Political Economy

Quantitative Easing (QE). Now there’s a phrase to ruminate about. It was created by Dr Richard Werner, Professor of International Banking at the School of Management, University of Southampton. He used this phrase in order to propose a new form of monetary stimulation policy by the central bank that did not rely rely on traditional methods of stimulating the economy which appeared to have failed in Japan.

When you make a deposit into the bank, the bank will lend out that fraction of the deposit that will leave it with its desired or regulated reserve ratio. So if the reserve ratio is 10% the bank will lend out up to 90% or £90 out of every £100 you deposit.

The bank into which the £90 loan is deposited will in turn lend out 90% or £81 of this deposit. The money merrygoround continues until the banks have lent out £1000. Your £100 represents the 10% reserve ratio. This represents an increase in the money supply since all depositors can access the £1000. But if there are many hundreds of thousands of depositors the chance of this happening at the same time is very low, unless there is a run on the banks. Banks therefore depend on the average of all deposits and withdrawals  in a day netting out to almost zero.

This simple analysis is, in fact, not quite correct. If the £100 you deposit has been withdrawn from another UK bank then that bank will have had to reduce its loans setting up a merrygoround in the opposite direction. So in this case there will be no net change in deposits. For this reason it is possible to treat all UK banks as one when doing this sort of analysis.

The Money that comes from central banks, however, is new money. When it is deposited in a commercial bank it can be lent out and start the money merrygoround without any corresponding opposite reaction.

When a crisis hits the banks they have a problem of knowing which of the loans or investments they have made are sound. Because of this they will all decide to hold more cash, perhaps 30% more, so that their desired reserve ratio is now 40%. If the banks had £1000 of loans and £100 of cash they will now wish to call in any loans they can, like overdrafts, so that they now have £250 in loans and £100 in cash in order to meet their, new, desired reserve ratio. This 75% reduction in loans would, if allowed to happen, cause havoc in the economy.

The solution is to give the commercial banks sufficient money to stop this happening. In this case deposits would have to increase by £300 to have the desired effect. Now with £400 a loan base of £1000 can be supported.

To do this the Central Bank buys government securities and perhaps high grade corporate bonds from the banks using new money created for the purpose. This gives the banks more money, so allowing them to increase their deposits to the desired £400 required to stop the loan recalls.

Buying in the government securities from the banks causes their price to increase and this means that, happily, interest rates drop. Just what you want in a crisis!

If you now do nothing the crisis will abate and banks will now increase lending so as to get back to their 10% ratio. But they now hold £400 to act as reserves. This means that deposits, and hence money supply, will increase to £4000 compared to the original £1000. So much money going into the economy so quickly will lead to massive inflation. What can be done?

Well the central bank will now try to sell the securities and bonds back to the banks in return for the excess cash. The bankers will protest. After all they are lending to companies and people just as the government wanted them to. But, eventually, they will sell the securities back, not of course at the high price the central bank originally paid, but at a much lower price. This will give the banks a(nother) good profit and interest rates will as a result of the lower price go up, so helping to choke of any incipient inflation.

Of course the Central Bank must commence selling the securities back to the banks at the correct moment. Too early and any recession is extended, too late and rapid inflation occurs.

What could possibly go wrong? Next week the grizzly story!

GHTime Code(s): 1a95b 

Westminster is in a mess.The Economy is a mess. The war in Afghanistan is a mess. And British politicians in the main parties do what comes naturally. They dump on the English.

So the heavenly duo (they come from up there after all, don’t they) have come up with the bright idea of selling off English Assets. Gordo’s list of quick sales; the Dartford tunnel, the Chanel tunnel, the Tote and so on are all English. When he says that he will be asking local authorities to make sales of their assets he is referring only to English local authorities.

Note that he will not be selling off Scottish assets, even though the two worst offenders in the current Banking crisis are Scottish Banks. That is because Gordo, when he worked on the legislation to form the Scottish Parliament and give the Scots Home Rule, made quite sure that it completely protected the assets of Scottish local authorities so that Westminster could not direct the sale of their assets as he can those of English local authorities.

This means that every school playing field, every public space, every local airport, the pride and joy of the local people as well as a source of employment will be up for sale, quite possibly to foreign European companies flush with back-handers from their governments. And are they going to employ local workers or will they bus in their own people?

However when it comes to preserving their own power and egos it isn’t just plundering English assets that the heavenly duo are so good at. They also deal a good hand in cynicism. On Wednesday  14th October 2009 the government announced a plan to spend £12 million in 130 white working class wards. Where is this money coming from? From the £16 billion of English Assets. In other words the Labour government intends to buy votes in next years general election by returning to the English less than 0.1% of the money it gets from selling their playing fields, leisure centres and employment opportunities.

