Money demand that doesn’t raise interest rates

The standard narrative is that money serves three functions:

• Medium of exchange
• Unit of account
• Store of value

Central banks have the mandate of ensuring that these functions all work smoothly so as to best serve the economy. When they don’t, problems with the monetary system can snarl up the real economy. For instance, if there is an insufficient supply of money to meet the demand for medium of exchange, then interest rates will spike up. The most familiar role of the central bank is in providing more base money so as to avoid crises of that type. Where things become murkier is when there is a deflationary slow down with great demand for money as a store of value. That situation is profoundly different and in such circumstances, interest rates can fall to zero. Should we expect the central bank to be able to deal with a situation of that type? In the 1930s that economic condition was prevalent.  Something similar reappeared in Japan twenty years ago and now has spread across much of the developed world.

Market monetarists such as Scott Sumner make the case that lack of nominal economic growth is always down to unmet demand for money and it is vital that the central bank meets any such demand whether it is driven by a requirement for medium of exchange or by a desire to hold money as a store of value. However, a key distinction between demand for money as a medium of exchange and demand as a store of value is that monetary base can be a limiting factor for the medium of exchange role. Whenever banks settle up the net payment transactions that have occured between customers of one bank and  another, base money is the only form of money they can use. The amount of base money required for that purpose is very small in terms of the total value of financial assets in the economy but nonetheless vital. By contrast there is nothing special about base money when it comes to providing the store of value role. Any other form of risk free broad money will serve that role just as well. Asset holders seeking to hold wealth as money will readily exchange other assets for base money but they will just as readily hold wealth in the form of broad money such as short term, risk free, debt securities. That is why interest rates are at the zero-bound; that after all is what it means for interest rates to be at the zero-bound.

So if the central bank takes it upon itself to conduct quantitative easing (QE) to appreciably alter the supply of money applicable for the store of value role, it has a massively larger job on its hands. Furthermore, broad money is readily constructed outside the central bank by the commercial financial system. To some extent, the increase in the money supply from QE gets offset by the shadow banking system reducing its output of broad money because demand for broad money is being met by QE.

I think the most crucial issue to examine is whether unmet demand for money as a store of value is actually what is impeding the economy and if so, what that implies.  In an idealized system, financial intermediation would match those who had savings with those who had need of finance for ventures that would subsequently pay a return. A problem arises when financial savings have instead built up on the basis of lending to fund unaffordable consumption, house price inflation and financial speculation. Servicing such debts has been based indirectly on further credit expansion providing the necessary  flow of funds. When much of the wealth in an economy is based on such a shaky foundation, asset holders seek money as a store of value rather than risk being caught up in a collapse in asset values.

Some economists such as Bill Mitchell advocate massive government deficit spending as a way to extricate ourselves from this situation. That could provide a flow of funds to enable debtors to service their debt burden and could provide ample risk free government debt securities as a way for savers to hold wealth. What actually seems to be being done is a toned down version of that approach. Just enough deficit spending is reluctantly being eked out to keep debts serviced and asset prices aloft. In the USA, QE is being used to purchase mortgage backed securities and in the UK the government is backstopping mortgage lending. This provides support for asset holders who don’t trust that asset prices won’t collapse. Meanwhile debtors are weighed down with debt servicing costs and unemployment squanders much potential that we instead permanently loose. The tragedy is that this scenario could persist pretty much indefinitely or even get worse over time.

As bad as our current situation is, I have grave doubts about the longer term consequences of taking the Bill Mitchell massive deficit route. My view is that the best option could be to ensure that money circulates through the system by replacing all current taxes with a tax on gross asset values and paying everyone a citizens’ dividend.

Related previous posts:

Does QE increase the preference for cash as a way to store wealth?

Monetary policy, the 1930s and now.

Sustainability of economic growth and debt.

Is it unjust to tax assets.

Bail out the customers not the banks.

Fiscal autopilot.

Rich people could benefit if everyone else were also rich.

