Relax, Central Banks Can Still Save Us (Ambrose Evans Pritchard)

I think this will be the last time I use AEP’s ruminations to get my point across.

Once again. I am not an economist. I am as far removed from academe as is possible. It is just that I find in AEP’s opinions the prevailing attitude that permeates both the wider public and the establishment and as you can imagine I have a bone to pick with both.

Relax, Central Banks Can Still Save Us

Full article with my comments interspersed:

GUIDO: The title is all you need to know. AEP places his entire faith in the banks for the well being of society. He may think Central Banks are a different animal entirely from your garden variety banks, but you and I can see that empirically, they are not. As I stated in previous posts, during the past century banks and governments in the West have successfully introduced the notion that it is the banks that create capital. Here AEP confirms that he either genuinely believes this notion to be true or he perpetuates it by design.

Even if Europe and America slide back into recession with fiscal deficits already dangerously stretched and interest rates on the floor, financial authorities still have the means to prevent a spiral into debt-deflation.

GUIDO: And this is the question our leaders still have to answer. Why is debt deflation so undesirable? When any official statistic you care to pull up shows that just in the past 40 years in the West debt has grown at a far greater clip than GDP (let alone capital formation), why is the potential reduction in debt so feared? Empirically and mathematically, considering that interest rates “are on the floor” we are already finding it difficult to service debt. Why would more debt be desirable or even a cure? If more debt was a solution than why not just keep piling it on thus obviating the need to work at all?

Whether they have nerve to use those means if necessary, and whether they can overcome deep rifts to act in unison and with overwhelming force, is another matter. It would help if China and other reserve powers stopped sniping from their clay towers. They will suffer just as badly, or worse, if the damn breaks.

Perhaps oddly, I am not as uber-bearish as some at this juncture. It is far from clear to me that the US is crashing into a second slump. While the Philly Fed’s manufacturing index for August was catastrophic at minus 30.7, it is a twitchy index.

Paul Dales at Capital Economics says it flashed false warnings in 1995 and 1998. The US Conference Board’s leading indicators are more reliable. They are signalling sluggish growth.

Andrew Haldane, the Bank of England’s financial stability chief, says global banks have raised equity by $500bn since the bubble burst. They have slashed assets by $3 trillion, and halved leverage ratios from 40:1 to a long-run average of 20:1. “UK and US banks’ cash ratios are at their highest levels for several decades,” he said.

GUIDO: Here AEP quotes Andrew Haldane but since he quotes him, we are given to understand that AEP agrees with the assessment. If memory serves (but am truly unsure and can’t be bothered to look it up because it makes no difference), I believe Andrew Haldane was in the papers some days ago advocating that banks should be allowed to take more risk to save society from implosion… which totally omits to point out that society is imploding because banks have taken risks far greater than their respective national GDPs… but such is the warped logic of the establishment… Regardless! That global banks should have raised equity since the bubble burst is the best we could have hoped for. But what remains a problem is how they have done so if they have done so at all. Last time I checked, banks were still allowed by sundry regulators to disregard a bunch of accounting rules pertaining to mark-to-market. That being so, how exactly did banks raise equity? We all know the answer to that do we not? Public funds… and considering that in the past three years whilst smack bang in the midst of a crisis of historic severity banks have distributed the largest bonuses in history… should we really take what this Haldane character is advocating seriously?

Citizens and firms on both sides of the Atlantic are running a “financial surplus” near 2.5pc of GDP, compared to a 1pc deficit five in 2006. US companies are sitting on $2 trillion in cash. The West is better cushioned this time.

GUIDO: The banks certainly are. As far as the rest of us, AEP or Haldane should check with the 45 million folks on food stamps.

There is much wreckage left, of course. A quarter of US mortgages are under water. A shadow inventory of unsold homes must still be cleared. Detox will be long and painful.

Yet it no longer makes sense to talk of a US housing bubble. The price to incomes ratio has halved to three, among the world’s lowest. Cleveland, Detroit, Cincinnati, and Atlanta are down to 2.4.

