Posted by: Dirk | September 3, 2014

Spanish unemployment goes up again

Reporting unemployment numbers is always a bit of a game. Cyclical variations mean that you can either show that unemployment goes up or down, you just need to pick the right moment in the cycle. At this point in the cycle, many Spanish summer jobs are over. School restarts, and people don’t go to the beach anymore in September (though not this September, as Mediterranean temperatures rise above 30 still.) So, unemployment goes up, as El Pais reports (have look at part time contracts – parciales – to see the story). This comes hardly a week after German chancellor Merkel visited Spanish president Rajoy. Deutsche Welle reports:

Visiting Chancellor Merkel also lauded the gradual Spanish turnaround, saying it was the result of “very challenging and difficult reforms” embarked upon by Rajoy’s government. Merkel said that “the foundations are now laid” for a more sustained improvement of the Spanish economy.


The crisis in Spain continues, and given the contractionary fiscal policy stance in the whole of the euro zone it remains to be seen how and when growth will revive. If everybody spends less, the demand will continue to be weak. This problem has been with the euro zone since 2010, when worries about the ability to repay its debt started in Greece. Spain will not see its unemployment rate return to normal until something is done to the aggregate demand problem. The market was supposed to heal itself, but since the crisis in Spain started in 2007 that has already taken 7 years and it doesn’t look like things are improving.

Reuters reports from the Jackson Hole conference of late August, writing that the Bank of Japan’s governor Kuroda has proposed to set benchmarks for wage negotiations:

Low long-term interest rates will likely not rise until the 2 percent target is reached, he said, adding that the BoJ’s 2 percent inflation target, once met, could serve as a benchmark for wage negotiations.

This is quite interesting, because it goes completely against neoclassical thought. This school of economics recommends that government stays out of the market in almost anything, and that higher (real) wages lead to more unemployment. Since neoclassical economics assumes that the inflation rate is determined by the stock of money supply, a rise in nominal wages would increase real wages and hence increase unemployment. Kuroda begs to differ, based on the view that the inflation rate is mostly determined by the change in the nominal wages. More inflation is good because it allows debtors to pay off debt more easily. If my wages are rising 2% a year rather than not at all, it is easier for me to repay any debt that I have contracted.

The comments by Draghi have already been reported in the press, but in case you want to see the ECB president speaking of demand problems again, here is the paragraph from the transcript:

Cyclical and structural factors

Cyclical factors have therefore certainly contributed to the rise in unemployment. And the economic situation in the euro area suggests they are still playing a role. The most recent GDP data confirm that the recovery in the euro area remains uniformly weak, with subdued wage growth even in non-stressed countries suggesting lacklustre demand. In these circumstances, it seems likely that uncertainty over the strength of the recovery is weighing on business investment and slowing the rate at which workers are being rehired.

I would add that it is not uncertainty over the strength of the recovery which is the problem, it is the certainty that in a situation of lack of demand that is the problem. Maybe Draghi agrees but can’t say that much. After all, his job depends on Merkel and the other heads of state, who constitute the European Council (Wikisource):

11.2. In accordance with the second subparagraph of Article 283(2) of the Treaty on the Functioning of the European Union, the President, the Vice-President and the other members of the Executive Board shall be appointed by the European Council, acting by a qualified majority, from among persons of recognised standing and professional experience in monetary or banking matters, on a recommendation from the Council after it has consulted the European Parliament and the Governing Council.

Nothing on this planet is ‘independent’, and the same goes for the ECB. The power is – at least to some extent – with politics, as it should be. Whether a central bank should be ‘independent’ at all is a different discussion.

Posted by: Dirk | August 26, 2014

Sparpolitik is actually Investitionspolitik

German blog Nachdenkseiten comments on the crisis of the French government by saying that the vocabulary needs to be rethought. The German Sparpolitik could be translated as policy of thrift. Whatever its name, in Europe it does not seem to work well as an economic policy. The self-equilibrating forces of the market seem not come to the rescue, and the cuts in government spending imposed on the European periphery largely translated into reductions of income and a subsequent rise in unemployment.