Political Consequences of risk free financial assets.

Related stuff on the web:

Money creation in the modern economy -Bank of England (link added 19March2014 ht JKH)

The Myth of Japan’s Failure -E. Fingleton -NewYorkTimes

The Supply and Demand for Safe Assets -Gary Gorton, Guillermo Ordonez

Capitalism for the masses- Ashwin Parameswaran

The Road to Debt Deflation, Debt Peonage, and Neofeudalism -Michael Hudson

Depression is a Choice -Interfluidity

Debt and Demand -JW Mason

To save the environment, target poverty.

I think the greatest threat to our environment is human poverty. This may seem counter-intuitive since in general each rich person consumes and pollutes far more than each poor person. It has been estimated that it would take five Earths to provide all seven billion of us with a current US lifestyle. An astonishingly low environmental impact is achieved by the poorest . On the face of it, if everyone managed to lift themselves out of poverty, increases in pollution and environmental degradation might be expected to cause an environmental calamity. However if having all seven billion of us living an affluent lifestyle poses an environmental challenge, a more serious environmental challenge is posed by having ten billion people sharing the planet even if two billion of those don’t pollute or degrade the environment much due to poverty. To my mind population growth is the crucial environmental issue and population growth comes from poverty.

Hans Rosling makes a very compelling case that the poorest two billion people are the source of global population growth. People from utterly different cultures all over the world on average have large families when child mortality rates are high and small families when they are low. Over the past few decades there has not been an explosion in the number of poor people because thankfully many poor people do manage to escape poverty. But enough remain poor to maintain a steady source of global population growth. The poorest two billion people today are just as poor as the poorest two billion a few decades ago and just as likely to see their children die and just as likely to have large families. Poor people  are the progenitors of the increased future population of better off people who eat meat, drive cars and water their lawns. If you believe that the world can only support a limited number of affluent people then the answer is to ensure that everyone is affluent.

Obviously if each of us who has the good fortune to be comfortably well off chooses to consume in a way that minimises environmental problems; then that is great. We can spend our money on say dance classes for our children rather than new hardwood flooring or whatever –reduce, reuse, recycle. Environmental concerns do also feed into politics though. Many people want the political system to steer other people towards behaviour that protects the environment.  I think it is crucial that people living in the rich world channel the politics of environmental concern towards ameliorating the extent to which the rich world impoverishes the world’s poorest. I don’t think policy makers in the rich world intentionally impoverish the world’s poorest. It comes as a by-product of efforts to ensure prosperity in the rich world or to protect special interest groups in the rich world. Agricultural tariffs and subsidies are a classic example. They lead to what otherwise would be uneconomic intensification of agriculture in the developed world so as to dump food at a loss in the poor world. There is consequent destitution of people who could otherwise be involved in commercial agriculture in the developing world both for local consumption and for export. In the 1800s the case was successfully made that repealing the English “corn laws” would benefit almost everyone with the exception of those wanting increased rents and mortgages from English farmland. I think the same arguments hold today.

In the USA in particular there is much popular support for protectionist tariffs and subsidies*. The USA is such a large country that it can cope relatively well even if global trade gets shut down. I think it is crucial that we unpick the motivation behind such protectionist views. Much of it seems to stem from the conflict between “labour” and “capital”. The owning class has the most to gain from globalization. The owning class can own whichever companies are most profitable where ever they are based. They can lend money to whoever in the world provides the highest return. Workers on the other hand lose bargaining power. Jobs become outsourced to where ever in the world has the lowest wages for a given level of competency. As I see it the answer is to ensure that everyone belongs to the owning class. Replacing all current taxes with an asset tax and paying a citizens’ dividend would have that effect. If the increased profits that came from offshoring jobs went to everyone rather than just a select owning class then much of the current resentment would evaporate.

