Money. Doing it Right this Time.

[JerichoHill]

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.

Well, by banning such fees you would incentive lower income folks either heading to payday lenders (or the like) or to the shadow banking sector. Neither of those appear to be good options. This is particularly problematic for those individuals who do not have a banking account. Where does your paycheck go? How do you keep track of funds? We do not want to push these folks to even less desirable alternatives.

The operative framework should be easily discloseable fees and transparency. I think there's an opportunity for gov't involvement here. Just like we have a credit score, have a card score, so on every application a customer sees that this card is a 45, and can compare that to a 55. Such a system would make it easy for even non-sophisticated users to understand costs of a product.

Keep in mind the cost of financial services is not free, particularly when the business involves labor and land costs (bank branches?).

 

[Cutlass]

Yes, those are problems I'm aware of as well. And I'm not saying I have complete answers that fit all situations. The answers, to the extent that I have some, are looking towards a simplification of the system, even when that is less than optimal in all cases. I don't see the growth of complexity has really been beneficial for most people. Just as I don't see how allowing predatory practices like payday lenders and tax return lenders are any better than loansharks. Does this lend to easy or perfect solutions? No. But I do think that any improvement lies in that direction.

 

[innonimatu]

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

Capital is absolutely dwarfed by the loans on their balance sheet. If it wasn't no bank would have had the trouble they're in now. Present facts show this in an absolutely irrefutable way.

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

We already established that capital can be dismissed. Present facts have shown that, and I don't think I need bother linking to all the stories about banks receiving capital from states to avoid bankruptcy.
As for the collateral, you don't contest my point: that the collateral they're using are state bonds. Making them parasitical middlemen.

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.

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.

How can I shatter your illusions? And is it worth the trouble? I don't think so, you've already chosen what you wish to believe...

But try this: look for historical precedents, up to now, of stats clinging to the fiction of "central bank independence" and states controlling their own central banks directly. In the developed world you have exactly one case of hyperinflation not directly following war or independence and new government, which is that of the Weimar Republic. And guess what: it was not due to state "printing" of money to balance its internal spending. It was due to the external balance of payments problem they had, in an exceptional situation where they could not default on external debt because of the military pressure they were under. "Concession of national sovereignty" was what caused hyperinflation, it's never a solution to it!

Banks can exist with little trouble with a state-controlled central bank. Most central banks were and are directly state controlled, the EU (and the US to a lesser extent) is an aberration. Even the UK in Europe has no qualms about using its central bank as a state policy tool to carry out what they call "quantitative easing" - find me the hyperinflation in the UK!
What banks cannot do easily with a central bank tightly controlled by the state is pay arbitrage for high profits as parasites taking cheap loans from the central bank and lending back at high interest to the state or to private clients. Which also explains why the UK's state debt is not paying high rates whereas that of less indebted countries locked into the continental bankers' euro fiefdom is...

 

[Monsterzuma]

Inno, I've already expressed the caveat that the rules change when banks burn through their capital on a system wide scale. This addresses any and all of the points you raise in your latest post. No need to preach to the choir.

 

[innonimatu]

The banks are always under-capitalized when they meet a crisis, capital requirements are and have always been ridiculously low. That's what makes finance so profitable. Otherwise it'd be a public service and it'd have to be public-run or mutualist or whatever, because private interests would not get into it. The crisis are cyclical, as they have repeatedly lent recklessly in advance of building reserves. It's a matter of when, not if. It's built into the nature of private finance to abuse whenever possible, and public regulation always eventually gets corrupted or incompetent enough to allow them to do it.

So I ask again: what is the difference between trusting the state to be a responsible borrower/lender, or trusting the state to be a responsible overseer of borrowers/lenders?

The difference is that when the state has the role of borrower/lender, it gets the profits as well as the losses. It has most, if not all, the tools at its disposal to fix inbalances when they become evident.
But when the state is only the "regulator" the profits are private and privately held, and the losses end up having to be covered by the state... with what? The problem takes a long time to be fixed, because the state must somehow track down those private gains and tax the hell out of them to fix the mess, or coordinate a default.
The fix is the same: the state must oversee a transfer of wealth on the opposite direction to fix the problem, there is no other way to fix it. But the political difficulty of doing it wit private finance in the game is much greater.

