Transcript Werner Solutions for..

Centre for Banking, Finance
& Sustainable Development
Management School
Solutions for Greece
– other than default, euro-exit or giving up
national sovereignty
Richard A. Werner
Centre for Banking, Finance and Sustainable Development
University of Southampton Management School
Athens University of Economics and Business
Athens
24 January 2013
Centre for Banking, Finance
& Sustainable Development
Management School
How did Greece get into trouble?
• We all know, it started by Greece giving up control over its
money and joining the euro
• Since then, the ECB has been making monetary policy in Greece.
• What sort of monetary policy did it pursue?
• What is the best way to measure monetary policy?
• What is money?
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& Sustainable Development
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What is Money?
Textbooks and central banks do not tell us clearly:
 “It is much harder to measure than one would have first thought.” (p. 119)
Chamberlin and Yueh (2006)
 “Although there is widespread agreement among economists that money
is important, they have never agreed on how to define and how to
measure money” (Miller and Van Hoose, 2004:42)
 Today, even the Federal Reserve cannot tell us just what money is:
“there is still no definitive answer in terms of all its final uses
to the question: What is money?”
Centre for Banking, Finance
& Sustainable Development
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What is the Role of Banks?
Textbook View of Banks as Financial Intermediaries
RR = 1%
Saving
(Lenders,
Depositors)
Banks
& other financial
intermediaries
= “indirect finance”
Investment
(Borrowers)
Purchase of Newly Issued Debt/Equity
= “direct finance”/disintermediation
Thus when the financial crisis hit, the leading economics models and
theories did not include banks as they were not considered
important or special.
3
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What Makes Banks Special?
But empirically, it had been found that banks are special!
Their function cannot be easily replaced by other financial players or markets.
- Fama (1985) shows that banks must have monopoly power
compared to other financial institutions.
- Ashcraft (2005) shows that the closure of small regional banks
significantly hurts the local economy.
But economic theory could not explain why.
Here is why.
4
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Where Does Money Come From?
 Over 80% of the population thinks that it comes from the central bank
or the government.
 No money comes from the government.
 Only about 3% of the money supply comes from the central bank.
 Who creates the remaining 97% of our money supply and who allocates
this money?
The ‘leading’ economic journals and textbooks are silent on this.
Answer: The banks
 They are not financial intermediaries but the main creators of money.
They have a license to create money out of nothing.
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Banks Do Not Lend Money
Balance Sheet of Bank A
Step 1
Assets
Deposit of $100 by customer at Bank A
Liabilities
$100
Step 2
$100 used to increase the reserve of Bank A
Assets
Liabilities
$100
$100
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Banks Do Not Lend Money, They Create it!
Step 3
Loan of $9,900 granted, by crediting borrower’s bank account. Where do
the £9,900 come from? From nowhere. The borrower is treated as if
she/he or the bank had actually deposited the money, but no money
was deposited or transferred from anywhere else.
Assets
Liabilities
$100
+
$9,900
$100
+
$9,900
NB: No money is
transferred from
elsewhere
There is no such thing as a ‘bank loan‘.
Banks create money through ‘credit creation‘.
This is how 97% of the money supply is created.
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Bank Credit Creation: Not in Economics Textbooks,
but Admitted by Central Banks:
“The actual process of money creation takes place primarily in banks.”
(Federal Reserve Bank of Chicago, 1961, p. 3);
“By far the largest role in creating broad money is played by the banking sector
... When banks make loans they create additional deposits for those that have
borrowed.” (Bank of England, 2007)
“Over time… Banknotes and commercial bank money became fully
interchangeable payment media that customers could use according to their
needs” (ECB, 2000).
“The commercial banks can also create money themselves… in the eurosystem,
money is primarily created by the extension of credit… ….” (Bundesbank, 2009)
8
/
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Banks are Not Financial Intermediaries
RR = 1%
Saving
Banks
Investment
(Lenders,
Depositors)
(‘Financial
Intermediaries’)
=“indirect finance”
$99
$100
(Borrowers)
“direct finance”
They are the Creators of the Money Supply.