But let us concede – as a ‘Gedanken Expirement’ – that arch-bears are right to fear a full-blown global slump. Are we powerless?

The US cannot easily crank up fiscal stimulus with a deficit already at 10.8pc of GDP (IMF estimate). Much as I admire Nobel Laureate Paul Krugman – vindicated in his prediction that US 10-year bond yields would fall to historic lows – he misuses history to argue that spending on the scale of World War Two could safely lift America out of slump.

Yes, the US pushed public debt above 120pc of GDP to defeat Hitler, and Britain topped 200pc defeating Napoleon. Both countries marched on to greatness, but in each case they were the world’s paramount industrial power.

Who was going to threaten US Treasuries or the dollar in the late 1940s when Germany and Japan were under US occupation, and America accounted for half of global GDP?

Military demobilisation allowed an instant cut in the US budget deficit. Today the rot is structural, a failure to stop health care and ageing costs spiralling out of control.

GUIDO: I guess here AEP at least partly redeems himself as even though he may admire Krugman at least he can see through the “utility” of war to kick start an economy.

Have to run now. Will add to my comments later

So with fiscal policy exhausted, the burden must fall on monetary policy. Here we have barely begun to use our atomic arsenal even at zero rates. As Milton Friedman taught us – though nobody in Frankfurt — it is a fallacy to think that low rates are loose. Zero can be extremely tight.

GUIDO: AEP is advocating nagative interest rates. That would be nominally negative rates. Here AEP perpetuates the notion that saving is anathema to a healthy economy. Wealth comes about through spending thus savers and people that do not make use of debt must be punished because they are causing the implosion of the economy. So that if you are a boomer and have just retired with nary a penny to your name, you are supposed to take out even more debt to help the economy along.

That may be the case now with US Treasury yields signalling deflation and M2 velocity collapsing as it did pre-Lehman.

To those who argue that the Fed is pushing on the proverbial string, David Beckworth from the University of Texas replies that the Fed showed between 1933 and 1936 that it could deliver blistering growth of 8pc a year despite debt deleveraging in the rest of the economy.

GUIDO: Assuming that is correct, did that gambit result in a mended economy at the time?

My own view is that Ben Bernanke has strayed from classic Friedman policy, blunting the effect of his two rounds of QE. Under his doctrine of “credit easing” he has steered bond purchases to banks. This has limited effect on the quantity of money.

GUIDO: The Money Multiplier says that money has lost it’s presumed multiplier effect on the overall economy. From this point of view, even more money only debases the currency… which incidentally is exactly what is happening.

A Friedmanite would argue that Bernanke has barely tried monetary stimulus. Yet he has greatly eroded his political capital in the process, especially by arguing that the purpose of QE2 was to push up inflation and help Wall Street. These were tone deaf justifications. “Treasonous” is the verdict of Governor Rick Perry of Texas. That was to be expected, but it does complicate matters.

The eurozone obviously needs looser money. M3 broad money is stagnant and real M1 deposits have turned negative, even in Germany and Holland. Real M1 is contracting at an alarming pace in Italy. EMU growth has wilted, five countries are spinning towards default, and the banking system is seizing up. This cries out for a change of course, yet the European Central Bank is still tightening.

The ECB’s Jean-Claude Trichet said “we do not do QE”. Indeed, Germany forbids it. Not only has the Bundesbank forgotten that the Bruning deflation of 1931 destroyed Weimar – not the hyperinflation of 1923 – it is imposing its policy blunder on the whole currency bloc. The visible result of piling monetary contraction on top of fiscal contraction is to push the Club Med over the edge.

The lesson of 2008-2010 is that further QE by the Fed alone risks a dollar slide and a further global crisis. A successful monetary blitz – if required – would need joint action by all major central banks in concert, including the ECB with no ‘ifs’, ‘buts’, and hostile body language. Some $6 trillion would suffice, or 10pc of global GDP.

