Home > Economics - General > Wall Street isn’t Worth It

Wall Street isn’t Worth It

November 15th, 2013

That’s the title of my new piece at Jacobin, which links back to a variety of discussions at Crooked Timber, in particular this one from Ingrid Robeyns. Mankiw, whom Ingrid cites, offers an implicit defence of the 1 per cent, implying though not quite asserting, that the gains accruing to those in this group (largely senior executives and the financial sector) have been the price we pay for a process that benefits everyone, yielding a Pareto improvement. As Ingrid says, Pareto improvements aren’t as self-evidently desirable as Mankiw assumes. My argument focuses on Mankiw’s factual premise, concluding that the expansion of the financial sector has made the majority of people worse off. This implies that a response to the global financial crisis focused on attacking the financial sector is feasible as well as being, in my view, politically necessary as an alternative to rightwing populism.

Jacobin doesn’t appear to have a comments section, so feel free to comment and criticise here. I’ve had an interesting discussion with Daniel on Twitter already, but it’s not really a great medium when more than a few people are involved.

Categories: Economics - General Tags:
  1. TerjeP
    November 15th, 2013 at 07:54 | #1

    You dance around Bretton Woods but never quite say what seems so obvious. The growth in exotic international finance is an inevitable consequence of abandoning the relative (though not ideal) sanity of the Bretton Woods scheme.

    Under Bretton Woods governments regulated currency production with the goal of attaining fixed exchange rates (via parity with the US dollar and gold). Whilst they maintained external price stability they had to wear a lack of control over domestic parameters like interest rates and inflation. In general these were highly tolerable anyway with inflation and interest rates rarely being exceptional. However sometimes domestic attempts to control these other factors created political pressures that meant an abandonment of fixed exchange rates. Often the consequences were negative but the global nature of the framework had a normalising effect that lead nations to return to the scheme pretty quickly, all be at an altered fix.

    Given it’s prime position in the scheme, once the US gave up on gold and began devaluing the US dollar, Bretton Woods was doomed. Other nations (such as Australia) were right to decouple. The tragedy however is that no alternate global financial order emerged. Governments now created currency in an undisciplined fashion and the system became open to widespread gaming. Some of the gaming, like hedging, notionally provided a useful service to producers. A lot is just a casino where money flows to those best able to predict the next move of central banks and the knock on effect for everything else in the economy.

    You can call this neoliberal financial deregulation. Many neoliberals would probably agree with you. However in my view it is simply a failure of monetary policy. By focusing on external price stability we got that plus low inflation. By focusing on low inflation only we get that plus a global casino.

    Adam Smith would know how to reform our monetary system. So would Karl Marx and Keynes. But for some reason modern man is blind to it.

  2. Ikonoclast
    November 15th, 2013 at 08:03 | #2

    I agree completely with the article. What is puzzling is the lack of existence of a real Left to do anything about it. In Australia, Labor is not a Left party anymore. The Greens are Left on social and environmental issues but only Left Lite at best on economics issues.

    How long can the parasitic financial sector grow or even continue at its current large size? Eventually, parasites that are too large or too numerous kill the host. The parasitic financial sector is seriously draining and weakening our economy. When will our immune response get going? When will we fight back? Let them call it class warfare when we fight back.

    If a body is not fighting parasites it calls into question the issue of suppression of the immune response. What are they (the 1%) doing that so effectively quashes our immune response to defend ourselves and stand up for ourselves? That is the question.

  3. TerjeP
    November 15th, 2013 at 08:08 | #3

    To continue that analogy the parasites are here because the host is sick. They are the symptom not the cause.

  4. Justin Kerr
    November 15th, 2013 at 08:28 | #4

    I have thought this was the case for years and now your excellent article has confirmed it. Thank you!

  5. PeakVT
    November 15th, 2013 at 08:52 | #5

    Generally good article, though the shifting back and forth between language that could be interpreted as applying to the Anglosphere as a whole and specifics about the US does leave me wondering how much the the equivalent of Wall Street and the City has captured governments in AU, NZ, CA, and IE. Discussing that was probably outside of the scope of the article, however.

  6. Michael
    November 15th, 2013 at 09:25 | #6

    I’m still waiting for an answer to the question Paul Woolley from the Centre for the Study of Capital Market Dysfunctionality poised before the GFC: if the theory of efficient markets is true (which it obviously isn’t) how are super profits possible in a sector that is supposed to enable efficient transactions and services to the real economy? The answer seems to be that they have totally gamed the system through corrupting politics.

  7. Newtownian
    November 15th, 2013 at 09:34 | #7

    @Ikonoclast

    I second your sentiments and agree with using a biological analogy. But I think you have the wrong biological entity.

    Parasites don’t tend to kill their host and sometimes in the fullness of time can enter into a degree of symbiosis – the gut flora of normal animals lives off the animal’s consumption but simply through hanging around provides protection from virulent pathogens, a nice give and take having been struck. A second issue is parasites are different organisms to the host. Finally you can get rid of parasites and be none the worse as any defleaed dog will tell you.

    None of the above seems to apply to the Finance sector.

    Thus the better and much more alarming alternatively analogy is that the financial sector and its various manifestations has become more like a cancer. The financial people aren’t much different to you or I, they have children who depend on the current economy. But their ilk are growing out of control turning more and more of us into entities like them – focused on short term single gain and not the health of the body politic. And despite the near crash of 2007 they have shown no remorse or reevaluation and are currently reinflating the bubble with obvious implications.

