This was written in the Business Insider in Australia in 2012:
On Saturday, we wrote that more and more people are starting to wonder if central banks like the Bank of England and The Fed can just “rip up” the debt that they've bought via Quantitative Easing, and reduce the national debt of these countries with the stroke of a key.Asking this question, and thinking about the implications of it, is the equivalent of taking the ‘Red Pill' of economics. The Red Pill, of course, is what Neo took in the Matrix, and it exposed his mind to an entirely different view of the world that was far less comfortable than the one he inhabited. If you start thinking about the possibility that the central bank could just rip up a government's debt, with few negative ramifications, then you might start thinking about government finances in a totally new way that makes you uncomfortable.
You might start to realise that this whole construct of a broke government, deeply in hock to the Chinese (and everyone else) is an illusion, that complete distorts the realities of sovereign finance.
Now I stress, the magazine in question came to the conclusion that the mass cancellation of sovereign debt via the quantitative easing programme would lead, in their opinion, to the risk of serious inflation, but I want to stress that things have moved on since 2012.
We now know that $6.5 trillion of quantitative easing has not only failed to create inflation, but has actually led us to a point where there is no inflation at all.
And there are now technical arguments as to why this is the case, with it being entirely plausible to argue that when there have been such large-scale labour market reforms that any inflationary pressure can outsourced to an under-regulated and, in the case of the growing army of the self-employed, an under-measured workforce, then unless and until an increase in real wages becomes the focus of inflation policy there is no risk of that phenomena returning.
The point is a real one now: I suggest that now is the time for us to review just what the realities of sovereign finance are. I would argue that they are very different from the mainstream perception.
I would also argue that this is something we need to get used to. Just as it took until April 2014 for the Bank of England to accept that bank loans were not made out of depositors' savings but were, instead, created out of thin air, which was something some of us had argued for a very long time, the time has come for a review of sovereign finance when that has also been misunderstood for far too long.
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I have to say it surprised me at the time and since that no one appears to have remarked upon the fact that the Bank of England should even have been researching the question of exactly how the system over which it presides actually works in practice.
I have been saying for several years now that a far greater, and indeed existential myth remains undispelled which such a review of sovereign finance would in my view also dispel.
This relates to the precise nature of the ‘modern money’ created by banks.
The new conventional wisdom is beginning to be that banks create credit/modern money when they make loans, and with few exceptions economists who even get as far as thinking that (and there are not many) believe that this modern money is destroyed or cancelled when loans are repaid. There is also a conflation of undated call deposits (current accounts and reserves) and dated term deposits(loans by depositors to banks) as ‘liabilities’ of banks.
In my analysis, modern money created by Central Banks is created as an agent of the Treasury and not an accounting counterparty. What the Central Bank is doing is creating Treasury credits each returnable in payment of £1.00 in tax and then holding them on behalf of the recipient bank into whose account these credit instruments have been deposited.
In accounting terms, the Central Bank is maintaining a memorandum account (not an account payable), exactly as though it were a warehouse or custodian holding valuables on deposit.
These account entries in what is essentially a title registry for modern money can only ever be positive, and loans occur when an agreement is made to sell and repurchase these credit instruments, which thereby gives rise to loans, and to accounts receivable and payable of these ‘look-alike’ treasury credits.
The Central Bank creates and where necessary cancels these Treasury credits on behalf of the Treasury. Note here that it is completely open to the Treasury to create credits directly itself. During the first world war the Treasury created ‘Bradbury’ Treasury notes as money: likewise there is still a rump of US Treasury ‘Greenback’ Notes circulating in the US in addition to Federal Reserve Notes.
So far, so good. But the £640 billion question is the nature of private bank credit.
In my analysis, this private bank credit/modern money ALSO consists of ersatz Treasury credits manufactured by private banks as fiscal agents of the Treasury. This virtual modern money is indistinguishable from Central Bank money and can only be destroyed/cancelled by the Central Bank. It is NOT destroyed when loans are repaid, as is easily demonstrable by a simple thought experiment.