What the world needs are advances in efficiency and technology. We need to be able to do more with less. To my mind it makes much more sense for people to be freed up to push new technologies in the developed world. A compelling case can be made that developing countries benefit from “learning by doing”. If a basic manufacturing process can be done well in a developing country then it makes sense for it to be done there, providing jobs there. Hopefully the experience gained will raise capabilities so that all of the world can be at the forefront.  People like working not simply because they want money but because they find it satisfying to create and provide, to master skills and innovate. To truly satisfy that motivation, people need to be doing work where they are really making a difference for the better. The duplication and waste that comes from trade barriers runs counter to that.

Even more than trade barriers, I think policies aimed at encouraging capital flows from the developing world to the developed world have been the overriding influence on world poverty. I’ve examined this in the previous post “Isn’t a financialized economy the goose that lays our golden eggs”. People in the UK are not callously minded towards people in the developing world. I’m sure that the decimation of the real value of the median wage across the developing world that occurred during the 1980-2000 “great moderation” period is not connected in most people’s minds  with the apparently miraculous affordability for global commodities that came in that period for those in the developed world. Ignorance is no excuse though. We need to get real and face up to the consequences of the policies we vote for. Making the UK a perfect piggy bank for capital flight from developing countries does far more damage than can be put right by some charitable donations.

It is striking that the popular sympathy for protectionism as a way to “keep jobs here” is at odds with nurturing capital flight from poorer countries as a way to gain prosperity by sleight of hand. If money were staying in poor countries, causing those countries to develop a prosperous economy of their own, then that would raise wages there. That would avoid the issue of jobs being offshored from the rich world to lower wage countries. Furthermore if the whole world were prosperous, then countries that are currently poor would become potential importers of products made by workers here.

The cost of natural resources does however increase if the whole world can afford them. If what we really want are more jobs in the rich world, then perhaps we should be more sanguine about that. There are lots of potential job opportunities in renewable energy and recycling. To my mind it makes no sense to at the same time put up trade barriers so as to “keep jobs at home” and yet entice capital flight so that we can get all the world’s natural resources and put off the day when we need to recycle and use renewables.

*As an aside, I think protectionism also is a very bad idea because it provides a compelling motivation for imperialism. In the absence of world trade, a country needs to have a large internal market and that means that countries need to be as large as possible.

see also posts:

We choose for renewable energy to make no financial sense.

Rich people could benefit if everyone else were also rich.

Globalization, Triffin’s dilemma and demurrage crypto currency.

Isn’t a financialized economy the goose that lays our golden eggs?

Related stuff on the web:

People and the planet -Royal Society

Stop blaming the poor. Its the wally yatchers who are burning the planet – George Monbiot

populationmatters.org

The mother of invention – Interfluidity

Globalization, Triffin’s dilemma and demurrage crypto currency.

I’m convinced that global trade is critical for economic development.

In the timeframe of the whole sweep of human existence, it has only been since very recently that we didn’t all live off the local land as hunter gathers (with astonishing levels of violence). We were then living sustainably. We don’t now have the option of sustained existence in a 20^thC style using 20^thC technology; we would simply foul our nest and perish in a few generations. To live well, we need to keep ahead of things. From what I can see, that is a big challenge and it will take the combined ingenuity of all of the world’s population to meet it. I’m convinced that our best hope is if ideas and tools, goods and services are exchanged freely across the whole world and no one is economically excluded.

I also think it is critical that different cultures flourish in their own way. I think it is critical that we don’t develop a pan-global group think. Different cultures make breakthroughs at different times and everyone else benefits. Early Islamic mathematicians drew upon knowledge established in India along with a separate body of knowledge running from Ancient Egypt through Ancient Greece. That work was then built upon further in northern Europe. Iron working was invented in India and much later perfected in Japan then brought into mass production in England. Possibly, at each step, the particular cultural and political scenario at each place at each time was critical -it wasn’t a case of one culture continuously leading. History seems to repeat the pattern where political, economic and cultural unification initially leads to a flourishing followed by stultification and decline. Previously such unification was only relatively local. Qin Shi Huang’s China was a huge civilization as was the early Islamic world but in each case most of the world was not included. Today we face the prospect (danger) of having all of our eggs in one basket.

