I suspect that quite a lot of readers did not get to section 10 of my blog on why shares are overvalued, published yesterday. It did, however, include the most important arguments in the whole post, touching on issues that have only recently occurred to me but which seem of some significance now I have noticed them.
As I argued:
Keynes still has value but too much of what is called Keynesianism has been tarnished by the neo-Keynesian school of thought that has been far too close to neoliberalism for comfort. And Keynes did not, in any event, foresee the end of the gold standard worldwide; the universal supply of cost free money created by sovereign currency issuing governments and the end of the shortage of supply of money as a consequence.
I cannot stress this appreciation enough. Money is, in our fiat world, cost free for a government. And I think this appreciation is now becoming more commonplace. As I argued:
This new cost-free money supply has meant the effective near elimination of official interest rates as governments can no longer charge for what they can create for free, and at will. In other words, what Keynes could not have foreseen was the ending of interest rate policy as a mechanism for controlling the economy, although that is what has actually happened.
I then continued:
This fact is at the very core of the crisis we now face. We have an economy, and systems of economic management, plus policy for managing pensions, that are all built on the idea that because money is scarce interest must be paid for its use. But that is no longer true: money is not scarce. And its price, at least to government, reflects that fact:
And this has widespread ramifications:
As the official price of money has fallen, so too have asset prices inflated. But that's because money is still seeking what is, in effect, a risk free (or nearly risk-free) interest rate return when there is almost none to be had. This is true even in the case of equity investments: the number of these that actually fail is tiny.
This must change our thinking:
The fact is that then new economy has to be built on the basis that there is going to be little interest return. And what this means is that monetary policy is, and will remain redundant as a tool for macroeconomic policy management. The focus will now be on fiscalism; that is the use of spending and tax to manage the economy. There will be no choice: these will be the only tools we have.
I think this appreciation is the foundation for a new way of economic thinking. We can dispense with the old: free money has priced it out of existence.
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Given John Deadwood’s recent comments, some of the politicos on the right seem to have recognised some of the above. leaving the open question: when does gov policy catch-up with economic reality and national need?. Other open question: do the leading members of Labour even understand the above?
I am involved with efforts to communicate this
No opportunity cost, next to no manufacturing cost. No justification for interest then, (as we’ve said here before, I recall) other than that bankers have to make a living, which could perhaps be granted them through a flat money-creation fee. It’s perhaps to disguise this that the great obfuscation of what fiat money actually is has taken place, IMO, all the way back to Downing explaining his ideas for what became the treasury, the national debt and an exchequer bank (an idea which idea mutated into the BofE a while later) during which, as Lord Clarendon observed at the time, ” He wrapped himself up according to his Custom, in a Mist of Words that Nobody could see Light in, but They who by often hearing the same Chat thought They understood it.”” (‘The Godfather of Downing Street’, John Beresford).
Need to get this straight in my head, so forgive what might be nonsense. Interest on a loan is part service charge and part maintenance of value given inflation. For savers it is just the latter. All the rest is rent (i.e. unearned income – because only labour creates wealth).
These days most of the charge is effectively default insurance
Completely agree, fiscal is the only game in town now, but politicians are either in the pockets of the asset rich or just do not understand.
However, I would probably not use describe money as ‘free’ as this misses your ‘promise to pay’ point that you put across very well a few days ago. Money only has value if it makes things happen. It is real ‘resources’ (in the broadest sense – as societal and human capital are the most important resource of all) that count. Money is just a means to facilitate (speed up) society’s ability to develop and utilise its ‘resources’, Developing human ‘capital’ via investment is the key if we want to move forward.
Free means ‘has no cost to government to create’
But I will rethink the right wording
A couple of thoughts on MMT, if I may. No doubt I’ve misunderstood.
