Monday, 24 November 2014

The Sovereign Money Illusion

"Because a good magician can do something shouldn't make you right away jump to the conclusion that it's a real phenomenon." —Richard Feynman
I've always been fond of magic. I love the stuff Derren Brown does particularly where he demonstrates the same 'powers' as so-called psychics. Professor Richard Wiseman, originally a professional magician, has some excellent You Tube videos on the science of persuasion. And of course I've been a fan of James Randi for many years now - arch skeptic and debunker of myths everywhere. Those in the UK should take the opportunity to watch his biopic. Everyone else should read the NY Times article. It's very enlightening.

One of the key points that comes out of all this is that humans have a tendency to be easily fooled and they love simplistic solutions - particularly if it is mixed up with a lot of fancy sounding hocus pocus.   There are whole sets of channels on TV designed solely to part you from your money with the most amazing claims about all sorts of things - from jewellery to jesus.

As Randi himself points out, and discovered with his work to expose Uri Geller, the more you highlight and debunk nonsense, the more popular it tends to become. And that's the main reason I've largely stayed away from the Sovereign Money debate.

Marketing and PR clearly work. People who are good at talking and writing can hoodwink pretty much anybody if they choose to. They may even believe it themselves - who knows. You can't really ascertain that from watching them.

What I can do though is show you how the illusion is done. Because it is just an illusion. Nothing fundamental changes, but a few unpleasant things are cleverly hidden that are worth highlighting.

The Fundamentals

Sovereign money stimulates the economy by increasing the price of and therefore reduce the level of bank lending and then replaces that in the economy by increased government spending or tax cuts. Essentially the government does the borrowing from its own bank so you don't have to. 

And that's it. 

We can do that with the current arrangements. We already do of course, but we can do it more if we choose to. 

The basic theory is that increasing the price of bank lending automatically selects the correct projects to receive bank lending. Unfortunately what it is likely to do is encourage ponzi schemes since those are the ones with the returns necessary to pay the higher price.

The correct approach, as highlighted by the MMT view, is to reduce bank lending by banning its use for anything that isn't constructive. Bill Mitchell regularly suggests that 97% of financial transactions should be illegal. You should narrow banks directly by taking action rather than indirectly by 'influence'.  Then you can leave the price of loans low - allowing those projects with a low marginal efficiency of capital to receive funding. In a world with ever decreasing returns on useful projects that is important.

The Tricks

Beyond that there is a lot of bamboozling going on.

Let's start with the "stopping banks creating money" myth. 

Here's a model of the current UK bank structure. 

When a bank makes a loan, and the payments made with it, savings have a tendency to drift to National Savings (because they pay an interest rate and are 100% secure - since it is part of government). That drains the cash buffer of the bank. So you would get this. 

A bank can't continue to operate like that as it would quickly run out of cash. So all banks have a Treasury department who have the job of maintaining the buffers and ratios of the bank at the required levels. So they compete with National Savings to attract back the deposit (or more likely prevent it leaving in the first place) by paying the required interest rate. This, plus the running costs of the other liabilities on the balance sheet, determines the bank's funding costs which in turn determines the price of the loans the bank makes. 

And that dynamic feedback process across assets and liabilities maintains the usual static image of a loan creating a deposit and the bank balance sheet expanding:

Essentially modern commercial banks are always 'fully funded'. They have to be to counteract the persistent drains towards National Savings and into Gilts. 

The plain money version of the Sovereign Money system simply changes the focus of your attention to National Savings. The difference is that rather than holding the Banks reserves directly on the balance sheet of the central bank (in the banking department), they are held in the equivalent of National Savings (a new transaction department). Effectively National Savings moves from HM Treasury to the Bank of England and starts doing white box current accounts. You haven't changed anything here. Just moved things between balance sheets. 

So the process is the same. Here's the starting position:

When a bank creates a loan the cash buffer of the bank would tend to shrink without further intervention as the bank transaction a/c drains,  ending up as 'deposits':

Again a bank can't continue to operate like that as it would run out of cash. So the bank's Treasury department does what it always does to maintain the necessary buffers and ratios of the bank. It attracts back the deposits by offering savings at an appropriate required interest rate. And you end up like this. 

Which is exactly the same as the current situation. Hardly surprising since banks are always fully funded in the current system as well. 

So where does this "banks won't be able to create money" come from - when clearly the balance sheets will expand and contract just as they do now? The sleight of hand is quite clever. You just redefine 'money' to only mean that which is held in the transaction department. 