In other words, the undated credit created by private banks is not a loan – it is the OBJECT of a loan, or the credit instrument which is held on deposit and lent like any other security.
So what? The answer is that the so-called National Debt is not and never has been debt. It is a form of National Equity, with Bank of England’s reserves of £375bn equating to a form of equity in UK Incorporated paying a dividend of 0.5% pa, and Treasury gilt edged stock equating to redeemable preference shares.
Far from being equivalent to that of a household, the UK balance sheet is better seen as that of a ‘Profit for Purpose’ Company. This opens up an entirely different narrative in relation to investment in productive people and assets and to national dividends as basic income. Note here that this road has been trodden before albeit obscurely, by the Social Credit movement and it lives on in name only in Canada’s ATB Financial
http://www.atb.com/about/Pages/our-history.aspx
Chris
You are way ahead of most people
Richard
The Red Pill, indeed. I would assert that QE, as currently practiced, has inflated asset-price bubbles, and that these have fed inflation into the real economy through rents on residential and commercial property.
This inflationary effect of QE has been masked by the deflation associated wealth worsening wealth concentration: the beneficiaries consume very little and invest even less in productive enterprises; much of the money created by QE has ben used to purchase rents.
Rent-seeking is inherently deflationary and its role in macroeconomics is being ignored; and the ‘rent on money’ most of all.
It follows that I am in agreement with you in saying that there has been far too little economic research on the nature of sovereign debt, and no sensible political discussion at all – or not until the last year or two.
However, I must take issue with this:
“…it took until April 2014 for the Bank of England to accept that bank loans were not made out of depositors’ savings but were, instead, created out of thin air, which was something some of us had argued for a very long time”
That’s not quite true. The mechanics of Fractional Reserve Banking have been known since the days of Jacob Fugger – state bailouts included – in the early 16th Century.
Commercial lenders before that often lent out more than they held; but Jakob Fugger und Gebrüder Söhne codified the concept of a reserve – both of deposits and of shareholder capital – and operated under the de facto guarantee of bailouts from their backers, and ultimately from the Holy Roman Emperor.
All modern banks, and the Bank of England itself, are the Fuggers’ descendents.
What’s new is that the Bank has finally realised that lending and the creation of money is driven by demand for loans.
They’ve spent 200 years concentrating on the regulatory safeguards of limiting lending by mandating the maintenance of reserves – the deposit side of a lender’s balance sheet – and successive Governors and governments had come to believe that deposits were the controlling factor on the creation of money.
This was and is the regulating factor on the creation of money; and we need that regulation more than ever. But it is only lately, and late, that the Bank has come to understand that lending is *created* by demand for loans; and this is fundamental to an understanding of economic growth.
This sheds light on PQE: we’ve always known that there are consequences in monetary economics to growth originating in government action, rather than in private investment and demand. But we’ve never truly examined how governments can create growth through a better understanding of money and the underlying processes by which money is created – all we’ve has so far is talk of ‘printing presses’ and the Weimar hyperinflation…
…From economic dilettantes with a political agenda, and a wilful conflation of ‘banknotes’ with the underlying concept of ‘money’, which is actually bank lending and bonds, with coins and banknotes being something of a sideshow.
Indeed
Nile says “Rent-seeking is inherently deflationary and its role in macroeconomics is being ignored; and the ‘rent on money’ most of all.”
That’s a good point, Nile, in a good post. I like that phrase, the ‘rent on money’; I’ve been arguing for years that a prime driver of inequality is the fact that money, in its current form, allows the rich to take the medium of exchange out of circulation and charge everybody else for the privilege of using it.
