Prof. Steve Keen at a meeting addressed by European and US central bankers wears the new uniform set by Yannis Vanoufakis – finance minister of Greece… a leather jacket with shirt!
The 4th February late-night decision by the European Central Bank to reject Greek bank collateral for monetary policy operations will, I confidently predict, precipitate not just a run on Greek banks; not just greater price instability across the Eurozone – but ultimately, the collapse of the fantastic machinery that is the ‘self-regulating’ economy of the Eurozone.
As is well known, the primary duty of the ECB is to promote price stability. Subject to price stability it has a duty to promote the union’s Treaty objectives that include:
Before the decision of 4th February, the ECB had failed lamentably in its primary duty: to maintain price stability and to do so at a self-imposed target, at or close to 2%. In December, eleven out of eighteen Eurozone countries were in annual deflation. This is not just lamentable monetary policy failure, it is technocratic misconduct on a grand scale. The Spanish economy has recorded months of negative inflation. Italy registered -0.1% deflation in December, 2014; Ireland -0.3%; Portugal -0.3%; Belgium -0.4%; Greece -2.5%. Greece has been in annual deflation every month since February, 2013.
While failing in their primary mandate, ECB technocrats bypassed their European political masters and last night flouted wider EU Treaty objectives for social and political stability and for solidarity amongst member states.
But this arrogance, this disregard for the governments and the political will of the Greek people in particular and the peoples of Europe in general – is wholly in line with the Maastricht Treaty’s utopian vision for the Eurozone. As Wynne Godley argued way back in 1992, the architecture of the Eurozone is premised on the notion that economies are
This machinery was made to fit a financier-friendly ideology based on contempt for democratic government. According to this ideology governments are ‘rent-seeking’ and should be marginalized. Economic policy (monetary and fiscal) must be privatized in the hands of financial markets that, surprisingly, are regarded as having no such ‘rent-seeking’ instincts.
The ECB’s mandate, as Godley argued, is premised on a belief that
Instead the fantastic machinery of invisible, unaccountable capital markets is entrusted with the task of managing and above all, disciplining Eurozone economies, governments and peoples.
This enhanced Treaty-embedded role for the private finance sector led to the profligate financing of speculative activities in Greece, Spain and Ireland by German, French and British bankers before 2007. It led to the immense enrichment of the financier class; and to the sector’s co-responsibility for the inevitable financial and economic crises of 2007-15. The crisis in turn demolished the mythology of the free market. Instead financiers socialized losses and extracted government and taxpayer guarantees to protect them from risk.
But just as in the 1930s, the ideologues that laid the foundations of the Eurozone, and those that have against all odds upheld it, were not prepared for the Greek election result. They were not prepared for the fact that, as Karl Polanyi once argued, society would take measures to protect itself from the fantastic, unaccountable and ruthless machinery of capital markets.
For on 25th January 2015 the people of Greece took a second, bold step at reversing austerity and restoring some form of social and political stability. They did so by electing a Syriza government dedicated to resolving the debt crisis and reversing the “fiscal waterboarding” policies of the Troika.
This followed an earlier attempt by Greek society to restore some accountable form of government. In October 2011 an angry reaction to the terms of a Troika-imposed economic programme led to social upheaval. According to the Finanical Times:
The capital markets immediately sprang into action and proceeded to discipline not just Greek but other European governments, their firms and their peoples. The Financial Timesagain:
European leaders, including President Sarkozy and Chancellor Merkel rallied behind the capital markets and forced the Greek Prime Minister into a humiliating climb-down.
Today’s Eurozone’s architecture and associated economic policies are not different in intent from the “fetters” or “corset” that was the Gold Standard, and that regarded the role of governments with the same contempt. They are the same policies that led 1930s Europe into unbearable degradation, poverty, and misery. Today these policies once again threaten to unleash dangerous tensions. Society – locally, nationally, and internationally – is making ‘concerted efforts to protect itself from the market’. History is repeating itself. Current resistance to market liberalism echoes past resistance. As Karl Polanyi argued in his great, and increasingly relevant, work, The Great Transformation, the second ‘great transformation’ of the 20th century, the rise of fascism, was a direct result of the first ‘great transformation’ – the rise of market liberalism.
