I am having a discussion on monetary policy with a Green Party economist who is sceptical of monetary reform on this post.
These debates usually get into a tangle, so I am trying to take a constructionist approach, building on what we agree on.
So far we agree on this:
1 Money is being created.
2 Banks create money by lending at interest.
3 Although banks also borrow from depositors at interest, the interest rates are always lower for savers than for borrowers, and the amounts retained on deposits are in the order of one percent of the amounts lent out.
4 To pay back the interest means that the borrower has to make a profit on the market.
Next, I wish to insert this line:
5 This system is an important driver of economic growth.
To back this point, a thought experiment is needed:
Imagine 2 companies, A and B, which are in competition. They are in stable equilibrium, each having 50% of the market, and both are sound.
Now company A goes to the bank, borrows capital, and invests it in new machinery. His firm's productivity goes up, so he is able to lay off workers, who go on to social security. His share of the market goes up, so he now has 75% of the market.
His competitor, company B, has no choice but to borrow, invest in new machinery, and lay off workers.
B is successful in this, so they are now back in equilibrium, with a 50-50 share of the market.
However, they are both now burdened with debt interest which reduces their profits, so they must increase output by invading other markets, or by producing goods with shorter working lives, or both.
So the system has "progressed" from equilibrium to equilibrium, but in the process hands have been laid off, the banks have secured a source of income, and A and B are marketing more goods more aggressively.
This is the essence of a book by Willem Hoogendijk, "The Economic Revolution", Green Print/Jan van Arkel, London/Utrecht 1991
So, Alison: do we agree line 5
5 This system is an important driver of economic growth.
?
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23 comments:
No, and I didn’t agree with line 4 either. Interest can be paid with money earned elsewhere. The interest paid on mortgages is an example, usually its paid out of money earned as wages, not from profit on the mortgage.
What is wrong with line 5 is that if repayment of debt exceeds new loans, there is economic decline, not growth.
The companies in your example can only borrow capital if there are lenders who think there is opportunity for profit. In the last 3 years, there haven’t been many lenders like that. Economic pessimism usually lasts beyond the turning point when it is no longer justified, as does economic optimism. As Ambrose Evans-Pritchard commented in the January 3 Telegraph: the Atlanta Fed’s law is that every year of debt-based boom is roughly offset by equal years of debt-purge bust.
AM: What is wrong with line 5 [5 This system is an important driver of economic growth.] is that if repayment of debt exceeds new loans, there is economic decline, not growth.
RL: You are underlining my point. Economic growth requires (at least in part) increasing loans. If loans do not increase, the economy fails. Thus the economy is driven by debt, in the way that Hoogendijk says. It is a system that must keep expanding if it is to exist. Which is of course against the laws of Nature.
AM: "4 To pay back the interest means that the lender has to make a profit on the market".
I didn’t agree with line 4 either. Interest can be paid with money earned elsewhere. The interest paid on mortgages is an example, usually its paid out of money earned as wages, not from profit on the mortgage.
RL: Not quite sure what you are saying. Where is "elsewhere?". I am using "market" to signify the non-state economy.
Can you suggest another form of words?
RL: If loans do not increase, the economy fails.
AM: In other words, this statement means: zero economic growth is failure. This is heresy in the Green Party. Zero Economic Growth (ZEG) and Zero Population Growth (ZPG) are like two unofficial founding principles.
In practice ZEG can only be approximated by keeping the fluctuations between growth and decline as small as possible. In other words, keep new loans approximately equal to repayment of old ones. It’s the loans that are the new money, not the interest on the loans. However if there is population growth or mass unemployment, non-zero economic growth is probably more appropriate.
How to damp down economic booms and busts is a great unanswered question in economic theory. In the last boom there was unjustified faith in inflation targeting. This was made more unrealistic by the fact that house prices were excluded from the inflation index. In the boom before that, the one that ended in the 1970s, Keynesian spending was thought to be a recipe for living happily ever after. The trade unions and Ed Balls still believe this, also Krugman, Blanchflower, Stiglitz, and many Green Party members.
International capital flows are a big unsolved problem. I don’t favour a Tobin tax because I think it would be easily avoidable by big multinational companies but not by smaller more locally based businesses. Protectionism is blamed for the 1930s depression, but has never been stopped, may be unavoidable, and may just need to be managed more fairly.
I think land tax would be more effective than monetary reform in stabilising the economy. Also I think an explanation for long Kondratieff waves may be a major missing link in economic theory. Why do major international recessions occur about twice every century (in the 1880s, the 1930s, the 1970s, and the 2010s)? My theory about this is on my website, in Couples and the K-wave, at ammpol.wordpress.com/ammwave.
