out over the fine details of how to turn a central bank into a useful instrument of macroeconomic policy, into disabusing ARG of the false narrative implicit in his question. And that's probably why it became unintelligible.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Thu May 12th, 2011 at 06:18:51 PM EST
[ Parent ]

Re: But isn't that (4.00 / 3)

The fourth narrative is that you can only really understand what's happening by removing all money and accounting from the discussion.

Some relevant questions:

What does it mean that a business plan sucks? How does the bank know? Is the bank correct? [So - insert paragraph about actuarial risk analysis here. But...]

To what extent do the banks themselves create the social conditions in which certain business plans can be guesstimated to suck, while others appear not to?

What is the true cost of the percentage cut taken by the banks? Is that cut a good use of social and natural resources?

How could "business" - let's pretend we know what that means - be organised in ways that don't require these costs?

These questions don't have obvious and simple answers.

In fact, I think providing good answers to them would be rather like removing the idea of god from medieval politics.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Thu May 12th, 2011 at 07:18:53 PM EST
[ Parent ]

Re: But isn't that (none / 1)

What does it mean that a business plan sucks? How does the bank know?

Somewhat related: If the bank actually had to put up the whole amount the central bank would have to duplicate the whole credit evaluation process since nearly all funding would stem from the discount window. Or am I completely wrong?

by generic on Thu May 12th, 2011 at 10:27:53 PM EST
[ Parent ]

Re: But isn't that (none / 1)

The Central bank can police the internal workings of its regulated banks. It can look at the repo'ed portfolio a bit at a time, by sampling. Remember the commercial banks receive liquidity from short-term (weekly, in the ECB's case) repos. An asset that was accepted last week can become unacceptable next week, or experience a higher haircut.

It's a bit like quality control or customs inspections. You don't want to inspect every item in every box in every container but if you sample and do find a faulty item you can quarantine an entire shipment pending further investigation.

Evidently, running the discount window properly would require a lot more manpower than banking supervisors currently deploy...

Economics is politics by other means

by Carrie (migeru at eurotrib dot com) on Fri May 13th, 2011 at 04:28:22 AM EST
[ Parent ]

Re: But isn't that (none / 1)

That's a feature, not a bug. As the system works today, the central bank (or the Treasury, but that comes to the same thing) ends up footing the bill for bad lending in any event. Might as well put them in the loop.

On the other hand, if the central bank imposes a 10 % haircut for the bank on top of the 20 % margin it forces on the borrower, it can probably make do with rules of thumb for most asset classes. Few houses are 28 % below their official valuation even in a deep crisis. They might drop 28 % below the bubble value, but the CB would only be on the hook for 72 % of the official value. The rest would be margin - something that would, in itself, discourage bubbles.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Fri May 13th, 2011 at 04:30:08 AM EST
[ Parent ]

Re: But isn't that (none / 1)

Also, if an untrained intern has difficulty understanding the asset, it shouldn't qualify as collateral at the discount window.

Economics is politics by other means

by Carrie (migeru at eurotrib dot com) on Fri May 13th, 2011 at 04:36:56 AM EST
[ Parent ]

Re: But isn't that (none / 1)

What does it mean that a business plan sucks? How does the bank know? Is the bank correct? [So - insert paragraph about actuarial risk analysis here. But...]

Here's a business plan that sucks:

Collect underpants
?????
Profit!

Now, in an ideal world it's the job of the bank to have specialist analysts whose job it is to study business plans and the running operations of businesses in particular industry sectors. That's what banks are supposed to do: concentrate the risk-analysis function of society. Ask Jérôme what his porject finance work was actually about.

How do venture capitalists decide a business plan sucks? Are they correct?

If the government wants to lend directly to worthy projects, how does it know they're worthy? It is correct?

In the ideal world, too, there are a multitude of banks each specialising in a different mix of products, industry sectors, consumers and geographies. until two years ago, if you wanted to build a wind farm and your local bank didn't understand the risks, you switched banks and went to Jérôme's bank... Then Jérôme left the bank...