1) If a mortgage holder is unable to keep up repayments, there is foreclosure and the property defaults to the lender, who unloads it at a discount. (There were a lot of foreclosures in the early nineties, after rates went skywards in the late eighties.) If the mortgage lender borrowed the mortgage capital from elsewhere, reclaiming the property allows the lender to reduce its loss. But if the mortgage is QE money, the mortgage lender has not suffered any loss of capital from the default, only future interest payments. (These interest payments are profit after operating costs are paid). Unless the lender is penalized by whoever licenses it to issue QE money, for permanently increasing the money supply via the failed loan. With QE money, foreclosures, and secured loans in general, seem unfair.
2) In the eurozone, Germany lent Greece money to import German exports. After the crash, Greece was unable to repay the loans and the debt was socialized. But again, if the loans were QE money, there was no cost to Germany.
But the only people who get money for free under QE are the government so 1) is not true
And 2) is not true as the loans were not from QE
Thanks for replying, but…
I’ve misused the term “QE money”, it’s too literal. Originally I used the term “fiat money”, but I thought it might be wrong. I want the term for “money created out of thin air, not borrowed from somewhere else”. I thought you’d been saying that that was what mortgage lenders did these days.
In the eurozone, are lenders not allowed to “create euros out of thin air”? In my ignorance, I don’t see the problem.
Now I am not sure I am following you….
Mike –
Does it help to think more in terms of this money created from thin air as being a promise? When the borrower takes out a mortgage, they are effectively making a promise to repay the lender. If they can’t do it in sterling for whatever reason, the agreement states that the promise can be fulfilled in money’s worth, i.e. foreclosure and seizure of the asset.
Remember, the bank only creates the money under license from the state. The state is saying “It’s OK for you to release more sterling into circulation” – but all money travels in a circle… it’ll eventually end up back with the state through taxation. The bank effectively promises the state that it will pay the amount back at some point. Much in the same way the mortgagee promises to repay the bank.
You see it as intrinsically unfair that the bank can get something for nothing (i.e. it gets your house if you fail to give it the money it never toiled for in the first place) and I suppose that’s a natural first reaction – but the bank has an obligation to the state. At least that’s how I see it.
It’s all about the promise.
@Geearkay: Thanks for answering my question. You’ve understood me.
So the loan isn’t created out of thin air at all. It is at least nominally borrowed at no cost from the state and must be repaid, else the bank owes the bad debt to the state. Though whether the state would ever call in the bad debt seems highly political.
This kind of lending is not the direct analogy to quantitative easing by the state that it seems.
No it is thin air: the loss is to the bank, not the state, and it does not have to make it good to the central bank as such
Mike –
Not quite – if the bank doesn’t recover the money it lent out, it doesn’t have to pay anything back to the Government. It created the money itself – the loss is its own – but it creates it under licence from the state. So, it is effectively an agent of the state.
If it incurs enough bad debt that it has to go under, that’s the cost to the state. This is sometimes an unfortunate outcome of poor management by banks (Northern Rock for example)… but sometimes the loss to the state would be too much (i.e. RBS… too big to fail).
Waiting for the LP to act on this is like waiting for Godot. Might be more effective to cut out the middle-man and go direct to the public. ‘The Magic Money Tree’ meme could be a good starting point. “Yes it does exist and here’s why ….”. Well co-ordinated, sustained pressure from the bottom up will win in the end. Just takes a bit longer. Of course if the LP made it a central pillar of their economic policy then mind-set change could come about quicker. Even then I reckon it’ll take at least a decade to sink in to level when it will significantly affect voting patterns. Altering the Household Budget analogy in people’s minds is a really tough marketing challenge, as anything counter-intuitive always is.
As I found on LBC with Ian Dale yesterday
Fiscalism? Sounds like something nasty you catch on a foreign holiday on a cheap offer.
If fiscalism is now the “only game in town” this obviously puts the emphasis back on tax collection methods for economy regulation but when the rich can contrive to lodge ownership of income streams and property in far flung tax havens this makes fiscalism a global as well as a national issue. It also relates it to the detail of trade agreements and the accountability of trade organisations managing those agreements, the WTO’s, EU’s, etc. of this world. As a species (witness Brexit) we don’t appear yet to have grown out of our chauvinistic mentality making cooperation extremely difficult on fiscalism.
I suppose what I’m talking about could be lumped under the term “macro-fiscalism” and the necessity thereof.