    Facing ‘transition to retirement’ as I have become acutely aware of this situation and the Devils alternative it has generated for my next 20-30 years that I cannot get away from this mindless movement – Option 1. I must trust the financial spruikers in the superannuation industry who keep trying to sell me more products ‘for a small fee’, try to con me at every face to face encounter, and operate using short term economics because they must. Its what they do. In effect I must encourage them even more.

    Option 2. I must take complete control of my income stream and become a petty bourgeois rentier capitalist – i.e. become like them and seek to maximise short term gain ahead or be a mug. And there is a whole baby boom generation just like me with no alternative.

  8. ZM
    November 15th, 2013 at 10:30 | #8

    I hope this is ok to copy down.

    I have read the piece through, and have some initial comments. In agreement that this is the critical decade, I hope being a little critical is welcome, and this is written expecting that you agree with the report by the CCA you worked on in which the goal is contract and converge by between 2040 and 2050.

    You write “society as a whole would be better off” but you do not define who you include in “society” – every little person in the round world? Those in developed countries? Managers? Cleaners?

    ? [Also – you do not define what you mean by the term better, if you are constructing an indicator, like the GPI you must define your terms thoroughly for other people]

    “A political strategy based on cutting the financial sector down to size…”
    I do not know if it is wise to declare enemies before trying to win people over? For instance, as a toddler I was friends with twins, and they came in and out of my life since, and they were the children of a certain loose group of 60s/70s people – so us children, as Belle Waring might know, might share some certain perspectives on our elders – one of the twins now works for PwC – but to declare war on finance and its people so preemptively would perhaps be such a clashing sort of thing that the opportunity to win people over might be ruined. We were talking about this last night as we discussed Sunday’s climate change day of action – if there is pageantry, like moomba, it is more open to people to feel they might be welcome, than to preemptively declare war. Also – because we are all complicit in our society’s economic system we ought to approach it from a place of outraged humility, including ourselves.

    “…must involve a direct conflict with the financial sector, and must imply a substantial contraction in the size, wealth, and power of that sector”
    This is true. But the contract and converge method implies a substantial contraction in the wealth and power of ourselves at our various positions as well.

    “A necessary condition for such a strategy to be feasible is the premise that the incomes flowing to the financial sector come at the expense… of working people.”
    Again, which working people – London solicitors or phillipino telephone workers?

    “The great moderation as an illusion….tens of millions of households saw their savings wiped out”
    This is because, as anyone who hides bars of gold under their mattress knows, money and savings based on money are imagined, in the sense of Benedict Anderson’s view of Imagined Communities. You might use the word construct. Or I’m sure there are other words to choose.

    “Liberalization of markets in goods and services has been accompanied by continual financial repression”
    This is difficult to word. but, to take it to a great magnitude, imagine you are conquered by a great civilisation and become the agent of the civilisation so much as to see barbarism everywhere without.

  9. John H.
    November 15th, 2013 at 11:16 | #9

    Thanks John. Very good read, have passed on to various people.

  10. November 15th, 2013 at 11:39 | #10

    John, I have been reading your work for several years but this is by far the best thing you have ever written. I’m impressed by the balls you have to call it like it is, although i suspect your google-armed critics will selectively quote to discredit you.

    Having worked in and around the financial sector for a couple of years I can confirm that it is enitrely a charade, with most employees cheerfully understanding how little their jobs contribute to the wider economy but happy to milk the status quo for all it is worth.

    It is a very sad world when the majority of the modern workforce feel they contribute nothing.

  11. Royton De’Ath
    November 15th, 2013 at 12:02 | #11

    Thanks PrQ. Very informative and interesting article.

    Having just come from reading this I’m walking in disorderly, distracted orbits, muttering darkly …

    On one hand Taibbi underlines in no uncertain terms what is identified in the Jacobin article. But. He also throws a switch on a Kleig light … illuminating some of what it will take to deal with the issues you’ve identified.

  12. Jim Rose
    November 15th, 2013 at 14:53 | #12

    John, you seem to be attributing the GFC to a negative productivity shock?!

  13. Ernestine Gross
    November 15th, 2013 at 15:34 | #13

    @TerjeP

    Your post @1 makes more sense to me than Mankiw’s macro texts. Lets focus on your: “The tragedy however is that no alternate global financial order emerged. ”

    Well, something emerged. A series of increasingly severe financial crises and increasingly unequil income distributions. This is not sustainable.

    The problem, as I see it (in the light of a series of theoretical papers in post 1950s G.E., referred to on several occasions in the past on this blog-site), is that governments have outsourced the ‘supply of currency units’ (as distinct from the allocation of savings and increases in currency units under the control of monetary authorities among competing applicants for credit) to ‘the market’. Your description of what goes on in this ‘market’ is quite adequate for the purpose at hand.

    The falacy of this belief in ‘the market’ for currency units stems from the apparent lack of understanding of the difference between the supply of fruit and vegitables ‘in the market, on a particular day at a particular place’ with the supply of numbers – there is no bound on the numbers of currency units that the international high finance people can generate. But there is a bound on the number of potatoes. The numbers they generate become the debt of other people. Surely it doesn’t take a proverbial Einstein to realise that those who make income (false profit) from generating numbers will become richer while those who buy these numbers (debt holders) lose.

    Obviously, the ‘game’ is never put as simply as that. It takes place under the protection of smoke screens, the elments of which have names such as CDOs, debt-equity swaps, interest swaps, currency swaps, insurance contracts , etc, etc. Each time an element is created, the intermediaries ‘make money’ (for themselves).

    When the last big game (GFC) collapsed, the FED replaced the privately generated US dollars with official currency units. The gamers are being rewarded. This is the point where, IMO, the government becomes responsible for the game, not as is often argued that ‘the interest rate’ was too high or too low’.

