NGO Another Way (Stichting Bakens Verzet), 1018
SUSTAINABLE, LOCAL INTEGRATED DEVELOPMENT PROJECTS FOR THE WORLD’S POOR.
Edition 02 : 29 January, 2013.
Edition 03 : 09 February,
Summaries of monetary reform
papers by L.F. Manning published at http://www.integrateddevelopment.org
referenced papers :
COMMENTS ON THE
T +64 4 2986890
comments were sent to authors Benes and Kumhof on the 29th August,
2012 one month before the actual presentation of their paper in
My brother and I
have been through your paper. Neither of us is a specialist in DSGE [Dynamic
Stochastic General Equilibrium] modelling so we cannot comment on the modelling
itself other than to say the work is impressive and you seem to have provided a
superb (albeit orthodox) “state of the
art” analysis of the hypothetical introduction of The Chicago Plan (CP).
Despite the many
assumptions inherent in the analysis, I think the conclusions in support of CP
boost the cause of monetary reform worldwide.
In my view, your
paper seriously understates the benefits of CP because it assumes there is some
kind of DSGE in macroeconomics. Direct deposit interest is eliminated under the
CP initiatives, but I tend to support Paul Volcker and the many prominent
economists who say there is no equilibrium in the present system. My own work
shows that exponential debt growth is endogenous to the present
interest-bearing debt system. A feedback loop generated through the payment of
unearned income on banking system deposits creates what I call systemic
inflation in the productive economy, causing exponential generation of
new debt. That exponential debt growth is periodically slowed a little by the
business boom and bust cycle volatility you deal with. Business cycle
volatility occurs through repeated doses of inflation therapy whereby
interest rates are raised to reduce the demand for new credit. Raising interest
rates increases the transfer of unearned income from debtors to deposit
holders, reducing effective demand in the productive economy. This leads to
recession and sometimes even depression. My work accurately identifies the
points on the debt generation curve where this occurs.
The reduction or elimination
of deposit interest should be the key effect and achievement of CP because it
can lead to near-zero inflation and system-wide financial stability. If the
private banks are to continue providing full competitive banking services, the
incentive for private banks to compete for deposits by offering interest on
them must be removed. This can be done by replacing private bank debt with
public money, either as electronic cash or e-notes or, in the case of new
productive investment lending, by what you call Treasury Credit.
The difficulty I have
with the UK Positive Money proposal as set out in the proposed Bank of
While CP may seem
to be a tighter proposal than BoE, secondary debt would, in my view, be
generated under CP as well. In CP as modelled, reserves equalling total
deposits are created using Treasury Credit. Of that Treasury Credit an amount
equal to 120% of GDP is used to cancel all Government bonds and “Short term and
Mortgage loans” while “the government is assumed to tax away the [7% of GDP no
longer needed to meet the banks’ risk based asset requirements] equity payout
of banks to households before injecting those funds back into banks as treasury
credit” (Page 8).
In my work I take
Domestic Credit as the debt base. Perhaps you could explain why 60% GDP of
government debt held outside the banks is deducted in your study? That
government debt is still interest-bearing debt and is counted
as such in Domestic Credit. The banks’ existing investment loans, assumed at
80% of GDP, become fully backed by treasury credit and residual bank
equity. The loans are interest bearing
even though there is no deposit interest being paid directly on the
corresponding deposits. In my paper “The DNA of the Debt-based economy” I
submit that the outstanding productive investment debt at any time must equal
GDP rather than the 80% of GDP assumed in the modelling. The difficulty, if
there is one, arises from the method of aggregate cancellation of 100% GDP of
Short-term and Mortgage loans and the failure to take account of the government
debt held by non-bank institutions.
The 100% Short-Term
and Mortgage Loans seem in your proposal to be cancelled by conceptually
“paying” each person an individual share of treasury credit to directly reduce
his or her debt, while the equal share each depositor receives is used to
increase his or her deposit. To balance the books and cancel the bank debt,
“the government transfers treasury credit balances to restricted private
accounts (Simons’ non-monetary debt
instruments of investment trusts referred to at page 35) that can only be used
for the purpose of repaying outstanding bank loans” (Page 7).
