28 Nov 2015

Adair Turner - "Between Debt and the Devil: Money, Credit and Fixing Global Finance"

I've been a bit quiet of late. But of course, there has been plenty going on in the world - not least the massacre of 130 innocent people by a bunch of totally deranged and brain-washed fanatics in Paris. I'm not really a very religious person. But there are times I wished I was. I would love to be able to believe that Allah, or whoever their God is, will make their souls suffer in Hell for eternity in punishment for what they did. Unfortunately, I suspect that the suicide bombers are no more, could never again feel any guilt for their actions. It is the families of the victims who will be suffering now, along with any right minded human on the planet.

But, I digress. Let me talk about something much more encouraging. It's the book by Lord Adair Turner, the ex-head of the UK's Financial Services Authority that came out last month - "Between Debt and the Devil: Money, Credit and Fixing Global Finance".

There are some recent reviews in papers such as the Guardian, the Independent, and the Financial Times, and has been well received by Positive Money (not surprisingly when you read what he says!).

For someone so very well placed, Adair Turner is amazingly lucid about the real causes of the recent financial crisis that hit the world. I lost count of the number of places where he made it abundantly clear where he thought  the blame should be laid. I quote:
"the most important causes of the 2007-2008 crisis and most-crisis recession [..] lay in the specific nature of debt contracts, and in the ability of banks and shadow banks to create credit and money"
"The dangers of excessive and harmful debt creation are inherent to the nature of debt contracts. But they are hugely magnified by the existence of banks...."
"... banks do not intermediate existing money, but create credit, money and purchasing power which did not previously exist... [...] the vast majority of bank lending in advanced economies does not support new business investment but instead funds either increased consumption or the purchase of already existing assets, in particular real estate and the urban land on which it sits."
"...unless tightly constrained by public policy, banks make economies unstable".
"...banks left to themselves will produce too much of the wrong sort of debt."
 "Banks, unless constrained by policy, have an infinite capacity to create credit, money and purchasing power; so do shadow banking systems..."
"Banks and shadow banking systems left to themselves are bound to create too much of the wrong sort of debt and leave economies facing severe debt overhangs".
"The amount of credit created and its allocation is too important to be left to bankers: nor can it be left to free markets in securitized credit".
"Left to themselves, banks inevitably choose higher leverage than is good for society as a whole".
"... even banks that never fail and never need to be rescued with public money can cause economic harm if, along with the other banks in the system, they create excessive quantities of debt";
"Unless deliberately constrained, banks and shadow banking systems can create private credit, money, and purchasing power in limitless amounts".
".. we cannot leave either the quantity of credit created or its allocation among different uses entirely to free market forces".
"We cannot therefore avoid the need to intervene to offset the inefficiency and instability that free financial markets will invariably generate".
 "At the core of financial instability in modern economies [...] lies the interaction between the infinite capacity of banks to create new credit, money and purchasing power, and the scarce supply of irreproducible urban land. Self-reinforcing credit and asset price cycles of boom and bust are the inevitable result'.
 He is scathing in his opinions on effects of innovations in the financial sector.
"The summary scorecard on three decades of financial innovations is therefore simple: whatever their theoretical advantages, their actual impact was a disaster".
He is also scathing about the failures of modern economics, noting that "modern macroeconomics largely ignored the operation of the financial system and in particular the role of banks." As he points out, "You cannot see a crisis coming if you have theories and models that assume that the crisis is impossible".
"Modern macroeconomics focussed little attention on the role of banks. But when economists and financial theorists did describe banks, they usually made a dangerously simplistic assumption - that banks take deposits from households to lend money to businesses and entrepreneurs, allocating capital resources between alternative investment projects. In fact [..] most bank lending in modern economies [...] is unrelated to business investment but instead funds a competition among households for the ownership of already existing real estate".
Turner "rejects the pre-crisis orthodoxy that global financial integration is limitlessly beneficial and argues that some fragmentation of the international financial system is a good thing".

 He also makes it clear that there are solutions.
"We need to reject the idea that the quantity and allocation of private credit can be left to free market forces".
"Several economists who lived through the boom of 1920s America and the subsequent Great Depression, such as Irving Fisher and Henry Simons [..] believed that "fractional reserve banks," which [...] can create credit and money, were so inherently dangerous that they should be abolished. Milton Friedman made the same case in 1948".
"In 1948 Milton Friedman argued that such fiat money creation, financing small puhblic deficits with government created money, would be a better and more certain way to achieve stability and low inflation than relying on private bank credit and money creation".
"In the depth of the Great Depression several eminent economists presented a truly radical plan - the Chicago Plan - to President Roosevelt". That plan said nothing about punishing bankers, limiting their bonuses, ensuring good risk control, or fixing misaligned incentives. Instead it proposed abolishing fractional reserve banking".
Turner repeatedly points out that even in times of weak growth:
"there is always one more option left. That option is 'fiat" money creation, using central bank-printed either to finance increased public deficits or to write off existing public debt".
"Friedman was right: governments and central banks together can always overcome deficient nominal demand by printing and spending money. That is just as well, since without the option of money finance there may be no good way out of our debt overhang predicament".
"...once we admit that money finance is possible, there is no technical limit to how much fiat money can be created and how much nominal demand produced.."
"...there is not reason the use of monetary finance cannot be appropriately constrained within precisely the same discipline of central bank independence. Central bank committees that today vote to approve interest rate movements or quantitative easing operations could also be given the power to approve or disapprove either a Bernanke-style helicopter money drop or one-off government debt write-off."
"Faced with ta debt overhang and a deficient nominal demand, we must be willing to use the money finance option".
"...central banks cannot focus solely on low and stable inflation nor financial regulation only on the solvency and liquidity of individual institutions. Public policy needs quite explicitly to manage the quantity and to influence the allocation of credit allocation: it cannot rely on free markets in credit to produce optimal socia results."
"...we must constrain the overall quantity of credit and lean against the free market's potentially harmful bias toward the "speculative" finance of existing assets". 
I also note that he thinks that "policies such as financial transaction taxes might make economies more efficient".

He also takes quite seriously the possibility of some form of QE for the people. For example,  he notes that:
"A government could, for instance, pay $1,000 to all citizens by electronic transfer to their commercial banks deposit accounts".
"Printing money in its modern electronic form is thus without doubt a technically possible alternative to either pure fiscal or pure monetary policy".
"..it works through putting new spending power directly into the hands of a broad swath of households and businesss, rather than working through the indirect transmission mechanism of higher asset prices and induced private credit expansion. It does not rely on regenerating potentially harmful private credit growth, nor does it commit us to maintaining ultralow interest rates for a sustained period of time".
In sum, a remarkable book, from someone very well placed within the world of international banking and finance. Well worth reading.

OK, he goes short of fully backing the 100% reserve banking model. But frankly his arguments are not convincing. I get the impression that he is just trying to walk a delicate tight-rope - if he went for an all-out "let's abolish banks" position, he might lose some of the key players that he is trying to convince.

Nor does he address the question of why we ended up with the current system, and largely ignores the fact that the system will be difficult to reform because of the enormous vested interests that will fight to keep the bankers' gravy train on the rails. But at least he has come very clean about the major problems inherent to the current unregulated financial system. And he makes a strong case for the idea that we should be taking very seriously the option of allowing central banks and governments to do some money creation of their own.

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