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Weekend reflections

February 13th, 2009

It’s time once again for weekend reflections, which makes space for longer than usual comments on any topic. As always, civilised discussion and no coarse language.

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  1. Chris Warren
    February 13th, 2009 at 14:54 | #1

    Bad News for the Weekend?


    If this pans out the way I think it will, huge economic ructions will sweep across the globe.

    Friday’s Aust Fin Review reprinted Keynes’ 1932 call to print money (Re|View 5) and his call for a global plan that “must be spectacular”.


  2. Jim Birch
    February 13th, 2009 at 16:42 | #2

    “Crazy” doesn’t really rate as an economic argument with me. Could you elaborate?

  3. Chris Warren
    February 13th, 2009 at 18:04 | #3

    Jim Birch

    Are you aware of the likely problems if world economies simply print money as Keynes recommended in the AFR article?

    Did you read the article?

    If you think that printing notes is not crazy, then how does this fit into the circular flow?

    Which economic model can you point to that reaches equilibrium if you simply adjust values by printing cash?

    Isn’t the argument based on the fact that no rigorous economic theory supports solving a debt crisis by printing notes.

    This is apart from the social equity aspects where wages never follow increased or hyper-inflation.

    If before counterfeit dollars exist, producers sell goods for $X, they can then purchase equal value because the prices they purchase at should equal $X.

    But if in the meantime more dollars have been produced, selling prices will be $(X + x).

    Fixed wages will be particularly vulnerable.

    Notice how no “print money” theorists have said that workers wages should be indexed to maintain purchasing power.

    Printing money is a direct attack on wage earners and others on fixed incomes.

    How do you ensure equity of foreign creditors who have long-run contracts in currencies subject to extra-printing. Are they more or less likely to deal with you if you cannot control your currency?

  4. Kevin Cox
    February 14th, 2009 at 06:24 | #4

    Chris printing money does not have to be inflationary. It is what we do with the money that causes inflation.

    Money is a representation of something of value. Money was invented to make it easier to exchange goods and services. In the beginning there was no money. Someone had to create some. In a growing economy we need to keep creating new money to grow the economy and if we increase trade then we will need more money. There is a need to keep printing money.

    Our problems with the financial system are caused by way we create new money. Here is a transcript of an ABC Perspective talk I gave in December. http://www.abc.net.au/rn/perspective/stories/2008/2448111.htm

    I also discussed this last week on reflections http://johnquiggin.com/index.php/archives/2009/02/07/weekend-reflections-112/

    Here is the argument again.

    Separate the creation of money from the creation of debt by only creating new money when there is a productive asset to back the new money. I have outlined one way to do it by the government printing zero interest money and giving it to citizens who can only invest the money in productive assets. Once the money is invested then it can start to earn interest. This will not cause inflation provided we can be assured that the investments will – on average – return more money than is invested.

    The way to ensure the money is invested wisely is to invest through an open transparent market place in technologies that will save money or generate more money than is invested. The obvious market place to do this that is a “no brainer” is investment in ways to save energy and in ways to generate renewable energy. We know that finance charges on money (interest and repayments) dominate the costs of these investments and by removing interest and repayments they become very profitable investments and will return more money than is invested. As we will be able to sell all the energy we can produce we know we can use this to create as much money as is needed to keep the economy humming along.

    The M3 money supply has been increasing at a compound rate of about 11% for the past 30 years and that is obviously too much because the real economy has not grown at that rate. We could expect in the long term to need about 5% increase in money supply each and that is about the order of 40 billion dollars a year. If we invested 40 billion each year in ghg reducing technologies we would have zero net emissions in about seven years.

    So stop the banks lending money they do not have and give everyone in Australia $20,000 in restricted money that earns no interest and must be invested in ghg saving infrastructure. For those people who cannot be bothered investing set up a market place where they can sell their $20K in restricted money. It will be sold at a discount and what that will be is anyones guess but it doesn’t matter as sooner or later the $20K will be invested.

    It all seems too good to be true but this is what investors try to do all the time. They invest money in the hope of getting more money back than they put in. Why shouldn’t the community do the same.

  5. Chris Warren
    February 14th, 2009 at 06:50 | #5

    The cost of US capitalism…


    But the real tragedy is that, even if the bailout works, this only means that the next crisis will be far worse.

  6. Alanna
    February 14th, 2009 at 09:20 | #6

    3# Chris said
    “Printing money is a direct attack on wage earners and others on fixed incomes.”

    I agree Chris, but when exactly isnt there attacks on wage earners?

    At the height of the boom we got workchoices “to make labour more flexible”, there are attacks on minimum wages and conditions pretty well constantly “to get rid of the rigidities in the labour market” (we are just supposed to ignore the rigidities caused by tenure and excessive remunerations unrelated to market performance at the top of the labour force).

    Now we cant have a fiscal bailout because financial markets need all the intervention and protection, not workers or jobs.

    Its a pretty sustained attack (and I mean long, long, long term). There is only one outcome that would stop the attack on wages and that is slavery.

  7. Socrates
    February 14th, 2009 at 10:35 | #7

    I agree with Kevin Cox that printing money isn’t automatically inflationary. If it matches GDP growth its fine. If we are in a liquidity trap it might avoid deflation, which is worse anyway.

    Every policy option will harm some group. Lower interest rates and investors are worse off. Raise them and debtors are worse off. Similarly with money supply, income and price inflation.

    The question in present circumstances might be which is the least bad option. Isn’t that what economists should seek – the optimal solution? Normally we hope it will be the one which creates the most growth. If a policy minimises losses then in current circumstances that might still be the optimal solution. I’m not saying I am certain we should print money, but we shouldn’t dismiss the idea because it makes some groups worse off than others either.

  8. observa
    February 14th, 2009 at 12:15 | #8

    So that US commitment is now $8.8 trillion and counting eh Chris? Here’s a thought for those Obama Keynesians. Forget all that squabbling in Congress and just give that amount of US$1300 for every man woman and child in the world, straight to them. That should really get the globe fiscally stimulated and win lots of friends to boot. Wheee! This social, fiscal stimulus stuff is so easy when you keep it warm, fuzzy and simple.

