Interview with Lord Turner on Monetary Reform

Lord Turner has been a Senior Fellow at the Institute for New Economic Thinking since 2013, and in 2015 became Chairman of the Institute’s Governing Body. Prior to that he chaired the UK Financial Services Authority from 2008 until 2013, during which time he played a leading role in the redesign of the global banking and shadow banking regulation as Chairman of the International Financial Stability Board’s major policy committee.

Lord Turner has combined a business career with public policy and academia. He led the McKinsey practice in East Europe and Russia in the early 1990s, and was Director General of the CBI (Confederation of British Industry) 1995-2000. He was Vice-Chairman of Merrill Lynch Europe (2000-06) and a Non-Executive Director of a number of companies, including Standard Charteredd plc (2006-08). In 2015 he joined the Board of UK start-up bank OakNorth, and became non-Executive Director at Prudential in September.

He became a cross-bench member of the House of Lords in 2005; served as the first Chairman of the Climate Change Committee (2008-12), and chaired the Pensions Commission (2003-06) and the Low Pay Commission (2002-06). He has also been a Trustee of the British Museum since 2013. His publications include ‘Just Capital-The Liberal Economy’ (2001); ‘Economics After the Crisis’ (2012); and ‘Between Debt and the Devil: Money, Credit and Fixing Global Finance’ (Princeton 2015). He is Senior Fellow at the Centre for Financial Studies (Frankfurt); a visiting professor at London School of Economics, Cass Business School and City University; and as of recently, Visiting Fellow at the People’s Bank of China School of Finance, Tsighua University (Beijing); and Visitig Professor at the International Center for Islamic Finance (INCEIF) in Kuala Lumpur.

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Max Rangeley: The cover of your book is adorned with the image of Faust and Mephistopheles. In Goethe’s Faust, the Emperor is granted the right to create money ex nihilo, whereas we currently have this Faustian pact with the banks, so before we get into the technocratic, economic aspects, does this create any moral issues?

 

Lord Turner: I don’t know whether I would use the word “moral”, because I don’t think that the banks are guilty of a sort of deliberate conspiracy to create money without the populace understanding it. Indeed, it’s noticeable that many individual private bankers do not understand that, collectively with all other bankers combined, they create credit and money ex nihilo. However, while I would not use the word moral, I do think it’s striking that we have, as it were, outsourced an inherently social function, which is the increase in the level of aggregate nominal demand, and we have, relied on the banking system to do that for us, without asking searching questions as to whether, and under what conditions, they will perform that crucial macroeconomic function effectively.

 

Max Rangeley: So should there always only be a small number of credit institutions that have the right to create money in such a fashion?

 

Lord Turner: If we’re going to grant this power to banks, we should very tightly regulate how they are able to use it, and we can regulate the amount of money that banks create, for instance, by having reserve requirements which limit the size of the money supply relative to the size of the monetary base : and since the government and central bank together determine the size of the monetary base, if you have a system of minimum reserve requirements, you can constrain and control the ability of the banks to create money. But it’s notable that while reserve requirements, and we’re talking here about the reserves which commercial banks have to hold at the central bank, were a key element in many monetary policy systems before the 1970s, they were largely junked by the major central banks of the advanced economies after about 1970, and I think that was a mistake.

 

Max Rangeley: Touching on that regulatory aspect, your book frequently talks about the extent to which banks create credit for the property market relative to capital investment. So, as well as the actual money creation, what role do regulatory restrictions have in this? For instance, in the Basel requirements, property loans have a risk rating of 35%, whereas business loans are 100%, so one might argue that, all other things being equal, a bank would actually need to be irrational to invest in businesses under these circumstances.

