Tim Iacono
About this author:- Profile & More Articles
- Tim's blog: The Mess That Greenspan Made
- Subscribe to Iacono Research
In this Financial Times commentary, Wolfgang Münchau comes ever so close to asking what must be one of the most difficult of all questions for any practicing economist to ask, "What if what they taught you is wrong?"
[Note: This is similar to what some U.S.-based financial advisers might be asking themselves today, eight years into a secular bear market in stocks where "stocks for the long run" may not make a whole lot of sense for someone whose "long run" is only 15 years or so and happened to begin around 2000.]
In a story appearing elsewhere at the Financial Times under the much more direct title of "The villains are not the bankers, but the economists," Mr. Munchau questions the very foundation of accepted economic theory and modern central banking. As the Bank of International Settlements said in its latest annual report, subprime might have been the trigger for this crisis, but not the cause. We do not have a full understanding yet of what happened but the BIS suggested that fast expansion of money and credit must have played a role. I would go further and say this is not primarily a crisis of financial speculation, but one of economic policy. Its principal villains are therefore not bankers, but economists – not in their role as teachers and researchers, but as policy advisers and policymakers... Several of them have been leading proponents of an economic theory known as New Keynesianism. It is, in fact, probably the most influential macroeconomic theory of our time. At the heart of the New Keynesian doctrine stands the so-called dynamic stochastic general equilibrium model, nowadays the main analytical tool of central banks all over the world. In this model, money and credit play no direct role. Nor does a financial market. The model’s technical features ensure that financial markets have no economic consequences in the long run. This model has significant policy implications. One of them is that central banks can safely ignore monetary aggregates and credit. They should also ignore asset prices and deal only with the economic consequences of an asset price bust. They should also ignore headline inflation. Wow! Distilled to its essential elements, this New Keynesian doctrine sounds like a real recipe for disaster! Negative real interest rates, government bailouts, and moral hazard are all apparently part of what passes as "accepted wisdom" amongst modern-day economists. Does any economist who proudly displays the letters PhD after his/her name have a reasonable explanation why we are now battling problems caused by too much easy money with even more easy money? Are there still economists out there who believe that easy money was not a principle cause of the current mess? Mr. Munchau's proposed solutions - let asset prices fall, focus on price stability including asset prices, and let banks fail - sound a lot more like Austrian Economics than the Keynesian variety as if he had channeled Andrew Mellon, Herbert Hoover’s Treasury Secretary, describing his solution to the 1929 downturn: Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate... It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people. Should this approach be adopted, the important question will become, "Are there enough enterprising people left?"
Related Articles
|
Top Rated Comment Streams:
-
1.Hedged In661
- 2.
-
3.Smarty_Pants400
-
4.cos1000307
-
5.axelrod608296
This article has 23 comments:
-
fedhed
-
5 Comments
Jul 09 09:46 AM-
notsosmart
-
1251 Comments
Jul 09 09:57 AM-
Edward Janeck
-
133 Comments
My Website
Jul 09 10:00 AM-
Mike K
-
10 Comments
My Website
Jul 09 10:58 AMCase in point: Banks are liquidating homes in the low end right now below 2000 prices in the very low end in southern california, despite the higher end not having come down enough. I actually believe this is below where the market will stabilize. Furthermore, their minimal carrying costs combined with a booming rental market put them in the perfect position to become landlords and actually *not loose* any more on these properties without liquidating.
So why aren't banks in the business of becoming landlords? Status quo. There is an arbitrary rule that banks blindly follow that is keeping them out of the business. The same arbitrary rules misrated subprime debt (rating agencies' fault), with banks blindly following suit (bank manager's faults). When there is no one with common sense nor initiative driving the car, of course it will crash. Perhaps one could blame the corporate shield for this - no otherwise intelligent individual would have taken the risks personally that banks were taking this past 5 years. But the corporate shield allows behavior that goes unchecked -- a firing is in no ways a meaningful threat when decisionmaking can be levered to have downside that in no way equates with the punishment.
So let me propose: It is greed, the corporation, and sheepish herd mentality that got us into this mess. Not laws or doctrines of economics. Fundamentally, people are stupid? Take a look below.
www.youtube.com/watch?...