Adherence to this utopian vision of how economies work explains the ECB’s crude and inept handling of the democratically elected Greek government’s attempt to resolve its debt crisis. Their actions will shake the foundations of the Eurozone.
Just as the collapse of the Gold Standard in Britain and the United States led to a dramatic pre-war recovery in those countries, so the collapse of the utopian blueprint that is the Eurozone may herald good news for Europe’s economies, for its thousands of firms and for its millions of unemployed. Above all it may revive popular faith in a united, peaceful European Union based on collaboration, shared responsibility and solidarity.
Indeed we may yet come to thank ECB technocrats for shaking the very foundations of the current, ill-constructed Eurozone.
… “welcome news”
What is deflation? What has caused inflation to fall? And why is there no such thing as ‘good deflation’?
On Monday the Office of National Statistics (ONS) announced that inflation at 0.5% was lower than the 1% rise that had been predicted by the Bank of England as recently as November. And it was lower than the prediction of most economists who believed prices would rise by to 0.7%.
We at PRIME are not surprised, as we have tracked Britain’s disinflation (falling prices) for some time. And we warned as far back as 2003, and again in 2006, 2010, and e.g. inOctober, 2014 of the threat of global debt-deflation. Because policy-makers lack the tools to correct a deflationary spiral, the prospect of deflation is frightening.
We therefore find ourselves at odds with the British Chancellor, George Osborne who announced that the fall in inflation to 0.5% was “welcome news”; with the Bundesbank President, Jens Weidmann, who argued recently that “an inflation rate that for a few months lies below zero, for me, doesn’t represent deflation”; and finally with the Financial Times which ran the following headline on the news of Britain’s low inflation rate: ‘Good deflation’ seen as spur to growth”. (Note: this headline appeared in the paper edition of 14 January, 2015, and not in the digital edition.)
For ordinary consumers, workers, farmers and for the owners of firms and shops – especially those with debts – there is no such thing as “good deflation”.
What is deflation?
Deflation occurs when prices (not necessarily all prices, but the average price level) fall below the costs of production – i.e. when prices become negative. So in a deflationary environment producers will sell a good or service at below the level of profitability or below the cost of making that product. They will do this just simply to get products off the shelves and out of the warehouse – before prices fall even further.
Deflating prices may appeal to the consumer, and may boost consumption in the short-term, but they are associated with savage costs that will quickly catch up with British and European, and potentially even American consumers.
The reason is as follows: if producers or retailers sell their wares below cost, then they will invariably make a loss on those sales. Their business will become less profitable. The sensible response when a firm is not able to price its goods to make a profit, or to cover costs, is to produce less of what it is unprofitable. In other words: to shrink productive activity. This is done by cutting production, trimming wages and inevitably, laying off staff. Thus the fall in prices, leads to a fall in profits, which leads to falls in wages and to a rise in unemployment. Unemployment means that workers lack disposable income, and find it harder to buy products and services on offer. As a result producers sell even fewer of their already low- priced products or services. Bankruptcies and unemployment rise, while wages and prices fall further, and so the deflationary spiral takes hold.
Furthermore, the price indices managed by government –in particular the Consumer Price Index (CPI – are used to fix wages in private and public sector wage negotiations. Benefits received by disabled people and pensioners increase (or decrease) in line with CPI inflation. So when the CPI falls, be sure wages and benefits will fall too. (And with a political consensus in the British Parliament promising savage spending cuts in the next Parliament, pensions and other benefits will have to be cut in line with the falling level of CPI, if the proposed extreme spending targets are to be met.)
For whom is deflation good?
Deflation is good for those on fixed incomes, as these will rise in real terms as prices fall.
Deflation is good for creditors/money-lenders or the rentier class. This is because while prices can fall below zero, interest rates cannot. So while wages or incomes may fall below zero, interest rates (at what is known as the ‘zero-bound’) will rise relative to these falls. If prices fall below zero, say to minus 2% but the interest rate remains at plus 2%, then the real rate of interest rises to 4% in a deflationary environment.
And while prices, wages and incomes can fall below zero, debts remain fixed, and in relation to falling wages and incomes – rise in value.
