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By Toby Baxendale, on 30 August 10
A reader has sent in his thoughts about the recent proposals to reform the regulatory apparatus of the UK banking system:
Last Friday I had a quick view at the report by HM Treasure on a proposal to reshuffle the institutional setting for financial system regulation and oversight in the UK. The introduction (4 pages) is interesting but sometimes depressing. It openly recognised that UK authorities (Bank of England and FSA) failed to see the problems coming and to react adequately. Good. However, the solution it proposes is not to improve the understanding of the building up of bubbles and imbalances, or to reinvigorate the political will so it can make decisions even if those affect the banking status, or to stop trying to achieve the unachievable (a big apparatus able to foresee everything in the system as a whole), but… just rearranging chairs… (every one else in the world, G20, ECB, FED, is rearranging chairs too, so this reshuffling is quite mainstream). However, maybe in the case of the UK there is a possibility to introduce sound thinking in this new Bank of England-based structure (and stop the endogamic kind of thinking within current monetary authorities), through the external members of the newly created “Financial Policy Committee”. The report says (p. 17) among other things:
2.43 It will be important to ensure that the external members of the FPC are able to provide sufficient levels of expertise and challenge to the Committee’s deliberations – this will not only include experience of banking, but also other financial sectors such as insurance and investment banking and, of course, macroeconomic expertise.
2.44 In addition to the chief executive of the CPMA, the Chancellor will appoint four external members of the FPC using a similar recruitment process to that used for the MPC. The Government will look carefully at the best way to ensure that external members demonstrate ample relevant knowledge and experience and the ability to work constructively in a committee environment, without conflicts of interest that would prevent them participating fully in the work of the Committee.”
My take on this is that the external members of the FPC have to be radically different in make up than the internal members of the current MPC i.e. usually a academic, or some who has come from that background. Entrepreneurs, great business leaders and representatives from the SME sector , all who operate at the coal face would have more of an idea about what is and is not actually going on in the economy, better still, why not think about reforming the whole system anyway so we do not rely of 20 or so central planners to determine the value of our very currency, arguably with language, the foundation of civil , peaceful society.
Above all, if we are only tinkering and not radically reforming, he concluded “please appoint those WHO DID SEE it coming and who have a sound theoretical framework behind it (and kick out those who were clueless…)”
Bravo to that, we can name a number of Austrian School economists and Austrian influenced fund managers and entrepreneurs who could do this job.
By Steven Baker MP, on 30 August 10
Via Bank plans to cap risky mortgages – Telegraph:
Mortgage lending would be “capped” to stop borrowers taking out risky loans under radical Bank of England plans to prevent a repeat of the credit crisis, a senior official has disclosed.
But why did borrowers wish to borrow so much, so riskily? And why did lenders wish to lend so much, at such risk?
In the first place, credit has been too cheap for too long. Low interest rates are bound to encourage people to borrow more and save less. Therefore, people saved less and borrowed more. This was the result of the Bank of England’s decisions.
House prices kept rising because people kept borrowing and pumping money into housing. Housing was excluded from the Bank’s measure of inflation, so rates stayed low.
The appearance of inevitable and uninterrupted house price rises gave the impression that we were in a new era within which the old rules did not apply: borrowing caps could be raised to excessively risky levels and borrowers could rely on price increases to deal with the capital.
Lenders used models which fundamentally understated risk. For example, markets do not behave within the Gaussian or “normal” distribution: extreme events happen more often than a normal distribution predicts. Furthermore, the risk of mortgage default correlates across similar mortgages when the economic environment changes. Still, the models said risks were lower than they were, so more credit could be extended.
Since the lenders were neither, on the whole, mutuals or partnerships with open-ended liabilities and since the employees making the decisions shared only in the upside, there was insufficient motivation to manage to the true level of risk.
Moreover, securitisation of mortgage pools and so forth palmed off the risk onto hapless investors who probably trusted the risk models and the market environment created by excessively cheap credit. And, “Hey, look at the returns!” The personal touch was missing from the relationships between borrowers, ultimate lenders and intermediaries, further corrupting the system.
Of course when the pantomime ended, the taxpayer was forced to pick up the bill. And still bonuses were paid in bailed-out banks!