 

Lord Turner: Yes, I think you are right and focusing on a crucial issue here. I think the difficulty is that seen from an individual bank’s point of view, lending money against property may well be – probably is – much less risky and certainly much easier than lending money to, for instance, a non-property based business. It’s easier because you can, if you want, reduce your credit analysis to simply focusing on the ratio between your loan and the value of the property, the loan to value ratio, and provided that is low enough, and provided you can repossess, you might be okay even in the middle of a dramatic downturn : whereas when you lend money to a business which isn’t a property business, you’ve got to do the hard job of looking at the cash flows of that business, looking at the competence of the managers of that business, thinking about the market in which they operate. So property loans look easier to do, and they look less risky, and they may be, for the individual bank. But they are not for the economy in total, and this is what I call the paradox, in the book, of “good lending can be bad”.
  Lending, which is good from a private perspective lending privately, can have an adverse social effect, and the crucial thing to understand here is that property lending can cause harm in the economy, even if the vast majority, or even if at the limit, everybody who borrows those property loans,aactually pays back all the money That’s because it’s the fact that people get over-leveraged, and then in an attempt to deal with over-leverage, cut consumption and investment in an unanticipated fashion, that drives the economy into a recession . So the paradox here is that banks can do things that from an individual point of view look entirely rational, like lending to property rather than non-property businesses, but they have an adverse social effect.

The implication for regulation is that we were quite wrong, in Basel II, and this is true in Basel III as well, to believe that the risk weight attached to lending should reflect the risks to the banks themselves. We should understand that there is a wider social externality which will never be reflected in individual banks’ assessments of risk, and on that basis the risk weightings for property loans ought to be much higher, relative to the risk ratings for non-property business loans.

 

Max Rangeley: And in a sense they did a similar thing with government debt as well, didn’t they? Whereby any government debt, including Greek government debt, was actually rated as very secure in the Basel system.

 

Lord Turner: The crucial problem with the Greek government debt actually is slightly different. It is a failure to understand the inherent nature of the Eurozone, which is that in a Eurozone where you have a set of fiscal authorities which are no longer currency issuing powers – they don’t have their own central banks and they don’t have their own currency – we really ought to think about Greek government debt, or Spanish government debt, or Italian government debt, as being functionally equivalent to State of California debt, State of Illinois debt, not to US T-bonds or UK Gilt. There is a fundamental change in the nature of government debt when a government t no longer has the ability to buy its way out of problems by printing money. Now, essentially a UK Gilt and a US T-Bond is pretty much zero risk in nominal terms, but is stress, nominal terms. It might have a risk in real terms, because the very process of printing money to repay it will degrade the value of it, but in nominal terms, it is extremely, extremely, extremely unlikely ever to default. And that is not true of State of Illinois debt, or State of California debt, because they don’t have a central bank . And there was a fundamental failure when the Eurozone was launched , to understand clearly enough the implications of the fact that the nations of the Eurozone were no longer truly sovereign in monetary terms .

 

Max Rangeley: At the end of the book, you touched on the economics establishment and where they’ve gone wrong with this. Paul Krugman, for instance, said that the idea that banks can create demand out of thin air when they make new loans is, quote, “banking mysticism”, and that banks are essentially just intermediaries, taking deposits and lending them out. So why do even prestigious economists get this issue factually wrong?

 

Lord Turner: It’s a very good question , and Paul Krugman, whom in many areas is a really excellent economist, and certainly not at all taken in by some of the other major problems of modern economics, such as the rational expectation hypothesis and the efficient market hypothesis : but on this I just disagree – I think he is just wrong .   And the reflects the more general phenomenum that t many post-war Keynesians, quite as much as postwar neoclassicists, moved away from a focus on what banks essentially do, and that in new Keynesian models, as much as in classical models, or even in the Keynesian IS-LM models which became dominant in the post-war era, there isn’t a focus on the banks and the financial system. So I do I think Paul is simply wrong on this and I’d love to have a detailed debate with him on it . I think it is absolutely clear, if you sit down with a bank balance sheet and think through what happens when a banker – and I mean here evena nice old-fashioned banker like George Bailey in the famous US film, Its a Wonderful World – if you think through what they do, and you follow their balance sheets through, you will find that at the end of the day the process of lending creates credit and money ( or more precisely some or other category of bank liability ) :, and as a result it creates , purchasing power. And all the assertions that it doesn’t disappear, if you sit down, work through the balance sheets , , and work out who does what, and what the first and second and third and fourth round consequences are.
  So I do find that very intriguing that, as you say, Paul Krugman takes that point of view because in many other aspects of his economics, I think he rightly attacks some of the problems of modern economics. But I think there has been a huge bias in a lot of economics, and it starts from about the 60s onwards, to believe that we could simply ignore the real details, the real balance sheet details, of what the banking system does.

