The FT has reported tonight that:
Italy has moved to shore up confidence in its fragile banking system after agreeing to pump €5bn of taxpayers' money into two failed mid-sized banks while handing their good assets to Intesa Sanpaolo, the country's strongest lender. Veneto Banca and Banca Popolare di Vicenza, based in the country's prosperous industrial north-eastern Veneto region, will be wound down by Italian authorities after the European Central Bank said they were failing.
Pier Carlo Padoan, Italy's economy minister, said on Sunday that the state would offer additional guarantees of up to €12bn – meaning a possible total of €17bn – to cover losses from the two banks' bad loans.
Two weeks ago I noted the failure of Banco Popular in Spain at a cost of at least €8bn. I wrote:
With luck a Spanish banking crisis can be contained. But a wary eye is required on what might be a fast developing situation precisely because banking risk is contagious. And if there is a crisis coming we need to be ready.
Three things. First, the probability that there will be contagion looks to be considerably higher now.
Second, we are not ready for it. I explained why in the post on Banco Popular.
Third, if contagion happens it changes everything. I stress the 'if' but it is absurd to ignore the possibility, so I won't. What might contagion mean?
It will reveal that the decisions banks take are not independent of each other. All banks are part of a system and to pretend that banks can in these situations be treated as if they are distinct from each other is simply wrong: they are not. Banks have to trade with each other and are dependent upon each other to settle their liabilities on time. If one cannot do so the counter-party risk is what creates contagion: its limit cannot be known, and changes in systems since 2008 have not as yet changed that.
The action of the Italian authorities in this case reveals another usually ignored fact. It is claimed that banks create money by lending, and it is undoubtedly true that lending does created money, but the risk of their doing so always rest with the state via central banking authorities. This is why I argue that all money is created by governments: if they carry the can when it all goes wrong then it is their guarantee that gives money its worth.
In that case the question now is whether the collective government's of Europe (and maybe beyond) can persuade the world that their guarantee can still give money the worth that sustains economies without inflation resulting. Let me be clear, that the money creation is possible: there is no limit to the amount of money central banks can create. But if there is serious contagion we have no idea how much money central banks will need to create to deal with this issue and what the inflation consequences will be.
But we know that those consequences are likely. And last time the inflation was almost entirely in asset prices and the result was the rich got richer and everyone else was left even more behind than before. And that too me would be the unacceptable outcome this time.
Banks will have to be bailed if necessary.
But this time real reform will have to be imposed. I wrote so much on this in 2008, but this time the banks' entreaties must be ignored: the farce that we have still not put in place all the measures thought necessary then cannot be repeated.
And we have to make sure that the new money benefits the economy. And that can only happen with stringent taxation measure as well as active fiscal intervention. So this time there has to be a wealth tax. And this time, if there is a this time, there has to be a Green New Deal to direct money to where it is needed.
I know it's a touch crass to say it, but if we're going to have another banking crisis then this time it has to be different.
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One might reflect that the agreement to ignore the EU rulebook to effect this bailout shows the absurdity and irrelavance of much of the economic ideology embedded in the EU constitution/treaties.
http://www.primeeconomics.org/articles/the-gaping-contradictions-in-eu-bank-bail-out-law-and-policy
Nice piece of writing. I thought for a moment you were going to lead an article with the need for more wealth taxation and more Green New Deal programmes, and run it back to the latest headline about the world heading south.
But no, you ran the argument the other way. Nice.
I totally concur with everything you have said.
Once more it is private debt causing the problem and a Government bail out that sorts it out. And will this lead to further consolidation of debt via more austerity in Spain and Italy? Likely.
What worries me is that this sort of thing becomes the norm and the wider opportunities provided by the central bank’s ability to print money are ignored (Green QE and other things like public sector wage rises, other investment projects that benefit society).
The world seems to ignore something that this blog has made abundantly clear: issuing money as interest bearing debt is the equivalent of the ice packs melting and cooling down the gulf stream with the resulting environmental chaos. If we swap the thermal capabilities of the gulf stream for the value of real money, debt kills the value of real money and the economic environment goes bad.
Wealth taxes – absolutely.