In the real world, of course, people lend to their golfing buddies or on the basis of whether the business plan is a spiffy ppt, the banking sector is incresingly concentrated so there is less opportunity to go to a different bank for funding, and so on...

Economics is politics by other means

by Carrie (migeru at eurotrib dot com) on Fri May 13th, 2011 at 04:35:45 AM EST
[ Parent ]

Re: But isn't that (none / 1)

Here's a business plan that sucks:

Ironically, you've chosen a business plan that doesn't necessarily suck at all. (Although it does seem to be illegal now.)

That's what banks are supposed to do: concentrate the risk-analysis function of society.

...

In the real world, of course, people lend to their golfing buddies or on the basis of whether the business plan is a spiffy ppt, the banking sector is incresingly concentrated so there is less opportunity to go to a different bank for funding, and so on...

Bingo.

My point is partly that finance is supposedly about risk analysis in the same way that job interviews are about finding the best person.

Supposedly it's a formal, serious process. In practice it's often a bit of a pantomime, where you'll be assessed on your dress sense, social caste, and overall seriousness as much as on the numbers.

Has there even been a formal study of the predictive accuracy of investment models? Consumer credit scoring seems a fairly simple solved problem - providing nothing blows up - but is there any evidence that business plan risk analysis really does model investment outcomes accurately?

As for VC - the standard VC game is to throw a lot of money at various projects and hope some of it sticks.

It turns out to be fairly easy to make money like this in any market where large IPOs and/or sales to a bigger idiot are possible, because you only need one big success in every ten or twenty to be in profit overall - and you can write the other losses off against tax.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Fri May 13th, 2011 at 05:54:38 AM EST
[ Parent ]

Re: But isn't that (4.00 / 2)

My point is partly that finance is supposedly about risk analysis in the same way that job interviews are about finding the best person.

Economics is politics, money and accounting are about power, and banking is part of political planning about who has the power to get things done. How's that?

The conceptual metaphor "money is a thing" (specifically, a gold coin) is particularly damaging in this setting. Politically, fiat money and expansionary fiscal policy means "if you have a worthy project you won't have to stay idle", whereas hard money means "you can only do what I tell you to".

Economics is politics by other means

by Carrie (migeru at eurotrib dot com) on Fri May 13th, 2011 at 06:24:17 AM EST
[ Parent ]

Re: But isn't that (none / 1)

I'd prefer:

Economics is politics, money and accounting are about power, and banking is part of political planning about who has the power ~~to get things done.~~

The conceptual metaphor "money is a thing" (specifically, a gold coin) is particularly damaging in this setting. Politically, fiat money and expansionary fiscal policy means "if you have a worthy project you won't have to stay idle", whereas hard money means "you can only do what I tell you to".

Or what I allow you to - because the ability to block constructive and useful effort is as much a part of the syndrome as the ability to sponsor it.

This is what I was implying earlier about business plans. For example in energy, some forms of energy get subsidies, while others - especially renewables - are considered inherently unserious, and don't. Therefore finance models for renewables have to be more precise, the risk analysis has to be absolutely cast-iron, and so on. While other modes - like nuclear - get a pass.

And all this because the financial industry has a bias against certain kinds of activity, and a bias towards other kinds of activity.

The rationalisations that support these arbitrary decisions use the rhetoric of risk analysis and the rest. But the reality is that the industry simply likes certain kinds of activity more than it likes other kinds, for reasons that are either irrational or sociopathically self-interested.

So while Jake thinks banks aren't so bad akshually, I think banking in its current form is an epic disaster on the scale of the Black Death or a major natural catastrophe.

For two reasons:

The first is that perfectly reasonable - and welcome - kinds of activity are vetoed in favour of other activities that are stupid and self-destructive. The industry's record of failure on this is absolutely reliable.