    The ‘game’, as you call it, is played in an environment where inflation has to be kept low, student loans are non-recourse and wages are to be flexible.

    IMO, this is no longer consistent with the desirable aspects of the theory of a ‘market economy’ (setting side for the moment the serious issue of incomplete markets regarding the environment). This is immoral.

  14. Ernestine Gross
    November 15th, 2013 at 16:32 | #14

    JQ, I wish you wouldn’t have linked your argument to ‘The Left’ because it invites being pigeonholed as ‘political’ while the argument about the financial sector is a mainstream economic argument, defendable on theoretical and empirical grounds.

    In which world does Mankiw live?

    Surely, ‘everybody’ knows that seeing people in the US living involuntarily in tents and on foodstamps is sufficient to empirically prove that his idea of Pareto improvement is not consistent with the definition of the same.

    His presentation was not well received at the 2011 Lindau meeting.

  15. Ikonoclast
    November 15th, 2013 at 16:35 | #15

    @Ernestine Gross

    In your reply to TerjeP you say some interesting things. And I agree with them. At least, I think I agree if I understand correctly. Your comments which caught my interest in particular are;

    1. “…governments have outsourced the ‘supply of currency units’ (as distinct from the allocation of savings and increases in currency units under the control of monetary authorities among competing applicants for credit) to ‘the market’. ”

    2. “When the last big game (GFC) collapsed, the FED replaced the privately generated US dollars with official currency units. The gamers are being rewarded. ”

    With respect to point 1, I assume you mean not the movement away from a gold standard necessarily but the movement towards allowing the generation of debt money without reserves and perhaps also all the modern complicated financial instruments. A number of theorists now posit that private banks lend and then look for reserves by borrowing from other banks or from the so-called discount window at the Reserve. This means they can create (debt) money ahead of the requirement to lend against reserves. This equates to privately creating currency which circulates until destroyed by repayment against the debt and doing this without a genuine reserves requirement. Is this what you meant?

    With respect to point 2, the privately generated currency I assume is bad debt and/or toxic assets (including complicated financial instrument) which the Fed bought up with “standard” US dollars in the TARP (Troubled Asset Relief Program). And it raises the question, will the Fed eventually have to write off losses on some of the Troubled Assets it bought up? This would then equate to “the FED replaced the privately generated US dollars with official currency units. The gamers are being rewarded.” Is that what you meant? It’s how I interpret your analysis. I would be pleased to be enlightened by confirmation or correction. Thanks.

  16. nick j
    November 15th, 2013 at 21:01 | #16

    Good article, the payment system should be a utility, decoupled from the banks. I’m not sure of the mechanics though?

  17. Jordan
    November 16th, 2013 at 00:41 | #17

    @Ikonoclast
    It sure looks like E. Gross is going MMT.

  18. Jordan
    November 16th, 2013 at 01:27 | #18

    @Ernestine Gross
    I would rather argue that governments are taking away the currency creation from banks.

    I take much longer period then 50 years to look into who is outsourcing money creation. Lets start from banks in medieval times when banks suported developement of capitalism independently from governments (kings and queens) who would rather have feudalism. Then through Bank of England and first Treasuries to finance governments. All of it points toward banks as original creators of debt currency and capitalism.
    Then come first atempts to enforce fiat money in colonies in Africa, then Greenbacks by Lincoln and Confederate Dollars by Davis. Then FDR and developement banks that created money for employment and war effort. Now, FED is issuing pure fiat money to save banks by taking over their failing MBSs giving them “official currency units” just by “marking up their accounts on keyboards” as Ben Bernanke said.
    “the FED replaced the privately generated US dollars with official currency units”

    Therefore, i would rather say that governments are taking over the currency creation from banks instead of outsourcing it to banks. It was outsourced to begin with.

    Other indication that points toward such view is the communlst financial arangement. In Yugoslavia which used have 100% loan reserve requierment and governments were those that issued currency directly without any constraints such as capitalist governments are straped with. Communlst governments would decide on budgets and money will be issued as needed. This is obviously how the future will turn out.

    I would say that governments are extremely slowly taking over the currency issuance from banks on a 500 year term.

  19. Jordan
    November 16th, 2013 at 02:00 | #19

    J.Q.
    I would rather take a 100 year term to see what drove this financialisation and also the collapse of the Bretton Woods system instead of 20-30 year terms as You used.

    I have a cirquitist view of an economy. From it it comes that money as a store of value is working against money as exchange value. In a cirquitist view money has value only when it is used (spent).

    From it i conclude that all such finacialisation came from two policies that supported money as a store of value destroying the value of exchange.
    Those two policies are giving up on 90% marginal tax rate and pushing for retirement plans (private plans, 401K and annuation) that invested funds into finace instead of into spending.

    90% marginal tax rate is the most effective regulation policy against fraud and exorbitant compensations. I would argue that by strictly enforcing 90% marginal tax rate you could get rid of all finacial regulation because with it there is no incentives for fraud. Incentives for fraud and speculations are incomes. Limit the income and there is no incentive.

    Private retirement funds are taking away from spending and freezing those assets into stocks. original intent of Social Security is to have incoming funds being spent right away contributing to agregate demand. PAYGO is not taking away funds from AD while private pension plans do to be used later.
    I witness this at the time of Croatia implementing 4% of pension tax toward individual private pension plan. Result of few years of this plan are catastrophic. State continued paying out old pensions while not receiving all income from new contributions. State went into high debt in order to keep the pension standards while economy suffered from rise in interest rates from such debt. Croatia is on a fixed exchange regime.
    Comparing it to the USA where there is floating exchange so FED kept the power over interest rate setting, such surge in savings produced lower interest rates and compounded the growth of savings that kept pushing interest rates down to ZLB.