Well I can do that in the current system. I hereby declare that all accounts unable to accept debit card instructions are 'not money' because you have to do stuff to those accounts to make them 'money'.  Job done. 

So what are the downsides of the change? What is hidden under the deluge of marketing and PR?
  • deposit protection disappears, so 'savings' with banks become unprotected. What that does is put the price up and reduces the supply of savings and banks will be able to loan less due to the increased cost of funds. That is intentional. Restricting bank lending through higher prices is the aim as I mentioned earlier.
  • safe savings that earn interest disappear. Your only option other than saving at risk with banks is to store your money. National Savings stops being a savings entity and starts being an electronic wallet - storing cash in 'dematerialised' form. Essentially all your savings get forcibly stuffed under an electronic mattress and rot quietly at the pace of inflation. 
  • free banking disappears. One of the great innovations of the British system has been free transactions while in credit and free withdrawals from ATMs. That came about for historical reasons - largely the great number of mutuals that came together to create the LINK system, which allowed all British cash cards to be used in pretty much any ATM machine, plus Tony Benn's creation of National Girobank which created free banking while in credit.  It was and remains a magnificent achievement of co-operation that I don't think would happen today now that the mutual sector has been decimated. 
What we really need from an electronic money system is free transactions for everybody and hard enforcement of drawdown limits without charge. In a computerised system the marginal costs of doing that are negligble and should be absorbed by the system. It is sheer profiteering to suggest otherwise. 

Rather than dismantling the co-operative achievements of LINK at sharing the infrastructure costs, we should be building on it so that all electronic transactions in the banking system are free to all users and instantly cleared. That eliminates frictions and cash flow issues that discourage real transactions - a real boon to business efficiency since it helps reduce the overall amount of working capital required.  The transaction system should be seen as a public utility and provided as such. Charging for it is as daft as charging tolls on roads - particularly as it can scale and handle congestion much better. 

The next myth is the "magic of time deposits"

The suggestion here is that if you just stop deposits being instant, then magically all will be well because then they are 'not money'. It's a really silly idea when you stop to think about it for a second. 

At any point in time, on any given day there will be, in any material sized bank, some 7, 30, 90 and 180 day savings maturing and requiring rollover. If the bank can't rollover that money then it runs out of cash and goes bust due to 'cash flow problems', regardless of how its loan book is performing. That is the case for any structure where the assets and the liabilities are not perfectly maturity matched - i.e. the bank acts as principal in the transaction and stands in the way rather than agent matching two third parties and charging an agency fee. 

So bank runs will still happen, and the lack of deposit protection will likely make them more severe and certainly just as disruptive.

This boils down to the 'bond fallacy': the idea that if you wrap money up as some other instrument you change something fundamental. You don't. People holding savings and bonds still feel wealthy. It takes time to sort out any material transaction of any size that requires access to savings - nearly all of which would be longer than notice periods. If the world starts locking assets up, then those selling things will start offering credit periods equivalent to the notice periods to get the punters through the door. The world of Tabs simply reappears. 

This leads onto probably the most zombie like myth which is the belief in "loanable funds"

Loanable funds is based on the idea that you reduce somebody's purchasing power before increasing somebody else's. It's an ordered notion, and economic types love it. It forces the world into their Newtonian clockwork view and they cling to it like starving rats. 

The problem is that it is impossible. The world endogenously creates credit all the time as a function of trade. In fact we don't actually ever really buy things with 'money'. We always buy things on credit and then settle with 'money', although we can settle with anything that the seller deems acceptable. The time between credit and settlement is indeterminate, as is the time between initiating a sales process and the granting of any credit.

If you invest in a bank, or open a time deposit with a bank you get a receipt for your investment. That becomes part of your wealth. You are still wealthy and feel wealthy, which means that you will likely spend like a wealthy person - safe in the knowledge that the system is very keen on making sure you have the liquidity to transact as long as they can see evidence of your wealth. 

It's the very basis of the 'wealth effect' - the very same one lovers of monetary policy get so excited about. All of it alters expectations wildly. 

AFAICS Loanable funds really only works if you become less wealthy when you save; where you materially cannot transact because you don't think you can settle; where you never even enter into negotiations to buy something at some point in the future so you don't affect expectations. 

