Money. Doing it Right this Time.

[Conspirator]

By keeping a lid on the private sector you mean don't allow the banks to excessively take advantage of their privileges, such as money creation?

 

[Cutlass]

I mean like don't let them do stupid stuff like make loans with no collateral.

 

[Conspirator]

Your idea of a better money system has been addressed in other places. It is nonsensical. It improves nothing while making many matters worse. Inflation would be far worse. Bubbles would be worse. Instability would be worse.

The system we have, while flawed, as a whole works. All that is really necessary in this system is for the government to keep a lid on the private sector. They stopped doing that in the 00s, and you see the result. In your system the government has to micromanage everything. And they have immense incentive to get it wrong.

To be honest man I don't think you're right, why would inflation be worse, bubbles, etc.?

 

[Cutlass]

Because you eliminate any controls on the money and make it a purely political function.

 

[Leoreth]

Can you explain the following to me?

Central banks lend money to private banks at low interest. These banks then lend this money to states at high interest rates, turning in a profit for what is essentially moving money from one part of government to another. Where's the value in this?

Several leftist parties are demanding to allow central banks to lend money directly to governments. I'm pretty sure that turned up on Hollande's platform, and didn't even the Sarkozy government have plans that amounted to this at some point? Aside from the fact that the independence of the central bank is important and it should not base its decisions on the government's need for cheap loans, I haven't been able to come up with a good argument against it.

Am I missing something?

 

[Monsterzuma]

Central banks lend money to private banks at low interest. These banks then lend this money to states at high interest rates, turning in a profit for what is essentially moving money from one part of government to another. Where's the value in this?

it means that any losses due to defaults are absorbed by private capital rather than public funds. the central bank is not supposed to be in the business of judging the appropriate level of risk when making investments. that is what private banks are for. the spread (difference in interest rates) between the rate at which the central bank provides funds and the states can borrow them is roughly equivalent to the risk premium, i.e. the extra charge to account for the possibility that a default will occur. the central bank wants to be 100% risk free if possible, so it provides cheap funds only to very safe institutions.

Several leftist parties are demanding to allow central banks to lend money directly to governments. I'm pretty sure that turned up on Hollande's platform, and didn't even the Sarkozy government have plans that amounted to this at some point? Aside from the fact that the independence of the central bank is important and it should not base its decisions on the government's need for cheap loans, I haven't been able to come up with a good argument against it.

the problem is that when the situation gets seriously out of control, there will be a temptation for the central bank to start monetizing (i.e. "inflating away") government debt rather than letting governments default. when private banks are the ones taking the risks, the central bank can more or less "safely" let the governments fail (usually meaning their creditors go unpaid or partly so). this puts governments under additional discipline. without discipline like that, there is no limit to how much governments are incentivized to spend.

that's more or less the theory. the reason why it's being criticized is of course that the private banking system is under so much stress that it is becoming a source of instability of it's own, meaning that any losses on their part are collectivized anyway. but there are also some that (underhandedly?) advocate it because they think monetization is less harmful than default (which is a slippery slope thing that tends to spiral out of control, imo).

 

[wolfigor]

it means that any losses due to defaults are absorbed by private capital rather than public funds. the central bank is not supposed to be in the business of judging the appropriate level of risk when making investments. that is what private banks are for. the spread (difference in interest rates) between the rate at which the central bank provides funds and the states can borrow them is roughly equivalent to the risk premium, i.e. the extra charge to account for the possibility that a default will occur. the central bank wants to be 100% risk free if possible, so it provides cheap funds only to very safe institutions.

What would happen if the state (or central bank) mandates a strict ceiling on the spread that commercial banks can apply (possibly different levels depending on the type of lending)?

In my experience in UK in 2000-2006 banks were having a very risky policy about credit cards debt.
It wasn't uncommon to see some credit cards charging up to 26% of interest on the debt (16% was more common).
People in the sector told me that they usually expect half of the debt to don't be repaid that's why they had such obscene interest on credit cards (the few who paid back were supposed to cover for the many defaults).

