Social credit

There was an interesting exchange in the NZ Herald recently. The NZ Initiative, a conservative “think tank”, published a report basically saying that it is bad for governments to fund deficits by printing money. (I told you they were conservative.) The NZ Social Credit Association responded with a full-page ad in the NZ Herald setting out their view of Modern Monetary Theory and how it could work in practice.

Bryce Wilkinson, one of the senior NZ Initiative fellows, then published an opinion piece in the newspaper trying to discredit the Social Credit article. Shortly after that, Chris Leitch of the Social Credit Association published another response.

These last two pieces are reproduced below. I was profoundly unimpressed by the NZI piece. It is mostly a litany of strawman arguments, obfuscation and bad faith. This is strange because the NZI’s audience is mostly fairly narrow, so when they actually publish something in a national newspaper I thought they would make an effort to construct a clear and persuasive argument.

The Social Credit response was better, though Leitch does stoop to replying in kind to some of Wilkinson’s jabs. Still, after pondering the two articles I have spent a bit more time reading about how the financial system works and how it could work better. I still await a really good article that actually explains these issues properly, but I still enjoyed reading these ones.

That old snake oil idea that central bank credit is a free lunchBryce Wilkinson

Last Wednesday, The New Zealand Initiative published a 13-page research report explaining why reliance on central bank credit to fund fiscal deficits is not a free lunch and it is economically dangerous to claim otherwise.

The New Zealand Social Credit Association subsequently placed a full-page advertisement in the weekend’s Herald espousing the opposite position. (Older readers will remember the Social Credit Political League from the 1950s and 1960s with its ‘funny money’ A+B theorem.)

Its argument is that conventional borrowing helps banks and wealthy investors while hurting the public, and Reserve Bank credit was a costless alternative.

If the reader has a queasy feeling this position is too good to be true, or that trickery is afoot and someone must be paying for the $9-10 billion paid out in wage subsidies and much more, this article explains why those fears are justified.

The first claim, that conventional borrowing benefits banks and wealthy investors, is false. There is no wealth transfer when a person buys a car, a house, an item on Trade Me, or government stock at fair market value. The asset seller gets the buyer’s cash, and vice versa. The government gets investors’ cash, investors get government bonds of equivalent value. Neither the Crown’s nor investors’ net worth is changed.

The second headline assertion – that funding by Reserve Bank credit is costless – is seductive, false and dangerous for the stability of New Zealand’s financial system.

When the Crown borrows from the Reserve Bank, the bank treats the loan as an asset and the amount it credits to the Crown’s account as a liability. Neither the Reserve Bank’s nor the Crown’s net worth are changed because no wealth has been created or transferred.

To fund its fiscal deficit, the Crown can now draw on its deposit balance at the Reserve Bank. The recipients of that spending deposit the money in their bank accounts. Their banks record those deposits as a liability and hold the asset deposited as a claim on their banker, the Reserve Bank.

This means the Crown’s deficit spending has been funded by borrowing from the banking system. The reduction in the Crown’s deposit account at the Reserve Bank is offset by increased banking system deposits at the Reserve Bank. It also means Crown net worth falls because of the fiscal deficit while the public’s net claims on the banking system rise. The banking system’s net worth is unchanged just like the Reserve Bank’s net worth. There is no free lunch.

Why doesn’t the Reserve Bank just write-off its loan to the Crown? After all, no debt surely means no cost? Not so. The value of the Crown’s ownership of the Reserve Bank would fall by the amount written-off. The write-off would not alter Crown net worth.

Nor can the Reserve Bank reduce the cost to the community by refusing to pay interest on the banking systems’ deposits (settlement balances) at the Reserve Bank. To do that effectively taxes bank depositors, borrowers and shareholders in some way by widening the interest rate margin between bank borrowing and lending.

A basic point is that when the government reallocates resources, it stops some people from using those resources in a different way. For instance, when the Crown employs builders on its social housing projects, they are not available to build homes on the private market.

