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Edition 01: 09 May, 2013.
(VERSION EN FRANÇAIS PAS DISPONIBLE)
Summaries of monetary reform
papers by L.F. Manning published at http://www.integrateddevelopment.org
The
referenced papers :
00. Summary of papers published.
01. Financial system mechanics explained for the first time. “The Ripple
Starts Here.”
02. How to create stable financial systems in four
complementary steps.
03. How to introduce an e-money financed virtual minimum
wage system in New Zealand.
04. How to introduce a
guaranteed minimum income in New Zealand.
05. The interest-bearing debt system and its economic
impacts.
07. The DNA of the debt-based economy.
08. Manifesto of the debt-based economy.
09. Unified text of the manifesto of the debt-based
economy.
10. Using a foreign transactions surcharge (FTS) to manage the exchange rate.
11. The Manning plan for permanent debt reduction in the national
economy.
12. Comments on the (Jaromir
Benes and Michael Kumhof) Chicago Plan Revisited
Paper.
13. Missing links between
growth, saving, deposits and GDP.
15. Measuring Nothing on the Road to Nowhere.
16. Debt bubbles cannot be popped : Business cycles
are policy inventions.
THE
By
Sustento Institute,
29th April, 2013.
CONTENTS.
EXECUTIVE SUMMARY.
BACKGROUND OF CPRII.
CPRII DOES NOT RESOLVE
DEBT AND INFLATION ISSUES.
THE SIX CLAIMED ADVANTAGES OF
THE PROPOSAL :
(a) REDUCTION OF GOVERNMENT
DEBT & INTEREST BURDEN.
(b) MUCH BETTER CONTROL OF
CREDIT CYCLES.
(c) REDUCTION IN PRIVATE DEBT.
(d) ELIMINATION OF BANK RUNS.
(e) A LONG TERM INCREASE IN
OUTPUT OF 10%.
(f) THERE IS NO LIQUIDITY TRAP
......
CONCLUSION.
EXECUTIVE SUMMARY.
This paper is a
response to the IMF Working Paper WP/12/202 “The Chicago Plan Revisited” by Jaromir Benes and Michael Kumhof
(BK), and more particularly to the revised draft of that paper released on 12th February 2013 (CPRII).
The CPRII paper models the Chicago Plan (CP) proposals. The CP
proposals date from the 1930’s and grew out of concern that the current
debt-based financial system is inherently unstable. That view has been
reinforced by the instability leading up to the recent debt crisis and, more
recently, large scale Quantitative Easing and Eurozone
debt problems. The CP has always been supported by many of the world’s leading
economists. Many of its main provisions have formed the basis of monetary
reform movements for almost a century.
CPRII uses Dynamic
Stochastic General Equilibrium (DSGE) modelling to
study six main claims made for the Chicago Plan:
(a) Reduction of government debt and the interest
burden it creates.
(b) Much better control of credit cycles
(c) Reduction in private debt
(d) Elimination of bank runs
(e) A long term [relative] increase in [GDP]
output of 10%
(f) There is no liquidity trap, so that “steady
state inflation” can drop to zero.
BK find strong
support for all six of the claims they make for CPRII.
This paper shows that many of
the claims are unfounded because the CP itself is insufficiently robust to work
properly as it is presented and modelled. It would work if it were slightly
revised along the lines of the Manning plan for permanent debt
reduction in the national economy available at website www.integrateddevelopment.org.
It is likely that a more robust form of the CP would demonstrate outcomes
vastly superior to those obtained by BK in their
modelling.
The present
structure of the CP retains the functional elements of the existing financial
system except that Savings and Loan debt replaces Bank debt. Apart from
government spending, it leaves the private financial institutions in full
control of money allocation and credit. The large financial institutions and
business are the primary beneficiaries from the CP as it presented. The asymmetrical
imbalances in debt, income and wealth aggregation remain unresolved.
The “People’s” money advocated
by CPRII needs to be made available and used by the
people, for the people, rather than by the banks for the banks. Otherwise the
Chicago Plan reforms cannot be a sufficient response to financial system
failure.
BACKGROUND OF CPRII.
Unless otherwise indicated,
all page references in this paper are to CPRII.
The BK paper has received a lot of attention around the world.
Much of it has been favourable. CPRII gives the
history of the CP at p. 28-29. The plan originated with Frederick Soddy in
1926. Professor Frank Knight (
The key feature of
the CP “was to call for the separation of
the monetary and credit functions of the banking system, first by ensuring 100%
backing of deposits by government-issued money, and second by ensuring that the
financing of new credit can only take place through earnings that have been
retained in the form of government issued money, or through the borrowing of
existing government-issued money from non-banks, but not through the creation
of new deposit money, ex nihilo, by financial institutions”. [p. 4]
For the productive
economy this is tantamount to a verbal restatement of the basic tenet of orthodox
economics, seen in almost every economics text published prior to 1980, that
Savings=Investment where investment is defined as new productive capital investment.