Let’s revisit the idea of Sparpolitik, which is the idea of a rise in savings being somehow good for the economy. Trichet, former president of the ECB, is on the record with this:

“It is an error to think that fiscal austerity is a threat to growth and job creation. At present, a major problem is the lack of confidence on the part of households, firms, savers and investors who feel that fiscal policies are not sound and sustainable”

But how do you increase the savings of an economy? I mean, in real life, not in some high theory macroeconomic model. Well, we have a set of identities, and it should not be that hard to find out how to increase savings of an economy. Let’s start by defining income (GDP) as consumption plus investment plus government spending:

Y = C + I + G

We omit foreign countries, because we don’t want to increase the savings of our economy so that the savings of some other economy comes down. So, we have income Y and now we need to define savings as income not spend by neither private sector (C) nor public sector (G):

S = Y – C – G

Obviously, the difference between the two equations is the omission of investment (I), but let’s not take that short cut now. In order to run a proper Sparpolitik, you would want to increase savings. That only works if income rises or government spending or consumption are reduced. There is a slight complication with the latter two: consumption and government spending feature in our equation (1). If these two segments of demand go down, than income will also go down and hence savings will not go up. The fall in consumption (C) or government spending (G) will be exactly matched by a fall in income (Y). So, the only road open to us leads through an increase in income Y. How is this going to happen?

Looking back at equation (1), we see that a rise in income could come about trough a rise in consumption, investment or government spending. Keeping in mind that equation (2) has Y-C and Y-G on the right sight respectively, an increase in consumption (C) or government spending (G) cannot lead to a rise in saving, since income (Y) rises simultaneously only with C and G.

Hence, there is only one way to increase the savings of a single national economy and that leads through an increase in investment! Only with an increase in investment would income rise in equation (1) and savings in equation (2), since investment is not part of the right hand side of equation (2)!

Sparpolitik is then not the proper name of any policy intended to raise savings – it should be called Investitionspolitik!

Why is investment not on the rise in the European Union? Interest rates are close to zero (or below), but still investment doesn’t seem to jump upwards. What can be done to increase private investment is to increase public investment. An increase in government spending shrinks public saving but increases private savings since the private sector will have more government bonds, which constitute income not spend. So, there is no rise in savings, but if as a result of this policy private investment will pick up then an expansionary private sector can drive investment and with it savings up.

This is just a small exercise in national income accounting. The two equations from above are identities, which means that they cannot be ‘wrong’. Either you define savings and income like we did above or we don’t. Since the Great Depression economists use these identities, and it should be crystal clear that there is no Sparpolitik without Investitionspolitik – actually, they are two sides of the same euro.

Posted by: Dirk | August 25, 2014

Banking is boring … in Japan

Bloomberg reports that banking is incredibly boring in Japan – apparently, the Citibank CEO’s salary is higher than the profits of its Japanese branch:

Citibank Japan Ltd.’s net income of 1.34 billion yen ($12.9 million) in the year ended March compared with CEO Michael Corbat’s total 2013 compensation of $14.5 million. The U.S. bank has begun approaching Japanese companies including the three biggest lenders, trust banks and regional lenders, a person familiar with the matter said this week.

Unprecedented monetary stimulus has cut the spread between lending rates and deposit rates at Mitsubishi UFJ Financial Group Inc. to a record low in the first quarter. Cash and deposits at the nation’s biggest bank and its two closest rivals piled to 82 trillion yen last quarter. Citigroup is considering a retreat from Japan after pulling back from retail banking in markets with low returns, including Spain, Greece and Turkey.