-
shadrak
-
3 Comments
Jul 09 10:58 AM-
Flav
-
19 Comments
Jul 09 11:07 AM-
Martin Ranger
-
2 Comments
Jul 09 11:32 AM-
Left Coast Rick
-
13 Comments
Jul 09 11:38 AM-
Alex Filonov
-
334 Comments
My Website
Jul 09 11:40 AM-
Enough with the buffoonery
-
5 Comments
Jul 09 11:54 AMBut it is not.
We shouldn't discard this article, though; it's here to remind us the negative effects of labor specialization: software engineers should work with software, not financial markets. And we should be cautious when we read what they write about central banking and monetary policy. Their production in the Economic and Financial fields are less likely to have roots in profound knowledge of the subjects than in personal audacity and temerity.
-
vaduz
-
109 Comments
My Website
Jul 09 12:22 PM-
2 Observations
-
34 Comments
My Website
Jul 09 12:32 PM-
Old Wizard
-
145 Comments
Jul 09 12:41 PM-
morgan77
-
89 Comments
Jul 09 01:25 PMwww.greenfaucet.com/th...
sounds like it could be a long ride!
-
flow5
-
417 Comments
Jul 09 03:03 PMAny institution whose liabilities can be transferred on demand, without notice, and without income penalty, by data networks, checks, or similar types of negotiable credit instruments, and whose deposits are regarded by the public as money, can create new money, provided that the institution is not encountering a negative cash flow.]
From a systems viewpoint, commercial banks as contrasted to financial intermediaries, never loan out, and can’t loan out, existing deposits (saved or otherwise) including existing transaction deposits (TRs), or time deposits (TDs) or the owner’s equity or any liability item.
When CBs grant loans to, or purchase securities from, the non-bank public (which includes every institution, the U.S. Treasury, the U.S. Government, state, and other governmental jurisdictions) and every person, except the commercial and the Reserve Banks), they acquire title to earning assets by initially, the creation of an equal volume of new money- (TRs).
The lending capacity of the member CBs of the Federal Reserve System is limited by the volume of free gratis legal reserves put at their disposal by the Federal Reserve Banks in conjunction with the reserve ratios applicable to their deposit liabilities (transaction accounts), as fixed by the Board of Governors of the Federal Reserve System.
Since 1942, money creation is a system process. No bank, or minority group of banks (from an asset standpoint), can expand credit (create money), significantly faster than the majority banks expand. If the member banks hold 80 percent of all bank assets, an expansion of credit by the nonmember banks and no expansion by member banks will result, on the average, of a loss in clearing balances equal to 80 percent of the amount being checked out of the nonmember banks.
From the standpoint of the individual commercial banker, his institution is an intermediary. An inflow of deposits increases his bank’s clearing balances, and probably its free gratis legal reserves, not a tax [sic] – and thereby it’s lending capacity. But all such inflows involve a decrease in the lending capacity of other commercial banks (outflow of cash and due from bank items), unless the inflow results from a return flow of currency held by the non-bank public, or is a consequence of an expansion of Reserve Bank credit. Hence, all CB liabilities are derivative.
That is, CB time/savings deposits, unlike savings accounts in the “thrifts”, bear a direct, one-to-one, unvarying relationship, to transactions accounts. As TDs grow, TRs shrink pari passu, and vice versa. The fact that currency may supply an intermediary step (i.e., TRs to currency to TDs, and vice versa) does not invalidate the above statement.
Monetary savings are never transferred to the intermediaries; rather monetary savings are always transferred through the intermediaries. Indeed, as evidenced by the existence of “float”, reserve credits tend, on the average, to precede reserve debits. Therefore, it is a delusion to assume that savings can be “attracted” from the intermediaries, for the funds never leave the commercial banking system.
Consequently, the effect of allowing CBs to “compete” with S&Ls, MSBs, CUs, MMFs, IBs and other intermediaries (non-banks) has been, and will be, to reduce the size of the intermediaries (as deregulation did in the 80’s) – reduce the supply of loan-funds (available savings), increase the proportion, and the total costs of CB TDs.