Agreed . MMT in a nutshell . Who needs a Monetary Policy Committee ?
You are right
This is why I am still working on it
Academic papers on the issue are now heading to journals
In round numbers how much money is due to be printed ( using QE ) this financial year by the BoE?
The amount rolled over
I have not checked
It will exceed £20 billion
Increasing interest rates do not fight inflation or weaken the currency. The opposite is true.
They are price adjustments, pure and simple. Higher rates equate to higher prices and higher prices mean higher inflation as the increased cost of credit gets passed on. Inflation is not good for currency. Higher inflation is good for inflation-sensitive stuff like gold and commodities as well as some stocks.
Currencies are a bit like bonds, the only difference being they have zero maturity. Everyone seems to understand that when rates go up bond prices go down. It’s an inverse relationship. The discount to par reflects the implied yield and that discount increases as rates go up.
Same with currencies. The spot price of a currency can be considered par. In a rising-rate environment the forward prices of a currency are lower. The market is literally pricing in a lower exchange rate. The degree of discount to par reflects the implied yield. Buy a forward and hold it over time until it converges to spot and you will earn the implied yield.
Gold and commodities exhibit the opposite behavior. They don’t earn. They cost you to hold. There are interest payments and storage costs so the natural “curve” of gold and commodity markets has a positive slope. (Deferred contracts are priced higher than spot.)
In a rising-rate environment, forward contracts for gold are priced higher. That reflects the “cost” of holding, which equals the interest rate plus storage, etc. Prices rise in a rising-rate environment and they fall in a falling rate environment.
Of course this does not reflect short-term portfolio shifts based on traders’ beliefs. Many believe that lower rates are bullish for gold or bearish for a currency and vice-versa. As a result, they act on those beliefs and buy and sell accordingly. However, that’s not the true fundamental effect. That’s why so many people lost money buying gold when they believed rate cuts would be inflationary. Similarly, they wrongly sold the dollar. These mistakes are being repeated now, only in reverse.
The Fed thinks it is fighting inflation when actually it is feeding it via these rate hikes. Any commodity curve will show this in reaction to a rising-rate environment. The curve will instantly reflect higher future costs.
In addition, their policy and statements seem to reflect a lack of understanding of the government being a net payer of interest. They talk about being on guard against further fiscal stimulus when it is the Fed itself that is doing the stimulating. It is paying. That is income added, not removed. While some may find it harder to borrow because of the higher cost of credit, that is offset by the additional income earned by creditors and savers. There is net income received by the economy and that is by no means a brake on economic activity.
Pick a graph any graph after 6 US rate hikes. There’s thousands of real data points to choose from.
It’s akin to religious fundamentalism. If people believe and have faith that interest rate hikes make a currency stronger and fight inflation then when the FED starting hiking they would have…
Shorted GBP/USD @ 1.2 in the belief the $ was going to strengthen
Shorted EUR/USD @ 1.06 in the belief the $ was going to strengthen
Shorted Gold @ $1020 in the belief it was going to fight inflation
Long USD/YEN @ 1.21 in the belief the $ was going to strengthen
There is another aspect to the foreign exchange channel, interest rates, and inflation. The spot and forward price for a non perishable commodity imply all storage costs, including interest expense. Therefore, with a permanent zero-rate policy, and assuming no other storage costs, the spot price of a commodity and its price for delivery any time in the future is the same. However, if rates were, say, 10%, the price of those commodities for delivery in the future would be 10% (annualised) higher. That is, a 10% rate implies a 10% continuous increase in prices, which is the textbook definition of inflation! It is the term structure of risk free rates itself that mirrors a term structure of prices which feeds into both the costs of production as well as the ability to pre-sell at higher prices, thereby establishing, by definition, inflation.