The difficulties to make money probably have something to do with the weak demand for loans in Japan. Obviously, banking is demand-led. You cannot supply borrowers if they don’t demand anything. For the last 20 years, the private sector has been reducing its liabilities. To make up for the shortfall in effective demand, government spent hundreds of billions of yen to keep the economy at somewhere close to full employment. Compared with what Spain and Greece are going through it has been a resounding policy achievement so far. However, government bonds are boring for bankers, especially if the central bank buys them up and clearly fixes the prices (which it does anyway, but it is more obvious now in Japan then ever). There does not seem to be any indication that this will change in the near future, especially not after the unsurprising big dent to GDP growth after the latest tax hike (Reuters).

The thing that isn’t boring can be done from without: exchange rate speculation. As Bloomberg reported last year:

George Soros made almost $1 billion since November from bets that the yen would tumble, according to a person close to the billionaire’s $24 billion family office.

The Japanese wager helped the firm return about 10 percent last year and 5 percent so far this year, said the person, who asked not to be named because the firm is private. The yen has weakened 17 percent versus the dollar since about the start of the fourth quarter, the worst performance over a similar period since 1985.

With no further weakening of the yen in sight, bankers and central bankers in Japan might as well enjoy a vacation or two. Probably it would be their first since ‘the crisis’ which started in 1991. They could try to think about a new concept to describe what has happened to Japan and discuss existing economic theories in order to solve the countries economic woes. One hint: another tax hike is not a good idea. Another hint: it is not a problem of social justice or the budget, it is a macroeconomic problem. Which some say started with Wicksell back in 1898.

Posted by: Dirk | August 4, 2014

There is no ‘great bond mispricing’ in the US.

FT Alphaville has a discussion government bond (treasury securities) prices:

The theory is that taper talk prompts dumb money to sell safety, and the smart money — which knows there’s no such thing as underpriced principal safety these days and that taper implies risk-off — to pile into safety at an even faster rate.

However, from a monetary theorist point of view there should be no discussion. The price of US treasury securities is not set by the free market, it is set by arbitrage. This graph from FRED2 shows you 1-Year constant treasury maturity minus federal funds rate:


The price of treasury securities is set – via arbitrage – by the short-term interest rate on the money market. The different maturities are connected via arbitrage, too. Bond prices and therefore effective yields are not set by central banks of emerging economies and the interactions of supply and demand. They are set by the Fed and by market makers ‘playing’ the yield curve. As long as the Fed’s interest rates are low, the price of US treasury securities will not go anywhere.

That does not mean that you cannot make money in the bond market, obviously. However, I’d argue that the closer the line of the graph above is to zero, the less money you can make. Sovereign Bond markets have been boring (while people shouted: “Hyperinflation”), are boring (“Debasement of the Dollar!”) and will be boring for some time (“The Great Bond Mispricing”). If you want action, look at ‘sovereign bonds’ denominated in foreign currency drafted under foreign law.

German Sunday paper FAS, which belongs to FAZ, has an article named “Hilfe, die Bank will mein Geld nicht” in today’s paper. The title translates to “Help, the bank doesn’t want my money”. The author seems to understand that low interest rates at the ECB are the major cause, but he doesn’t go further and asks why they are so low. Perhaps the German public is not ready yet for the admission that austerity has driven Europe’s economy into a hole, which even ultra-low interest rates can’t fix.

For the first time in the conservative press I see an intent to put forward “endogenous money”, as the author writes:

Zwar ist die verbreitete Vorstellung, Banken könnten nur dann Kredite ausleihen, wenn sie vorher gleichviel Geld bei den Sparern eingesammelt haben, ein populärer Irrtum. “Einlagen- und Kreditgeschäft einer Bank sind nicht unbedingt gekoppelt”, sagt der Bonner Ökonom Martin Hellwig. Banken können sich auf unterschiedliche Weise finanzieren: über Spareinlagen, aber auch über den Geldmarkt oder die Notenbank.