    On Bretton Woods. The system was based on free $US to devastated Europe that was creating AD for the USA. But such arangement of basically single currency world can not survive without continuing fiscal transfers as it became obvious in EuroZone. Bretton Woods lasted 23 years and EZ only 18 before started toward dissolution from the lack of fiscal transfers. There are same mechanisms at play in Bretton Woods and in EZ. That is why it came to the collapse of the BW. Gold standard can not last without cirquit of fiscal transfers for too long.
    Yanis Varoufakis explains it very eloquently in his The Global Minotaur about why BW collapsed. And what replaced it. USA switched from surplus country providing for rebuilding of Europe to soaking up surpluses of other countries providing them with AD when they did not know how to reise domestic AD.
    Such deficit soaking provided US finacial markets with about $89 B every day to deploy and invest. Financial inovations are the result of huge surpluses from wealthy, private pensions and foreign surpluses that were given to the Wall Street to manage.
    Present Wall Street is just a natural result from years of accumulated savings with reduced productive investment oportunities that came from low marginal tax and private pension systems. ZLB is also the result of saving glut that came from such policies.

  20. Ernestine Gross
    November 16th, 2013 at 08:55 | #20

    Jordan :@Ikonoclast It sure looks like E. Gross is going MMT.

    Most definitely NOT

  21. November 16th, 2013 at 13:24 | #21

    Newtownian :
    @Ikonoclast
    I second your sentiments and agree with using a biological analogy. But I think you have the wrong biological entity.
    Parasites don’t tend to kill their host and sometimes in the fullness of time can enter into a degree of symbiosis – the gut flora of normal animals lives off the animal’s consumption but simply through hanging around provides protection from virulent pathogens, a nice give and take having been struck. A second issue is parasites are different organisms to the host. Finally you can get rid of parasites and be none the worse as any defleaed dog will tell you.

    That’s only one possible parasite behaviour in a spectrum, one that emerges when the trade-offs favour staying put in a single host. Here are some other possibilities:-

    – The parasite finds itself in a non-standard host, which it damages even though it is “well behaved” in its usual host. That’s why certain dog parasites cause human blindness; in their search for the dog organ they can get along with, they find their way to human eyes – where, after causing much damage, they dead end their life cycle.

    – The parasites evolve virulence to spread to other hosts, even though their first host becomes less hospitable from the incidental damage of greater virulence. Malaria, sleeping sickness, cholera and many others work like this.

    – Things may not yet have settled. It may be hard to believe, but syphilis is now much milder than it was just a few centuries ago, even if it is left untreated (syphilitics nowadays have long infectious periods with no serious symptoms – and then it really damages them).

    – Something else is going on at the same time. Leprosy died out in northern Europe with the rise of TB; at first, researchers thought that TB caused enough cross-immunity to prevent leprosy infection even though not enough to halt TB, but now the favoured theory is that people with both diseases died too quickly to allow leprosy to sustain itself in the population (and leprosy made it easier for TB to get going).

    And it is certainly possible to categorise finance as “other”; ideas of “directly productive” attempted to get at this (among other things). The catch is that “natural” definitions tended to throw babies out with bathwater. Teachers are no more directly productive than bankers. But it does yield insights when we look at how such rules of thumb fail, insights that help us to distinguish in principle between bank loans that end up raising productivity and those that end up catalysing externalities (say); unfortunately, they don’t help in practice as the distinction can often only be made in hindsight, if at all (if it bursts, it was a bubble – but then again, even the 1840s railway bubble left infrastructure).

  22. November 16th, 2013 at 13:45 | #22

    Jordan :
    @Ernestine Gross
    I would rather argue that governments are taking away the currency creation from banks.
    I take much longer period then 50 years to look into who is outsourcing money creation. Lets start from banks in medieval times when banks suported developement of capitalism independently from governments (kings and queens) who would rather have feudalism. Then through Bank of England and first Treasuries to finance governments. All of it points toward banks as original creators of debt currency and capitalism.
    Then come first atempts to enforce fiat money in colonies in Africa, then Greenbacks by Lincoln and Confederate Dollars by Davis. Then FDR and developement banks that created money for employment and war effort. Now, FED is issuing pure fiat money to save banks by taking over their failing MBSs giving them “official currency units” just by “marking up their accounts on keyboards” as Ben Bernanke said…

    Some minor corrections and extensions:-

    – The mediaeval governments would not rather have had feudalism. They would rather have had absolutism, it was just that they were constrained in practice. They ended up implementing absolutism (when they could) by co-opting, buying out and hollowing out the forms of feudalism; it was this hermit crab version that was misnamed feudalism when the revolutionaries overthrew it, and which they so disliked.

    – You left out the 18th century experience of fiat currency in Europe, from what John Law did within France to what the revolutionary wars did, first within France and then to exploit puppet states. (To be fair, that sort of thing isn’t part of the English speaking world’s direct experience, apart from the isolated cases of continental dollars and greenbackism).

    – There was also the whole early 19th century debate between bullionists and real bills theorists, mostly in the U.K.

    – You didn’t mention the Chartalist backing of fiat currencies with taxes, e.g. under colonialism (this can make fiat currencies sustainable).

  23. Ernestine Gross
    November 16th, 2013 at 14:31 | #23

    Ikonoclast: I’ve made a more general argument many times in the past, except that I started off with reference to Radner’s 1970s G.E. models and a result by O. Hart. from the mid-1970s. In this framework I talked about ‘securities’ (‘financial assets’) while in my reply to TerjeP I talk about currency units.

