Friday, 25 November 2011

Just one question...

"You always remember that moment, if you've done it, when you get that key and you walk into your first flat, it's a magic moment. It's a moment I want everyone in this country to have, not just better-off people."

My question to David Cameron is this: If everyone was to get mortagages to buy houses... who would they be borrowing from?

Tuesday, 22 November 2011

How can demand be less than supply?

There are some economists who believe that total demand in an economy must equal its total supply. The argument goes something like this: When people sell their produce, they must, almost by definition, receive enough money to buy the equivalent value of other peoples goods. Or to put it another way, the sum total of what people earn from producing their stuff, must be enough to purchase the sum total of all the stuff produced in the economy. So the idea of a lack of demand being a cause of unemployment is seen as nonsensical.

The obvious potential flaw in this argument is that people may choose not to spend all of the money they just earned from selling their produce. The counter argument to this though, is that if people choose not to spend a portion of their earnings they must instead save it. But savings are simply used by banks for investment. Savings can therefore be seen as simply spending on investment projects like building new factories or buying new machinery. Thus saving is simply spending on different types of produce. New plant and machinery are still the fruits of people’s labour and so can provide just as much employment as any other type of produce. This is an argument often used by economists from the Austrian school. I shall be returning to this point later, so I will summarise it as follows:

The Austrian argument…
All earnings must be spent on something, even if that spending is in the form of investing in new plant and machinery.

So if the Austrians are right, there is no way for demand to be less than supply.

Another argument in favour of demand keeping up with supply is that it if weren’t true, there would be huge amounts of unsold goods building up continuously. There would be mountains of the stuff!

A clash of ideas: The idea that demand must equal supply clashes with the notion of the “paradox of thrift” whereby attempts by too many people simultaneously saving, leads to a lack of demand and a downward spiral of recession and unemployment. This idea was popularised by Keynes though it seems it was known of since antiquity.

So who is right, the Austrians or Keynes? The answer is undoubtedly Keynes. There are in fact two separate mechanisms that can lead to a shortfall of demand:

Mechanism 1. A falling money supply: Not many people are aware of the fact that the money supply can fall as well as rise but it most certainly can. This is because our monetary system was designed such that most money has a certain lifecycle. It comes into existence when banks make a loan, and it expires back out of existence when the principal is paid back. During depressions the desire to take out new loans (creating money) falls below the rate at which existing loans are paid back (destroying money). This state of affairs can go on for years, even decades. During the great depression, the money supply in the US fell by around a third.

The fact that there may be a small net expiration of money interferes with the “Austrian argument” made earlier. In a falling money supply environment, not all earnings will be spent on something. A small net flow of earnings will be given back as loan principal repayments where the money will expire out of existence. This is where things get a little more complicated. The thing is, if everyone adjusted their prices downward perfectly in step with the falling money supply, then demand could once again be matched to supply. Unfortunately, the economy is not quite capable of coordinating a fall in prices without some companies getting into trouble. The problem is that the fall in demand will inevitably be uneven and nobody will want to lower their prices unless they get a clear and sustained signal that they need to do so. You never see a restaurant adjusting its prices up and down a few percentage points depending on the previous night’s demand and you would never see an arrangement where a shopkeeper could have his rent reduced by 2% because the takings over the previous week had been below par. Both of these mechanisms can occur to some degree, but it is not quite slick enough to occur without some companies going bust in the process.

At this point we must address the question of why there aren’t piles of unsold goods building up in the process. Surely everything that is made has to be sold, so even if the money available in each round of selling is less than in the one before, prices must fall. Indeed this is true. Virtually everything will get sold, but a portion of them will be at newly distressed prices by people whose companies are in the process of being liquidated.

Mechanism 2. Purchasing non productive assets:

Another problem with the Austrian argument is the notion that savings must be spent on something that requires work to be done, like building a new factory. There are in fact many things that can be purchased as a form of savings that require almost no work to be produced. Land, traded gold, shares purchased on the secondary market. All sorts of financial products correspond either to work that was completed in the distant past, work that will be done at some point in the future, or even no work at all. An aggregate increase in the flow of spending on these types of product will naturally result in a fall in spending on products that require work to be done in the present. So even with a constant, or even rising money supply, there can be a fall in the money available for items that require current labour.

High unemployment for years to come?

Politicians everywhere are proclaiming that we must all reduce our debts and they acknowledge that this process may take many years. What they don’t seem to realise is that the money supply and our levels of indebtedness are almost one and the same thing. Under our current monetary system reducing debt necessarily means reducing the money supply. The employment outlook for the coming years is therefore rather bleak. This is on top of the unemployment that will necessarily come through public sector cuts.

Is there any way to repay debts without the money supply falling?

