Upending economics
Steve Keen's Debunking Economics is less a critique than slashing out the legs upon which economics has rested for centuries. One of the pillars he topples has a direct connection to the deflation dichotomy, as he attempts to explain to Mish why the Federal Reserve's big increase in bank reserves has not led to more lending:
This also helps explain why the artificially low interest rates maintained by the Bank of Japan and the Federal Reserve, have not, as the monetarists expected, produced increased borrowing.
That "increase reserves to increase lending" argument is so hard to shake, but reserves can't be lent from simply from a double-entry bookkeeping point of view.As Keen points out in his book, it's not merely an accounting perspective that suggests the conventional economic understanding of the relationship between deposits and loans in a fractional reserve system cannot be correct, but the empirical observation of banker's activities as well. Loans not only don't depend upon deposits, they usually precede them.
The way that accountants keep track of the "assets equals liabilities plus equity" rule is to record an increase in assets as a positive and an increase in liabilities as a negative (your liabilities rise, so a negative gets bigger). Reserves are an asset, as are loans, and shown as a positive. Deposits--which are created by a loan--are a liability and shown as a negative
So to lend to a customer, a bank has to show a negative on that customer's accounts. This can be matched by a positive on the loans entry--because the loan has increased in size. No problem.
But if banks were to lend from reserves, they would need to record a minus there--reserves have fallen. And on the liabilities side, they want to ... also show a negative. Whoops! No can do.
The end result of this logic is that reserves are there for settlement of accounts between banks, and for the government's interface with the private banking sector, but not for lending from.
Banks themselves may (if they are allowed--I simply don't know the rules here) swap those assets for other forms of assets that are income-yielding, but they are not able to lend from them.
This also helps explain why the artificially low interest rates maintained by the Bank of Japan and the Federal Reserve, have not, as the monetarists expected, produced increased borrowing.
Labels: economics
44 Comments:
Does this help or hurt yours or Nate's position? Or is it irrelevant?
Vox: Would you then recco. Keen's book as a purchase? Is he an Austrian Econ. guy at heart?
Banks themselves may (if they are allowed--I simply don't know the rules here) swap those assets for other forms of assets that are income-yielding, but they are not able to lend from them.
Mr. Keen is implying there are rules for banks. Interesting...
Does this help or hurt yours or Nate's position? Or is it irrelevant?
It would tend to help mine since it supports the idea of bank-created money.
Would you then recco. Keen's book as a purchase? Is he an Austrian Econ. guy at heart?
Definitely. No, he's a Post-Keynesian. He tends to be considerably more optimistic about government than the Austrians, but he is much more favorable to the Austrian perspective than the Neoclassical, (which is to say what we would call both Monetarist and Keynesian branches of the mainstream), due to the Austrian recognition of debt.
You can read today's follow-up response from Keen and a little more of the debate in the comments section here.
Well, there's this liquidity trap thing:
http://strikelawyer.wordpress.com/2012/02/22/liquidity-trap-explained/
http://strikelawyer.wordpress.com/2012/02/25/liquidity-trap-theory-and-practice/
Is it the result of "hoarding" savings, or bank reserves? As you say, lending and borrowing precede deposits as a statistical or empirical matter. But the dogma is that it's a hoarding problem.
The dogma is wrong, of course. It's a debt saturation problem, and debt saturation is the only situation, empirically, that has generated a liquidity trap.
But try explaining this to Keynesians. Or Austrians, for that matter.
Mish and Keen agree on the issue of lending preceding reserves. Mish rightfully took Keen to task over the debtor bailout he proposed. Leaving aside any moral hazard arguments, Keen sees loan demand from debt consumers as driving the creation of credit money and propsed a debt jubilee (bailout) for individuals that must be used to pay down debt. While I see how this would initially deleverage the recipients, I also see how this would likely spur a new round of credit/debt money creation as the debt consumers promptly releverage to their previous levels of indebtedness.
Also, can someone tell me why Keen thinks private debt matters, but public debt does not? The very same people/economy ultimately have to support both private and public debt.
@Stilicho:
I've talked with Keen quite a bit about all this. I'm not sure he thinks that public debt doesn't matter, but if he does I'll agree that's a problem.
All debt, public and private, would have to be canceled in a "jubilee"; and in my opinion that could only be done by law, probably a constitutional amendment.