USA inflation okay until the increased interest rates
https://d3fy651gv2fhd3.cloudfront.net/charts/united-states-interest-rate.png?s=fdtr&v=201805021801v&d1=20130101&d2=20181231&url2=/united-states/inflation-cpi
Canda inflation okay until they hiked interest rates
https://d3fy651gv2fhd3.cloudfront.net/charts/canada-interest-rate.png?s=cclr&v=201804181410v&d1=20170101&d2=20181231&url2=/canada/inflation-cpi
Russia shows you how to fight inflation
https://d3fy651gv2fhd3.cloudfront.net/charts/russia-interest-rate.png?s=rrefrate&v=201804271040v&d1=20130101&d2=20181231&url2=/russia/inflation-cpi
Argentina’s problem with the Peso is all down to wrong policies.
Cut the interest rate it will stop inflation in its tracks.
It’s a complete joke central bankers can’t see
a) Interest rate hikes are price hikes
b) Interest rate cuts are price cuts
c) They completely ignore the interest income channels
Interest on Treasury securities, $144.6 bln, up $13.4 bln y-o-y. Growing 10.2%. One of the largest spending items at the moment.
During Reagan’s boom interest payments outstripped military spending.
That’s why they’ve never understood QE and if they don’t understand QE then they’ll never understand balance sheet reduction.
Powell putting his foot to the pedal. Well ahead target.
Fed balance sheet down $18 bln in the week ending May 2. Largest single-week decline since Aug 2016. Lowest level in 4 years.
Treasury holdings declined by $7.5 bln. Largest single-week decline in 5.5 years.
Treasury holdings have declined $60 bln since Oct. That is $18 bln more than the Fed targeted.
MBS down $9.2 bln. Lowest level since Feb 2017.
Fed’s securities holdings are projected to decline about $400 billion this year and another $460 billion next year as Treasury and agency securities continue to roll off gradually from the Fed’s portfolio.
How right you are Derek. That ship sailed in 2008 and it ain’t coming back . No amount of rigging by the FED will produce a 2008 ante world. This is the hidden in plain sight reality that Powell, Carney, Draghi and co don’t get . Their day is over. The question that hangs in the air beyond this is, ‘ what is the future for the retail bank ? ‘ People’s QE via state created retail bank . Any takers ?
Yes….
Or Carney does get it and lies everytime he opens his mouth like Draghi.
Speculators dumped a net, 42k British pound contracts last week. That was the largest, single week liquidation since Jan 2016. It was even bigger than Brexit. The 2-week liquidation came to 63k contracts. That is the equivalent of nearly 4 billion British pounds.
They’re still net long, but only 32k contracts now, down from 95k just 2 weeks ago. As soon as the specs get short that’s when you get long.
7 simple words from Carney – the rate rise is not a certainty.
7 simple words to weaken the £ without having to take the risk of inceasing the interest rate and thus increasing inflation in a fragile economy.
You can decide amoung yourselves which is true is he stupid or a liar ?
Sorry – what contracts?
FX contracts GBP/USD
Ok
I must have missed that
Apologies
Fed Balance Sheet
https://4.bp.blogspot.com/-VniYzlCzMtI/Wu8xIGJGx7I/AAAAAAAABFo/YhYsVkTWIrMABbEE3SX5UJeSjv2cREzWwCLcBGAs/s400/FedBalance.png
Market parcipitants will do the wrong thing when they catch onto this.
That’s 100% certainty.
it’s the reverse of QE as they let them mature instead of killing them. They still don’t get QE.
Sorry Richard for dumping all that on you in one go.
But the truth has been annoying me now for a long time. I hope it has been informative.
It seems useful
So I let it on
Thanks
I did read to the end of your article. I confess I thought the end (point 10?) should have been at the beginning. It was perhaps the most important part of the article, and certainly made me think.
I am not quite there yet; I am still trying to grapple with whether in fact we stumbled incouciently or unconsciously over important elements of MMT at the outset of WWI in 1914; and if we did, whether anyone knew? (MMT, or whatever name we give the thread of ideas surrounding ‘the creation of money from nothing’. I confess I remain uncomfortable with the disposition to ideology that seems to infect economics – and too many of the various ‘schools’ acolytes; whose desire to be authoritative too often seems almost biblical in its aspirations, and intolerant in their promotion of the underlying ideas).