We are not there yet. The August squall may pass. US growth may surprise, and China may avoid a hard landing. For all our squabbling, we still live in a benign world where ships and capital move freely and leaders talk to each other.

Remember what the world looked like when Franklin Roosevelt moved into the White House in March 1933 and shut down the US banking system.

The front page of the New York Times on his first Monday in office announced: “Hitler Bloc Wins A Reich Majority, Rules Prussia”; “Japanese Push On In Fierce Fighting, China Closes Wall, Nanking Admits Defeat”; “City Scrip To Replace Currency”; “President Takes Steps Under Sweeping Law of War Time”; “Prison For Gold Hoarders”.

That was a serious situation.

End of article

GUIDO:  In his various incarnations, AEP has been a Monetarist and a Keynesian in equal measure. If not dictated by an agenda, in light of the sheer mountain of incontrovertible empirical and legal evidence that shows the major banks to be at the heart of the problem afflicting us today, AEP’s staunch belief in and support for the centrality of banks in our socio-economic construct has to be admired.

If he is not advocating purchasing sovereign debt a outrance he is pushing for monetary gimmickry that borders on the criminal like negative interest rates. It is hard to believe that professionals of the presumed caliber of AEP, be they pundits, economists or politicians, are collectively unable to draw parallels with the rise and fall of states and societies of the past. Of two things one. Either the people that could make a difference truly believe they can create their own reality, or they are deliberately intent on inflicting the greatest damage on the largest percentage of the population. The third option of course would be that our leaders are incompetent useful idiots. But if one believes in the inherent rationality of man, then one must perforce conclude that it is unlikely that so many leaders could be truly ignorant collectively and simultaneously.

One other thing. In a very recent opinion piece, AEP stated that there is an inherent difference between the fiscal characteristics that apply to individuals and those that apply to the state. AEP made the statement in order to advocate state intervention beyond parameters that would conversely be damaging to individuals. AEP’s thinking appears to go something like this. Individual economic actors have real mathematical and legal limits that they must abide to vis-a-vis making use of debt. Not so the state. And here we can only presume that AEP feels that sovereignty confers to the state the ability to suspend the laws of mathematics (by extension, we must further believe that AEP feels this to be the case particularly if the state in question is the owner of the global reserve currency).

But how can that be possible?

Any state funding must come from individual economic actors. Similarly, the ability of a state to borrow money is predicated on the ability of the members of the state to be economically active.

If economic actors for whatever reason should be unable to maintain the same level of economic activity due to, say, their inability to keep up with current debt service payments, then it is clear that state funding will suffer proportionally more. That is because not only fiscal revenue declines but the ability to sell sovereign debt decreases too.

But, apparently, AEP believes that in this case, the state should just go on to buy its own sovereign debt a outrance and everything will be put right again.

This line of thought of course omits to take into account two basic arithmetical truisms.:

First. If the state is forced to purchase its own sovereign debt because economic actors are unable to make ends meet, then incrementally adding state debt can only result on an even greater fiscal burden on the economic actor.

Second. Adding incremental debt in the absence of a corresponding increase in productive output can only result in debasement of the currency. Debasement of the currency places a further burden on economic actors by needlessly increasing the nominal price level of commodities at a time that economic actors are already struggling to service existing debt.

But I am not an economist. So, what do I know.



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9 Responses to “Relax, Central Banks Can Still Save Us (Ambrose Evans Pritchard)”

  1. Pat Donnelly Says:

    The invisible hand is envy lust and greed!

    The seven sins cause economic activity beyond the lower tiers of Maslow’s pyramid. TV etc cause consumption. Taxes and loans are predicated on this engine, but not for the first time. This is just another part of the cycle.

    AEP is using sophistry to bolster confidence among the historically ignorant!

  2. Pat Donnelly Says:

    Manor, you still believe that banks create money out of savings when it hass been demonstrated that they do so out of lending.