From that perspective, I have doubts about your comment about ‘coins and banknotes being something of a sideshow’. It may be true in terms of the value of transactions it mediates but I think the fact that it retains its nominal value indefinitely creates the floor which makes negative interest rates practically impossible. My view is that we won’t be able to establish a stable monetary system until we effectively separate the medium-of-exchange and store-of-wealth functions of money.
No, I wouldn’t try to separate the store of value and the medium of exchange: consider what would happen if these two separate forms of currency existed, and diverged.
Stored value would become increasingly remote from everyday consumption and production – like houses and apartments in London, unattainable within a lifetime of white-collar labour and exchanged for unimaginable sums between members of a distant overclass who value them as tokens for exacting rents.
We have an historical precedent for that: gold in the pre-mercantile Middle Ages. Consider the position of a Publican, who ‘owns’ his business serving ale to citizens and peasants: he’s paid for beer in in copper coins, and exchanges that to pay his rent in silver. But ‘his’ building and the land it stands upon is owned by His Lordship, and it would be sold for a significant sum of gold, so far beyond the value of the rings and trinkets worn by the publicans wife that there is little point considering them ‘gold’ at all. His Lordship and the publican inhabit different economic countries with a geographic overlap – and that is where divergence between value and exchange can take us.
Alternatively, the official ‘value’ tokens would diminish in popularity and certificates of ownership of assets with a rental value – shares in privatised utilities would spring to mind – become exchangeable tokens of stored value.
As for coins and banknotes having an intrinsic value: they have never been anything more than physical records of a bank or Mint’s decision to create and issue money, and they have been diminishing in their importance ever since the first promissory notes and bonds were issued and exchanged.
A separate point, and one you should consider a personal remark:
Economics is not a spectator sport; and you should consider, very carefully, exactly what or whom you’re cheering on.
They might not be ‘your team’, or on ‘your side’ at all, even if they’re paying all of us to turn up to the game; and you and I and they are not spectators.
Supporting the ‘winners’ – if one side is truly winning, in our lifetimes – doesn’t automatically admit you to their team; and the medals and the celebrations and the banquet – and the food banks for the losers – are still the field of play for the participants in economics.
Nile said: “His Lordship and the publican inhabit different economic countries with a geographic overlap — and that is where divergence between value and exchange can take us”.
Thanks for the response, Nile, but I think you must still be taking the blue pill. The convergence between store-of-wealth and medium-of-exchange is the very thing that makes ‘rent on money’ possible; it’s one of the key causes of that divide between the rich and poor. If the rich can take the medium of exchange out of circulation they can restrict everybody else’s ability to trade and they can therefore effectively charge others for the use of money. That, as Silvio Gesell pointed out, is the root of why people receive interest on their savings despite the fact that, in the real world, storing wealth has a carrying cost.
The significance of coins and banknotes lies in the fact that they are, as you say, ‘physical records of a bank or Mint’s decision to create and issue money’. As physical records they are controlled by whoever happens to hold them and they can only be cancelled when they come back into the hands of the government. Their physical existence — the fact that they can be physically hoarded — makes it next to impossible for monetary authorities to charge a carrying cost on savings. The result is that the authorities are forced to treat modest inflation as desirable — the only way they have to counter hoarding of money is by degrading its function as a unit of account.
You say “Stored value would [be] exchanged for unimaginable sums between members of a distant overclass who value them as tokens for exacting rents.”
I dare say there are ways of doing it that would have that effect, but the way I’ve proposed clearly wouldn’t (except with the collusion of a corrupt government). The essence of it is that the medium-of-exchange money shouldn’t hold its value indefinitely and therefore the store-of-wealth money cannot be transferable (otherwise people would use it as a medium of exchange). The clauses I proposed for the LSE’s crowdsourced constitution project (the piece I linked to above) required that the store-of-wealth money would only be exchangeable for the medium-of-exchange money, at rates ‘which shall vary according to a formula deemed by the appropriate independent body to be consistent with maintaining a stable medium of exchange’.
