Feb 16, 2016 @ 04:54 AM 5 views

Tilting At Windmills: The Faustian Folly Of Quantitative Easing

http://www.forbes.com/sites/stevekeen/2016/02/16/tilting-at-windmills-the-faustian-folly-of-quantitative-easing/#2ab572c8358c

Steve Keen ,

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As I explained in my last post, banks can’t “lend out reserves” under any circumstances, which undermines a major rationale that Central Bank economists gave for undertaking Quantitative Easing in the first place. Consequently, the hope that Bernanke expressed in 2009 is “To Dream The Impossible Dream”:

To dream the impossible dream
To fight the unbeatable foe
To bear with unbearable sorrow
To run where the brave dare not go

Former Chair of the Federal Reserve Ben Bernanke listens while US Secretary of the Treasury Jacob Lew speaks at the Brookings Institution July 8, 2015 in Washington, DC. AFP PHOTO/BRENDAN SMIALOWSKI (Photo credit should read BRENDAN SMIALOWSKI/AFP/Getty Images)

But without the poetry:

Large increases in bank reserves brought about through central bank loans or purchases of securities are a characteristic feature of the unconventional policy approach known as quantitative easing. The idea behind quantitative easing is to provide banks with substantial excess liquidity in the hope that they will choose to use some part of that liquidity to make loans or buy other assets. (Bernanke 2009, “The Federal Reserve’s Balance Sheet: An Update”

What a folly this was—almost. The one out that Bernanke gives himself from pure delusional babble is the phrase “or buy other assets”—because that’s the one thing that banks can actually do with the excess reserves that QE has generated.
But rather than rescuing Central Bankers from folly, this escape clause is an unwitting pact with the devil: they are now caught in a Faustian bargain. Any attempt to terminate QE is likely to end in deflating the asset markets that it inflated in the first place, which will cause the Central Banks to once more come “riding to the rescue” on their monetary Rocinante.
While Central Bankers can personally still join Faust and ascend to Heaven—thanks to their comfortable public salaries and pensions—the rest of us have been thrust into the Hell of expanding and bursting speculative bubbles, hoist on the ill-designed lance of QE. Bernanke is a rich man’s incompetent Frank N. Furter: confronting a wet and shivering couple, he promises to remove the cause—but not the symptom:

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So, come up to the lab,/ and see what’s on the slab!/ I see you shiver with antici…  …pation./ But maybe the rain/ isn’t really to blame,/ so I’ll remove the cause…/ [chuckles] but not the symptom. (“Sweet Transvestite”)

Bernanke’s QE instead maintains the symptoms of the crisis, but does nothing about its cause. It generates rampant inequality, drives asset prices sky-high and causes frequent financial panics—while doing nothing to reduce the far too high a level of private debt that caused the crisis.
Let’s put QE on the slab in my lab—my Minsky software—and track the logic of the monetary flows that QE can trigger. Figure 1 shows the full model; the Tables in this post go through it step by step.

Figure 1: The full Minsky model of QE (with no simulation settings as yet)

[Here’s a quick primer on Minsky’s accounting conventions for those who haven’t read the previous post. Minsky shows Assets as positive sums, and Liabilities and Equity as negative, so that any operation on a row sums to zero: therefore, positive entries increase Assets, and reduce Liabilities and Equity; while negative entries reduce Assets, and increase Liabilities and Assets. This might look strange on first glance, but it (a) enforces the “Fundamental Law of Accounting” that “Assets minus Liabilities equal Equity”, since when a transaction is properly recorded, each row sums to zero; and (b) since Minsky maintains interlocking “Godley Tables”—named in honour of Wynne Godley—it shows a Liability from one sector’s point of view as an Asset from another’s. The program can thus accurately track how money flows through the financial system.]

I make some genuine simplifying assumptions to make the Godley Tables simpler to read (genuine in the sense that my results don’t depend on the assumptions—unlike so-called “simplifying assumptions” in much of Mainstream economics). I treat QE as a loan (rather than a bond purchase), and I ignore all other transactions in the economy apart from those related to QE.
The first step in the model is the Central Bank loan of QE to Private Bank 1 (PB₁). That increases the Assets and Liabilities of the Central Bank: Loans_PB rise by QE, as do Reserves_B!. Since Central Banks now pay interest on excess reserves, I include the flow of interest payments Int_ER as well. This is financed from the essentially limitless equity of the Central Bank, and—from its point of view—adds to the Reserves of Private Bank 1 (if the rate is positive). These operations are shown in Table 1:

Table 1: QE and interest payments on Reserves from the Central Bank’s perspective

Central Bank	Asset	Liability		Equity	Row Sum
Flows ↓/Accounts→	LoansPB	ReservesB1	ReservesB2	EquityCB
QE loan	QE	-QE			0
Interest on Reserves		-IntER		IntER	0

These same operations are recorded on Private Bank 1’s accounts as shown in Table 2. This confirms one of Joe Stiglitz’s points about QE from his article that I otherwise criticized in my last post: Banks have indeed been earning “earning nearly $30 billion – completely risk-free – during the last five years” thanks to QE.

Table 2: QE and interest payments on Reserves from the recipient Private Bank PB₁’s perspective

PB1	Assets		Liability			Equity	Row Sum
Flows ↓/Accounts→	Shares	ReservesB1	LoansCB	Poor	Rich	EquityB1
QE loan		QE	-QE				0
Interest on Reserves		IntER				-IntER	0

Now what happens to the QE funds once they’re in Private Bank 1 (PB₁ for short)? It can’t simply lend them out, as I showed in my last post—the belief that they can violates the Fundamental Law of Accounting. But PB₁ can buy assets with it, which I’ll show here as a purchase of shares from a broker who banks with another Private Bank PB₂. This does of course decrease PB₁’s reserves—mission half-accomplished.