There is a difficult balancing act between facilitating global exchange and yet not trying to mould each other into doing things “our way”. We benefit tremendously from being able to buy and sell specialist equipment and services pretty much anywhere in the world. The same is true for bulk commodities. What is scarce in one place is plentiful in others. Global trade needs some level of common currency and legal framework and yet I believe it is imperative that we don’t go overboard with political integration.

“Pieces of eight” from Latin America provided the first global currency. Then as now severe trade imbalances meant that money failed to recirculate. China sold more goods to Europe than were sold in return. Immense amounts of silver were mined (with enormous human suffering) in Boliva and Mexico to perpetuate the imbalance for centuries. When the Spanish Empire lost its Naval power and so the supply of silver dried up, silver stopped being the global standard of money and the Chinese hoard lost most of its purchasing value. It is now mostly in waste dumps across the world in the form of photographic emulsion.

Today the USD is the global currency;  and consists of electronic ledger entries. This is a legacy of the Bretton Woods agreement in the aftermath of WWII. At that time gold provided the global unit of account but WWII had left the USA with the bulk of the global stock of gold and the USA was also the only country with the capacity to supply the world with much needed equipment and goods for post war reconstruction. Keynes argued that the world needed a stable currency for global trade and proposed the bancor concept. That bancor currency would have been pegged to a basket of commodities and any country running a trade surplus would pay a tax to deficit countries. However the USA was in a position to dictate terms and chose for the USD to become the global currency.

There are issues with the current USD based global system. If China buys iron ore from Australia or Japan buys oil from the UAE; that requires USD. A lot of USD are required for such global trade. All of that has to be obtained by selling real goods and services to the USA. Across much of the world it is resented as a free lunch for the USA and yet for the average Joe in the USA it becomes manifest as loss of jobs. US military spending consumes much of the “exorbitant privilege” and that leads to an unpleasant perception that much military focus is on perpetuating global USD hegemony simply so as to maintain the ability to do so. Furthermore any long term trade contracts can be “gamed” by expansion of the stock of USD bank reserves and treasury bonds. US trading partners such as China and Japan have endeavoured to stabilize currency exchange rates so as to avoid trade disruption. That has entailed vast state accumulations of US treasury bonds in both China and Japan. There is much finger pointing and squabbling. On the one hand if the USA limited military spending to the level of tax revenue, there would be no need for the Chinese government to accumulate US treasuries in order to stabilize the exchange rate. On the other hand China could leave the Chinese currency to appreciate against the USD and leave the private sector to sort out contracts that accommodated shifting exchange rates.

Efforts to ameliorate the system have included piecemeal bilateral currency swap agreements between China and twenty other countries. China has also made vast accumulations of Euro zone government debt. I guess the reality is that what is sort-after are jobs, trade and accumulation of expertise and productive capacity (not to mention maintaining control for the Chinese government). Perhaps the trillions of dollars in US treasuries accumulated by the Peoples Bank of China and Bank of Japan could almost be thought of as a waste product of efforts to that end.

Greenwald and Stiglitz have argued that global trade would be better served if a basket of all of the major currencies were used as the unit of global trade instead of using the USD. Zhou Xiaochuan expressed support for the concept and called the original Bancor argument made by Keynes at Bretton woods “far-sighted”. I wonder whether the same overall argument couldn’t be taken further. The limited composition of a currency basket would still provide a distorting privilege. The weighting between the various currencies depends on a politically negotiated formula and so could be an endless source of bickering and instability. Smaller, poorer, countries would be excluded. I think a better solution would be to view the “exorbitant privilege” of seigniorage of the global currency as being directly due to all seven billion individual people in the world.