For the non-productive economy, the
non-productive “investment sector”, it is a clear statement that credit for the
purchase and exchange of existing capital goods must take place through the
on-lending of deposits as a “savings and loan” (S&L)
function. That on-lending creates secondary debt and increases the speed of
circulation of the financial system monetary deposits. The S&L
function is the opposite of funding the purchase and exchange of existing
capital goods through the creation of new interest-bearing bank debt and its
corresponding deposits that have become the norm over the past thirty
years. The differences between a
financial system based on savings and loan and one based on increasing bank
debt are explored in detail in a paper by the author Capital is debt published at www.integrateddevelopment.org.
CPRII DOES
NOT RESOLVE DEBT AND INFLATION ISSUES.
The current system
creates bank debt and maintains a low speed of circulation of the total
financial system deposits. Bank debt is typically cheaper than secondary debt
borrowed from non-bank institutions. In most industrialised countries there is
a reasonably close relationship between domestic credit and total debt defined
as domestic credit plus non-bank secondary credit but not between debt and
capital investment. One exception is the
That balance is much less than
the total debt.
FIGURE 1 : OUTSTANDING INVESTMENT PRINCIPAL AND
GDP NEW ZEALAND 1962-2012.
The outstanding
principal in Figure 1 has been calculated empirically. Figures 1 and 2 are
based on adding the net annual capital formation in any year to the cumulative
outstanding principal from the previous year and multiplying by 0.983. The
calibration “works” because the depreciation (consumption of fixed capital
“CFC”) shown in the national accounts is higher than the true loss of value.
The distorted tax business depreciation figures included in today’s tax laws
mask a large portion of the principal repayments. The GDP, Gross Capital
Formation and Consumption of Fixed Capital used for the graphs are taken
directly from the NZ National Accounts. It should be noted there are
substantial differences between the latest published series downloaded from www.stats.govt.nz on 15 April 2013
and the data published in the various earlier official data. This contrasts
sharply with the CPRII modelling under heading I [p.
44], where the depreciation rate rather than outstanding capital is used to
assess capital accumulation.
FIGURE 2 : OUTSTANDING INVESTMENT PRINCIPAL v.
GDP NEW ZEALAND 1962-2012.
Principal
repayments are not “constant” over time as assumed, for simplicity, in the
figures. There could, for example, be changes in tax depreciation rules (such
as the recent removal of tax depreciation from residential housing investment
in
Contrary to the
modelling assumptions made by BK in CPRII there is no equilibrium in the investment sector
whatever stochastic shocks are applied in the modelling process. Instead,
economic performance (Figures 1 and 2) is specifically related to new capital
investment including new investment in non-productive assets on a 1:1 basis
whereas the money supply shown in Figures 3 and 4 is not.
FIGURE 3 : GDP AND (M3-0.05 GDP) FOR NEW ZEALAND
1996-2013.
FIGURE 4 : GDP v M3-0.05 GDP NEW ZEALAND
1995-2013.
While business
investment decisions rely on generating enough extra income to pay interest and
repay principal, debt servicing of non-productive investments like residential
housing is more difficult. Borrowers must typically decrease their consumption
or rely upon uncertain future income expectations. As long as the share of
productivity gains in the productive economy paid as incomes to income earners
(over and above what is needed by business to service its own productive
capital investment) is less than their debt servicing costs, it is
theoretically impossible to fund those costs out of the productive economy. The
reason is simple: Saving within the economy is used up to purchase new capital
investment (including new housing) as shown in Figures 1 and 2. Otherwise the
economy cannot grow and the market cannot clear all the goods and services it
produces.
Figure 5 shows the basic
dynamic flows in a simple economy.
Figure 5 is broadly
similar to the structure proposed by CPRII. The money
supply (top left) is increased using government-issued debt-free money as the
productive capacity of the economy increases. Incomes equal to the value of new
capital investment are saved and then on-loaned to entrepreneurs. Some Savings
have traditionally been hoarded as shown at the upper right of Figure 5. When
hoarding increases, not enough savings are being recycled to clear the market
of capital and consumption goods and pay the non-productive debt servicing
costs. Either more money must then be injected into the system, the Treasury
credit in CPRII, or the S & L funds (The CPRII “Investment Trust” funds) have to be recycled faster.
In addition, the existing debt base must, as a minimum, be maintained to avoid
a collapse in existing asset prices. For that to happen, the secondary
(Investment Trust) debt and Treasury credit must together be at least as large
as the present debt base less transaction account balances and government
capital assets. The aggregate interest paid on that debt is likely to be as
much as it is now. The more interest there is the faster the money supply will
have to grow to keep pace with the purchase and exchange of non-productive
assets and provide for systemic inflation.
FIGURE 5 : THE TRADITIONAL DYNAMIC ECONOMIC
CYCLE.
In figure 5 the investment in
each cycle = new savings less new hoarding.
Figure 6 represents
the existing debt-based financial system where savings are decoupled from the
productive economic cycle by bank intermediation. As BK
say in CPRII, bank lending depends only on the banks’
willingness to lend and the customers’ willingness to borrow. This is the
concept of “endogenous” credit so widely discussed among economists today.