Table 3: Buying shares from PB₁‘s perspective

PB1	Assets		Liability			Equity	Row Sum
Flows ↓/Accounts→	Shares	ReservesB1	LoansCB	Poor	Rich	EqB1
Buy shares from broker	SharesQE	- SharesQE					0

But Oh Dear! This increases PB₂‘s reserves by precisely the same amount as PB₁‘s reserves have fallen—see the first row of Table 4. However, finally, the QE money gets into the money supply, because by buying shares off the broker, the liabilities of the banking system rise, and therefore money has been created—money that mainly goes to the wealthy people (the Super-Rich) who generally own shares, from whom the brokers buy more shares—shown in the second row of Table 4.
The Super-Rich spend of course, but more slowly than anyone else relative to their wealth, simply because they have so much more of it than anyone else. And they spend a lot of that on each other—buying and selling assets and luxury possessions. Given the slower speed at which they spend, the money created by QE dwells here the longest—and therefore their wealth grows more than that of any other social group thanks to QE.

Table 4: PB₁‘s purchase of shares from PB₂‘s perspective

PB2	Assets	Liability		Equity	Row Sum
Flows ↓/Accounts→	ReservesB2	Broker	SuperRich	EquityB2
Sell shares to PB1	SharesQE	- SharesQE			0
Buy shares from Super-rich		SharesQE2	-SharesQE2
Pay Dividends	-Dividends	Dividends			0
Pay bonuses to staff	-Bonus	Bonus			0

The inflow of money to the broker triggers two other flows that reduce PB₂‘s reserves: paying dividends back to PB₁ (conflating the broker and the company whose shares have been bought, again to save adding another column) and paying wages and bonuses to their staff, whom I assume bank at PB₁–and are Rich rather than Super-Rich. The first two rows of Table 5 show these operations from the point of view of PB₁.

Table 5: Payment of dividends and bonuses from PB₁‘s perspective

PB1	Assets		Liability			Equity	Row Sum
Flows ↓/Accounts→	Shares	ReservesB1	LoansCB	Poor	Rich	EquityB1
Pay Dividends		Dividends				-Dividends	0
Pay bonuses to staff		Bonus			-Bonus		0
Buy goods from dealer				-Dealer	Dealer

Oh Dear! The reserves that PB₂ got rid of by paying dividends and bonuses out have ended back at PB₁. There has therefore been no net change in the aggregate level of reserves. But, finally, there is an operation that puts money into the hands of poorer households: the Rich households use part of their Bonus to buy something from the Poor households (far be it from me to insinuate that this might sometimes be something illicit!).
Now let’s take stock—to coin a phrase. All these operations have done nothing to reduce the aggregate level of Reserves: they’ve simply shuffled them from one bank to another. In fact, even if QE stops, reserves grow at the rate of interest on reserves.
Banks come out of this as rather innocent: they can’t do what Ben Bernanke (and now Joe Stiglitz) are berating them for: not only can’t they lend out Excess Reserves, they can’t get rid of them either. It’s not their fault that the only way they can individually attempt to do so amounts to playing “hot potato”— trying to reduce their reserves while simultaneously boosting another bank’s reserves—by buying assets, since this is what Don Quixote (sorry, Bernanke) intended them to do in the first place. However, these misunderstood institutions are nonetheless “crying all the way to the bank” with the risk-free earnings that QE has given them.

The only ways that Reserves can fall are (a) if the Central Bank takes them back or (b) if some part of the public withdraws its money from deposit accounts as cash. Under the dynamics of QE itself, Reserves can only rise (so long as the interest on Excess Reserves is positive—which may be one unstated reason why Central Banks are implementing negative rates now, if anyone inside one of them has worked this out).

US Federal Reserve chair Janet Yellen testifies before the House Financial Services Committee on Capitol Hill in Washington, DC, on February 10, 2016.Federal Reserve Chair Janet Yellen warned that the US economy faces risks from tightening domestic financial conditions as well as global economic turmoil. / AFP / NICHOLAS KAMM (Photo credit should read NICHOLAS KAMM/AFP/Getty Images)

QE gets into the money supply—not via lending, which is impossible, but via asset purchases, which far and away benefit rich households more than poor ones. Rich households also benefit from the income the share transactions generate. And finally, some of that money gets to poor households when the rich ones—made richer still by QE—buy some services off them.
The real economy has thus received some impetus from QE, but only a relatively trivial amount of the money created has got into circulation in Main Street. As Michael Hudson puts it, Bernanke’s helicopter dumped money on Wall Street, not Main Street.
The bubble before the financial crisis had already exaggerated income inequality past what is sustainable in a capitalist society. Central Bank meddling via QE has made this problem worse, and without the illusion of a boom (like the Internet and Subprime Bubbles) to make it seem somehow palatable.
It has done this, not only by giving money to the Super-Rich, but by inflating asset prices, driving them well above the increase in consumer prices and wages. This is yet another symptom of the bubbles before the crisis, when speculative lending by banks drove asset prices (shares in the DotCom Bubble, house prices in the SubPrime Bubble) into the stratosphere in the first place. The S&P 500 fell from 45 at the peak of the DotCom Bubble to around 25 when the SubPrime Crisis began, and 15 in the depth of the crisis—see Figure 2. QE drove it back up to 25.

Now Stockmarkets worldwide are falling again, partly in response to the The Fed’s tentative and foolish attempts to unwind its original bold and foolish intervention into inflating asset prices. But it will be dragged back in again if it attempts to unwind QE, because all the dynamics explained in the preceding Tables works in reverse as well. So long as it continues to believe that sky-high asset prices are actually good for the economy, it can’t afford not to continue meddling in them.

Figure 2: Robert Shiller’s Cyclically Adjusted PE Ratio
Figure 3: Shiller’s long term real house price index

All the while, the Fed has not only ignored the real cause of both the Asset Price Bubbles and the crisis itself—the private debt bubble that financed the DotCom and SubPrime Bubbles—its Impossible Dream was that QE would cause this debt bubble to rise again too. Quoting Bernanke from 2009 again, “The idea behind quantitative easing is to provide banks with substantial excess liquidity in the hope that they will choose to use some part of that liquidity to make loans”.
Bernanke and his Central Bank colleagues around the world have made the symptoms of the crisis worse, in the hope that the cause would get worse, thus curing the patient.
Take a good look at Figure 4. Anyone who thinks than more private debt in America is a good thing is as delusional as Don Quixote.