 

Max Rangeley You mentioned the IS-LM model. Would you say they more or less fall to pieces– they’re largely based on loanable funds, aren’t they? So would you say they, to quite a large degree, fall to pieces once you take into account that banks can individually create money like this?

 

Lord Turner: I don’t think IS-LM falls to pieces, I think it simply becomes somewhat incomplete because it fails to take account of endogeneous money creation . . It also becomes incomplete because it fails to take account of lending aganst property and the role of irreproducible land in our economy .. Most modern economics attempts to think about the world on the real economy side as having two factors of production, labour and capital. And it assumes that capital equals wealth, and that wealth is only accumulated, and capital is only accumulated, out of net capital investment each year, and that the banking system fundamentally delivers money for net capital investment, which accumulates capital. But actually if you look on an empirical basis, at the source of wealth in modern economies, and this is clear from Thomas Piketty’s figures, ( which whatever you think about his theoretical conclusions are a remarkable piece of meticulous empirical analysis) that the vast majority of wealth of modern economies derives from urban real estate and not from the constructed value of the urban real estate, but from the irreproducible land on which it sits. And once you introduce into an economic model, both irreproducible land and a banking system creating credit and money which is then used to purchase real estate and land that already exists, you can have a whole load of dynamics which are not captured by an IS-LM model. The IS-LM model does not have either the autonomous ability of the banking system to create credit money and purchasing power, nor does it have a large role in the economy for capital assets which are irreproducible and which simply exist, rather than being built out of the accumulation of each year’s net capital investment.

 

Max Rangeley: Onto a slightly different but related topic, Bill Gates, Richard Branson and others have been praising Bitcoin over the last few months, even saying it will revolutionise global commerce. So what role, if any, would private digital currencies such as Bitcoin play in your ideal monetary system?

 

Lord Turner: I am a real skeptic about the importance of Bitcoin, and I find it useful to divide its nature into two aspects, each of which I think we can fairly easily understand .So we consider the two aspects s separately , and then when you put the two together, is the sum of the two any more than the aspects considered separately – I am not convinced ?

One aspect of Bitcoin that it is simply an arbitrarily chosen store of value. And ee can at any time go off and decide to be believe in an arbitrarily chosen store of value. In a sense that is what gold is, and there have always been in our society gold-bugs, who say paper money is not worth anything, gold is worth something, and the crucial thing you need with an arbitrarily chosen store of value, like gold, is that it isn’t easy to create more of it, because otherwise it will collapse in value. So you either want something which is completely restricted in supply, or the supply of which only slowly increases because it’s expensive to mine it and there’s only so much of it in the earth. And f Bitcoin is in part just some very clever mathematical algorithms to create something which is in restricted supply – it’s actually slowly growing in supply – but its supply is restricted.

Now you can do that if you want, you can decide to attach value to gold, and if lots of other people attach value to gold, gold will have value. And you can do the same with bitcoin , but it will go up and down in value, in exactly the same way that we see gold goes up and down in value. But we e could do the same with Faberge Eggs or some specific carved stones of which only a finite number existed or whatever . anything that is relatively unique, relatively difficult to create more of, we can decide to treat as a store of value . . And we’ve understood that function for years, but I don’t there is anything new about bitcoin in that respect . .

 

 

 

 

 

 

But second Bitcoin is also an electronic transfer system : , but you know, we have had electronic transfer systems for decades . I haven’t been into a bank branch for 30 years, and the crucial issue here is whether we have electronic transfer systems which are anonymous or not- that’s the only thing bitcoin adds versus already existing electronic banking systems. At the moment, paper currency is anonymous, but electronic transferred money is not So the authorities can, if they want, see it going from a to b. Now that raises some interesting issues about whether we want electronic money to be anonymous in the same way that paper money is anonymous. On the one hand libertarians might rather like it to be . On the other hand, Ken Rogoff would point out that the vast majority of paper money in the world, and in particular dollar bills, paper money, is fundamentally used by drug dealers, by terrorists, by money launderers, etc , so what’s so desirable about extending anonymity to electronic money ?. So considering Bitcoin as a transfer system , there are issues about ease of electronic transfer, cheapness of transfer: but on those dimensions , its not clear it has any inherent advantages . And there’s anonymity.
  What’s not clear to me at all with Bitcoin is whether there’s anything where the sum of the parts is more than those parts. I think of it as an arbitrarily chosen store of value : plus an electronics payment system . As a store of value its just like long familiar gold : as a payment system its not inherently faster , cheaper , or easier than any other bank based electronic payment system could be . , y?but I don’t think it’s a fundamentally new thing we haven’t seen before .. So maybe I’m wrong in that, but that’s the way I think about it.