So, it is a popular myth that banks can only make loans after they have acquired savings to the same amount. “Deposit and Credit business of a bank are not necessarily connected”, says Bonn economist Martin Hellwig. Banks can finance in different ways: through savings deposits, but also through the money market or the central bank. I must say that I am amazed to read this. It is a first try to ‘get’ the endogeniety of money, which describes the fact that banks create loans and deposits from nothing. Also, Martin Hellwig is not the reference for endogenous money, and in his 2012 book with Anat Admati he definitely does not understand it:

Banks use both borrowed and unborrowed money to make their loans and other investments. Unborrowed money is the money that a bank has obtained from its owners if it is a private bank or from its shareholders if it is a corporation, along with any profits it has retained.

This is traditional loanable funds theory: bank borrow money to ‘make their loans and other investments’. It is good that Martin Hellwig has changed his opinion, I’m glad he did. However, this should be the start of a big rethink. If those people who held the loanable funds theory dear have been wrong, what about the people who have been right all along? Shouldn’t we be saying: “there was a contest in the discipline of economics to explain how money works, and one side succeeded?” After all, the stuff in the textbooks is still wrong. Olivier Blanchard’s book (2003 edition, but I am very sure it did not change) says:

  • High-powered money is the term used to reflect the fact that the overall supply of money depends in the end on the amount of central bank money (H), or monetary base.

Well, that is wrong. Banks don’t need reserves to make loans. Hence the overall money supply does not depend on central bank money. And economists wrote about it long ago. Here is an example from Knut Wicksell:


That seems to be right. When was this written? Well, in 1898. Yes eighteen-98! And Keynes in his early years was a ‘Wicksellian’, writing about the monetary circuit from a balance sheet perspective. Where does the money come from, where does it go, etc. If economics is a science, then it must be about a competition of ideas – which we might call theories if they are more complex – and regardless whether we like it or not, the winner should be made ‘mainstream’, by including this theory in all textbooks, and the runners-up should be put into boxes in textbooks (if they are interesting enough) and books on history of economic thought. After all, we can never be sure that we are right when it comes to social arrangements. Nevertheless, endogenous money is a theory that is able to fit with reality on a lot of things, whereas loanable funds doesn’t.

Loanable funds theory, for instance, assumes that the interest rate is set endogenously in the money/capital market. However, it is quite clear that the ECB, the Fed, the BoJ, the BoE and so on all set interest rates. Then, it can’t be determined in the market. Also, these central banks deny that they control the amount of reserves. Here is the ECB (my highlighting):

Standing facilities aim to provide and absorb overnight liquidity, signal the general monetary policy stance and bound overnight market interest rates. Two standing facilities, which are administered in a decentralised manner by the NCBs, areavailable to eligible counterparties on their own initiative.

Marginal lending facility

Counterparties can use the marginal lending facility to obtain overnight liquidity from the NCBs against eligible assets. The interest rate on the marginal lending facility normally provides a ceiling for the overnight market interest rate.

Deposit facility

Counterparties can use the deposit facility to make overnight deposits with the NCBs. The interest rate on the deposit facility normally provides a floor for the overnight market interest rate.

The marginal lending facility is open 30 minutes after the closing of the market. If banks borrow more reserves after markets closed, there is nobody at the ECB or its member central banks who could counter the increase in reserves.

I sincerely hope that in the coming months we will see a wider discussion of endogenous money as a description for how banks work. It will then become clear that repayment of loans destroys money in the form of deposits, and that this is what is holding the European periphery, nay, the whole euro zone back. If we as European consumers have less deposits in our bank accounts, how are we supposed to buy more stuff? If we don’t, then unemployment will stay above 10% in the euro zone and the slump continues. This is an unhealthy situation brought about by ‘the free market’, and if economic policy does not intervene then the weak economy will continue. What this means for European politics should be clear to everybody (article by Reuters):

French far-right leader Marine Le Pen would reach the final round of a presidential election if voters were to vote now, winning more votes than any mainstream party in the first round, a poll showed on Thursday.

The survey by pollster IFOP showed Le Pen winning 26 percent of all votes in round one of the two-round election, versus 17 percent for either President Francois Hollande or his more popular prime minister, Manuel Valls.