If there was a strict ceiling on the spread then banks would be forced to check much better the credit they were giving out.

In the same way I saw banks giving mortgage for 120% of the house value (assuming that the property value would always go up).

 

[Monsterzuma]

What would happen if the state (or central bank) mandates a strict ceiling on the spread that commercial banks can apply (possibly different levels depending on the type of lending)?

my guess is it would leave a lot of bonds unsold at a certain point, meaning the governments would be forced to default. either that or the lending would take place on a black market.

another effect might be that governments make use of the relatively cheap funding to spend even further beyond their means, if i'm wrong and the funding does come available.

 

[Terxpahseyton]

@Leoreth
If you stop private banks from lending money to the government, you basically destroy the private life insurance and pension insurance market. Remember what is mandated where those insurances are supposed to go to be secure: public debt.
In other words, the interests the state pays for loans has become a hidden way the state enables people to save for their retirement making use of the private market.
Does this actually make sense? I don't see how. But that's the situation we are in...

it means that any losses due to defaults are absorbed by private capital rather than public funds.

That is the theory. A theory which right now is not a reflection of reality if you look at all the panic over a Greek default and the fear of domino effects for the banking sector. If the interests the private bank get for their function actually served their purpose, Greece could just default and do a fresh start.

 

[Cutlass]

The problem is that there developed a differential between the theory and the reality. In theory the banks should have controlled for the risk of the borrowers, but in practice they did not because they believed that either the risk wasn't there, or that the risk was on someone else, and not on them. When banks cease to control for the risks of the loans they make, then you can get credit greatly in excess of what should be loaned.

In the US, the Federal Reserve buys and holds US Treasury bonds. This is the same as lending directly to the government. But it is part of their tools for the overall control of the money supply and interest rates. The European Central Bank is much more inflation averse than the Fed. It is their operating principle by statute. If the ECB was just lending money to any government as needed, then they risk losing control of inflation, which is by law their primary responsibility. That policy is the core mistake in the creation of the ECB, and results as now in that the ECB cannot do it's real job of protecting the economy because it is constrained to prevent inflation at all costs. And so the ECB fiddles as the Eurozone burns.



@ wolfigor, with interest rate ceilings, as you get to the point where the spread between inflation and the nominal interest rates squeezes tighter than the banks feel they can make a profit at, lending just seizes up. Banks will refuse to make the loans.

 

[Monsterzuma]

That is the theory. A theory which right now is not a reflection of reality if you look at all the panic over a Greek default and the fear of domino effects for the banking sector. If the interests the private bank get for their function actually served their purpose, Greece could just default and do a fresh start.

yeah i mentioned that caveat in my first post on this topic. basically when option of bank bailouts is put on the table the rules of the economic game change completely. that can be a reason to just cut to the chase and drop any pretense of individual responsibility where issues of credit extension are concerned, i.e. by making the central bank act like an activist institution. but changes on that scale are politically difficult to bring about, not to mention hard to predict the effects of.

 

[wolfigor]

@ wolfigor, with interest rate ceilings, as you get to the point where the spread between inflation and the nominal interest rates squeezes tighter than the banks feel they can make a profit at, lending just seizes up. Banks will refuse to make the loans.

Yes, I agree on this point; a ceiling would be detrimental for borrowing to companies for productive investments.

Would be the same for private debt (like credit cards)?
My question came from by the fact that banks were overly aggressive on credit card loans and private house mortgages and failed to asses the risk properly (or didn't concern too much for the long term capability to repay debt).

 

[innonimatu]

it means that any losses due to defaults are absorbed by private capital rather than public funds. the central bank is not supposed to be in the business of judging the appropriate level of risk when making investments. that is what private banks are for. the spread (difference in interest rates) between the rate at which the central bank provides funds and the states can borrow them is roughly equivalent to the risk premium, i.e. the extra charge to account for the possibility that a default will occur. the central bank wants to be 100% risk free if possible, so it provides cheap funds only to very safe institutions.

