Governments, Money, Economy
Comment
In order for an economy to grow, we need savings.
Wrong
Credit from banks to businesses do not depend on savings. Private banks create the credit out of thin air.
(In comparison government spending does not cause money creation, unless during “unorthodox” times like after 2008 with QE, or occasionally in small amts during normal times by the FED to nudge short term rates).
Additionally: “savings are not needed for growth” does not mean “let’s screw the savers”. Ultra-low interest rates not only created a bubble in the financial markets but also punished thrift.
[From The New Paradigm in Macroeconomics] Without fully reflecting the implications of credit creation, macroeconomic theories were doomed to misunderstand also other concepts, such as the role of savings and the determinants of growth. Most of modern economics assumes – and policy-makers cite regularly – the idea that there is a given amount of savings that poses a physical limit for the total amount of money that can be raised by firms and hence invested. In reality, savings are not limited at any moment in time. They are not a constraint on loans or investment. Occasionally economists worry about a ‘savings shortage’ or ‘capital shortage’, which they feel is holding back growth. There is no such thing. Savings do not impose a limit on economic growth. If more money is required for investment, banks can simply create it.
There
Comment
Countries need foreign direct investment to grow.
Wrong
Question
What are GDP activities, what are non-GDP activities
See Werner
New Paradigm in Macroeconomics. Non-GDP activities are construction, real-estate, mortgage bonds, financial speculation (margin loans), pure consumption. Credit should not flow to these activities. Credit to businesses (preferably small) producing services, products that others want to buy are cool.
The vast majority of money held by the public takes the form of bank deposits. But where the stock of bank deposits comes from is often misunderstood. One common misconception is that banks act simply as intermediaries, lending out the deposits that savers place with them. In this view deposits are typically ‘created’ by the saving decisions of households, and banks then ‘lend out’ those existing deposits to borrowers [..] Indeed, viewing banks simply as intermediaries ignores the fact that, in reality in the modern economy, commercial banks are the creators of deposit money. This article explains how, rather than banks lending out deposits that are placed with them, the act of lending creates deposits — the reverse of the sequence typically described in textbooks
Yes
Banks do not need deposits to lend money. They create money out of nothing and just lend it.
There are some limits of course (not in the amount they can create -that has other limits, in a bigger sense-, which gives them great power), for example they cannot create money for themselves, and simply write it as profit. They must make money from the interest they lend out. It is little weird but this is how finance system ended up to be, at least in the Western context, that is somewhere between government and commercial spheres, distributed among many actors. Some dark corners of politics is trying to crush those distributed smaller actors by ultra-low interest rates, but that is a topic for another day.
Question
So they are not trying to grow the economy through low rates but crush smaller actors?
Yes
Low rates wouldn’t cause growth anyway. This is another lie.
All of [that] leaves us to wonder: If banks do not lend their depositors’ money, why are they always scrambling to get it? Banks advertise to attract depositors, and they pay interest on the funds. What good are our deposits to the bank?
Deposits are cheap
(From the same link) Ever since the Federal Reserve Act was passed in 1913, banks have been required to clear their outgoing checks through the Fed or another clearinghouse. Banks keep reserves in reserve accounts at the Fed for this purpose, and they usually hold the minimum required reserve. When the loan of Bank A becomes a check that goes into Bank B, the Federal Reserve debits Bank A’s reserve account and credits Bank B’s. If Bank A’s account goes in the red at the end of the day, the Fed automatically treats this as an overdraft and lends the bank the money. Bank A then must clear the overdraft.
Attracting customer deposits, called “retail deposits,” is a cheap way to do it. But if the bank lacks retail deposits, it can borrow in the money markets, typically the Fed funds market where banks sell their “excess reserves” to other banks. These purchased deposits are called “wholesale deposits.”
Note that excess reserves will always be available somewhere, since the reserves that just left Bank A will have gone into some other bank. The exception is when customers withdraw cash, but that happens only rarely as compared to all the electronic money flying back and forth every day in the banking system.
Borrowing from the Fed funds market is pretty inexpensive – a mere 0.25% interest yearly for overnight loans. But it’s still more expensive than borrowing from the bank’s own depositors.
If banks can create money, then how do they become insolvent? After all surely they can just create more money to cover their losses? Or, since they simply create money out of nothing, than those loans are “non-performing (not paid back)”, why does it matter? They were created out of nothing and they became nothing.