The other is that instead of preventing and minimising risk, banks actually create it - in obvious ways through asset inflation that destabilises productive economies, through speculation, and by vetoing efforts towards stable and productive activity.

So you have the paradox - or the Big Lie - of an industry which claims to be engaged in strategic risk management for everyone's benefit, but which is actually the primary creator of risk and social insolvency.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Fri May 13th, 2011 at 05:51:02 PM EST
[ Parent ]

Re: But isn't that (none / 0)

For example in energy, some forms of energy get subsidies, while others - especially renewables - are considered inherently unserious, and don't. Therefore finance models for renewables have to be more precise, the risk analysis has to be absolutely cast-iron, and so on. While other modes - like nuclear - get a pass.

But the problem here is surely that risk analysis that is not absolutely cast-iron gets a pass, not that people are actually doing their jobs when assessing wind farm finance?

What I want to do is force banks to either (a) demand equally cast-iron risk assessment from other sorts of projects, or (b) go play with their own money. Option (b) is, of course, only of rhetorical interest, to counter claims that I want to nationalise credit creation, since banks utterly abhor the though of playing with their own money instead of the central bank's.

So while Jake thinks banks aren't so bad akshually, I think banking in its current form is an epic disaster on the scale of the Black Death or a major natural catastrophe.

The black death killed off a double-digit percentage of the European population. Unless the banksters manage to trigger a sufficiently bad depression that it results in a serious shooting war (a possibility that I am a lot less sanguine about dismissing than I was a year ago), they will not rack up that sort of body count, however damaging their activities may otherwise be.

The first is that perfectly reasonable - and welcome - kinds of activity are vetoed in favour of other activities that are stupid and self-destructive. The industry's record of failure on this is absolutely reliable.

Cock-ups happen. Some of those cock-ups are even intentional. Others will be systemic. The solution to that problem is to create checks and balances - reduce the power of bankers and increase the power of parliamentary, civil service and civil society organisations. It is not to abolish the institution that makes cock-ups. If we did that with any consistency, we would soon run out of social institutions.

So you have the paradox - or the Big Lie - of an industry which claims to be engaged in strategic risk management for everyone's benefit, but which is actually the primary creator of risk and social insolvency.

The point of having banks is not to reduce risk. The point is to increase it in a reasonably controlled manner. Because a society without banks runs too few risks, and therefore misses out on benefits it could have obtained.

The key term here is in a reasonably controlled manner. The problem currently is that there is too little control of the risk, and that is the problem that I am addressing.

It is not the only problem with banking as it is currently practised. Among the more prosaic problems are endemic fraud and rampant racketeering. But dealing with those are outside my area of expertise.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Fri May 13th, 2011 at 06:58:15 PM EST
[ Parent ]

Re: But isn't that (none / 1)

But the problem here is surely that risk analysis that is not absolutely cast-iron gets a pass, not that people are actually doing their jobs when assessing wind farm finance?

No, the problem is that rhetoric - in the form of a thing called "risk analysis" - is being used to implement strategy without public discussion or democratic oversight.

Put simply, banking subverts democracies and leads democracies away from stability (and sanity.)

There is no good real-world reason why we don't already have a culture that uses renewables for energy. Absolutely none.

The fact that we're still desperately fighting a battle that shouldn't even have been started forty years ago, when the obvious rational choice was a move to renewables, proves just how distorted the decision-making process has become.

The black death killed off a double-digit percentage of the European population. Unless the banksters manage to trigger a sufficiently bad depression that it results in a serious shooting war (a possibility that I am a lot less sanguine about dismissing than I was a year ago), they will not rack up that sort of body count, however damaging their activities may otherwise be.

They already have. Not in Europe - but have you seen the state of Africa recently?

Of course we assume it couldn't happen here, because we're privileged and special.

We aren't. We're disposable. Ask Greece or the poor in the US.

This is a critical point. We have to broaden our experience to take an honest look at what's happening. Just because it's not happening to us personally doesn't mean what's happened to others is trivial.