    The former is more general than the latter because there are many types of securities denominated in the same currency unit and there are many currency units. It is quite clear that the private issue of securities, denominated in currency unit X, can and does affect prices, denominated in currency unit X (and others) and default on debt introduces a serious discontinuity in the system.

    Since financial ‘deregulation’, the types of securities issued by private agents has increased in numbers and the legal form of business of investment bankers has changed from partnerships to corporations. In other words, the institutional environment has changed and therefore the properties of ‘the system’ has changed. It is ‘complex’.

    IMHO, neither the Keynesian approach (deficit financing in the short – ‘over the cycle’) nor MTT take these complexities into account. TerjeP’s approach ‘let them go bust’ (the banks) doesn’t work either because of the central role of finance in a monetary economy.

    In other words, the ‘balance sheet’ based notion of ‘money’, which we have, is inadequate and discussions of ‘monetary policy’, are in some sense not well grounded.

    I don’t like quoting authority as the sole justification for my argument. But I now shall quote from Papademos and Modigliani – recognised authors in monetary economics – chapter 10, Handbook of Monetary Economics, 1990, p 400:

    “First, in economies charactrized by a variety of financial intermediaries and a large spectrum of financial assets, the identification of “money”, the mechanism of money creation and the ability of the central bank to control the supply of money became important issues for policy. Second, in such economies a fundamental question for monetary policy emerges, namely whether the monetary authority should aim at controlling nominal income by controlling the supply of money, as conventionally defined, or whether they may achieve the final policy targets more effectively via the control of the stocks of other financial assets or by determining the levels of interest rates or exchange rates of domestic money for foreign moneys. ”

    The guidelines (and rules) issued under the name Basel (I, II..) also indicate that the ‘balance sheet notion of money’ is inadequate.

    Papademos and Modigliani state the issue. Basel tries to impose additional rules to the balance sheet model of money. I say, the fundamental problem of private ownership economies with financial securities is evident in Radner’s model. This is the problem which needs to be addressed. Restrictions on the types of securities that can be issued as well as the quantity of the allowable securities is, IMHO, an important policy direction. I have used the Radner-type literature (math econ) as the conceptual framework for interpreting the financial crashes.

  24. November 16th, 2013 at 15:34 | #24

    My comments here:

    http://badoutcomes.blogspot.com/2013/11/john-quiggin-argues-in-jacobin-that.html

    In short, how can you argue that exchange rate risk devastated manufacturing, without acknowledging that a benefit of a well-developed financial system is the ability to hedge exchange rate risk. You didn’t seem to realize you were arguing against your own thesis.

  25. Ikonoclast
    November 16th, 2013 at 15:37 | #25

    @Ernestine Gross

    Basically, I agree with you. My understanding of econonomics and “what actually money is” is not nearly as technical and deep as yours. However, what you are saying seems to accord with the reality as best as I can understand it as a layperson. Money is complex and transforming its shape and manifastations all the time, at least under financial laissez faire.

    The whole issue goes to the question of whether we want corporations in general and financial corporations in particular to rule our lives or whether we want our democratically elected governments to rule on our behalf, for the general good and be accountable for their policies at the ballot box.

    Money, as it is used now and in all its “gamed” complexities under relative laissez faire, is not just a medium of exchange and measure of value. It is also a gamed “commodity” and one tool among a number used by the elite; used for power, domination and exploitation.

    We really have to decide. Are we going to let a few rich corporate oligarchs rule us or are we going to reassert our rights to democracy and equality?

  26. Jordan
    November 16th, 2013 at 18:54 | #26

    Here is what Michael Kalecki said in 1943 on why it is natural tendency to get to the ZLB.

    The rate of interest or income tax [might be] reduced in a slump but not increased in the subsequent boom. In this case the boom will last longer, but it must end in a new slump: one reduction in the rate of interest or income tax does not, of course, eliminate the forces which cause cyclical fluctuations in a capitalist economy. In the new slump it will be necessary to reduce the rate of interest or income tax again and so on. Thus in the not too remote future, the rate of interest would have to be negative and income tax would have to be replaced by an income subsidy. The same would arise if it were attempted to maintain full employment by stimulating private investment: the rate of interest and income tax would have to be reduced continuously.

    This of course is caused from savings or capital accumulation. The cost of production has to be equal to revenue in order to keep the level of production and employment. Therefore, there should not be savings / capital accumulation in order to keep employment steady. That is also why the productivity rise have to keep up the wage growth at the same speed. Distributed cost of production towards those that are more likely to save (management) will produce unemployment over time. There is inescapable need for growth of money to compensate for the savings in order to keep the employment up.

  27. sunshine
    November 16th, 2013 at 20:21 | #27

    On the question of why we are letting this be done to us and why doesnt a Left movement naturally form to stop them doing it ;-
    The Left(in the West) has had the stuffing beaten out of it for decades now and is discredited in the eyes of the general public .There simply arent many Left leaning people about compared to the Right . Money and its associated power tend to accumulate in the hands of Right minded people (as they are more selfish) who use it to further strangle the Left . I think it is a (perhaps the ) critical fact in this scenario that it is easier to encourage people to fear others than it is to get them to trust others . On the surface at least, the Rights economic society needs no faith or trust in others -they are merely my competitors for consumption . Appeal to fear and greed trumps compassion. We’ve been presented with a model that says ‘the best thing you can do for others is to maximise your consumption’ and further -‘caring about others is dangerous as it builds inefficiencies into the system ,and they may just take advantage of your trust anyway’.

    The blows that would break the backs of these Masters of the Universe may come from the extreme Right not from the Left.