It is still a loss
Even though the main capital may not matter, they would be losing the interest they’d be making. They could simply make new loans, but that could take a long time to come back as profit (the principal, when it is paid back, is destroyed by the way, aint that weird?). If there is a systemic crisis where most loans are non-performing, then the bank could be missing out on a lot of the profit it could be making, and its liabilities (of which deposits are one) can exceed its assets, it can go under - become insolvent.
That kind of insolvency can easily occur if banks are allowed to loan into a bubble, ppl keep coming to the bank, bank keeps creating money, useless money grows bubble, then pops. Regulation such as Glass-Steagal Act could slow such trends, but were done away by corporate Democrats.
The problem with insolvency is that if it is widespread banks will be hesitant to loan to real businesses which produce value. Credit crunch occurs, growth falters.
Question
Are my deposits in any kind of danger at a bank?
Depends on the amount
All deposits below certain value (in the 10s of thousands, but not in the millions) are insured by the government.
Question
How does the FED effect the credit market
Indirectly
If banks do not have enough deposits to meet reserve requirements, banks lend to each other everyday, the average of that rate is the famous Fed Funds rate. FED itself can lend to banks, or sell / buy treasuries to effect a rate it targets, but it cannot go against the market in obscene ways. That’s why in Werner’s analysis rate is seen to follow growth, not lead it.
Economy is lead through its credit creation. Now, commercial banks can be in an illegal collusion with eachother to nudge it in a certain direction, or be guided through the central bank in insidious ways, or government can effect banks somehow (as in Japan resulting in its infamous recession that never ends), but economy is always guided through its credit.
Question
Then can we say banks create deposits?
Yes and No
When banks create money for credit they would put that money in deposit account at their branch. But that money could go into another deposit account in another bank, and it could also leave the country to finance some plant there, etc.
But yes, since all money is credit, deposits, which are money, are also credit, hence created by banks.
Richard Werner
(From New Paradigm in Macroeconomics) The representation of banks as mere intermediaries [..] depict it as a process of successive lending of already existing purchasing power [..] Bank A receives a new deposit of USD 100. If the reserve requirement is 1%, textbooks say that the bank will lend out USD 99, and deposit USD 1 with the central bank as reserve. The USD 99 will, however, be deposited with another bank, Bank B, which will also be able to lend out 99% of that amount (USD 98.01), and keep 1% as reserve. This process continues until in the end a total of USD 9900 has been lent out [..]
While even this description does conclude that the overall banking system creates money, credit creation seems to be the result of a diffuse process, in which money ‘circulates’ in the economy (in line with the concept of ‘velocity’ in the quantity equation). Most of all, we are told that each bank can only lend 99% of the money deposited with it. This renders banks similar to fund managers who lend out savings deposited with them and thus they are considered mere financial intermediaries. Thus Bernanke’s understanding of credit creation as the (successive?) ‘channelling of savings’ to investors is not far-fetched and most economists do consider banks merely an alternative channel to capital market or other intermediation.
[A] more accurate presentation of credit creation [..] depicts the balance sheet of a bank that receives a new deposit of USD 1, recorded as a new liability of the bank. Instead of lending out USD 99, as the textbooks tell us, the bank will use the USD 100 as reserve with the central bank (entered as asset on its balance sheet). The USD 100 can now become the 1% on the basis of which the bank can lend out 99 times as much. Thus this very first bank can grant a new loan amounting to USD 9900. The moment the loan is granted, the bank simultaneously increases its assets by USD 9900 (the amount of the loan, which is an asset for the bank) and its deposits by USD 9900 – the per- son or company who receives the loan of USD 9900 will actually obtain a book entry of USD 9900 in his or her deposit account – money that can now be spent on transactions. The money the bank has created, USD 9900, is 99% of the increase in the bank balance sheet (USD 100 new deposit plus USD 9900 in loans/deposits). Thus the reserve requirement is met.
Right
Comment
If it wasn’t for the stimulus after 2008 crisis the economy would have been worse
If that’s true, why was it discontinued?
There was no new round on the stimulus during late 2009, when unemployment was still high, and economy was still sluggish. Why?
Because it didn’t work.
Question
But government spending can energize an economy
Wrong
Government spending crowds out private spending thereby reduces investment and growth.
If you simply give money for existing production, that can be inflationary. It will not induce more production, hiring.
