{"id":10858,"date":"2014-06-30T10:00:14","date_gmt":"2014-06-30T14:00:14","guid":{"rendered":"http:\/\/multiplier-effect.org\/?p=10858"},"modified":"2014-06-30T10:41:50","modified_gmt":"2014-06-30T14:41:50","slug":"something-is-rotten-in-the-state-of-denmark-the-rise-of-monetary-cranks-and-fixing-what-aint-broke","status":"publish","type":"post","link":"https:\/\/blogs.bard.edu\/multiplier-effect\/something-is-rotten-in-the-state-of-denmark-the-rise-of-monetary-cranks-and-fixing-what-aint-broke\/","title":{"rendered":"Something Is Rotten in the State of Denmark: The Rise of Monetary Cranks and Fixing What Ain\u2019t Broke"},"content":{"rendered":"
\n

Horatio: \u00a0He waxes desperate with imagination.<\/p>\n

Marcellus: \u00a0Let\u2019s follow. \u2018Tis not fit thus to obey him.<\/p>\n

Horatio: \u00a0Have after. To what issue will this come?<\/p>\n

Marcellus: \u00a0Something is rotten in the state of Denmark.<\/p>\n

Horatio: \u00a0Heaven will direct it.<\/p>\n

Marcellus: \u00a0Nay, let\u2019s follow him.<\/p>\n

\u00a0Hamlet Act 1, scene 4<\/em><\/p>\n<\/blockquote>\n

Marcellus is right, the Fish of Finance is rotting from the head down. It stinks. As Hamlet remarked earlier in the play, Denmark is \u201can unweeded garden\u201d of \u201cthings rank and gross in nature\u201d (Act 1, scene 2<\/em>). The ghost of the dead king appears to Hamlet, beckoning him to follow. In scene 5, the ghost tells Hamlet just how rotten things really are.<\/p>\n

Denmark, is of course Wall Street or London. Far more rotten than anyone can imagine.<\/p>\n

In the aftermath of the Great Recession, we all wax \u201cdesperate with imagination,\u201d looking for explanation. For solution. For retribution!<\/p>\n

The financial system is rotten. Our banking regulators and supervisors failed us in the run-up to the crisis, they failed us in the response to the crisis, and they are failing us in the reform that we expected in the aftermath of the crisis.<\/p>\n

Heaven will not save us, either. The Invisible Hand is impotent. Just wait for Scene 5!<\/p>\n

In times like these, we thrash about, desperate for ideas, for imagination, for leadership. There\u2019s nothing unusual about that. Read the entry,\u00a0monetary cranks,\u00a0<\/strong>by\u00a0David Clark<\/a>\u00a0in The New Palgrave: A Dictionary of Economics<\/em>, First Edition, 1987, Edited by John Eatwell, Murray Milgate and Peter Newman.<\/p>\n

You\u2019ll find many of the same proffered reforms bandied about now. Many of them make sense, or at least partial sense. I\u2019ve always used that entry in my money and banking courses as an example of sensible ideas being rejected by the mainstream, labeled \u201ccrank\u201d to discredit them.<\/p>\n

When I use the term\u00a0monetary cranks,\u00a0<\/strong>I use it as a term of endearment. We need some cranky ideas because all the respectable ones failed us. There is nothing, and I mean literally nothing, that will come out of the mainstream that will be of use.<\/p>\n

Chicago Plan<\/strong><\/p>\n

The \u201cGreat Crash\u201d (as JK Galbraith called it, AKA the \u201cGreat Depression\u201d) generated a similar outpouring of \u201ccranky\u201d proposals. Even quite mainstream and respectable economists got involved. A group of them published \u201cthe Chicago Plan\u201d\u2014supported by Irving Fisher, Milton Friedman, and Henry Simons.<\/p>\n

The idea was to prevent another run-up in speculative fever by restricting banks. They could issue deposits but could not make loans. To ensure safety of the deposits, they\u2019d hold only the safest assets\u2014such as US Treasuries. (For more on the history of the Chicago Plan, see the great book by my good friend and Levy colleague, Ronnie Phillips, (1995)\u00a0The Chicago Plan & New Deal Banking Reform<\/em>, Armonk, NY: M.E. Sharpe.)<\/p>\n

Hyman Minsky wrote an endorsement for the book, but he also wrote that the Narrow Banking plan was aiming to \u201cfix what is not broke.\u201d Yes, the plan would carve out a section of the financial system that would remain safe\u2014the payments system. However, with a central bank that acts as a lender of last resort and with the treasury providing deposit insurance, our payments system is perfectly safe.<\/p>\n

You want proof? We just went through the worst (global) financial crisis since the 1930s with not even a hiccup in our insured deposit system.<\/p>\n