Among the screeds of jargon and complex mathematical modelling, the simple
truth remains that if savings can be recycled for profit as in Figure 5, they
will be. If interest-bearing debt can be created for profit as in Figure 6, it
will be. That is human nature.
Private debt is
fundamental to capitalism. Without primary and/or secondary private debt there
can be no private productive investment, no privately created GDP and very
little exchange of privately owned capital goods. Only the government would be
able to invest in capital goods by first injecting money to pay for their
production and then taxing that same money out of circulation afterward when
required. In that hypothetical case, hoarding could be constrained within the
bounds of the circulating money supply, initially the 5% or so of GDP of
figures 3 and
Four of the major
claims made by Irving Fisher in
(a) Reduction of government debt and the interest
burden it creates.
(b) Much better control of credit cycles.
(c) Reduction in private debt.
(d) Elimination of bank runs.
BK claim there are
two further advantages:
(e) A long term increase in output of 10%.
(f) There is no liquidity trap, so that “steady
state inflation” can drop to zero.
The claimed advantages are
described at some length at pages 5-12 of CPRII.
The six claimed advantages are
now considered in turn.
THE SIX CLAIMED ADVANTAGES OF THE PROPOSAL.
(a) REDUCTION OF GOVERNMENT
DEBT & INTEREST BURDEN.
The details in the CPRII proposal are conclusive. The proposal can reduce
or eliminate government debt and its associated interest burden.
However, using CPRII to produce that outcome is unnecessary.
A nation’s authority to eliminate government debt by
exercising its sovereign right to seigniorage on the
creation of the nation’s money supply already exists, as it has always
done.
Most governments have always had the constitutional right to issue
money, as, for example, set out in the Constitution of the
Replacing
government debt with “public” money is simple. As government debt matures it is
replaced by an equal amount of debt-free interest-free deposits created as
journal entries in the Treasury accounts. The financial institution holding the
government paper cancels the debt by writing off both the debt (the institution’s
asset) and the credit (the cash deposit payment it receives) reducing both
sides of its balance sheet by the same amount but leaving its net worth intact.
Since the transaction affects rights under the original debt contract, the
relevant existing original bank deposits remain in the banking system
“magically” backed by public equity instead of private interest-bearing bank
debt.
Where banks
previously held the government debt they will have lost the bank spread on the debt
that has been retired, but the spread is very small in most major economies
today. On 16/4/2013, US Treasury 2/5 yr was 0.23%/0.70% , Japan 2/5 yr
0.13%/0.26%, Germany 2/5yr 0.03%0.34%, and China 2/5yr
2.99%/3.15%.
There are practical
ways to deal with the banks’ loss of bond income should the need arise, such as
by using controls on some deposit interest rates. In other cases (especially
the
There is no valid
reason to embed “public” money within a complex proposal such as the CP. Making
“public” money dependent on reforms like the CP raises suspicion that the
proposals serve primarily to preserve the present dominance of private
financial institutions.
(b) MUCH BETTER CONTROL OF
CREDIT CYCLES.
CPRII claims (p. 5) that
the CP largely eliminates “sudden changes
in the willingness of banks to extend credit [that] not
only lead to credit booms or busts, but also to an instant excess or shortage
of money, and therefore of nominal aggregate demand.”
BK write correctly
that in the present system with each new loan made “[T]he aggregate money supply has therefore increased” whereas
under CPRII “lending banks, now referred to as investment
trusts, would no longer be able to generate their own funding in the act of
lending” (p. 6).
The solution
provided in CPRII is thus two-fold. First, have the
government create the money supply (the quantity of money). Secondly, allow
investment trusts (that will include private banks) to provide the quantity of
credit (secondary debt) the economy needs to function. The credit comes either
as Treasury credit (CPRII
p. 79 Figure 1) from the government or by on-lending private deposits placed in
investment trusts (CPRII p. 6 top). In this scenario
the banks sit as intermediaries on the fringes of the system, clipping the
ticket, risk free, on nearly every financial transaction that takes place in
the economy. This represents a “free lunch” for the banks. Even were such a
proposal acceptable to the public at large, it would still be founded on two
monumental assumptions. The first is that the demand for money is independent
of the demand for credit. The second is that the demand for credit is limited
because it is provided through investment trusts that transfer physical
deposits from lenders to borrowers instead of by banks creating new credit
through the act of lending. Neither assumption bears scrutiny.
There is a direct
link in
M3 = DC +
NFCA + Residual (1)
Where M3 is the aggregate
deposit base, DC is Domestic Credit, NFCA is the Net
Foreign Currency Assets of the M3 institutions and the Reserve Bank, and
Residual is the net worth of the M3 institutions. In
Assets = Liabilities + Net worth.
(DC + NFCA) = M3 + Residual (2)
The Residual is positive in the equation (2) format.
In
At a national
level, debtor countries like
It is possible to
use the Net International Investment Position (NIIP)
in this work. NIIP includes capital flows as well as
current flows. Using NIIP changes the numbers a
little but not the principles being discussed.