This is why creditors encourage, and even pressure politicians and policy-makers (central bankers and officials) to apply deflationary policies – because deflationary policies protect and even increase the value of their most important asset – debt.
To repeat: whereas inflation erodes the value of debt, deflation increases the real value of debt.
So in a deflationary environment, creditors (effortlessly) grow richer as the value of debts owed to them rises (until their debtors default); and debtors with falling incomes find their debts become unpayable.
Keynes once wrote that:
So no, Chancellor, 0.5% inflation is not “welcome news”.
What causes deflation?
Taken from: What lies ahead: Ten predictions for 2015, first published by the IPPR on 6 January 2015
Europeans have no experience or memory of deflation. This is a worry. Britain and the EU will likely experience deflation in 2015. Disinflation – a slowing in the rise of price inflation – is already a feature of our economies. To understand disinflation and deflation, it helps to view both through the lens of debt.
Lending to the finance, insurance and real estate (FIRE) sectors far outweighs lending to the real, productive economy. Some estimates have put lending to the FIRE sector at 80 per cent of the total. Borrowing to finance the purchase of pre-existing assets rather than new, productive activity invariably inflates the prices of assets. Before the crisis, central bankers ignored inflated asset prices, but applied downward pressure on wages and prices.
Rises in asset prices oblige new commercial and household borrowers to borrow higher sums. But the larger the share of total income aimed at debt payments (even with low rates), the smaller the share of income that is aimed at investment and the purchase of goods and services. This places further downward pressure on both consumer prices and wages.
This disturbing phenomenon was a feature of the UK economy before the crisis. All three are linked, and conspire to contract activity in the real, productive sectors of the economy. UK bank lending to the real estate sector has started to decline, and house price rises have slowed. Falling asset prices will likely only exacerbate both the debt overhang and falls in consumer prices and wages.
It is doubtful whether central banks and finance ministries have sufficient policy tools to arrest a generalised, downward spiral of prices, which will lead to declines in profits, further falls in real wages, rising unemployment and ever-sharper falls in prices. Which is why deflation is such a terrifying prospect.
In 2007 a remarkable thing happened: the poorest households in the United States – defined as sub-prime – defaulted on their mortgages and very nearly brought down the global capitalist system. Powerful banks (including Goldman Sachs) dependent on the high rates associated with risky ‘sub-prime’ loans, were on the brink of failure. Lehman’s collapsed. This was probably the first time in history that the poor had exercised such power.
In 2015 the poorest country in Europe is shaking the foundations of globalization – by threatening to democratically elect a moderate political party that wants to restructure the country’s debts.
The very hint of such an intention by the impoverished and weakened Greeks has the European political establishment and global stock markets severely rattled.
Why should this be so? Greece’s economy is tiny and almost irrelevant to the European economy, not to mention the global economy. Second, the global economy appears to be recovering. The price of a key commodity, oil, is falling and many economists regard this as welcome in that it raises global disposable income. Third, the ECB promises to soon channel a generous dose of QE to the private finance sector. Fourth, deflation, while forcing down prices, wages and incomes, effortlessly raises the value of the finance sector’s most prized asset – debt.
Fifth, and perhaps most importantly, the globalized economic model of de-regulated, offshore capitalism, rising private debt, shrinking public sector services, deflating wages and prices, coupled with the privatization of public assets, remains intact.
What’s not for global financial markets to like?
After all, and from the point of view of financial markets, politicians and central bankers have done nothing to re-structure, re-balance or manage the existing economic model more effectively. Indeed the economic model that caused the gravest financial crisis in history has been strengthened since 2009. European (and notably British) politicians from across the political spectrum do not challenge the merits or weaknesses of the model. They turn a blind eye to offshore capitalism and instead have chosen to make a fetish of domestic budget deficits.
Misled by their politicians, taxpayers are similarly focused on domestic issues: budget deficits, immigration and scandals. They are not on the streets protesting at the guarantees, subsidies and other forms of financial ballast their governments generously provide to offshore finance.
Coupled with this, central bankers dish out largesse in the form of low rates and QE to global financiers. The result is that business for bankers is better-than-usual. Now, with deflation taking hold in Europe as well as Japan, the sector can sit idly by as its biggest and most valuable asset – the vast European private debt overhang – rises effortlessly in value, relative to both incomes and prices.