Another twist to this free lunch argument is the academic ‘thought’ experiment that the government could drop irredeemable paper money as if from a helicopter. The hope behind this imagined giant lolly scramble for adults is that the expanded money supply will induce extra spending to lift output and incomes, without increasing the public debt.

Yet if the helicopter money is irredeemable and so not public debt, anyone who gathered some of these banknotes would not be able to use them to pay IRD. So, what would the notes actually be worth? If the government will not accept its own money, why would anyone else? The Initiative’s paper examines this proposal in much greater detail.

Another idea, perhaps to save helicopter fuel, is for the government to simply gift $1500 to every New Zealand adult and $500 for children. That should generate applause from an unthinking public and make a great campaign slogan: “Vote for us if you want $1500!”

But if central bank funding is costless, as some believe, then why would government be so miserly? Why not make it $15,000 or $150,000 for that matter?

Disturbingly, the Minister of Finance, Grant Robertson, has not ruled out a gift money option , but he has acknowledged one difficulty – that the gifting plan is not targeted at need. To give money to those who do not need it is to fail to give the same money to those who do.

Money handed out to Kiwis must be taken from other Kiwis, one way or another, sooner or later. A conservative estimate is that it costs the community $1.20 for every $1 the government gives away. “Free” money is far from free.

A good fiscal constitution should constrain politicians from deciding to fund deficits by borrowing from their central banks. Transparent, non-inflationary funding of fiscal deficits is much safer. To do otherwise is a slippery slope of treating deficits and debt as unimportant, threatening financial stability.

The case for fiscal deficit spending to fuel economic recovery is a different issue, as is the question of the best monetary policy actions for the current time. Either way, central bank credit financing of fiscal deficits is not a free lunch.

No Snake Oil Here BryceChris Leitch

In his Herald on-line opinion piece Bryce Wilkinson resorts to using ‘funny money’: a term dreamt up by political opponents to discredit Social Credit sixty years ago, and adds ‘snake oil’ in an apparent attempt to do so again. That nonsense long ago went the way of the dinosaurs as increasing numbers of international experts recommended the Social Credit concept of using the country’s central bank (Reserve Bank) to fund government activity. Here are just a few. Adair Turner, former chairman of Britain’s Financial Services Authority, Anne Pettifor, advisor to governments and honorary research fellow at the Political Economy Research Centre, University of London, Richard Werner, economist and professor at University of Southampton and Steve Keen, head of the School of Economics at Kingston University, London. An International Monetary Fund report in 2012, co-authored by Michael Kumhof, now a senior researcher at the Bank of England, strongly advocated it.

First, let’s examine Mr Wilkinson’s claim that conventional government borrowing does not benefit banks and wealthy investors.

Banks purchase government bonds (the conventional way government borrows), by creating a book entry in their accounts (in effect printing money) – the same method they use when they advance loans for the purchase of houses, cars, holidays, and for business expansion and overdrafts. Banks do not lend money that people have deposited with them.

As the Bank of England clearly states in its first quarter 2014 Bulletin. “Money creation in practice differs from some popular misconceptions. Banks do not act simply as intermediaries lending out deposits that savers place with them. How bank deposits are created is often misunderstood. The principal way is through commercial banks making loans. Whenever a bank makes a Ioan it simultaneously creates a matching deposit in the borrower’s bank account thereby creating new money. Rather than banks receiving deposits when households save and then lending them out, bank lending creates deposits.”

The Bank of England is not alone. The German Central Bank, our Reserve Bank and others state it too, as do a plethora of international economists and economics professors.

Interestingly, despite this, NZ universities still teach their economics ‘ students the old, disproved theory.

Banks purchase government bonds because it is profitable and that profit adds to the profit from their other lending activities and is paid out as dividends to their shareholders, many of whom are domiciled overseas.

In the case of bonds, the profit is provided by the government paying interest on the bonds using tax paid by taxpayers.