True, our uninsured money market mutual fund system faced disaster, and required expansion of the government safety net to save it. And virtually every other part of our financial system also had to be rescued. As my Ford project<\/a> team has documented, it took $29 TRILLION of subsidized loan originations by the Fed to prop up Wall Street, London, and Brussels.<\/p>\n

But the protected deposit-based payments system went through unscathed.<\/p>\n

(The UK did have a hiccup, precisely because it did not offer 100% insurance; it had to expand insurance to 100% to stop bank runs that never occurred in the USA.)<\/p>\n

So what do our monetary cranks want to do? Well, a lot of them want to go back to the Chicago Plan. They want to solve a problem that does not exist.<\/p>\n

Like Minsky, I don\u2019t object. Maybe there is a better way to do the payments system. Personally, I\u2019ve always liked the idea of a nationwide, universally accessible, government-funded, postal savings system. Let\u2019s go for it.<\/p>\n

It\u2019s a crazy idea only in the USA. It is easy to find PSSs around the world. Last time I looked, the Japanese PSS was the biggest \u201cbank\u201d in the world (but maybe one of the bankster banks has surpassed it now\u2014propped up, fed, clothed and diaper-changed by Uncle Sam).<\/p>\n

We do not have to reinvent the wheel. We don\u2019t need a Chicago Plan. Let\u2019s just restore the US Postal Saving System (which, as I recall, lasted into the 1960s).<\/p>\n

Centralized Committee of Experts<\/strong><\/p>\n

However, the crank can be taken too far. Some\u2014even the FT\u2019s Martin Wolf??\u2014are not talking about carving out a tiny part of the financial system, but rather are talking about lock-stock-and-barrel replacing it with narrow banks. (See the great critique by Ann Pettifor, Out of thin air \u2013 Why banks must be allowed to create money<\/a>.)<\/p>\n

Now that is cranky.<\/p>\n

The idea seems to be that we don\u2019t need no stinking banks\u2014at least the kind we\u2019ve got now.<\/p>\n

As I\u2019ve been arguing, our banks \u201ccreate money\u201d (in the form of demand deposits) \u201cout of thin air\u201d when they make loans. It seems that everyone except Paul Krugman now gets this. And lots of people don\u2019t like it, including Martin Wolf.<\/p>\n

So we\u2019ll eliminate that kind of banking, and just let narrow banks take in deposits and then buy safe treasuries. No more money creation out of thin air.<\/p>\n

Who will do the lending? There are two options. We could allow specialized intermediaries that would take in savings and lend them out. Or we could have special government banks. I\u2019m only discussing the first of these today.<\/p>\n

While the cranks who support private intermediaries have not explicitly stated it, what they seem to be proposing is a riff on Islamic banking. The idea is that savers can lend their saving to investors. Sure it is risky! The savers effectively share in the rewards or the losses incurred by the investors.<\/p>\n

In many religions, interest is (or at least was\u2014damn usury!) prohibited, but there is nothing wrong with sharing profit (or loss). Since matching savers and investors is time-consuming, special intermediaries rise up to perform that function (taking some of the profit off the top).<\/p>\n

As an enterprise model, this is as old as the hills\u2014going back to Mesopotamia. As Michael Hudson argues, the interest rate charged was 20% or 33% depending on the type of economic activity (lower for commercial, higher for consumer).<\/p>\n

In its modern dress, the proposal is to set up a centralized nongovernmental committee of experts to decide who gets the loans.<\/p>\n

According to Pettifor, this is pushed by the \u201cUK NGO, Positive Money. They agree\u00a0that all \u2018decisions on money creation would \u2026 be taken by a committee\u00a0independent of government\u2019. Furthermore, Wolf argues, private commercial banks would only be\u00a0allowed to:\u00a0\u2018\u2026loan money actually invested by customers. They would be stopped from\u00a0creating such accounts out of thin air and so would become the intermediaries that\u00a0many wrongly believe they now are.\u2019\u201d<\/em><\/p>\n

For me, that\u2019s a crank too far.<\/strong><\/p>\n

First<\/strong>, I do not like centralization and I worry about a committee of experts deciding who is going to get credit. I like the idea of having thousands of decentralized financial institutions making such decisions.<\/p>\n

I like a variety of types of financial institutions as well: credit unions, local community banks, mutual savings and loans (those were the old thrifts that offered mutual shares and made mortgage loans; they never failed and they served their communities), and even some mid-sized banks with a few branches.<\/p>\n

(I also support government development banks, which lend for public purposes. And there is a need for direct lending by Treasury for student loans and other public purposes. However I would not want to eliminate private lenders or cooperatives and mutuals. I do not believe government will generally do a good job of underwriting\u2014so I would favor government direct lending where the public interest trumps good underwriting, and leave the rest to \u201cprivate\u201d lenders, including coops etc.)<\/p>\n