Since fewer than
half of all people are net debtors most of the 100% treasury credit to be used
for debt reduction will finish up with net system depositors in restricted
private accounts. Those deposits will then be on-loaned to debtors to cancel
their existing bank debt.
Interest-bearing bank debt is replaced by interest-bearing on-loaned
deposits, creating exactly the same debt and inflation problem we have now.
While the on-loaned deposit balance arising from the initial distribution of
treasury credit decays over time as the existing debt is repaid, it is
continually replenished and expanded by further on-lending of deposits each
time an existing asset is bought and sold. That further on-lending will not
come from the restricted accounts because they are extinguished as the
on-loaned initial treasury credit deposit is repaid. Much the same applies to
the 60% GDP of government debt held by non-bank institutions. This results in
the bulk of the existing Domestic Credit in the US (around 235% of GDP according to world
bank/CIA data) still being represented by secondary debt in the form of
investment loans (for 80% of GDP), by non-bank held government debt (about 60 %
of GDP) and by restricted private account debt replacing much of the Short-Term
and Mortgage Loans (say, up to 80% of GDP).
When the 20% cancelled government debt and the 20% cancelled private
debt are added the total comes to 260% of GDP instead of 235%. The global
numbers you have used in the modelling therefore seem to be roughly 25% of GDP
Irrespective of the
accuracy of the numbers, interest is still being paid indirectly on most of the
system deposits, transferring productive incomes to existing deposit holders.
This makes the situation similar to the BoE one. The amount of treasury credit
as % GDP will therefore have to expand much faster than the modelling shows.
This is in addition to small increases in productive sector transaction
deposits, which by my estimate are about 5% of GDP in
inflation will occur during the lengthy transition period foreseen in the
modelling because the non-transaction investment deposit base will be forced to
expand much as it does in the present system. This asset inflation could be
nearly 100% over the period. The modelling does not take this into account.
At page 46, the
paper refers to the exchange of existing assets. It says “a significant portion
of the remainder represents purchases of pre-existing houses where additional
investment is only a minor consideration”. This understates the importance of
the issue as most property and equity deals relate to existing assets. Their
price is governed by M3, the total deposits in the broad investment sector,
less the productive and investment transaction deposits (broadly speaking, M1).
Continuing the existing system might yield worse outcomes than CP even when the
full extent of secondary debt is included in the analysis of the present system
presented in the paper. That is because inflation will be lower, according to
the paper, but it will not be zero or even close to zero in practice. The
inflation level will, according to my work, depend on the regulatory oversight
imposed on the on-lending of deposits. Without restraint, inflation could even
be higher than it is in the present system.
Deposit interest on
on-loaned deposits produces exponential secondary debt and inflation whether or
not the original deposit is debt-free and interest-free. In this CP is not very
different from BoE.
Even when there is
little inflation and relatively little systemic risk, human nature will take
its course. In the absence of stringent restraint on on-lending, there would be
a powerful temptation to on-lend deposits at interest.
Deposit on-lending is not as widespread now as it would be under CP or BoE
because in addition to providing “competitive” interest on deposits, the
banking system by and large offers cheaper credit to borrowers than they can
get on the secondary market. That will change dramatically once new treasury
credit is restricted to new productive investment, forcing (so it appears) the
exchange of existing assets to take place by borrowing from existing
depositors. That on-lending is additional to and outside the use of the
restricted private accounts you refer to in the paper.
At the end of the
day, my brother and I see in CP the way it is formulated, a resurgence of debt
in the secondary markets that will eventually require another debt “jubilee”.
Having “used up” the CP option, what, we wonder, would be the next
solution? It seems to us much better to
do the jubilee once and for all. One very simple way of doing this without
disrupting the financial system is set out in the “The Manning Plan” I will be
releasing shortly. The formulation of the Manning Plan is quite different from
that of CP, but at the same time the plan contains many of the elements
included in CP.
aspects of CP as they are presented in the paper are cause for concern. The
paper does not cover the impact of accumulated foreign account deficits. In
M3 = DC +
NFCA + Residual (NFCA is negative
in debtor countries and Residual is always negative assuming the banking system
is not bankrupt),
where NFCA is the
country’s net foreign currency assets and Residual relates closely to the net
worth of the banking system.
