The Slough of Despond

by
Frances Coppola
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Bored with this crisis. Bored with endless calls for bank reforms. Bored with never-ending stories of inadequate bank resolution and legal battles which benefit no-one but lawyers. Bored with ineffectual monetary policy and fiscal gridlock. Bored with seeing the same things proposed over and over again, even things we know don't work and will never happen.

Today, Mike Konczal wrote a piece on why restoring Glass-Steagall wouldn't solve anything. He's right, of course. But it is now seven years since the crisis, and we have known for most of that time that restoring Glass-Steagall wasn't going to happen and wouldn't solve anything anyway.Why are we still discussing it now? Why can't we just accept that Glass-Steagall is dead, and move on?

Today, I had to explain YET again that although banks create money when they lend, that does not mean lending doesn't need funding. Payments are deposit outflows. That applies whether the deposits concerned are created by the bank through lending or placed in the bank by customers. So no, banks can't "just lend" without any form of funding. Banks have to fund deposit outflows. If they don't, they can't allow money to be removed from deposit accounts. Look what happened in Greece when the ECB limited the funds available to Greek banks.

Today, I read yet another piece proposing that the UK should have a system of small savings banks "just like Germany's". Because, you know, banks aren't lending to SMEs. Laudable, but creating a UK Sparkassen network isn't by itself going to solve the problem. There are very significant differences between Germany and the UK. In the UK, most lending goes towards house purchase. In Germany, much less of it does, because fewer people own their own homes. Because of this, German households hold far more of their savings in the form of bank deposits than UK households do. UK households' savings are mostly in the form of property and pensions. So where are the deposits going to come from to fund a new network of Sparkassen focused on SME lending? And what would the consequences be for the funding of existing banks and building societies? It's blindingly obvious that 250 new deposit-funded banks are simply going to take deposits from mortgage lenders, forcing them to make greater use of bond issuance and wholesale funding. Like that worked so well for Northern Rock. Why don't researchers think things through?

Today, I was sent a copy of a proposal to the Dutch parliament to "replace bank-created money with Government-created". That old chestnut, again. Yet another version of the Chicago plan. I've lost count now of the number of full reserve banking proposals I've seen. I've yet to see one that actually succeeded in eliminating bank money. And I've also yet to meet an advocate of full reserve banking who understood that it is to all intents and purposes a strict gold standard, with alchemists replacing miners. I keep saying it is a really bad idea because central banks get their forecasts wrong ALL the time and anyway economies work better if demand for money leads supply. But the idea keeps coming back to haunt me. I worry that some lunatic government will actually try out one of these idiot schemes one of these days.

Today, I heard that Barclays is to appoint an investment banker as CEO. Thank goodness. The vilification of investment banking and reification of retail banking in recent years has been poisonous. It has caused the near-destruction of an industry that is vital for business investment. No wonder business investment has been so poor.

In September, the Bank of England's Andy Haldane discussed negative rates and the end of cash as if these ideas are new. As if they have never been discussed before. But we've been discussing negative rates and their effects for years, and we've been discussing eliminating physical cash, or at least finding ways of discouraging people from hoarding it, for even longer. Hasn't Haldane heard of Silvio Gesell?

We now have empirical evidence that banks may raise interest rates to borrowers when they are charged for depositing money at the central bank. The G30 report released last week observed that Credit Suisse raised mortgage rates in January 2015 because of the ECB's slightly negative interest rate on reserves. If interest rates were significantly more negative, what do you suppose banks would do? Yet we are still talking about negative interest rates as if they are expansionary monetary policy. They aren't. They are direct taxation of bank deposits, which is financial repression. And financial repression is contractionary, especially in the absence of a trade surplus. We KNOW this. It is not rocket science. Why are we still considering negative rates?

We seem to be completely stuck. Unable to escape from the Slough of Despond, we flail around in circles.

Wherefore CHRISTIAN was left to tumble in the Slough of Despond alone; but still he endeavoured to struggle to that side of the slough that was farthest from his own house, and next to the wicket gate: which he did, but could not get out, because of the burden that was upon his back. But I beheld, in my dream, that a man came to him whose name was HELP, and asked him what he did there?

Chr. "Sir," said CHRISTIAN, "I was bidden to go this way by a man called EVANGELIST, who directed me also to yonder gate, that I might escape the wrath to come; and as I was going thither, I fell in here." 

Help. But why did you not look for the steps? 

Chr. Fear followed me so hard, that I fled the next way and fell in.

Central banks are terrified of raising interest rates, because it might cause bankruptcies on Main Street and crashes on Wall Street. They look at below-target inflation, flat wage growth and awful productivity, and think "there is no reason whatsoever for raising interest rates". I never thought I would find myself writing this, but - yes, there is. Purchasing power in today's fiat money economies is created by bank lending, and very low interest rates are deadly for banks. They can't make money when yield curves are flat and the slightly-below-zero bound is binding. The longer very low interest rates remain, the more difficult it is for banks to survive. They could improve their profitability by doing riskier things, but we don't like that either: prudential regulation is making it ever more expensive to take risk. Then we wonder why M4 lending growth is persistently negative (see table A2.2.3). Meh.

But even worse is the fiscal terror that prevents governments acting to restore their economies,  or even forces them to do lasting damage in the name of "setting fiscal finances on a sustainable path". We know that trying to eliminate a fiscal deficit when the private sector is highly indebted and the external sector is in deficit depresses growth. We know that fiscal surpluses are contractionary. We know that spending cuts hurt the poorest most, and tax cuts all too often benefit the well-off most. We know that high unemployment among the young scars them for life. We know that high adult unemployment is associated with increased suicide risk, particularly among men.

We know that programmes of public works restore depressed economies, fast and effectively. Dammit, even Hitler knew this. Why don't we do them? Because we are scared.

We won't let our governments borrow for long-term public investment because "OMG Greece!", even though interest rates are on the floor and investors are crying out for safe long-duration assets. We won't let our governments print money for long-term public investment either, because "OMG Weimar!", even though public investment would raise production whereas Weimar's problem was that production had been trashed. We talk about the "burden of debt service for the next generation", while refusing to invest in the tangible and intangible assets that would help ensure the next generation actually has a future.

I fear for my children. But not because of public debt. No, I fear for them because of unemployment, underemployment, low wages, debt, poverty. And war. OMG, war. Can't we see that the path we are on now has in the past always led to war?

There is no justification for this. The obstacles are entirely political. We need Help.

So, here are my Helpful suggestions:

• Stop proposing new bank reforms. We've heard it all before. Get capital buffers up to 20%, then leave banks alone. Particularly, stop attacking investment banks. They have a job to do.
• Stop trying to restrict what central banks can do. Liquidity is lifeblood to the financial system. Trying to restrict it causes gangrene. Let central banks provide it freely. 
• Stop expecting central banks to restore growth. They can't. 
• Stop worrying about public debt. Borrow to invest for the future. Then central banks will be able to raise interest rates, since increased borrowing would tend to push them upwards anyway. 
• Stop trying to balance budgets. They will balance themselves in due course. 
• Stop worrying about inflation. There isn't any. If it appears, cheer.