    There is still the crux: no one wants a loan, as there is nothing, conventionally, that will repay with interest to repay the loan. Deflation, therefore, is established by the lack of stupidity in would be borrowers. They have had all the education they need that property does not always go up!

    Another point occurs. In the land of AEP house prices are expected to rise! This has everything to do with devaluation of the currency! Do it well enough and everything will rise! Bingo! Trouble is, the brains of that society will ship everything of value away from what is about to happen! Money walks!

    A lot of that lending has been destroyed as the collateral is dropping. But the vendor may not have gone back to the property market as a greater fool! Taxation is the only way to get that money!!!!

    Hence public involvement. The state can confiscate gold silver and tax capital and income to recover the or some of the money lost.

    But try recovering an economy in those circumstances!!!!! War allows massive taxation increases.

  3. guidoamm Says:

    Edited for clarity

    Hi Manor Mouse,

    The invisible hand is not naturally asking for negative interest rates.

    Although I suppose it is possible that even in a healthy economy unencumbered by intervention the invisible hand might be asking for negative interest rates at times, we don’t have a healthy economy now.

    Interest rates that are persistently and artificially lowered like we’ve had for the past ten years cannot give rise to savings thus there cannot be productive capital investment. Productive investment can only arise out of savings. No savings, no capital investment. Without savings, you have consumption of productive capital. And as already pointed out, politicians and banks have successfully introduced the notion that capital can be created by the banks; hence the need for declining/low interest rates hence our consumer societies.

    The invisible hand has been twisted to ask for negative interest rates. Left to its own devices, interest rates would surely be higher simply because there cannot be productive investment in the absence of savings.

    • Manor Mouse Says:

      “Productive investment can only arise out of savings. ”

      “…there cannot be productive investment in the absence of savings.”

      I have a much less clear cut view of this than you. In my woolly mind I see no difference between the banks using others’ savings to fund their loans (investments), or effectively issuing new money. We know that people’s savings are just bank-issued money anyway, aren’t they? If the economy must grow, then new money must be issued.

      I fail to see why people’s savings should be considered to be so specially sanctified, because as I said above, most people just stick their tokens in a bank or building society, relying on government regulation and bail-out pledges to make their money ‘safe’. Their salaries come from activity funded by bank loans so it’s all just one big merry-go round, with the punters neither caring nor knowing what is done with their tokens. Now, take away the regulation and bail-out pledges, and suddenly people might begin to worry a bit more about where their savings go, but they would still end up relying on ‘professionals’ to invest it wisely, and that would be the bankers presumably.

      To my woolly mind, the big questions that bother me are:
      (a) Are the ideas of Adam Smith, the Invisible Hand, supply and demand, the free market, price discovery, rational actors, perfect information etc. valid in the first place, given that people are not rational (someone did cut the last tree down on Easter Island!) and information is never perfect?
      (b) Is our monetary system, which seems to rely on perpetual growth to function, compatible with (a)?
      (c) Is it even possible to have a self-organising economy that can cope with limited physical resources (i.e. an economy that may have to perpetually shrink) or must you then resort to central control?

      • guidoamm Says:

        “…but they would still end up relying on ‘professionals’ to invest it wisely, and that would be the bankers presumably.”

        You have answered your own question.

        In the past century, we have allowed banks to become the one and only pillar of socio-economic development. That is exactly my beef.

        Whether you like it or not, money is THE ultimate (as opposed to proximate) driver of the entire human construct. Nothing can take place, no decision can be taken unless individuals can exchange their ideas and products for something they deem to be more useful. What matter is not what is used as money. What matters is the framework that manages money. And in a free market, banks have no business managing money particularly when management takes place by decree behind closed doors and at interest.