‘but the risk of their doing so always rest with the state via central banking authorities.’
In the case of the Eurozone, of course, their are no individual central banking authorities (only arms of the ECB) so the Italian bailout will be presumably done using bond ‘financed money’ as it has no central bank to ‘print it’ as we have in the UK. Italy’s debt levels (132%) are approaching that of Greece (179%). This will, no doubt force more austerity :
Not looking good:
‘This would imply that the Italian banks will not be able to rely on a European safety net without a drastic reduction of the level of non-performing loans (through fire sales at discount prices) and of the weight of government bonds within total assets. New, costly rounds of recapitalizations are looming during 2019 for Italian banks, without any guarantee of success.
The proposed reforms ultimately have the potential to reduce vulnerabilities in the Eurozone banking sector. But at what cost? The monetary union could become considerably more resilient without having to change the current framework that generates persistent imbalances in terms of trade flows and strong differentials in inflation, growth and employment.
Indeed, somewhat paradoxically, with a more stable financial system the weaker economies already under a regime of austerity would be forced to recover their competitiveness exclusively via the mechanism of internal devaluation, that is the reduction of prices and wages. This is already happening in Greece, where the average salary decreased of more than 25% in 6 years and the unemployment rate persists at over 23%. An unpalatable perspective for the Italian economy.’ (www.socialeurope.eu/2017/06/new-reforms-envisaged-brussels-path-towards-austerity-italy/)
What does the government make that adds value, and hence grow the economy?
I agree it is the bed rock of the country…. in setting direction, framework, regulation and enforcement. It has no income in of itself. So I agree it needs to be financed and hence rightly we have tax, but there is not enough tax as you point out in many articles.
So where does the extra tax come from?
We still don’t have CbC reporting yet, which is a real shame, so the like of ATOS G4S Google Amazon…… pay little or no corporation tax. Cash in hand is rife as you’ve also commented on. Reducing denomination sends a message is all, it still leaves plenty of scope for anonymity and of course we have Crypto currencies as well.
So we have some choices either burden the existing tax base even more which may be perceived as unfair, and therefore damaging to whatever party is in power. So find additional tax base and debt default (at least on classes of debt.)
Paying tax is accepted or even embraced if it’s perceived as fair which at this point in time it is not.
We all want all this good stuff you write about, but alas politicians do not engage in an adult conversation on what that really means. I don’t blame them it is us who elected those same politicians.
I have never said there is not enough tax
Time and again I have said we do not need tax to fund the government: tax simply recovers what the government has spent
Apologies missed the word “taken” Not enough tax taken
I understand what you mean, as to which way round it is.
Government can create currency, but it has to borrow it into existence by issuing debt first surely? otherwise we’d have hyper inflation.
So Tax (demand) is also created simultaneously to service that debt and pay off the principal which it can never do of course as we borrowed the interest payments into existence
Government creates currency by borrowing it form its central bank (the BoE in the UK)
It is tax that prevents inflation: that is its primary role
All gov’t spending is borrowed money
Then tax reclaims it
Rather than borrowing, isn’t it just that governments spend the money into existence and agrees to recover the deficit (spend – tax) via bond sales. The central bank is to first order irrelevant in the government spend and tax fiscal circuit – however it is relevant via interest rate setting in the monetary private banking circuit which of course has a bank action on the fiscal circuit.
The bonds part provides confidence that the government will not spend excessive inflation-creating amounts, i.e. it links money creation to activity in the real economy such that the unit of exchange is not devalued.
But if the government spends it has to do so via a bank….and does
Bonds then clear the account, I agree
I do not agree re your final para: I think it is actually tax and, if you like, interest rates that do this, not bond rates per se. What bonds do is create the chance to impose a rate
This is what HM Treasury wrote in response to a FOI request.
The Government does not borrow from the Bank of England to finance the
fiscal deficit. Government borrowing from the central bank is illegal
under the Maastricht Treaty.
See
https://www.whatdotheyknow.com/request/does_the_treasury_borrow_money_f
Funny that they refer to EU rules – was always a convenient get out!