Figure 4: Estimated long term US private debt to GDP ratio using Fed data since 1945 and Census data since 1834
The Man of La Mancha’s magnificent song “The Impossible Dream” ends with this stirring paean to chivalry:

And the world will be better for this
That one man, scorned and covered with scars,
Still strove with his last ounce of courage
To reach the unreachable star.

Central Bankers, the Don Quixote’s of our modern age, are making the world a far worse place than it would be without their foolish gallantry.

President of the European Central Bank (ECB) Mario Draghi attends a debate at the European Parliament in Strasbourg, eastern France, on February 1, 2016. / AFP / PATRICK HERTZOG (Photo credit should read PATRICK HERTZOG/AFP/Getty Images)

PS: I note that Frances Coppola states on her Forbes blog that lending can reduce excess reserves—which is quite correct (“It Was The Financial Crisis That Stopped Banks Lending, Not Interest On Excess Reserves”). If banks lend and have excess reserves, then part of these become required reserves and excess reserves fall. But the total amount of reserves remains constant—as Frances and I both observe. So bank lending can reduce excess reserves, but banks still can’t “lend out reserves” themselves, as Frances explains there and as I did in my previous post (“Hey Joe, Banks Can’t Lend Out Reserves”). And Frances is also quite right that the financial crisis brought bank lending to a halt,  not interest being paid on excess reserves.

Technical Appendix

Here’s a screenshot of a “quick and dirty” simulation using this model, including the ability to turn off or reverse QE. It would be fun to add an asset price component here (assume fixed supply and the flow of new money from QE driving price change) and see what happens.

If you’d like to check this out, here are the links: Minsky model before simulation added (Model; LaTeX code; Matlab code); model after simulation added (Model; LaTeX code; Matlab code). To run Minsky, download it from here. The current Windows-only beta build overcomes speed issues with Godley Tables in the current release version (but it might introduce some other bugs)

The equations for the model (generated by Minsky as LaTeX output from the file menu) are:

A very simple way to save the banks: cash-in your deposit !

A very simple way to save the banks: cash-in your deposit !
by The Money Doctor

In the Balance Sheet of a bank, the biggest liability is: DEPOSITS FROM CUSTOMERS. To erase this liability - and thus saving the bank - all depositors should cash-in their A/C and redeposits the cash in a Safe Deposit Box. The content of safe deposit boxes is segregate from the bank balance sheet - it is not a liability like A/C . So, contrary to what the public believes, the best way to save a bank is by taking away your deposit from the bank and use a Safe Deposit Box instead. Furthermore, there is no more problems with withdrawals: you can take out how much cash you need without any further delay...

Quantitative Easing and the Quantity Theory of Credit

http://www.res.org.uk/view/art5jul13features.html

While the effects of QE continue to be debated, Richard Werner¹ explains the origin of the term (and some misconceptions surrounding it).
‘Quantitative easing’ (QE), has received much publicity in the past five years. However, its effectiveness remains disputed. Moreover, there are different views about what constitutes QE. It is the purpose of this contribution to review the origins and varying applications of QE, using and thereby explaining the macroeconomic model that gave rise to the concept. Called the ‘Quantity Theory of Credit’, this is arguably the simplest empirically-grounded model that incorporates the key macroeconomic role of the banking sector — a task belatedly recognised as crucial by researchers in the aftermath of the 2008 crisis.

1. The Quantity Theory of Credit after 20 years

I presented the Quantity Theory of Credit in April 1993, at the RES Annual Conference at York.² The central argument is a dichotomous equation of exchange distinguishing between money used for GDP-transactions (determining nominal GDP) and money used for non-GDP transactions (determining the value of asset transactions). Money is not defined as bank deposits or other aggregates of private sector savings. Banks are recognised as not being financial intermediaries that lend existing money, but creators of new money through the process of lending. Growth requires increased transactions that are part of GDP, which in turn requires a larger amount of money to be used for such transactions. The amount of money used for transactions can only rise if banks create more credit. Banks newly invent the money that they lend by pretending that the borrowers have deposited it and thus crediting their accounts without transferring any money from elsewhere. This expands the money supply and it suggests that the accurate way to measure this money is by bank credit.³ It can be disaggregated into credit for GDP transactions (CR) and credit for non-GDP (i.e. asset) transactions (CF). The former drives nominal GDP and the latter asset transaction values. Under further conditions, they determine consumer and asset prices:

Another feature of the model is that it does not assume perfect information — a fundamental condition for market clearing. As a result, markets cannot be expected to be in equilibrium. Then the ‘short-side principle’ applies. Given steady demand for credit and rationing by banks (due to the issues identified in Stiglitz and Weiss, 1981), the supply of credit is the short side.
This simple model explains a number of empirical anomalies, including the often reported lack of empirical significance or the ‘right sign’ of interest rates as explanatory variable of economic activity (rates are not the cause of growth; they do not appear in the model); the ‘velocity decline’, which is due to the neglect of asset transactions in the standard quantity equation; why interest rate reductions and fiscal expansion of historic proportions failed to trigger a sustained recovery in Japan (rates do not cause growth; pure fiscal policy is growth neutral since it does not create credit); what makes banks special and how their activities are related to growth (their creation of money for GDP transactions is the necessary and sufficient condition for nominal GDP growth). It also explains asset price determination and the ‘recurring banking crises’ .
So the effect of bank credit depends on its quantity and quality — the latter defined by whether it is used for unproductive transactions (credit for consumption or asset transactions, producing unsustainable consumer or asset inflation, respectively) or productive transactions (delivering non-inflationary growth). Credit used for productive transactions aims at income growth and is sustainable; credit for asset transactions aims at capital gains and is unsustainable. When credit creation slows after an asset bubble driven by credit for asset transactions, the ensuing fall in asset prices, capital losses and non-performing loans can easily trigger a banking crisis (banks have less than 10 per cent of equity; a drop of their asset values by little more than 10 per cent implies bank insolvency).