And they decide who gets the money and for which purpose it is used.
This decision shapes the economic landscape.
Banks thus decide over the economic destiny of a country.
Credit creation is the most important macroeconomic variable.
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The Quantity Theory of Credit (Werner, 1992, 1997):
 Money is best measured by its credit counterpart (C) which created it.
 Financial transactions are not part of GDP.
 If we want a link to GDP, we must divide money/credit into two streams:
C
Credit used for GDP transactions, used for the ‘real economy’
(‘real circulation credit’ = CR)
Credit used for non-GDP transactions (‘financial circulation credit’ = CF)
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The Quantity Theory of Credit (Werner, 1992, 1997)
∆(PRY)
= VR ∆CR
nominal GDP
∆(PFQF)
real economy credit creation
YoY %
YoY %
12
12
10
10
8
8
6
nGDP (R)
4
= VF∆CF
asset markets
financial credit creation
YoY %
YoY %
80
40
70
35
60
30
25
50
6
40
4
30
Nationwide Residential
Land Price (R)
Real Estate
Credit (L)
20
15
10
20
2
0
0
83
85
87
89
91
93
95
97
10
0
0
-5
99
-2
-4
5
2
-2
CR (L)
-10
-10
71
-4
73
75
77
79
81
83
85
87
89
91
93
95
97
99
01
Latest: H1 2001
Latest: Q4 2000
Real circulation credit determines
nominal GDP growth
Financial circulation credit determines
asset prices – leads to asset cycles
and banking crises
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Bank credit creation determines economic growth.
The effect of bank credit allocation depends on
the use money is put to
Case 1: Consumption credit
Result: Inflation without growth
Investment credit
(= credit for the creation of new
goods and services or
productivity gains)
Case 2: Financial credit
(= credit for transactions that do
not contribute to and are not part
of GDP):
Result: Growth without inflation,
even at full employment
Result: Asset inflation, bubbles
and banking crises
= productive credit
creation
= unproductive credit
creation
12
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Credit for financial transactions explains boom/bust
cycles and banking crises
 A significant rise in credit creation for non-GDP transactions
(financial credit CF) must lead to: 30%
- asset bubbles and busts
28%
- banking and economic crises
26%
 USA in 1920s: margin loans rose
from 23.8% of all loans in 1919
to over 35%
24%
 Case Study Japan in the 1980s:
CF/C rose from about 15% at the
beginning of the 1980s to almost
twice this share
16%
CF/C
22%
20%
18%
14%
12%
79
81
83
85
87
89
91
93
Source: Bank of Japan
CF/C = Share of loans to the real estate
industry, construction companies and nonbank financial institutions
13
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Warning Sign: Broad Bank Credit Growth > nGDP Growth
This Created Japan's Bubble.