The next presidential election is in 2017.

The end of Europe as we know it is what it could mean.

In a NYT article, Laurence Kotlikoff gives us his account of economics as it used to be: a science to confuse the public about what a government can and can’t do:

HOUSEHOLDS can’t spend, on a continuing basis, more than they earn. Countries can’t either, at least not over the long run. But countries can certainly leave the bill for their current spending to the young and to future generations. Official borrowing is the old-fashioned way to do this: Sell Treasury bonds, and other securities, and spend the proceeds. But borrowing in broad daylight has a drawback: The more you do it, the more lenders worry about repayment, and the more interest they charge for their loans.

This might sound very logical, except that there is a problem: a government is not a household. Why not? Well, households don’t have an account at the central bank, as the US Treasury has. Households also cannot sell treasury (or household) bonds that are risk free, because if push comes to shove the central bank will buy these bonds on the secondary market to an extent that all actors on the primary market will engage in arbitrage. If banks buy treasury bonds (and bills and notes) directly from the government, and they know that they can turn around and sell them to the Federal Reserve Bank for a profit, then there should be no doubt about one thing: the US government cannot go bankrupt. Which household can say that?

Kotlikoff continues:

The fiscal gap — the difference between our government’s projected financial obligations and the present value of all projected future tax and other receipts — is, effectively, our nation’s credit card bill.

Right. If the US government spends more than its tax income in the future, then it is charged to ‘our nation’s credit card bill’ today. As I have described above, the US Terasury does not have to rely on bank loans or credit card companies to finance its expenditures (above taxes). Let’s jump to his conclusion:

What we confront is not just an economics problem. It’s a moral issue. Will we continue to hide most of the bills we are bequeathing our children? Or will we, at long last, systematically measure all the bills and set about reducing them?

That is utter nonsense. We will not bequeath any bill to our children. If government spends more than it collects in taxes, it issues treasury bonds. These treasury bonds are bequeathed to our children, too. Somebody will be quite rich, as there are quite a lot of government bonds outstanding. Inequality can be a problem, because the future tax payers transfer money to those that are holding the bonds. Conveniently, Kotlikoff overlooks this issue.

The framing used by Kotlikoff to talk about US government debt is misleading. It is based on false analogies, starting with the idea that government spends just like a household. One could argue for lower social security payments, but not on the basis that the US government can’t afford it.

Posted by: Dirk | July 28, 2014

The ECB on money: enhancing monetary analysis

The ECB discusses money in its paper “Enhancing monetary analysis”. Chapter 1 is titled “The role of money in the economy and central bank policy”. It was prepared by Giacomo Carboni, Boris Hofmann and Fabrizio Zampolli. The ECB distinguishes inside and outside money.

Banknotes and coins – or in short, currency – are normally the most secure form of money. They are issued by the central bank and/or government, which vouches for their general acceptability and the stability of their purchasing power. Equally safe are the deposits held at the central bank, normally available only to banks. Banks use them both as a means to settle payments among themselves and as a reserve to meet unusual demands for withdrawals of currency by their depositors. Along with the currency in circulation, the deposits held at the central bank constitute the so-called “monetary base”, “central bank money” or “outside money”.5 This money is usually “legal tender”, which means that any potential creditor is obliged by law to accept it in settlement of any debt.6

5 It is known as “outside” money to highlight the fact that it is created by the public sector as opposed to the private sector (and could be in principle controlled more easily) or as “high-powered” money to stress the fact that it constitutes the basis of the entire monetary pyramid whereby banks – by operating a fractional reserve system – create a volume of media of exchange that is a multiple of the money created by the central bank.
6 Importantly, the exact definition of “legal tender” may differ from country to country.