Money and finance are in fact extremely simple things by themselves. All the apparent technical difficulty has been introduced in order to obfuscate the simple fact that it is simply a wealth transfer game between different players. The political difficulty of managing that game, that is complicated... but the political expedient of "leaving it up to the markets" is one of the worse ways to try to do it.

 

[Conspirator]

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

On the contrary there would be greater control of money and of course it wouldn't make it a purely political function. It's money man. If anything it would make it less of a political function.

innonimatu, you have my support. Our current system is madness.

 

[Ayatollah So]

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

I prefer to start with the expected-rate-of-return theory in a Hotelling model of an exhaustible resource, explained here by Krugman. Basically it assumes that "the last bit of gold" will eventually command a certain real price, and speculators will bid the current price up or down such that the real price follows an exponential curve determined by real interest rates. When real interest rates go down, the price of the resource rises, because its price-as-a-function-of-time path must meet the same ultimate fate, but now rising more slowly. Yeah yeah, that oversimplifies a lot, but the oversimplifications don't totally undermine the point that low real interest rates can cause high gold prices via this mechanism.

 

[Monsterzuma]

Cool. That is actually pretty close to what I was getting at in my first attempt at explaining the issue.

 

[Conspirator]

Hi guys, if anyone can watch the BBC iPlayer I really recommend watching this documentary, which talks about the subject of money, debt and the problems of continuous exponential growth. There are some really interesting points brought up by professors, ecologists, economists and government officials from all over the world. There is also an economic historian on there talking about past civilizations defaulting on debts, and the problems in the past with money accumulation. Really, really interesting guys.

http://www.bbc.co.uk/iplayer/episode/b01jrlsf/Surviving_Progress/

The documentary is called 'Surviving Progress' and if you are not able to watch the iPlayer due to your location I am sure you can find the program on as a torrent.

synopsis:

Documentary telling the double-edged story of the grave risks we pose to our own survival in the name of progress. With rich imagery the film connects financial collapse, growing inequality and global oligarchy with the sustainability of mankind itself. The film explores how we are repeatedly destroyed by 'progress traps' - alluring technologies which serve immediate need but rob us of our long term future. Featuring contributions from those at the forefront of evolutionary thinking such as Stephen Hawking and economic historian Michael Hudson. With Martin Scorsese as executive producer, the film leaves us with a challenge - to prove that civilisation and survival is not the biggest progress trap of them all.

 

[Monsterzuma]

Just something I'd like to throw out here that ties in with my views on endogenous money. It's intuitively obvious to a lot of people that elevated debt levels (private and public) somehow slow down an economy. Most of the time, though, people don't make the next inferential step: a slowed down economy has a relatively suppressed CPI, which leads to increased monetary easing, i.e. a decrease of the interest rate, on the part of the central bank. As a result, the increase in debt, in as far as it slows down the economy, is self funding. To the extent it raises interest rates by sopping up savings, it lowers interest rates by a commensurate amount by inducing monetary easing.

And that's how aggregate debt levels in an economy can increase by many, many multiples of itself while interest rates fall rather than rise, like they have in OECD economies in the last 40 years.

I don't want to imply that this makes the debt buildup unproblematic or perpetually sustainable, though. As the interest rates fall, there is probably a rise in carry trading from the economy in question to economies without suppressed interest rates. So as this dynamic is driven to a further and further extreme, sooner or later, the economy gets drained dry by capital flight.

 

[Monsterzuma]

I'm trying to understand this text:

The rates are United States breakeven inflation rates. They are calculated by subtracting the real yield of the inflation linked maturity curve from the yield of the closest nominal Treasury maturity. The result is the implied inflation rate for the term of the stated maturity.

http://www.bloomberg.com/quote/USGGBE01:IND

What is the "inflation linked maturity curve"? I used speculate this was somehow based on the yields of TIPS sold on the secondary market (i.e. a 5 year TIPS sold 4 years after issuance is in effect a 1 year TIPS?), was I at all right about that, or is this based on a completely different principle?

 

[Cutlass]

I'm trying to understand this text:



http://www.bloomberg.com/quote/USGGBE01:IND

What is the "inflation linked maturity curve"? I used speculate this was somehow based on the yields of TIPS sold on the secondary market (i.e. a 5 year TIPS sold 4 years after issuance is in effect a 1 year TIPS?), was I at all right about that, or is this based on a completely different principle?

I don't know. I think you need some one that follows investing more than I do to explain that one.