The point of having banks is not to reduce risk. The point is to increase it in a reasonably controlled manner.

What risk do you mean, exactly? What physical bad consequences result if a bank backs a "risky" project that is deemed to be a failure by current accounting standards? (Assuming that a project fails for reasons other than banker whim in the first place.)

Not economic consequences - physical and social consequences.

When you can prove to me that the physical and social consequences of a failed "risky" enterprise are reliably worse and more damaging than the (largely imaginary) economic consequences, then I will believe that banks have a useful role to play.

Until then, banks are a problem - possibly the problem - and not a solution.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Fri May 13th, 2011 at 07:47:42 PM EST
[ Parent ]

Re: But isn't that (none / 0)

There is no good real-world reason why we don't already have a culture that uses renewables for energy. Absolutely none.

Well, no, but what does that have to do with banks?

I can name the politician who killed US wind dead. I can name the politicians who killed the Danish offshore sector. They didn't need any help to do that.

Wind is crucially dependent on market structure. And the banksters don't decide that - the politicians do. Now, it may be that those politicians have been bought and paid for by the banksters, which means that you need to stop the banksters from buying politicians.

They already have. Not in Europe - but have you seen the state of Africa recently?

I am perfectly aware that there is a civil war in Libya. But I don't see how the banksters have much of anything to do with that.

What risk do you mean, exactly? What physical bad consequences result if a bank backs a "risky" project that is deemed to be a failure by current accounting standards?

People lose their homes.

People lose their incomes, which in our current institutional framework means that they will have to rely on charity and hand-outs to get food.

You get gas-fired power plants used for baseload, because of a failure to price in the systemic cost associated with increased gas reliance, and the systemic risk of monocropping your source of electricity.

When you can prove to me that the physical and social consequences of a failed "risky" enterprise are reliably worse and more damaging than the (largely imaginary) economic consequences, then I will believe that banks have a useful role to play.

But... you have more risky enterprises with banks than without. So that's an ass-backwards sort of demand to make.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sat May 14th, 2011 at 04:29:13 AM EST
[ Parent ]

Re: But isn't that (none / 1)

Well, no, but what does that have to do with banks?

If banks were capable of intelligent reality-based strategic management, they would have been fighting the other corner, surely?

I am perfectly aware that there is a civil war in Libya. But I don't see how the banksters have much of anything to do with that.

In that case you might want to become more perfectly aware of the rest of Africa too.

People lose their homes. [...]

Er - you do realise that the only reason all of your examples have been happening for the last few years is because of the state of the banking industry?

I was looking for examples of what happens when banks aren't in the way. You provided a list of failures that have been created by banking.

This is rather odd, and worrying.

To repeat - I am talking about social transactions which are not financialised, and not primarily for profit or the generation of the abstract feudal debt management system known as "interest."

It might be useful at this point to think about what that might involve.

But... you have more risky enterprises with banks than without.

No, you don't. This is exactly the point of the argument. You have more risk and instability when banks are pretending to manage the economy - because in reality, the banks have very little interest in decreasing risk, and they can make more short-term profit when risk increases.

Banks can deny certain kinds of business models if they happen not to suit them - but the proper definition of "suit" is not "too risky", it is "not obviously profitable enough."

But these rules are only for the little people, not for the banks themselves. If risk explodes - as it always seems to - the stranglehold the banks have on government means they can always steal public cash.

The whole financial industry is predicated on the (accurate) assumption that it is possible to profit hugely from risk.

This is not a good basis on which to expect much useful risk limitation to happen - as reality bears out, repeatedly.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Sat May 14th, 2011 at 11:57:29 AM EST
[ Parent ]

Re: But isn't that (none / 0)

In that case you might want to become more perfectly aware of the rest of Africa too.

Unless you believe Africa begins somewhere north of Greece, I don't see where you're coming from here.