On government spending the left needs to use the angle of social help, not growth. Policing is a social service, does not (directly) cause growth. But it helps an environment where ppl can live, produce, etc. Even direct money schemes like UBI are not helpful in growth per se. Indirectly they will help happier citizenry, which will help a better functioning economy.
Do not argue for anti-austerity during crisis in growth terms either. Crisis’ are caused when credit is fed into speculative finance. That needs to be kept apart from the real economy. If crisis happens you jail bankers, take away their money, wealth, cancel people’s debt, nationalize bankers’ assets, or tar and feather them, who cares? As long as their shit does not touch the real economy it will be fine.
Comment
The Great Depression of 30s ended when World War II started, All that government spending helped the economy to recover. Then in a sense WWII ended the Great Depression
Wrong
The end of the war ended the depression.
From link
“A common fallacy is that the Great Depression was ended by the explosive spending of World War II. But World War II actually institutionalized the sharp decline in the standard of living caused by the Depression. The Depression was actually ended, and prosperity restored, by the sharp reductions in spending, taxes and regulation at the end of World War II .[..]
Statistics showed a rise in GDP during the war. But that just reflects misdefined statistical analysis. The military guns, tanks, ships, and planes produced and counted as showing rising GDP did not reflect improved standards of living for working people, or anyone else. Yes, they did win the war, and that victory was a social good [..]. But these were not economic goods and services, and should not be counted as such.
The sale prices of goods and services sold in voluntary market transactions reflects the true value of the goods and services produced, because they reflect what consumers are willing to pay for them, and so reflect the benefit that consumers see in them. But the same voluntary market transactions where consumers are spending their own hard earned money were not involved in the government’s acquisition of the military guns, tanks, ships and planes produced during World War II. The cost of all that military materiel was simply added to GDP, as if it reflected increased production. But would not a better measure of the economic value of that military materiel, and of any coerced government transaction, be to subtract the cost of that production from GDP, rather than adding it?
Perhaps this economic reality can be seen better in other military conflicts. Did the American Civil War reflect a time of soaring economic prosperity for America, when both the South and the North were producing weapons of as much mass destruction for Americans as was feasible at the time? What about the cost of the Mexican-American War in the 1840s? Did the cost of the Vietnam War represent a net addition to, or a net subtraction from, American GDP? Or the cost of the most recent wars in Iraq and Afghanistan?
I am not a pacifist who thinks defense spending has no value. But that value cannot be measured the same as consumer or productive goods and services that do increase the standard of living for working people and their families, and are purchased through voluntary market transactions.
World War II institutionalized the falling standards of living of the Depression through wage and price controls, and extensive rationing of consumer goods and services. The economic deprivation, and reduced standards of living, continued, although people perceived it was now for a good cause.
But increased government spending does nothing to create economic recovery, growth and prosperity. That is because the money to finance that increased government spending is drained from the private sector, either through increased taxes, or increased borrowing. That entire transaction involves a net drag on the economy. Increased taxes to finance the increased spending involve counterproductive incentives that reduce production and growth. Increased government borrowing drains investment capital from productive activities in the private sector and reallocates it to non-productive government consumption.
There can never be inadequate demand for any good or service in a free market economy, which is the problem Keynesian witch doctors think they are solving. If demand for any good or service is insufficient to buy up all the available supply, the price for the good or service will decline, increasing demand and reducing supply, until they are equal.
This was all further demonstrated by the end of World War II. As George Gilder explains [..] “After World War II, when ten million demobilized servicemen returned to an economy that had to be converted from a garrison state to civilian needs, economists steeled themselves for a renewed depression. A sweeping Republican victory in the Congressional election of 1946, however, brought an end to the wartime government-planning regime [..] “Every Keynesian economist confidently predicted doom. [..] Gilder, however, explained what actually happened, “But a drop in government spending after a war does not depress creativity; it unleashes it. [..] Economic growth surged by 10 percent over two years and the civilian labor force expanded by seven million workers….[..]”
Eisenhower
Every gun that is made, every warship launched, every rocket fired, signifies in the final sense a theft from those who hunger and are not fed, those who are cold and are not clothed.
Exactly
[In the depths of the great depression] the Government should have people dig up holes and then fill them up.
Not a GDP Activity
Economic activity, as measured in GDP, captures producing something that people want to buy.