  9. Kevin Cox
    February 14th, 2009 at 12:28 | #9

    Socrates everyone who gets an interest free amount of money to invest is better off and no one loses. How can that be? It is because investing wisely makes us wealthier. That is the pot gets bigger if we invest wisely.

    The current system gives “new money” to people who already have money because they are the ones who can get loans.

    The scheme I am proposing does not change investing existing money. That is the wealthy can still get as many loans as they already get.

    The approach effectively distributes zero interest loans across the whole community. It is like the micro loans schemes we hear about in places like Bangladesh which are a success.

    If you can’t find fault with the scheme and you like it please start to spread the ideas to others as that is the only way it will get introduced. The reason is that politicians in particular will not take a different idea and use it until they see the community accepts it.

  10. Chris Warren
    February 14th, 2009 at 13:09 | #10

    Kevin Cox

    I totally agree with you – and this understanding was my assumption.

    My post was in the context where this sort of normal money creation was not the applicable scenario.

    If money boosts production then there is no inflation.

    Your links were very interesting.

    However to print money in Keynes’s scenario (which I cited) – to do something ‘spectacular’ to jolt capitalists out of their douldrums, seems to be a direct road to inflation.

    I object (specifically) to printing money supposedly fix a crisis that is cause by other factors namely debt-inflated values which must now deflate to real levels.

    How can this happen if we print cash as if to catch-up with the money-levels in the bubble?

  11. observa
    February 14th, 2009 at 14:35 | #11

    Kevin says
    ‘everyone who gets an interest free amount of money to invest is better off and no one loses. How can that be? It is because investing wisely makes us wealthier. That is the pot gets bigger if we invest wisely.’

    Depends on whether that interest free amount of money is ‘commodity money’ or ‘credit money’ as Mises pointed out a long time ago and then if it’s non-inflationary ‘commodity money’, whether or not it will be invested wisely or not. Unlike ‘credit money’ the saver/lender of ‘commodity money’ has a serious vested interest in the answer. As every budding entrepreneur knows and Stalinist dictators don’t have to concern themselves about, ‘wisely or not’ is one helluva good question that taxeaters always seem to know the answer to, a priori. In that, it appears to place them on that lofty pedestal with ‘credit money’ issuers, which might explain their particular chumminess of late.

  12. Kevin Cox
    February 14th, 2009 at 14:43 | #12

    Chris you are correct. The method being adopted by the government of borrowing money from banks that the banks do not have but are able to lend because the government guarantees the loan is foolish.

    What it will do will be to create a bigger bubble the next time around or as you say create inflation because it is not addressing the problem of reducing debt. Equating money – whose purpose is to represent wealth – with debt whose purpose is more to do with allocating ownership of wealth is unnecessary.

    It is even more puzzling that we are doing it because it is so easy to solve. All we need to do is to change the way we create money so that we increase the money supply without increasing debt.

    There is no need for the government to go into deficit. There is no need to borrow money from overseas to solve the money supply problem. We just do it by increasing the money supply and make sure the new money is spent creating productive assets (and productive jobs).

    Fractional reserve banking as the way to create new money was introduced into the USA by a group of private bankers in the early years of the last century. The bankers still control the USA Federal Reserve. The reason they introduced the system was to retain control of the US money supply.

    Australia has a similar scheme in which the banks issue most new money through creating debt by lending money they do not have. It is time for our community representatives to take back control of the money supply. Equating money with debt leads to an unpredictable system that the Reserve Bank, through changing interest rates, is unable to control. The best we have been able to do is to get stability for awhile by allowing – indeed encouraging inflation through an inflation target!. Inflation is unnecessary and a government that has a policy of allowing its currency to devalue is not doing its job.

  13. Socrates
    February 14th, 2009 at 22:10 | #13

    Kevin or others

    I have a further suggestion/question – has anyone considered reintroducing a government owned bank to provide competition in credit markets? If the americans are ideologically incapable of nationallising banks, then why not introduce a government one to provide competition? Note I mean government owned, not government run. Also I realise that government owned banks have collapsed in the past (eg SA and Vic State banks) so I don’t suggest that a govenment bank should be so large as to dominate the sector.

    But consider the alternative – at present we are paying a lot for government to provide the security for banks anyway (and the credit too in the US) with evidently little improvement in credit markets. If banks are too important to fail, get government subsidy, and make above normal profits, then why not have a government creditor to keep them honest? I know its not fashionable, but its not so long ago we had a Commonwealth Bank. If claims about the self-regulating nature of markets are disproven, then isn’t the argument to only have private banks also invalid?

  14. boconnor
    February 14th, 2009 at 22:32 | #14

    Socrates at #13

    Completely agree. How much would it cost to set up a government bank? $1billion, $2billion? Cheaper than the many billions transfered to the private banks. You could setup a bank with a very transparent, conservative lending and savings policy, so that it is a conservative option that consumers and businesses need if they want simple loans.

    If competition theory is true, then it might be the antidote to the caustic reluctance of banks to lend.

  15. Socrates
    February 14th, 2009 at 22:40 | #15

    Thanks boconnor. In the US particularly the marginal cost of setting up a government owned bank at present would be almost nill – there are collapsed bansk available complete with staff, the government is already on the hook for the debts, and they are also providing the credit! What is there to lose?

  16. observa
    February 14th, 2009 at 23:00 | #16

    ‘I have a further suggestion/question – has anyone considered reintroducing a government owned bank to provide competition in credit markets?’

    They have and they’re called central banks and along with those infamous State banks you mentioned, how are they all doing along with the private competition? Add in the Fannies and Freddies and I recall that salutary warning about institutions that want to do both good and well. On that point I note Swan’s moral suasion that the CBA give interest relief to a customer who had her house burn down and with that Govt guarantee, what could they possibly say? You can see where that noble sentiment will ultimately lead everytime some borrower has some unforseen hiccup along life’s road. ie why bother taking out various mortgage insurance when other mortgagees will be made to pick up the tab?

    It still comes back to ‘commodity money’ vs ‘credit money’ and we’ve seen how we can’t trust monopolist central bankers to get that balancing act right, the US Fed being the example par excellence. Glenn Stevens has as much as apologised for that now with his virtual admission they took their eyes off inflation in asset prices, which left the odd CEO of Scottish banks to profoundly apologise for their part in the credit mess.