YoY %
20
Broad Bank Credit
15
10
Excess Credit Creation
Nominal GDP
5
0
-5
-10
81
83
85
87
89
91
93
95
97
99
01
03
05
07
09
11
Latest: Q3 2011
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Out-of-control CF is the problem, creating the Bubbles
and Crises in Ireland, Spain
Broad Bank Credit and GDP (Ireland)
Broad Bank Credit and GDP (Spain)
30
100
90
25
80
20
70
60
15
50
10
40
30
5
20
10
0
nGDP
nGDP
0
-5
-10
-20
19
98
/
19 Q1
98
/
19 Q3
99
/
19 Q1
99
/
20 Q3
00
/
20 Q1
00
/
20 Q3
01
/
20 Q1
01
/
20 Q3
02
/
20 Q1
02
/
20 Q3
03
/
20 Q1
03
/
20 Q3
04
/
20 Q1
04
/
20 Q3
05
/
20 Q1
05
/
20 Q3
06
/
20 Q1
06
/
20 Q3
07
/
20 Q1
07
/
20 Q3
08
/
20 Q1
08
/
20 Q3
09
/
20 Q1
09
/Q
3
-10
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q
7/ 88/ 89/ 90/ 91/ 92/ 93/ 94/ 95/ 96/ 97/ 98/ 99/ 00/ 01/ 02/ 03/ 04/ 05/ 06/ 07/ 08/ 09/
8
19 19 19 19 19 19 19 19 19 19 19 19 19 20 20 20 20 20 20 20 20 20 20
Broad Bank Credit Growth > nGDP Growth
15
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Greece:
Management School
1993-2009: over 10% credit growth
1995-97: over 20% credit growth
2001-2: over 30% credit growth
Greece: Credit Creation
Index
YoY (%)
500
50
400
40
Bank Loans (R)
300
30
200
20
100
10
0
0
nGDP
-100
Central Bank LLI
(L)
-10
-200
-20
81
83
85
87
89
91
93
95
97
99
01
03
05
07
09
11
Latest: Oct 2012
RESEARCH CENTER LTD.
Broad Bank Credit Growth > nGDP Growth
16
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What happened in 1993/4? And in 2000/1?
• The Bank of Greece was established by League of Nations (Annex
to the Geneva Protocol of 1927) in 1928, as a Société Anonyme
• In 1994, the Bank of Greece was made more independent from
the government, and monetisation of government policy stopped.
“As of 1994 the Bank of Greece no longer provides finance in any form to
the public sector. …prohibition of monetary financing.” (Bank of Greece)
• In 2000, the Bank of Greece was made fully independent from
the government, without democratic accountability.
• In 2001, the Bank of Greece became an integral part of the ECB.
• Note: the ECB is independent of and unaccountable to any
government or democratically elected assembly in Europe
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The Great Greek Asset Bubble of 1994-2009
• was created by the policy of excessive credit creation by the
Greek central bank and the ECB.
• increased tax revenues and economic growth projections.
• encouraged the government to overspend and undersave significantly
• the bubble was unsustainable – as they always are – and thus would,
without fail, result in a banking crisis and a fiscal crisis
• what happened since 2009 has been predictable and was caused
by the monetary policy of the central bank and the ECB.
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Greece:
Management School
1995-97: over 20% credit growth
2001-2: over 30% credit growth
Greece: Credit Creation
Index
YoY (%)
500
50
ECB control
Independence
from govt
400
300
40
30
Bank Loans (R)
200
20
100
10
0
0
Central Bank LLI
(L)
-100
-10
-200
-20
81
83
85
87
89
91
93
95
97
99
01
03
05
07
09
11
Latest: Oct 2012
RESEARCH CENTER LTD.
19
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The Solution, as told by the ECB:
• Greece must increase its debts by borrowing more from the
IMF/EU/ECB.
• An exit from the euro or full default must not happen.
• Greece must implement deep fiscal and welfare cuts.
• All must tighten their belts.
• The ESM must be established and fiscal policy controlled
centrally by the EU/ECB (loss of national sovereignty).
BUT: No policies to stimulate growth and employment!
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What must happen with shrinking credit creation?
A deepening slump and higher unemployment
Greece: Credit Creation
Index
YoY (%)
500
50
400
40
300
30
Bank Loans (R)
200
20
100
10
0
0
Central Bank LLI
(L)
-100
-10
-200
Bank credit
creation:
-7.2% YoY
-20
81
83
85
87
89
91
93
95
97
99
01
03
05
07
09
11
Latest: Oct 2012
RESEARCH CENTER LTD.