In a word yes. You may have noticed that earlier on I said “most money has a certain lifecycle”, this is because there is a small fraction of the money supply that does not expire. So called debt free money. Our monetary system can work perfectly well with either type. If new debt free money is injected into the system at the same rate or faster than there is net debt-money expiry, then the money supply can be held constant even as loans are repaid. Unfortunately EU regulations currently forbid the creation of additional debt free money... but in the current environment we may need radical solutions. It is time to change the regulations.

Thursday, 27 October 2011

Central banks are attempting to stop the money supply falling...

I have been telling everyone that would listen that the problem we have been facing for the past few years is a falling money supply. The so called "credit crunch" is in fact, a "money crunch". Frustratingly, over the past four years I have not heard a single person in the mainstream media concur with this fact... until now. On the 25th October, the Governor of the Bank of England, Mervyn King said

"What we were doing was injecting money into the economy and what the banking system has been doing is destroying money".
"What we were doing was to partially offset what would otherwise been an even bigger contraction."

Thursday, 6 October 2011

Book review

I was excited to see a very nice review of my book has just appeared on the renegade economist website. Take a look.

Saturday, 24 September 2011

The crisis has nothing to do with Greece

Even if God himself came down and magically cured the Greece problem then we'd simply be having a Portugal crisis a few months down the line. If it wasn't for Portugal it would be Italy, if it wasn't for Italy it would be Spain. The list goes on and on and ultimately includes the UK and the US.

The problem lies with fractional reserve banking and the ability of banks to create money for non productive purposes like trading shares on margin. In our current fractional reserve monetary system, the idea is that money gets created and destroyed at approximately equal rates. But if there is a lack of enthusiasm for trading on margin then the money supply starts shrinking and share prices fall. The normal trick of lowering interest rates to encourage more trading on margin can not work right now, so we are on a one way ticket to a shrinking money supply and lower share prices and lower house prices. This should bankrupt most banks, but it seems that governments can't bear for this to happen. Instead they will tax the poor and donate that money to the bankers to keep them afloat. At some point the poor will get fed up and take to the streets - the sooner the better I say.

For years I have been telling people that the crash of 2007 was the hors d'oeuvre, you'd better brace yourself for the main course.

Thursday, 22 September 2011

Guest blogging for PositiveMoney

I have started writing guest blog entries for where I can reach a larger audience. PositiveMoney are a group campaigning for debt free money. My latest blog entry is called How fractional reserve banking leads to booms and busts.

Friday, 19 August 2011

My letter in the Financial Times

A week ago I wrote a letter to the Financial Times. My motivation was partly to publicise both my full reserve banking website and my book. When I heard nothing back I assumed that they had chosen not to use it. But then just now I discovered that it appeared in the paper yesterday and I never even saw it! To add insult to injury, they my put my name down as "Michael Reiss" without any explanation of my credentials. I was hoping for "Michael Reiss, author of what Went Wrong with Economics."

EDIT: As not everyone has access to the FT website, here's the letter:

Sir, The phrase “credit crunch” has been widely used to describe the freeze in lending that can occur at the tipping point of economic bubbles (for example “Spanish banks turn off the credit taps”, August 12). This is, however, misleading because it perpetuates the myth that “credit” is somehow fundamentally different from money.

Using this phrase allows the public to carry on believing the false notion that there is an essentially fixed pool of money out there and the only problem is the banks’ willingness to lend it out.

The truth is, credit is money. Due to the magic of fractional reserve banking, virtually every pound we spend is money that has been lent into existence. This is true even if we have no borrowings ourselves. During a so-called credit crunch, there is an aggregate preference for paying back loans over taking out new ones. This shrinks the amount of money in the economy. The opposite of lending money into existence occurs, that is to say paying back money out of existence. The fraction of people, or even politicians, that are aware of this fact, is frighteningly small.

A shrinking money supply has a host of unpleasant side effects, as anyone who lived through the Great Depression would testify. During the period 1929-1933 the money supply fell by a third.

Wednesday, 13 July 2011

"What Went Wrong with Economics" - published

At last! My book is finally published! It should appear on in about a week or so, but in the mean time, you can get your copy -> HERE.

Saturday, 9 July 2011

I'm going to start following Richard Koo

I have just watched the (rather long!) video below and read this article about Chinese savings, both of which lead me to believe that Richard Koo is smarter than the average economist. Having said that, I don't agree that government borrowing is the only way out of the crisis - debt cancellation would still be better.

Friday, 1 July 2011

Now I'm getting scared...

The idea that Gordon Brown rescued the world from an economic crisis three years ago and that now we're in a period of "recovery" is a fantasy of the highest order. Almost none of the problems revealed in 2007/8 have been fixed. In my opinion there are bigger economic disasters ahead of use. Just take a look at this recent interview with Alan Greenspan where he talks very seriously about a US default in the near future. He says that it all depends on Greece!

