Friday, 28 April 2017

Private banks do not charge interest in respect of the money they issue.


There is a popular myth to the effect that the above is the case. The myth is promoted by among others, Positive Money, an organisation I actually support because PM gets many things right. Also Bryan Gould (former member of the UK Labour Party shadow cabinet) seems to lend credence to the myth.

The idea that private banks DO CHARGE interest in respect of the money they issue stems from the “loans create deposits” phenomenon: that is, when a bank makes a loan, it does not need to get the relevant money from depositors or from anywhere else. It can simply open an account for the borrower and credit $X to the account – the money comes from thin air. The bank then charges interest on the loan.

Thus banks do two things there: first, create money, and second, charge interest. Ergo, so it might seem, they charge interest on the money they have created.

The flaw in that argument is that banks either charge for the loan or for the money. They cannot charge for both. I.e. if a bank charges 5% interest, is that for the loan or is it the lucky recipient of the money who is charged?

Take the case of a loan for $X which is granted to Y, who then spends the money, which ends up in the bank account of Z. There is no doubt that Y pays interest to the bank. But Z, the recipient of the money doesn’t.!! If anything, Z charges his or her bank interest (or put another way, Z’s bank will pay interest to Z, particularly if the money is put into a term account.)

 

Double checking the argument.

By way of double checking the above points, consider an economy where there was no borrowing or lending, but people did (understandably) want a form of money. And let’s say that money is supplied by, or at least supplied almost exclusively by private banks.

Those banks would open their doors for business. Customers would ask to open accounts and would ask for some specific sum of money to be credited to those accounts to enable day to day transactions to be done. Banks would demand collateral as appropriate.

Certainly banks would charge for ADMINISTRATION  costs there (e.g. the cost of checking up on the value of collateral). But there would at that stage be no reason to charge INTEREST because no real resources would at that stage have been transferred by banks to customers.

Moreover, even after customers started spending their money, there would still be no very good reason for banks IN THE AGGREGATE to charge customers in the aggregate for interest. Reason is that money leaving one account must arrive in some other account. (To keep things simple, I’ll assume there is no physical cash – a not totally unrealistic assumption, given that it looks like physical cash will disappear in the near future.)

Of course where specific customers ran down their bank balances, and left them in a “run down” state for extended periods, banks would charge interest to those customers. But in that case, real resources would have been transferred to those customers for an extended period. That is, the only way for that “extended run down” to occur is for relevant customers to buy stuff off other customers and leave it at that. I.e. the latter “buyers” would in effect be borrowing from the latter sellers with banks acting as intermediary. Sellers, would understandably want interest, and that interest would be passed on to buyers.

 

Conclusion.

Banks charge interest on loans. They also charge for administration costs when supplying customers with day to day transaction money. But it would not make any sense for banks to charge interest simply for supplying all and sundry with day to day transaction money.

Monday, 24 April 2017

Random charts XX.


Text in pink on the charts below was added by me.














Tuesday, 18 April 2017

Steve Keen and Mish make a fallacy of composition error?


I agree with Steve Keen and Mike Shedlock (“Mish” for short) about 90% of the time. But they’ve slipped up on the subject of bank reserves, unless I’ve missed something. I’ll use the word “bank” to refer to commercial banks (as distinct from central banks)

Mish challenges the conventional wisdom on interest on reserves (IOR), which is that IOR is an incentive for banks not to lend. The conventional wisdom is that if a bank gets say 5% on its reserves, and given that lending $X means the bank loses about $X of reserves, it won’t lend unless it gets at least 5% after expenses from the potential borrower.

Mish challenges that by pointing out that the decision by an individual bank (or indeed the bank industry as a whole) to lend more has no effect on the industry’s stock of reserves. He concludes from that that interest on reserves does not provide banks with an incentive not to lend.

Well it’s true that the decision by a bank or the bank industry as a whole to lend more has no effect on the industry’s stock of reserves. However, the flaw in the latter “Mish” argument is that “incentives” as seen by an INDIVIDUAL bank are not the same as “incentives” as seen by the commercial bank system as a whole. That is, if an individual bank (to repeat and over-simplify a bit) gets say 5% on its reserves, it has no incentive to lend unless it gets MORE THAN 5% from the potential borrower after expenses.

The fact that IF IT DID LEND, there would be no effect on the TOTAL AMOUNT the bank industry gets by way of interest on reserves is irrelevant because banks just don’t collude when it comes to the decision by an INDIVIDUAL bank to lend – they couldn’t collude if they tried. To illustrate…

Suppose that bank A is contemplating a loan of $Y to a customer, and suppose that in the event of the loan taking place, relevant monies will be deposited at bank B. It is plain impossible for both banks to get together and work out the effect on their combined incomes as a result of making that loan: reason is that each bank will be making thousands of loans per day. Moreover, in the latter example, relevant monies will not necessarily be deposited at just one bank (i.e. bank B): chances are they’ll be deposited at several banks. And worse still: relevant monies will not stay at recipient banks for long. Those monies will be re-spent and deposited at yet another set of banks.

Thus the idea that banks can somehow collude with a view to working out the effect on their total income as a result of one bank making a loan is wholly, completely and totally unrealistic.

Thursday, 13 April 2017

Random charts IXX.


Text in pink is added by me to the original charts.















Wednesday, 12 April 2017

Do Job Guarantee enthusiasts want the entire workforce raking leaves rather than doing something useful?