Now, having created the boom with cheap credit and moral hazard, the Bank plans, not to fix the root problems, but to pile intervention upon intervention…
There is much else to be said, for which I recommend The Alchemists of Loss and Money, Bank Credit, and Economic Cycles. However, on the face of it, the Bank’s present proposals merely extend the infantilisation of the financial services sector.
Later this week, I will indicate ten serious plans for financial reform.
By Tim Lucas, on 20 August 10
I was amused to read the recent UK inflation reports. The ONS said that in July it “fell” from 3.2% from 3.1% in June.
The measurement of inflation in itself is absurd given its dependence on entirely subjective decisions about what should be included in the basket and in what proportions. In addition, a good today is often not strictly comparable with an equivalent good measured a year ago – this is particularly the case with respect to items subject to significant investment such as technology. I wonder how my marvellous new HTC smart phone is considered in the basket for example – such a product did not even exist 2 years ago.
How, therefore, can a reduction to inflation of 0.1% in a single month be regarded as anything other than an insignificant change?
More important I would say is that CPI is running at 3.1%, which is well above the Bank of England’s target of 2%. RPI (yet another measure of
inflation) is measured at 4.8%.
Meryvn King’s response to inflation running above target was most illuminating. When this happens, he is required to write a letter to explain the issues to the Chancellor of the Exchequer. Amongst the usual bilge (food went up by x, rail fares held steady at y), he gave us an insight into his likely future response to the inflation that cannot be hidden even by understated government statistics*. He stated that he would “write more letters to the Treasury over the coming months”.
And there we have it. Our irresponsible central bank’s role as a committed inflationist is confirmed.
* For an illustration of how governments have manipulated inflation statistics to suit their own purposes, take a look at the Shadowstats site, where John Williams has removed the government adjustments to maintain a consistent view of price inflation over the years. He thinks that as inflation used to be measured, it is running at somewhere close to 8% in the US and has been doing so for years.
By Steven Baker MP, on 11 August 10
Over at CentreRight, I have set out briefly the mistake presently being made by policymakers in the US, which I expect to be mirrored in the UK later this morning. For example:
Injecting more new money, whether through QE or credit expansion in excess of real savings, will not “fight recession”. It will merely delay and worsen the eventual downturn, because injecting new money is bound to shift activity from sustainable economic action to action supported only by that new money.
Sooner or later, the mainstream economic paradigm must shift to accept the importance of time and hence a robust capital theory. Everyone’s prosperity depends upon it.
By Abhinandan Mallick, on 2 August 10
Why the Tories should abolish the Bank of England, and why they will politically benefit from doing so
The Conservative Party, since forming their coalition government have seemed to suggest, both from the actions they have taken and the announcements they have made, that they are ready to make radical reforms. Recent statements by Francis Maude would seem to suggest that this government is quite ready to continue in the direction of radical reform. Indeed an excellent article that recently appeared in The Spectator provided some hints as to direction the Conservatives, and in particular George Osborne, seem to be taking in order to wrest this country from its relentless state dependency. From this, a few things are clear.
The idea behind public sector cuts, devolution of schooling authorities tax breaks in particularly state employed areas, as well as removing the £545 child benefit tax cuts for families earning £50k a year seems to have been to cut the bloc of voters relying on state handouts to survive, and to begin to produce, in a Thatcherite fashion, a bloc of economically independent voters with what Shirley Letwin called “vigorous virtues.” Central to much of this is to reverse the tactics Labour had previously used against the conservatives, any further attempts to reintroduce state benefits and subsidies will have to face the burden of justifying where their funds will come from, in much the same way that Labour used to chide the Tories in opposition, whenever any hints of cuts or movement toward a balanced budget were made, as cruelly proposing the cutting of “critical services.”
Taking this as a given, it seems puzzling at least to this writer, why money has not entered the debate. This is since the inflationary phoney boom created through credit expansion, was the primary means of smoke and mirrors the former government used to so effectively mask the disastrous consequences of its unsustainable spending policies. One could compare the modern economic boom as a tool of statecraft comparable in character to the bread and circuses of the Roman Empire. It is time for this nation to cast the wool from its eyes.
A printing press, can be a terribly convenient tool of conducting “monetary policy”, if you own one. Statists and their apparatchiks have long been fond of it, and it provides a great vehicle for the growth of the state, since it allows them to gorge the wealth of the people they rule over, without encountering direct resistance. Why is this, you might ask? As Adam Smith pointed out a long time ago, money is not wealth.