I was looking for examples of what happens when banks aren't in the way. You provided a list of failures that have been created by banking.

Well when banks are not in the way, you don't get electricity in the first place. Nevermind gas-fired baseload.

Yes, the government can take over the strategic planning role currently fulfilled by the banks. The government can also monitor the banks to make sure they do their job. You have not provided any argument for why one of these solutions is universally superior to the other.

To repeat - I am talking about social transactions which are not financialised, and not primarily for profit

Since most European economies have been money-based since before they were industrialised, you may have a hard time finding any significant volume of industrial production that has ever taken place outside the monetary system.

You have more risk and instability when banks are pretending to manage the economy

A moment ago you were arguing that risk really wasn't so bad, so we didn't want to prevent it.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sat May 14th, 2011 at 03:11:54 PM EST
[ Parent ]

Re: But isn't that (none / 1)

The fourth narrative is that you can only really understand what's happening by removing all money and accounting from the discussion.

I don't think that's right. If you want to make sensible policy you have to understand your policy tools. Money and accounting are powerful policy tools, so you need to understand how the institutions in your economy react to them.

What does it mean that a business plan sucks?

That it is illegal, in violation of good business practise or not remunerative.

How does the bank know?

In a properly run economy, banks would have specialists on staff or retainer to evaluate business plans.

Is the bank correct?

Not always. If I were overly concerned with inflation, I might view that as a problem. But I'm not, so I don't.

To what extent do the banks themselves create the social conditions in which certain business plans can be guesstimated to suck, while others appear not to?

To a very large extent. Banking is fundamentally a political planning function. That's why parliaments periodically have to reassert democratic authority over banks that grow too big for their britches.

What is the true cost of the percentage cut taken by the banks? Is that cut a good use of social and natural resources?

Banks are essentially vehicles for providing private firms with state power (money). In a properly run economy, the advantage of having banks is that they can go tits-up, which should result in their management getting relieved of the jobs that they apparently found too onerous to do properly. A central bank, of necessity, cannot go bust in its own currency (that's why CB balance sheets are where crap assets go to die).

So having the private banks as a go-between between the central bank and the private firms who borrow is a vehicle for purging incompetent government bureaucrats by pretending that they are private bureaucrats.

How could "business" - let's pretend we know what that means - be organised in ways that don't require these costs?

You could abandon technically sophisticated, capital-intensive industrial mass production.

But if you're not going to do that, you need economic actors who do political planning, because technically sophisticated, capital-intensive industrial mass production requires planning, and planning is always political. You can have the state do that. You can have the firms themselves do it. You can have the banks do it. Or you can have someone else do it. But I've yet to see any evidence that properly run and supervised banks are sufficiently more corrupt, wasteful an incompetent than properly run and supervised politicians elsewhere in society.

Honesty and competence in your politicians: Accept no substitute.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Fri May 13th, 2011 at 04:58:26 AM EST
[ Parent ]

Re: But isn't that (4.00 / 2)

I don't think that's right. If you want to make sensible policy you have to understand your policy tools. Money and accounting are powerful policy tools, so you need to understand how the institutions in your economy react to them.

No. If you want to make sensible policy, you have to decide what sensible policy looks like, and make your policy aims clear, objective, and explicit.

You can't allow your tools to define that for you - which is what money and accounting do.

Economics is a political tradition. It's not a fact of nature. It's one particular proposed solution to one set of problems.

That it is illegal, in violation of good business practise or not remunerative.

That's a circular definition - apart from the "illegal" part. (And we know from Goldman etc that even that's up for debate.)

It doesn't examine what "not remunerative" means socially.

E.g. if a business is "remunerative" because it destroys other businesses and social networks, is that really a valid criterion for its continued existence?

But I've yet to see any evidence that properly run and supervised banks are sufficiently more corrupt, wasteful an incompetent than properly run and supervised politicians elsewhere in society.