This is a plainly ridiculous excuse. On at least two levels.
First: If a central bank assesses that lending to its own state is too risky, how come it lends to private banks that it knows will lend the money to the very same state? And the central bank indeed knows that, because it's taking as collateral from those private banks state bonds. The risk associated with these private banks cannot be inferior.

the problem is that when the situation gets seriously out of control, there will be a temptation for the central bank to start monetizing (i.e. "inflating away") government debt rather than letting governments default. when private banks are the ones taking the risks, the central bank can more or less "safely" let the governments fail (usually meaning their creditors go unpaid or partly so). this puts governments under additional discipline. without discipline like that, there is no limit to how much governments are incentivized to spend.

Second: how can lending to the very state which backs the central bank be "too risky"? If the state goes bankrupt, then so will all of its organizations, central bank included. Lending may be risky, but not lending is guaranteed self-defeating.

that's more or less the theory. the reason why it's being criticized is of course that the private banking system is under so much stress that it is becoming a source of instability of it's own, meaning that any losses on their part are collectivized anyway. but there are also some that (underhandedly?) advocate it because they think monetization is less harmful than default (which is a slippery slope thing that tends to spiral out of control, imo).

The reason this theory is being criticized is because it is a shameless, ridiculous self-serving lie promoted by the private banks.

 

[Cutlass]

Yes, I agree on this point; a ceiling would be detrimental for borrowing to companies for productive investments.

Would be the same for private debt (like credit cards)?
My question came from by the fact that banks were overly aggressive on credit card loans and private house mortgages and failed to asses the risk properly (or didn't concern too much for the long term capability to repay debt).

My belief is that credit card rates should be capped. Probably at no more than 12%. Card companies charge the high rates in part because they can, and in part because they cover the costs of those that don't pay. And, quite frankly, if people can't or don't pay, they should not have a credit card. We would do a lot of good for everyone in the long run simply by placing regulations that significantly reduced credit card issues.

 

[Monsterzuma]

If a central bank assesses that lending to its own state is too risky, how come it lends to private banks that it knows will lend the money to the very same state?

Those private banks have capital reserves that they can draw on to absorb losses due to default events.

And the central bank indeed knows that, because it's taking as collateral from those private banks state bonds. The risk associated with these private banks cannot be inferior.

The collateral is just there in the event the bank can't repay the loan, which they can if they have adequate capital reserves.

Second: how can lending to the very state which backs the central bank be "too risky"? If the state goes bankrupt, then so will all of its organizations, central bank included. Lending may be risky, but not lending is guaranteed self-defeating.

Hardly. It just involves a debt restructuring most of the time, often coupled with asset sales. It's painful but not exactly the end of the world. Just a concession of national sovereignty to compensate for past failures to contain spending. A destruction of the currency on the other hand brings about hell on earth.

The reason this theory is being criticized is because it is a shameless, ridiculous self-serving lie promoted by the private banks.

Those banks would have no trouble whatsoever finding a way too profit from the rampant hyperinflationary tailspin situation you would put in this one's place.

 

[Monsterzuma]

I'm wondering if I understand the European situation correctly if I describe it like this:

From what I understand from the "sumner critique", austerity works by suppressing demand so that it can be counteracted by expansionary monetary policy. Since the demand that is reduced this way subtracts from public sector expenditure and the demand that is newly generated adds to private sector expenditure, the ratio between public and private expenses shifts in favor of the private sector, which is positive from various supply side considerations. It also means government default risks are reduced, leading to increased business confidence.

Now a potential source of problems is the fact that the negative effects of austerity are conferred on local areas that engage in austerity, whereas the positive effects of monetary expansion are conferred on the whole currency area. This creates the potential for a beggar-thy-neighbor strategy where one local area refuses to engage in austerity along with the rest of the countries in the currency block, but nevertheless benefits from the monetary expansion engendered by the other areas' austerity policies.

