Saturday, July 21, 2012

Mish, apparently, does not.

Okay. First of all I don't understand any of his accounting. But Steve Keen's Mish & Steve Debate: Steve Says (I) -- or the parts of it I do understand -- are superb.

When he's done with all his double-entry tables, Keen writes:

So the bottom line here is that eliminating “Fractional Reserve Banking” does nothing to eliminate the capacity for banks to create money: that will exist in a purely free market system just as much as it does today.

The bottom line is eliminating “Fractional Reserve Banking” does nothing to eliminate the capacity for banks to create money.

I would say, you cannot eliminate fractional reserve banking any more than you can eliminate gunpowder or nuclear weapons or the sunrise. Fractional reserve banking existed long before the Federal Reserve. It will continue to exist long after we make our best changes to the system.

But that's okay. The problem is not fractional reserve banking. The problem is excess. The problem is not that there is more debt than money. The problem is that there is so very much more debt than money.

Up top, Keen has a make-nice intro where he summarizes Shedlock's criticisms of his (Keen's) “Modern Debt Jubilee” proposal. Right off the bat we find Mish saying:

Giving money away will not cure any structural issues such as the high cost of education, pension underfunding, medical costs, prevailing wages, student loans, etc., etc.

Indeed, I think it would compound those problems.

I got that far, and knew I was gonna write this post. Keen seems not to focus on this particular criticism by Mish. I picked up on it right away.

The purpose of a debt jubilee is not to "give money away". The purpose is to reduce debt. If Mish misunderstands that, then Mish misunderstands the economic problem.

Debt has accumulated to the point that the economy can no longer function as we need it to function, because of the cost of that debt. Nothing could be simpler. If we want to have an economy that is not dysfunctional, the one essential thing is to reduce debt.

Keen understands this. Mish, apparently, does not.


Anonymous said...

A debt jubilee substitutes one moral hazard for another.

The banks can lend as much money as they want with taxpayer backing (income tax or inflation tax).

The debt jubilee poposal seeks to substitute one moral hazard for another.

The solution is to allow people to borrow as much as they want with taxpayer backing and again little to no repercussions?

The goal should be to reduce the credit boom in the first place. The only way to do this is let the demand for money from push up interest rates, which can only happen when there is a finite amount of money in the system.

The Arthurian said...

"The goal should be to reduce the credit boom in the first place."

Yes I agree absolutely with that.

I do think it would help if we could get some vigor back into the economy again, and I think having less accumulated debt would help there.

Whether that is practical or not, is another question.

"The only way to do this is let the demand for money from push up interest rates, which can only happen when there is a finite amount of money in the system."

I think letting the demand for money push interest rates up is ONE way to do it. I also think it is essential to gradually remove all the inducements designed to get us using MORE credit: Inducements to save more, and inducements to borrow more and inducements to spend more while the quantity of money is restricted. Gradually and carefully removed.

I would also like to see taxes used in a way that duplicates interest rates going up under monetary policy. For example: A tax rate that varies with the taxpayer's debt (or with his debt relative to income, or something), so that the heavy borrower pays more "interest" (in this case, "tax") than the low-debt person does. This can work just like interest rate changes, except it applies to the borrower individually. It doesn't force high interest rates on the whole economy all at once.

That plan must be coupled with a way to get those higher taxes down, which is by making some extra payments on the debt owed. Which would help with deleverage. And with the vigor I mentioned.

These ideas are exactly like the monetary policy you describe, except they would be far less likely to create recession.

Thanks for the visit!

Anonymous said...

I know this is late, from previous blogs, but just found it, thought you might enjoy it:

‘The Formula That Killed Wall Street’?
The Gaussian Copula and the Material
Cultures of Modelling

Extracting reliable estimates of a large set of partial derivatives such as a deltas from a Monte Carlo
copula model was vastly more time-consuming than using the model to price or to rate a
CDO tranche. In a situation in which the IT departments of many big banks were
struggling to meet the computational demands of the overnight runs – ‘some days,
everything is finished at 8 in the morning, some days it’s finished at midday because it
had to be rerun’, an interviewee told the first author in early 2007 – the huge added load
of millions of Monte Carlo scenarios was unwelcome. The requisite computer runs
sometimes even had to be done over weekends: an interviewee told the first author of one
bank at which the Monte Carlo calculation of deltas took over forty hours.


Tom Hickey said...

This is about who is going to take the hit and when. TPTB are resisting as long as they can the reality that debt which cannot be repaid won't be. They can take some writedowns and restructuring now or they can wait for the collapse. What don't they understand about capital at risk? They extended credit imprudently and now they are holding the economy hostage in their demand to be repaid in full, principle and interest.

A debt jubilee is one way to do it, which Keen and Michael Hudson favor. I'd send Bill Black, Hudson's colleague at UMKC and former regulator, in as special chief regulator for a re-do of the S&L resolution, which he participated and where there were over 1000 successful prosecutions of lenders.

The Arthurian said...

I am clever to take the same view as Keen and Michael Hudson, don't you think? :)

I don't care so much about prosecutions as I do about (1) getting the economy going again (which requires debt reduction ASAP) and (2) making sure that we never again allow debt to accumulate to even half the present level.

But I could live with it.

Nashface said...

