In light of recent events, we’re bringing forward this proposal from June 2010.
There’s two ways to view the financial meltdown that occurred in 2008. The first is that it was a rare and unfortunate blip that can be remedied with calm and enlightened improvements in the regulatory framework. The second is that it exposed a serious flaw in the entire monetary system, and is likely to be repeated unless a radical transition takes place.
It’s no surprise that politicians, bankers and regulators – the architects of the banking industry – favour the first idea. This is why their response has skirted around the edges instead of dealing with the core. Even supposedly extreme measures such as nationalising banks are in fact attempts to preserve the status quo.
For those of us who favour the second idea, 2008 provided a golden opportunity to join the public debate and present a credible alternative. Perhaps we missed it. But if indeed another crisis is coming, this article attempts to outline a 14-point plan that could be implemented quickly and genuinely reform the institutions that create financial instability.
The key aspects of this proposal have been made previously, notably by economists Kevin Dowd and Richard Salsman. It could be implemented in three phases:
Over 2 days the aim is to ensure that all operating banks are solvent
Deposit insurance is removed – banks will not be able to rely on government support to gain the public’s confidence
The Bank of England closes its discount window
Any company can freely enter the UK banking industry
Banks will be able to merge and consolidate as desired
Bankruptcy proceedings will be undertaken on all insolvent banks
Suspend withdrawals to prevent a run
Ensure deposits up to £50,000 are ring fenced
Write down bank’s assets
Perform a debt-for-equity swap on remaining deposits
Reopen with an exemption on capital gains tax
Over 2 weeks the aim is to monitor the emergence of free banking
Permanently freeze the current monetary base
Allow private banks to issue their own notes (similar to commercial paper)
Mandate that banks allow depositors to opt into 100% reserve accounts free of charge
Mandate that banks offering fractional-reserve accounts make public key information (these include: (i) reserve rates; (ii) asset classes being used to back deposits; (iii) compensation offered in the event of a suspension of payment)
Government sells all gold reserves and allows banks to issue notes backed by gold (or any other commodity)
Government rescinds all taxes on the use of gold as a medium of exchange
Repeal legal tender laws so people can choose which currencies to accept as payment
Over 2 months the aim is the end of central banking
The Bank of England ceases its open-market operations and no longer finances government debt
The Bank of England is privatised (it may well remain as a central clearing house)
You can download a copy of the plan in pamphlet form here.
We are currently incurring costs akin to having a gold standard – in that we are using gold for monetary purposes, as an inflation hedge. But we don’t get any of the benefits.
Following Friedman and White we first need to know the ratio of gold to money. This is equal to the typical reserve ratio (like White I used 2%) multiplied by the ratio of currency notes and demand deposits to M2 (52.7%), plus the ratio of coins to M2 (0.18%).
G/M = R + Cp/M = [(R/N)+D][N+(D/M)] + Cp/M
(Where R is bank reserves, Cp is gold coins held by the public, M is M2, (R/N)+D is the ratio between gold reserves and demand liabilities, (N+D)/M is the ratio of notes and deposits (but not coins) to M2).
Assuming the marginal reserve ratio is equal to the average reserve ratio, the resource cost is equal to this ratio (1.2%) multiplied by the change in money supply that would keep the price level unchanged, multiplied by the ratio of M2 to GDP.
ΔG/Y = (ΔG/ΔM) (ΔM/M) (M/Y)
I used 4% for the former (as a rule of thumb), and 176% for the latter (from the World Bank). All in this suggests that a gold standard would cost 0.085% of GDP, which amounts to around £31bn, or £512 per capita.
Back of the envelope calculations, to be sure. I encourage others to give it a better stab.
Amongst the swathes of books released following the financial crisis, this is both readable and full of sound economics. It explains fractional reserve banking, introduces readers to Austrian economics and to behavioural finance, and is done so in a highly engaging style. It will make you laugh out loud and shake your fist in anger.
I strongly recommend it, and indeed was lucky enough to read several drafts of the manuscript. At under a tenner it’s the perfect gift for people who moan at bankers and politicians, but want to understand a bit more about the monetary system.
In this article for City A.M. I discuss Joseph Schumpeter’s concept of “creative destruction”, and why Karl Marx was wrong to suppose that capitalism generates an increasing concentration of capital:
In 1987, Forbes magazine released a study looking at how large companies fare over time. It took the 100 biggest companies in 1917 and looked at what had happened to them since. Rather than see the big companies getting bigger, they found the opposite. As the chart shows, 61 per cent of the companies became defunct. 21 per cent still existed, but had fallen outside the top 100. That left only 18 of the biggest 100 companies in 1917 still there 70 years later. Of those, 16 companies underperformed the market as a whole, leaving just two companies that managed to “beat” the market. One of those companies was GE, and the other was Kodak.
