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...

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".

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?

Comedy of the week: A book on economics by Gordon Brown

I was looking in my local bookshop at the latest batch of books on economics. I did a double-take when I saw this:

Gordon Brown was one of the main cheerleaders of the financial bubble. How he has the cheek to lecture anyone on economics is beyond me!

Luckily the book has a reassuringly bad set of reviews on amazon.com.

Bill Black

Bill Black speaks with great authority about the Fed and the crash in this interview with the real news network here.

Mickanomics - the book!

It's about 70% complete and I'm now seeking feedback - you can view the current state of the book here.

Definition of the money supply

There seems to be little agreement about how the "money supply" should be defined, and I'm just now beginning to understand why. This can by illustrated by first giving my definition:

The money supply is the sum, for all people and businesses, at any single instant, of the answer to the question "How much money do you have at this instant that you are freely and legally able to buy things with".

At this point you may be thinking that this "definition" is rather sloppy because "freely" is rather vague. My answer to this criticism would be "Exactly! - and that's why economists can not agree of a more formal definition".

Its rather like the problems definition of defining almost any complex item. Say for example a "car". Imagine you had a slicing machine that could cut off thin slices of a car one by one. At what point would the remaining chunk of metal fail the definition of a car... its not so clear. Indeed it makes far more sense to say that its actually a "matter of degree" i.e. as the car gets slices taken off it becomes less and less like a car.

So now as an example, take a debatable point within the definition of the money supply - time deposits. If the time deposits are strictly enforced, i.e. there is no possibility at all of getting your money out early, then clearly this can not be considered part of the money supply. But what if you can take the money out early with some penalty - now its a grey area! Under my sloppy definition, I'd say the the degree to which the time deposit is part of the money supply is a function of the size and form of the penalty.