Figure 7 also shows the debt
(domestic credit) as % GDP in
Most of the
accumulated current account deficit, (NZ$ 194.3 billion–NZ$ 41.6 billion or
NZ$ 152.7b. of it), shows up as direct foreign ownership of
The latest debt figures from Reserve Bank of
The demand for money is therefore not independent of
the demand for credit. This is because the need for foreign exchange funding
and the accumulation of residual by the financial system must be added to the
accumulation of productive capital investment. In CPRII,
when those sums are added to the unrestrained growth of secondary (investment
trust) debt discussed at pages 15-17 of this paper below, it becomes evident
debt cycles can still occur.
From 1978 to 2012
the slopes of the Debt/GDP and Accumulated Current Account (ACA)/GDP curves for
Much of the
additional debt in
Without the NZ$
194.3 billion accumulated current account deficit, New Zealand’s total debt
would apparently be just NZ 126.2 billion, being Domestic Credit $320.5 billion
less current account deficit of NZ$ 194.3 billion. Figures 1 and 2 show that,
in the present system, NZ$ 126 billion is far too little to sustain a NZ$ 200
billion economy which would need about NZ$ 200 billion (GDP) + 5% GDP for the
productive transaction accounts + NZ$ 28.5 billion (bank residuals) or nearly
NZ$ 240 billion. In that case, deposits would be NZ$ 210 billion, just a little
more than GDP instead of 1.4 x GDP as shown in Figures 3 and 4. Moreover, the
economy would be owned domestically instead of a large part of it being owned
by foreigners. New trade agreements like the proposed Trans Pacific Partnership
Agreement (TPPA) are likely to worsen these
structural imbalances unless strong provisions are put in place to protect the
current account.
CPRII (p. 57-58) claims
to take at least some of the
The sum used in CPRII appears to include “at least a conservative estimate of the liabilities of the shadow
banking system...” (p58 – top). That suggests that US$ 4.4 trillion, about
30% of GDP, needs to added to the liabilities side of CPRII
Figures 1-3 (p. 79-81) while about 30% of GDP needs to be added to the debt
side to satisfy equation (1). In other words the diagrams given in CPRII are about 30% of GDP too low. The author assessed the
error at about 25% in a previous detailed critique of the original paper which
can be found in Comments on the IMF (Benes and
Kumhof) paper “The Chicago Plan Revisited” at webiste www.integrateddevelopment.org. That critique was circulated
to BK on 30th August 2012. The claim at
p.14 that “Nobody has so far challenged
our economic model or the model simulations” is therefore factually
incorrect.
Leaving aside the
many other assumptions made in the CPRII model calibration
and the use of DSGE modelling for a macroeconomic
exercise like this, this error alone could be large enough to affect the model
simulation. This assumes the DSGE simulation itself
(pages 32 to 60) were valid. Even then it would still be subject to error
theory where potential error in each variable accumulates through the whole
model simulation. No sensitivity analysis is provided in the CPRII text so the impacts of changes in even a few of the
main variables are not available, rendering the simulation results suspect.
The extra debt is
mostly private debt and BK do not appear to consider
the impact of that private debt redemption on currency exchange rates, the
current account and trade.
The CPRII model calibration for the real economy uses US data “for the period 1990-2006 where available
..... to compute averages ”(p. 55). But for the calibration for balance
sheet data “we use a calibration based on
the final years preceding the crisis” (p. 55). It is hard to see how such
an approach can have either validity or reliability even if the analysis were
really just a “before” and “after” comparison.
A wider objection
to the CPRII analysis and simulation is that control
of the money supply (the deposit base) does not limit the supply of credit as CPRII claims.
Whether or not a
citizens’ dividend is used to convert existing bank debt into credit is
immaterial to the broad outcome of the reform. Investment trusts would still be
needed to channel savings deposits to borrowers. They also provide a pathway to
redistribute a citizens’ income so that existing bank debt can retired. In the
absence of a citizens’ dividend or an on-going citizens’ income, the investment
trusts will still function as S & L institutions to provide secondary
lending in the non-bank debt market as shown in Figure 5 of this paper.
The total debt
(less government debt that has been retired) remains much the same as it is
under the current system except that interest-bearing bank debt is replaced by
interest bearing secondary non-bank lending.
Figure 2 and
equation (1) clearly show that the debt base in the reformed system must be at
least a little more than GDP less the outstanding principal on government
investment even when the money supply is created debt-free. Otherwise there could
be no capital markets and no capitalism because there would be no way to fund
capital investment (see Figures 5 and 6).
The prudential
policy used for modelling CPRII [p. 52-53] is
different to that used for the existing system [p. 45] so changes in the model
results are unsurprising.
The
model calibration in CPRII based on 80% GDP is
therefore unsatisfactory.
In practice,
whether the lending is done through investment trusts or through other forms of
savings and loan institutions there will still be interest-bearing debt. That
total debt could quickly become greater than it is now because CPRII puts no restrictions on non-bank S & L lending
through investment trusts. The same funds can be on-loaned more than once.