Reason I ask is that it’s not entirely clear where JG enthusiasts stand on this one. For example Pavlina Tcherneva is one of the more vociferous advocates of JG, but in the opening paragraphs of an article of hers (Levy Economics Institute Policy Note 2012/2) she criticises conventional stimulus and sings the praises of JG type employment.

So how far does she want to take that point: abolish all forms of conventional employment, and instead have the entire workforce raking leaves, planting trees and doing the other assortment of jobs normally given as examples of what JG / make work scheme employees can do?

Strikes me as pretty obvious that the optimum policy here is to boost demand as far as possible, and get as much of the workforce as possible into conventional types of employment (public and private), and then use JG to deal with the remaining and unemployed members of the workforce. But there is no hint in her article of the latter idea.

More evidence of the dim view she takes of conventional forms of employment comes in this tweet of hers where she castigates dangerous car factories. Well the solution to that is proper and properly enforced health and safety laws, not closing down every car factory in the country and putting redundant employees onto raking leaves and planting trees.

Amazing that it is even necessary to explain this, isn't it?

Factories that produce cars and other items produce what people actually want and are prepared to pay for (shock horror). JG work is inevitably less productive because if a given JG job really was more productive than the less productive regular jobs, market forces would bring the former into existence and dispense with the latter, all else equal, i.e. assuming a constant level of aggregate employment.

Moreover, it’s not as if there is a total absence of injury and death on JG projects: a significant proportion of the JG scheme which operated in the 1930s, namely the WPA, involved constructing buildings, roads, bridges and so on. That sort of work is inevitably quite dangerous.

In contrast to today’s deluded JG advocates who will get precisely nowhere under the current Republican administration, the JG ideas I was advocating about 20 years ago have actually been put into effect, albeit in a small way.  One idea I advocated was that JG type work should be with EXISTING employers rather than on specially set up projects, as per WPA. Second I advocated that there should be no preference for public sector employers as compared to private sector employers (or vice-versa).

Those two ideas are in fact inherent to the only JG type scheme up and running in the UK, i.e. the Work Programme.

For my latest ideas on this subject, which have not changed substantially from 20 years ago, see my recent paper in the journal below. This is an exercise in tidying up and bringing things up to date.




Sunday, 9 April 2017

Random charts XVIII


Text in pink is added to original charts by me.

















Saturday, 8 April 2017

Nonsense from the World Economic Forum.



A recent World Economic Forum publication claims everyone in any given country would have to “contribute” something if that country’s national debt was to be paid off. Er – no they wouldn’t because (to over-simplify a bit) for every dollar of so called debt, there is someone with a dollar of a financial asset called “government bond” or similar. (“Treasury” in the case of the US or “Gilt” in the case of the UK for example).

Thus in the simple case of where a country’s national debt is held entirely by residents of the relevant country, the national debt could be wiped out by for example by simply having government announce it no longer owed anything to anyone. Debt holders would lose $X, while others would be relieved of the obligation to repay $X to debt holders, thus the average “contribution” per citizen would be zero.


A more subtle and less dramatic way of doing the same thing would be some sort of tax on debt holders combined with tax cuts and/or increased social security payments for the less well off. But the end result would be the same: a zero net “contribution” per citizen.


Of course in the real world, most countries’ debts are to some extent held by foreigners. But that makes little difference if the amount of country A’s debt held by citizens of country B is balanced by the amount of country B’s debt held by country A.


And so far as the World as a whole goes, the same applies as in the above example of where all of a country’s debt is held by natives of that country: that is, debts and financial assets in the form of government bonds net to nothing for the World as a whole.

In contrast to the above sort of “net to nothing” scenarios, a country can of course be left in debt to other countries after all the above “netting off” has been done. Such a country clearly has a problem, maybe a serious problem, maybe not: depends on the size of the debt.



 

 Kenneth Rogoff.

This is all reminiscent of the nonsense spouted by Kenneth Rogoff, Carmen Reinhart and other economists at Harvard luniversity. According to Rogoff, what he calls “financial repression” has to be endured for a country to pay off its national debt. And “financial repression” according to Rogoff is bad, bad, bad and horrible.

In fact, as MMTers have pointed out ad nausiam, a country which issues its own currency has total and complete control of the rate of interest it pays on its debt. Thus it can perfectly well organise things so that the REAL or “inflation adjusted” rate of interest on its debt is zero or even negative. In the latter scenario, national debt is not any sort of burden: in fact in that scenario, if anything, it’s the debtor who rips off the creditor rather than vice-versa.


But that does not mean it’s a good idea to let debts rise for ever (relative to GDP). The time to cut the debt is when the economy has a fit of Alan Greenspan’s “exuberance” and inflation looks like getting uppity. In that scenario, taxes can be raised and some of the debt can be paid off. But note that that DOES NOT constitute any sort of Rogoff type “standard of living reducing repression”: the object of the exercise is simply to control inflation – there is no effect on GDP or average incomes.


Indeed, given that excess inflation imposes various real costs on the country, a rise in tax (given excess inflation) far from being any sort of “repression” equals an all-round benefit for the country.


Kenneth Rogoff’s “financial repression” is pure, unadulterated bullshit.
And the final important point to understand about national debts (as pointed out over and over by MMTers) is that national debts are self limiting. That is, debt (to repeat) is a financial asset as viewed by the private sector, and the more such assets the private sector holds, the more it will spend, all else equal. If someone gave the average household a million dollars worth of debt, what would the average household do? It wouldn’t just sit on it! Doubtless it would save or “sit on” some of it. But at the same time it would try to sell and spend away a significant proportion.