The second paragraph are the footnotes of the first. A different term for central bank money would be reserves. The paragraph on legal tender is somewhat interesting. Footnote 6 says it may differ from country to country. Nevertheless, tax payments ultimately are made in reserves (or what the ECB calls central bank money). Sadly, the ECB does not mention this and completely erases the fiscal part from the whole story. That probably has created the blind spot which led to the creation of a euro zone in which sovereign bonds were not risk free. The ECB continues then describes endogenous money (my highlighting):

Deposits issued by private banks, which are what most individuals and companies have access to, are held for the safety and the convenience that they offer over currency. Not only are they less subject to the risk of theft, but they also offer the convenience of a range of payment options, such as cheques (now less common than in the past), debit and credit cards, and electronic transfers. Other types of securities are also used as a means of payment – for example, certain IOUs issued by private non-financial corporations and widely traded on financial markets (commercial paper), or units in money market funds. The overall amount of money in circulation is, to a large extent, determined by the behaviour of banks and the (profit-seeking) behaviour and interaction of a myriad of private agents.

This, I think, is correct. The amount of money (=deposits in banks) in circulation is largely determined by banks lending to the private sector. What does not determine the amount of money (=deposits in banks) is the central bank, which is in the business of setting the interest through, as the ECB says, variations of the amount of reserves (=central bank deposits of banks). The text goes on describing the money multiplier, but then backing away from this concept:

However, as recently pointed out by Goodhart (2010), a major drawback of the money multiplier approach to money supply analysis is its entirely mechanistic character, which does not offer an account of the behaviour of the central bank, private banks or the private sector money-holders. The pace of financial deregulation and financial innovation over the last few decades has certainly challenged the notion of a stable money multiplier. Also, in times of crisis, money multipliers may prove to be highly unstable and hence may be a poor guide to predicting the effect of monetary policy measures on the money supply. This has become manifest during the global financial crisis, where the massive expansion of base money by central banks was not reflected in the development of broader monetary aggregates because of a collapse of money multipliers when banks were hoarding reserves.

So, the view of the ECB of money is correct. There are some parts omitted from the picture, like the idea that taxes drive money and not price stability, but the description of the two monetary circuits – bank deposits and central bank deposits – is correct. One would have hoped for some more detailed descriptions of interbank clearing and fiscal operations, but there is some good literature (like Fullwiler 2008 and Wray’s MMT Primer) out there which explain it from a balance sheet perspective. Since the BoE and other institutions and academics agree with this, maybe we have New New Consensus?

El Pais reports that the Spanish government has sold Catalunya Banc for €1.1 billion to BBVA. The newspaper writes:

Esta operación supone que los contribuyentes pierden definitivamente 11.839 millones de euros, una cantidad que se acerca a los recortes en sanidad y educación hasta 2013, que suman 13.800 millones.

La entidad, que llegó a ser la cuarta mayor caja de España, tenía unas ayudas directas del Estado de 12.050 millones y otros 572 millones inyectados posteriormente por el FROB para la venta de la cartera de hipotecas tóxicas. En total ha puesto 12.622 millones y recibirá 783 millones con la venta porque solo tiene el 66% de Catalunya Banc. La operación incrementará el déficit público porque el FROB valoró en sus libros a Catalunya Banc en 1.858 millones y percibirá 783.

So, the tax payers lose definitively €11.8 billion, which is about the full amount of cuts in health and education until 2013, which stand at €13.8 billion. The bank, which was the fourth biggest of Spain, had direct aid from the government of €12.05 billion and another €572 million from the sale of the toxic mortgages from the ‘Fund for Orderly Bank Restructuring’ (FROB). The public deficit will go up as a result of this operation because FROB valued Catalunya Banc at €1.848 billion and will receive €783 million.

This is what happens when you bail-out a bank that is not illiquid, but insolvent. I think that there needs to be a discussion why you use €11.5 billion for bank restructuring, which then become a definite loss, and not for propping up health care, education or other government services which have been cut harshly over the last years. The Spanish governments (Zapatero, Rajoy) had a political choice to increase taxes or cut government spending, to bail-out their insolvent banks or to let them fail in an orderly way (yes, there are rules for that), they had the possibility to press for a European solution because Spanish banks owed German banks hundreds of billions of euros on the interbank market, they could have pressed for a less harsh interpretation of the deficit rules, etc. Whatever they did, the results have basically been zero. Yes, they kept Spain in the euro zone, but that is the status quo and it is unclear whether it was a good idea to stay in, given that the institutions (fiscal rules, banking regulation) are what they are.