Here's a laymen's view, but I think its worth offering:

Debt levels are a function of the future. In some sense, the brighter the future looks for everyone, the more debt we can accrue based on the reliability that people will have good lives, will work hard and be justly compensated, and will save in the sense of accumulating non-predatory debt to build valuable assets (houses come to mind, but lots of things could work in the future). A smart, reliable debtor who buys a home should be forgiven a larger debt level in the context of a steady employability, hard work ethic, and the idea that he is building something, whether its IT innovation, or flipping hamburgers to feed people, or whatever. The problem lies in the structure of the economy, and although debt levels were too large, debt per se should not be some fixed level. It is a tool, by and large, with which to ameliorate some of the more outrages swings in the relative wealth of people who actually produce things.
So if we are going to talk about debt further, the type of debt, and who owes what to whom, should be front and center. This doesn't negate the need I see for higher levels of government debt, in the interest of infrastructure and education and research, for instance, in addition to a stronger safety net. So advocating for that does not make my view a dinosaur because of its unspecificity.The other issue is that there are structural problems we need to address a la Mish about our economy, and there is a difference between who you are guaranteeing the debt of, the banks or the people. I would say that the type of debt we took on was much more a self-aggrandizing financial douche bag debt than any kind of consumer recklessness, so the idea of a debt jubilee, or debt forgiveness, aimed at consumers is almost certainly a better "moral hazard" than the one we have now (LIBOR, the London Whale, offshore tax havens, refinancing small print ponzi schemes anyone?) The overall course of action to address the structural problems could very easily include a debt jubilee, as they are essentially somewhat separated issues. I think economists conflate them for the purposes of cutting each other down to build themselves up, like their theories are robots and they are battling them off to find a winner. But robots should be tools, and a structure addressing robot shouldn't be fighting a debt analysis robot, and neither should be fighting a stimulus robot (esp in the face of low borrowing costs, a stalled economy, and barely existant inflation). Debt and deficits should be looked at as a tool. The problem is the underlying assumptions about our economy.


Nashface said...


Mish, as an Austrian economist, thinks government can't do anything right I assume, so right there you have a sticking point. As the planet heats up, as we use up natural resources, I think the idea that the free market will anticipate and solve these problems for monetary gain is short sighted. The environment doesn't crash overnight, and can't stay afloat from a bailout. All successful markets are regulated and transparent, and their efficiency stems from that. So the Austrian idea really can't do any good as long as air pollution, global warming, sea level rise and a realistic and transparent energy market (ie non subsidized) are encouraged by, you guessed it, a governmental regulating body that ensures such markets work well. If everyone knows that the planet is getting more and more unlivable, debt will continue to shrink because the future will be darker. "getting the economy going" is a short sighted goal in light of the actual pessimism out there that things will always just suck for most people, hence grab the money and run. Thats why the smartest and most motivated essentially run a top down financial scam, and their booms and busts never address the fundamental issues. So yeah, they should go to jail, because the market is opaque and corrupt, and seeing that just grabbing and running could be a jail-able offense would encourage people to look more closely about not only what they are doing for the economy, but also whether going into a profession based on market manipulation is really the smartest option: one structural issue solved. So I would argue that prosecutions are more important than an un-thought out, arbitrary level of debt to stay under. We need to address debt in a smart way, that does not reward the sharks. The same for structural changes in the economy, the same for deficit spending. We need better quality, not the arbitrary confiscation of one issue or another. We need money not to be such an explosively powerful force. And thats when things start to get better.

Anonymous said...

I think that Steve Keen is saying that there is no such thing as Fractional Reserve banking from his other works (talks/blogs).

So the fractional reserve stuff is really just nonsense. Lending is not limited by reserves. The GFC pretty much proves this point since reserves have exploded but lending has not followed.

Greg said...

I think its time to put the moral hazard arguments against a jubilee to rest............. for ever.

We have already bailed out the bondholders and banks or are in the process of doing so. There were the same moral hazard arguments against this as well................. but they were ignored.

Somehow now though when its being considered to provide relief for the other side of the balance sheet (the debtor), THIS moral hazard will result in the end of civilization!!??

Considering the moral character of the average person screaming about these things (we all fall pretty far short of most standards over all) I think we should collectively yawn when we her such opposition and just say "Get on with it, so we can get on with life". Its this limbo period that is killing us all.

The big question is how, after we've bailed all out, do we prevent it from reoccuring. Banks worried about people borrowing more than they can pay can do real income checks on people but more importantly we can decrease the reliance on private credit money for our economic activity in the first place by making debt free money a larger portion of everyones income.

Neil Wilson said...

The debt jubilee will reset the system, but you have to have put in place prudential regulations of the banks ability to expand its balance sheet before you do the reset.

Otherwise you just wind the clock back and we head towards another financial calamity in the future.

There has been some debate about what the regulation should be and how it is to be enforced, but not enough I think to get a system design to drop out that will hold up under fire.

Neil Wilson said...

The problem with the term 'Fractional Reserve Banking' is that most people misunderstand what it is getting at.

Fractional banking works by having a small buffer of capital sat there to absorb the expected losses from bad loans. Loans that are many multiples of that capital

That is the 'fractional reserve' - reserve here being using in an accounting sense of an equity buffer not freely allocated to the owners of the business.

It has nothing to do with Central Bank Reserves - which are a form of loan from a commercial bank's point of view.

The Arthurian said...

Hi Neil.
"The debt jubilee will reset the system, but you have to have put in place prudential regulations of the banks ability to expand its balance sheet before you do the reset."

So, you would let the economy languish until all the policy predictions are agreed upon and the policies in place? I don't think we can wait that long.

Anyway it is simple. What we need is to realize two mistakes in our underlying assumptions.

1. Yes, printing money causes inflation, but so does lending.

2. Yes, credit is good for growth, but not if we have too much debt already.

If people and policymakers could make those simple mental corrections, all the rest would be easy.

Thanks for the visit. Hey, I had a lot of hits on this post. Do you know the source of that?

Greg said...

" Hey, I had a lot of hits on this post. Do you know the source of that?"

Probably the mention of Mish in your title. He's a pretty popular guy