The choice to fund
government spending using interest-bearing bank debt is a matter of convention.
Article 104 of the 1992 Maastricht Treaty setting up the Eurozone
constrains the direct supply of central bank debt funding to governments. That
constraint is not a constitutional necessity and it doesn’t apply to the supply
of money by individual sovereign governments, especially were it, for example,
in the form of electronic cash or large denomination coins.
When existing bank debt is repaid from
existing deposits as it matures, or where Investment Trust debt is repaid where
a citizens’ dividend is used, the corresponding deposits are removed from the
banking system. In the absence of new money injections, rolling over the new
secondary debt needed to fund a capitalist economy would require the speed of
circulation of the remaining investment deposits to increase and eventually
approach infinity. If the deposit base were to fall dramatically, the entire
economy would collapse due to massive deflation in the investment sector. On
the other hand, without an independent public monetary authority to properly
manage the new credit injection, there is no way to constrain the growth of
secondary debt. Instead, there would be a cascade of secondary debt from
multiple on-lending of the deposit base. Once an investment trust accepts a
deposit, it must on-lend the deposit at a profit. It must pay interest to its
investors and charge a higher interest rate to borrowers, otherwise it would
quickly become insolvent. In the present system lending, and therefore the
deposit base, is nominally constrained by banking ratios and rules like the
The post reform secondary debt is not all shown on the
CPRII balance sheets (Figures 1-3 p. 79-81) because
it involves a physical and sequential transfer of deposits from lender to
borrower.
If the economy is
to grow under CPRII, there must be a continuous
injection of new non-debt credit into the economy through large-scale
government spending programs and/or by replacing the initial citizens dividend
with an on-going citizens’ income. Otherwise there would not be enough deposits
to meet the needs of both the productive economy and the investment sector. CPRII does not provide for any of this.
There is therefore no evidence that CPRII will limit the demand for credit and no evidence that
credit cycles will be better controlled notwithstanding asymmetric prudential
policy.
(c) REDUCTION IN PRIVATE DEBT.
The CPRII text does not prove there will be a reduction in
private debt; only that there will be a reduction in bank debt. So, in CPRII Figure 1 (p. 80) there is 80% of GDP in investment
loans backed by Treasury Credit and bank equity, exactly the same as there is
at present. The foregoing discussion shows it is theoretically impossible to
support a capitalist economy using a debt of 80% of GDP. That means that at
least some of the deposits must be
on-loaned through savings and loan institutions.
Under the CP
proposal “private credit is now only
extended [by the government] to capital investment funds” (p. 47).
Since 80% of GDP is insufficient to support the productive economy either the
government will have to lend more, or capital investment will also have to be
funded from secondary debt.
CPRII refers to this on
page 48 where there appear to be two kinds of trusts: Treasury funded
investment trusts to fund capital investment and privately funded trusts
initially established to “smooth” the retirement of bank debt when a citizens’
dividend is used to enable bank debt to be repaid. The aggregate surplus
citizens’ dividends have to be on-lent to net debtors as part of the transition
process. To prevent those deposits from being spent and adding to productive
sector transaction account money, the surplus deposits “could then be converted into the equity shares or non-monetary debt
instruments of the investment trusts envisaged by Simons”.[p. 48] However, the surplus deposits can only
become liquid as the secondary debt is repaid.
Note that the Manning plan for permanent
debt reduction in the national economy available a www.integrateddevelopment.org also requires the
surplus citizens’ income deposits to
be sterilised during a transition phase.
In practice, almost
all the system deposits will be either borrowed from the Treasury (capital investment) or on-loaned at least
once by private investment trusts.
Today, private bank
debt is unequally distributed in the population at large, so only a relatively
small proportion of it (it’s about one third in
Investment Trusts
cannot afford to pay interest on deposits unless they on-lend them. The only
possible conclusion is that there will be relatively little reduction in
private debt and that it is likely that private debt could increase through the
cascading effect of deposit recycling. Without a worthwhile incentive to save,
investment sector deposits could leak into consumption, causing rapid inflation
in the real economy.
(d) ELIMINATION OF BANK RUNS.
This claim might
seem at first sight to be valid in so far as the deposit base is fully secured
against reserves, but it is not necessarily so. There will probably be bank
runs just as there are now because the financial system will be no more stable
than it is now. There is nothing in the proposal that suggests there will be
less risk-taking by financial institutions. If the capital investment trusts
borrow Treasury credit (CPRII Figures 1 -3 p. 79-81) and private investment trusts
on-lend much of the deposit base, lending institutions would still collapse if
defaults on those loans were to exceed their (reduced) equity. If a financial
institution collapses, or even looks like doing so, depositors are still likely
to withdraw their deposits. All that happens is that the institution’s assets
(reserves) and liabilities (deposits) decrease by the same amount, rapidly
shrinking the institution’s balance sheet. However, that safety net applies
only to the current holders of the deposit base. It does not apply to the
investors who have on-loaned deposits through the investment trusts. They will
still lose that part of their
on-loaned deposits that cannot be recovered from the realisation of their loan
security, just as they do now. The aggregate deposits remain the same but the
investment trusts can be easily bankrupted with all the same outcomes as at
present. Many lending institutions could be more vulnerable than they are under
the present system because, according to BK Figures 1
and 3, their equity has been drastically reduced while the aggregate debt base
including secondary debt has not.