The Tories are no better. Despite the fact that their web site calls them the English Tories their leader, David Cameron, is on record as saying “I do not want to be the Prime Minister of England”. Well Mr Cameron, the Leader of an English Parliament would be the First Minster, as in the Scottish Parliament. Only someone totally uninterested in England and the English could make that mistake.

The best that can be said about the Liberal Democrats is that they simply ignore England.

Only a few days ago the Sun newspaper transferred its allegiance to the Tories from Labour. Gordo’s response was proudly to  announce that it wasn’t the Sun that would decide who ruled at the next general election, it would be the British People.

Wrong, Gordo! it is the English people, as always, who will decide who rules next.

Will they vote for Gordo, the financial genius who sold off more than half of England’s gold at $275 and ounce or $3.5 billion when at today’s price of  $1063 per ounce it would have been worth $13.5 billion, the financial genius who claimed to have put an end to booms and busts, the financial genius who claimed to have saved the world?

Will they vote for Cameron, surely he must be a Scot, who cares so little for the English that he has stated that he doesn’t even want to lead them?

Will they vote for Nick Clegg, a man indifferent to the aspirations of the English?

Or will they vote for a party that will put England first, that wants England to be a nation once again, a party that cares for England, English jobs and English assets?

Only time will tell!

GHTime Code(s): 7d860 

What if the Law and the Constitution enshrine something that we know is morally wrong? What then?

In the Government of the People, by the People and for the People this question is  important, it is difficult and, in its propensity to bring about civil strife, it is dangerous. Abraham Lincoln asked this question and struggled with it for many years. His simple answer, that  no individual or community had the right to do what was wrong led to his selection as the Republican candidate for President. And as they say, “All the rest is history”.

For the rest of us the issues are never so great, but the result, when we fail to adopt Lincoln’s answer, can be just as significant in our lives as well as in the lives of others.

Two examples of a moral failure in this respect have recently been before us in the news. The first is the matter of MP’s expenses and the second was a the case of a man sent to a private clinic, by the National Health Service, for an everyday knee operation who died because the clinic had no blood supplies on hand.

In both cases the defence is the same, “I/We followed the rules. I/We are blameless”. Well, not if you are Mr Lincoln, you’re not, say the rest of us!

It must surely be obvious to the parties in cases such as these that if harm results then the excuse of following the rules is not admissible. The degree of accountability  depends on the degree of the error and the level of knowledge and responsibility at which the parties operate.

In the case of the MPs there had already been concern raised within the House.  The failure to recognise that, helping yourself liberally from the public purse is morally wrong, whatever the rules may be, is worrying. It points to our premiere legislative body consisting of people who, in the main, appear to be unable to make moral decisions. And if they cannot do this then they are not fit to rule us.

The case of the clinic is perhaps worse in that a man died, perhaps because of the clinic’s failure to put difficult moral questions to itself. The answer, to the reporter’s question that surely it should be obvious that if an operation is being carried out then blood may be required as a matter of extreme urgency, of “We followed all the rules”  is clearly a failure of moral sense. We expect the professionals who treat us to do so in a safe manner having regard to all the unfavourable events likely to occur and to the importance of the outcome. Surely death as an outcome is important in any moral society?

The willingness of what appears to be many important people, organisations and their leaders to act at all time, without respect to other peoples safety or their property, in other words to act without morality, is a cancer in the side of our present society. A cancer moreover inserted by those who far too frequently have been heard to make harsh judgments on other people, often poorer and less well educated than themselves.

The answer is to change the law, if indeed the law needs changing. We all need to know that the law requires of us to carry out, when the health and safety of others or their property is in question, at the level of competence it is reasonable to expect from us, an analysis of the  importance of outcomes and of their likelihood of occurrence irrespective of any rules or contractual agreements in force. If for some reason we do not like the answers or cannot implement them  then we should be expected to take the moral decision and not go ahead with what was intended.

In the meantime, whilst we wait for the civil authorities to make their minds up about wrong doing, we should surely expect those who have failed this moral test to do the moral thing. Apologise and make recompense!

GHTime Code(s): 83b49 

27th September 2009

Single handed Gordon Brown has all but ruined England.

His hatred of the English, his incessant greed for power, his insane fixation on getting re-elected at any cost, his fear of rivals and almost paranoid attempts to “fix” things in his favour, his willingness to lie, to Parliament and the country, in order to achieve his own selfish ends, his inability to see the wood for the trees in all he does, but most of all, his mismanagement of the economy and of the financial system, have made of him a political monster almost without peer in English history.

Last month the government deficit was £16 billion – enough, in one month, to almost replace the Trident fleet. It is now running at an annual rate of £192 billion as against the Treasury figure of £175 billion.

We live today in the biggest economic shambles of all time.

Banks have £680 billion in toxic assets some 85% of the worst are likely end up in the governments Asset Protection Scheme causing some commentators to talk about a ‘massive fraud’ on the taxpayer

Why did all this happen?