2. The origin and definition of QE

The QTC suggests that neither interest rate reductions nor fiscal expansion, nor reserve expansion, nor structural reforms would be able to stimulate nominal GDP growth. Based on this model I proposed in 1994 and 1995 that a new type of monetary policy be implemented in Japan, which aimed not at lowering the price of money, or expanding monetary aggregates, but at the expansion of credit creation for GDP transactions.⁴ Since the expression ‘credit creation’ was considered difficult to understand in Japanese, I prefaced the standard Japanese expression for monetary stimulation (‘monetary easing’ or ‘easing’) with the word ‘quantitative’ to declare that ‘Quantitative Easing’, defined as credit creation for GDP transactions, would create a recovery (Werner, 1995). ‘Quantitative easing’, or, in long, ‘quantitative monetary easing’ are literal translations of the Japanese expressions 量的緩和 (ryōteki kanwa) or 量的金融緩和 (ryōteki kinyū kanwa), kanwa, respectively. These expressions had until then not been used to refer to the money supply, bank reserves or deposit aggregates. I suggested in numerous publications that the central bank purchase non-performing assets from the banks to clean up their balance sheets, that the successful system of ‘guidance’ of bank credit should be re-introduced, that capital adequacy rules should be loosened not tightened, and that the government could kick-start bank credit creation and thus trigger a rapid recovery by stopping the issuance of bonds and instead entering into loan contracts with the commercial banks (e.g. Werner, 1998).
My articles caused consternation among economists of diverging schools of thought. The Keynesians, such as Richard Koo, disputed that further monetary stimulation of any kind was needed and that fiscal policy on its own was going to be ineffective. The government listened to Mr Koo, and Japan continued to expand its national debt in massive spending programmes, while credit growth continued to stagnate. So did the economy. Monetarists, such as Peter Morgan or Alan Meltzer, likewise argued that a lack of bank credit was not a problem and ‘quantitative easing’ in the form of credit creation was not needed. Instead, they argued, an expansion in bank reserves at the central bank would do the job. But massive reserve expansions failed to make any impact and due to stagnating bank credit, economic growth remained well below its potential for most of the following decade and a half. Supply-side economists and proponents of real business cycle models argued that a lack of bank credit could not be the problem — after all, their models did not include banks! I warned during the 1990s that fiscal expansion funded by bond issuance was likely to crowd out private demand, that the expansion of bank reserves would have no impact as idle reserves do not translate into bank credit growth when banks are risk-averse, and that structural reform, if able to increase productivity (which is doubtful) would merely boost potential growth, while Japan’s economy had remained in recession due to a lack of demand.
While my recommendations were not heeded, the label I used caught on. Critics from both the Keynesian and monetarist camps began to redefine QE as an expansion in bank reserves — despite the fact that I had been arguing that such a policy would not work. A new name for an old policy was only likely to cause confusion.
Initially, the Bank of Japan refused to adopt this distorted definition of quantitative easing. It relented in 2002-3, adopting the expression QE to refer to bank reserve expansions and, despite arguing frequently and correctly that such a policy would not work, adopted it for five years, starting in March 2001. Bank reserve targeting had been tried by the Bank of England and the Federal Reserve in the early 1980s but was abandoned as a failure. The puzzle was why the Bank of Japan, despite seconding me in my argument that reserve expansion would not work, chose to adopt it, while giving it the label of a policy I argued would be successful. It certainly had the result of tarnishing the idea of QE. In 2006 the Bank of Japan announced that it abandoned ‘QE’ as, predictably, it had not been successful.

3. QE, QTC and how to end post-crisis recessions
 
This did not stop the Bank of England from adopting a similar policy in March 2009, with the variation that bond purchases would be made from the non-bank private sector (one of the conditions I had mentioned in the 1990s for central bank bond purchases). Better still would have been to boost bank credit by directing any central bank asset purchases to non-performing bank assets. As a result, UK-style QE also failed as bank credit growth continued to stagnate (Lyonnet and Werner, 2012). Meanwhile, Ben Bernanke, who participated in the debates on Japanese policy in the 1990s, seemed to have listened more carefully: In his January 2009 speech at the LSE he insisted that the Fed was not engaging in Bank of Japan-style QE, since reserve expansion would not work, and instead was pursuing a policy more directly targeting credit, which he called ‘credit easing’. This seemed to take us full circle to the original meaning of QE. And the US purchases of non-performing bank assets did seem to do the job of allowing banks to create credit again (with credit growth reaching over 5 per cent by early 2013, and the US economy recovering).
Meanwhile, the Bank of England and HM Treasury began to recognise that policies more directly targeting bank credit creation are more appropriate: the UK ‘Funding for Lending Scheme’ (FLS) cites a key concept from the Quantity Theory of Credit, namely that a successful quantitative monetary stimulation policy needs to be ‘designed to incentivise banks and building societies to boost their lending to UK households and private non-financial corporations — the “real economy”’ or CR of equation (2).⁵ Further, for FLS the authorities had adopted almost the same definition of bank credit for the real economy that had been presented to the Bank of England in 2011, when the QTC was applied to the UK (published as Lyonnet and Werner, 2012). In this paper we showed that the Bank of England’s ‘quantitative easing’ had failed to make an impact on bank credit creation, although bank credit creation for GDP transactions remained the main determinant of nominal GDP growth. Unfortunately, it is not clear that FLS is going to work. Direct targeting of bank credit by the central bank, relaxation not tightening of capital adequacy rules and, most of all, switching the funding method of the public sector borrowing from bond issuance to borrowing from banks, remain surer bets.
The same applies to Europe. Nominal GDP contractions, record unemployment and widespread corporate bankruptcies in Ireland, Portugal, Spain and Greece are driven by credit contractions. Governments can end this by adopting true quantitative easing, easiest in the form of stopping bond issuance and instead borrowing from the banks in their countries. This should be particularly attractive since bond issuance yields have been pushed far beyond the prime lending rate for bank credit. But perhaps it needs to take Japanese leaders - the well-intentioned new prime minister and central bank governor - to finally show the world how true quantitative easing, suggested twenty years ago, can be made to work. For this, however, the continued emphasis on bank reserves needs to be ditched in favour of direct targeting of bank credit.