As an example of misinformation that is staggering
No mention of QE
No mention of how the money for QE was created
No mention that interest is not paid on QE debt so that the BoE does not receive it
No mention that the profit accumulated by the BoE until interest was stopped was reclaimed by HMT
That was in that case a Freedom of Misinformation answer
“Government can create currency, but it has to borrow it into existence by issuing debt first surely? otherwise we’d have hyper inflation.”
I think you have few concepts confused.
When the Gov wants to spend money (on a nurse’s salary, a motorway repair, a dole or pension payment, or a new aircraft carrier…) it simply instructs the BoE to credit, at a keystroke, the reserve accounts of the commercial banks of the intended beneficiaries of that spending.
It has no need *whatsoever* to check beforehand that every person, or company, has paid their taxes to date, to’ borrow’ money from the private sector by issuing a 10 year Gilt, or to scrabble behind the Chancellor’s sofa cushion… in any way whatsoever.
That money that the Gov has spent will then flow through the economy as those initial transactions take place, and are then followed by further secondary and tertiary transactions… and so on, in an arithmetic progression.
At each transaction, however, various taxes will be incurred (PAYE, NI, VAT, Corporation Tax, Excise duties, etc etc…) until, eventually, all that initial spend will have returned (“re-venue”) to the Exchequer, where it is effectively destroyed.
It is destroyed, so that the entire process can continue anew, each day, every day (hopefully!) ad infinitum, without creating the massive hyper-inflation that would ensue, were those taxes *not* constantly draining off the excess.
Any that is money saved, rather than spent, by the private sector, remains untaxed, and equals, to the penny, the Budget Deficit, i.e. that amount on tax yet to be collected – and which will be, should those savings ever be spent.
So the deficit is simply the savings desires of the private sector. Although it absolutely does not need to, the government very kindly offers a safe destination for those savings in the form of Gilts, which also allows it to achieve a target interest rate.
But, just as the Gov has no direct control over how much the private sector, in aggregate, decides to save – it equally has no real control over the size of the deficit. However much it pretends it has.
My understanding of QE is that it is an asset swap – longer term financial assets like bonds for shorter-term ones like bank deposits and no new money is actually created, hence why we don’t get inflation as a result. Is that not correct?
Not at all: it explicitly creates new money
That is exactly why it was done
So they create, for example, £1b of new money to swap for £1b of bonds that have already been purchased previously?
They create new money to buy back debt which is then effectively cancelled
It’s a ruse to get round direct lending from the BoE to HMT
But the net consequence is that is what it does
@ Marcus:
“What does the government make that adds value, and hence grow the economy?”
“It has no income in of itself.”
It doesn’t need “income”: it creates the currency. As much of it as it likes. Without it, you would have no money.
“So where does the extra tax come from?”
From spending the money. More, and larger transactions, resulting from initial and subsequent direct government spending incur taxes on those transactions in the normal way. The fact that they are larger and more frequent means that more tax is automatically collected.
It cannot be otherwise, if you think about it – the only money that is not eventually returned to the Exchequer is that which the private sector chooses to save instead of spend.
“We all want all this good stuff you write about, but alas politicians do not engage in an adult conversation on what that really means.”
Because that would mean admitting to the voting public that *taxes do not fund spending* – and that it’s actually the other way round.
At which point, there is no longer any rational economic excuse for austerity, other than that resulting from the insidious, sado-masochistic political ideology that is neo-liberal Toryism.
Austerity is an essential policy and tool for Tory Governments, whose ambitions are to weaken the public sphere in order to privatise its depleted remains, reduce the working population to a state of fear for their jobs and their futures via the threat of unemployment and homelessness, leading them to accept low wages and desperate conditions, and to increase the profits for banks and other lenders via the inevitable increase in private indebtedness, and corporations via ever expanding privatisations, the NHS being the next in their sights.
There is no rational reason *not* to run our economy at its full capacity, for the benefit of all the nation’s people – apart from a cruel and twisted ideology.
Agreed, entirely
Oh I agree it is the other way round. The spending (borrowing first) creates tax.
But they wont say that. but we only have ourselves to blame really.
Yes agreed Austerity to pay off debt is a pointless exercise and cruel illusion that can never be reached. As the interest on the principal has also been borrowed into existence.