We have emerging technologies that potentially enable electronic currencies to be extremely decentralised and yet secure and protected from counterfeit (the best known are bitcoins). Freicoin is such a “crypto-currency” that has the important property of demurrage; it decays at a rate of 5% per year. The intention is to ensure that it is not held as a store of value but instead remains in circulation. That helps to ensure that it provides a unit of account with stable value. The demurrage is constantly replaced by fresh freicoins so as to maintain the overall stock. Freicoins seem more of a proof of concept than anything else. That is probably just as well because if freicoins became significant, the seigniorage privilege would confer inordinate financial power to the unaccountable “freicoin foundation” –it would create an utter monster  –perhaps like the Heritage Lottery Fund on a super power scale.

I think however that the freicoin concept suggests a possibility for an equitable global currency in a way that would minimize any need for political or legal integration across countries. Trade within each country need not be affected. Each country could continue to use whatever monetary system they chose. However international trade could use such a universal demurrage crypto-currency (let’s call it X). There could be say $1Tn full units of X in existence with it all suffering an extremely rapid rate of demurrage (say 0.05% per hour). Every person in the world would be equally eligible to receive seigniorage profits. Companies could compete to administer each person’s seigniorage rights much as companies today compete for business in supplying mobile phone network for people even in poor regions. People would choose a seigniorage provider on the basis of how much money it paid them (paid in their own local currency). Perhaps such administration would often involve the mobile phone network companies and people might automatically receive payment over the phone network. Presumably commercial pressures would cause an effective system to evolve. The companies providing the service would need to immediately exchange the X for local currency so as to provide importers with the X required to pay for foreign goods and services and to get local currency to pay everyone and to pay for costs. Speculators could intermediate but obviously there would be an imperative to clear the market extremely fast so as to minimize the considerable demurrage cost. Consequently, currency exchange rates would be set by trade flows rather than by speculative hoarding. The imperative to have extremely rapid exchange out of X and into local currencies would ensure that the value of X was minimized. So despite the rapid demurrage and replacement; the “unearned”seigniorage benefits would be modest and would be equally distributed to all seven billion of us.

I suppose some countries would allow multinational companies to operate the system; elsewhere local companies might do it and statist countries might insist on state monopolies. Presumably North Korea would keep all of the benefits for the state. I still think globally it could be much more equitable and harmonious than what we currently do.

Inevitably some level of international co-ordination would be required but I think it might be less than currently required for the USD system. The current bitcoin network has demonstrated the potential simple robustness of crypto-currency networks. I think the most important international agreement needed would be to end the holding of foreign exchange by anyone – people and institutions would only hold a countries currency in that country for use in that country. There is the critical issue of what to do with the current stocks of foreign exchange reserves. Perhaps a write down of those stocks could be negotiated as a deal to secure an end to the current system. Countries that currently issue reserve currencies (largely the USA) would see an end to the “exorbitant privilege” but also the worrisome foreign owned US treasury debt would disappear. Presumably China and Japan never intend to draw down and spend their stock of US treasuries. If they are simply a by-product of efforts to stabilize exchange rates, then their job is done; and no harm would come from writing them down.

Foreign government holdings of US treasuries could never anyway be drawn down to pay for anything that the USA did not consent to since they are entries in the ledger on the computer that is part of the US administration. Gold perhaps has the potential to be exchanged in a less constrained manner in the event of a war or crisis and so is held as a type of reserve for such “just in case” situations. Hopefully an end to our current system would provide a stable global financial system such that worldwide currency devaluation no longer caused appreciation of the gold price and it would stabilize just below the extraction cost. Critically I think the most important reserve asset any country can accumulate is the capability of its population. Hopefully we all realise that.