Notes:
1. Richard A. Werner, D.Phil. (Oxon), is Professor in International Banking at the University of Southampton Management School and Director of its Centre for Banking, Finance and Sustainable Development. He is also a member of the ECB Shadow Council and advises institutional investors. Email: werner@soton.ac.uk
2.Werner (1992). This was reviewed favourably by the Economist (Economics Focus, 19 June 1993) and published later as Werner (1997c). I toned down the title from 'quantity theory' to 'quantity theorem' in the bashfulness of my youth - possibly influenced by harsh comments from referees who hardly seemed ready for monetary models based on bank credit creation or the warnings I had been sounding since 1991 about the imminent collapse of the Japanese banking system (Werner, 1991).
3. See Werner, 1997c, 2005, 2012a, b. See also Ryan-Collins et al. (2012).
4. E.g. Werner (1997a, 1997b, 1998).
5. See the Bank of England’s Churm et al. (2012).

References:
Churm, Rohan, Amar Radia, Jeremy Leake, Sylaja Srinivasan and Richard Whisker (2012), ‘The Funding for Lending Scheme’, Bank of England Quarterly Bulletin 2012 Q4, 306-320.
Lyonnet, Victor and Richard A. Werner (2012), ‘Lessons from the Bank of England on 'quantitative easing' and other 'unconventional' monetary policies’. International Review of Financial Analysis. 25, 1-17
Stiglitz, Joseph E. and Weiss, Andrew (1981). ‘Credit rationing in markets with imperfect information’. American Economic Review, 71(3), 393-410.
Werner, Richard A. (1991). The Great Yen Illusion: Japanese Capital Flows and the Role of Land, Oxford, Institute of Economics and Statistics. Applied Economics Discussion Paper Series, No. 129, December.
Werner, Richard A. (1992). Towards a quantity theory of disaggregated credit and international capital flows. Paper presented at the Royal Economic Society Annual Conference in York, April 1993, and the fifth annual PACAP Conference on Pacific-Asian Capital Markets in Kuala Lumpur, June 1993
Werner, Richard A. (1995). Keiki kaifuku, ryoteki kin'yu kanwa kara. Nihon Keizai Shinbun, Keizai Kyoshitsu, 2 September, p. 26 (in Japanese; English translation at www.eprints.soton.ac.uk)
Werner, Richard A. (1997a). Ryoteki kinyu kanwa de keikikaifuku. Nihon Keizai Shinbun, Keizai Kyoshitsu, 26 February.
Werner, Richard A. (1997b). 'Shinyo Sozoryo' ga Seicho no Kagi. Nihon Keizai Shinbun, Keizai Kyoshitsu, 16 July.
Werner, Richard A. (1997c). ‘Towards a New Monetary Paradigm: A Quantity Theorem of disaggregated Credit, with Evidence from Japan’, Kredit und Kapital, 30, 276-309.
Werner, Richard A. (2005). New Paradigm in Macroeconomics. Basingstoke: Palgrave Macmillan.
Werner, Richard A. (2012a), ‘Economics as if banks mattered - A contribution based on the inductive method’, Manchester School, 79, September, 25-35.
Werner, Richard A. (2012b), ‘Towards a new research programme on “Banking and the Economy”- Implications of a quantity equation model for the prevention and resolution of banking and debt crises’, International Review of Financial Analysis, 25, 94-105.

A SOCIETY WITHOUT MONEY

A SOCIETY WITHOUT MONEY

Steve Keen on Forbes: Banks Can't Lend Out Reserves

Hey Joe, Banks Can't Lend Out Reserves

http://www.forbes.com/sites/stevekeen/2016/02/12/hey-joe-banks-cant-lend-out-reserves/#671e82bb3faf

Steve Keen ,

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I began another post critical of Joe Stiglitz’s analysis with the caveat that I like Joe. I’ll add to that that I respect his intellect too, both because he’s very bright—you don’t win a Nobel Prize (even in Economics!) without being very bright—and because compared to some other winners, he is very capable of thinking beyond the limitations of the mainstream.
But there are some mainstream concepts that are so deeply embedded in even highly intelligent, flexible thinkers like Joe, that they continue thinking in terms of them, when a bit of really serious thought would show that the concepts are in fact nonsense.
Some of these are so deeply embedded in the psyche of economists that they even permeate the alternate economic universe I work in—known as Post Keynesian Economics (even here I’m a bit of a maverick). I attended a presentation by a non-mainstream colleague recently, and while she was critical of the mainstream, she also seemed to agree with Joe on the same topic: that private banks can lend their excess reserves to the public.

NO. THEY. CAN’T.

Here’s Joe on this subject recently in Project Syndicate, in an article entitled “What’s Holding Back the World Economy?”:

As a result, excess reserves held at the Fed soared, from an average of $200 billion during 2000-2008 to $1.6 trillion during 2009-2015. Financial institutions chose to keep their money with the Fed instead of lending to the real economy, earning nearly $30 billion – completely risk-free – during the last five years.

As I’m about to explain, banks didn’t “choose to keep their money with the Fed instead of lending to the real economy”. They have no choice but to “keep their money with the Fed” and…

THEY. CANNOT. LEND. RESERVES. TO. THE. REAL. ECONOMY.

But the fact that economists believe they can matters—really matters—to the real economy right now, because giving private banks excess reserves via QE is the main tool that Central Bankers are using to try to attempt to revive the economy. Since the economy is still pretty sick, 8 years after the global economic crisis of 2008, and because we in the public are in effect their patient, it matters that they give this patient the right medicine.

AND. QE. IS. NOT. THE. RIGHT. MEDICINE.

“Quantitative Easing”: it sounds like a bowel movement. Did you ever imagine you’d even hear such a term, let alone find yourself discussing it over a beer with friends, as many of you probably have? This is the “Magic Bullet” that Central Bankers worldwide are relying upon to restart the global economy. And because in most countries it’s been far less effective than they expected, they’re blaming bankers for not doing their job, and lending the damn stuff to the public.
THEY. CAN’T. DO. IT.
For me, watching academic economists and Central Bankers (the vast majority of whom trained as economists) tell the banks to “lend your excess reserves to the public, dammit!”, is akin to watching some delusional person in a playground watching two kids playing on a see-saw, and criticising them because they weren’t both up in the air at the same time.
So why can’t banks do what the vast majority of economists believe they can and should do—lend the excess reserves that QE has created to the public? And why don’t economists realise that banks can’t actually lend reserves?
Here’s where I’m going to have to explain something to you that is, on the surface, really, really boring: accounting.
But it’s not, really. Yes OK, the day to day life of an accountant might be less exciting than, say, that of an airline pilot. But just like a pilot, they have some arcane knowledge which makes doing what they do both intellectually challenging, and very, very useful to the public. The useful stuff pilots know is beyond me (but I implicitly and happily rely on it every time I fly); the useful stuff accountants know is double-entry bookkeeping.