    As to founding money in some form of value other than gold, or a commodity basket, I mentioned rooting money supply conservatively in mortgages over real estate and other saleable assets, transport, equipment and machinery. Clearly the bulk of that value would be in RE, but that raises the question of some fixed, long term ‘safe’ proportion, being eroded by speculation and animal spirits (essentially feedback effects) We’d need to knock off current incentives to do that like negative gearing, tax deductibility of interest, capital gains holidays and the like. It’s right about here I come in and remind you all about those many benefits of completely ditching income tax for resource and carbon taxing. That’s the really big picture stuff again, while you’re still worrying about how the hell you’re gunna put all that ETS derivatives stuff into the hands of all these eminently qualified financial experts. Good luck with all that wellness and goodness.

  17. Donald Oats
    February 15th, 2009 at 00:18 | #17

    It would be comical if it wasn’t so tragic: the best government owned institutions I grew up with in the 70s are the ones we wish to create once more, or are compelled to bail out in some way.

    We sold them all off on the assumption that capitalism and free markets would demand efficiencies not met under government ownership. The PMG/Telecom Australia/Telecom/Telstra, the ASX which on one occasion properly policed Section 3.1 (but no more), the Commonwealth Bank of Australia, numerous electricity generation and/or distribution infrastructure, and our water.

    The pieces of eight we received for these assets did not, in my opinion, justly compensate the troubles we’ve had with these infrastructure areas since. Power blackouts, house evictions, the Great Financial Crisis, lack of an emergency warning system for homeowners in bushland, the list goes on.

    Perhaps I’m just grumpy because the garden is dying for lack of water…or I’m the right age to qualify for “Grumpy old Men.”



  18. Socrates
    February 15th, 2009 at 00:45 | #18


    I’m a grumpy old engineer and you are not alone. I do NOT suggest that we have government controled everything, or even an example of a government owned competitor in each market. But it seems to me that the decision should depend on the market. Public goods that can be made competitive like mobile phones can be privately owned. Public goods that are not competitive, or are natural monopolies, shoudl have at least one government participant in the market. Railroads are a good example of the latter. Alos the answer may change over time as technology changes the nature of some markets. I suspect banks are now requiring a governmetn competitor as well. The move to electronic banking has greatly increased monopoly power in banking.

  19. Kevin Cox
    February 15th, 2009 at 05:24 | #19

    Socrates/Donald it does not matter who owns what if the system is broken.

    Economists base their responses and their policy suggestions on the notion of equilibrium of markets or the laws of supply and demand with price as the controlling mechanism. The assumption is that given a freely functioning market then it will settle into an equilibrium state in the absence of external stimuli. This equilibrium state then becomes the state that allocates resources in the most cost effective way. This theory is very persuasive and when it works it does achieve its magic and hence it is sensible for us to try to allocate resources through market mechanisms.

    The fact that few markets behave the way they are supposed to is explained away by saying the systems are very complex and there are a lot of external stimuli. Others who recognise that things are not going as suggested say that market places are still the best way to go because there does not appear to be any better alternative. Others think that we can introduce controls or governors that will stabilise the system. It is possible to introduce controls but these have to be changes with the way the market operates – not external controls (like changes in ownership) that cannot react quickly enough or with enough variability to enable control to work.

    If we recognise that instability can be caused by the internal dynamics of the market place and the best way to control these markets is to remove the causes of instability by changing the rules in the market place then markets will start to perform their magic of efficient allocation of resources.

    Instability is caused from internal positive feedback mechanisms that cause unpredictable changes in the absence of external stimuli. That is, a small change in a state variable will cause a runaway set of changes. We can recognise unpredictable markets by finding those whose price changes cannot be explained.

    A well studied market is the stock market and time after time studies show that price of stocks is unpredictable and the past cannot be explained let alone the future predicted. One cause of instability is that the market for any individual stock has an internal positive feedback mechanism that causes instability. The law of supply and demand says that if we increase demand and we cannot increase supply then price will rise to dampen demand. In a stock market a price rise causes demand to increase and supply to decrease which in turn will cause the price to increase. Prices keep rising to an indeterminant level until they start to drop again to another indeterminant level. A market that behaves this way cannot give the price signals that will result in the best allocation of resources because the prices do not reflect the underlying value of the product being sold but rather the internal dynamics of the market.

    If we thought it sensible to make stock markets predictable – and I think most would – then let us remove the causes of instability. One way to make an individual stock price stabilise is to require the company to issue more stock when prices rise beyond a given level and to buy stock if the prices drops. That is we give a mechanism to increase or decrease supply. By building in rules that determined how the price trigger levels change – for example if say 1% of stock traded above a given range then the price could be deemed to have changed and the companies trigger prices would change as well. If these changes caused stock prices to stabilise and be predictable for an individual stock we could move them to the whole stock market. If they didn’t we would have to look for the other causes of instability and fix those.

    We could do the same thing with the debt market and rather than the Reserve Bank trying to set the price let the market set the price.

    Of course all these presuppose that we have stabilised the money markets and the first step there is to change the way we create new money.

  20. Chris Warren
    February 15th, 2009 at 07:29 | #20

    Is it not the case that any State or Territory government can set up small scale banks at the stroke of the pen but only within their own jurisdiction.

    They can also issue securities at whim, but cannot “coin money” (Const. 115).

    Such small scale banks, particularly if on a not-for-profit basis, may have a protective benefit for those at risk of personal bankruptcy from enormous unethical credit card interest rates.

    Or is there some other problem?

  21. Socrates
    February 15th, 2009 at 07:40 | #21


    I appreciate that but I have come to question some of the assumptions about profit maximising private firms that underlie such market theories. We know too that profit maximisation is a “second best” theory – we know there are agency problems and it is imperfect.

    But in a modern era with institutionalised shareholders often removed from influencing management, I think it goes well beyond agency problems. The majority of “sharehlders” are actually wage earners compulsorily investing their super, and they have no control over it. Managers of super funds (and mutual funds in the US) get themselves elected to boards and are just worried about their fees, with high exit fees deterring members leaving. The link between shareholders and management is effectively severed. Hence firms are not profit maximising, but executive playthings.

    Add to this executive bonuses so large that they encourage short term risk taking at the exclusion of all other considerations, and it is a recipe for disaster. The US big 5 trading banks that collapsed were paying bonuses equal to 40 to 55% of gross profits in the 2004-2007 period! even the better manageed firm(s) like Goldman Sachs were guilty of this.