  28. Chad
    November 16th, 2013 at 20:36 | #28

    Fantastic article John,

    thoroughly enjoyed it.

  29. rog
    November 16th, 2013 at 20:56 | #29

    @Ernestine Gross Ross Garnaut recently argued that we are plagued by a fluctuating $AU and called for the RBA legislation to be amended to include foreign exchange. Garnaut calls for aggressive and sustained rate cuts to bring the $AU down – would this require an increase in money supply?

  30. Jim Rose
    November 17th, 2013 at 10:10 | #30

    @rog can there be low inflation and a large nominal depreciation? does monetary policy affected the real exchange rate?

  31. Ernestine Gross
    November 17th, 2013 at 13:49 | #31

    @rog

    My comments are my reply to your statement without constituting a comment on what Prof Garnaut argued (I haven’t read or heard it).

    a) Exchange rate ‘stability’ is part of the description of the RBA’s objective. See reference 1 below.
    b) The term “rate cut” in the Australian setting means lowering the target cash rate (and vice versa)
    c) A change in the target cash rate per say may or may not have any implication for any ‘market’ interest rate on any one of the days during the decision making period.
    d) The decision making period is 1 months.
    e) There is a distinction between the target cash rate and the actual cash rate.
    f) The actual cash rate is determined in the ‘money market’ where short term securities (90 or 180 day bills) by financial institutions are traded with the RBA (exchange settlement).
    g) By sheer chance it is possible that the actual cash rate is equal to the target cash rate.
    h) The RBA uses ‘open market operatons’ to bring the actual cash rate close to the target. These operations involve buying or selling short term securities by the RBA.
    See reference 1 for further details.

    As to the effect on ‘money supply’, the first question that arises is what is ‘money supply’? As can be seen from reference 2 below, there are several measures. Moreover, the measures have changed over time, reflecting changes in the institutional environment. Note the variations in the type of financial securities over time and the variations in borrowings from foreign sources.

    All of the above assume ‘the system’ is working (ie no catastrophic point such as the Lehman event).

    Reference 1: http://www.rba.gov.au/monetary-policy/about.html

    Reference 2: http://www.rba.gov.au/statistics/tables/xls/d03hist.xls

  32. Ernestine Gross
    November 17th, 2013 at 13:51 | #32

    rog, my reply is in moderation, probably because I included links to references

    Jordon, my reply to your post is also in moderation. My answer is definitely NO

  33. Jordan
    November 17th, 2013 at 17:26 | #33

    rog
    such suggestions probably come from recent revelations about forex manipulations by banks just as with Libor.
    Matt Taibi wrote about it in November 5 piece in Rolling Stone

    To lower $AU, RBA buys $US and money stays at the RBA, it is not put into circulation but increases demand for $US and the supply of $AU which lowers the value of $AU.

  34. TerjeP
    November 17th, 2013 at 21:30 | #34

    The falacy of this belief in ‘the market’ for currency units stems from the apparent lack of understanding of the difference between the supply of fruit and vegitables ‘in the market, on a particular day at a particular place’ with the supply of numbers – there is no bound on the numbers of currency units that the international high finance people can generate. But there is a bound on the number of potatoes.

    EG – I don’t mean to trivialise your point regarding the quantity of such units that might get created but more significant is the value of those units. It is the reliability of this value, and the expectations of reliability or otherwise, on which long term contracts and commitments in the world of commerce are made. Entrepreneurs sign long term office leases or incur debt to finance machinery on an expectation that such contracts are built on a foundation of units that will represent fair value over time. Likewise a regular citizen takes a mortgage to finance a home or buys a bond to finance retirement on a similar basis. Those buying or selling in spot markets are far less concerned by changes of unit value over time. In fact if all markets were spot markets the value of monetary units would hardly matter.

    The value of base money is conditional on both supply and demand but given that governments (via central banks) have a 100% monopoly on the supply of base money then they have absolute control over the value of base money. Even if credit money dampens demand for base money through product substitution the government can accommodate through tightening.

    The value of credit money (or debt money depending on your perspective) depends on two key factors. One is the credit worthiness of the debtor. The other is the value of the unit in which the debt is denominated. The later is generally some base monetary unit so it in turn is also entirely controlled by the government.

    Distilling this there are thus two factors that determine in general the reliability of money as a credible unit of value:-

    i) monetary policy decisions. ie supply adjustments for base money.
    ii) credit worthiness of debtors.

    When the financial system encounters a crisis we can implicate the private banking sector only in the latter. It is culpable only in so far as it has failed to correctly account for the credit worthiness of debtors in the circumstances that prevail. Not in so far as it has lent too much or monetised too much.

    There are many ways to attempt to deal with this failure. One is to nationalise or regulate the banks and hope that people do a better job when the state provides their pay cheque. A dubious notion. Another is to look at the incentives associated with failure. This is where letting banks go bankrupt comes in. Ideally in this scenario the bank would generally still operate whilst the shareholders would just surrender or dilute their holding.

    None of these measures can guarantee a system free from crisis. But the right ones can help.

  35. Jordan
    November 17th, 2013 at 22:27 | #35

    It is culpable only in so far as it has failed to correctly account for the credit worthiness of debtors in the circumstances that prevail.

    But overall creditworthiness is acctually determined by amount of the “base” money in the system. It is not determined ex-ante on individual debtor level as you imply, but more on the liquidity in the system.

    It is measured on an individual basis to individual debtor worth of the credit. But , that can change in time which is determined by the growth of the money in the system. Suddenly, ex-post creditworthy becomes unworthy ex-ante due to the overall growth(fall) of the money in the system.