21
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The same is happening in Ireland, Portugal, Spain & Italy
Ireland Liquidity
YoY(%)
Index
1200
1100
1000
900
800
700
600
500
400
300
200
100
0
-100
-200
110
100
90
80
70
60
50
40
30
20
10
0
-10
-20
Bank credit: -17% YoY
Bank Loans (R)
LLI (L)
81
83
85
87
89
91
93
95
97
99
01
03
05
07
09
11
Portugal Liquidity
YoY(%)
Index
800
750
700
650
600
550
500
450
400
350
300
250
200
150
100
50
0
-50
-100
-150
Bank credit: -6.6% YoY
Bank Loans (R)
LLI (L)
81
83
85
87
89
91
93
95
97
99
01
03
05
07
09
11
Latest: Aug 2012
RESEARCH CENTER LTD.
300
250
Italy Liquidity
YoY(%)
Bank credit: -1% YoY
200
500
25
400
20
Bank Loans (R)
10
5
100
5
0
0
0
-5
LLI (L)
-100
20
Bank Loans (R)
200
10
0
25
15
100
-50
Bank credit: -0.3% YoY
300
15
C
YoY %
Index
30
150
50
Latest: Oct 2012
RESEARCH CENTER LTD.
Spain Liquidity
Index
55
50
45
40
35
30
25
20
15
10
5
0
-5
-10
-100
-5
-10
-150
-15
87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12
Latest: Oct 2012
LLI (L)
-200
81
83
85
87
89
91
93
95
97
99
01
03
05
07
09
-10
11
Latest: Oct 2012
RESEARCH CENTER LTD.
RESEARCH CENTER LTD.
22
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But there is a solution – without costs and fiscal pain,
producing a recovery and lower unemployment
• the policy proposal would have reduced government debt and deficits
• it would solve the funding problem in the bond markets
• it would help the banks and increase credit creation without extra
costs
• no need for centralisation of fiscal policy or issuance of European gov’t
bonds
23
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How to Create A Recovery After a Banking Crisis:
Werner-Proposal of 1994:
A new policy called “Quantitative Easing” = Expansion in
Credit Creation = Total Effective Purchasing Power
Richard A. Werner, Create a Recovery Through Quantitative Easing,
2 September 1995, Nihon Keizai Shinbun (Nikkei)
24
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Applying this Framework to Solving the
European Sovereign Debt Crisis
Werner-Proposal of 2011
 Greece, Ireland, Portugal, Spain and Italy need to stimulate economic
growth. This means stimulation of credit creation.
 Their governments need to save money and reduce borrowing costs.
 Bank credit growth needs to expand and banks need a safe way to
expand their business and their returns
 Here is how all of this can be achieved:
 Governments need to stop the issuance of government bonds
 Instead of borrowing from the bond markets – who do not create
money – governments should fund their borrowing requirements
entirely by borrowing from all the banks in their country.
25
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Werner-Proposal: The solution that maintains the euro and
avoids default
 Governments should enter into 3-year loan contracts at the much lower
prime borrowing rate.
 Eurozone governments remain zero risk borrowers according to the
Basel capital adequacy framework (banks are thus happy to lend).
 The prime rate is close to the banks’ refinancing costs of 1% - say 3.5%.
 Instead of governments injecting money into banks, banks create
new money and give it to the governments.
26
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Why fiscal spending programmes alone are ineffective
Fiscal stimulation funded by bond issuance
(e.g. : ¥20trn government spending package)
Non-bank private sector
(no credit creation）
-¥20trn
Funding
via
bond
issuance
+¥20trn
Fiscal
stimulus
Ministry of Finance
(no credit creation)
Net Effect = Zero
27
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How to Make Fiscal Policy Effective
Fiscal stimulation funded by bank
borrowing
(e.g. : ¥20trn government spending package)
Bank sector
deposit Non-bank private
(credit creation power)
sector
Assets　Liabilities
(no credit creation)
¥20 trn
¥20 trn
+¥ 20 trn
Funding
via bank
Loans
MoF
(No credit
creation)
Fiscal
stimulus
Net Effect = ¥ 20 trn
28
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Advantages of this Proposal
 The proposal will not increase aggregate debt.
 Each country remains in charge of and liable for its debts.