The statement at CPRII p. 49 that there is a large increase in the business
sector (manufacturers) balance sheets appears to be based on the assumption
that because manufacturers form one group of economic agents in the modelling
all business debt will be retired using a “manufacturers dividend” similar to
that proposed for households.
Such a proposal is morally and legally unsupportable
The statement [p. 49] that Manufacturers’ “principal
is instantaneously repaid through the citizens dividend” is manifestly
unjust because, in the US alone, it would represent a US$ 3 trillion gift to
business shareholders in addition to their own citizens’ dividend. Instead, the
citizens’ dividend should include the manufacturers’ debt, so the manufacturers
borrow from the private investment trusts like most other private individuals.
Under CPRII, while Manufacturers will no longer be carrying bank
debt in aggregate, most will still be carrying a similar amount of private debt
because the Manufacturers’ dividend will be asymmetrically distributed just as
private debt is.
The “riskless debt”
assumption made in the text is also incorrect as is the claim that the “steady state level of this borrowing is
however zero”. Business lending is always risky, and, as already discussed,
business debt must at least equal to GDP whether or not the money supply itself
is debt free. There might conceivably be some useful reason to consider
negative real interest rates for Treasury credit supplied to investment trusts
for new business capital [p. 51]. However, if that is done for business, the
same benefit should also apply to households, using, for example an on-going
citizens’ income payment. Otherwise, a negative real interest rate would
represent yet another handout to business shareholders.
The CPRII proposal as it is
presented does not eliminate bank runs because banks can still fail and
investors’ claims on the banks’ deposits can still exceed the banks’ deposit
base if the ratio of secondary lending to deposits exceeds 1. That applies
whoever legally “owns” the deposits and despite the strenuous efforts to take
account of loan losses in the model parameters. Perhaps, the only way to avoid
the moral hazard implicit in the proposal is to carefully manage secondary
lending as proposed in Available in the Manning plan for permanent
debt reduction in the national economy at www.integrateddevelopment.org which incorporates a
variable business citizens income for each full time equivalent employee but it
is not a lump sum payment as in CPRII. It would
probably also be subject to regulatory wage requirements.
(e) A LONG TERM INCREASE IN
OUTPUT OF 10%.
The preceding
discussions (Figures 1 and 2 above) show that when investment capital and
resources are readily available it is a simple matter to dramatically improve
relative economic outcomes far in excess of the 10% claimed by BK (actually 8% on CPRII Figure 5
p. 83). By far the main benefit in the CPRII proposal
is the direct funding of investment capital to business in the form of low
interest Treasury credit. Careful allocation of that credit will enable large
increases in output over a short time frame. That is one major reason
A US$ 500 billion net injection of productive capital
into the
The 10% long-term
output increase over 12 years is far too conservative.
The intent of the
model simulation is to compare economic outcomes before and after the CPRII changes are introduced. Such a comparison is bound to
be artificial because the format of the model forces an outcome consistent with
the modelling assumptions and calibration. The simulation results shown in CPRII Figures 4 to 7 (p. 82-85) in all likelihood
overestimate the performance of the current system and underestimate the
economic benefits of the plan.
The model simulation claims an
increase of output of 10% but, on the basis
of error theory, such numbers are meaningless. Based on 100 variables each with
10% error it is likely to have a 95% confidence limit of +/-
1000% or more. There are, however, far more than 100 variables in the
model.
With a confidence limit
of 95% one might be confident a numerical value of 1000 has a 95% probability
of being between -9000 and + 11000....but that would hardly be appropriate for
meaningful analysis. Error theory applies both to the model equations (p.
32-55) and to the calibration (p.55-61). The equations and numbers also assume
the DSGE modelling technique is applicable to this
kind of macroeconomic analysis. Even when the same errors apply to each
individual term used in modelling the existing system and the CP, they will not
accumulate symmetrically in the results if the equations, or even the weighted
use of the same equations underpinning the modelling are different, as is often
the case.
There are too many
modelling issues to discuss in detail in this paper. Just a few are mentioned
below to give some idea of their scope.
The BK analysis assumes everyone will respond the same way
under the different financial regimes though no evidence is offered for that
assumption. There could just as likely be dramatic changes in public perception
and confidence were the financial system to become more trustworthy,
transparent and accountable.
The model
parameters are all based on an equilibrium “optimization” over time spread over
all agents in each category. For example,
(p. 43) “All manufacturers have
the same initial stocks of deposits, loans and net worth” and “all manufacturers make identical choices in
equilibrium”. Even if there were any equilibrium there is no reason to
suppose such model boundary conditions exist now or would ever apply
symmetrically across different financial systems. The entire modern economy is
based on asymmetry gained through corporatisation, globalisation, and
institutional preferential treatment. An economy satisfying egalitarian model
assumptions would quite likely be more efficient and productive than the
present multinational oligopoly protected by a plethora of perks and patents.