If you accept that banking is essentially strategic planning - which I agree with, up to a point - it becomes inevitable that banks cannot remain supervised and accountable, because they're already at the top of the political food chain and are able to wrap it around themselves.

If banks and businesses are implicitly political, they should be explicitly democratically accountable.

If they're not democratically accountable, they have no business making policy.

Otherwise this:

Honesty and competence in your politicians: Accept no substitute.

is an impossibility.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Fri May 13th, 2011 at 05:38:58 AM EST
[ Parent ]

Re: But isn't that (4.00 / 3)

No. If you want to make sensible policy, you have to decide what sensible policy looks like, and make your policy aims clear, objective, and explicit.

Clear, objective, explicit. Pick any two.

You will always need to give your regulators some amount of discretionary power. Otherwise, you'll be playing a never-ending game of whack-a-mole with too-clever-by-half rules lawyers who move to the next exploit as soon as you close the previous one. The only way to deal with rules lawyers is to be clear and explicit, but not too objective.

You can't allow your tools to define that for you - which is what money and accounting do.

I know roughly what I want to do.

I want everybody to have the option of living in a reasonably functioning, technically sophisticated industrial society, where they are free from arbitrary violence (social, physical and economic).

But when I'm making policy proposals, I don't make them in terms of the end point I'd like to see. I make them in terms of the institutions and policy tools that actually exist and are available to policymakers, and check that they are consistent with the end point I'd like to see.

It doesn't examine what "not remunerative" means socially.

That's not a bug, that's a feature. I don't want banks to be making that decision, because I think that they're structurally inclined to make bad decisions in that area of policy. Parliament and civil society are much better places to make that decision.

E.g. if a business is "remunerative" because it destroys other businesses and social networks, is that really a valid criterion for its continued existence?

No, but then the solution is to make the business non-remunerative or non-legal. Banks enable business, they do not (or at least should not) run it. Or if, as is the case for certain intoxicants, this is impossible then at least tax the shit out of it.

If you accept that banking is essentially strategic planning - which I agree with, up to a point - it becomes inevitable that banks cannot remain supervised and accountable, because they're already at the top of the political food chain and are able to wrap it around themselves.

Well, if the (proper function of) the Civil Service is essentially strategic planning, which no-one of sound mind will presumably dispute, then couldn't you say the same thing for it?

If banks and businesses are implicitly political, they should be explicitly democratically accountable.

Yes. That's part of the point of giving the central bank a de facto veto over their political decision, and then making the central bank accountable to Parliament. As Jerome perspicaciously noted at the very beginning of this thread.

If they're not democratically accountable, they have no business making policy.

Yes and no. Courts are not democratically accountable in the conventional sense. Yet no sensible person would suppose that they are not making policy. And that is generally seen as desirable. Civil society organisations are not democratically accountable in the traditional organisation-flowchart-of-government sense either (and indeed the difference between "civil society organisation" and "special interest pressure group" is mostly whether you agree with them or not). Yet nobody could doubt that they make policy, and sometimes do it better than Parliament.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Fri May 13th, 2011 at 06:11:15 AM EST
[ Parent ]

Re: But isn't that (none / 1)

Clear, objective, explicit. Pick any two.

Why?

I'm not talking about regulation. I'm talking about stating explicit political goals and monitoring progress towards them, or away from them.

Currently the banks have their cake, and they don't just eat it they sell it over and over.

They can state fuzzy goals like "low inflation", they can move the goal posts that define how inflation is calculated, they can enforce policy that is supposed to influence inflation, and they can shrug and say "Oops - we didn't see that coming" when that policy doesn't work.

Regulation isn't the problem here. Neoclassical brain rot is.

But when I'm making policy proposals, I don't make them in terms of the end point I'd like to see. I make them in terms of the institutions and policy tools that actually exist and are available to policymakers, and check that they are consistent with the end point I'd like to see.

And what happens when you not only don't get the policy you want, but you do get policies which are clearly destructive to the policy you want?