Second<\/strong>\u2014and maybe more importantly\u2014the proposal is based on a fundamentally flawed view of the saving-investment and deposit-loan relationship.<\/p>\n

For those who\u2019ve got Econ 101 under their belt, it is based on the loanable funds notion that \u201csaving finances investment.\u201d As we\u2019ve known since Keynes, that is precisely wrong. I won\u2019t go into it here, but it is best to think of this the other way round: investment creates the income that can be saved.<\/p>\n

But if the Keynes view is right (and of course it is right), then what finances investment (and any spending in excess of income)? Credit. Where does it come from? Out of thin air.<\/p>\n

I can just hear our cranks: \u201cThere you go again, that is what we want to eliminate!\u201d<\/p>\n

Yes, I understand. But crankiness can only take you so far. You\u2019ve got to have the correct theoretical framework. As Pettifor rightly says in her piece, if we really did limit our finance to saving, then we\u2019d run our economy right into the ground.<\/p>\n

Saving is a two-step decision: a decision to NOT spend, and then a decision to hold your saving in some form. Only a portion of saving will ever make it into our intermediary to finance loans. (Some portion will go into the narrow bank, some portion will go under the mattress in the form of currency.) Each period, the amount saved, lent, and then spent would probably decline (leakages into those mattresses).<\/p>\n

Yes, you could instead grow government (\u201cthin air money creation\u201d) to fill the demand gap. Government deficits create saving. I\u2019m all for sufficient government spending to fulfill the public purpose. But I think there\u2019s also important private purposes. As I\u2019ve argued before, the sizes of government is mostly a political decision (with economic effects). The US (along with Japan) desires a government sized at the small end of the scale; France is on the big end. I\u2019ve got nothing against French-sized government. The majority of Americans are not with me on that.<\/p>\n

We need that thin air money creation to keep the lending, spending, and growing moving forward. At least some of it needs to come from the private sector fulfilling the private purpose\u2013maybe less than in years past, but sufficiently large that government budget deficits are not likely to fill the hole if we eliminate private thin air money.<\/p>\n

Now, before I\u2019m accused of advocating the full-speed-ahead excesses of late 1920s banking or early-to-mid 2000s banking, let me say that (with rare exceptions, as discussed above) lending requires underwriting (credit assessment). I do want \u201cexperts\u201d to do that. I want every community bank, credit union, or mutual thrift to have committees of loan officers to do the underwriting.<\/p>\n

What failed us is that the biggest global banks decided underwriting is not needed. They got rid of their loan officers. They off-loaded all their loans to securitization. There is absolutely no hope that a Citi or a BofA will ever do good underwriting again.<\/p>\n

I agree with our cranks (I\u2019m as cranky as they are) about shutting down\u00a0all<\/strong>\u00a0of the biggest financial institutions. They serve no public purpose, and their business model ensures they cannot serve any private purpose, either, except enriching the top tenth of one percent.<\/p>\n

However, we need \u201cthin air\u201d money creation, albeit with decentralized and incentivized underwriting determining which activities ought to get financed. (Good underwriting is incentivized if loans are held to maturity.)<\/p>\n

The Limits of Legislation<\/strong><\/p>\n

But here\u2019s a more fundamental question. Is it really possible to legislate away \u201cthin air money creation\u201d?<\/p>\n

As Minsky said, \u201cAnyone can create money\u201d (How? Thin air), \u201cthe problem is to get it accepted.\u201d<\/p>\n

How can government prevent me from writing \u201cIOU five bucks\u201d? Our economy is based on \u201cI-O-U\u2019s\u201d and \u201cU-O-ME\u2019s\u201d. Since the time of Mesopotamia, we\u2019ve run up bar tabs\u2014cleared at harvest time on the threshing floor. Retailers routinely receive wares on trade credit, payable thirty days hence.<\/p>\n

If you think about it, it\u2019s all trade credit of some sort or other. You work for a month and accumulate wage claims on your employer. At the end of the month he gives you a credit redeemable at a bank, which gives you a credit redeemable at another bank.<\/p>\n

And we\u2019ve carried this to the \u201cnth\u201d degree\u2013$700 trillion of contingent commitments, promises to pay if exchange rates move, if someone\u2019s credit gets downgraded, if a peasant dies, if the Fed moves rates.<\/p>\n

Now, how the heck do you eliminate all of that? And why would you want to?<\/p>\n

Yes, some of it stinks, like that rotten fish head in Denmark. But do you really want a centralized committee somewhere trying to tell you whether you can write an IOU for five buckaroos? Or whether you can place a bet that sterling will rise against the dollar?<\/p>\n

Or that your peasant will die? (Wait a minute, that one certainly ought to be illegal\u2014a go to jail or to the gallows sort of crime.)<\/p>\n

Here\u2019s my proposal: let a thousand flowers bloom, but don\u2019t protect all of them from wilting.<\/p>\n