Parenthetically, I think "moral hazard" concerns, having been ignored for decades as applied to the ruling/political classes, and in recent years dramatically (disgustingly) so, it is too late, and manifestly unjust, to apply them to the serfs.
Reset and start over is the only way out of the situation we're in. Moral hazards have nothing to do with it.
While I see how this would initially deleverage the recipients, I also see how this would likely spur a new round of credit/debt money creation as the debt consumers promptly releverage to their previous levels of indebtedness.
Well, the deleveraging is going to happen anyhow. Debts that can't be repaid won't be. A debt jubilee is not a bailout, because the creditors are going to be wiped out. I'm not saying that I support it, because I haven't thought the matter through - although it is a surprise to see a secular economist endorse a Biblical economic principle - I'm merely noting that a debt jubilee is simply default in one fell swoop.
And while consumers would happily leverage up again, the difference is that the surviving banks would not let them. Debt is a supply-side issue, not a demand-side one.
Of course, the biblical debt jubilee wasn't a handout, but a way to structure debt repayment so that massive credit bubbles did not accumulate...and it also contains what we would think are restrictions on property rights (although gk chesterton would view those restrictions as protecting the right to property, which is different than the right to do whatever thou wilt with thy property).
A few months back I was very active in commenting over on Stephen Kinsella's Irish blog on this subject:
http://www.irisheconomy.ie/index.php/2012/02/22/eviction-in-ireland-in-2012-i-stopped-the-sheriff/
Just trying to be efficient here, in case anyone is interested in the jubilee subject.
Of course increased reserves doesn't create more lending. People have to take out loans in the first place.
When there is too much debt, both the debtor and the creditor need to suffer for it, else suffer Moral Hazard.
A debt jubilee would make creditors suffer, but it would also be an outright gift to many of the stupidest (or the smartest, in the event a debt jubilee actually takes place) and most irresponsible creditors. Also, given that all status - including financial - is relative, responsible, debt-free people would come out on the short end of the stick by default.
I can't see how that is a good thing.
Thanks Vox, I agree with your position. That which cannot be paid, will not be paid, and the deleveraging will happen regardless. 2 things: 1) What Keen was calling a jubilee (or maybe Mish misnamed it--mea culpa for continuing the error) is a QE for the masses--direct payment of money to individuals with the caveat that they use it to reduce debt (it could also be accomplished by payment to banks to reduce consumer debt on a per capita basis I suppose), so the banks would benefit as well; and 2)You disagree directly with Keen who sees debt as a demand side issue, or is there some synthesis I'm missing?
No, Keen also sees debt as a supply side issue: banks make more money when they lend more, so they have an incentive to constantly increase their outstanding loans.
p.s. a bank can lend excess reserves. Keen is wrong here. The liability (deposit) is already on the left side of the ledger. The asset (reserve) is on the right. lending it out is merely a matter of transferring the amount from one group (reserve) to another (loan)on the asset side. This does not mean his larger premise is wrong (lending preceding reserves), this just means that bank accounting does not prohibit MMT from working.
Josh, explain this:
However, in the real world, they [banks] do control the creation of credit. Given their proclivity to lend as much as is possible, the only real constraint on bank lending is the public’s willingness to go into debt. In the model economy shown here, that willingness directly relates to the perceived possibilities for profitable investment—and since these are limited, so also is the uptake of debt.
Steve Keen, The Roving Cavaliers of Credit.
In other words, he's saying banks' credit creation (supply side) is controlled or limited by the demand side.
It's really two sides of the same coin...keen is saying that the bank willingness to lend is a constant, and what moves total debt is the demand for credit...given that banks are still unwilling to lend today, his model needs to be changed...
It's really two sides of the same coin...keen is saying that the bank willingness to lend is a constant, and what moves total debt is the demand for credit...given that banks are still unwilling to lend today, his model needs to be changed..
Agreed, but that means he's pretty close to animal spirits territory in his model.
I actually Just bought Debunking Economics through Amazon last week. I have only read the first 20 pages, but it is looking like a masterpiece already, way more than I was initially expecting. I can't wait to read his critique of modern financial education via rational expectations, random walk theory, and the Capital Asset Pricing model.
It's really two sides of the same coin...keen is saying that the bank willingness to lend is a constant, and what moves total debt is the demand for credit...given that banks are still unwilling to lend today, his model needs to be changed.