Related stuff on the web:

wiki Triffin dilemma

A Modest Proposal for International Monetary Reform – Greenwald and Stiglitz

Why the Fed is more likely to adopt bitcoin technology than kill it off -JP Koning

31% of Kenya’s GDP is spent through mobile phones -Christopher Mims

Freicoin: a peer to peer digital currency delivering freedom from usery – official web site

Freicoin: Occupy’s online currency for the 99 per cent – New Scientist

de-dollarization-dismantling-americas-financial-military-empire – Michael Hudson

Reinventing Bretton Woods: Global Finance in Transition- Jesse Cafe Americain has links to other related posts too

America’s growing trade deficit is selling the nation out from under us. Here’s a way to fix it -and we need to do it now -Warren E. Buffett  see also wiki Import Certificates

China is not the problem -Bill Mitchell

www.freicion.org discussion / rebuttal of this blog post (I added this link on 10May2013)

Wary of Bitcoin? A guide to some other cryptocurrencies– Wired (I added this link on 10May2013)

Beyond Money.net – Devoted to the liberation of money and credit (I added this link on 11May2013)

The hidden hand of American hegemony- David E Spiro (I added this link on 12May2013)

More on M-pesa and e-money -FT (I added this link on 16May2013)

Reserve Accumulation and International Monetary Stability -IMF (I added this link on 29May2013)

A Proposal for International Monetary Reform – James Tobin 1978 (link added 01June2013 ht Ramanan)

Chance, luck, risk and economic democracy

We all know the Samuel Goldwyn quote, “the harder I work the luckier I get”; as a personal maxim it has some considerable advantages over, “what will be, will be.” Capitalism revolves around the idea that control amasses to those who have done well. To some extent that ensures that the economy is governed by the competent. However it would be irresponsible and delusional to deny that the effects of personal effort are overlaid on a canvas of stochastic dumb luck. Serendipity is the backdrop to many a success and many losers are potential future winners. If we want our economy to best provide for all of us and make best use of every ones‘ talents, then we need to face up to this randomness.

Ole Peters has posted a fantastic video lecture about the nature of chance (bear with him past the grasshopper stuff). He describes a simple game where a coin flip decides whether the player gains 50% or loses 40%. Clearly winning  gains more than losing loses BUT a subsequent win does not make up for a preceding loss and a subsequent loss loses more than was gained by a preceding win (1.5×0.6=0.9<1); that is the “magic” of compounding.  This simple set up means that a large enough population of players will, in aggregate, steadily gain from playing the game but all of the winnings will randomly accrue to an ever smaller minority of players whilst almost everyone loses almost everything. Ole Peters points out that from an individual’s perspective playing such a game appears highly unattractive. A critical point to emphasize is that it is just as unattractive for a winner to continue with the game as it is for anyone else. A winning or losing streak does not influence the future. A rational winner would choose to stop and keep the winnings.  If wins and losses are pooled and rebalanced across many players, then the game becomes universally attractive.

Perhaps this simple game has more similarity to real life than we care to admit. Starting an enterprise entails financial risks and from an individual’s perspective the financially prudent course of action is typically to hold back. However, if we do that, nothing gets done and we are all poorer.  Perhaps much of the regulatory and legal framework of our financial system is an attempt to entice participation in the perils of enterprise risk so as to add to the overall greater good of society. Whatever lies behind how our financial system has come to be the way it is; I think it has lost its way. Limited liability and bankruptcy laws protect owners from the full financial consequences of bankruptcy. Winnings are kept but losses can be transferred to creditors. Ultimately the state subsidises credit provision to socialise losses whilst leaving profits with owners. This would all be very well if the only sort of risk being subsidised were true enterprise risk from potentially productive endeavours. We all need people to be making valiant attempts to create the next technological breakthrough or provide services in a more effective manner or whatever. The problem is that blindly subsidising financial credit and risk also encourages concoction of synthetic financial risk through use of financial leverage*.

The incredibly complicated to manage and idiosyncratic world of creative innovation or micro-enterprise is not an easy zone to park a vast fortune into. A vast fortune can however prosper very well in circumstances where enterprise risk is avoided and instead exposure is taken to the stochastic fluctuations of global asset and commodity prices. Then economies of scale favour the biggest players –it becomes more affordable to have market beating ultra-low-latency trading systems and to employ the best of the best to develop and operate them. Wealth deployed in that way however is not providing for the future; it is merely gathering money from other people in a zero sum redistribution towards the richest. Unfortunately leveraged speculation also exacerbates price volatility and that can have tragic real world consequences such as the starvation that occurred from the 2009 spike in grain prices.