    Hence I think we need to reform the nature of the firms and the relationship between mutual fund investors and management, not just markets. I think we have a serious problem of corporate governance, that requires fixing. Where this makes a crucial market (credit) disfunctional, then IMO it is appropriate to intervene. I think a publically owned bank may be a means to do this. I don’t think we will get a stable credit market without reformed firms in it. I could be wrong, that is just my perception.

  22. Donald Oats
    February 15th, 2009 at 12:15 | #22

    Andrew Bolt on Jan 30th on about how the heatwave in Victoria hasn’t broken any records, and thus concludes climate scientists and Labor pollies have got it all wrong…what is Bolt thinking?

    Unfortunately (for him at least), he went on the attack a week too soon. All time records tumbled as the heat wave ground on throughout the week, and unfortunately the bushfires far exceeded the most pessimistic assessments – fire chiefs and climate scientists at BOM (Bureau of Meteorology) called it correctly however. [What will it take to stop the misinformation flow emanating from Bolt’s brain?]

    He seems to have changed tack since that blog and now is attacking environmentalists for preventing controlled burning of the awesome Eucalypt wet-forest in Victoria. No mention of the virtual impossibility of burning wet-forests on most days of the year, or the scale of the job.

  23. Alanna
    February 15th, 2009 at 13:51 | #23

    Socrates # 20 said

    “The US big 5 trading banks that collapsed were paying bonuses equal to 40 to 55% of gross profits”

    All these solutions re printing money or nationalised banks seem to ignore the obvious. Legislate caps on executive remunerations. Any payments in cash OR KIND or any other fringe benefit or equity interest above the capped amount MUST be approved by 75% of shareholders – not a mere majority. Give greater power to shareholders over executive remuneration packages. Place shareholders representatives on boards. Oh and jail ALL executives that were guilty of approving bonus payments like those mentioned above. This is criminal corporate theft from shareholders by management and nothing less than that. That is why the system is broken.

  24. Chris Warren
    February 15th, 2009 at 16:29 | #24

    Legislating caps on executives sends warning bells to me.

    It may be better to set up alternative not-for-profit enterprises. They will have a much more attractive cost structure and much more attractive client services.

    Minimalistic banking is not expensive. It only takes a very few public servants to control the most complex financial operation worth any sum you’d like to name. Even small shire councils have the skilled public servants able to administer a basic bank.

    A public bank, deliberately and transparently not-for-profit, will destroy these smart-arsed executives.

    They only have their wealth because they have mates within the Frasers, the Howard’s the Keatings and Latham’s and the Kelty’s and academic economists such as Warwick McKibbon (sp?) seem too willing to go along for the ride.

    Rudd won’t do anything unless every nation on earth does the same.

  25. Kevin Cox
    February 15th, 2009 at 17:10 | #25


    What you say is true but I have a different view of markets that leads to different cause and effects. I view a market as an “algorithm” for obtaining the best use of resources. That is, the idea of having a lot of buyers who have different needs, a lot of sellers offering the same or different goods for the same purpose, and both sides having the choice of working out whether to buy and sell and for what price is an algorithm. The market place with the players if you like is the “machine” on which the algorithm operates. Having written lots of computer algorithms to optimise resources I see the market place as algorithm as a useful mental image. Markets are a remarkably good way of finding the best allocation of resources – if they work the way they are supposed to work and seek equilibrium. However if they don’t then they are remarkably poor at getting the best and most efficient allocation.

    When they do not work the way they are supposed to we get these aberrations such as the obscene profits made by the financial markets and we get the ridiculous situation in Western Economies where 25% of our profits are made in the financial markets where it is only money moving around with limited innovation and few goods and services being provided at outrageoous prices. You think bank fees are high. Just see how much it costs you to raise capital.

    What you so rightly observe shows that markets and the profit motive are not doing a very good job in some markets. However, we should try to fix markets by changing the way they operate rather than try to control their emergent properties. This is different from the free market people who believe markets will work if only we will let them alone. I say some markets do not work and there are various ways of telling they do not work – one of them being where obscene profits for very little work is achieved. My solution to the problems is to change the way the markets work – not try to control markets with rules and regulations that do not fix the problems. Where markets fail to work and we cannot fix them then we should simply abandon them and not have them at all and find another way of allocating resources.

    Money markets can work if we break the link between debt and money by creating money the way I have suggested. That is if we view markets as algorithms then we should find the bugs in the algorithms and remove them rather than try to patch up the emergent properties of the systems we create. You will notice that I do not propose the same solution for the money market and the stock market but propose changes to the internal structure of the way the markets work so they will achieve stability.

    Once we have this idea of a market as an algorithm then we can extend it in most interesting ways. We can put other objective functions as part of the algorithm – for example reduce ghg emissions to a given percentage and let the market find the solution. The current models of economic systems are based on planetary motion!!! What I am proposing is that we think of markets as optimising algorithms with multiple objective functions. I also propose many different markets for different purposes. A market to restore waters to the Murray Darling. A market to reduce homelessness. Markets to give all Australians an adequate education and health care.

    I am calling them “Markets with a Purpose”. Watch this space as I think their time might be coming:)

  26. Alanna
    February 15th, 2009 at 19:42 | #26

    24# Kevin says “Markets are a remarkably good way of finding the best allocation of resources – if they work the way they are supposed to work and seek equilibrium.”

    I think the problem here is that when you have incredible concentration of market power in a few large global financial institutions (and lets face it – the big ones are concentrated) and you have literally millions and millions of consumers forced to keep feeding these institutions, by legislation, with their super flows – you just cannot call that a market.

    It is dysfunctional like so many of our markets (oil, petrol, groceries, pharmaceuticals).

    They are no longer functioning markets. There is no equilibrium because there is no price flexibility. There is no balance between demand and supply. Its a monumental edifice to assume that you can ignore the growth of monopolistic powers and expect “the market will deliver an efficient allocation.” The trusts of history have disproved market theory time and time again.

    We need to take the blinkers off our eyes.