RL: To pay back the interest means that the lender has to make a profit on the market.
AM: I think you mean borrower not lender. I suggest: The borrower may use profits made from the loan to pay back the interest, or may use some other source of money which is also already in circulation, such as wages.
Even better, just delete this line. For you, interest is where new money comes from. For me, it isn’t.
AM: zero economic growth is failure. This is heresy in the Green Party. Zero Economic Growth (ZEG) and Zero Population Growth (ZPG) are like two unofficial founding principles.
RL: I hope you agree that it is impossible to grow forever in a finite system. Please confirm.
RL: . . . interest is partly paid for by newly created money taken out by the competitor.
AM: It may be in your example, but usually it isn‘t.
RL: The key point is that if economic progress is mediated only through bank loans, there is an burden of debt that drives companies to increase productivity to pay it off. Therefore the monopoly of the banks in the matter of money creation drives economic growth.
AM: This is the reverse of the mistake I made when I wrote: The amount of money circulating is decided by the amount of economic activity. What I meant was that it’s the loans that create the money, not the interest.
We both left out velocity. As you also wrote: there are 2 factors relating money to economic activity. Economic activity can increase using the same amount of money if there is a speeding up of the velocity of money.
The equation is: spending equals money supply multiplied by velocity.
We now have a new disagreement: Whether the money supply drives spending or spending drives the money supply. The first alternative is the monetarist one. I think either alternative can happen.
RL: Since non-green economic growth is unsustainable and ecologically illiterate, the monopoly of the banks to create money must be ended.
AM: The banks haven’t got a monopoly. When it became necessary the state (the Bank of England) did quantitative easing. The central bank can also slow things down by increasing interest rates. This is what started the financial crash in the USA, an increase in interest rates from 1 percent to 5.35 percent between 2004 and 2006.
RL: The monopoly must certainly not shift to the State. The power to issue new money should be shared more or less 50-50 between the "National Bank" - by whatever name - and the private banks. This could be determined by setting the Fractional Reserve at 50, I believe.
AM: I think central bank money would be equal to broad, non-central bank money if the effective fractional reserve ratio was 50 percent. That’s a big change from recent fractional reserves which have been less than one percent. But I’m glad we agree that the state should not have a monopoly of money creation.
RL: I hope you agree that it is impossible to grow forever in a finite system.
AM: Yes of course.
Alison, in order to avoid fruitless entanglement, I need to know that we agree on basics. You agree that it is impossible to expand forever into a finite space. This underpins the unique Green Party opposition to economic growth.
Greens do need to refine our objection to growth. It is throughput of materials - the take from mining &c, and the output of "waste" materials - that cannot expand forever. This is the aspect that must stop expanding and that must contract towards zero.
On the other hand, we happily are in the position where we can have "green growth" as we make the transition from unsustainable to sustainable economy.
Do you agree with this outline?
I only ask because the tone of your remarks about greens and zero growth suggested that you did not.
Thanks
Richard
AM: The tone of my remarks was a response to the tone of your remarks. What you wrote was:
RL: Economic growth requires (at least in part) increasing loans. If loans do not increase, the economy fails.
AM: This equates zero economic growth (ZEG) with economic failure.
I replied with:
1. A semi-defence of ZEG, with details about how it is compatible with the banking system. In other words it isn't economic failure.
2. Alternative ideas about why the economy is unstable.
I agree with trying to achieve a sustainable economy. Whether the transition to a sustainable economy causes economic growth or decline doesn’t really matter, as long as welfare is properly looked after, there is paid employment for people who want it, childcare is properly paid for, including the work of mothers at home, and the financial system isn’t carelessly destroyed.
I’m not as enthusiastic about green growth as you are. Public spending on Green technology is an uncertain route to all of its goals: meeting carbon reduction targets, preventing fuel poverty, and ending the economic recession.
Camdenkiwi wrote: “As we build our renewables, putting up those thousands of turbines in the North Sea, investing millions, or billions, in wave and tidal systems, and subsidising the rooftop-owning half of the country to install solar photovoltaics, are we really replacing CO2 emitting fuels, or are we just adding more generating capacity which will get absorbed by the future growth that’s so very important to our politicians?"
She quoted Jeanette Fitzsimons, the first Green Party MP in New Zealand: all the renewables in the world and all the efficiency measures don’t matter unless the coal stays in the ground.
