Written by John Lounsbury
A lot of attention was paid last week to the IMF conference presentation by Larry Summers that bemoaned the stagnating state of a global economy stuck in a zero-bound liquidity trap. Paul Krugman joined in the mournful dirge and others followed. But little notice was taken of a talk by Ken Rogoff which preceded Summers and was quite the opposite to the former Treasury Secretary’s description of conundrum; Rogoff was very forward looking and discussed a framework for solution to many of the problems we have faced, are facing and will face in the future.
Rogoff suggested that we need a world where there is less “plain vanilla debt” (bank credit). He suggests that there needs to be more debt that is linked to asset values rather than pure bank credit with fixed principal. And even more outside the box he suggested that anyone should be able to have an account at the Fed. He suggested that the Fed should offer variable principal bond funds that would pay a fixed rate and vary in value with market rates.
Advance the video to the 33 minute mark for Rogoff’s 12-minute presentation.
Rajiv Sethi posted a blog this week entitled The Payment System and Monetary Transmission which picked up on Rogoff’s theme and examined some of the details. (Sethi is Professor of Economics, Barnard College, Columbia University, and External Professor, Santa Fe Institute.) The Rogoff theme resonated with an idea that Sethi discussed further in his blog: Make the Federal Reserve the repository for all deposit banking.
But the discussion has started to go far beyond what Rogoff opened up. A lot of worms have started to come out of the IMF conference remarks can.
Sethi has previously suggested that having prefunded accounts for every man, woman and child in the U.S. held at the Fed would be an effective tool for anti-cyclical monetary policy. He suggested a change in the relationship of the Fed to the people, cutting out the Treasury Dept as a middle man:
I would prefer the following:
(i) create an account at the Fed for every US citizen with a valid social security number, including minors,
(ii) stop transferring profits on Fed assets directly to the Treasury,
(iii) credit all accounts in equal measure to dissipate all profits,
(iv) restrict withdrawals from these accounts to tighten monetary policy, and remove restrictions to ease,
(v) continue open market operations as necessary, especially in a liquidity crisis, lending at high rates against good collateral to solvent institutions in accordance with the Bagehot rule.
This last policy should result in windfall gains after a crisis. The direct transfers to account holders will boost aggregate demand when most needed.
This would be a form of “permanent money creation” to dampen the extreme swings that can (and do) occur in the credit dominated monetary system run by private banks today. The idea of permanent money is derived from Milton Friedman’s proposals (1948) for the use of (as part of all ‘money’) “non-interest bearing securities” for improved economic stability. A specific statement from Friedman:
“Another reason sometimes given for issuing interest-bearing securities is that in a period of unemployment it is less deflationary to issue securities than tio levy taxes. This is true. But it is still less deflationary to issue money.”
In times of deficit spending in the face of deflationary pressures Friedman proposed the best course of action was to print debt-free money. He foresaw the money entering the economy through bank deposits, not through bank reserves which was the pathway available to Bernanke.
An aside: Among many who have discussed the utility of debt-free money most notable recently has been Lord Adair Turner. See GEI News.
So, when Ben Bernanke fired up his helicopter engines he took the only path available to him to create additional debt-free money by replacing interest-bearing government debt with newly created bank reserves. The government debt thus added to the Fed balance sheet resulted in the interest paid by the U.S. Treasury being returned to the government. The result? Debt-free money, in effect, minus a service charge largely composed of a 0.25% interest payment to banks for excess reserves held by the Fed.
The problem with the Bernanke path? The helicopters dropped all the money into a hole in the ground (excess reserve accounts) and very little made its way into the economy. It was essentially a rearrangement of the balance sheets of the creditor nation with little impact on the debtor nation.
Now enter Rogoff opening a new can of worms. The possibilities for the worms that have come out of the can Rogoff opened include:
- A pathway is open for investment banking and depository banking to be separated from each other. It is a pathway to a banking and monetary structure analogous to that under Glass-Steagall.
- If depository banking and base money creation is under the control of the Fed without direct linkage to speculative credit creation by private banking, systemically important financial institutions (SIFI aka TBTF – too big to fail) cease to exit. There may be behemoth banks but they can fail without destroying the general payment system of the economy.
- The operation of the Fed as a true public bank and repository for all federal banking transactions.
- The operation of the bank in the mode of a postal savings system for the general populace.
- The operation of a countercyclical monetary policy in the real economy becomes a simply operated and transparent mechanism.
Sethi articulates a fundamental contradiction of the current QE policies:
In contrast, monetary policy as currently practiced targets creditor balance sheets. Asset prices rise as interest rates are driven down. The goal is to stimulate expenditure by lowering borrowing costs, but by definition this requires individuals to take on more debt. In an over-leveraged economy struggling through a balance sheet recession, such policies can only provide temporary relief.
It seems very fundamental: To resolve a debt crisis one of two things must happen:
- The value of debts must be written down by the creditors (through default, restructuring or liquidation of reduced value assets); or
- More money must be found by the debtors.
Plain and simple, I repeat, debtors must find money to satisfy creditors or creditors must lose money and debtors lose remaining assets.
The fatal flaw of QE is that it delivers money to the accounts of the creditors and does nothing for the accounts of the debtors. Bad debts remain unserviced and the debt crisis continues.
The only logical pathway with current monetary policy is to resolve a debt crisis with more debt.
The only logical pathway to resolve a debt crisis in my world is with more money (or debt write-off).
Now that we have a collection of juicy worms, wouldn’t be a great time to go catch some fish?
Hopefully one of the first fish we catch will come with a message: It is idiotic to resolve a debt crisis by giving money to the creditors (who already have all the money) and not to the debtors who are the ones who need it to resolve debts.
Further reading on this topic:
- The Payments System and Monetary Transmission (Rajiv Sethi)
- Why Should Banks be the Only Ones with Accounts at the Fed? (Yves Smith, Naked Capitalism) Sethi post with additional commentary.
- IMF Economic Forum (Conference presentations, 08 November 2013)
- What We Could Do with A Postal Savings Bank: Infrastructure that Doesn’t Cost Taxpayers A Dime (Ellen Brown)
- How the Fed Could Fix the Economy—and Why It Hasn’t (Ellen Brown)
- Steve Keen: We are in a Depression but There is a Way Out (GEI News article about Steve Keen) In video, watch debt jubilee discussion at about 7-minute mark.
- Is a Debt Jubilee the Answer? (Joseph M. Firestone)
- A Copernican Turn in Macro (Derryl Hermanutz)
- The New Feudalism (Derryl Hermanutz)
- Fantasy Fed Speech (Scott Baker)
- ZIRP and the Permanent Slump (Steven Hansen)
- The Conservative Karl Marx (Sig Silber)