 

Max Rangeley: The Chicago plan was discussed in your book; would you say this would contract the credit markets or quantity of credit beyond tolerable levels in a modern economy? Or do you think it is feasible?

 

Lord Turner: Well, I think there are two points. One, would it have been better if we had never created fractional reserve banks? I’m not absolutely sure of that, but I’m also not absolutely sure that I’m right to be not sure, if you see what I mean. I find that a tricky issue. I think that there is a role for a banking system which has some autonomy to create new money and credit, as long as we tightly control it. And I’m worried about relying entirely for our growth of aggregate nominal demand on sovereign money creation, because I say in the book that has its significant dangers as well,. Indeed my crucial theme in the final chapter, the Epilogue, is to say we must iconise neither the state nor the free market in relation to its creation of of money. We can have states and governments that create too much sovereign money and hyper-inflation, and we can have private banks that create too much private money. It’s a balance between the two.

So I think even on a greenfield site, I wouldn’t quite go for the Chicago Plan, I would allow fractional reserve banks , but with the fraction allowed much, much, much larger, than we allowed before the crisis.

And then if we turn from an imagined greenfield econmy to the real world , , , I think that even if the ideal were the Chicago Plan of 100% reserve banks, it would be difficult to go from here to there. And that was the bit of Michael Kumhof’s paper where I wasn’t totally convinced. He has a set of mechanisms where we take these huge amounts of mortgage debt, and then at the end of it a lot of this mortgage debt has been written off. Now, economies can sometimes enjoy free lunches, eg if we can stimulate economic activity to get bring actual output closer to potential . But those potential free lunches are usually relatively small a few per cent of GDP. Whereas in the Chicago Plan Revisited paper, you get a large number of people who previously had a huge amount of mortgage debt, and then suddenly they don’t have any mortgage debt, and I think logic tells us that they cannot have been made that better off without someone else being made considerably worse off.

  My summary is, I’m not convinced that on even in a greenfield economy we should go all the way to Chicago Plan, but I’d go quite a long way in that direction, and I was not entirely convinced that Michael Kumhof and others had cracked the problem of how we transition from the excessive levels of debt that we have already created.

 

 

Max Rangeley: On a more recent note, do you think the current global debt levels of over $200 trillion now mean the Federal Reserve and other central banks are now beyond the point of no return, i.e. any increase in interest rates would spark a global depression.

 

Lord Turner: Well I think you capture there the essence of our current situation , and why it is proving so extraordinarily difficult to increase interest rates. We have so much debt in the world that in order to maintain aggregate nominal demand at a reasonable pace, we have to keep interest rates very low, because if we increased interest rates across the world to normal levels –  I mean if tomorrow we increased Japanese and ECB and US rates all to even 3%, the debt servicing requirements would be so large that it would drive us back into a depression. So we’re caught in a trap there, and the trap also has the interesting paradox to it that on the one hand we can’t increase the interest rates for fear of producing a depression. On the other hand, the the longer we keep interest rates close to zero, the more we will tend to take on new debt.
  For instance one of the interesting phenomena we’ve seen over the last four years is a very significant increase in emerging market corporate debt, denominated in dollars. In some ways the motivation is quite straightforward, the dollar interest rate was very low, a lot of corporates thought alongside their business of doing whatever it was, they’d get involved in carry trades, borrowing cheap dollars and then investing in slightly higher return local currencies. But they are now significantly vulnerable to an increase in dollar interest rates.

So overall we have got so much debt in the world that it really isn’t possible for us to simply grow our way out of it, .. Which is why I have ended up saying that we have to consider one of two radical options.