This confidence is most manifest in the City of London, which is on a roll. Recruitment is expanding; the British Chancellor is working hard to defend bankers’ bonuses from attack by the EU; and financiers are pushing up rents in the City as the sector once again expands, sure of political protection.
Given that so little has changed since 2007; given that capital mobility for the super-rich oligarchs remains unchallenged; and given that financial elites can expect more central bank largesse – why the latest stock market jitters over Greece’s threatened revolt?
The answer is that while the model might be dominant, the system is weighed down by costly, unpayable debt, and is therefore fragile and volatile. A poor, sovereign debtor could easily bring it tumbling down.
American sub-primers were punished for their “revolt” with brutal evictions from homes. Politicians, lawyers, economists and central bankers did not rise to their defence, but aligned with bankers. Now the global financial system is set to punish Greece, and is bolstered in that aim by heavyweight politicians and commentators from across the European Union.
They will probably succeed. The odds against Greece being treated fairly, or even humanely by European financial institutions and markets are very low indeed.
But for now, the poorest of the world are once again at the centre of the vortex – shaking the foundations of freewheeling, reckless, offshore capitalism.
“There is no path to growth and prosperity for working people which does not tackle the deficit”. Ed Milliband, 11th December, 2014.
The Labour leader has finally succumbed to a baying media pack that insisted he commit himself to an economic goal set by Labour’s opposition: namely “tackling the deficit.”
I am no politician, but such capitulation to economically illiterate commentators, is surely both politically unwise as well as economically nonsensical. The reason it is politically unwise is that Mr. Milliband is succumbing to the Chancellor’s flawed and frankly dishonest framing of the public deficit as the biggest challenge facing Britain’s economy. But while Mr Osborne must be delighted at luring his opponents into a debate that cannot be won, he is plainly very, very wrong.
The biggest threats facing the people of Britain, and therefore the economic issues upon which they will decide their votes, are as follows. First, the broken banking system – still not fixed seven years after ‘credit crunched’ in 2007, and still not lending at low rates to the real economy, in particular SMEs. Simmering public anger at a greedy and fraudulent banking sector has not diminished. Second, a vast overhang of private debt, and the threat to the solvency of households, SMEs and corporates posed by a rise in interest rates. The “Alice in Wongaland” economy is not sustainable, and we all know it. Third the threat posed to all British voters by falling wages and spiralling deflation. Few of us understand deflation, but be sure it poses a very grave threat. Fourth, the threat posed by climate change.
By overlooking these threats, and focusing on the public deficit, Labour is not economically credible, and will fail to win the confidence of voters.
This is particularly so because Chancellor Osborne has proved beyond doubt that governments – even his ruthlessly focused Treasury – cannot control the budget deficit. We argued as much back in July, 2010, when Professor Victoria Chick and I published “The economic consequences of Mr. Osborne”. We wrote then that: “the public sector finances are not analogous to household finances. A household can reduce its deficit by cutting its spending, but the public sector is too important for that. What happens to the public deficit depends on the reaction of the economy as a whole.” By focusing on the deficit, Labour emulates the Coalition in viewing the economy through the wrong end of a telescope.
The plain fact is that the deficit is a function of the health of the economy (its share falls when the economy (i.e. employment) is expanding, and rises when the economy is failing). Because it is a function of the expanding or contracting”cake” that is the economy, government is not able to control its size – as George Osborne has found to his cost. Why would his opponents want to repeat his errors and failures?
Instead of promising to cut the deficit, Labour should be promising the people of Britain policies for investment in e.g. green infrastructure and nationwide high-speed broadband – investment that will generate skilled, well-paid employment, for all, including the millions of under- or part-time or zero-hours employed. Furthermore, because all expenditure (both public and private) is income for someone else – both those in the public and the private sectors will gain from such public investment. The investment to boost current private and public incomes can be financed by borrowed or printed money. Because the investment will generate income for both the private and public sectors -and tax revenues for government – the investment will pay for itself. Its not rocket science!
By raising wages, Labour could turn back the threat of deflation. And by tackling both the broken banking system and the overhang of private debt – Mr. Milliband could offer the electorate a credible exit from the chronic, ongoing crisis of globalised capital.