        The other thing I would also like you to see is that the expansion of the economy is not at all dependent on expanding the money supply. Think of money as you would of socks. The economy could well expand without the need to add more money in circulation. In this case what happens is that as the economy expands, the amount of money that is already in existence is revalued according to people’s preference to hold money or to spend it in order to buy socks. Think of Warren Buffet’s Berkshire Hataway investment vehicle. Mr. Buffet has always refused to split the stock of his company with the result that it is now worth US$103000.00 – that is one hundred and three thousand US Dollars. By refusing to add more stock in circulation, Berkshire stock price has been revalued upwards. In other words, Berkshire’s stock is more desirable than other stocks or items people could purchase with their money.

        Money should be and could be a public good. As it is, money is the privileged preserve of a handful of banks known as the Primary Dealers who are the members of the Federal Reserve. Worse still, due to the magic of floating exchange rates, the management of the currency of any sovereign that is a member of the floating exchange rate mechanism is too in the hands of the Federal Reserve (hence the need for swap lines when the central banks of other countries are in trouble).

        As I pointed out in previous posts, the privilege to create the currency is a very lucrative privilege for the creator of the currency and its close acolytes. A lucrative privilege that has no corresponding cost structure. In a system of value based money the expansion of the monetary base can only occur by expanding the wider economy because you need to employ people, resources and machinery in order to find and process whatever gives your currency value. So in a value based monetary system, creating more money carries a cost that is represented by the expansion of the wider economy. Similarly, in a fiat world based on a fixed amount of fiat money, if economic actors want to accumulate more money, they would have to feed the wider economy in order to produce more socks in order to acquire more money.

        In a debt based fiat world the Federal Reserve can just create the currency by decree. In this case, there is no corresponding positive feedback loop in the wider economy. Worse still. Our current money carries interest meaning that it is debt. Debt must inherently be repaid PLUS INTEREST. But the creator of the currency has no cost structure. Whereas, the user of the currency (you and me) we are bound by a deep cost structure. So the creator of the currency puts out money that costs nothing and earns a disproportionate profit in the interest we have to pay. THis asymmetric relationship results in the transfer of productive capacity to the creator of the currency and the entities that gravitate around it.

        Having the privilege to create currency and lend it fractionally, empirically and naturally leads to do so excessively, pervasively and aggressively. This dynamic of course results in debasement of the currency, thus inflation, thus a rise in prices. As prices rise, people feel that saving results in loss thus savings are foregone. Once savings are gone but prices are still rising, people need to take out loans. As prices rise further still, the need for debt transitions from a need for critical needs to a need for every day things. As prices rise further still, debt will be used for increasingly short terms needs… till the cookie crumbles… that would be today.

        So now, premising that we should not be in this situation in the first place, whereas the cure to what is happening today is debt deflation, banks are still telling us that we need even more debt in one form or another. Worse still, politicians, egged on by pundits and economists that are either genuinely misguided or have an agenda, are in total agreement and there is no difference whether the politicians are from the right or the left. The right says that we can borrow more but we can cut taxes, the left says we can borrow less but we can increase taxes. Either way, society must foot the bill.

        The only way more debt could be beneficial to our current situation would be if every unit of new debt had a directly proportional effect on the expansion of GDP. But empirically, it is clear that is not the case. Debt conforms to the law of diminishing marginal utility. Hence the reason that since 1980 in the USA for example, Federal Debt has progressed by 1000% whereas GDP has barely doubled. ANd that’s only Federal Debt.

        What we need is debt deflation. Better still, we need a different monetary system.

        Money should and could represent the effort and the productivity of society. As it is, this variety of money is a vehicle devoted to the exploitation and the impoverishment of the many for the benefit of the few.

        • Manor Mouse Says:

          I like what you say, but I’m still not convinced that money per se is *the* major factor in our problems.

          OK, so we find ourselves in a country where no one starves, and people don’t have to work terribly hard to make a comfortable living. A small number of our money tokens can buy incredible riches – even the jobless have iPads. We have running water, reliable power. Until recently the retired could expect to live for 30 golden years of travel and golf. Even now, our youngsters can spend three years at university doing whatever course they fancy – even media studies or mediaeval history if they want. Our biggest worries seem to be how often the bins are collected, and how soon the potholes get filled in after a frosty winter.