  27. Socrates
    February 15th, 2009 at 19:51 | #27


    Perhaps I look at it simplistically as an engineer but to me that “25% of our profits made in the financial markets” are NOT profits at all, but simply costs forced on other indsutries. There is no tangible good or IP service output for them. I am all too aware of the cost of raising capital, having worked on a few PPP projects and seen the fees extracted by those who simply arrange capital, not supply it.

    I am not sufficiently competent in theoreetical economics to say whether I think your idea would work. Certainly we need to do something different. I suppose though that the point of my post was that while in theory what you say is true, I contend that in practice profit is NOT the motive for the finance industry, its fees to execs and brokers. Whether the answer is to change the structure of markets or change the structure of firms I don’t know. Maybe both.

    Alanna I agree we need to fix exec salaries; they have just become a perverse incentive to take risks with other people’s money. However I am pessimistic about salary rstrictions alone. I think that will just lead to attempts to hide information and restructure the payments. I think there needs to be a change to corproate governance structures so that we get directors who are motivated to protect shareholders. Maybe then we will get executives motivated to maximise profits in a rational risk averse manner.

  28. Kevin Cox
    February 16th, 2009 at 05:11 | #28

    26# Alanna well said. Markets are not working as expected and are getting worse. A major reason are the rules and regulations that have sprung up that at first sight are meant to “control” markets – particularly the ones to protect us from ourselves. What they do is to stop innovation in the way things are done and protect incumbents.

    27# Socrates you are right about corporate governance. Part of the problem here is the lack of choice and the difficulty of changing the personnel in governing bodies. We need to build systems so that they can can evolve. A good place to start is how we select the boards of major institutions. Why should the shareholders be the only ones who can vote for the board members of the Commonwealth Bank? Why should existing boards through the rules regarding proxies and procedural matters dominate the selection process and make elections almost irrelevant. Where are the mechanisms to introduce variety into board composition. Do this and we will start to see change.

  29. Alanna
    February 16th, 2009 at 08:24 | #29


    That is my whole point. We have a theory (market theory) which is premised on an underlying assumption of COMPETITIVE markets but we are ignoring the fact that many markets are increasingly UNCOMPETITIVE and we have always needed regulation to protect competition and this very regulation protects capitalism and markets from dishonest and corrupt practices. The excessive rewards removed by executives are not related in many cases at all to the value their managerial activities added to production.
    These are not competitively derived salaries – they are salaries awarded because of an ability to close the shop and effectively criminally misappropriate the returns from production from shareholders, lenders and employees.

    No market adjustment will correct for this except the scale of the crisis in global financial markets we have just witnessed. The financial markets are crying out for regulation. These activities of excessive remuneration are fraud carried out within financial markets and need criminal sanctions, not some airy fairy “wait and see what the market does” attitude.

    The markets closed these institutions down, but it didnt close down the morally bankrupt attitudes and activities of the so called managers did it? Humans need to take responsibility for that, not markets.

    Its laws, police, regulation and litigation that correct criminal activity, not markets.

  30. Alanna
    February 16th, 2009 at 08:46 | #30

    Kevin says
    “Why should the shareholders be the only ones who can vote for the board members of the Commonwealth Bank?”

    I agree. Why not permit other stakeholders in the firm to vote for board representation including the employees, the bank depositors and any creditors. Too often its the large fund managers representing substantial diverse and uninformed shareholders who get to vote as one party, who also may have interests on the board and cosy relationships with management of firms and they are clearly scratching each others backs at the expense of others with legitimate interests in the firm. The sheer size of funds under management has accorded excessive powers to these institutional investors.

  31. Chris Warren
    February 16th, 2009 at 09:09 | #31

    Kevin Cox

    At first glance most would agree with you that:

    “Markets are a remarkably good way of finding the best allocation of resources – if they work the way they are supposed to work and seek equilibrium.”

    But capitalists and wealthy individuals get in the way and construct a different world through politics.

    What is an example of a regulation that discourages innovation in the ways things are done?

    I think “innovation” in the way credit is handled and assessed has destroyed the world economy.

    Competition Policy seems to discourages innovation in the ways things are done.

    Free trade agreements also seem to discourage innovation in the ways things are done.

    So there is good innovation and bad innovation.

    But, in theory, competitve markets, with free entry etc. should work. Unfortunately we live in a capitalist economic environment where this does not apply.

    So we need regulation and innovation to produce equitable outcomes for all.

  32. Kevin Cox
    February 16th, 2009 at 10:15 | #32

    #31 Chris,

    In order to hold “deposits” that can be used as general purpose money a company has to be an authorised deposit taking institution. Anyone can hold deposits if the deposits are for a particular purpose but if I want to build a business that takes your money and puts it in an electronic wallet so that you can use it for whatever purpose you wish then I have to go through a number of hurdles and it will cost a lot of money to set up.

    Many people have attempted to overcome this problem and create online payments systems to break the stranglehold of the banks. They have pretty well all failed except paypal who got around the problem by starting with credit cards until they became so large they were then permitted to hold deposits.

    This is an example of a regulation that has stopped innovation.

    Here is another one.

    A company cannot advertise that it wants investment money to the general public and accept money from anyone that wants to invest. There are an amazing number of regulations about accepting money to purchase shares in companies. One of the stupidest is that it is ok to accept money from as many “sophisticated investors” as you can find but you can only accept money from 20 unsophisticated investors per year! Sophistication is defined by how much money you have to invest and/or how much salary you earned. This regulation makes it very difficult to raise money from the general public for innovative ventures.

    and another

    You cannot reward employees in an innovative company by giving them shares – for which there is no market but which has a nominal value – without them being liable immediately for income tax based on the nominal value. So the avenue of letting employees take some of the risk of taking innovation to the market place is not available.

    I can go on and on. If you want to innovate in just about any area you will come up against rules and regulations that make it very difficult because regulations are put in place to preserve the status quo and hence they tend to stop innovation which questions the status quo.

  33. Kevin Cox
    February 16th, 2009 at 10:26 | #33

    #29 Alanna I agree that many markets are not competitive but it is worse than that. It is easy to take a properly functioning competitive market and show how the internal dynamics of the market can cause it to be unpredictable. That is, if the time taken for supply to increase to meet the new demand and for the supply to decrease with dropping demand are different but “in phase” then market prices will keep going up or down by an indeterminate amount.