Someone digging a hole and filling it up is not a service, a product anyone wants. We might as well give everyone free money, which is fine, but we need to realize this is social help, not economic activity.
Comment
We printed money to pay for the extra US military spending in the 2017 budget.
No we did not
US paid for that with debt. It issued bonds, a debt obligation sucking up existing money from the system. It did not create new money. Let’s be careful while speaking on money creation. It is one of the basic tenets of the economy. All variables like growth, inflation depend on it.
Question
MMT says we print money until we see inflationary effects, then we balance it with taxing
Well..
If you can balance it with taxing, why not spend, issue bank credit to private enterprise (the only driver of growth) responsibly, and tax appropiately from get-to? Why go into all this roundabout way of excessive printing, then taxing?
Essentially what we definitely do not want is marrying money printing to the budgetary Congressional sausage making process. If money creation is tied to that shit, it will be a disaster. Look at Zimbabwe, Argentina, Turkey.
Also, let’s not take the special case of US with its reserve currency, and create an entire system out of it. US dollar, because of the petrodollar system, is always on demand. That’s why excessive printing, when it was done by the central bank, or through shadow banking, etc never caused excessive inflation. The rest of the world takes all that money and it does not return to US. But one cannot rely on this scheme to go on forever. Surely we cannot build a “new” system on top of that assumption.
I put “new” in quotes because MMT is not new. It is governments printing currency - see Zimbabwe, Venezuella (yes their government is truly a piece of crap, neocons not liking a country does not automatically imbue them with righteousness).
MMT is also used as a psychological tool by some on the left, trying not to ruffle too many feathers with new spending saying “no need for new taxes, we’ll just print money”. There is no need to go to this roundabout way just to feel good about stuff. There is enough existing money for free college, Medicare-for-all. Hell M4A will make healthcare even cheaper than it is now!
Question
Bill Clinton balanced the budget 1998-2001, did that help the economy?
Yes
He did it for the wrong reasons, they scared him with “the bond market”, and other financial voodoo he didn’t really understand, but yes, balanced budget was the right thing to do.
Comment
We don’t need to worry about government deficits we print our own money
No we don’t
FED does not monetize all Treasury debt (printing money and giving it to gov). This line of thinking comes from MMT, they supposedly discovered something in government payments, but what they thought they “found” is a timing quirk, between the supposed money creation and payment. But at the end of the day, for that year, there is balance in the budget, MMT folks know this. They asked Stephanie Kelton the other day “if we print our money why issue bonds?”. She said “we don’t have to, we are simply giving someone interest for holding our debt”. So gov deficit is financed with bonds – right now. Then MMT makes it sound like “wout bonds, you’d miss on the interest, that’s all”. But it is more than that. Bond issuence pulls money from economy so it is not inflationary. MMT money printing would be inflationary.
What happens today: yes, FED prints money and buys / or sells gov bonds sometimes, to nudge money base in either direction. Keyword - sometimes. Nowadays most money creation comes from private banks. And the current system (with proper controls) ain’t that bad. If small banks are protected, given more incentive to lend for public use, it would work even better.
We also know government spending crowds out private spending => we don’t want gov spending excessively => balanced budget.
Question
But austerity during crisis hurts the economy
Apples and Oranges
For 2008 conditions you say, “cutting public spending to cover up / save Ponzi activity is senseless”. The real economy and Ponzi economy are different, and should be kept away from each other (ideally credit for speculative aims are cut off, the fake economy does not exists, boom and bust never happens, at least in the size it does today as to hurt the real economy).
I see economists (!) making the mistake of making anti-austerity arguments on real economics grounds -aw but someone need to spend during crisis maan-. No. Credit flow needs to be restored during crisis and u do whatever it takes for that (write-off debt, nationalize, watch some bankers go bust). Gov does everything to keep that shit away from the real economy. That is the main variable to fix. Don’t go off in the boonies trying to justify emergency measures on lukewarm economics grounds.
Then, in the normal economy where ppl engage in GDP producing activities, pay tax, etc, no deficit spending. No MMT. There is enough money to pay free-college, Medicare-for-all.
We designed government to always work with existing money, take in through tax, finance deficits with bonds. If gov has printing ability, it will get out of hand, fast.
Question
The well-known policy conclusion of Keynes’ analysis of the 1930s depression was that in recessions, when private demand is weak, government demand needed to step in and boost aggregate demand until the economy was back at full employment. But some say this increased government spending “crowd out” private investment, meaning gov spending simply replaces private one and overall investment does not change. Is this true?