But that fact also is hidden from us.
“The spending (borrowing first) creates tax.”
No, no, no no no!!! There is no “borrowing” first!!
Please read my post above!
There has to be borrowing to create the money
There is no other way in which money is created
That’s just the way it is
It is all within the government space via BoE but there is definitely borrowing to create the money to pay for the spending – but no third party outside the government is involved
I understood Marcus’s interpretation to mean that no gov spending could take place until the gov had ‘borrowed’ money from the private sector via Gilt issuance. (Which would be incorrect).
You are presumably treating Treasury spending as ‘borrowing’ from the BoE then? As the Treasury owns the BoE, are they not effectively a single entity, within the Whole of Government accounts?
When I moderate it is hard to see who a person is responding to
Given the reading you suggest I agree with your comment
I stressed, there was no third party lending but a mechanical process of loan recording does take place within government to create the form of debt or the money could not exist
Here’s Professor Mary Mellor’s explanation http://www.thelondoneconomic.com/tle-pick/magic-money-tree-fact-two/26/06/
I have a lot of sympathy with Mary and her work
Richard, what is being borrowed? The money is spent into existence as a net asset, there is no debt attached (or doesn’t need to be though the money itself is an IOU-but that is not the debt I mean here). Tax then, is simply the money being withdrawn from circulation which is a + sign for the treasury account and a – sign for the reserve accounts.
Bonds are issued to reduce the reserve levels corresponding to the spending to maintain the interest rate policy, that’s why tax is not immediately removed from reserves but kept in accounts within the reserve system so that it can be removed as part of the interest rate maintenance.
The B o E is part of the consolidated Government .
Can’t see how there is any ‘borrowing’ along the line. You could , I suppose, pay people in bonds which would then be exchanged for cash but it would amount to the same thing.
As I understand it QE was primarily about flattening the yield curve and reducing interest rates. As Richard says, it has been done by creating money with keystrokes, so it isn’t ‘taxpayers’ money’ even by mainstream measures. It didn’t cause inflation because the debt is bought by large institutions that reinvest it in more assets (bonds!).
The government spends
So that’s a debit in its accounts
Where is the credit? Let’s ignore the BoE. It is either income, liability or equity
Only an optimist woukd call it income – a pure gain
We do not have equity in government
So it is a liability – value is owed
The value is cancelled by dr loan cr income when tax is paid
Of course there is a loan
Add the central bank and internally this is like any other bank loan but the parties are HMT and NoE
“I stressed, there was no third party lending but a mechanical process of loan recording does take place within government to create the form of debt or the money could not exist”
Ok, but it’s a bit like writing yourself an IOU then. And not really ‘debt’ as most would understand it.
Promulgating the notion that the Gov has to get itself into debt before it can spend a single pound is not helpful terminology if one’s trying to communicate in simple layman’ sterns the fact that the gov is not constrained by how much money it has to spend, but by how much in the way of available real resources there are are in the economy.
Sometimes the use of accounting identities can obscure as much as it can reveal, it would seem.
I think it has to be said it is debt : because it is
May be the word “promise” is better than debt.
The government promises to pay the teacher and that “promise to pay” can be transferred as payment throughout the economy, eventually getting cancelled as a tax credit and disappearing again.
All government spend is a promise on behalf of all of us so that we will deliver the public services we desire – simple as that!
It’s is like in private banking but not completely the same. In anther circuit, I promise to teach to pay the person whose house I now live in, with the bank acting as a intermediary so I can live in the house now rather than later.
The government and banks need to keep accounts and when they spend/loan they enter that as a minus and tax/repayment as a plus, BUT the minus on the government account is not like the minus at a bank because a private bank is not underpinned by the whole of society – the bank cannot tax everyone.
Consequently although there are similarities using the same language in both cases can be misleading.
I note that the use of the new “bail-in” arrangements have not been discussed yet in relation to the struggling Italian banks.
Two banks in Italy go bankrupt no one looses any money.the Italian government stands behind the gaurantees.the Italian government creates term bonds for 20 billion Euros and SELL them to E.C.B at a discount.Het presto!
Machiavelli,lives.