 

[Cutlass]

Just something I'd like to throw out here that ties in with my views on endogenous money. It's intuitively obvious to a lot of people that elevated debt levels (private and public) somehow slow down an economy. Most of the time, though, people don't make the next inferential step: a slowed down economy has a relatively suppressed CPI, which leads to increased monetary easing, i.e. a decrease of the interest rate, on the part of the central bank. As a result, the increase in debt, in as far as it slows down the economy, is self funding. To the extent it raises interest rates by sopping up savings, it lowers interest rates by a commensurate amount by inducing monetary easing.

And that's how aggregate debt levels in an economy can increase by many, many multiples of itself while interest rates fall rather than rise, like they have in OECD economies in the last 40 years.

I don't want to imply that this makes the debt buildup unproblematic or perpetually sustainable, though. As the interest rates fall, there is probably a rise in carry trading from the economy in question to economies without suppressed interest rates. So as this dynamic is driven to a further and further extreme, sooner or later, the economy gets drained dry by capital flight.

I'm not really sure how to articulate these points. So bear with me a bit. There is a distinction that I feel should be made concerning types of debt. And the reason the distinction should be made is because the affects of each is very different. Investment debt, whether it is business investment, public investments, infrastructure, even household debt such as education and homes, these have a positive payoff as a whole. Any specific one may fail to pay off, but as a whole they do. They generate the creation of new wealth sufficient to pay off the debt and make a profit beyond that. So when you are concerned that all debt ends badly, it doesn't. It really doesn't. It makes no difference how high investment debt is, because it will pay for itself in greater wealth creation within the economy. Forget the effects on the money supply. They are of no relevance to this. If the money supply has to expand to accommodate this, so be it. Let it expand. There is no downside.

Now the flip side of this is non-investment debt. And here I agree that we are facing a very severe problem. Non-investment debt does not generate the creation of new wealth, and so does not pay for itself. What we have seen since ~1980 in the US is that the the amounts of investment debt are not rising to keep up with the growing economy. But rather the debt expansion has been in non-investment debt. It is not just a problem that Reagan switched government policy to near endless debt, but rather the core of the problem is that he switched government debt from investments to consumption. Supply Side economics fails to pay for itself because the added debt is consumed rather than invested.

Now consider the chart you posted in the other thread:

You see an explosion of government debt. And we have already discussed that. But you also see an even bigger explosion of private debt. And that private debt is mostly not business investment. Much of it is the explosion in the costs of education. But also the explosion in the costs of housing. But even worse, the explosion in consumption oriented consumer debt.

This consumption debt does not pay for itself. And so if the economy fails to grow fast enough, or if it gets too high, then it must be defaulted on.

Even worse is debt for speculative reasons. Nothing backs this at all. It's just gambling. And when a gambler loses, then they have to default. So anyone stupid enough to lend to the gambler is saddled with the gambler's losses. And that destabilizes the system.

 

[Monsterzuma]

I see what you're getting at and I agree that private debt is the main focus in all this, because it is much larger in volume that public debt. I would invite you to read this excerpt from the work of Hyman Minksy, who in it divides debt into three categories:

Hedge Finance: debt that is taken on with the capability to repay both principal and interest from the cash flow of the operations concerned.

Speculative Finance: debt that is taken on with the capability to pay the interest from the cash flow of the operations concerned, but not principal, meaning that the assets bought with the debt either need to be sold at the end of the term, or the debt needs to be refinanced.

Ponzi Finance: debt that is taken on without the capability to pay either interest or principal from the cash flow of the operations concerned, meaning that increasing amounts of debt need to be taken on to keep the operations going. This is usually done to profit from rising asset prices.

What uniquely characterizes the third of these is it's complete lack of economic productivity: any debts taken on for these purposes can necessarily not lead to lasting a rise in GDP. As a result, it creates an lingering overhang of debt in the economy, meaning that the ratio between debt and GDP is elevated by it for as long as the debts are not defaulted on.

When you see the ratio between debt and GDP rise to the extent it has in many OECD nations in the last 40 years, there is a strong indication that a lot of the third form of financing has been happening.