In principle financial intermediation might be hoped to distribute risk and so create a situation where enterprise risk is readily taken on. The problem is that true enterprise risk is massively dependent on the details of what is being done. That is something that can only be assessed and managed by those intimately involved in each specific project. It is utterly unsuited for pooling across the whole economy. Large corporations have a tendency to only engage in cutting edge developments after it becomes clear that the most risky, initial stages are in the bag. When broader pools of funding for investment are available, it is all too often the case that genuine attempts at innovation become displaced by those cynically attempting to tap into a gravy train. There are plenty of ghastly anecdotes from the 1990’s tech bubble. One scientist told me about how a financier in the 1990’s tried to persuade him to start a biotech company. The financier was triumphantly boasting that none of the many companies he had started had any prospect of commercial viability and all investors had been conned. Even within large companies, it is very hard to keep cutting edge innovation on an effective focussed footing. All too often projects flounder in a way that wouldn’t happen if those involved all saw the project as theirs rather than the companies.

The mainstream view seems to be that innovation would best be fostered by facilitating concentration of wealth. I wonder whether the opposite might not be true. A universal citizens’ dividend could provide a necessary small measure of financial freedom that would help anyone who fancied to have a go at developing some innovation perhaps together with other like-minded people. The history of the 19^th century industrial revolution is full of examples of very small groups of individuals tinkering away and making ground-breaking technological advances. Jean-Pierre Garnier then head of GSK has stated that, “The basic philosophy for modern R&D should be to morph big into small in recognition of the fact that critical mass in fundamental research is the size of one human brain.” To my mind that is an argument for ensuring that much financial power is also at the scale of each and every human. The key thing is that people having a go at developing an innovation whilst being partly supported by a citizens’ dividend would have a lot of skin in the game. Their time and money would be theirs and so they would be so much less likely to simply “go through the motions” in the way they might if they were simply following orders.

I also think the same principle applies to provision of everyday goods and services and not just to cutting edge innovations.  In some circumstances it may be most efficient to supply say groceries through a huge supermarket chain but there are also certain efficiencies in having a dispersed small scale system. Currently, holders of outdoor market stalls selling food may be displaced by a supermarket not because they are less efficient or convenient but simply because a supermarket chain is more suitable for accommodating large scale impersonal financial investment. It might be argued that bank lending provides finance to small scale enterprises such as market stalls. However as Ole Peters so clearly demonstrates in his lecture, an enterprise financed in that way becomes dramatically more risky. The repayments are fixed but the revenue stream is subject to the variances of real life. That is why in the UK and USA the (relatively predictable and secured) purchase of pre-existing housing stock accounts for 80% of bank lending and banks are so wary of business lending. An asset tax and citizens’ dividend system might cause the economy to be conducted at whatever scale was most effective rather than having the current bias towards ever greater scale (this pdf describes such a possible economic arrangement).

*This subject is explored in further detail in the section “A zero interest rate policy does not reduce the financial overhead” on page 18 of this pdf.

Related material on the web:

Opaque and stinky logorrhea- Interfluidity and the many many links therein

We Love Banks – Monetary Realism

Cutting Edge Capital Raising for Small Business – katovich (I added this link 11May 2013)

VC for the people -Interfluidity (link added 17April2014)

Fiscal autopilot

In the 1960s and ‘70s, the US and UK economies gyrated along what became described as the political business cycle or partisan business cycle. The idea was that before each election, looser fiscal and monetary policy caused a surge of expansion that was then curtailed after the election so as to keep a lid on inflation. Alternatively alternate governments of differing hue would alternately focus on controlling inflation or on expansion. Our current political wariness of fiscal policy and over-reliance on monetary policy dictated by unelected central bankers is a sorry legacy born from that experience. Currently fiscal policy is typically only deployed in an automatic way. If we are in a boom period, then tax revenue tends to increase because more taxable economic activity takes place whilst in slumps, welfare payments tend to increase and tax revenues drop. These counter-cyclical effects are termed the “ automatic stabilisers”. I consider many of the economic policies of recent decades to have been deeply misguided. However, I’m wondering whether an entirely automatic, non-reactive, form of fiscal automatic stabilisers could be consistent with economic democracy.