Can this be seen as a reason for Germany's relative success compared to the rest of Europe? I do remember correctly that Germany has cut back on government spending less than most other areas?

 

[Monsterzuma]

Here's another attempt at understanding the rise of gold + relatively tame TIPS spread:

Most analysts that I listen to that I think have the right idea about things explain worst case scenarios in terms of what Eric Janszen calls "Ka-Poom theory". According this theory, negative shocks to an economy at first produce asset-deflationary effects ("ka"), possibly multiple ones in close or remote succession, but as the solvency of the most safe institutions in the economy gets threatened more and more, the situation edges closer and closer to a breakdown even that has the effect of very high inflation ("poom"; not necessarily hyper-inflation; WW2 is an example of this).

The "poom" event here is a tail end event: it is the absolute worst case scenario. The important thing to realize is that during the boom years of the 1990s, this kind of event was on almost no one's radar screen, so it's estimated probability must have been extremely low. Even at this extremely low probability, the price of gold was around 200-300$ an ounce. What we're basically seeing happening is that this expected probability is gradually being magnified, and the price of gold reflects this. The take home message is that even at many multiples of the expected probability of a poom-event in 90s, the probability could still be extremely low. Another message, however, is that if ever a poom event DOES occur, the price of gold will not just rise by a little bit, but absolutely skyrocket.

Thoughts? Criticisms?

 

[JerichoHill]

My belief is that credit card rates should be capped. Probably at no more than 12%. Card companies charge the high rates in part because they can, and in part because they cover the costs of those that don't pay. And, quite frankly, if people can't or don't pay, they should not have a credit card. We would do a lot of good for everyone in the long run simply by placing regulations that significantly reduced credit card issues.

The problem with capping is that then you incentive card companies to pursue revenue by charging higher fees elsewhere. There is a notion that access to funds is a good thing, which by restricting access to those at the lower income levels you may wind up doing more harm.

Look at the debate surrounding prepaid cards right now due to Frank-Dodd. (I can speak about the general nature of costs of providing credit to various groups, but given my current work revolves around changes stemming from Frank Dodd I can't comment further on specific programs (unless I am not actively writing papers on them))

 

[Cutlass]

Interesting way to frame it. But I don't see how it changes much of anything. You are still talking about a flight to safety among a subset of the population. Given great uncertainty, gold seems solid. Given less uncertainty, gold doesn't seem to have a great ROI. With bounded rationality, irrational actions, animal spirits, and just the unpredictability of the future factored in, gold seems a certainty the more uncertainty that people see in the world.

I don't claim to know a great deal about personal investing. So I may not be the one to describe this the best.

 

[Cutlass]

The problem with capping is that then you incentive card companies to pursue revenue by charging higher fees elsewhere. There is a notion that access to funds is a good thing, which by restricting access to those at the lower income levels you may wind up doing more harm.

Look at the debate surrounding prepaid cards right now due to Frank-Dodd. (I can speak about the general nature of costs of providing credit to various groups, but given my current work revolves around changes stemming from Frank Dodd I can't comment further on specific programs (unless I am not actively writing papers on them))

I am aware that there are other problems. As I am aware that companies resort to a myriad of fees to raise revenues other than the conventional method. It is a complicated situation. I would ban such activities because they reduce transparency. Now I know that none of this would result in the perfect system. I'm not looking for perfect, nor do I have any expectation that perfect can be found. Nor am I doing a policy prescription level of analysis. I'm just trying to ballpark a reasonable layman's understanding of the issues.

Now I know that low income people do need access to funds. But I'm very concerned that too many people who quite frankly should not have access to that level of credit are causing distortions to the system that cause at least as much other problems. I am concerned that the credit being offered is too predatory. And I'm concerned that many people lack the sophistication to handle that credit responsibly.


Welcome back, btw. If you have the time and inclinations, maybe you could share a few other thoughts on the issues we've been discussing. I don't have the depth in all the areas under discussion, and Integral hasn't got the time. Whomp hasn't often been around either.