Reality is constructed through politics, and politics can be quite one-sided. That, it seems to me, is the lesson to be learned from Spain, where creditors are saved once and again at huge fiscal costs while youth unemployment stands at 54%. Spain’s GDP today is still below that of 2007.

Posted by: Dirk | July 17, 2014

A fresh look at Positive Money

The World Economics Association has featured an article on Positive Money in its latest newsletter. Let me discuss some aspects of this text because I think that there are still many open questions regarding both the analysis and the policy recommendations. The article starts its analytical part like this:

Now, which are the malfunctions of the present monetary system?

1. Money is created as debt.Today, money comes into existence by debt creation when commercial banks borrow from central banks and when governments, producers or consumers borrow from commercial banks. Thus, the money supply of the economy can only be maintained if the private or public economic actors get into debt. Economic growth requires a proportionate increase in the money supply in order to avoid deflation that would paralyze business, but an increase in the quantity of money involves a simultaneous increase in debt. This way, economic actors run into danger of excessive indebtedness and bankruptcy. It is not necessary to say that overindebtedness causes serious problems to societies and individuals in the face of the ongoing debt crisis.

As I find myself in disagreement with almost all sentences, let me tackle them one by one. (I am doing this because I think that the analysis is flawed, not because I don’t like the conclusions.) The first sentence of the answer is correct, but imprecise. What is meant by money? Money-reserves created by the central bank? Money-deposits created by banks? Money-deposit certificates created by money market funds? As we start here with “money” being highlighted – although not defined – and loan demand and interest rates neglected we’re roughly in the Monetarist camp.

The next sentence could have cleared things up – but it doesn’t because the readers are not experts in monetary theory and don’t know that “when commercial banks borrow from central banks” it is central bank money (reserves) that is created while “when governments, producers or consumers borrow from commercial banks” it is bank money (deposits). And, it is wrong to put government in one list with the private sector. The government, while often able to do so to some extent, actually does not “borrow” from commercial banks. It is selling government bonds. Selling government bonds is different from getting a loan because in most monetary system the government is not in danger of a failed auction. Selling government bonds in countries with a sovereign currency always succeeds. Exceptions are few, and only the euro zone with its no-bail-out clause chose a difference path (which Draghi corrected in the meantime). So, while a loan is not always granted, a government bond is always placed in the market, and if banks don’t buy it the central bank will (if not in the primary than in the secondary market). I find it quite wrong to place government, which is issuing riskless assets in almost all sovereign money systems, in one category with private sector loans, which are prone to default. Especially since government bonds are promises to pay central bank money (reserves) while private sector bank loans only promise to pay deposits. Next sentence:

Thus, the money supply of the economy can only be maintained if the private or public economic actors get into debt.

With no clear definition of a money supply it is impossible to evaluate whether this is true or not. The next question is whether that “or” is an “and/or” or an “exclusive or” (in a closed economy private sector wealth equals public sector debt). As general as was written, the sentence is wrong. If the private sector keeps its share of loans steady, then no increase in public debt is necessary to maintain the money supply (if that includes deposits). Also, a country with a current account surplus can have a rise in deposits and hence the money supply while both the private sector and the public sector run a surplus, meaning that the private sector saves more than it invests and the government’s tax income is higher than its spending. Next sentence:

Economic growth requires a proportionate increase in the money supply in order to avoid deflation that would paralyze business, but an increase in the quantity of money involves a simultaneous increase in debt.