Probably another disagreement between us is whether voluntary unemployment is a good thing. I suspect that you are one of those high-energy people, who for some reason which I don’t really understand, feel it is your duty to help everyone else to be more like you.
Hi Alison,
We have had a semantic misunderstanding over this:
RL: Economic growth requires (at least in part) increasing loans. If loans do not increase, the economy fails.
AM: This equates zero economic growth (ZEG) with economic failure.
Try this:
RL: Economic growth requires (at least in part) increasing loans. If loans do not increase, the economy, as it is presently structured, fails.
There is an inescapably Ponzi-like aspect of the present economy. Ponzi schemes must either grow or collapse. There is no equilibrium point.
This may suggest an answer to the long economic cycles like Kondratieff (?sp).
A possible factor in economic cycles is engagement and disengagment with reality. There is an analogy to be drawn between bipolar illness and the market. Here.
This is introducing another strand. Maybe we should take this over to the .wiki
(Sorry about the advert link on the front of the wiki. I didn't put it there. I haven't touched it for a long time).
Cheers
To clarify, I agree that the interest is paid with money that is in circulation. The new money is created at the point that the bank enters a loan into the account of the borrower. This new money is spent into circulation.
My model of businesses A and B holds, because the only valid reason to borrow is to invest. One cannot sustainably borrow in order to provide for daily living needs.
Alison, will this cover it?
4 To pay back the interest means that the borrower either has to invest the loan to make a profit on the market, or from earning wages.
I take your point about housing, although people do regard housing as an investment, assuming house price rises. With consequences that we all know about, to our cost.
Alison
We need to sort out the impact of debt on growth.
You say "What is wrong with line 5 is that if repayment of debt exceeds new loans, there is economic decline, not growth".
The converse is that for the economy (as presently constituted) to prosper, new loans must exceed loan repayment. This is clearly a recipe for ever-increasing loans, and therefore ever-increasing debt values. Paradoxically, debt has shifted from being a virtue ("Leverage", "deficit funding") to a vice.
Hoogendijk has shown that debt necessitates ever increasing production and productivity.
Increasing productivity implies increasing unemployment, which entails increasing SS payments, which increases the country's deficit.
Interesting point from Atlanta Fed. If booms and busts cancel each other out, there has to be a better way of arranging things. In order to attain a steady-state economy, which is what ecology requires, we need to ground our economics on ecological reality.
AM: The banks haven’t got a monopoly. When it became necessary the state (the Bank of England) did quantitative easing.
RL: In the UK, they routinely produce 97% of new money. That's pretty close to a monopoly. Quantitative Easing was an emergency event, that demonstrated that national/social/state (delete according to preference) is the ultimate guarantor of money production.
Leaving whether "Bank Monopoly" is precisely correct or not, the substantive proposal is that the ratio should move from 97/3 to ~50/50.
Does this meet with your approval?
RL: Economic growth requires (at least in part) increasing loans. If loans do not increase, the economy, as it is presently structured, fails.
AM: This still says that equilibrium in the economy, as it is presently structured, is failure. Zero economic growth is statistically very improbable in any economic system, but a stable balance between small amounts of economic growth and decline is possible in the economy as it is presently structured. For me economic failure is what was happening in 2008, extremely negative growth.
Economic growth or decline is about GDP, in other words, money. Sustainability is about resources, climate, population, and other species, as well as money.
RL: A possible factor in economic cycles is engagement and disengagment with reality. There is an analogy to be drawn between bipolar illness and the market.
AM: Bipolar illness doesn’t have the regularity of the long Kondratieff cycles (K-waves). Goldstein wrote that “ the relatively fixed length of a generation” is like “a clock that links long waves to calendar time.” My demographic explanation has this regularity, its wavelength is 1.7 generations.
RL: To clarify, I agree that the interest is paid with money that is in circulation. The new money is created at the point that the bank enters a loan into the account of the borrower. This new money is spent into circulation.
AM: It doesn’t really matter whether the credit or the debt is defined as new money, as they are equal amounts of money. One is new money, the other is old money, one circulates, the other doesn‘t.
The debt doesn’t circulate, it stays in one place until it disappears when it is cancelled by the repayment by the borrower. Meanwhile the credit could more appropriately be described as “continuing to circulate”, not “ being spent into circulation”.
RL: My model of businesses A and B holds, because the only valid reason to borrow is to invest. One cannot sustainably borrow in order to provide for daily living needs.
AM: Yes one can. Mortgages are an example. They are a way of transferring housing from old people to young people, while the interest on the mortgages transfers money in the other direction, to pensions.