Printing money, or producing electronic credit, or rather “inflation”, as it used to be understood, never can and never does produce neutral effects. Quite obviously, those that receive the new money first can enrich themselves at the expense of others since they can spend this new money first. By doing so they increase demand for certain goods, causing their prices to get bid up relative to what they would have been, while others must cope with paying these increased prices whose income has not been raised have thereby been robbed of their wealth and had the purchasing power of their money destroyed. What is most sickening about this process is that it hurts the poor, the ones who have the least money to begin with, the most; while the same sycophants and interventionists who espouse these destructive policies nowadays are the very ones who claim to have their interests at heart.
Even more insidiously, while dumping newly created money to buy government and “high quality” private bonds, the Bank of England through its irresponsible quantitative easing policy is keeping interest rates at 0.5%. In much the way these easy money policies created this crisis, they will continue to exacerbate it. The manipulation of interest rates causes capital to appear less scarce than it otherwise would have been, causing submarginal long term investments to appear more profitable, producing an inevitable cluster of errors down the road, once the interest rates correct and the real scarcity of capital is revealed. This occurs since the consumer savings to needed to make such projects have any hope of being sustainable were never made.
Yet economic booms are a political tool, and really the most insidious among them. If the Tories continue to allow the Bank of England to operate as it does, they are preventing a real correction, and are fermenting a crisis that will surely punish them in 4 years time. Yet if they truly are wanting to be radical this time around, there is no better way of consolidating their political position than allowing the privatisation of money, allowing people to use non-monopolised currencies like gold and silver not controlled by mercantilist bigwigs who seek to actively destroy the savings of the citizenry.
This would “shut the door”, preventing any future Labour government of allowing itself to engage in profligate and damaging spending; removing their ability to hide the robbery of the citizenry through inflation, since they would now have to account for any spending increases through taxation. Predictably, people would resist this much more vehemently. What better way to create Shirley Letwin’s kind of people!
Repeal of the legal tender laws would be a place to start, with the ultimate goal being to abolish the demonic institution that has been at the heart of our troubles: the Bank of England. Alternatively, any of one of the excellent plans for monetary reform that have already been suggested on this website can begin to be considered.
Furthermore, as already noted such a reform, when clearly stated as above would shame any opposition from either Labour or the Lib Dems if they even once tried to state they were doing so in favour of the poor. By advocating inflation they are and have been destroying both the poor and the middle class! Therefore, I must ask the Tories out there, what are you waiting for? Privatise money!
By Anthony J. Evans, on 3 June 10
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.
By Andy Duncan, on 1 June 10
Let us be generous to the Bank of England. Let us avoid quibbling about that original £198bn of ‘quantitative easing’ coming from out of thin air. Let us agree that the principal securities in their UK gilt fund are now worth £199bn and that they have received £8bn in coupon interest payments, presumably to buy more UK gilts with. Let us even forget that the whole ‘quantitative easing’ programme is simply one element of the British government printing up some currency and then ‘buying up’ IOUs with it from another element of the British government. We will even forget about the £1bn in interest they had to pay themselves on their reserves.
Overall, we must suspend disbelief for a few moments about the kind of person who plays the banker in Monopoly and who keeps winning because they can’t resist the urge to help themselves to ‘free’ money from the game’s money supply.
If we can bring ourselves to do all that then we are left with a £207bn pound output from an initial input of £198bn pounds. To make the mathematics easy on ourselves, we will assume that the quantitative easing programme has been in place for exactly one year, since June the 1st, 2009, which delivers a healthy sounding return of 4.5%.
However, that return is all in one sinking paper currency, the pound sterling, and has only ‘grown’ recently in relation to other paper currencies, specifically the euro, because these other currencies are sinking even faster and people are shuffling their euro-based bond securities into pound-based bond securities in a fearful bid to find a ’safe haven’. All of the world’s paper fiat currencies are sinking because central bankers everywhere possess just one weapon, the electronic printing press, and they are all firing this weapon like there is no tomorrow. And they will continue to do so because they have no other strategy.
If they do keep going like this, then there really will be no tomorrow, certainly for the paper pound, which could eventually reach its intrinsic value, which is that of poor quality firelighters.
The unmentionable elephant in the room, however, is that all of these paper currencies are sinking against gold, which is their joint mutual enemy, because they all shrink and seem far less valuable within the reflective cast of its lustrous yellow metallic sheen.