Superficially
egalitarian model assumptions cannot properly be applied to an intensely
asymmetrical economy. Notwithstanding that, the CPRII
analysis seems to be weighted in favour of the existing system and against the CPRII reform proposals that could be used to reverse some
of the existing financial system asymmetry. The modelling bias may be
intentional: taking a very conservative approach may help mask some of the
other issues relating to the model methodology even though in doing so it
underestimates the economic benefits of the proposal. BK
could justifiably argue that if the CPRII proposal
“works” under the model parameters they have applied in their paper it would
work much better if more appropriate reform parameters were used.
It is easy to
increase economic output when all aggregate business debt has been forgiven and
when a low defined steady state
interest rate is conveniently built into the model variables (CPRII p. 51) and only directly affects decisions on
physical investment. “The government
subsidizes investment trusts to equalise the average funding costs of the
government and of the lowest-risk private corporations.” [p. 52]
As already noted, this by
itself should translate into very high output gains.
Undoubtedly, the
giant multinationals would be perceived as the lowest risk private
corporations.
Overall, the assumptions made
for key variables are ideological, not practical.
There is no reason
to suppose growth needs to be artificially restrained at 2% or inflation at 3%
or default for investment loans at 1.5%. The distribution of net worth is
managed so that manufacturers’ (corporations, banks) do not reach the point
where debt financing becomes unnecessary (CPRII p.
40). Everyone is perfectly rational. There is no relative flow of net worth
among different groups. Business mortgage property debt and residential
property debt are given the same risk weighting (0.5) even though business risk
is 100% and residential property 35% (p. 56). The same goes for keeping the
labour share of income fixed... and so on.
Nor is there any
logic in assuming a steady rate of consumption between constrained and
unconstrained households of 4:1 (CPRII p. 55). The
implication is that the relative household income distribution and expenditure
patterns will not change under the proposals. If the population at large does
not benefit from the changes there would, from the public perspective, be
little point in making them. This is especially important when considering the
existing lopsided wealth and income distributions.
CPRII will continue the
concentration of private wealth and income into fewer and fewer hands because
it does little, if anything, to reduce either the debt servicing burden placed
on the public at large or improve wealth and income
distribution.
There is an
acknowledged moral judgement in this statement. BK
can justifiably argue that the CP was never intended to benefit the public at
large but to stablilise the financial system. But
what would be the point in stabilising the system so the existing tiny
financial and business elite (the 1% of the “occupy” movement) can become
tinier and even more elite? Without a moral dimension promoting broad public
and environmental benefit, CPRII becomes just another
proposal to further consolidate the power of financial institutions.
(f) THERE IS NO LIQUIDITY
TRAP.
This claim is partly true.
The relative
proportion of transaction (non-interest-bearing) deposits to total deposits may
vary over time depending on the demand for debt and the interest rates expected
by the investor, which is the investment trust, in the secondary debt market.
The interest rate will be determined by the supply of new money. In CPRII this is done using a “nominal money growth rule that controls the broad money supply and
thereby inflation”[CPRII p. 10].
The CPRII modelling uses a Friedman nominal money growth rule
formula (CPRII equation 31, and p.61 top). That only
controls inflation in the productive sector if just the right amount of new
money is allocated to the productive transaction accounts used to generate the
economic output. However, measured inflation is not just about the amount of
new money, but where it goes. In the CPRII proposal
it seems to be directed into new production, which is good. However, as shown
in Figures 3 and 4 of this paper, setting money growth equal to the growth rate
of output is insufficient in a debt-based system, whether that debt is bank
debt or secondary S& L debt. BK also use a “conventional forecast based interest rate
rule” (CPRII equation 20) to model the policy
inflation rate (price stability) in the present system. The target inflation is
expressed in terms of the change in government debt and a “steady state nominal interest rate”.
Neither of the above formulae
represents the real economy because neither of them enables the basic
accounting formula equation (2) (p. 10) in this paper to be satisfied.
Assets = Liabilities + Net worth.
(DC + NFCA) = M3 + Residual (2)
Equation (2) can easily be
expressed for the post CPRII reform as in equation
(3):
Assets =
Liabilities + Net worth.
Treasury credit + Residual
debt + NFCA = Deposits +
Residual (3)
Where:
-Treasury credit is
the debt-free central bank credit,
-Residual debt is
the sum of [remaining bank debt during the reform transition period + any
central bank lending to banks or investment trusts for government and private
productive capital investment]. The Residual (the banking sector’s net worth)
is expressed in equations (2) and (3) as a positive quantity because it is not
part of the money supply.
-Deposits are the
total deposits (M3) in the banking system,
-NFCA is the net foreign currency assets of the financial
institutions.