    I don’t mean to trivialise your point regarding the quantity of such units that might get created but more significant is the value of those units.

    Value comparing it to what?
    It is the reliability of this value, and the expectations of reliability or otherwise, on which long term contracts and commitments in the world of commerce are made.

    Reliability of that is determined by real interest rate. Why are you claiming that inflation is not calculated in such contracts and commitments?

    Inflation was low for so long and trending down for so long and you still want to claim that inflation protection is more important then exchange value of the money. Do you really want to claim that exchange value of the money is less important then money as the store of value?

    What is this new term; credible unit of value? People accept the prices, why are you telling to people that they should or should not accept “credibility” of such value? Why are you trying to tell people if they should or should not accept “credible” value of their work that they were offered for such “non-credible unit of value”. Because that is what you introduced with such term “credible unit of value”. There is the system that determines credibility of such unit of value, why are you trying to introduce it all over again against the system that produced no crisis in credibility of unit of value since 1933? Or 1971. It shows no signs of crisis of unit of value at the present, indication is inflation, right?

  36. Lucien_Reeve
    November 18th, 2013 at 07:00 | #36

    In your article, at one point you say:

    The financial services sector as a whole accounts for more than 20 percent of US GDP, and this share has grown by around 10 percentage points since the 1970s.

    I was just wondering what your source was for this? I have found other sources that say that the financial sector in the UK accounts for only 9.6% of GDP.

  37. Jim Rose
    November 18th, 2013 at 18:14 | #37

    Buchanan liked to quite his old teacher Frank Knight:

    I can’t figure out if people are bitching about the market because it works or because it doesn’t work.

    HT: thinkingonthemargin blog

  38. Ikonoclast
    November 19th, 2013 at 13:34 | #38

    @Jim Rose

    It’s actually because it works for rich exploiters and for nobody else unless moderated and controlled in a mixed economy.

  39. JamesH
    November 19th, 2013 at 15:25 | #39

    Matt Taibbi writes in Rolling Stone about the extent to which the finance sector’s rent comes from criminal behaviour. It suggests a nice tactic for the left in JQ’s suggested campaign – demand law and order!

  40. Ernestine Gross
    November 19th, 2013 at 16:27 | #40

    You are using the so-called ‘money multiplier’ model. This is fair enough, given it is a ‘mainstream model’ in monetary economics texts and, except for some important observations and qualifications, the RBA’s data on ‘monetary aggregates’ is starts off with ‘notes and coins’, M0, M1, ………

    It is the case that this model worked quite well in West Germany, the Netherlands and a few other so-called ‘nordic countries’ (ie northwestern Europe). It doesn’t work now. This change has nothing to do with the unification of East and West Germany nor with the creation of the Euro per se. It happens that the life of West Germany roughly corresponds to the period of relatively stringent financial market regulations – the Keynesian period – and, and this is an important ‘and’, the risk-preferences of the population matched the policy objectives of low inflation to keep the purchasing power of monetary savings by individuals (‘households’; yes it is also useful for long term contractual relationships in the business sector) to avoid a repetition of the 2 hyper inflations of the earlier part of the 20th century.

    The monetarists postulate (assert) there is a stable relationship between ‘base money’ and other measures of money and therefore the monetary authority can control the ‘supply of money’, as you suggest. The trouble is, even during the Keynesian period, researchers in Australia and elsewhere did not find evidence in support of the monetarist assertion. (I am using the term assertion deliberately because in contrast to the methodology in other areas of economics, they avoid the word ‘assumption’.)

    I suggest you look up the behaviour of the monetary base for the US Dollar and the Euro. It is after the GFC that the base money measure spiked upward. I also suggest you look up the history of the development of the ‘monetary aggregates’. The number of these aggregates has grown with the spreading of ‘financial deregulation’ (ie allowing ‘agents’ to issue essentially any type of financial security they want – “freedom”).

    You concede the private sector carries responsibility to the extent that they failed in credit worthiness assessment. The proverbial Wall Street bankers (not all of their international ‘partners’ are located at Wall Street) outsourced credit assessment of their synthetic loans – to rating agencies. Wall Street isn’t worth it, even by your criterion.

    Can you think of a Wall Street type banker who hasn’t or isn’t currently in Court as a defendant?

    It is all very nice to suggest improvements to the system. The damages in terms of income distribution remain. Due to the balance sheet notion of ‘money’, the national debt has grown as a consequence of governmental actions to prevent a total collapse of commerce (good on you for naming what we are talking about – not ‘the economy’ but the commercial part of ‘the economy’). This national debt has grown even in the risk averse Germany.

    You avoided my conclusion in my post to which you replied. I am now asking you explicitly: Would you agree that under the actual circumstances a substantial wealth tax on those who have benefitted from the build-up of the GFC is morally justifiable?

  41. Ernestine Gross
    November 19th, 2013 at 16:29 | #41

    My post at 40 is addressed to TerjeP in reply to his post at 34.

  42. sdfc
    November 19th, 2013 at 22:18 | #42

    By sheer chance it is possible that the actual cash rate is equal to the target cash rate.

    That’s rubbish Ernestine. The cash rate target is a direct price, it is pretty much always hit. It is determined by the RBA. Leaving aside credit and portfolio considerations, the money market basically tries to guess what the RBA is going to do.

  43. sdfc
    November 19th, 2013 at 22:20 | #43

    Sorry about the extra italics.

  44. sdfc
    November 19th, 2013 at 22:45 | #44

    Terje

    Growth in the money stock, which is the money you and I use, is overwhelmingly driven by banks credit creation. Growth in base money, when the CB is not conducting QE-type operations, is largely a function of that increase.