Well, if the (proper function of) the Civil Service is essentially strategic planning, which no-one of sound mind will presumably dispute, then couldn't you say the same thing for it?

No, because the proper function of the Civil Service is implementation, not strategy. It's not the job of the Civil Service to decide whether a high speed rail line should be built. It's the job of the Civil Service to try to get it built as cheaply and reliably as possible once the decision to build it has been made by ministers.

Yes and no. Courts are not democratically accountable in the conventional sense.

On most political science courses, courts are considered an explicit part of the machinery of government. If there's a constitution, the role of the courts is usually defined in it, typically on the basis of checks and balances. Voters don't elect judges, but there is a clear relationship between courts and elected houses.

Banks are not considered an explicit part of the machinery of government.

The original role of the Bank of England was coin counting and bill settling. It had no other function. Currently in most countries there is no explicit constitutional relationship between banks and the other parts of the government machine. The central bank may be mentioned, but the rest of the industry won't be.

And yet we find that banks - not just the central bank, but industry figures in general - have more influence on policy than voters, courts, elected assemblies or individual ministers.

So I'll say again: this should be considered a privilege, it should be made explicit, and if banks want to play the policy game the most useful thing a democracy can do is to define their role explicitly and make them explicitly accountable - not in the sense of being required to send a letter to the Chancellor, as the Bank of England currently is, and not in the sense of regulation, but in the sense of having the effectiveness and wisdom of their policy choices formally debated, questioned and tested in public - to destruction, if need be.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Fri May 13th, 2011 at 06:20:31 PM EST
[ Parent ]

Re: But isn't that (none / 1)

I'm not talking about regulation. I'm talking about stating explicit political goals and monitoring progress towards them, or away from them.

Can you give an example of a clear, explicit and objective policy goal, and a clear, explicit and objective way to measure how it is attained?

Regulation isn't the problem here. Neoclassical brain rot is.

Neoclassical brain rot unfortunately produces inappropriate (lack of) regulation. And insane constitutional amendments. If it did not, it would not be a major problem. So if and when the neoclassical brain rot is purged, we must have workable policies to replace the neoclassically-inspired garbage that's been foisted upon us.

And what happens when you not only don't get the policy you want, but you do get policies which are clearly destructive to the policy you want?

Then I organise in a political party or a civil society organisation that can exercise useful amounts of power over decisionmaking and is broadly sympathetic to the policy I want. Or, if no such civil society organisation is available, I attempt to become A Very Serious Person so I can influence policy directly. I don't hold much hope at this point on either count, but one does not need hope in order to put up an honest fight.

But I can't do that until and unless I know what policy I want. Or rather I can, but then I'll get taken for a ride.

the proper function of the Civil Service is implementation, not strategy. It's not the job of the Civil Service to decide whether a high speed rail line should be built. It's the job of the Civil Service to try to get it built as cheaply and reliably as possible once the decision to build it has been made by ministers.

On the contrary. It is precisely the civil service's job to decide whether a given rail line should be built, given the government's overall fiscal and infrastructure policy. It is the minister's job to light a fire under the civil service to get them to produce reasonably coherent policy proposals on matters that interest him. And it is the minister's job to then reject, approve or decide between the proposals presented to him. But he has neither the staff, the training nor the institutional support to conduct serious strategic planning himself.

So I'll say again: this should be considered a privilege, it should be made explicit

I don't understand the need for private banks to be placed explicitly in the government chain of command. Private banks exist at the pleasure of the central bank and financial regulator - if the latter two so desire, they can pull the plug on any and all banks' business model almost literally overnight.

Make the central bank subservient to parliament, rather than this neoclassically-inspired "independent central bank" bullshit (which is in reality simply a bit of sophistry to avoid saying "bankster-run central bank"). Give it a financial stability mandate. And a clear and explicit standing order to use its big stick to beat any misbehaving private bank firmly about the head until it mends its ways or goes tits-up.