Carve out various sectors of the financial system that are designated \u201cpublic-private partnerships\u201d that do have safety net protection, but are closely regulated with respect to what they can do. Further carve them up so that they perform designated public purpose activities. Some help to run the payments system (keep them very safe); others make mortgage loans (closely watched to guard against lender fraud); some make commercial loans (with good underwriting); others provide investment services (with more risk but transparently revealed).<\/p>\n

Horses for courses. We\u2019ve got a huge and complex economy with varied financial services needs.<\/p>\n

Right now, we have far more finance than we need. Exactly how much of it we could eliminate as unnecessary is up for debate. I wouldn\u2019t be surprised if our economy would actually run better if finance was downsized by 90%\u2013that would put it somewhere near where it was in the early postwar period\u2014the so-called golden era of US capitalism.<\/p>\n

But we\u2019re not going to eliminate all excesses through legislation. We can, however, refuse to support excess and refuse to rescue the perps of excess. The warning should be explicit and it must be believable. That is hard, no question about it.<\/p>\n

Some will say that with Wall Street running our government, you\u2019ll never remove the safety net of the biggest, crookedest, riskiest banks. They might be right. But if they are, I cannot see how they will do the impossible: legislate away Wall Street\u2019s excesses.<\/p>\n

Simon Johnson, who wants to break up the biggest banks, made an interesting point when we shared a panel in Washington last year. He really believes it is not only possible to break them up, but that it will happen. Why? Because there is growing support among all the banks that are not \u201ctoo big to fail.\u201d<\/p>\n

For the most part, those smaller banks played no role in the shenanigans that led to the crisis. They increasingly recognize the huge public subsidies given to the \u201cbanksters\u201d (I use that term accurately to designate those institutions that are run as control frauds\u2014as Bill Black calls them) in the form of low interest rates plus a government backstop in the event that their bad bets go wrong.<\/p>\n

He might be right. It might be easier to break them up and shut them down than to legislate away their excesses. Heck, much of what they did is already illegal!<\/p>\n

The Role of Monetary Cranks<\/strong><\/p>\n

Yes, the rotting fish on Wall Street and in London stinks. We need downsizing. We need reform\u2014not only of the financial system that exists, but also of the crisis response that we will need when the system fails next time. You can be sure there will be a next time.<\/p>\n

This is the time for monetary cranks.<\/p>\n

No good ideas will come out of the mainstream. They never saw the crisis coming, indeed, their advice in the speculative run-up made the crash not only inevitable but much worse than it would have been. They were behind the bail-outs of Wall Street and London. Their rescue of the banksters will hasten and deepen the next crisis. Do not listen to them.<\/p>\n

We need to remember two things, however, as we assess the proposals of our cranks.<\/p>\n

First, there is no final solution.<\/strong>\u00a0There is no magic reform that will prevent another crisis. As Minsky said, \u201cstability is destabilizing.\u201d Any successful reform will lead to the recreation of instability that will lead to another crisis.<\/p>\n

Second, it is essential that the reform proposal is based on a coherent and valid theoretical framework.<\/strong><\/p>\n

One way to judge the monetary cranks that are proposing reforms is to ask: \u201cWhere were you a decade ago?\u201d Did you see \u201cit\u201d (the crisis) coming? Did you have a coherent theory which explained why a financial crisis would occur? Is your proposal consistent with that theoretical framework? What the heck is your monetary framework?<\/p>\n

(cross-posted from EconoMonitor<\/a><\/em>)<\/p>\n","protected":false},"excerpt":{"rendered":"

Horatio: \u00a0He waxes desperate with imagination. Marcellus: \u00a0Let\u2019s follow. \u2018Tis not fit thus to obey him. Horatio: \u00a0Have after. To what issue will this come? Marcellus: \u00a0Something is rotten in the state of Denmark. Horatio: \u00a0Heaven will direct it. Marcellus: \u00a0Nay, let\u2019s follow him. \u00a0Hamlet Act 1, scene 4 Marcellus is right, the Fish of […]<\/p>\n","protected":false},"author":208,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[111],"tags":[408,562,261,30,924,407],"class_list":["post-10858","post","type-post","status-publish","format-standard","hentry","category-financial-reform","tag-chicago-plan","tag-deposit-insurance","tag-finance","tag-minsky","tag-monetary-cranks","tag-narrow-banking"],"jetpack_featured_media_url":"","_links":{"self":[{"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/posts\/10858","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/users\/208"}],"replies":[{"embeddable":true,"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/comments?post=10858"}],"version-history":[{"count":3,"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/posts\/10858\/revisions"}],"predecessor-version":[{"id":10862,"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/posts\/10858\/revisions\/10862"}],"wp:attachment":[{"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/media?parent=10858"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/categories?post=10858"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/tags?post=10858"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}