  34. Chris Warren
    February 16th, 2009 at 11:10 | #34

    I can only guess that these micro-regulations were put into place in response to some experience in the past.

    They may have been band-aids to avoid harm.

    However they stop innovation and should always be reviewed by those with the necessary experience.

    I do not see borrowing and investing, as only aspects of capitalism. Normal borrowing and investing does not, by itself, lead to debt blow-outs.

    Financial innovation is often good, provided all the second effects and long-run consequences are estimated – transparently.

    Financial innovation is often bad, where politcs and alliances behind closed doors, and ‘commercial-in-confidence’ and etc. pollute the process.

  35. Alanna
    February 16th, 2009 at 11:21 | #35

    Im starting to think we (governments, policy makers, regulators) have all placed far too much emphasis on a wonderful theory (market theory) and have stuck a multitude of heads deep into the mud, ignored a growing storm, and relied not enough on plain old fashioned commonsense, laws, a sense of the common good, and ethical regulation and the willingness to provide effective teeth for legislation. We are never going to get rid of crooks, shonks and fraudsters with market based solutions ONLY and in some many cases over reliance on market based solutions has allowed crooks, shonks and fraudsters to actually flourish (actually – to get away with blue murder).

    There is innovation and then there is decimation.

  36. Kevin Cox
    February 16th, 2009 at 13:17 | #36

    #35 Alanna to “solve” the problem of crooks etc. in the market places we make all participation voluntary. That is, each person has to agree to participate and no one is forced to. What this means is that the market places have to be attractive and worthwhile places to join. We also need to have discrete marketplaces for different objectives. However, the main reason is that rather than punish people for being “bad” (e.g. not obeying the rules of the market or taking advantage of the vulnerable or being unethical) – by not allowing them to play in the market. We banish them from particular market places.

    Market places are places for us to communicate and share rather than places to profit from others. We can do this and we can make many of our market places operate this way and we can build such objectives into our market place construction criteria. Getting appropriate communications at the transaction levels will lead to many desirable outcomes. To see the power of getting basic communications right have a look at this talk on ants. We do not have to know beforehand all the impacts of changes we might make. We observe and see if we are happy with changes and if we are we let them stay in place.


  37. Alanna
    February 16th, 2009 at 13:37 | #37


    Participation in markets is voluntary but consumers are entitled to expect some code of ethical corporate behaviour when they give their own money over to a company. Doesnt mean the market should be regulated only by the freedom (or not) to choose participation. That is like saying well, we choose to live in a bandit ridden wild west town so its the citizens fault for living there. No, its the sheriffs fault for not maintaining order. This “free to choose” view is lovely and one can see a lot of benefits, but its not an excuse to stop policing the rules of the game (markets) and I dont believe even Friedman would have taken deregulation this far (alas how often do economists get twisted and misconstrued by lesser mortals along the way). Another example of “leaving things to the market”. Its like saying….well if we invest in companies where the agenda of management is short term, excessive remunerations or asset stripping of viable companies then its buyer beware…caveat emptor. If you run in to a crook like Madoff and lose your money – well its tough luck for you – dont buy if you dont want to be burned.
    I do not agree at all with this view, Kevin. We regulate criminal, fraudulent or anti competitive market conduct (or we should be to a greater extent than now) but the legislation has to have teeth and be effective and also act as a deterrent to sharks in suits.

    Its not enough to get a slap on the wrist, a ban from being a director for a period, an insignificant fine in terms of annual profits, a short term of weekend detention and to be able to get away with transferring the evil loot to the accomplice wife or to make a large charitable donation shortly before failure, that circles back to you via mates in politics. How often does this happen? Too often.

  38. Kevin Cox
    February 17th, 2009 at 01:49 | #38

    #37 Alanna – I agree with you that we have to punish wrong doers – but what I am saying is that we build the rules into the market place itself rather than have a set of regulations that are external to it. When a person signs up to join the market they agree to a set of rules for the market place itself and we can even set the punishment within the those rules. It might be that if you disobey the rules then you agree you should go to gaol or pay a hefty fine or simply be banned from the market place. Enforcement is achieved through the normal legal process of breaches in contract law. (Interesting question is can one set the punishment – such as go to gaol – within a contract agreement?)

    There is a big difference in the operation of rules in a market place and regulations external to the market place. Rules are more flexible and easy to change and we can even get it so the market participants set the rules.

  39. Socrates
    February 17th, 2009 at 08:07 | #39


    I don’t know exactly what sort of market rules you propose, but it seems to me that some regulations will be needed. How can you change the nature of the market other than by regulation? A different arrangement of property rights for example would still require regulation. Economists like to work towards win win outcomes, but some games just don’t work that way. If current circumstances make these markets win-lose for shareholders and others, then I say regulate until that changes.

  40. Alanna
    February 17th, 2009 at 08:23 | #40

    “Enforcement is achieved through the normal legal process of breaches in contract law. ”
    That wont work because of the sheer market power of some firms. have governments had much success getting microsoft or de beers into court? Contract law relies on civil litigation and when it comes to small shareholders and mighty firms we know that the mighty firms have the deepest pockets and the most expensive barristers and can use civil litigation to their own advantage, civil litigation a small shareholder cant afford. That is why government regulation is needed.

  41. Donald Oats
    February 17th, 2009 at 10:36 | #41

    We use umpires in sports precisely to have an independent and impartial monitoring and enforcement of the “rules of the game.” I am unaware of any market-based regulation that has worked consistently and rigorously over long time frames.

    Consider for example the Australian Stock Exchange. It’s profits depend upon share trading activity, and in particular the listing of new companies. Enforcement and punishment of offenders in relation to continuous disclosure, to name one problematic case, is in direct conflict to the ASX profit year on year. If too many cases are brought to penalty, then private companies may decide against listing on the ASX, in order to dodge the added scrutiny.

    Plenty of other conflict of interest cases exist. For example, the ASX has a commercial interest in growth of transactions, and this leads to promotion of products that stimulate such activity. Some of these products increase the risks that consumers assume, often without their awareness of those risks – look at trading in CFDs for example. Why bother with this sort of difficulty when government regulation allows an independent and impartial umpire?



  42. Ian Gould
    February 17th, 2009 at 23:50 | #42

    “So that US commitment is now $8.8 trillion and counting eh Chris?’