Why don’t economists know this themselves? Today’s economists simply don’t study it—just like they don’t study history either (“Great Depression? Never heard of it.”). Economists of Joe’s generation often did learn accounting as undergraduates—it was often then required as part of an economics degree—but very few of them ever integrated accounting concepts with their economics.
There are good reasons for that in general: economics can’t be reduced to accounting, just as biology can’t be reduced to organic chemistry (if it could, we’d know how to create life). But just as you can make mistakes in biology if you have a theory that requires chemically impossible reactions to take place, you can make mistakes in economics if your economic theory relies on processes that defy the laws of accounting.
And there is a “Law of Accounting”: that “Assets equal Liabilities plus Capital”. And the belief that banks can lend out their reserves (excess or otherwise) violates the Law of Accounting.
I didn’t learn accounting at University; instead, I’ve learnt it the hard way as I designed an Open Source software package to simulate monetary flows that I named Minsky (in honor of the great non-mainstream economist Hyman Minsky; you can read about and download Minsky for free from here).
Minsky implements this Law, so it lets me show that banks can’t do what Central Bankers (and Joe Stiglitz) think they can do—lend reserves to the public. Most economists, on the other hand, believe in a model of money creation known as “the money multiplier”, which is an intimate part of the concept of “Fractional Reserve Banking”, in which lending reserves to the public is what banks actually do.
In this model, if the Central Bank creates say $1 trillion, and the “Required Reserve Ratio” is 10%, then that $1 trillion of new reserves in banks will create $10 trillion worth of money in the real economy—so that the value of the “money multiplier” is 10. This is the model that Obama’s economic advisors used to convince him that the best way to rescue the economy from the crisis in 2009 was not to give money directly to the public, but to give it to the banks, and for them to then lend to the public:

And although there are a lot of Americans who understandably think that government money would be better spent going directly to families and businesses instead of banks – “where’s our bailout?,” they ask – the truth is that a dollar of capital in a bank can actually result in eight or ten dollars of loans to families and businesses, a multiplier effect that can ultimately lead to a faster pace of economic growth. (“Obama’s Remarks on the Economy”, April 14 2009)
That is poppycock. The actual amount of money that banks can lend to “families and businesses” out of $1 trillion of new reserves is not $10 trillion, but $0. Zip. Nada. Nil.

THE. MONEY. MULTIPLIER. IS. ZERO.

Therefore, the $1.4 trillion of excess reserves that QE has created in the USA alone  has added precisely $0 to the lending power of banks.
To understand why, you’re going to have to follow me down the arcane path of double-entry bookkeeping.
Double-entry bookkeeping is a set of conventions that mean that financial transactions are accurately recorded. One part of it, the so called Accounting Equation, is easy enough to follow: it simply says that if you subtract your Liabilities from your Assets, what’s left over is your Capital:
Assets minus Liabilities Equal Capital.
The hard bit to follow is the set of conventions that accountants have developed to make sure that each transaction they record is done so correctly. This involves the use of the terms DR (for Debit) and CR (for Credit), and rules about which term is used which vary depending on whether the account is an Asset, a Liability, or Capital.
I’ve implemented those in Minsky, but because I find them confusing—as many students of accounting do—I’ve developed another convention that is also quirky, but I think easier to follow. It has two rules:

1. All transactions are shown as a positive entry for the originator, and a negative entry for the recipient; and
2. Assets are shown as positive sums, while Liabilities and Capital (which I normally call Equity, since the word “Capital” has very different meanings in economics than in accounting) are shown as negative sums. Showing a Liability as a negative makes sense: from the point of view of the entity represented by the table, a liability is a negative. The counter-intuitive bit is showing equity as a negative too, but if you do that then you get the check on your logic that every row must sum to zero. 

So a double-entry bookkeeping view of lending $100,000 by a bank, payment of $5,000 in interest, and repayment of $50,000 of the debt, looks like Table 1:

Table 1: A double entry view of lending, interest payments, and debt repayment

Action	Assets (+ive)		Liabilities  (-ive)	Capital  (-ive)	Row Sum
	Loans	Reserves	Deposits	Bank
Starting position	0	0	0	0	0
Lend money	+100000		-100000		0
Pay interest			+5000	-5000	0
Repay money	-50000		+50000		0
Final position	50000	0	-45000	-5000	0

Note that every row sums to zero—as it should—and creating a debt increases the bank’s assets (and liabilities) while repaying the debt reduces them.

Now what about the idea that banks can—and should—lend out the excess reserves that QE has created for them? How does that idea look in a double-entry bookkeeping table? In a word, it looks impossible.
The first stage is the Central Bank makes a loan to the Private Bank—say of $1 million. That is shown in Table 2, and at this point the accounting is accurate. QE itself is both an asset for the banks, and a liability: they get the reserves from the Central Bank, and they are liable to return them to the Central Bank if it asks for them. So that row—“QE from Central Bank”—sums to zero as it should.

Table 2: QE increases both the assets and the liabilities of the Private Banks

Action	Assets (+ive)		Liabilities  (-ive)		Capital  (-ive)	Row Sum
	Loans	Reserves	Debt to CB	Deposits	Bank
Starting position	0	0		0	0	0
QE from Central Bank		+$1mn	-$1mn			0
Final position		+$1mn	-$1mn			0

But “lending from reserves?”. If a bank lends its reserves, its assets fall: it has to make a negative entry in its Reserves column. But to show that the money has been lent to the public, you need a negative entry in the Deposits column as well. So the row sum for that operation in Table 3 is not zero, as it should be. The bank simply can’t lend out its reserves.