And you must don the monk's habit prior to anybody else getting access to spending power. Yet the very application for a loan alters expectations. You start lining up things to buy in expectation. Those expectations of sales alters buying behaviour down the line, etc. 

The failure of the loanable funds model is very clear indeed in the work Steve Keen has done on dynamics. I would go further than he has and suggest that there can never be a loanable funds mechanism construct that generates the dynamics the theory requires. People project into the future in time too much and transact over time rather than in an instant. It doesn't work out.

Banks work conceptually with two departments - a lending department and a treasury department. 

They are linked together with a cash buffer and a price. Beyond that they operate asynchronously and autonomously - because that is the only way they can possibly work when there are thousands of payments and transactions going through the books on a daily basis, all coming in at different times from across the globe. You can see this clearly in the simple dynamic models Steve Keen put together. The Assets and the Liabilities move in different circles in different ways at different speeds. 

The process of lending actually takes a long time - several weeks - during which time the sales pipeline and the statistical level of completion of all those loan proposals informs the treasury department so they can line up the funding to backfill the buffer. Funding generally take a lot less time - a few days at most. After all you only need the money at very final moment of the lending process. Up until then the loan proposal is just useful information that again informs 'expectations' internally.  

So there is no real concept of prior or after at the core of the banking process. Only asynchronous. 

There's nothing particularly unusual about the process of course. It is the same system used to deal with government spending and funding since the government sector overall tends to act like a bank.

Endogeneity is innate within the transaction system and no amount of wishing really hard will make it go away. You have to come up with control processes that work with it.

The final myth is by far the most pernicious and the most disturbing.  And that is the "Solomon Fallacy"

If you centralise the creation of money, then you need to initially create it. The question then is who decides how to do that and how much? It's not a problem in the current system, since it is dynamically created and destroyed on demand by the lending and spending system according to price and an interest rate target. In other words it is 'automatic' - ideally allowed to grow and shrink as required to ensure that all real transactions that are worth doing get done. 

Arguably it would work better if you dispense with the interest rate target. That is the weak spot in the system since it is set by a group of human beings who frankly haven't got much more of a clue that the rest of us. So it doesn't really work, is largely just a point of theatre and it was entertaining to see how wrong they got it in 2008 because they were reading the wrong set of tea leaves. At least until you lost your job because of it. 

And that is the main issue. The Very Serious People that sit on these committees do not have the Wisdom of Solomon. They make mistakes. They suffer from groupthink like the rest of us.  And yes they are subject to being lobbied by those in wealth and power however much they have 'trained their souls'.

Just because they have awarded each other prizes doesn't make them any more effective. Credentials are no predictor of success. They are just tickets to bamboozle - like the terms 'Amazing' and 'Magnificent' magicians use in front of their names (and often followed by the suffix 'Master of Illusion'). 

So, of course, the Sovereign Money idea is to use one of these failed committees of Very Serious People, but give them authority to restrict what parliament can spend. If you thought the Debt Ceiling farce in the US was bad, then this is the next stage up. At least with the Debt ceiling it was the members of Congress that were tying themselves in knots, rather than allowing somebody else to apply the ropes. 

Those with a knowledge of parliamentary history will have heard of the People's Budget from 1910.  This implemented taxes on the wealthy and extensive spending on social welfare. At that time the House of Lords, who are appointed not elected, could veto the budget of the elected house. So they vetoed the Budget as passed by the House of Commons. This caused a constitutional crisis which eventually resulted in the removal of the Lords veto over Finance Bills.

The Sovereign Money proposal reinstates the veto by committee - effectively by a new 'House of Lords'. It is exactly the same as giving the 'Lords Spiritual' veto over a Finance Bill passed by the Commons. A small number of no doubt very moral and very learned individuals that believe some, frankly, odd ideas, given final say over the future of the country!

That is simply not acceptable in a modern democracy. 

It's a disgraceful idea that should be abhorrent to anybody who dares to call themselves a democrat and any political party supporting such an idea I feel has lost the right to call themselves a democratic party (particularly if at the same time they are proposing an elected second chamber to replace the House of Lords!)

Now of course it may simply be a piece of political theatre designed to make it look like something is being controlled when it really isn't (The old Wizard of Oz trick). But that again is more bamboozling when we really need honesty. 

