Tuesday, February 14, 2017

Should democracies reclaim power over production of money?

Ann Pettifor writes a blog post drawing on her new book "The Production of Money: How to Break the Power of Bankers" saying as much. At the outset I must say that I love to read her articles and posts and I have tremendous respect for her.

Her diagnosis is that our present predicament is the following: (emphasis mine)
It is my view that current economic disorder is largely caused by the invisibility, the lack of transparency, and the intangibility of the international financial system – the cause of recurring global economic failure. The fact that the system cannot be seen or understood, that it is opaque to society, means that it cannot be changed or transformed by society. Widespread ignorance of the workings of the great public good that is our monetary system has made society vulnerable. Ignorance enables those financial interests that have wrested control of the system away from democracies, to continue to undermine the security of society. 
If democracies are to once again subordinate the finance sector to the role of servant to the real economy, it is vital that the public gains greater understanding of the monetary system – which I believe to be a great public good. That is the ambition of my modest book, The Production of Money.
This book indeed will be interesting. At present, I am only commenting about this post. I am with her up to this point.  Understanding the monetary and banking system is indeed important. But then she cites an example of the system:
The reality of life under a model that elevates the global over the domestic economy was starkly exposed recently by the fate of a small tea room based in Highcliffe Castle, Dorset. The tea-room had been owned and run by a local, Sean Kearney, for 17 years. It was put out to tender by the council. The company that won the tender was a global behemoth – the $14bn Aramark corporation, that owns prisons and canteens worldwide and is headquartered in Philadelphia. 
This ‘storm in a tearoom’ as The Times dubbed it, was a classic example of how today’s economic model fails the people of Britain. It pits the minnow of a locally-owned tea room against a globally powerful and financially mobile shark. This is not free market competition. This is grossly unfair, economic slaughter of a viable business. As a result Sean Kearney may well now become one of those ‘left behind’ by British government policies.
I am not sure I understand this. There are too many confusing ideas at play. Are we against a buyout of small companies by big ones? Are we against a buyout of local companies by foreign companies? Are councils beholden to grant tenders to local individuals? 

Then she says:
Depressingly, our politicians – on both sides of the House – learn nothing from this. Despite all the nationalist rhetoric, we know that the dominant economic model that led to the populist uprising for Brexit has not been seriously challenged by the Conservative party, or any of our politicians. The government will continue to stand aside as footloose, mobile capital uses its absolute advantage to swallow up the enterprising minnows of the economy, and to wreak havoc on society’s social, economic, and political goals.
This example is very casually stated - it does not buttress the case of the book. In fact, governments that intervene in such deals are frowned upon by commentators like Ann Pettifor. Such protectionist interventions are limited to companies where strategic interests are involved. (Ports, dams, critical road or intellectual property etc.) What is surprising are the steps suggested to control the capital are even more onerous.
Capital control over both inflows and outflows, is, and will always be a vital tool for doing so. In other words, if we really want to ‘take back control’ we will have to bring offshore capital back onshore. That is the only way to restore order to the domestic economy, but also to the global economy. 
Second, monetary relationships must be carefully managed – by public, not private authority. Loans must primarily be deployed for productive employment and income-generating activity. Speculation leads to capital gains that can rise exponentially. But speculation can also lead to catastrophic losses. Loans for rent-seeking and speculation, gambling or betting, must be made inadmissible. 
Third, money lent must not be burdened by high, unpayable real rates of interest. Rates of interest for loans across the spectrum of lending – short- and long-term, in real terms, safe and risky – must, again, be managed by public, not private authority if they are to be sustainable and repayable, and if debt is not going to lead to systemic failure. Keynes explained how that could be done with his Liquidity Preference Theory, still profoundly relevant for policy-makers, & largely ignored by the economics profession.
This takes the pendulum in the other direction. I have a problem with this approach.

Removing the power of creating money from Banks 
It is a bad idea. The function of banks in a properly governed system is to create money where there is a potential for creating value. This distributed money creation helps create money at the point where it is most useful. And the same time if it is not useful a money incurs a cost that is interesting and expense on the bank's balance sheet. The core principles of this process have been undermined in the recent years. But that does not mean the principle is bad. 

Dr Pettifor suggests that a public body needs to take charge of this function. In fact, governments or public agencies are absolutely the worst agency to create money. If you imagine a bureaucratic agency like central bank to take it over then you will end up with delays. Further such bureaucratic institutions are open to regulatory capture by the same banks.

The alternative is the political system. Political systems are best geared to determine "policy direction" and not operations. Thus, without expertise, if you let politicians determine the money creations you will have a worse system than what you have.

The problem with the present system is not that it has failed. But it is that it does not fail enough. The regulatory mechanisms are mollycoddling the banking industry. Because of regulatory interventions, banks do not fear the losses from risk-taking. In my book, Subverting Capitalism & Democracy I call this failure of attribution. Regulation should make these losses more directly attributable to the banks. So no bailouts. Increase capital buffers - Anat Admati recommends 30%. There should also be an unlimited liability to shareholders to the extent of losses caused by their firm. 

The "bad" debt and capital issue
Dr Pettifor is right when she says that interest rates cannot be ridiculously high. Credit-card industry is a prime example. It is in a dire need for regulatory oversight. The Elizabeth Warren's initiative to reduce the credit-card agreement to readable short form is commendable.

She is also right to the extent that loans should not be made for non-productive uses. In effect, she implies we need to differentiate good debt from bad debt. This is absolutely critical and I have said so before. Productive debt creates an asset of higher value than the debt itself.

The question we need to ask is why banks were ready to lend for non-productive activities. The answer lies in the export-led growth model pursued by developing countries - first Japan, then South East Asia and then finally China. To hold their exchange rates low they created dollar reserves sending large amounts of capital into the US. The US has benefitted enormously from this available capital. It pushed the risk curve lower thereby sending funds (venture capital) into high-risk ventures. Without the return-lowering effect of this capital Google, Yahoo, Facebook none of this would be possible.

Another side of the problem, the expert central banks have kept interest rates too low for too long. This low-interest rate regime has caused some damage resulting in mal-investment. It has also pushed capital as an alternative to labour leading to lower quality employment.

In recent years the tide has turned. The new capital was generated by consumption overseas. This capital does not want to return to the US - because of taxes and other reasons. But more importantly, this capital does not want to finance bad investment (debt or equity). If you really think it through most of the low-hanging "productive" opportunities are in developing countries. In effect, what the capital is saying is that - on a post-tax level the capital cannot create a positive, real return in the US. If such returns were possible this capital would have flown back to the US.

The real problem
Dr Pettifor's line that "you need to cut out the bankers from the production of money" may be paraphrased for marketing reasons but it is not a solution. However simple we want life to be, the reality is it is quite complex. The solution to the 2008 financial crisis is fixing the various failed incentives structures created by public systems. The solution is not the let public systems go berserk in other areas. The solution is to reorient the incentives - one by one. It is not a glamorous solution but it is the only thing that will work.