Economic democracy is a movement hoping for a reformed economic structure. I’ve tried to make the case that the best way to achieve economic democracy might be to replace all current taxes with a tax on gross assets and to replace all means tested benefits with a citizens’ dividend. People advocating for a broadly similar argument have made the case for using a variable blend of different types of taxes and transfer payments to fine tune fiscal policy so as to supposedly steer along an optimal macro-economic course. This post is an argument in favour of instead setting up an automatically self-correcting fiscal framework and then leaving things to take their course.

Imagine that a gross asset tax was set at say 5% per year, all other taxes were abolished and a citizens’ dividend was paid at say £7000 to all citizens of all ages. No active attempt was subsequently made to balance the budget or provide fiscal stimulus or to moderate inflation. The government just left the economy to it and concentrated purely on doing stuff that only the government was well placed to do (such as policing, maintaining infrastructure etc), endeavouring to provide such government services for the best value with no regard to job creation or such like. If a consequence was that government spending outpaced taxation, then the increased stock of government issued money would soon provide a larger source of revenue for the asset tax (the details about the proposed tax are in this pdf). If asset values increased greatly due to economic growth (or bubbles) such that taxation was greater than government spending, then the asset tax demands would cause asset price deflation so increasing the real value of the citizens’ dividend to the point where it stayed proportional to the expanded economy. Government employees could have pay scales proportional to the fixed citizens’ dividend. If everyone became lazy and just lived off the citizens’ dividend, then supply shortfalls would soon push up consumer prices to the point where it was easy to make lots of money by working and harder to live off the citizens’ dividend. It would be a self-correcting system. The key point is that the government has unlimited ability to maintain the nominal size of the citizens’ dividend, the pay of government employees and the asset tax. The government also has the unlimited capacity to electronically “print” the money to pay for it and to automatically electronically deduct the asset tax from that money.

The great advantage of such an automatic system is that it does not obscure price signals and allows firms to plan long term on the basis of how they predict the economy is going to be based on a long term fixed system rather than the fickle whims of political expediency. It provides no scope for gaming the system around reactive government interventions because there aren’t any. The only way to make money is by providing customers with what they want to pay for. Speculators would know that a credit fuelled asset bubble would never become a “new normal” because the consequent asset tax would bring everything down to earth. Conversely investors could see that genuinely useful new productive capacity would provide earnings that could not be matched by speculative asset bubbles.

Monetary policy would be permanently set to “maximum looseness” with a zero interest treasury rate (as it has been in Japan for many years) and no issuance of anything but the shortest term treasury debt. However the gross asset tax would cause credit to be something that required careful consideration by those taking it on.

Deflation is the great fear of current economic planners and much of current economic planning is focused on ensuring that it never occurs. Much of that fear is because currently deflation would encourage money hoarding and because our economy is so indebted that deflation would cause a severe debt crisis. A gross asset tax would cause money hoarding to be much less attractive and would favour equity financing over debt financing. We do currently have spectacular levels of deflation in the prices of certain high technology products such as computers and DNA sequencing and that is celebrated rather than being seen as a problem. In an economy with minimal debt, deflation need not be at all distorting; it can be simply providing accurate price information leading to rational economic planning by the real economy. If the economy was growing strongly such that all prices were deflating in the way that the cost of computing has, then great.

Related stuff on the web (I added this link on 11May2013):

Monetary policy for the 21st century- Interfluidity

Direct economic democracy

Direct economic democracy

please click on the above link to view PDF