Under mainstream "neoclassical" theory, this principle is not often paid attention to for two reasons:
- it defies rational expectations; perfectly rational agents (in the sense of having prophetic foresight) don't bet on asset bubbles that collapse at a later point; somebody is always losing his/her shirt in these bubbles
- lending activity is not viewed as demand generating, but demand displacing, so the taking on of debt can not boost aggregate demand so as to create a rise in asset prices the way ponzi-financing does in Minsky's narrative

 

[Monsterzuma]

I was discussing NGDP targeting with a friend today and we had trouble understanding the following thing:

- as it is right now, monetary policy injects liquidity into the market by buying US treasuries
- if the Fed wants to engage in countercyclical inflation creation, this means they have to buy US treasuries during an economic slump. Treasuries tend to be high priced during economic slowdowns
- after the slowdown is over, the Fed still has these instruments on its books and needs to sell them to limit inflation during the boom period that follows, however, since it is now a boom period, treasuries are lower priced, meaning the Fed can not sell them at the price at which it bought them during the slump
- this leaves the fed without the means to control inflation during the boom period after the economic slump

How is this problem solved? They could obviously buy depressed assets during the slump instead and sell these at a higher price during the boom period, but doesn't this in effect amount to an equivalent of fiscal policy since this requires a much more active, handpicking approach to buying assets? Doesn't this rid monetary policy of it's politics-invariant and "automatic" character?

 

[Cutlass]

You are assuming the price differential is significant enough to prevent the Fed from selling. I really don't think that would ever be the case. Any price differentials are going to be already priced into their policy analysis. The Fed can also fight inflation, not with monetary policy, but rather with regulation. When setting the Federal Funds rate, they simply tell the market what the rate is. Now that does not control all other interest rates, however it has a powerful effect.

No matter what else becomes true in the economy, the Fed can always engineer a recession if it feels inflation is dangerously high. Until or unless Congress fundamentally changes the laws which govern the Fed's operating abilities, the Fed can always take actions which will cause a recession and relieve inflationary pressure.

 

[Bootstoots]

I'm going to go back to a question I had earlier, but modify it a little.

You are magically given absolute power over the European Central Bank. Furthermore, the ECB's charter has been modified so that it functions exactly like the Fed, so you can focus on growth and (for example) quantitatively ease the suffering of your fellow Europeans. You can do anything the Fed can do in the US, but no more, and politically Europe is just as it is in the real world. What do you do?

 

[Cutlass]

Start buying up a lot of debt. Mainly the large banks and weaker governments. Put a ton of money into the system. See if I can't get to around a 5% inflation rate.

 

[Monsterzuma]

Start buying up a lot of debt. Mainly the large banks and weaker governments. Put a ton of money into the system. See if I can't get to around a 5% inflation rate.

I think that's a good start, but I would sell short term treasuries* in the meantime to get the interest rate back to a level where monetary policy can easily control the situation and to induce debt reduction on the part of the private sector (the way to induce debt reduction is to take away the expectation that refinancing of debts can happen at a rate as low as the current one). Kind of like a massive operation twist program.

If you just generate inflation, my "fear" is that what will happen is that the private sector leverages itself up further and it won't be long before another 2008 style event occurs. In other words you would get a return to the "great moderation" but it would be more than you bargained for, because part of the GM's trends is the rise in private debt accompanied by continually falling real interest rates, unhalted by their already being negative. And if a 2008 style event happens while real interest rates are negative, the need to lower real interest rates even further would defy all limits to the scale on which inflation can spiral out of hand.

Another thing I would advise is to deliver any inflation engineering in as quick and sudden a shock as possible so capital can not "fly" out of the currency in expectation of it. Of course that in itself is quite a risky endeavor. But a slow and predictable "higher inflation target" style inflation policy would induce a lot of capital flight.

* edit: I just realized this is only how the US central bank controls inflation... substitute this for whatever the ECB does to make rates rise.

 

[Integral]

If you just generate inflation, my "fear" is that what will happen is that the private sector leverages itself up further and it won't be long before another 2008 style event occurs.

If you just generate inflation, then you've hit the vertical bit of the SRAS and monetary policy can't do a damn thing anyway.


But yeah, what Cut said. Drop the short-term rate to zero, start doing QE and announce that you'll continue to do QE until AD is back on trend. Use NGDP or the price level or asset prices to proxy AD. The CB can't do much to solve supply-side/structural issues besides providing a stable demand environment.

Well, okay, the CB can provide lender-of-last-resort services to ease strain on the financial sector, and can do a few other structural things, but it can't do much on its own to rectify structural problems.