Table 3: How “lending out excess reserves” looks in a double-entry bookkeeping table

Action	Assets (+ive)		Liabilities  (-ive)		Capital  (-ive)	Row Sum
	Loans	Reserves	Debt to CB	Deposits	Bank
Starting position	0	0		0	0	0
QE from Central Bank		+$1mn	-$1mn			0
Lend out excess reserves		-$1mn		-$1mn		-2000000
Final position		0	-$1mn	-$1mn		-2000000

Notice another problem. While the bank has—somehow—given money to its depositors, according to Table 2, it hasn’t recorded that it’s lent them the money. As it stands, as well as bad accounting, this is a free gift from the banks to the public (heaven forbid that that might happen!).

What if the bank tries to fix up this mess by adding an additional row to record the loan? Then you get the mess shown in Table 4. It shows that the impact of a bank attempting to “lend out its Reserves” results in the bank’s assets remaining constant (loans have risen by $1 million while Reserves fall by the same amount) and its liabilities rising by $2 million (the $1 million received from the Central Bank in QE and the $1 million it’s “lent” to the public).

Table 4: Attempting to fix the error simply creates a bigger mess

Action	Assets (+ive)		Liabilities  (-ive)		Capital  (-ive)	Row Sum
	Loans	Reserves	Debt to CB	Deposits	Bank
Starting position	0	0		0	0	0
QE from Central Bank		+$1mn	-$1mn			0
Lend out excess reserves		-$1mn		-$1mn		-2000000
Record Loan	+$1mn	-$1mn
Final position	+$1mn	-$1mn	-$1mn	-$1mn		-2000000

What if the bank lends from its excess reserves liability to the Central Bank, rather than from its assets? That, at least is technically feasible, as shown in Table 5: the Law of Accounting is not violated. But just as with Table 4, so far the Bank has given money to its depositors but not recorded that it’s made loans to them: can’t have that!

Table 5: Lending from reserves as a liability

Action	Assets (+ive)		Liabilities  (-ive)		Capital  (-ive)	Row Sum
	Loans	Reserves	Debt to CB	Deposits	Bank
Starting position	0	0		0		0
QE from Central Bank		+$1mn	-$1mn			0
Lend out excess reserves			+$1mn	-$1mn		0
Final position	0	+$1mn	0	-$1mn		0

Table 6 records the loan, by adding a $1 million asset in the Loans column. To balance the row, the bank has to record minus $1 million in the “Debt to CB” column—thereby undoing the effect of “lending from reserves” in the first place.
The final situation has Reserves increasing by $1 million (because of QE) and Loans increasing by $1 million as well (because of the loan to the public), but Reserves have now played no role in the lending: they are back to where they were after QE.

Table 6: Bank records the loan and the lending from Reserves disappears

Action	Assets (+ive)		Liabilities  (-ive)		Capital  (-ive)	Row Sum
	Loans	Reserves	Debt to CB	Deposits	Bank
Starting position	0	0		0	0	0
QE from Central Bank		+$1mn	-$1mn			0
Lend out excess reserves			+$1mn	-$1mn		0
Record Loan	+$1mn		-$1mn			0
Final position	+$1mn	+$1mn	-$1mn	-$1mn		0

This is, if you’ll pardon the pun, the bottom line: reserves play no role in lending at all, regardless of QE. The “Money Multiplier” model is a myth.
But that myth is the basis of the attempt by Central Banks to rescue the world from the economic crisis. It’s little wonder that that rescue attempt isn’t going as smoothly as planned.

Central Banks Are Trojan Horses, Looting Their Host Nations

Posted on February 11, 2016 by WashingtonsBlog

http://www.washingtonsblog.com/2016/02/central-banks-trojan-horses-looting-host-nations.html

 

A Nobel prize winning economist, former chief economist and senior vice president of the World Bank, and chairman of the President’s council of economic advisers (Joseph Stiglitz) says that the International Monetary Fund and World Bank loan money to third world countries as a way to force them to open up their markets and resources for looting by the West.
Do central banks do something similar?
Economics professor Richard Werner – who created the concept of quantitative easing – has documented that central banks intentionally impoverish their host countries to justify economic and legal changes which allow looting by foreign interests.
He focuses mainly on the Bank of Japan, which induced a huge bubble and then deflated it – crushing Japan’s economy in the process – as a way to promote and justify structural “reforms”.
The Bank of Japan has used a heavy hand on Japanese economy for many decades, but Japan is stuck in a horrible slump.
But Werner says the same thing about the European Central Bank (ECB).  The ECB has used loans and liquidity as a weapon to loot European nations.
Indeed, Greece (more), Italy, Ireland (and here) and other European countries have all lost their national sovereignty to the ECB and the other members of the Troika.

ECB head Mario Draghi said in 2012:

The EU should have the power to police and interfere in member states’ national budgets.
***
“I am certain, if we want to restore confidence in the eurozone, countries will have to transfer part of their sovereignty to the European level.”
***
“Several governments have not yet understood that they lost their national sovereignty long ago. Because they ran up huge debts in the past, they are now dependent on the goodwill of the financial markets.”

And yet Europe has been stuck in a depression worse than the Great Depression, largely due to the ECB’s actions.
What about America’s central bank … the Federal Reserve?
Initially – contrary to what many Americans believe – the Federal Reserve had admitted that it is not really federal (more).
But – even if it’s not part of the government – hasn’t the Fed acted in America’s interest?
Let’s have a look …
The Fed:

• Bailed out foreign banks … more than Main Street or the American people.  The foreign banks bailed out by the Fed include Gaddafi’s Libyan bank, the Arab Banking Corp. of Bahrain, and the Banks of Bavaria and Korea

• Offered to bail out Mexico, if it would agree to join the North American Free Trade Agreement (NAFTA)

• Threw money at “several billionaires and tens of multi-millionaires”, including billionaire businessman H. Wayne Huizenga, billionaire Michael Dell of Dell computer, billionaire hedge fund manager John Paulson, billionaire private equity honcho J. Christopher Flowers, and the wife of Morgan Stanley CEO John Mack

• Bailed out wealthy corporations, including hedge funds, McDonald’s and Harley-Davidson

• Artificially “front-loaded an enormous [stock] market rally”.  Professor G. William Domhoff demonstrated that the richest 10% own 81% of all stocks and mutual funds (the top 1% own 35%).  The great majority of Americans – the bottom 90% – own less than 20% of all stocks and mutual funds. So the Fed’s effort overwhelmingly benefits the wealthiest Americans … and wealthy foreign investors