Contrary to the DIDMCA underpinnings, member commercial bank disintermediation is not, and has not been, predicted on interest rate ceilings. Disintermediation for the CBs can only exist in a situation in which there is both a massive loss of faith in the credit of the banks and an inability on the part of the Federal Reserve to prevent bank credit contraction, as a consequence of currency withdrawals. The last period of disintermediation for the CBs occurred during the Great Depression, which had its most force in March 1933. Ever since 1933, the Federal Reserve has had the capacity to take unified action, through its "open market power", to prevent any outflow of currency from the banking system.
However, disintermediation for financial intermediaries-S&L... MSBs, CUs, (non-banks), etc., is predicated on their loan inventory (and thus can be induced by the rates paid by the commercial banks); earning assets with historically lower fixed rate and longer term structures. In other words, competition among commercial banks for TDs has: 1) increased the costs and diminished the profits of commercial banks; 2) induced disintermediation among the "thrifts" with devastating effects on housing and other areas of the economy; and 3) forced individual bankers to pay higher and higher rates to acquire, or hold, funds.
Savers (contrary to the premise underlying the DIDMCA in which CBs are assumed to be intermediaries and in competition with thrifts) never transfer their savings out of the banking system (unless they are hoarding currency). This applies to all investments made directly or indirectly through intermediaries. Shifts from TDs to TRs within the CBs and the transfer of the ownership of these TRs to the thrifts involves a shift in the form of bank liabilities (from TD to TR) and a shift in the ownership of (existing) TRs (from savers to thrifts, et al). The utilization of these TRs by the thrifts has no effect on the volume of TRs held by the CBs or the volume of their earnings assets.
In the context of their lending operations it is only possible to reduce bank assets and TRs by retiring bank-held loans, e.g., the only way to reduce the volume of demand deposits is for the saver-holder to use his funds for the payment of a bank loan, interest on a bank loan for the payment of a bank service, or for the purchase from their banks of any type of commercial bank security obligation, e.g., banks stocks, debentures, etc.
The financial intermediaries can lend no more (and in practice they lend less) than the volume of savings placed at their disposal; whereas the commercial banks, as a system, can make loans (if monetary policy permits and the opportunity is present) which amount to server times the initial excess reserves held.
Financial intermediaries (non-banks) lend existing money which has been saved, and all of these savings originate outside the intermediaries; whereas the CBs lend no existing deposits or savings; they always, as noted, create new money in the lending process. Saved TRs that are transferred to the S&Ls, etc., are not transferred out of the CBs; only their ownership is transferred. The reverse process, which is called “disintermediation”, has the opposite effect: the intermediaries shrink in size, but the size of the CBs remains the same.
Professional economists have no excuse for misinterpreting the savings investment process. They are paid to understand and interpret what is happening in the whole economy at any one time. For the commercial banking system, this requires constructing a balance sheet for the System, an income and expense statement for the System, and a simultaneous analysis of the flow of funds in the entire economy.
From a System standpoint, time deposits represent savings have a velocity of zero. As long as savings are held in the commercial banking system, they are lost to investment. The savings held in the commercial banks, whether in the form of time or demand deposits, can only be spent by their owners; they are not, and cannot, be spent by the banks.
From a system standpoint, TDs constitute an alteration of bank liabilities, their growth does not per se add to the “footings” of the consolidated balance sheet for the system. They obviously therefore are not a source of loan-funds for the banking system as a whole, and indeed their growth has no effect on the size or gross earnings of the banking system, except as their growth affects are transmitted through monetary policy.
Lending by intermediaries is not accompanied by an increase in the volume, but is associated with an increase in the velocity of money. Here investment equals savings (and velocity is evidence of the investment process), where in the case of the CB credit, investment does not equal savings but is associated with an enlargement and turnover of new money.
The difference is the volume of savings held in the commercial banking system is idle, and lost to investment as long as it is held within the commercial banking system. Such a cessation of the circuit income and transactions velocity of funds, funds which constitute a prior cost of production, cannot but have recessionary effects in our highly interdependent pecuniary economy. Thus, the growth of time deposits shrinks aggregate demand and therefore produces adverse effects on GDP and the level of employment.