    Only if you assume:

    1. none of the loans will be repaid;

    2. all of the equity investments end up being written down to zero; and

    3. all of the loans guaranteed are defaulted on and result in 100% write-offs.

  43. Ian Gould
    February 17th, 2009 at 23:52 | #43

    ” Feb. 17 (Bloomberg) — Shipping costs have more than doubled this year, so it may be time to buy kroner, Aussies and loonies.

    The 147 percent jump in ocean-transport prices is evidence that China’s $580 billion stimulus plan will lift raw materials, said Ihab Salib, who oversees $3 billion at Federated Investments Inc. in Pittsburgh. That would benefit countries exporting them, so Salib is “actively trading” Norway’s krone and Australian and Canadian dollars, nicknamed Aussies and loonies.

    Salib and other currency traders have started using the Baltic Dry Index’s global gauge of raw-material shipping costs to help make such decisions. The index and the value of a basket of those three resource-rich countries’ currencies are increasingly moving in tandem — 96 percent of the time in the past year, up from 84 percent in the past decade, data compiled by Bloomberg show.

    “Historically, the Baltic Dry Index is a good leading indicator for commodity prices,” said Salib, who declined to detail his investments. “Commodities are very depressed right now, and they offer good long-term value. Once they come back, these currencies should do well.”

    The shipping gauge is a sign that China’s stimulus spending on housing, highways, airports and power grids will have impact beyond its borders. By Feb. 28, it will have spent 25 percent of its stimulus budget, Deutsche Bank AG said Jan. 20, predicting the country’s economy will grow at a 12 percent annual rate between the fourth and first quarter, after shrinking 2.3 percent between the third and fourth. ”

    It almost sounds like we aren’t all doomed.

    Nah, can’t be.

  44. Kevin Cox
    February 18th, 2009 at 10:01 | #44

    #39, #40, #41 I am thinking of separate market places not general solutions to all market places. The sort of thing I imagine is the website Amazon.com Amazon is a market place with buyers and many sellers – not just amazon. If you buy and sell through that market place you have to obey the rules and regulations of that market. If you buy and sell outside the market then of course the rules of the market do not apply.

    Within the market place there can be all sorts of rules and procedures – but the may only apply to that market place.

    It becomes impossible when we try to have one set of rules and regulations for all possible situations and all markets. If we divide the problem by having discrete market places and have “markets with a purpose” then we can experiment, innovate, change to our hearts content and get it right.

    I am trying to get support to build a market place with the purpose of reducing green house gas emissions. That is sellers only sell infrastructure products that if we invest in them will reduce ghg emissions by some amount. The sellers have to say how much for what cost and the buyers have to report on their experiences. If these “rules” are broken then the buyers and sellers are banned from the market.

    The rules will inherit other rules perhaps like – like price fixing – consumer protection and it might get rid of some rules it says do not apply to it.

  45. Socrates
    February 18th, 2009 at 12:45 | #45

    Sorry to change the subject but this one bothers me:
    GM has lodged its restructure plan with Congress. It is now asking for US$30 billion in loans and will slash 47000 jobs; 21000 from within the US and 26000 internationally. There are no specifics on how many from Holden.

    The more I read of that GM plan the more worried I get. They need somewhere around US $15billion per year to stay afloat right now. They are asking for US$30 billion which might only last the rest of teh recession.

    The promised saviours, electric cars like the Volt, are now promised in 2012. (Before it was 2010). They are just starting to build a plant to produce the Lithium Ion batteries essential for electric cars. But why so late? They claim to have been developing the Volt for the past few years, yet they are only now starting to build the plant to make the most crucial component? What have they been doing on the Volt project?

    Even if not I have to ask, is it worth spending $30 billion to save 100,000 jobs? (80,000 after the cuts). They say the total of indirect jobs is 1 million, but I doubt that. I can’t believe the job multiplier would be higher than 4. Lets say its 320000 jobs then. That is US$100,000 per job for maybe two years of employment. Why don’t they just file for bankruptcy? This seems like a deal to ensure shareholders get soemthing back at taxxpayer expense. I think they are dead.

  46. Kevin Cox
    February 18th, 2009 at 17:45 | #46

    #45 Socrates: It would be interesting to see how much is it costing the US car makers in pensions, how much is costing in finance costs, how much in health benefits. One of the difficulties with the US system is that their competitors have few of those costs.

    Another approach would be for the government to take over these social charges and see if they can compete.

  47. Alanna
    February 18th, 2009 at 18:38 | #47

    I think the biggest problem for the US carmakers is that they ignored the Japanese carmakers and continued to produce BIG when demand shifted to SMALL.

  48. Socrates
    February 18th, 2009 at 19:57 | #48

    No doubt that is true Kevin and I am not a fan of the US system in this respect – their employer benefits are an obvious pyramid scheme. The trouble is they are so wedded to it, and politicians so desperate for GM not to fall over (even though it must eventually) that they spend a fortune trying to prop up the rotten corpses of companies.

    I suppose what I mean is, if the government took over the social charges (GM doesn’t have the money for them) it would still be another case of letting a badly run company escape its debts. If they did though, when they looked at GM and its cost to save, they would probably realise its a dumb investment of $30B. Other things might generate more jobs.

    I can’t help feeling that Holden is like a dinghy tied to the Titanic.

  49. boconnor
    February 18th, 2009 at 22:16 | #49

    Kevin Cox @ 46

    Well hopefully the Americans will see the benefits of moving to a more taxpayer funded system of universal health financing: a reduction in the overhead costs to business of employer paid health insurance, and a break in the nexus between a person’s employment status and their access to health care.

  50. Kevin Cox
    February 19th, 2009 at 03:33 | #50

    #47 Alanna just in case you have not come across them there is a wonderful book – the innovators dilemma http://www.amazon.com/Innovators-Dilemma-Revolutionary-Business-Essentials/dp/0060521996 and another – the innovators solution – http://www.amazon.com/Innovators-Solution-Creating-Sustaining-Successful/dp/1578518520
    that describe why it is so hard for large successful organisations to change.

    #48 Socrates although it is attractive to think of dismantling these dinosaurs it is better to transform them. Transformation does not have to be immediate and can be done with relatively small changes to bottom level communications.