    I’ve become a bit of a fan of the Chicago Plan for 100% money.

    http://www.imf.org/external/pubs/ft/wp/2012/wp12202.pdf

  45. rog
    November 20th, 2013 at 03:40 | #45

    This is what I was referring to, Garnaut on the dollar

    ROSS GARNAUT: First of all, we’ve got to bring down interest rates. Australian economic growth per person, growth output per person, per worker is lower now than in the United States or Japan and yet our interest rates are two percentage points higher. There’s some worry that that could give rise to inflation.

    As Ben Bernanke said in his recent book reflecting on American monetary policy over the last decade or two, if you’ve got a worry about risk in the housing sector, you deal with that through macro-prudential measures and you don’t let that be the reason you don’t bring down interest rates to bring down the exchange rate.

  46. ZM
    November 20th, 2013 at 06:05 | #46

    Do people’s perspectives on economic matters and structures change if it is brought up that we need to move very quickly to the contract and converge economy, to come to a complete sustainable global convergence between 2040 and 2050?

  47. Ernestine Gross
    November 20th, 2013 at 09:43 | #47

    @sdfc

    In reply to your post @42:

    “Domestic Market Operations
    The Reserve Bank undertakes transactions in domestic financial markets to ensure that the operational target for monetary policy – the cash rate – remains close to the target rate set by the Reserve Bank Board. The cash rate is the interest rate on unsecured overnight loans between authorised deposit-taking institutions, such as banks, building societies and credit unions. Transactions are also undertaken to provide liquidity to the payments system and manage the financial risk of the Bank’s balance sheet.

    The cash rate is determined by the supply of and demand for exchange settlement (ES) funds. These are funds held in accounts at the Reserve Bank by a number of financial institutions, and are used by these account holders to meet settlement obligations.

    The Reserve Bank is able to control the supply of ES funds through its open market operations. When the Bank buys securities, it pays for them by crediting the ES account of its counterparty (or the ES account of the financial institution of which its counterparty is a customer), adding to the overall supply of ES funds. Sales of securities have the opposite effect. The securities which the Bank is prepared to purchase in its domestic market operations are limited to highly rated Australian dollar denominated securities.

    The Reserve Bank also operates a number of liquidity facilities that are principally used to provide financial institutions with funding to manage their (and their customer’s) payments activity. Funds accessed from these facilities are either repaid to the Reserve Bank on the same day, or are held overnight in the recipient’s ES account with the Bank. On the rare occasion that a financial institution fails to repay intraday borrowings or holds an insufficient balance in their ES account (relative to any borrowings from the liquidity facility), a penalty rate of interest is applied.”

    Source: RBA, current web-site.

  48. sdfc
    November 20th, 2013 at 12:07 | #48

    And?

  49. sdfc
    November 20th, 2013 at 12:17 | #49

    Also I apologise for using the word rubbish Ernestine, that was pretty rude.

  50. Ernestine Gross
    November 20th, 2013 at 13:07 | #50

    @sdfc

    Nevermind politically correct language; not important to me. I think in my post you referred to I fell between two chairs in terms of the amount of detail. This is how I took your comment.

    In any case I concur with the heading of the thread.

  51. sdfc
    November 20th, 2013 at 14:30 | #51

    Ernestine

    It’s not the lack of detail but the fact that you were flat out wrong that I had a problem with. The RBA almost unfailingly hits the cash rate target, because it sets the price cash, there is no “sheer chance” involved. Bill prices are largely determined by cash rate expectations, not the other way around.

    As to whether I agree with the title of the post, the answer is yes and no. Under the current framework and conditions large financial institutions can’t be just “let go” that is the road to debt deflation and depression.

    I do agree with the thrust of John’s article however that the current structure of the financial system is inherently unstable. Though we shouldn’t forget the role Keynesian demand management played in laying much of the groundwork for that instability.

  52. Jim Rose
    November 20th, 2013 at 15:57 | #52

    @Ikonoclast the mixed economy is the byproduct of the rise of middle class and dirdctors law

  53. Ernestine Gross
    November 20th, 2013 at 21:35 | #53

    sdfc,

    I do believe you are exaggerating a bit now regarding me getting something ‘flat wrong’. First, you quoted only 1 of my 2 related paragraphs. I then provided details from the RBA site directly. Surely, this removed any ambiguity I might have created for you in my first post in which I had also linked to the RBA web-site. (This conversation reminds me of one I had some years ago with an accountant. I said you use the colour black for positive profit numbers and the colour red for negative profit numbers. Which colour do you use for zero profit? His answer was: This doesn’t happen in practise.)

    On the more important point, the topic of this thread. As the content of the article you linked to indicates, many people are working on redesigning the international financial system. I’ve already indicated my preferred approach and my reasons.

  54. sdfc
    November 21st, 2013 at 18:10 | #54

    Ernestine

    By sheer chance it is possible that the actual cash rate is equal to the target cash rate.

    Maybe you should clear up what the above statement means. I don’t see what it has to do with accounting.

  55. Ernestine Gross
    November 22nd, 2013 at 08:32 | #55

    @sdfc

    I’ve mentioned before you quote out of context.

    In context, the statement you quote says: The chance that at any time t, excess demand for exchange settlement funds (at the actual cash rate at time t) = 0 and the RBA’s open market operations (at the target cash rate at time t) = 0 is small but it is possible to happen.

    All commercial financial transactions (ie excluding the black market and gifts among private individuals) involve accounts with debits and credits.

    The colour coding of profit numbers anectode illustrates, in a small way, the difference between analysing a system and the views of practitioners.

    I hope this is the end now.

Comments are closed.