Given the four big Australian banks control the lion’s share of banking here, and that it’s highly unlikely people on average or below average income can afford shares in Westpac, for example, at $16.73 a share, it is demonstrably correct to claim that conventional borrowing benefits wealthy investors as it transfers wealth to them from taxpayers.

He then goes on to claim that under the Social Credit proposal – government accessing funds direct from the Reserve Bank . the resulting spending will end up in the accounts banks have at the Reserve Bank (on which they are paid interest) and therefore the government’s spending has been funded by borrowing from the banking system anyway.

Firstly, some of the money that the government pays out in its rescue package will pay off loans, credit card debt, and overdrafts and be cancelled out of existence.

Some will be used to purchase overseas (Amazon, Alibaba) and from retailers who have imported their stock and will pay their overseas suppliers, and it will therefore not end up being deposited in New Zealand banks. What ends up in their accounts at the Reserve Bank will be reduced by these actions.

To imagine that banks leave that money in their Reserve Bank accounts at an interest rate of up to 1 below the current official cash rate of quarter of a percent (leaving the banks paying the Reserve Bank to hold their money) defies belief. Any bank chief executive not seeking a better return on billions sitting in its Reserve Bank account would soon, I fancy, be finding another job.

Even if banks were getting interest on the money in their accounts at the Reserve Bank, the relatively small amount left there overnight means the Reserve Bank’s interest liability would likely be small and would in no way support the claim that government was ‘borrowing from the banking system’.

Payment of interest on the bank settlement accounts at the Reserve Bank didn’t start until March 1999 with the introduction of the OCR, and are a choice that reflects the ideology of the current system that rewards bank shareholders.and penalises taxpayers.

Mr Wilkinson queries why the Reserve Bank couldn’t just write off its advance to the Crown. He says the value of the Crown’s ownership of the Reserve Bank would fall by the amount written-off, but that write-off wouldn’t alter Crown net worth. Exactly, so where’s the problem? Both are, as his statement proves, just two arms of the same entity. The Crown would have simply borrowed from itself.

The advance the Reserve Bank made to the Crown was not sourced from anywhere else. It was created at the time the advance was made, so it increased the Bank’s net worth and therefore the Crown’s). Writing it off once it had been transferred to the Crown and spent, simply reinstated the status quo.

Thirdly Mr Wilkinson claims that when government re-allocates resources it stops people using those resources in a different way. He cites the example of the Crown employing builders on social housing projects making them unavailable to build homes in the private market.

So what? Why is building houses on the private market more important than building social housing?

Mr Wilkinson’s (and the New Zealand Initiative’s) approach, appears to be that the market, in which only those in the upper levels of income can freely participate, should dominate everything else – a line of thinking many claim has led to inequality growing dramatically, increasing numbers of people without adequate housing, and hundreds of thousands of children living below the poverty line.

Finally, Mr Wilkinson suggests that payouts for the crisis, which may yet turn out to be a gift of ‘helicopter money’ to every adult of $1500, may as well be $15,000 or more. It might well be that in the current circumstances that could be necessary and appropriate.

“Why not make it $150,000”, he writes. lt’s patently ridiculous to think that eating one ice cream without becoming ill means you can happily eat a hundred.

Social Credit has never advocated the Reserve Bank create money in an unrestricted fashion. A key part of its policy is setting up a New Zealand Credit Authority with independence similar to the Judiciary, and accountable to Parliament as a whole. Its task would be to assess the economy, measure its unused capacity and labour capability, and determine how much new money the Reserve Bank could safely create for the government to spend without generating inflation.

Social Credit has swum against the tide of orthodox economic opinion throughout its 100 year history, but that tide has now turned and there is a tidal wave of opinion both internationally and locally that sees value in what Social Credit has been proposing.

They may not call it Social Credit, but that is irrelevant.

What is relevant is that judicious use of credit creation by the Reserve Bank can (and should) be used by the government to do lots more things to benefit kiwis, and that money paid by taxpayers for hospitals and schools should not go instead into the pockets of the overseas shareholders of the banks.

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