• Is largely responsible for creating the worst inequality in world history

• Turned its cheek and allowed massive fraud (which is destroying the economy). Fed chair Greenspan took the position that fraud could never happen.   Fed chair Bernanke also falsely stated that the big banks receiving Tarp money were healthy when they were not

• Acted as cheerleader in chief for unregulated use of derivatives at least as far back as 1999 (see this and this), and is now backstopping derivatives loss

• And for subprime loans

• Allowed the giant banks to grow into mega-banks, even though most independent economists and financial experts say that the economy will not recover until the giant banks are broken up. For example, Citigroup’s former chief executive says that when Citigroup was formed in 1998 out of the merger of banking and insurance giants, Greenspan told him, “I have nothing against size. It doesn’t bother me at all”

• Argued that economists had conquered the business cycle, and that modern, technologically advanced financial markets are best left to police themselves

• Preached that a new bubble be blown every time the last one bursts

• Had a hand in Watergate and arming Saddam Hussein, according to an economist with the U.S. House of Representatives Financial Services Committee for eleven years, assisting with oversight of the Federal Reserve, and subsequently Professor of Public Affairs at the University of Texas at Austin.  See this and this

• Intentionally discouraged banks from lending to Main Street, which has increased unemployment and stalled out the economy

Moreover, the Fed’s main program for dealing with the financial crisis – quantitative easing – benefits the rich and hurts the little guy, as confirmed by former high-level Fed officials, the architect of Japan’s quantitative easing program and several academic economists.  Indeed, a high-level Federal Reserve official says quantitative easing is “the greatest backdoor Wall Street bailout of all time”.  And see this.
Some economists called the bank bailouts which the Fed helped engineer the greatest redistribution of wealth in history.
Tim Geithner – as head of the Federal Reserve Bank of New York – was complicit in Lehman’s accounting fraud, (and see this), and pushed to pay AIG’s CDS counterparties at full value, and then to keep the deal secret. And as Robert Reich notes, Geithner was “very much in the center of the action” regarding the secret bail out of Bear Stearns without Congressional approval. William Black points out: “Mr. Geithner, as President of the Federal Reserve Bank of New York since October 2003, was one of those senior regulators who failed to take any effective regulatory action to prevent the crisis, but instead covered up its depth”
Indeed, the non-partisan Government Accountability Office calls the Fed corrupt and riddled with conflicts of interest. Nobel prize-winning economist Joe Stiglitz says the World Bank would view any country which had a banking structure like the Fed as being corrupt and untrustworthy. The former vice president at the Federal Reserve Bank of Dallas said said he worried that the failure of the government to provide more information about its rescue spending could signal corruption. “Nontransparency in government programs is always associated with corruption in other countries, so I don’t see why it wouldn’t be here,” he said.
But aren’t the Fed and other central banks crucial to stabilize the economy?
Not necessarily … the Fed caused the Great Depression and the current economic crisis, and many economists – including several Nobel prize winning economists – say that we should end the Fed in its current form.
They also say that the Fed does not help stabilize the economy. For example:

Thomas Sargent, the New York University professor who was announced Monday as a winner of the Nobel in economics … cites Walter Bagehot, who “said that what he called a ‘natural’ competitive banking system without a ‘central’ bank would be better…. ‘nothing can be more surely established by a larger experience than that a Government which interferes with any trade injures that trade. The best thing undeniably that a Government can do with the Money Market is to let it take care of itself.’”

Earlier U.S. central banks caused mischief, as well.  For example,  Austrian economist Murray Rothbard wrote:

The panics of 1837 and 1839 … were the consequence of a massive inflationary boom fueled by the Whig-run Second Bank of the United States.

Indeed, the Revolutionary War was largely due to the actions of the world’s first central bank, the Bank of England.   Specifically, when Benjamin Franklin went to London in 1764, this is what he observed:

When he arrived, he was surprised to find rampant unemployment and poverty among the British working classes… Franklin was then asked how the American colonies managed to collect enough money to support their poor houses. He reportedly replied:
“We have no poor houses in the Colonies; and if we had some, there would be nobody to put in them, since there is, in the Colonies, not a single unemployed person, neither beggars nor tramps.”
In 1764, the Bank of England used its influence on Parliament to get a Currency Act passed that made it illegal for any of the colonies to print their own money. The colonists were forced to pay all future taxes to Britain in silver or gold. Anyone lacking in those precious metals had to borrow them at interest from the banks.
Only a year later, Franklin said, the streets of the colonies were filled with unemployed beggars, just as they were in England. The money supply had suddenly been reduced by half, leaving insufficient funds to pay for the goods and services these workers could have provided. He maintained that it was “the poverty caused by the bad influence of the English bankers on the Parliament which has caused in the colonies hatred of the English and . . . the Revolutionary War.” This, he said, was the real reason for the Revolution: “the colonies would gladly have borne the little tax on tea and other matters had it not been that England took away from the colonies their money, which created unemployment and dissatisfaction.”

(for more on the Currency Act, see this.)
And things are getting worse … rather than better.  As Professor Werner tells Washington’s Blog:

Central banks have legally become more and more powerful in the past 30 years across the globe, yet they have become de facto less and less accountable. In fact, as I warned in my book New Paradigm in Macroeconomics in 2005, after each of the ‘recurring banking crises’, central banks are usually handed even more powers. This also happened after the 2008 crisis. [Background here and here.] So it is clear we have a regulatory moral hazard problem: central banks seem to benefit from crises. No wonder the rise of central banks to ever larger legal powers has been accompanied not by fewer and smaller business cycles and crises, but more crises and of larger amplitude.

Georgetown University historian Professor Carroll Quigley argued that the aim of the powers-that-be is “nothing less than to create a world system of financial control in private hands able to dominate the political system of each country and the economy of the world as a whole.” This system is to be controlled “in a feudalist fashion by the central banks of the world acting in concert by secret agreements,” central banks that “were themselves private corporations.”
Given the facts set forth above, this may be yet another conspiracy theory confirmed as conspiracy fact.