 No further ECB intervention required or purchases by the EFSF/ESM
 The immediate savings will be substantial, as this method of enhanced
debt management reduces the new borrowing costs, even below postECB-purchase yields (E 10bn in the coming year for Italy alone).
 This helps the banking sector, as its core business, to extend credit, is
expanded, thus increasing retained earnings.
 These can then be used by banks to shore up their capital. Thus there
are substantial savings to the taxpayer as new bank rescues become
unnecessary.
29
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Advantages (II)
 This proposal addresses the core underlying problem: slowing growth
and the need to stimulate it. The proposal will boost nominal GDP
growth – and avoid crowding out from the bond markets.
 This is a problem as tight fiscal policy and tight credit conditions slow
growth, with bank credit shrinking: Germany (-0.1%), Greece (-3.5%),
Spain (-0.5%), Ireland (-14%).
 Bank credit extension adds to the money supply. From the credit model
we know that the proposal will boost nominal GDP growth – and avoid
crowding out from the bond markets.
 This increases employment and tax revenues.
 It can push countries back from the brink of a deflationary and
contractionary downward spiral into a positive cycle of growth, greater
tax revenues and falling debt/GDP.
30
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Prime Rate vs. Market Yield of Benchmark Bonds: Portugal
8.00%
6.00%
6.00%
4.00%
4.00%
2.00%
2.00%
20
12
8.00%
20
11
10.00%
20
10
10.00%
20
09
12.00%
20
08
12.00%
20
07
14.00%
20
06
14.00%
20
05
16.00%
20
04
16.00%
20
03
18.00%
20
03
18.00%
Latest July 2012
Portugal Prime Rates on Existing Loans to Non-Fin. Crops., Over 5 Year Maturity (%)
Portugal 10y Government Benchmark Bid Yield - Redemption Yield (%)
Portugal 5y Government Benchmark Bid Yield - Redemption Yield (%)
Source: Thomson
Reuters Datastream, ECB
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Prime Rate vs. Market Yield of Benchmark Bonds: Spain
1.70%
1.70%
20
12
2.70%
20
11
2.70%
20
10
3.70%
20
09
3.70%
20
08
4.70%
20
07
4.70%
20
06
5.70%
20
05
5.70%
20
04
6.70%
20
03
6.70%
Latest July 2012
Spain Prime Rates on Existing Loans to Non-Fin. Corps., Over 1 Year Maturity (%)
Spain 5y Government Benchmark Bid Yield - Redemption Yield (%)
Spain 10y Government Benchmark Bid Yield - Redemption Yield (%)
Source: Thomson
Reuters Datastream, ECB
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Prime Rate vs. Market Yield of Benchmark Bonds: Greece
62.00%
52.00%
52.00%
42.00%
42.00%
32.00%
32.00%
22.00%
22.00%
12.00%
12.00%
2.00%
2.00%
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
20
12
62.00%
Latest: July 2012
Greece Prime Rates on Existing Loans to Non-Fin. Corps., Over 5 Year Maturity (%)
Greece 10y Government Benchmark Bid Yield - Redemption Yield (%)
Greece 5y Government Benchmark Bid Yield - Redemption Yield (%)
Source: Thomson
Reuters Datastream, ECB
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Other solutions exist
 Bad debts in the banking system: can be extinguished at zero cost by
central bank purchases at face value (and not marking to market). As
done by the Bank of England 1914 and Bank of Japan 1945
 Central banks should be made accountable to parliaments
– This was the lesson from the Bundesbank. Normally it is said that the ECB is a
good central bank, because it is modelled on the successful Bundesbank.
– This is not true. The lesson from the Bundesbank was to make the central bank
accountable to parliament – its predecessor was not, and it was one of the most
disastrous central banks (Reichsbank).
– The ECB is the revived Reichsbank, unaccountable to parliaments
 Bank credit should be monitored to prevent harmful speculative
credit creation and encourage productivity (credit guidance – the
secret of the success of Japan, Taiwan, Korea and China).