You're mistaken. Banks are very willing to lend today. They simply can't find anyone to whom they can still lend who isn't hopelessly unqualified.
Excess reserves, since they are excess, are not, by definition reserves. As was pointed out Keen is calling for a direct directed subsidy to individuals. The debt would be sold to the central bank. It could, and should, be later repudiated to complete the partial jubilee.
the only real constraint on bank lending is the public’s willingness to go into debt
Well, you can always find members of the public who are willing to go into debt. They are simply not able or willing to pay the debt back.
As Vox says, the banks cannot lend to such individuals unless forced to by the government and backstopped by those of us who are more prudent and productive.
As an aside, much of the shitty public policy around home ownership, as well as the pResident's gutting of the Welfare work provisions, is all about buying votes using our dime. In addition, so is extending Title IX to STEM. There are lots of women out there who think that if the Dark Messiah says they can be rocket scientists, it must be those sexiss white males holding them back.
Must figure out how to withdraw our dime.
Excess reserves, since they are excess, are not, by definition reserves.
I guess that depends on the definition of Excess Reserves, doesn't it.
If they were excess reserves when a bank could realistically expect a default rate of 1-2% on their loan portfolio[1], they are probably not excess, and might even be under reserve requirements when the default rate is more like 5-10%.
[1] Because they were very careful to lend to people with a low likelihood of defaulting and with high future time orientation. That is, not NAMs.
Banks are very willing to lend today. They simply can't find anyone to whom they can still lend who isn't hopelessly unqualified.
Ergo, they are just lending to the government instead.
Also, I keep hoping somebody will address this. How much of the US public debt are the world's central banks outright monetizing, i.e., simply printing the money to buy the Treasury bonds? How long can that process last? Because now it's got to go on to infinity.
Another issue I can't grasp is the Fed's $2T balance sheet. Have we really found a way to make water flow uphill? That is, if there's a bunch of toxic junk out there, can the Fed really just buy it all up with its ginned-up notes and park it on a balance sheet somewhere? I wouldn't think so, or we could just do that whenever investments didn't pan out, but I'm not smart enough to figure out why.
You're mistaken. Banks are very willing to lend today. They simply can't find anyone to whom they can still lend who isn't hopelessly unqualified.
My mistake, I should have fleshed out my comment. It seems that keen thinks that banks are willing to lend regardless of the ability of the borrower to repay the note.
"But if banks were to lend from reserves, they would need to record a minus there--reserves have fallen. And on the liabilities side, they want to ... also show a negative. Whoops! No can do."
Their reserves will not have fallen if the loaned money went to a deposit account which would be the case for them to need to show a negative on the liabilities side. Once the person actually withdraws the money they borrowed, the banks reserves will decrease. Trying to claim that the bank has not lent out its reserves in this situation is balderdash.
OT Epic Islam Facepalm of the moment, tip ( and just the tip ) to Steyn:
Sodomy for the Jihad!
http://www.gatestoneinstitute.org/3158/islam-sodomy
"However, jihad comes first, for it is the pinnacle of Islam, and if the pinnacle of Islam can only be achieved through sodomy, then there is no wrong in it. For the overarching rule of [Islamic] jurisprudence asserts that "necessity makes permissible the prohibited." And if obligatory matters can only be achieved by performing the prohibited, then it becomes obligatory to perform the prohibited, and there is no greater duty than jihad. After he sodomizes you, you must ask Allah for forgiveness and praise him all the more. And know that Allah will reward the jihadis on the Day of Resurrection, according to their intentions—and your intention, Allah willing, is for the victory of Islam, and we ask that Allah accept it of you."
Why would people take out loans, even at a very low rates, if their disposable income and overall net worth is decreasing and they're pessimistic about their economic future?
"Why would people take out loans, even at a very low rates, if their disposable income and overall net worth is decreasing and they're pessimistic about their economic future?"
Apparently it is now the new 'Merkin Way. SuperBansta', protecting Debt, Fraud, and The 'Merkin Way.
http://www.washingtonsblog.com/2012/06/the-biggest-myth-preventing-an-economic-recovery.html
http://globaleconomicanalysis.blogspot.com/2012/07/reader-questions-on-credit-worthiness.html
Mish:
"Banks are not lending now for three reasons
Banks are capital impaired
Banks are worried about being repaid
The relatively small pool of credit-worthy borrowers who banks would lend to right now, do not want credit"
Mish, on Credit Worthy Borrowers and what changed
Banks are very willing to lend today. They simply can't find anyone to whom they can still lend who isn't hopelessly unqualified.