If you still have problems with misbehaving banks after that, we can start talking about constitutional amendments.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Fri May 13th, 2011 at 07:44:55 PM EST
[ Parent ]

Re: But isn't that (none / 0)

Jake:

ARG asked a question about how my recommended policy would influence [the effects of the money multiplier, as discussed in the wiki article]. Which is an unanswerable question, because [the idea of a money multiplier] is arrant nonsense.

I think we need to keep in mind that all of these concepts are constructs, some more useful than others. The "money multiplier" is a further elaboration of "the velocity of circulation" which was used to attempt to explain why available money could appear to increase or decrease while there was no change in base money. Both versions have been used by various economic textbooks to attempt to educate freshmen over the last half century, in part because the underlying phenomenon is important, and they were of some use in that respect. After all, there was, presumably, a need for Tobin to publish Commercial Banks as Creators of "Money" a half century ago. So describing them as "arrant nonsense" is a bit flippant and off-putting, even if substantially true, considering that this was what was taught to 90% of everyone who has ever taken ANY economics course. So your comment became unintelligible because you were "geeking out" and dismissed the implicit question rather than answering it in an understandable context.

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Fri May 13th, 2011 at 11:31:09 AM EST
[ Parent ]

Re: But isn't that (none / 1)

The "money multiplier" is a further elaboration of "the velocity of circulation" which was used to attempt to explain why available money could appear to increase or decrease while there was no change in base money. Both versions have been used by various economic textbooks to attempt to educate freshmen over the last half century

Well, yes, the money multiplier mythology is very useful in the context of schooling people in the neoclassical view of banking.

For understanding the how the actual institutions of modern economies... not so much.

So describing them as "arrant nonsense" is a bit flippant and off-putting, even if substantially true, considering that this was what was taught to 90% of everyone who has ever taken ANY economics course.

True. In my defence, when I wrote that I was in the middle of a Macro 202 assignment that was particularly stuffed with other, but similar, forms arrant nonsense. I may have been letting off a little steam that I could not well permit to enter into a liturgical work.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Fri May 13th, 2011 at 04:01:56 PM EST
[ Parent ]

Re: But isn't that (none / 0)

So it seemed. No problem. Just saying.

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Fri May 13th, 2011 at 05:08:00 PM EST
[ Parent ]

Re: But isn't that (4.00 / 2)

This is comment gold. Make it a diary...

Economics is politics by other means

by Carrie (migeru at eurotrib dot com) on Fri May 13th, 2011 at 04:19:34 AM EST
[ Parent ]

Re: But isn't that (none / 1)

Think I found an explanation:

MMT AND THE OPERATIONAL REALITIES OF THE MONETARY SYSTEM | PRAGMATIC CAPITALISM

First is the accounting logic of real-world transactions. Every transaction in a real-world economy affects financial statements of those engaged, and if an economic theory or a posited model is not consistent with how real-world financial statements are affected, then the theory is inapplicable. A typical example used by MMT'ers is the loanable funds market, which posits a demand for loanable funds and a supply of loanable funds available for the macroeconomy. This model is simply inapplicable to our current monetary system in which bank loans are created "out of thin air" without the requirement of prior reserve balances or deposits to "fund" the loan's creation. Completely contrary to the loanable funds model, in fact, the vast majority of bank liabilities have been created by banks simply growing their balance sheets through loans and asset purchases. Similarly, there are macroeconomic accounting identities, such as the often-cited sector financial balances equation in which the domestic private sector's net saving of financial assets is by definition equal to the government sector's deficit and the current account balance.

So has deposits nothing to do with the amount that can be borrowed out? What about the reserve requirement?

Sweden's finest (and perhaps only) collaborative, leftist e-newspaper Synapze.se

by A swedish kind of death on Thu May 12th, 2011 at 04:45:55 PM EST
[ Parent ]

Rediscovering Minsky's wheel, one pundit at a time | 77 comments (77 topical, 0 editorial, 0 hidden)

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