34
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Solutions exist
 Redesign the banking sector so that it consists of not-forprofit, local banks (like in Germany, public savings and
Regional,
cooperative banks)
foreign,
other
banks
Large, nationwide
Banks 12.5%
17.8%
Local cooperative
banks (credit unions)
26.6%
Local gov’t-owned
Savings Banks
42.9%
 The monetary system should be changed: do banks need to
be the creators of the money supply?
35
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State Money: Less Debt, Lower Taxes, More Growth,
More Equality and Fairness
China: Government-issued paper money (Kublai Khan)
Zero Government Debt, Zero Interest Payments
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State-Issued Money
太
政
官
Dajōkan
satsu
札
Japan: Government-issued paper money: 1868
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State-Issued Money
Colonial Scrip in North American British Colonies
“In the Colonies we issue our own money. It is called Colonial Scrip. …we
control its purchasing power, and we have no interest to pay to no one.”
(Banjamin Franklin, quoted by Senate Robert Owen, National Economy and the Banking System, Senate
document 23, Washington DC: US Gov’t Printing Office, 1939, p. 98)
38
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Colonial Scrip Banned by
Britain (Currency Act
1751 and 1764,
forbidding scrip to be
designated legal tender
and to settle private debt.)
Was the War of Independence fought over taxes on tea? (‘Boston Tea Party’)
Or over new English legislation forcing colonies to abandon their paper
money and use gold and silver?
“The Colonies would gladly have borne the little tax on tea and other matters had
it not been that England took away from the Colonies money, which created
unemployment and dissatisfaction” Benjamin Franklin (as quoted by R. Owen, 1939, op. cit).
39
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State-Issued Money
President Lincoln issued United States Notes
1863 United States Notes, aka ‘Greenbacks’
1862, President Lincoln signed the First Legal Tender Act
“The underlying idea in the greenback philosophy… is that the issue of
currency is a function of the government, a sovereign right which ought not
40
to be delegated to corporations.”
Davis Rich Dewey (MIT, 1902)
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State-Issued Money
Deutsches Reich: German government-issued paper money41
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Britain
1917
UK: Government-issued paper money: 1914-1928
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State-Issued Money
Island of Guernsey: Government-issued paper money
‘In 1817, the Island was desperately in need of infrastructure investment, but it was bereft of
money. The interest payments alone accounted for most of their tax revenue. They found that they
could not bleed any more taxes out of the people and they could not afford to borrow any more
money.’
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State-Issued Money
Management School
The standard
‘Federal
Reserve Note’
JFK’s 1963
‘United
States Note’:
No Fed seal
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Thomas Edison:
“People who will not turn a shovel full of
dirt on the project (Muscle Shoals Dam)
nor contribute a pound of material, will
collect more money from the United
States than will the People who supply all
the material and do all the work.
This is the terrible thing about interest ... But here is the point: If the Nation can issue a
dollar bond it can issue a dollar bill. The element that makes the bond good makes the bill
good also. The difference between the bond and the bill is that the bond lets the money
broker collect twice the amount of the bond and an additional twenty percent. Whereas
the currency, the honest sort provided by the Constitution, pays nobody but those who
contribute in some useful way. It is absurd to say our Country can issue bonds and cannot
issue currency. Both are promises to pay, but one fattens the usurer and the other helps the
People. If the currency issued by the People were no good, then the bonds would be no
good either. It is a terrible situation when the Government, to insure the National Wealth,
must go in debt and submit to ruinous interest charges at the hands of men who control
the fictitious value of gold. Interest is the invention of Satan.”
in The New York Times, December 6, 1921
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Further Reading:
Basingstoke: Palgrave Macmillan, 2005
New Economics Foundation, 2011
Centre for Banking, Finance
& Sustainable Development
Management School
Weitere Details:
München: Vahlen Verlag, 2007
M. E. Sharpe, 2003