Rent on money is not the only cause of inequality of course but we can’t expect to solve everything with a single reform — and therefore we can’t properly judge the potential of any reform except in the context of other necessary reforms. For the record I also advocate reforms of inheritance and land law which would, in future, let everyone inherit a fair share of the nation’s real estate and accumulated capital.
Malcolm
To be honest, I think we do need to keep debate here within the realms of reasonable possibility
I am not sure you are doing that
Richard
The boundaries of reasonable possibility sometimes shift very rapidly, Richard — and very much depend on perspective. A few months ago Jeremy Corbyn as Labour leader was well outside them but many people now find it credible that he might even become Prime Minister. Who’d have thought it?
If it’s the idea of splitting our existing money into two which you think is outside the realm of reasonable possibility, then I totally agree — I said as much in that proposal I wrote for the LSE project. That’s why I advocate creating the conditions in which a parallel currency can develop, which the private sector would in time adopt voluntarily. That process is something which could be done in stages and the hardest part would be the initial step of switching government accounting to a rational unit of account. Once that’s done, however, the next steps would be fairly straightforward.
Do you think that initial step would be beyond the realms of reasonable possibility? Personally, I think the reason the country’s fiscal situation is in such a mess is in large part down to using a unit of account whose value is arbitrary and largely subject to the whims of the money markets. I think Jeremy Corbyn would have no trouble making that case in a way that would resonate with the public. It would be reinforcing what many people already suspect and, with decades of boom and bust and currency crises behind us, the right would have difficulty countering it. It’s an argument which would shift the terms of the debate — and breaking away from stale narratives is one of Corbyn’s strengths, it’s where his integrity and quiet confidence are most persuasive. Addressing the problem at that fundamental level could give him the economic credibility which he is currently struggling to achieve.
In contrast, arguments about PQE and tax evasion are firmly within the established paradigm and are always going to be vulnerable to rebuttals like ‘magic money tree’ and ‘if only it were that easy’. The right’s talk of balancing the budget resonates with the public because most people know instinctively that what a society can do is limited by the resources available to it. The fact that real world resources cannot be created out of thin air creates a resistance to believing that money can be, so the PQE argument will always be an uphill task. What chance do you think there is of convincing the majority of the electorate that it’s a viable path? Abstruse technical arguments aren’t going to convince the public when you can’t even convince many on your own side.
Having said that, it’s probably time for me to stop commenting here and concentrate on pulling my own ideas together on my own blog, T’Reasonable Man. (In the past I’ve either put forward my ideas in submissions to official bodies or posted them on various other sites, such as the LSE’s constitution project, but I’ve now set up my own site.)
I had hoped that we could be allies, since you’re clearly as committed to social justice as I am. But, on its own, I see what you’re advocating as more of a barrier than a step forward. As I’ve said before, I think what you’re proposing would be useful as part of a transitional process, mitigating the existing injustices while new foundations are being put in place. But without a drive to address the fundamentals, mitigating strategies merely create an illusion of progress towards equality. In fact, I think they actually help entrench injustice because they divert political dialogue away from the underlying causes. Endless arguments over what level taxes should be levied at, or whether or not it’s safe to expand the money supply, will never make a good base for a healthy society. I hope that’s not the limit of your ambition but, if it is, I’ll leave you to it.
Good luck
But I will stick to what I see as the possible
Very interesting sidelight on the history of “rent extraction”:-
http://revisionistreview.blogspot.com/2015/05/may-4-1515-reign-of-loansharks-begins.html
“it took until April 2014 for the Bank of England to accept that bank loans were not made out of depositors’ savings but were, instead, created out of thin air, which was something some of us had argued for a very long time”
How banks create money was hardly a secret, Richard – I read about it in the eighties in a ‘Teach Yourself Banking’ book.
