The Errors of Posen, New MPC Recruit

Norma Cohen in the Financial Times of 26 October 2009 wrote:

Britain’s economy cannot recover unless its damaged banking system is restructured, the newest member of the Bank of England’s monetary policy committee warned on Monday night.

For a short moment, I thought we might see the Cobden Centre’s proposal for bank reform discussed intelligently! I publish the usual warnings that when you read it, you will find that the Emperor has no clothes. I will also be showing you that the world is not flat, but it is in fact spherical.

Posen quite rightly contends that we need to “fix” our banking system. This fix seems to be more banks. We have between 8.5 and 13.26 banks per million people in the Group of Seven countries. I do not see the connection with this earth shattering proposal to create more banks and new economic prosperity. It seems to rest on just having more lending channels.

I will stick with the banking proposal mentioned above, which is based on sound legal principle and robust economic theory.

Separately, however, he scotched suggestions that the £175bn devoted so far to quantitative easing in the UK – the vast majority of which involves gilts purchases rather than corporate bonds – could sow the seeds of future inflation, dismissing supporters of such a view as “nutters”.

If the Bank could create inflation easily under such circumstances, and if the majority of market participants and households believed that – not just the nutters – then we would be halfway home,” said Mr Posen.

Posen will certainly deem the Cobden Centre as “nutters” as we have opposed the terrible, unjust effects of QE. The last time I wrote fully on this matter was here.

In simple terms, new money introduced into the economy never enters it evenly. Indeed, it first goes to the bankers who organise to both sell and buy the bond and the bond holder who receives the newly minted money. In possession of this purchasing power, they may pay off a bit of debt which will make lenders think there is more liquidity to lend.

This means projects which were marginal and, more than likely, do not have much hope of survival come into existence. When this happens broadly, it is called a “boom”. This is a distortion of the capital structure and will only sow the seeds of a new bust. Thus Posen has no Theory of Capital. In the second section of this article I explain in more detail why you need to have a good theory of capital and a working understanding of the structure of production.

Conversely, recipients may go out and buy something with this newly-minted purchasing power. This will bid up prices. This will slowly but surely ripple through the economy and at each point in time, the next spender / purchaser down the line pays that little bit more for goods and services. Now, those on fixed incomes, pensioners, people on the dole or low incomes tend to spend less frequently. This means that they will pay, more than likely, the higher prices. Thus, we have a wealth transfer from the poorest in society to the richest in society.

For people interested in social reform as we are at the Cobden Centre, a stealthy transfer of wealth from the poorest to the richest is exactly the wrong thing to be achieving.

Also, when QE hits the banking system, as we have seen from our contributor Gordon Kerr’s brilliant article, the banker will create a credit derivative from this transaction and book up to 30 years’ profit to his P&L for doing so.

This is another reason why banks are now showing record recovery profits and our political masters are allowing this to go ahead.

I always ask readers who doubt what I say regarding QE to ask themselves, “if QE is so good for the economy, why not carry it on and end world poverty now?” Mr Posen is in the infamous company of the likes of Gideon Gono. This is the Reserve Bank of Zimbabwe supremo who in his book “Casino Capitalism” gloriously savours how all the best governments in the World have now followed his lead in printing money (another name for QE) so he must be right!

Much as we all want to come out of this recession as soon as possible, we must take note that it is only by entrepreneurs making things that people want, better and cheaper, creating more wealth than existed before, that we will be able to climb out of this Labour Party induced mess. Lower burdens on the productive class are the only sure policy initiative for doing this.