It is the job of parliament to decide how much needs to be spent in the economy, over and above that injected by the auto stabilisers. If we take just the Commons, that's a committee of 650 people able to take advice from anybody they choose. If they spend 'like drunken sailors' then we-the-people can kick them out at the next election. The banks and bankers who spent 'like drunken sailors' up to the crash in 2008 are often still in position! As Tony Benn famously said the important question is "How do you get rid of them?".

I find the move towards unelected committees of Very Serious People, who are appointed specifically to 'restrict' elected politicians, a disturbing trend. We're amassing quite a few - the European Commission and the Office of Budget Responsibility to name but a couple.  However it has a long philosophical lineage that goes right back the Plato's Republic, where Socrates proposed a class of people who believe a 'nobel lie' and are compelled to rule by virtue of their upbringing and training. 

He called this class of people the 'Guardian Class'. Those of you in the UK who know the type of people who tend to propose these ideas will find the irony in that name delicious. 

Later the Roman poet Juvenal wrote the famous phrase: 'Quis custodiet ipsos custodes?' - Who guards over the guardians? 

In a democracy the ballot box guards over the guardians, and that should always be the final arbiter. Guardians must be directly elected. 


The Sovereign Money proposal is an implementation of a particularly political philosophy known as 'The Currency View'. It's just a way of looking at things but, as I've shown, it offers no more systemic control value to the banking and monetary system than the existing view, which is a reasonably pragmatic mixture of the centralised 'currency view' and the decentralised 'banking view'.

The proposal is, ultimately, an illusion - however well performed and attractive. And obsessing about it detracts from creating a systemically useful control structure for the banks and a modern payment system that encourages and enables real transactions in the UK.

There may be value in pushing the current account clearing system completely under the auspices of UK Payments Administration (UKPA), and possibly nationalising that function (i.e. bring it under the ownership of the Bank of England). But that would primarily be a way of implementing electronic money that would be available free to all entities transacting in Sterling, and taking that cost out of the commercial banks. Something I feel the banks would appreciate, but it should be done in return for accepting permanent regulated restrictions on lending.

Beyond that the existing balance sheet structure is probably fine, as long as the Bank of England fulfils its regulatory function and operates as policeman to, and not best friend of, the banks. That means putting them into administration and forcing losses onto bank investors when the bank makes bad loans. This is a solved problem that FDIC in the US does on a regular basis. Yes, it might mean that the BoE balance sheet gets a bit hammered, but as we know that doesn't really matter. Or it might mean that we need to have much smaller banks to make the political process of resolution that much more palatable. But perhaps it shows that we need a public owned 'resolution partner' - a commercial bank of last resort that maintains the standards of all the others via competition. We used to have one of course. It was called National Girobank.

Additionally economists of all colours, and I include most of the Post Keynesian influenced groups here as well, are rather too fond of Solomon Fallacy solutions. Clearly many economists don't like and don't trust politicians. That's fine: I don't either. But what that means is that the system has to have a good automatic balance element in it - the MMT school uses the Job Guarantee as its counter-cyclical flywheel for example. However at any point that you require a human decision on anything impacting that control structure, that decision must be made directly by elected officials. Otherwise you are actually proposing a political system that is something other than a democracy.

And for those of us who are mere members of the 'demos' we need to watch out for illusions and tricks from political parties and lobby groups that undermine our democracy. We might be too busy to engage. We might find the whole thing completely boring.  But remember: "no one with power likes democracy and that is why every generation must struggle to win it and keep it – including you and me, here and now."

To that end I'd recommend watching a few Derren Brown shows. Each one has a subtle message about the nature of reality in them. They really are very good.

Friday, 31 October 2014

How Labour can solve the immigration conundrum

It's very simple really.

Implement a full Job Guarantee - create enough jobs and pay a living wage. Take people as they are and let them show they can produce something of value to society - working for the public good.

Of course with open borders that would mean you would likely end up with an awful lot of unemployed on your doorstep from the entire open borders area and, much as we'd like to help everybody, the country and the infrastructure can't cope with that.

Firstly there is the ecological footprint of the population on the country to consider, and then the impact on the social infrastructure - which takes time to augment even if you invest properly.

So as part of implementing the Job Guarantee you restrict the open borders to other parts of the world that have an equivalent Job Guarantee programme and social infrastructure. If you don't come from such country then you have to apply for a visa and be assessed.

It's quite difficult for a foreign leader to argue against that position, because if they do then they are essentially saying they want to dump their unemployment in the UK rather than deal with it themselves. The push back would be: Implement a Job Guarantee and we'll gladly remove the restrictions for your country.