If Labour were to do that, the deficit would take care of itself. ”
I am exasperated by John Kay in the FT today. His column The capitalists sold the mills and bought all our futures, is superb and for that reason deeply annoying. Its really aggravating when someone can cogently express points that have gnawed away at one for weeks, and yet rendered one incoherently inchoate.
Kay deals elegantly in his column with a flaw in Thomas Piketty’s analysis. It is to do with the definition and calculation of wealth, or patrimoine as defined in the French edition of his book, Capital. I have felt convinced that Piketty, like a good accountant, has conscientiously (“heroically” writes Kay) totted up all the tangible wealth that there is to count. But wealth, surely, is more than just the ownership of tangible assets.
It sure is, explains Kay. “If you want to measure the capital possessed by a nation, there are two ways of doing it. One is to travel the length and breadth of the country counting the houses, the bridges, the factories, shops and offices, and adding up their total value. The other is to knock on doors and ask people how rich they are. ….So there are two different concepts of national capital: physical assets and household wealth.”
Kay then explains that Apple, for example, has tangible wealth made up of “physical assets worth only about $15billion (and.. ahem… a $150 billion mountain of cash).” (Is Apples’scash tangible?) However it has a market capitalisation of $500 billion – a value based on “the anticipation of future profits.” In other words, its worth, its wealth, is not just those measly, tangible $15 billion worth of computers, phones, stores, tables, Apple t-shirts etc. The company’s real worth is the anticipation of future rents that Apple (and Microsoft)will extract from customers, by virtue of their oligopolistic position in the computer operating system market. And that position has been obtained not just by technological advances or skilful entrepreneurealism, but by virtue of great political power.
But the saving grace (if there is grace to be saved here) of both Apple and Microsoft is this: they make tangible things that can be bought and sold from stores, and are useful (on the whole). What of the men and women that sell debt? Or insurance? Or any other asset that is based on what is known in polite circles as ‘financial engineering’ . These are intangible ‘assets’ that can be created without engagement with either the Land or Labour (in the broadest senses); whose creation is virtually effortless, but which are assets that guarantee a stream of revenue many decades into the future?
The individuals and corporations that own these assets do not just enjoy historically unprecedented levels of wealth. They exercise vast power – political, economic, social and market power.
But like the slave-owners of old they face challenges too. By effectively cannibalising the body that is the real economy – that space where people work, make or grow products, provide services, and generate income with which debts and premiums can be paid; by cannibalising the real economy, avaricious oligopolists threaten to kill it too. Like slave-owners tempted to subjugate and starve their slaves almost to death, there comes a day when the logic of the capitalist system breaks down.
The question John Kay does not address in his column is this: when will that day come?
Today the British Parliament discussed the creation of money. The debate was led by Peter Baker, MP for Wycombe for the Conservatives and Michael Meacher, MP for Oldham for the Labour Party.
It was exciting that at last this issue is being raised at a political level. Much credit for this must go to the Positive Money campaign. However, we at PRIME have grave reservations about the proposals promoted by MPs for the centralised creation of the nation’s money supply.
We will write more about these reservations in due course. Watch this space.
The role of commercial and central banks in the process of providing credit may seem to be clearly understood by economists, bankers, and policymakers. But there are common misunderstandings about money creation, equilibrium, public money, central banks, and interest rates. The outlook for the global monetary system is not overly optimistic in the absence of overcoming these misunderstandings and altering the philosophies of bankers.
This presentation comes from the 67th CFA Institute Annual Conference held in Seattle on 4–7 May 2014 in partnership with CFA Society Seattle.
The liberalization of finance after the 1970s led to a significant buildup of debt in many parts of the world, especially in Africa, Latin America, and parts of Asia. The inexorable rise in private corporate, household, and individual debt leads to the question of whether professional economists truly understand money, finance, and credit. Good predictions and sound investments cannot, in my view, be made without a solid understanding of money.