Stated income no longer good enough?
Lenders have buried all the people they possibly can with the most debt they can, all but student loan vendors.
Speaking of economic activity, Adams Arms gets series A funding
Interesting.
Historic debt jubilees cleared debt levels that are nothing compared to today's debt levels.
Keen's plan is at least fair in its application, and it's politically practical. Everyone gets money. The poor have no debts, they will get money. A conservative pushing this plan could win the biggest landslide in history. Old people tend to have less or no debt, they will like it. People who are savers also receive cash. It will treat the debtors differently too: if your debt is a mortgage, you will have your debt reduced/paid off, and have a house. If your debt was profligately spent, you will end up with no debt, but also no asset.
Mish jumped the gun saying it's not a solution. I think it is a possible solution to the debt crisis, and given its likely popularity, it's the sugar that will make the medicine of tighter credit laws go down. However, while Mish is right about lending, he is wrong about tight money, as are the Austrians who favor it, for political reasons. It's the borrowers who want cheap money, i.e. most of us. The savers are a minority. Any system of hard money will collapse politically; the best solution is to have two monies in the economy, one for saving and one for spending and lending.
That is the very essence of Keynesian economics debt-slavery:
You are constantly working to earn money that is perpetually becoming more worthless, because the government borrowed it to begin with, and cannot discharge the debt due to interest.
IOW not only are YOU a slave, but so is the government; the real rulers are the bastards controlling the money supply!
Nice summary Galt.
I think Steve Keen is the most important economist in the world at this juncture. Actually putting the jubilee idea in play is an enormous public service.
That said there are lots of problems with his proposal.
I often say that our "economic crisis" is really a rule of law crisis, and my concern is that any solution that doesn't recognize that is just set up for failure in advance.
Maybe it sounds trite, but like all fundamental problems, this is about more than meets the eye. It is about more than money, or economics, although both are of course very prominent.
It is about self government; about whether we as a society have the law or not; about whether we can commit collective folly on a global scale and forgive one another rather than accuse and punish.
On the practical level the solution of doling out "money" to everyone sets a bad precedent. It reaffirms that the government can absolve sin by throwing money at problems, which is one reason we're in this position to begin with. It would be highly inflationary.
On a deeper level it leaves too much of what is wrong in place: the idea that economists with charts and graphs can solve what is essentially a moral and legal problem, effectively abdicating our moral, personal and political responsibilities to wonkery - which again is part of the problem in the first place. Maybe we can have a central bank, but we can't be utterly governed by one if we wish to remain free. And the illusory power to wave a magic wand of money to make problems disappear is the precise manner in which central banks have made subjects of us all, and made us unfree.
If we can manage to approach this problem as a legal and moral one, not an economic one, with a real jubilee - that is, forgiveness - at its core, we'll have a lasting solution with a sound foundation going forward.
Better Keen's jubilee than no jubilee, but the law should be the mechanism for accomplishing one, not economists' tinkering.
"But if banks were to lend from reserves, they would need to record a minus there--reserves have fallen. And on the liabilities side, they want to ... also show a negative. Whoops! No can do."
Bullshit. Another pseudo expert. First of all, it's impossible for any transaction to result in two "negatives (he's actually talking about credits) or two positives (debits). Double entry accounting records the same event in two different ways, one recording its effect on the balance sheet and the other its effect on the income statement. One is a debit or positive, and the other is a credit or negative. That technique, supposedly introduced by Pacini, makes the total come to zero, which makes double entry accounting self balancing. If it doesn't balance something is wrong. (Much better that the former single entry accounting.) Anything at all can be recorded by accounting, as long as the accountant is competent and understands what he is doing. Which is asking a lot, according to my experience, but it is possible. Accounting itself is like a magic mystery poetry machine. Accountants, however come in all shapes and sizes. Just like pseudo experts. This "no can do" stuff is completely inaccurate, misleading and pontificating.
So many think they understand accounting, but so few do.
Bullshit. Another pseudo expert.
I'm pretty sure Keen doesn't claim to be an expert in accounting. I've emailed him the relevant points from you and Stilicho. There are other, more convincing arguments against creating money through reserves, so I don't think he's inclined to cling to a faulty one.
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