What was the price of gold on the 1st of June, 2009? It was £595 pounds. What was it on the 1st of June, 2010? It was £840 pounds. This is a return of 41%.
Now that’s what I call a real investment.
This means that against gold, the current £207bn fund the Bank of England is so proud of, is worth just £147bn of last year’s money. This is a 29% loss. Or to put it another way, if £198bn of last year’s money had been placed into gold, it would now be worth £279bn. Which means that the celebrated men and women of the Bank of England have just lost £72bn pounds.
Yes, this is even more than the £5bn the late unlamented Gordon Brown threw away when he sold off a large chunk of the British government’s gold reserves, to exchange it for euros and other paper IOUs.
Gold is money.
We should accept nothing less.
By Toby Baxendale, on 29 May 10
I praise the Coalition government for their first brave attempt to tackle the £156 bn deficit with their £6 bn of net cuts. This, as we know, is scratching the surface of the problem.
I was speaking to a back bencher who used to have a senior role as an advisor to a current Cabinet member: he told me that their main objective was to cut the “structural deficit.” This is estimated to be about £70 bn. I get worried when the ambition is so low and assumes that growth will build up substantially this year, enough to bring in an extra £80 bn of tax revenue to “plug the gap.”
So I believe we will finish the year with £900 bn of national debt. This is forecast to cost £40 bn a year in interest service costs. This is nearly 30% of all income tax revenue. This is more than what we pay for the education of our children. What a shocking waste of our resources and a desperately onerous burden on the taxpayer.
If you follow this link to the Debt Management Office, you will see the perplexing sight that our very own Bank of England, part of the apparatus of the state, owns £190 bn of all outstanding debt. This is shown on the very first page, bottom left hand chart.
I say perplexing as it may have dawned upon you now that one side of the government issues new debt while the other part “buys” it with newly minted money. We the taxpayers get the privilege of paying the interest on this newly minted money that is now owed to the government!
Currently at the end of Q4 2009 the national debt was £796 bn, so £200 bn is 25% of this debt. Suffice it to say, I would think it reasonable to assume that ¼ of the £40 bn debt interest service is then totally unnecessary!
Our Chief Secretary to the Treasury, David Laws, is involved in the papers today with a £40k personal expenses scandal. This makes the front page of all major papers. This is nothing compared with this £200 thousand million debt problem and the £10 thousand million interest bill problem that this oddity generates! Yet no mention of this on the front pages!
This means £10 bn could be saved at a flick of a switch on a key board, with no economic consequences other than to relieve the burden of the taxpayer of having to pony up £10 bn in cold-blooded tax extractions. This savings could also be the equivalent of a 7% cut in income tax.
Now that would be popular.
I wonder if the real reason why one arm of Government must “buy” so much of the debt of another arm is to keep the illusion going that there is a market for UK debt. This then begs the question, “Did a bond strike happen a long time ago?”
Readers to this site know that I favour a solution that would totally eliminate the national debt as mentioned in these two articles:
However, today, this modest “pressing the button” reform could be done and should be done with no debate, and yet it is not!
The general lack of economic knowledge does concern me more and more. A timely reminder of this was in yesterday’s letter section of the FT, May the 28th .
‘Reminder of repressive US gold rush
‘Sir, Martin Wolf asks “How likely is financial repression?” (May 25). Based on the historical record, as he suggests, it’s pretty likely.
‘He does not mention a most egregious case of financial repression: the confiscation of all their gold from American citizens by their government in the 1930s, so they could be forced to hold depreciated fiat dollars. (The Federal Reserve Banks had their gold confiscated, too, and still own none.)
‘This was followed by default on the gold bonds of the US. For its citizens to own gold was made criminal by the American government, an outrageous and oppressive act that remained in force for decades.
‘Yes, when pushing comes to shoving, never underestimate what coercive measures governments will undertake. Mr Wolf’s reminder is timely.
Alex J. Pollock, Resident Fellow, American Enterprise Institute, Washington, DC, US’
I could not put this better myself.
We should all remember the following:
- The crisis always starts by Public Spending in excess of what we can afford.
- Deficit Spending then occurs, with no understanding that this risks the collapse of the economy.
- Denial of Any Problem is writ large amongst the incumbent ruling politicians.
- There follows a Lack of Political Will to do what needs to be done.