          What I want to know is how this could have been improved upon by an alternative monetary system…

          My own view is that with an alternative, more rational, system, it is highly likely that much of the above would not be true; we would all live much more frugally. and and everything would be much more expensive. People wouldn’t take risks, and our money wouldn’t purchase disproportionately cheap stuff from foreigners. Most of the oil would still be in the ground. We wouldn’t now be contemplating the whole system crashing.

          In practice, how would your non-DBFM system work? If I was an entrepreneur with a great idea for a gizmo, how would I pursue it? If I was an ordinary working man, how would I get the means together to buy the gizmo?

          • guidoamm Says:

            Removing the privilege to create money from the bank changes nothing to the dynamic of commerce and debt. Loans would still be made and wealth would still be accumulated by those that want to.

            The crucial change to returning money into the public domain is that the productivity of society stays within society.

            The creator of the currency enjoys asymmetrical and unfair advantages that result in the accumulation of the profits, hence the productive capacity, that rightly belong to society.

            Picture two circles. One circle much larger than the second circle which in relation would be the size of an atom.

            The first larger circle represents society. The smaller circle represents the creator of the currency.

            Government mandates the following:

            The small circle is allowed to create the currency to the exclusion of anyone else under penalty of incarceration
            The big circle MUST make use of said currency to the exclusion of anything else under penalty of incarceration
            The small circle must pay back any amount of currency it uses PLUS INTEREST

            Since the small circle has no cost of production, it can freely put out as much currency as it wants. It is no skin off its nose. But by putting out ever increasing amounts of currency not only does the creator of the currency earn interest on something that costs nothing, but it also debases the currency thus pushing the big circle into debt which, as it happens, the small circle is only too happy to offer … at interest… for something that is conjured and that did not give rise to a a positive feedback loop to benefit society…

            This is the closest thing to charging people for breathing.

            Mathematically speaking, in this construct, the small circle will gradually absorb the entire production structure of society. This is why as inflation progresses, nominal profits gradually concentrate in the finance industry.

            Inflation is the “financialiation” of the economy. The reason Derivatives, CDSs, CDOs and the alphabet soup of financial instruments that are invented daily are necessary is because they are the vehicles needed to detach intrinsic value and inflate it into financial value in order to support increasing debt loads that are necessary to sustain DBFM.

            In the absence of DBFM, the economy and commerce would very much work the same as they do now but profits would remain within society. Loans would not be conjured but would be based on a sound basis of previous profits and savings and as a consequence, values would remain tied to intrinsic value. The finance industry would not be allowed to make fabulous financial profits derived by arbitrary privilege and that they could use to acquire the productive capacity of society.

            As I pointed out to another blogger some time ago, in a non DBFM world someone could decide to work less and, provided they also opted to consume less, they could still be able to save a little something that would enable them to work less.

            In a DBFM world, someone could not decide to work less because any savings they would incur would be eroded by inflation and an increasing tax burden brought about by the very nature of DBFM.

            DBFM is inherently exploitative and it is the ultimate pyramid scheme.

  4. Manor Mouse Says:

    I perceive a slight inconsistency between

    “And this is the question our leaders still have to answer. Why is debt deflation so undesirable?”


    “…he is pushing for monetary gimmickry that borders on the criminal like negative interest rates.”

    Surely if the Invisible Hand demands negative interest rates, then that should be allowed, just as debt deflation should. Why should savers be automatically given a return on their ‘savings’ even if the economy is in no fit state to provide it? In a way, it is the savers who made the economy what it is today: they passively allowed their money to be ‘mal-invested’ in a giant Ponzi scheme built on executive flats that nobody needs, and service industries that boomed while our manufacturing went overseas etc. Had they thought about where their money was going, they might have been more careful what they did with it.

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