Misunderstandings about Money Creation
Satyajit Das (2010) noted in a post on his blog that “modern finance is generally incomprehensible to ordinary men and women. The level of comprehension of many bankers is not significantly higher. It was probably designed that way. Like the wolf in the fairy tale: ‘All the better to fleece you with.’” Misunderstandings about money creation are not uncommon, as can be seen from the title and content of Martin Wolf’s (2014) recent article in the Financial Times: “Strip Private Banks of Their Power to Create Money.” Wolf does not acknowledge that the power to create money is shared jointly between borrowers and bankers. Without applications for loans, banks would not enjoy the power to “create money (deposits) out of thin air.” As a result of this misunderstanding, and because Wolf regards bankers as irresponsible, he calls for a form of centralized control of the money supply. His proposed solution should worry us all.
Most economists conceptualize money as a commodity. By conceptualizing money in this way, economists have come to believe there can be either a shortage or a surplus of money. Furthermore, they believe that the role of bankers is to act as intermediaries between those holding stocks of money and those wanting to “rent” or borrow money—that is, savers and borrowers. This theory is deeply flawed, as is the orthodox neoliberal economic theory that assumes central banks serve as a powerful control system for sound money. An example of this thinking is Allan H. Meltzer’s (2014) article in the Wall Street Journal in which he berates the Federal Reserve Board for its role in the growing threat of inflation. A more realistic assessment is that central banks do not have as much power to control the supply of money as is typically assumed by neoclassical thinkers like Meltzer.
The Bank of England (BOE) helped shed light on the issue in its recent Quarterly Bulletin (2014a). The BOE’s staff explained that “the majority of money in the modern economy is created by commercial banks making loans” (p. 16). Mervyn King, the recent governor of the BOE, explained that UK private banks are usually responsible for 95% of the money supply; the central bank only provides 5%. The BOE staff went on to explain that “banks do not act simply as intermediaries, lending out deposits that savers place with them, and nor do they ‘multiply up’ central bank money to create new loans and deposits” (p. 16).
The bottom line is that there is no such thing as “fractional reserve banking,” which is the theory that a fraction of a licensed, commercial bank’s loans are backed by actual cash (or “reserves”) on hand. In contrast, savings banks do indeed lend out savings. There has been no such thing as fractional reserve banking since the BOE was founded to manage the banking system in 1694. This misperception is very common, even among respected economists.
The Bank of England’s Andy Haldane is a fine economist. He occupies an ideology-free zone. This is highly unusual in central bank circles. He has just made a particularly skilful, and nuanced speech. Many gushed over it. Gillian Tett of the Financial Times suggested that it was good enough to qualify Haldane as a journalist.
But Haldane is not a journalist. He is a central banker. And that makes his ‘Twin Peaks’ speech particularly ominous. For while he bows to his political masters in the Treasury by acknowledging the growth in UK employment, his speech tilts definitively towards gloom. Let’s analyse it more carefully than I was able to do in a brief BBC Newsnight interview (eleven minutes into the show).
First, as part of his positive ‘Peak’, Haldane notes that “consumer price inflation, at 1.2%” has reduced “the squeeze on households’ real disposable incomes”. That is questionable, given the ongoing squeeze on household incomes. [Later in the speech he gives it to us straight: “average weekly earnings growth adjusted for consumer price inflation – is currently running at close to minus 1%” (My emphasis).]
He then goes on to make a remarkable “positive” statement. “According to financial markets inflation is expected to return and stay close to target over the medium term.” That is in my view a highly unlikely trajectory. And Haldane appears to agree, because later, in his conclusion he makes a tortured reference to disinflation as “the weak pipeline of inflationary pressures” – weak because of falling wages and commodity prices. So the financial markets are likely to be wrong again. And all the while deflationary pressures intensify.
Note that he, a policy-maker at the Bank of England is not telling us what the Bank considers the future direction of inflation to be. Instead he implies that the future direction of inflation is in the hands of markets, and not the central bank. That is depressing, but right of course, because the Bank of England, like the Federal Reserve has done almost all that can be done to manage inflation, given that the committee of men and women who decide on policy, have only one, not very effective weapon or policy tool: the central bank rate of interest. The current rate cannot reasonably fall much lower. Indeed the Bank can only maintain a 0% nominal rate – or as it is known, a Zero interest-rate policy (ZIRP).
What Haldane is saying here quite pointedly is this: the Bank of England can do no more. Continue reading… ›