- Finally, Monetisation of the Debt. This always means your purchasing power goes down and a wealth transfer takes place from you to any of the programmes that the government is funding at the time. This is the best we can realistically hope for.
At the other extreme, we must hope the repressive measures of the Depression-era US authorities are not considered by modern British and European governments. But if the government lacks either the will or the knowledge to bag this easy £10 bn of savings, then it is hard not to infer that they actually want that money from the taxpayer in interest.
You then have to start wondering: where is this going to end up?
Further reading
The Crack-up Boom, a review of Mises’ The Causes of the Economic Crisis and Other Essays Before and After the Great Depression.
By Steven Baker MP, on 25 May 10
 In their working paper Assessing UK money supply measures in the light of the credit crunch, Toby Baxendale and Anthony J. Evans provide a better measure of the money supply. In this article, Steven Baker explores the background to the paper and indicates some key findings.
This article was originally published in October 2009.
Many people know the Bank of England is creating new money through quantitative easing but if the quantity of money is being increased, how is that quantity being measured? What is counted as money?
As the Bank of England explains:
When the Bank is concerned about the risks of very low inflation, it cuts Bank Rate – that is, it reduces the price of central bank money. But interest rates cannot fall below zero.
So if they are almost at zero, and there is still a significant risk of very low inflation, the Bank can increase the quantity of money – in other words, inject money directly into the economy. That process is sometimes known as ‘quantitative easing’.
But when I consider quantitative easing, I am concerned with the following problems:
- It is not clear that the Bank of England has a useful definition of the money supply. The present measures do not correspond to economic activity — which is what the Bank is trying to increase with new money — and this crisis was famously not foreseen.
- As commentators have reported, “the Bank’s Governor, Mervyn King, seemed pretty confident that QE could work. But even he would admit he has no idea how long it will take – or how much money he will have to print to get there.” This uncertainty seems less than ideal given the risk of price inflation.
- As the end of the present round of QE approached, it appeared it was not working.
- According to Austrian-School economic scholars including Hayek and Huerta de Soto, injecting new money can create only a harmful illusion of prosperity.
As my colleagues point out in their working paper, the fact that the monetary authorities have turned to increasing the quantity of money will focus attention on how that quantity is measured. This article provides some background information and indicates Baxendale and Evans’ key findings.
Continue reading “What is money?”
By James Tyler, on 24 May 10
To set Toby’s “Emperor’s New Clothes” proposal in context, we are bringing forward a number of classic articles.
This article was originally published on 20 January 2010. It is a speech by James Tyler to the Adam Smith Institute Next Generation Group on 6 October 2009. This speech is also available on hedgehedge.com.
I have spent the best part of the last two decades pitting my wits against the market. It’s an unforgiving game: I’ve seen ups and downs, and many of my rivals buried under an avalanche of hubris, passion, illogical thought and unchecked emotion.
I have witnessed the sheer folly of the ERM crisis, the Asian crisis, the failure of the Gods at Long Term Capital Management and the insanity of the tech boom.
I have enjoyed the ‘NICE’ decade (Non-Inflationary Constant Expansion), and scared myself silly during the credit crisis.
I am a trader.
I risk my own money and live or die by my decisions, and face the threat of personal bankruptcy every time I switch my screens on. I get no salary – indeed I turn up at the start of the month with a large office overhead – a ‘negative’ salary. I have no fancy company pension scheme, no lucrative monopoly or franchise.
I eat what I kill.
Mistakes cost me my livelihood, so, above all, my decisions have to be rooted in practical and logical decision making.
Some have called my kind parasitic, but I would have said that I bring order, efficiency, predictability, stability and deep liquidity to a crucial process: a process that makes the whole world keep ticking.
I make money work.
I make the market in interest rate derivatives: a market born out of the neo classical revolution in finance fostered in Chicago during the 1970s. I am a child of Friedman, Fisher Black, Myron Scholes and the modern international financial system.
My analysis was steeped in the neo-classical, efficient markets paradigm.
Friedman’s ideal was working. Enlightened central bankers guided the free market with gentle nudges and short term liquidity infusions, free floating currencies gently adjusted themselves to the constant flow of new information and efficient and rational markets took all in their stride.
Credit flowed, people got wealthier, economies developed and all was well.
And then the crisis struck.
Continue reading “My Journey to Austrianism via the City”
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