Secondary debt from
the on-lending of deposits through the investment trusts is not fully included
in equation (3) because it resides nominally outside the banking system even if
the banks act as intermediaries. Despite that, the secondary debt is crucial
when calculating economic outcomes because it is fundamental to the health of
the investment sector. There are various ways to visualise the secondary debt
as a proportion of Treasury credit or as a proportion of deposits while bearing
in mind that secondary debt can be higher than either the deposits or the
Treasury credit due to the cascading effect of multiple on-lending of the investor
deposit base.
When the amount of
secondary debt exceeds the deposits in the investment trusts the investment
sector must inflate because interest-bearing trust deposits MUST be on-loaned if
the trusts are to survive. That WILL create an exponential price spiral in the
investment sector. That means that the CPRII proposal as it is
presented will fail.
Neither equation
(20) nor equation (21) in CPRII takes the above
factors into account so they are unsuitable for modelling purposes. That is why
Friedman monetarism failed and why inflation rate targeting and attempts to use
a
Deposits other than
transaction account deposits must
circulate in the Investment trusts. If they do not do so there will be
catastrophic inflation in the productive sector. As the
interest paid on investment accounts falls toward zero there will be little
incentive to save the money in them. Some of the money will migrate into
transaction accounts where it will be
used for consumption. The reformed CPRII system relies on a worthwhile “incentive to save”
being offered to investors. That interest necessarily causes inflation in the
productive sector. For more detail see the various papers by the author at www.integrateddevelopment.org. That means there
can be no steady-state inflation under CPRII. The
inflation level will instead depend directly on the average interest rate the
Investment Trusts pay to investors and that will depend upon how the investment
sector as a whole is managed.
Since the
injections of new Treasury credit are specifically directed toward productive
investment they will stimulate monetised economic growth as long as there are
unused or underused resources available within the economy. As previously
noted, most of that new money injection
must be hoarded or saved in the investment trusts.
There is no risk of
a liquidity trap if the Treasury credit creation is managed properly but there
will not be zero steady state inflation.
CONCLUSION.
CPRII is designed to
position the banking sector so it can continue to dominate world banking and
finance following the introduction of broad-based monetary reform. That reform
is proposed in response to the now widely acknowledged failure of the current
financial system based on interest bearing debt created ex-nihilo by private
financial institutions.
BK openly acknowledge
this in their paper at p. 20:
“The volume
of credit would still be mostly controlled by private financial institutions,
and the allocation of that credit would be completely controlled by them”.
This is the
opposite of the statement BK made in Part V A : Banks at p. 34 (top) in their earlier paper: “Under this [CP] funding scheme the
government separately controls the aggregate volumes of credit and the money
supply.”
In CPRII
the word “controls” has been changed to the word “influences”.
The heart of the CPRII proposal is to separate the monetary and credit
functions of the banking system. Bank-created credit (interest-bearing debt)
will be replaced by government-issued money (debt-free Treasury credit). All
other credit the economy needs will be generated either from investing retained
profits or from on-lending the (non-bank created) deposit base. That on-lending
will create interest-bearing secondary debt, which is ignored in the CPRII proposal [Figure 1 p. 79].
Cancelling
government debt with government-issued money could improve government finances
but a large pool of secondary debt will still be needed to fund the exchange of
financial assets in the investment sector. Otherwise the investment sector will
quickly collapse. In CPRII the prices for and
quantity of that secondary debt are open-ended. Banks, acting as intermediaries
for the pooling and allocation of that non-bank credit, will still charge their
bank spread and other fees for their services. CPRII
substitutes secondary debt for bank debt while at the same time reducing the
banks’ risk and exposure to bad debt.
Under CPRII the commercial banks retain their present domination
and discretion over how funds in the private sector are invested. This power is
now used first in the interests of their shareholders and then in the interest
of their “friends” at the cost of small and private businesses and investors
and the taxpaying public at large.
Effective monetary
reform requires that the volume, price and allocation of debt funding as well as
money be managed for the public good rather than for private profit. This does
not appear to be the real objective of the CPRII
proposals.
THE REFERENCED PAPERS
The
referenced papers :
00. Summary of papers published.
01. Financial system mechanics explained for the first time. “The Ripple
Starts Here.”
02. How to create stable financial systems in four
complementary steps.
03. How to introduce an e-money financed virtual minimum
wage system in New Zealand.
04. How to introduce a
guaranteed minimum income in New Zealand.
05. The interest-bearing debt system and its economic
impacts.
07. The DNA of the debt-based economy.
08. Manifesto of the debt-based economy.
09. Unified text of the manifesto of the debt-based
economy.
10. Using a foreign transactions surcharge (FTS) to manage the exchange rate.
11. The Manning plan for permanent debt reduction in the national
economy.
12. Comments on the (Jaromir
Benes and Michael Kumhof) Chicago Plan Revisited
Paper.
13. Missing links between
growth, saving, deposits and GDP.
15. Measuring Nothing on the Road to Nowhere.
16. Debt bubbles cannot be popped : Business cycles
are policy inventions.
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