Half baked truths and fully baked lies
by Anthony de
Jasay
Teaching aids can
be treacherous instruments. Images, metaphors and little tales, addressed to
all and by no means only to children, are designed to convey some truth in an
easy to grasp and hard to forget. Some of these aids however, also contain
half-truths and falsehoods. Worse still, some of them do this by design,
deliberately implanting lies in people's minds. They are easier to plant than
to eradicate once they have taken root.
A classic example
is the representation of the national product as society's "cake".
Some good fairy flies in overnight, deposits the cake on the communal table,
ready for "society" to slice it and hand out the slices to its
members. The next step is unsaid, but suggested almost irresistibly: everyone
is entitled to the same size of slice as everyone else. Unequal shares would be
"socially unjust"—which it presumably would be if the cake really
fell from heaven, unaided by human hand. Once it waits on the table, ready to
be sliced, it is all too easy too ignore that human hands had first to bake it.
Helicopter money
is a less insidious, but no less misleading example of the wrong sort of
teaching aid. When the economy is producing at less than a comfortable rate,
with capacity utilisation at less than 90 and unemployment at more than 5 or 6
per cent, it stands to reason that easy remedies must be available to put this
right and only a government of retarded half-wits will fail to reach for one.
It needs nothing more clever and complicated than using helicopter money. It
can print a few hundred tons of banknotes, load them into helicopters and have
then fly up and down the country, letting the money pour down like blissful
rain in a drought. People will pick up the money, quickly spend most of it, and
add the rest to their savings. Consumption, investment and the production to
match them will rise to the desired capacity level and, like the pump once it
has been primed, will carry on at that level. Should it fall short, the
government can always dispatch a few more helicopters with cargoes of fresh
money. Admittedly, some of the money would be spent on extra imports and may
also absorb goods that would otherwise been exported, but these leakages will
only siphon off a small part of the beneficial irrigation of the economy.
However, for much
of the non-economist public, all this is a little too good to be true. The
graphic image of the "velocity of circulation" of money, drawn
by Irving Fisher as a
teaching aid to his quantity theory, is still lurking in the sub-conscious.(1) Money,
of course, has no "velocity" in the physical sense; it may stay with
the same owner for a long time, or it can pass from one owner to the next at
the speed of light, as the history of great depressions and great inflations has
shown. Nevertheless, the idea of money moving around with a velocity of its own
lives on in the mind of the lay public. It mistrusts helicopter money as
blissful rain. Instead, it sees it as a fuse that will trigger off inflation
before we know where we are. Fear of it might well nullify the good the
spraying of the parched land with banknotes could be hoped to do. Teaching aid
would be working against teaching aid.
He who sees that
"helicopter money" has the symbolic form of "quantitative
easing" uses it to explain how it works. In fact, it works quite
differently. Instead of spraying with banknotes, the traders of the Federal
Reserve Bank in New York are buying securities, primarily U.S. Treasury bonds,
at an annual rate of one trillion dollars or about 6 or 7 per cent of U.S.
national income. The sellers are paid by credits added to their balances at the
Federal Reserve System. In plain language, this is the Fed "printing
money". What the lay public overlooks and the commentators fail to
mention, however, is that while the Fed is issuing a trillion dollars of new
money, it also takes out of the economy a trillion dollar's worth of securities
that are the closest thing to money in the spectrum of assets. Both the assets
and the liabilities of the Fed increase by a trillion, but those of the economy
do not change. Only their composition is altered a little, holders of
securities that yield them interest of between near-zero and 2 per cent
willingly sell them to the Fed in exchange for money yielding zero. Manifestly,
they are not rushing to spend this money, nor even a significant part of it, on
consumer goods. Judging by how the stock markets are rising, some of it is
invested in shares in industry and commerce, and the indirect effect is a
potential stimulus to both consumption and investment. How the stimulus works
out depends on many things. One of them, alas, is the instinctive mistrust and
fear that the poorly understood "quantitative easing" is the same as
helicopter money and must come to some dire end. London and Tokyo are copying
the Fed and Frankfurt differs more in form than in substance, so that if a dire
end must come, it will come to us all. It need not come, unless by our mistrust
and lack of clear thought we bring about its coming.
By quantitative
easing, the authorities gently press the accelerator. By partially dismantling
the banking system to punish it for its post-2007 misbehaviour, they are
standing on the brake pedal. They seem surprised and disappointed that the
banks are shrinking their balance sheets, pulling in their horns, and starving
small business of credit. Except for household names, non-bank sources of
credit in Europe are embryonic and the withdrawal of bank credit from medium
and small firms is one of the chief reasons for Europe's present stagnation.
Whether the
near-crash of several large banks in 2008 was the fault of the bankers or of
the perverse incentives created by benevolent and confused regulation is
something economic historians will take decades to decide. The current
consensus is that insufficient regulation was the cause and that bankers must
be brought to heel with the severity they richly deserve. Everybody seems to
remember schooldays when they learnt how the Medicis, the Fuggers and the early
Rothschilds used to lend their own money rather than money entrusted to them by
others for safe-keeping. Instinctively, many observers and even some central
bankers feel nostalgia for such stone-age banking.
Suppressing
fractional reserve banking altogether, and requiring 100 per cent equity to
cover loans and investments, as some eccentric economists have advocated, would
be too much of a good thing. Yet the regulators feel that if banks had more
equity, they would somehow be safer, though it is not obvious how, nor why.
Deposit insurance, now ubiquitous, protects the vast majority of depositors and
for short-term liquidity there are lenders of last resort. Problems may arise
with solvency, which is assured by the intelligent selection of the bank's
assets rather than by the backing provided by its own equity capital. However,
under present accounting rules that require assets to be valued in balance
sheets at market prices, a 20 per cent decline of the prices in a major asset
class, a decline that easily happens in nervous markets, may render a bank
momentarily insolvent, although the assets in question need not be liquidated
and have every chance to recover their value if time is allowed for it.
Between 2008 and
2012, the Basel committee of European banking regulators has twice raised the
required solvency ratio in the rather touching belief that while neither 5 nor
7 per cent of equity capital is sufficient to withstand major economic upset, 9
per cent will be. An extra 2 per cent more or less in a storm will hardly be
decisive for solvency under the present accounting rules. Since, however, 2 per
cent more capital for the entire banking system cannot rapidly be found, most
European banks were forced to start shrinking their balance sheets. Hence the
sometimes brutal reduction in their lending to small business, which has been a
major reason for Europe's present stagnation.
Perhaps the
regulators believe that if the world got along from the Stone Age to the 17th
Century without fractional reserve banking, with bankers lending only their own
money and not acting as intermediaries between persons and between the short
and the long term, it can surely get along with one based on a modest 9 per
cent solvency ratio. The bankers should be grateful that more is not demanded
of them. Some economists, including the Nobel laureate Maurice Allais,2 believe
that only 100 per cent solvency would do. Among silly beliefs fostered by false
teaching aids and false lessons of recent history, this would surely be one of
the silliest.
Footnotes
1. See Irving Fisher, The Purchasing Power of
Money, its Determination and Relation to Credit, Interest and Crises, by Irving
Fisher, assisted by Harry G. Brown (New York: Macmillan, 1922). New and Revised
Edition. Chapter II, paragraph II.29.
2. Maurice Allais (1911-2010) was a French
economist and the 1988 winner of the Nobel Memorial Prize in Economics. See
his Nobel Prize Lecture given on
December 9, 1988, "An Outline of My Main Contributions to Economic Science
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