It began with the General Theory, John Maynard Keynes gives the impression that a commercial bank is an intermediary type of financial institution serving to join the saver with the borrower when he states that it is an “optical illusion” to assume that “a depositor and his bank can somehow contrive between them to perform an operation by which savings can disappear into the banking system so that they are lost to investment, or, contrariwise, that the banking system can make it possible for investment to occur, to which no savings corresponds.”
In almost every instance in which Keynes wrote the term bank in the General Theory, it is necessary to substitute the term financial intermediary in order to make the statement correct. Perhaps this is the source of the pervasive error that characterizes the Keynesian economics, the Gurley-Shaw thesis, Reg Q, the DIDMCA of March 31st, 1980, the Garn-St. Germain Depository Institutions Act of 1982, etc.
How does the FED follow a "tight" money policy and still advance economic growth.? What should be done? The commercial banks should get out of the savings business (REG Q in reverse-but leave the non-banks unrestricted). What would this do? The commercial banks would be more profitable - if that is desirable. Why? Because the source of all time deposits within the commercial banking system, is demand/transaction deposits - directly or indirectly through currency or their undivided profits accounts.
Money flowing "to" the intermediaries (non-banks) actually never leaves the com. banking system as anybody who has applied double-entry bookkeeping on a national scale should know. The growth of the intermediaries/non-ban... cannot be at the expense of the com. banks. And why should the banks pay for something they already have? I.e., interest on time deposits.
The only time a commercial bank becomes a financial intermediary is when they have a 100% reserve ratio applied to all of their deposits. I.e., the utilization of bank credit to finance real investment does not constitute a utilization of savings since financing is accomplished by the creation of new money (a leakage in National Income Accounting).
Dr. Leland James Pritchard (MS, statistics - Syracuse, Ph.D, Economics - Chicago, 1933) described stagflation 1958 Money & Banking Hough McMillian
“The Economics of the Commercial Bank Savings-Investment Process in the United States” -- “Estratto dalla Rivista Internazionale di Scienze Econbomiche & Commerciali “ Anno XVI – 1969 – n. 7
“Profit or Loss from Time Deposit Banking” -- Banking and Monetary Studies, Comptroller of the Currency, United States Treasury Department, Irwin, 1963, pp. 369-386.
-
PastTense
-
120 Comments
Jul 09 03:16 PMen.wikipedia.org/wiki/...
-
flow5
-
417 Comments
Jul 09 03:25 PMThis vast addition to the world's money supply has substantially contributed to the high rates of inflation that have prevailed since 1965. Nor can the E-D be defended as being in any way superior to the U.S. dollar as an international reserve and transactions currency since the acceptability of the E-D is totally dependent on the acceptability of the U.S. dollar.
-
Pete Murphy
-
4 Comments
My Website
Jul 10 09:19 AM-
Telling
-
10 Comments
Jul 10 09:26 AM-
svkoho
-
99 Comments
My Website
Jul 10 09:37 AM-
carey_jim
-
557 Comments
Jul 10 12:51 PMWeather reporting is necessary and beneficial but neither normative nor very accurate. Economics is similar to weather reporting.
It was always surprising to me that all Soviet economists were, miraculously, Marxists and that Marxism was described by these intelligent, hard working professors as scientific.
It was surprising because most of the Marxists and their leaders blinded themselves to the totalitarian nature of economic teaching and research in the Soviet Union while it was obvious to outside observers.
You would think that if economics were truly a scientific discipline, driven by experiment and reason, then there would be a broad consensus about what economics is and how to use it to build well functioning economies.
Marxists never argued about how to build bridges, for example.
World history teaches us that many other considerations come into play, not the least of which are pure grabs of power in the form of land, minerals, oil, gold, etc. which are controlled by other countries, states, territories, cultures, etc. (war.)
It is folly is to imagine that economic models are any more than heuristic devices which serve as guides for human beings working together to produce wealth and to drive back the chaos of nature.
Disease and the other entropic acts of nature, along with human crime, immorality, ignorance and stupidity account for much more suffering and chaos than bad economic models.
-
flow5
-
417 Comments
Jul 10 01:30 PM-
Enough with the buffoonery
-
5 Comments
Jul 12 05:34 PMBut what do you know, as Mr Iacono, many of you "have no formal training in economics, investments, or personal finance." (TAKEN FROM: www.iaconoresearch.com..., 5t paragraph).