That’s nice, here we can check the available data to see whether it is true that “economic growth requires a proportionate increase in the money supply”. Here is the data for the US via FRED2:


Well, the consumer price index change from year to year is inflation (fat black line), and it is positive almost all of the time. However, some monetary aggregates (M1, M3, MB) had negative growth rates from time to time. Also, inflation in the late 1970s does not correlate with movement in the monetary aggregate (M1). A rise in the monetary base (cash plus reserves) in the last recession also did not coincide with the inflation rate. Comparing all those colored line with the inflation rate, I can hardly make out which one is proportionately increasing in relation to the inflation rate. Can you? (If you can, you’d be a monetarist.)

Now for the second part of that sentence (“an increase in the quantity of money involves a simultaneous increase in debt”) I can not see how that can be true. Money is debt, sure, but not all debt is money. Government can create huge debts, which would allow the private sector to use the additional deposits (from incomes paid by the public sector) to pay down its own debt. This would shrink the private sector debt and therefore money and increase the amounts of government bonds, which are not counted as “money”. So, an increase in (public) debt can decrease the quantity of money. Probably this is part of the Japanese story of the last 20+ years.

“This way, economic actors run into danger of excessive indebtedness and bankruptcy.” Well, except that a government with a sovereign currency cannot go bankrupt. The case of Japan shows that government spending can prop up an economy is the private sector decides to pay down debt. Technically there is not a problem with the monetary system, quite the opposite. One just has to use it right. Also, “excessive indebtedness” is very vague. What is the yardstick? Sure, we can outlaw any loans, but then you can only start production if are very, very rich. Only the super-rich do not have to worry about “excessive indebtedness”.

It is not necessary to say that overindebtedness causes serious problems to societies and individuals in the face of the ongoing debt crisis.

Hmmm. This is very one-sided. After 1945, many Western societies had good growth rates. Many firms borrowed from banks to start and expand businesses, households borrowed to buy houses, etc. Now there are some countries that suffer, but they are mostly inside the euro zone (Spain, Ireland, Greece, Cyprus, etc.), which is a special case due to the lack of exchange rate adjustment. The UK was a case of self-imposed austerity, which was not necessary under the monetary system. Iceland defaulted on its bank debt and seems to be doing more than OK.

Going through the rest of the text I encounter many expressions which I think are just plain wrong: “interest has to be paid on all the money in circulation” (I pay no interest on my cash, do you? And banks can acquire cash from the central bank by selling government bonds to it), “Interest is a subsidy to the banks because the account money they create is handled as legal tender” (no, it is not), “In a sovereign money system the unnecessarily complicated two-level banking system would be replaced by a single-level system, in which money is no longer backed by reserves” (money is not “backed” by reserves today), and last but not least, “the existing bad framework that governments attempt to straighten out with evermore complex regulation consisting of the fractional reserve system, …” (we don’t have a fractional reserve system because banks cannot lend out reserves).

While I believe that many Vollgeld (100% money) supporters have good intentions, I’m afraid that their analysis once and again builds on a neoclassical world view which should have been discarded decades ago. Building on flawed foundations, the new financial house will be unable to wheather the storm – like the euro, which has also been build on neoclassical foundations (crowding-out, monetarism). Nevertheless, there are still many issues that are of shared concern: the role of private banks and financial markets in the crisis, the lack of concern for the real economy (jobs) and ecology, and political economy and macroeconomic problems resulting from a very unequal income and wealth distribution.

To sum it up: I am not convinced that the economic malaise in some European countries has been caused by inherent flaws in our monetary system and I am not convinced that these flaws cannot be remedied in the existing framework (through higher capital requirements, for instance). Yes, bank loans financing real estate have caused the boom (and the bust), but without those loans we would have had lots of unemployment and very likely negative growth rates. Of course, fiscal spending could have been used to fill the gap in demand, but the politicians (and economists) did not want to touch that policy except for that brief time during 2009. I cannot see how we need a new monetary system in order to clean up the mess in Europe. There is much to be done, but from the macroeconomic perspective freeing us from the fiscal constraints should be enough to return Europe to growth and prosperity shared by all Europeans.

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