  One of which is write off of debt. You simply have to tell the owners of debt , that the asset they own isn’t worth as much as they thought : , and we’ve seen that in Greece. And I think we’ll see more of that in Greece in future, I don’t think Greece can pay all its debts. I think we may see it in some other countries as well. And I think we should have seen more of that after the 2008 crisis, more overt write off of the nominal value of debt.

You either have to have that or you have to have permanent monetisation, and I will predict that that is what is going to happen in Japan. That there is no way whatsoever that the Japanese Government can repay its debt in the normal sense of the word repay, which is to switch from a primary budget deficit to a primary budget surplus and then repay the nominal value. I think the Bank of Japan will buy yet more Japanese t,Government debt, and will hold  it permanently on balance sheet. It will be as if the deficits had not been financed by debt, but had been financed by money.

  Now it would certainly have been better if we had never got into the situation where we have to consider one of those two radical options, either overt write off or overt monetisation. But the fact is we are now in that position

So I think we have essentially, as you suggest, global debt levels relative to GDP at a level where we’re not simply going to grow out of them and return to normal levels of interest rates.

 

Max Rangeley: Regarding the Austrian School, we have a tradition going back to Ludwig von Mises, Eugen von Böhm Bawerk and Friedrich von Hayek; the idea that Central Banks, if indeed they exist at all, should simply not set interest rates, that interest rates are prices just like the price of potatoes or other goods in that they coordinate and allocate preferences and scarce resources, in this case time preferences. So in other words if more people are saving then that will bring interest rates down. On the other hand if more people are borrowing than saving, that pushes interest rates up, so they become an equilibriating factor, just like any other prices in the economy. So do you have any sympathies with that– whether it would prevent these bubbles?

 

Lord Turner: The difficulty with that argument is that it doesn’t sit well with the insight, which is also a Hayekian insight, that the banks can create credit and money ex nihilo. If we hadan environment like that envisaged by the Chicago Plan environment, where the only function of a bank was to provide safe keeping and payments and where banks couldn’t therefore create credit, money and purchasing power, then I think you probably could say, well the role of the government is to simply set the monetary base growth at a reasonable level, and everything else is an intermediation of savings and investment. I might still be worried that we would get self-reinforcing tendencies where the government would have to intervene, but it’s possible that the most effective way for the government to intervene in those circumstances would be, as Milton Friedman suggested in 1948, either to simply print some money and put it in, helicopter money to stimulate the economy, or reverse helicopter money, you set taxes higher than public expenditure and take it out, if for some reason you needed to slow the economy down.

 

But if f you have fractional reserve banks and a credit money and creation process, you are inevitably drawn into a role for central banks which goes beyond that von Mises,  von Böhm Bawerk, Hayekian version.

  What I do believe however is that central banks should not convince themselves that they can control this just by using the interest rate without a set of quantitative restraints on the credit creation process as well.

 

Max Rangeley: With that, thank you very much, Lord Turner.

 

 

2 Comments

  • waramess says:

    Pretty awesome and changes my perception of Lord Turner. Pretty turned on sort of stuff and nobody’s prisoner.

  • Thanks so much for this.
    We all benefit from Lord Turner’s astute observations about the failures of the private money systems.
    What should be obvious is that Lord Turner is still learning about what might work in a modern monetary economy, knowing full well that what will not work is more of the same of trying to use private debt for money.
    His passionate selling of the Friedman “Fiscal and Monetary Framework” throughout his recent writings, where government provides the exchange media needed for achieving economic potential, invariably stumbles on Lord Turner’s traditions of being buddies with the world’s central bankers (Volcker Group, etc.) … the result being a rather ballsy, but unworkable, neither fish nor foul construct, of a money system proposal.
    ‘Of course banks will not lend unless they think the economy will pay them back’, is readily translated into ” Hell No, debt-based money is unworkable in a balance sheet retrenchment”.
    But unfortunately Turner is today incapable of making the leap of faith that the public money ‘taboo’ demands, of siding with Wolf, Kumhof and, of course Fisher and Friedman, in ending the private creation of money through fractional-reserve lending.
    A bridge too far for this intelligent novice of a public money student, perhaps.
    Maybe someday.
    Thanks.

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