So as well as solving the unemployment and poverty problem permanently, you make the Job Guarantee a viral requirement for open access to your advanced economy. At a stroke we have a positive reason for a temporary restriction on free movement.

The Job Guarantee could very easily become the GPL for the people - guaranteeing you a job and an income wherever you go.

Wednesday, 22 October 2014

A little light on the UK productivity puzzle?

The October Economic Review from the ONS has a section in it on productivity that is perhaps worth  highlighting.

The UK recovery has been puzzling people, because although we have not had the unemployment of other countries we have had a major impact to productivity that has been difficult to explain. Productivity has been flat to declining since the Financial Crash.

The review breaks that down by industry composition and that highlights the impact of a few sectors on UK productivity.

Part of the explanation for the weakness in productivity growth relates to the UK’s industrial mix, and in particular to the productivity performance of mining & quarrying. Productivity in this industry, which is dominated by the extraction of oil and gas from the North Sea, has been on a long-term declining trend, as the remaining reserves demand more factor inputs to reach and extract. As a consequence, while the level of productivity in this industry remains relatively high, it has fallen by more than 50% since 2008.
The drag on productivity growth is then shown in a graph showing change in output per hour.

*ABDE includes all non-manufacturing components of the production industries. This is dominated by the extraction, energy and water industries.
Looking at the change in productivity before the crisis and afterwards leads to this change graph:

Which shows a productivity decline across pretty much all the industrial sectors, with the biggest decline ex. oil and gas in the old bubble sectors - Finance and Pharma.

There is still no comprehensive explanation for what is going on here, but clearly retaining staff (contrary as that is to standard economic theory) and the return to rational pricing from bubble mania will have had some impact.

The atypical response of the UK to the crisis is a natural experiment - after all retaining staff while productivity falls is essentially a privatisation of unemployment benefits which would stop demand falling as far as it otherwise would - and a comprehensive analysis from the ground up would show some theories of the way firms work in aggregate are incorrect.

Hopefully we'll see an adaptation of ideas that can explain what has happened, rather then the usual filtering of facts to fit pre-conceived beliefs.

Thursday, 2 October 2014

UK Private Debt Levels - Q2 2014

As I mentioned in my sector post, this week's National Accounts release represents a complete review of the framework in the UK too bring it up to date with the latest European Standard - ESA 10.

This affected my private debt and credit accelerator calculation and I've had to go back to basics to rebuild it. The good news is that the review has simplified the calculation - since derivatives have been moved out into their own section on the balance sheet.

Additionally ONS now publishes a flow of funds presentation which gives a much clearer view of the interactions between the sectors, and between the UK and the Rest of the World. As usual with the ONS it isn't really indexed anywhere in the release calendar! You can find it though with a bit of perseverance

So now the private debt levels in the UK look like this:

Still the same picture really. The UK is deleveraging - mostly in the commercial sector. This shows the benefits of GDP growth and how it shrinks the percentage of debt very quickly. What is really interesting, though, is that the debt isn't just growing more slowly, it is actually shrinking in nominal terms.

All this means that the 'Credit Accelerator' has been negative now for four quarters, which suggests - if the concept still stands and my calculations are correct - that we probably have the brakes on. Debt reduction is weighing down on aggregate demand. It will be an interesting test of the idea to see if things start to slow up and everybody begins looking around puzzled wondering what happened, or if borrowing restarts with a vengeance to keep the party going, particularly with an election brewing.

Here's the chart:

Source: Office of National Statistics. Private sector debt based on tables NLBC, NKZA, NNQC, NNRE, NNXM, NNWK, NLSY, NLUA, NJCS and NJBQ (Lending and securities per sector, not seasonally adjusted) scaled by BKTL (Gross domestic product at market prices, not seasonally adjusted). Data and calculations are available online

Wednesday, 1 October 2014

The Political Aspects of a Basic Income Guarantee

Brian has put up a useful post called Consequences of a Basic Income Guarantee which runs through some of the technical issues of an Income Guarantee for Canada and other countries.

I'm from the UK, and we've had 'Means Tested' Unemployment Benefit, Housing Benefit, Universal Child Benefit, Universal Pensions and a National Health Service for decades.  The history of these benefits show why general income schemes just don't work properly in practice.

Let's run through some reality.