Last week saw the launch of the 2020 Tax Commission report on UK tax reform. It’s called “The single income tax” and can be downloaded from the website (PDF).
I was honoured to serve as a commissioner and learnt a great deal from the discussion meetings. It was a long process and the result is something I’m very proud of.
I think there are three important things to say about the report. Firstly, it is thorough. At over 400 pages we wanted to survey the academic and policy literature to base the proposals in strong theory and rich evidence. Secondly, it is policy-focused. It attempts to find a balance between being genuinely radical (which it is) and politically feasible. Or, if not feasible, then relevant to debate. It is not intended to be utopian, but at the same time stays true to some basic principles of public finance. Thirdly, it directly confronts the moral and ethical dimension of taxes. It discusses the libertarian perspective and does not treat ethics as a no go area. Indeed it is one of the few tax studies I’ve seen that attempts to engage with different ideological positions.
Personally, I find it hard to truly advocate 30% tax rates. But this isn’t about what we’d like in theory. It’s about mapping out a direction of travel, shifting debate, and engaging with policymakers and the public. If you believe such aims are futile, then you may be disappointed. But if you want a well researched and implementable proposal for radical tax changes – this is it.
In my latest City AM column I discuss Gordon Kerr’s recent book, which points to the role of accounting regulations in the obfuscation of the price system that contributed to the financial crisis:
When economists talk about the efficiency of the profit and loss system, we tend to take for granted that the profit and loss we observe matches with reality. But government interventions are liable to disrupt these signals – inefficient taxes, arbitrary subsidies, and monetary debasement all separate prices from the underlying conditions of demand and supply. Another source of noise is faulty accounting standards – as Gordon Kerr has pointed out in his fascinating new book The Law of Opposites: Illusory profits and the financial sector.
I was recently quoted in Management Today with some thoughts on current monetary policy:
The Bank of England’s policy rate has been historically low for some time now and this cannot continue indefinitely. The aim of low interest rates is to boost the economy by creating incentives to borrow money and invest. But higher capital requirements and policy uncertainty create counter forces that restrict bank lending.
In these circumstances the purported “benefits” of low interest rates fail to materialise, but the costs certainly do. These include the lack of an incentive to save (and actually rebuild banks’ balance sheets through voluntary lending), distortions to the capital structure of the economy (making white elephants like the HS2 line appear profitable) and the erosion of people’s savings.
The fact that real interest rates (the difference between inflation and the return you get on your savings accounts) is negative is a harmful confiscation of wealth.
When interest rates are close to zero policymakers look to alternatives, and quantitative easing has emerged as their favoured tool. However grateful banks and the financial community are in general to have an injection of freshly-printed money, it’s not clear how much this is helping the real economy. The aim shouldn’t be to preserve the status quo, but to find ways to allow banks to fail without exposing the general public to the fall-out.
Those of you based in London hopefully know that I have a regular column in City AM each Tuesday. Last week I discussed government vs. private investment:
When private sector investment declines, then the reasons need to be identified and a solution found. The key policy question needs to be “why aren’t businesses investing?” Attempting to offset it with government spending is just an accounting deception. And too much government intervention can be the underlying cause, not the cure – through high tax rates, burdensome regulations and policy uncertainty.
The print edition contained a chart in which I used the Gross Fixed Capital Formation data to compile and contrast government and private investment. That data has now been published by Kaleidic Economics: here is the announcement, and you can view the data here.
Regular readers will know that The Cobden Centre’s sister roundtable – Kaleidic Economics – is engaged in measuring the MA measure of the money supply, as discussed here several times. In October 2011 MA fell by 6.6% compared to the previous year, which is around twice the recent rate of contraction. As turmoil regarding the Eurozone and threats of a double dip recession continue, good policymaking requires good data. And the monetary aggregates paint a gloomy picture.
I think this is a complicated question to answer, and both sides of the debate have a tendency to over simplify.
If we understand the goal of QE to be an increase in aggregate demand such that the Bank of England’s implicit and explicit objectives are met, I think it’s reasonable to conclude that it worked “better” than its critics feared, but not as well as its advocates hoped. In other words, I think output is higher than it would have been without QE, inflation is lower than some people warned, but the former is lower than and the latter higher than the MPC would like.
In this week’s column for City AM I wanted to highlight an irony in the debate. If “above target inflation makes little difference if expectations remain anchored” one possible explanation of the muted effects of QE is the Bank’s decision to retain an inflation target. Therefore:
We now have the odd situation where those warning of impending hyperinflation – the sternest critics of QE – provide the intellectual prerequisites for it to work. By contrast, in pandering to those concerns, its proponents ensure that it will not.
It strikes me that unless the Bank of England allows inflation expectations to rise, QE will have a muted effect.