    #49 bocconor another “solution” is to move to individuals getting control of their health and retirement money. The self funded super system provided it is done appropriately can be applied to health care. I wrote an article on this in another context http://www.onlineopinion.com.au/view.asp?article=6741 but the principle of giving individuals control and choice still apply.

    If we removed the burden of health and retirement funding from GM it can be done in such a way as not to involve large amounts of debt. There is no need for governments to go into debt to banks and foreign countries. They can “lend” the money to be used in the future to itself and there is no need to pay itself interest. The idea of paying interest on money that does not yet exist is so stupid I cannot understand why we don’t do it – until I read the innovators dilemma when I realise that the biggest dinosaurs of all are governments. We need to fix the government problem and we can do that through dividing government functionality into separate compartments and allow variation. To give an example – let us have a taxation system where an individual can choose which tax regime they wish to operate under – but that is another story.

  51. Alanna
    February 19th, 2009 at 08:19 | #51

    you wrote “The self funded super system provided it is done appropriately can be applied to health care. I wrote an article on this in another context http://www.onlineopinion.com.au/view.asp?article=6741 but the principle of giving individuals control and choice still apply.”

    I have some grave concerns about how much choice individuals have really had over their super. Sure they can transfer from “balanced” to “aggressive” or “cash” but this isnt real choice when now we see that funds like Perpetual and Macquarie have been undertaking all sorts of highly leveraged actions within these funds that contradict the term “balanced.” What has been going on has been extremely risky – and individuals thought they had a choice? In most cases individuals have had no idea what goes on at fund management levels. They simply know they are forced to place super in a fund. If this is choice, it is an extremely limited choice for most wage earners. The opportunity costs of tracking down real comparisons between funds are simply too high – and the only information you can get is yearly or three yearly or five yearly performaces (but you can still cop a large capital gains tax bill). Then suddenly, returns are all negative, some funds are collapsing and its the new norm.

    The only real free choice arises from having direct individual control over super, not residual control after government taxes and management fees are first extracted and risky hidden fund management activities are engaged in.

  52. carbonsink
    February 19th, 2009 at 08:42 | #52

    The dam has broken on nationalisation:

    ”It may be necessary to temporarily nationalise some banks in order to facilitate a swift and orderly restructuring,” he said. “I understand that once in a hundred years this is what you do.”— Alan Greenspan

    FT: Greenspan backs bank nationalisation

    In an interview, Mr Greenspan, who for decades was regarded as the high priest of laisser-faire capitalism, said nationalisation could be the least bad option left for policymakers.

    The high priest has given his approval. Its only a matter of time now…

  53. Socrates
    February 20th, 2009 at 13:13 | #53

    Kevin cox 50

    I also have concerns abotu comparing self funded super to self funded health care. They are different in type. One is a form of saving for a predictable event (retirement). The other is a form of insurance for an unpredictable event (major illness). I am not a doctor, but my understanding is that health costs are not uniform – a small proportion of people whose lives end with complex illnesses consume a disproportionate share of the total system costs. I thought it was roughly the case that most of us will consume 75% of our life time health costs in our last ten years. Of these, 20% of the people will chalk up most of the costs. If you die of a degenerative illness that is long term you will cost us a fortune. If you live in moderate health till odl age and then die of a heart attack you will cost very little. The trouble is, how do you know in early life which category you are in? If we do know, how acceptable will it be to have massive premium differentials for people with identified risk factors? I can’t see it working.

  54. Kevin Cox
    February 20th, 2009 at 17:47 | #54

    #51 and #55 I agree with you both. However I use the Austrian (Hayek) argument to defend my position:)

    The fact that the systems do not work as well as they should is not a fault of the idea – but a fault of the implementation. We have not constructed the super system “properly” and super depends too much on dysfunctional markets. We need to fix the underlying money market and stock markets so they function in predictable ways and not be afraid that some people will fail with their super.

    I am going to “start again” on this week’s J.Q. weekend reflections and hopefully show how Emissions Permits can be made to work:) – not that I am a fan of them but if a government has decided that is what they are going to do then let us at least get them to work so they will be effective.

    The ideas I am trying to promote are

    Markets are good at allocating resources.
    If a market fails it is almost always because it is built to fail because it has positive feedback loops.
    Markets are good at allocating resources – they are not good at deciding where we should allocate resources.
    Markets viewed as algorithms can be used to optimise multiple objective functions – not just “best value” but also best value for a reason.

  55. Kevin Cox
    February 20th, 2009 at 17:56 | #55

    #53 Health Care. Socrates the idea of MediSave is not to handle the unpredictable but to handle the predictable. We will still need to handle the difficult cases and that is where we can have “special cases” and insurance.

    With respect to the higher costs at increasing age then I suggest that people will be happy to pay more in early life if they can be assured that they do NOT lose their contributions for use in later life.

    I also believe that people are kept alive too long and unnecessarily so. I have written my living will and made my intention known. If I am in pain and suffering with only a chance (<30%) of living for another one or two or ten years then I want the plug pulled.

  56. nanks
    February 20th, 2009 at 18:43 | #56

    From memory of my days in medical research – proximity to death rather than age is the predictor of health costs. There was work showing that, on average, people were better off saving for potential health problems rather than using private health. However this really follows naturally/statistically from most people never having any great medical problems. But for those that do require substantial care at some stage and do not have adequate care the results are devestating for both themselves and their families, as the USA experience shows. A mixed model with universal coverage for major treatment and co-payment for minor treatment (to discourage going to the GP for paracetamol) seems most efficient and fair overall.

    re contrasting the idea and the implementation – the US novelist James Elroy was asked about being a crime novelist and said something to the effect – “I don’t write about crime, I write about public policy at the level of implementation.” Implementation is what we live with and ideas regarding public policy mainly have value with respect to the effectiveness of their translation into implementation.

  57. Kevin Cox
    February 21st, 2009 at 01:36 | #57

    #56 nanks – Very interesting. Following on the proximity to death idea we could say the economic benefit to society is measured by the length of time the person will be able to function effectively after treatment.

    This becomes a relatively straight forward equation. Spend very little public money on the old or those likely to die and spend little on the people who are unlikely to function effectively after treatment no matter what the age.

    If you now equate this to medisave where the money you have saved for your health can be inherited by those left behind then the private interests of those making the decision to pull the plug coincide with the community good.

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