Exceptional then
And was never taught
Even now most people do not know are do not comprehend this
Hmmm. There seems to be hat tip missing here somewhere (just kidding). I’m really glad that you blogged this, although I am surprised that you didn’t include the last sentence from the article:
“Were not sure if the” (inflation warning) “is right, but the point is clear, just based on the fact that this is the top client question right now: more and more people are escaping the prison of their minds!”
Apologies
I could not recall who had sent the link
Sorry
Good addition
“We now know that $6.5 trillion of quantitative easing has not only failed to create inflation, but has actually led us to a point where there is no inflation at all.”
QE has stopped deflation. Which is surely proof that QE is inflationary. As Nile observes above.
How do you know?
Asset price inflation has occurred, as Nile has described above.
Asset price inflation and consumer price inflation are not and will never be the same. They are conflated to some degree in the housing market as well as in art & collectibles.
For the most part, however, they are separate. As separate as the world of speculation is from that of the real economy. The case of QE in the current era demonstrates this perfectly where strong asset-price growth co-exists with stagnant consumer prices.
Oh, and, for the record, two things:
1 Asset price bubbles in real estate do not necessarily result in higher rents. A growing disparity between rent and prices (declining or negative yield)is usually characteristic of a bubble – where capital gains are sought and rental losses are curiously ignored.
2. Nile wss talking about 2 different meanings of rent. The term ‘rent-seeking’ should not be confused with rent on residential or commercial property. (I’m just noting that on the off chance that someone may have confused the two, not Nile, but someone else perhaps ).
Asset prices increasing is not “inflation” as the term is applied in economics. Nobody complains about inflation when their home or stock portfolio values go up.
But yes, in general QE will increase the prices of other financial assets because QE removes a particular financial asset class (Term bank deposits at the Govt’s bank) while leaving the same amount of money in the system.
I.E. if there was $1 trillion in financial savings in an economy. It could go to a number of places:
1) Muni or corporate bonds (Say $100 B in each type)
2) Equities markets ($200 B here)
3) deposit accounts at commercial banks (both demand and term accounts) $150 B in each type here
4) deposit accounts at the Govt bank (both demand and term accounts) $100 B in reserve accounts and $200 B in securities accounts
= $1 trillion
Now if the Govt does $200 B in QE, the following changes happen:
There is the same amount of money at the Govt bank, but all $300 B is in reserve accounts (commercial bank checking accounts at the Govt’s bank) and now there is $0 in securities accounts = no “national debt” LOL
and we get a $200 B increase to the checking accounts of the public at commercial banks (we’re just assuming here that banks dont own any Govt securities bank deposits which is not true in the real world).
Now there is $200 billion in the hands of the public. They can either continue to save it in the form of Commercial bank deposits (low interest return, high liquidity) or they can save it in one of the other few places left now that Govt CDs are no longer an option. And its quite easy to see how $200 billion more dollars going into stocks or non Central govt bonds would increase the value of those financial assets.
So this is all the QE does, it removes one potential option of financial savings for the public which quite logically will cause other financial savings values to increase.
Or quicker and easier, if there is $1M and 5 identical houses for sale in an economy, if the Govt knocks down 1 of the houses, we would expect the value (nominal of course) of the remaining 4 houses to go up if the amount of money stays the same.
But PQE does not do this: it provides new money
Gilt issues can depress asset prices.
“QE” returns them to “natural” levels.
It does not pay off govt liabilities just swap non-interest bearing IOUs (cash and bank reserves) for interest bearing (gilts.)
“National debt” is for fools.
Richard,
The review should look at how we define sovereign debt. It should IMO include all liabilities of govt from the smallest issued coin upwards.
As your post shows it is possible, using mainstream definitions of debt, to “reduce the national debt of these countries with the stroke of a key”. I’d argue that this just isn’t possible in any meaningful way. It’s the definitions and understanding of debt that aren’t correct.
PM
You say that QE has produced no inflation. How do you know that it did not prevent massive deflation.
Because wage rates – which are far removed from QE – did not fall massively in current terms, even if they did in real terms