I have read recently that mortgages as well as current accounts are defined as retail banking, and mortgages are classified as medium risk. Unsecured loans are high risk.
But one of the bankers at the current World Economic Forum at Davos commented that “The most dangerous product that most of us as bankers have is a mortgage.” The bankers strongly attacked the critics of the universal banking model, which combines retail and investment banking. (The Times, 27 January 2011).
Another banker at Davos attacked “the extraordinary intellectual hubris of regulators, many of whom were the same people who helped us get into this mess in the first place but now think they have the blueprint to prevent it happening again. (The Times, 27 January 2011).
RH: Alison, will this cover it?
4 To pay back the interest means that the borrower either has to invest the loan to make a profit on the market, or from earning wages.
AM: No, there is interest from other investments, or unearned money such as the scandalous capital gains in the last house price bubble, or pensions, or winning the lottery. Any of the money that is already in circulation may be used to pay the interest on a new loan.
Anyway I don’t see the point of line 4 unless you are wanting to prove that interest is unsustainable, and I don’t believe it is.
RL: We need to sort out the impact of debt on growth. . . Hoogendijk has shown that debt necessitates ever increasing production and productivity.
AM: I have shown that it doesn’t. Total debt may increase, decrease or be stable. I don’t know who Hoogendijk is, but he wouldn’t be the first expert who has been wrong.
RL: Increasing productivity implies increasing unemployment, which entails increasing SS payments, which increases the country's deficit. . . In order to attain a steady-state economy, which is what ecology requires, we need to ground our economics on ecological reality.
AM: Yes, I agree. A Green tax shift from labour to resources and unearned capital gains from land is what is needed.
RH: Interesting point from Atlanta Fed. If booms and busts cancel each other out, there has to be a better way of arranging things.
AM: Its good that they cancel each other out but we need to make them smaller. Land tax, better management of protectionism, and better understanding of demography were my suggestions.
RL: In the UK, they routinely produce 97% of new money.
AM: This was your reply to my comment that the banks haven’t got a monopoly. They don’t routinely produce 97%. Some of it stays in circulation for a long time, and the rate of creation of new money varies. See my next comment.
RL: Leaving whether "Bank Monopoly" is precisely correct or not, the substantive proposal is that the ratio should move from 97/3 to ~50/50.
Does this meet with your approval?
AM: Not really.
1. I wonder how enforceable a required reserve ratio is.
2. The most appropriate level of the ratio probably varies depending on whether stability or a boom or a bust is happening.
3. 50/50 may be too extreme. Between 2006 and 2009 the money multiplier, defined as “broad money relative to central bank money” or “the link between central bank money . . . and money in the economy”, was highest, at about 64, in early 2007, and lowest, at about 25, in late 2008. (Financial Times, 6 March 2009)
So the ratio of broad money to the total of central bank money plus broad money varied between 25/26 and 64/65. That‘s between 96.2% and 98.5%, in three years in which there was a transition from a major bubble to an exceptionally large crash. So a reduction to 50% might be too revolutionary.
AM: So in the last 2 days we have found lots more disagreements, about growth, cycles, money creation, sustainable borrowing, interest, debt, cycles, broad money, money multipliers.
Its been interesting but I need to get on with the rest of my life, and don’t want to get involved in the wiki.
RL: Economic growth requires (at least in part) increasing loans. If loans do not increase, the economy, as it is presently structured, fails.
AM: This still says that equilibrium in the economy, as it is presently structured, is failure. Zero economic growth is statistically very improbable in any economic system, but a stable balance between small amounts of economic growth and decline is possible in the economy as it is presently structured. For me economic failure is what was happening in 2008, extremely negative growth.
Economic growth or decline is about GDP, in other words, money. Sustainability is about resources, climate, population, and other species, as well as money.
RL: A possible factor in economic cycles is engagement and disengagment with reality. There is an analogy to be drawn between bipolar illness and the market.
AM: Bipolar illness doesn’t have the regularity of the long Kondratieff cycles (K-waves). Goldstein wrote that “ the relatively fixed length of a generation” is like “a clock that links long waves to calendar time.” My demographic explanation has this regularity, its wavelength is 1.7 generations.
RL: To clarify, I agree that the interest is paid with money that is in circulation. The new money is created at the point that the bank enters a loan into the account of the borrower. This new money is spent into circulation.
AM: It doesn’t really matter whether the credit or the debt is defined as new money, as they are equal amounts of money. One is new money, the other is old money, one circulates, the other doesn‘t.