One may ask how on earth the tiny economy of Greece could have any impact on the mighty US economy. The answer is that the world economy, with its ridiculous levels of borrowing, is like an ever taller tower in a game of Jenga. The taller the tower the less it takes to make it topple. If there is a mighty crash when Greece defaults, it won't really be the fault of Greece, it will be the fault of governments around the world allowing the tower to get too tall. Debts that could not be repaid should have been defaulted on years ago - allowing the debts to carry on rising will be seen in years to come as a disaster.

Friday, 10 June 2011

What Went Wrong with Economics?

This is just a quick update on my book. Currently it is at the proof readers, I expect it back any day now. I've also decided on a title, its going to be called "What Went Wrong with Economics".

Tuesday, 24 May 2011

Austerity measures in the UK... scarcely begun.

For all the talk of cutting the deficit, it appears that we haven't even begun.

Sunday, 22 May 2011

I found that this domain was not being used, so I thought I'd snap it up and turn it into a resource for anyone researching the field. If you know of any websites or articles I'm missing please tell me about it.

Monday, 18 April 2011

The dangerous fraud being perpetrated by the Fed.

Eric deCarbonnel spells out the dangerous fraud being perpetrated by the Fed:

Tuesday, 12 April 2011

Great INET lecture

There has been no progress in stabilizing the world economic system. See this.

Monday, 28 March 2011

Before we all get too hysterical about Fukushima...

Before we all get too hysterical about Fukushima perhaps we should watch this BBC Horizon program from 2006 which suggests that low doses of radiation are not so bad, they could even be good for us!

Wednesday, 2 March 2011

Bernanke clarifies things...

Anyone looking for a lesson in oratory, need look no further than this part of Ben Bernanke's answer to the question "Would you attribute the stock markets rise to QE2?"

" yes I do think that er by taking these er securities out of the market and pushing investors into alternative assets erm we er we have led to higher er stock prices and to lower stock market volatility. By the way er when we the last time we did this in march 2009 was about a week before the absolute minimum where the standard and poor was in the six hundreds er and following our actions standard and poor, the stock market, rose quite considerably. So yes em the the policy is affecting the er er the stock market in really in two ways, one is by er, is by through, is by lowering essentially long term yields and forcing investors into alternative assets but also because er as this is process has been working through and as we have seen, er both in the earlier episode that a few months after we began the process we began to see a stronger economy this time we really began this process in August and now four or five months later, we’re seeing a stronger economy. As the markets see the stronger economy materialising that’s er incorporated into expectations about future profits and future economic activity and that causes the market to rise as well so it’s a virtuous circle in that respect. So as I described in my remarks, the whole idea here is to is to move interest rates and to move asset prices in a direction that will stimulate more economic activity, put more people back to work, and moo, and get rid of risk of deflation and create a stable price environment”

Don't worry, the world is in safe hands.

Saturday, 5 February 2011

Martin Wolf’s talk - impossible government projections.

Last night I saw a presentation by Martin Wolf of the FT outlining the UK government's plans for reducing the deficit. At one point he produced some graphs showing the projections upon which the plans are based. They are based on an assumption that the rate of growth of GDP and the rate of growth of tax revenue will increase at the same rate as before the crash. I instantly realised that the projections were almost impossible to occur.

The problem revolves around the money supply. Currently the money supply is being held up by the issuance of government bonds which increases government debt. If the government reduces its borrowings, which is of course the plan, then the money supply will fall unless someone else starts borrowing on a massive scale. The question now is: Who's going to do all this borrowing? Surely it can't be borrowing for mortgages - unless the government is hoping that house prices as a multiple of earnings is going to head towards Japanese levels circa 1990. Another problem not mentioned is the paradox of thrift. When the news is filled with stories of government job losses, people respond by tightening their belts. Who wants to take out new loans when you are worried about job security?

Unless the government can find another bubble to blow up (and let us pray that they can't) then their plan for reduction of government debt is guaranteed to fail.

Now one mights say - who cares about the money supply - we can still pay our taxes even if the money supply remains constant. Well the problem is that part of the projections Martin showed was a graph predicting a steadily growing nominal tax income. But if the nominal tax income rises whilst the money supply is falling then the fraction of our income paid in tax is going to be growing at a quite alarming rate. There will necessarily be a significant shrinkage in the money available for spending in the private sector. How is our GDP expected to grow at a healthy rate while the amount of money available for consumption is shrinking fast?

It just doesn't add up.

Of course if the government just printed the money debt-free instead of via the mechanism of selling government bonds, then the government may stand a better chance.

Martin Wolf is supposed to be a great economist - have I made some mistake? Comments please...

Tuesday, 25 January 2011

Khan acadamy nails fractional reserve banking.

I don't know how I missed this video - it's excellent. Salman Khan shows how fractional reserve banking, combined with FDIC insurance, allows banks to "arbitrage the yield curve".

Wednesday, 19 January 2011

Kowabunga! Fractional Reserve Banking on the Telly!

Sadly this may only be visible to British viewers and even then only for the next seven days. If anyone knows of an alternative way to view this program, please tell me.

Britain's Banks: Too Big to Save?