Yes
From New Paradigm in Macroeconomics, “In other words, given the amount of credit creation produced by the banking system, an autonomous increase in government expenditure g must result in an equal reduction in private demand. As the government issues bonds to fund increased fiscal stimulation, private sector investors (such as life insurance companies) that purchase the bonds must withdraw purchasing power elsewhere from the economy. With an unchanged national income pie (whose growth is restricted by [increase in credit going to productive enterprise] , the total amount of new purchasing power created – the overarching budget constraint on the economy), any increases in government spending must shrink the private sector share of the pie. The same applies (more visibly) to tax-financed government spending. With unchanged credit creation, every dollar in additional government spending reduces private sector activity by one dollar”.
The derivation and empirical test is here -Code,Data. The coefficient has to be -1 for verification, ours is around -0.57, could be due to data collection issues. Werner finds -1 for Japan.
Question
What are types of credit given for speculation? If gov wanted to stop this where would it start?
Here
From link
Margin loans (credit for financial speculation)
Loans to non-bank financial institutions
Credit for real estate speculation:
to construction companies
Mortgages, buy-to-let mortgages
real estate investment funds, other financial investors
Loans to structured investment vehicles
Loans to Hedge Funds
Loans for M&A
Loans to Private Equity Funds
Direct financial investments by banks
BTW, ultra-low interest rates, on top not being able to cause growth, can also adversely effect (read: increase) M&A - big actors gobbling up the small.
Also see the formula ΔP_f , how it was setup, very clean - Granger causality is from C_f to P_f.
Question
Do tax cuts cause growth?
No
Tax cuts that blow up the deficits will cause crowd-out effects, reducing growth.
This is the natural result of the way we setup government spending - we chose to make govs to always work with existing money, either by collecting money ppl already earned (tax), or when in deficit financing it through bond issuance which also takes existing money (in promise for repayment for later date). The choice was made, apparently, for govs not to fiddle with money creation (they do it through backdoor sometimes but still), keeping that away from politicians. I can see how this came to be.
“We had a lot of problems that happened in 70s, under Nixon and Ford. But those problems started in the 60s, the great society, the war on poverty, going to the moon. It was Lyndon Johnson’s ‘guns and butter’, it was all the money we printed in the 60s that gave us the inflation in the 70s”.
Schlefer, The Assumptions Economists Make
“Johnson’s policies of spending on ‘guns and butter’-Great Society social welfare programs and the Vietnam War - were seen as causing inflation to increase (as, in fact, Keynesian economists warned). And the 1970s saw rising inflation and inflationary fears. Monetarists, led by Milton Friedman, argued that government efforts to manage the economy often did more harm than good, and in particular they blamed the Federal Reserve for printing too much money. Their claim is debatable”.
The disagreement between two economy experts on such a basic concept is disconcerting.. And neither are quite right. Let’s check. By “printing money” it is usually meant expansion of monetary base, we use M2 measure for that. We also get data for non-finance credit expansion,
# Fred - 'M2SL','GDP','CRDQUSAPABIS','FPCPITOTLZGUSA','FEDFUNDS'
df['irate'] = df.irate / 100.0
df['inflation'] = df.inflation / 100.0
df = df.dropna(axis=0)
df = df.set_index('DATE')
w = 3
df['dcredit'] = pd.rolling_mean(df['nonfincred'].pct_change(),window=w)
df['dm'] = pd.rolling_mean(df['m2cd'].pct_change(),window=w)
df['dgdp'] = pd.rolling_mean(df['gdp'].pct_change(),window=w)
df[['dcredit','inflation','dm','irate','dgdp']].plot()
Increase in credit meaning money, more then necessary for GDP producing activities can easily explain this inflation. Then a sharp drop in credit creation in the beginning of 80s (Reagan years) helps contain inflation, they slammed on the brakes again during Bush I. There is also a period during mid-80s when M2 goes down credit goes up, it is the latter that effects inflation. Then there is the huge drop post 2008 of course due to subprime debt crisis.
Werner’s theory is very simple. Give credit for growth, any more than growth capacity is inflation. Do not give bank credit to speculative activities, or for pure consumption. If we print money (what banks do when they give credit) for speculation the result is Ponzi activity, everyone loses.