The UK Conservative party in their 2014 conference announced its intention to extended a benefits cap and reduce the amount of money going to the unemployed in order to 'fund' .... apprenticeships.

Yep that's jobs folks.

This is a wildly popular idea in the UK and has massive support in polls from the majority of the population.
"At heart, I want us to effectively abolish youth unemployment," Cameron said.
"I want us to end the idea that aged 18 you can leave school, go and leave home, claim unemployment benefit and claim housing benefit.
"We shouldn't be offering that choice to young people; we should be saying, 'you should be earning or learning'."
Reducing payments and increasing work, from those who are fit and able, is the political goal here, which is what chimes with the population.

Let's see what the other side has to offer.

The Labour party put forward proposals to limit Child Benefit - which was a universal benefit paying a massive £20 per week to a child. Basic income for a child in other words; although 'a pittance' would be a better description.

That has already been removed from high wage earners and the 'socialist' Labour party will remove the indexation of that benefit and will not restore universality. 'All savings used to reduce the deficit' - so there's not even any redistribution. A whole £400 million over five years - which is a rounding error in the UK budget.

It actually costs an awful lot to do the means testing rather than to simply pay out the money to wealthy people earning more than £50K. But "they don't need it" you see, and that's an important moral point. Again to huge applause from the general population and lots of column inches in the papers.

They also propose a 'Job Guarantee' - which isn't a full Job Guarantee but offers a limited amount of work to the young. Not much of a noise about that in the press and how it impacts our 'freedom'.

So there you have the political reality of operating a social security system in the real world with real human beings. It's not a matter of mathematics or accounting. It's got nothing to do with tedious technical economic issues about the nature of value.  It is simply a matter that the default Basic Income Job - "spend the money I'm given" - is not seen as sufficient recompense by the rest of society - even when the payment is universal. That makes it a non-starter.

Much is made of all the 'trials' and 'pilot projects' of basic income. You'll note that none of them ever get any traction after that. This is why. It's a political turkey.

Receiving money when you don't need it is seen as morally reprehensible, as is spending money and doing nothing of perceived value. Politically they get removed when they show up, or slowly chipped away at best. We've seen this in the UK since the Second World War - increasingly since the 1970s. Even the Universal Pension is moving the wrong way. The age at which you receive the pension is ever increasing despite having a clear contribution element that people can relate to.

Although many may benefit from being 'freed' from work, there are known detrimental effects to health amongst a chunk of the population that already receive income guarantees (the retired).  Unemployment can transform into social isolation, despair and depression unless there is active assistance finding something useful to do. That doesn't happen spontaneously. It has to be provided actively by the social support system.

I could come up with endless headlines, comment threads and quite a few TV shows that use the line: what are you doing that is of value to everybody else? Even the sympathetic press are often very keen to show people on benefits working for charities or volunteering in some way.

Getting to a useful Job Guarantee is going to be difficult enough - ensuring, as it must, that everybody is doing something they enjoy and that others see as valuable, as well as informing the general public constantly of that value in each local area. Broadening the concept of what work is and means is the main challenge. In fact in some countries it may be impossible until unemployment gets to depression levels, probably beyond that towards societal breakdown. Humans like to push things to the very edge before making a course alteration - as we're seeing with the response to Climate Change.

Ultimately BIG people tend to be interested in abolishing a quite narrow idea of 'work' as a matter of basic philosophy. It's a core value to them. They are a very small minority of people that like the idea of not having to do anything for a living and being 'free' - even though that freedom isn't really extended to those that will have to continue to work to keep the lights on, and who would have to pay a much higher tax rate for the privilege.

Essentially they come across as extreme individualists just like the free market bunch, with which they have a lot in common to the point where they can find agreement over this issue. That speaks volumes.

BIG fails in the same way that 'free markets' fail. Because you have these annoying things called human beings to deal with, operating in a social structure that requires a quid pro quo. Something that is innate and cannot be easily wished away.

But the good thing, politically, about having the Income Guarantee people pushing their line is that alongside it a Job Guarantee, within the context of Universal Health, Education and Pension provisions, sounds immensely reasonable. Something that perhaps should be made more use of in debate.

Tuesday, 30 September 2014

UK Sectoral Balances - Q2 2014

Today's Quarterly figures represent a complete review of the National Accounts framework in the UK to bring it up to the latest European Standards - ESA10. There have been quite a few alterations to the structure which have altered the net-lending positions of the sectors. The main one is the alteration to the pension accounting which is now on an actuarial basis and alters the position between the household sector and the finance sector a bit. The private debt calculations I usually put out will need checking first to make sure I've still got everything in there after the reclassification. Hopefully I'll be able to work that out and publish them soon.