The debt doesn’t circulate, it stays in one place until it disappears when it is cancelled by the repayment by the borrower. Meanwhile the credit could more appropriately be described as “continuing to circulate”, not “ being spent into circulation”.
RL: My model of businesses A and B holds, because the only valid reason to borrow is to invest. One cannot sustainably borrow in order to provide for daily living needs.
AM: Yes one can. Mortgages are an example. They are a way of transferring housing from old people to young people, while the interest on the mortgages transfers money in the other direction, to pensions.
I have read recently that mortgages as well as current accounts are defined as retail banking, and mortgages are classified as medium risk. Unsecured loans are high risk.
But one of the bankers at the current World Economic Forum at Davos commented that “The most dangerous product that most of us as bankers have is a mortgage.” The bankers strongly attacked the critics of the universal banking model, which combines retail and investment banking. (The Times, 27 January 2011).
Another banker at Davos attacked “the extraordinary intellectual hubris of regulators, many of whom were the same people who helped us get into this mess in the first place but now think they have the blueprint to prevent it happening again. (The Times, 27 January 2011).
AM: For me economic failure is what was happening in 2008, extremely negative growth.
RL: for us, economic failure is the rich poor gap, starvation when food is wasted, the use of natural capital as income without using the wealth it produces to render us independent of using capital, habitat loss, loss of renewable resources like soil, forest and fisheries, pollution, and all the rest of the manifold failures of the system.
Economic growth, with its irrational premise that it is impossible to expand forever in a finite system underlies most or all of these problems.
I feel the definition of economics underlies our inability to agree on most things. For you, economics seems to be about money. For us, economics is about life.
http://www.greenhealth.org.uk/GreenEconLonger.htm
AM: Bipolar illness doesn’t have the regularity of the long Kondratieff cycles (K-waves). Goldstein wrote that “ the relatively fixed length of a generation” is like “a clock that links long waves to calendar time.” My demographic explanation has this regularity, its wavelength is 1.7 generations.
RL: some bipolar illness has startling regularity. I remember a patient who had regular cycles that disappeared totally while he was fighting Hitler. I hypothesise that the life or death nature of his activity put him in touch with reality and put an end to his cycles.
However, I only offered it as an interesting analogy.
Your generational thoughts are interesting. Political oppression tends to last for about one generation also.
I take it you standardised the figures for a generation according to the life expectancy at the time you were measuring?
AM: It doesn’t really matter whether the credit or the debt is defined as new money, as they are equal amounts of money. One is new money, the other is old money, one circulates, the other doesn‘t.
The debt doesn’t circulate, it stays in one place until it disappears when it is cancelled by the repayment by the borrower. Meanwhile the credit could more appropriately be described as “continuing to circulate”, not “ being spent into circulation”.
RL: We agree that money is being created. If it is not created at the point a loan is made, where and when is it created, in your view?
RL: My model of businesses A and B holds, because the only valid reason to borrow is to invest. One cannot sustainably borrow in order to provide for daily living needs.
AM: Yes one can. Mortgages are an example. They are a way of transferring housing from old people to young people, while the interest on the mortgages transfers money in the other direction, to pensions.
RL: Mortgages are regarded as an investment at times when house values are increasing. However, by daily living needs I meant consumables: food &c. Surely you must agree that one cannot sustainably borrow - or eat into capital - in order to consume?
4 To pay back the interest means that the borrower either has to invest the loan to make a profit on the market, or from earning wages, or from other sources of income. This money passes back to the bank, increasing the banks' ability to lend out yet more money in the future, completing the vicious cycle of debt
The bottom line is that someone servicing a loan will have to produce more in the real economy than someone who is not servicing a loan.
Hoogendijk has shown that
AM: I have shown that [debt does not necessitate ever increasing production and productivity.]
RL; Two manufacturing firms in competition. One borrows to invest in increased productivity. The competitor does likewise. They are now in competition as before, but now they have to service their debt. How can this fail to drive both to boost throughput of materials?
AM: The most appropriate level of the ratio probably varies depending on whether stability or a boom or a bust is happening.
RL: Agreed, and the proposal can accommodate your other points on this.
To summarise:
1 Money is being created.
2 Banks create money by lending at interest.
3 Although banks also borrow from depositors at interest, the interest rates are always lower for savers than for borrowers, and the amounts retained on deposits are in the order of one percent of the amounts lent out.
4 To pay back the interest means that the borrower has to shift money fromm the real economy, from profits, wages, or other sources, back to the bank, who can then repeat the cycle on an expanding basis.
5 This system is an important driver of economic growth, since the real economy is burdened with the necessity of paying back interest.
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