It happened because Gordo allowed the mother-of-all credit booms in order to ensure his election to the premiership.

It happened because the UK had the most globalised banking system, and hence the one most open to the worlds financial risks,

It happened because we had the lightest touch, and probably the most dysfunctional, bank regulatory scheme going.

Something urgent and something significant has got to be done.

Don’t get me wrong. Commercial banks, the sort that lend to industry and consumers are absolutely vital to any economy.

They give borrowers access to the savings of the nation in an orderly manner and their lending activities increase the supply of money in the economy, which as the early 19^th century English economist Ricardo said “Oils the wheels of industry”. Without commercial banks you cannot have an economy in England that would support 25 million people let alone the 50 million we have.

But without a safe, regulated, commercial banking system you have an unstable economy. Mervyn King said in an interview some months ago that the regulators just did not have the tools they need to manage the situation.

Why? It has been 233 years since the publication of the ’Wealth of Nations’ and 315 years since the founding of the Bank of England.

So, why has this crisis occurred?

Well for Mervyn and the ‘Heavenly Duo’ (they come from ‘up there’ after all) here is my Alphabet of key Bank Regulatory changes.

A is for accountability. It is absolutely vital that the boards that run banks are held accountable, not just to their shareholders, but to the nation as well. They have in the US something called the Sarbanes-Oxley Act where by the CEOs and CFOs of businesses that falsely state they have an acceptable system of internal financial control which they have personally reviewed, can go to prison for up to 5 years and be fined up to $10 million. Notice that no business failure or fraud has to occur, only making a false statement.

This is the minimum penalty that should be applied to the boards of banks and there should be no wiggle room. If the regulator decides the bank needs saving then this is prima facie evidence in court.

B is for the Bank of England. It should be given the responsibility for regulating banks and other depositary institutions. The current system splits the responsibility 3 ways and has to go.

B is also for Booms. The bank must be given responsibility for controlling booms just as it is does inflation.  The Bank controls the rate at which retail prices rise and it should also be able to control the rate at which a range of other asset prices rise such as housing.

This is not just an idiosyncratic notion. We are attempting to control an economic and financial system. In the science that covers the control of systems there is Ashby’s law of Requisite Variety.

Put simply this means that for each variety of activity in the system the system regulator must have an equal variety of responses. Financial and economic systems go through booms and busts, bubbles and crashes. If you do not control both you control nothing.

C is for clarity. Without accurate information financial systems cannot work. We should no longer allow Banks and other institutions to create complex derivative products and then sell them privately so that no one knows what their exposure to the assets is and what the true risk is.

C is also for capital. In the event banks were vastly undercapitalized. Capital requirements need to be changed and this in turn requires our understanding of risk to change.

It is a technical matter but the world of mathematical finance has known since the PhD thesis of the French statistician Louis Bachelier in 1903 that current measure of risk underestimates the true risk by factors of 10 to 20! When Long Term Capital Management went bust in 1998 it complained of variations 25 times higher than normal. As a result banks are always chronically under capitalised. They will have to have more.

Banks should have to take out insurance against running out of capital the premium for which will be proportional to their risk as well as size.

Perhaps three Cs are too many but there is one more important one. Compensation. In return for being more closely regulated and accepting strict limits on compensation, commercial banks would not be open to criminal charges

The boards of investment banks will be open to criminal charges and therefore the only controls should be on bonuses and a requirement to relate pay to long-term returns.

D is for Division. We have to separate the commercial banks from the investment banks. In the UK our major commercial banks failed because they also had investment banking arms. Investment banking is by nature risky and we should never again allow the commercial banks, on which individuals and businesses rely to be brought down by investment banking activities.

F is for Foreign Governments. There is a great deal of international competition to attract as big a financial sector as possible.

Gordo in part made his reputation by the simple expedient of, in effect, saying to banks “Come here and do business and I will allow you to get away with whatever you want.”

Part of the regulatory powers will need to be the ability to limit companies operating in England from getting finance from banks operating under a lighter touch regulation elsewhere, perhaps by imposing penalty tax rates directly on those borrowings.

My final letter is L. L is for liquidity, that is the amount of cash held by the banks. In the year 2000 this was only 2% of sterling deposits and less than 1% for of sterling assets. This has to increase perhaps to 10% and banks will have to pay for their deposit insurance, with the premium related to their size and risk.

My final prescription is L for Leadership. Currently the bankers are leading governments around by the nose. This has to be reversed.

There are many other proposals that could be mentioned. We need to remember that we cannot get rid of booms and busts. But we can have a framework, that calms the boom, catches the bust before it becomes to big and puts the bankers that through their greed and negligence caused the problem, in prison.

GHTime Code(s): 2925c