The position in the
On the other hand,
the shadow economy should probably not be included in the modelling
because, worldwide, it nets out at zero. One person’s gain is another person’s
The effects of CP
on funded pension funds also need to be considered in the modelling. What will
be the effect on them if the initial issue of treasury credit is allocated
solely to individuals?
You affirm (at Page
50) the view that the monitoring of productive investment should remain a core
function, or privilege, of the private banking system under CP, especially in a
globalised interconnected system of multinationals where favouritism and
conflicts of interest are rife. We hold the opposite view that the choice of
resource allocation that creates winners and losers in the economy should be a
dual role where the government has the ability to “direct” investment in key
areas that concern it in accordance with the mandate it has received from
voters … though we accept that government can and would also invest directly in
public infrastructure on its own behalf.
We raise this
matter because the paper mentions it despite its not being a factor in the CP
analysis per se. If the banks are
treasury funded (page 18) it seems to us
to be reasonable that the government should have a say in the way those funds
are allocated. Our point, we think,
reinforces the well expressed views in the paper about moral hazard (page
Other matters which
might be considered in relation to fund allocation are the quantum of economic
growth and its measurement.
conservatively estimates relative increased economic growth at just 8% over 15
years (Figure 5). We believe that given the present resource
under-utilisation (high effective
unemployment, surplus capacity, low income structure, and so on) growth
measured in current terms should be much higher than the model shows. Perhaps
the model results are related to the failure to account for exponential debt
growth in the present system. We also think that resource allocation would be
better focused on “goods” such as addressing climate change and improving
public health rather than “bads” like trying to clean up the externalities left
by inappropriate corporate activity.
resource allocation (and associated policy) the quality and quantity of
GDP would increase and there would be a large relative improvement in the
quality of life for the people as a whole as well.
The paper refers to
aggressive raising of the reserve requirements (page 40) and increasing
interest rates in a lending boom (page 42). We understand, however, that there
shouldn’t be booms and busts under CP. We therefore infer that they might refer
to systemic stochastic shocks that are not part of the CP program and wonder
what might cause them.
We would like to
think modern modelling would attempt to take externalities such as social costs
and natural resource depletion into account in the calibration though we
realise doing so would further complicate the modelling. Nevertheless, externalities are crucial
because they play a substantial role in real (if presently poorly measured)
macroeconomic outcomes. We would argue these items are more important than
making an allowance for off-balance sheet derivatives as the paper does at page
Finally, the more variables a
Model contains, the more accurate the values given to them must be. This is to
avoid serious distortion of results caused by the addition of calibration
errors. The more generalised “logical” assumptions made in attributing values
are, the greater the risk of distortion of the results. I think the biggest
single source of error is that the endogenously self-perpetuating exponential
debt functions inherent in both the present financial system and the CP system
you have modelled are, in fact, considered capable of being represented by DSGE
analysis. T Lawson’s comments in the
recent World Economics Association Newsletter 2 (4) p. 7
reflect similar concerns.
smaller the number of variables used, the lower the number of possible errors, the
greater the probability of accurate results, and the easier it should be to
calibrate them using relatively accurate and published statistical data.
The beauty of my
revised Fisher Equation of exchange is its simplicity. There are just four
broad components linking the main dynamic macroeconomic indicators and Domestic
Credit. These are : transaction account deposits in the productive economy, the
debt representing foreign ownership of the domestic economy, the debt
representing unearned income on deposits, and a residual “bubble” debt.
The differential form of the revised Fisher equation can be used by anyone anywhere to check economic progress in real time. It also clearly illustrates why, for all practical purposes, all price is inflation.
Despite the above
comments, I think your paper is great. Like the BoE and NEED initiatives, it
provides food for thought, especially, I believe, in connection with the
importance of accounting for secondary debt in the reformed system.
THE REFERENCED PAPERS
referenced papers :
NEW Capital is debt.