Additionally the figures are now only available from the beginning of 1997.

What is interesting now is that the government balance pretty much exactly equals the Rest of the World balance. The domestic sectors are all about balanced - within the error bar - as we can see from the five sector chart.
So for anybody to 'get the deficit down' from this point requires either a significant adjustment to the external balance, or one of the domestic sectors going deeper into debt.

Right at the moment we effectively have a domestic 'balanced budget'.

Source: Office of National Statistics, tables RPYH, RQAJ, RQBN, RQBV, RPYN, RPZT, RQCH, DJDS (Seasonally adjusted Net Lending/Borrowing per sector plus residual error) and YBHA (Gross domestic product at market prices, seasonally adjusted).

Wednesday, 27 August 2014

Scottish Independence Myths - How to buy imports?

I've been amazed at how poor the understanding is on how cross border trade actually work in a modern financialised world. It's almost like they've never spent any time at the sharp end of a firm's invoicing and payment operation, and exposed to the constant stream of marketing from banks.

The introduction of an independent free-floating Scottish currency is no barrier at all to cross border trade - because the banks are already setup to support it and make money doing so. It's very straightforward.

Let's run through a scenario. As we have already learned Scotland runs balanced trade with the rest of the world and the trade deficit is therefore with the United Kingdom. So we'll take the case of a Shropshire based company exporting goods/services into Dumfries and Galloway.

The exporter could throw up their hands, refuse to accept Scottish money under any circumstances and demand payment in good old British pounds.  The result of that would be the loss of the customer (probably to a Scottish based competitor or one that read and understood bank marketing leaflets), reduced turnover and profit and perhaps even layoffs amongst the staff. Only economists would think that is a rational response to the situation or at all likely.

In a real business, sales is everything and you do whatever you can to keep the customer. Exporters need to export. The first call would be to the firm's bank to see what they can do.

Here is the overview of the situation:

For simplicity I'm assuming that the customers and supplier both bank with RBS. That isn't at all necessary. This setup just cuts out the noise of clearing and makes the point very clear. 

The Kirkcudbright branch operates primarily in Scottish Pounds and does its reserve operations with the Scottish Reserve Bank. The Telford branch operates primarily in British Pounds and does its reserve operations with the Bank of England. The customer's bank account is in Scottish pounds and the Exporters in British Pounds. 

RBS plc owns both the bank branches and produces its own balance sheet in British pounds - because that's its functional currency. That means Scottish assets are translated into the functional currency equivalent at the reporting date according to the usual IFRS rules. In other words Scottish assets are reported in British pounds even though they are actually denominated in Scottish pounds. 

So we take a sale of goods and services from the Exporter to the Importer. The exporter prices the invoice in Scottish Pounds because that's all the importer has. In this case 'no deal' unless the exporter does that. (Again that isn't necessary, the process works just as well in reverse). 

Of course Scottish Pounds are no good in Telford. So they have a word with their bank in Telford, who is quite happy to purchase the invoice at the current exchange rate. So the exporter is credited with British pounds (which as we know the Telford branch just created ex nihilo) and the Bank takes the invoice.

This expands the balance sheet of the Telford bank branch - it has an invoice asset and a cash liability to the exporter, plus a bit of profit for itself. 

Now because RBS has Scottish businesses it is quite happy to receive Scottish pounds. So it instructs the Importer to settle the invoice to the bank's own account at the Kirkcudbright branch - in the usual manner of any factored invoice. An intra group loan (which in banking circles is known as a 'deposit account') links that back to Telford and clears the invoice. 

What has happened here is that the bank has executed a swap because it has a foot in both camps anyway. Therefore it can provide the swap service quite happily to those entities that don't have that structure available to them - for a fee of course. 

The actual structure will be more complicated than this simple overview (the factoring operation is likely to be a separate subsidiary with multi-currency accounts for example), but the essence is the same.

From the point of view of RBS plc, it had liabilities in Kirkcudbright to the Importer and now it has slightly smaller liabilities in Telford to the exporter - plus an amount of profit for itself. The exporter produced and sold their goods and stays in business, the importer got their goods and can use them.

Win-Win all round. Another good day for dynamic currency systems.