Monday, 27 August 2012

Positive Money

A few people have asked me what I think about the proposals put forward by Positive Money:

Positive Money believes that the root cause of many of our current social, economic and environmental problems lies in the way that we allow money to be created. We campaign for fundamental reform of a system that is fueling debt, poverty and our economic and environmental crises.

Good start, agreed so far.
They have a good page explaining how the banking system works in general, the nub of which is this:

A customer, who we shall call Robert, walks into RBS and asks to borrow £10,000 to buy a new car. Robert signs a contract with the back confirming that he will repay £10,000 over a period of five years, plus interest. This legally enforceable contract represents a future income stream for the bank, and when the bank comes to draw up its balance sheet it will be included as an additional asset worth £10,000.

Robert, having committed to pay the bank £10,000, wants to receive his ‘loan’. So RBS opens up [a deposit] account for him, and types in £10,000. This is recorded as a liability on RBS’s balance.

Notice that no money was transferred or taken from any other account, the bank simply updated a computer database. A bank does not ‘lend money’ – to lend one must have money to lend in the first place. In reality a bank creates credit – money – when it advances loans.

A process which we can refer to as 'splitting the zero'. At least with a car loan, the bank is oiling the wheels of commerce a bit. Robert gets his car earlier than otherwise, the manufacturer can sell an extra car and the bank assumes the risk of non-payment by Robert (instead of the manufacturer having its own leasing-finance division, which many of them do).

Apply the same process to buying land, and the bank isn't actually providing anything (it does nothing to create the land rental values), it's just merrily splitting the zero, paying 2% on the deposit side and collecting 5% on the loan/mortgage side, so ultimately it is collecting land rent. If prices are high enough and interest rates are high enough, the bank is collecting more than the total rental value - from buyers who reckon that it is worth taking a small extra net monthly outlay on the chin (mortgage interest exceeds rental value) in order to make capital gains (and there are hundreds of thousands, if not millions, of such people at the moment).
They point out that the bulk of bank lending is for purely speculative purposes and address the housing bubble:

If you allow banks to create money when they make loans, and you allow them to pump the bulk of this newly money into a housing market with relatively limited supply, then house prices will go up...

A rising house price was treated like an unexpectedly sunny bank holiday; everyone was expected to rush to take advantage of the opportunity before it was over. I don’t recall seeing any decent analysis explaining that overall, constantly rising house prices simply benefit banks and the few individuals who plan to sell up and move into an old folks’ home or a caravan.

Again, completely agreed. If you minus off bricks and mortar from house prices, what you are left with is land speculation. Land prices are the product of about four variables:
+ the actual rental value of any site
- recurring taxes thereon
x availability of credit
+/- bubble/hope/despair element.

To choke this off you just need to bring the end value down to zero. Gross land rental values are A Good Thing of course, but if we taxed away those rental values, there'd be nothing left to speculate on. And the big bonus is that we can then phase out all the bad taxes on earned income, output and profits. Or a government could credibly threaten to do something which would cause land prices to plunge in the near future so that the negative 'despair' element brought selling prices down to nothing.
Positive Money are mildly sympathetic to Land Value Tax, but their preferred method is to reduce the amount of credit which commercial banks can create, which they explain here (pdf).

Briefly and broadly speaking, there will be two kinds of deposit account:

* Transaction accounts, which will be backed 100% by government bonds or deposits at the Bank of England, which will pay little or no interest and which will bear charges. So the government can limit the total amount of money in these accounts by reducing the amount of government bonds in issue or the BoE refusing to accept any more deposits.

* Investment accounts... In order to lend money after the reform is implemented, banks will need to find customers who are willing to give up access to their money for a certain period of time. In practice, this means that the customer will need to invest their money for a defined time period (1 month, 6 months, 2 years, for example) or set a minimum notice period that must be given before the money can be withdrawn (e.g. 7 days, 30 days, 60 days, 6 months).

Banks will then operate in the way that most people think they currently do - by taking money from savers and lending it to borrowers (rather than creating new money (deposits) whenever they make a loan, and walking a tightrope between maximizing profit and becoming insolvent).

Well, no.

On a purely practical level it will be easy to circumvent this and banks will be able to merrily continue splitting the zero so that people can speculate on rising land values.

i. Wadsworth Bank plc holds some spare government bonds, not matched by and in excess of WB's transaction accounts.

ii. Robert wants to take out a mortgage. WB can only make this loan by lending him some bonds. WB records this as a financial asset (it doesn't matter whether WB gives him notes and coins, a cheque or a number on a computer screen, the loan is always recorded as an asset in £-s-d in WB's books).

iii. Robert gives those bonds to the vendor, who turns up a few minutes later at WB (or any other bank, doesn't matter as banks are a closed loop) to deposit his bonds safely.

iv. WB's counter staff explain to the vendor that they are happy to open a transaction account to hold his bonds, but point out that if he leaves his money there, he will earn zero interest. Would the vendor not like to transfer money from his transaction account to an investment account paying a few per cent interest?

v. So the vendor does so. This means that WB no longer has to hold those bonds in a matched account on the vendor's behalf; WB now holds them as spare bonds on its own account again, which is can lend to the next would-be purchaser who walks through the door. Rinse and repeat.

vi. The end result of this is that while the total value of transaction accounts at WB and all other banks is fixed and constant, the total value of its assets (money lent to purchasers) and the total value of its investment accounts (money taken from vendors) is unlimited, and WB is still 'splitting the zero' into ever increasing amounts of mortgages and investment accounts.

vii. So we get the house price bubble going again nicely, until it all goes wrong again, at which stage the government steps in to guarantee investment accounts again.

For sure, we can think up all sorts of extra measures to stop banks from circumventing this, for example by making loans to acquire land (in excess of the rebuild cost/value of buildings thereon) unenforceable, not registering them at HM Land Registry etc.

But the land rents will still be collected privately; if current land owners can't sell to mortgage borrowers then vendors will just sell them to real Estate Investment Trusts in exchange for shares, and then the vendors can sell the shares for cash, or something, and if the REIT wants to sell residential land, it will do so with Islamic mortgages (where the borrower is legally a tenant for a fixed rent for a long fixed period, and ends up repaying exactly the same amount as if he'd taken out a mortgage at interest).
Finally, Positive Money make the assumption that the UK government actually wants to do anything about banking and land speculation. (The idea of taxing the rental value of land instead of taxing earned income faces the same problem, of course, but at least with that you can make it immediately clear that there would be far more winners than losers, hoping to grab the votes of the winners, and that the overall gains to society or to the economy would vastly outweigh any short-term collateral damage.)

The UK government has no intention of doing anything to cut the banking sector down to size or to end the house price bubble. Not only does this ensure them the continuing support of the vested interests and the promise of cushy well-paid jobs once they are booted out of office, in a perverse sort of way, rising house prices have shown themselves to be electoral gold.
And even if we the UK government were entirely benevolent and motivated by the overall interests of its citizens, how will they know what the correct total level of transaction accounts is?


Ralph Musgrave said...

Mark, I think that’s not a bad summary of Positive Money’s ideas. Plus I agree that private banks will always try to circumvent restrictions put on their money creation activities.

However I’m puzzled by the process you set out involving Robert getting a mortgage from Wadsworth Bank. In particular, I don’t see what government bonds have to do with it. There is nothing in Positive Money literature nor in the literature produced by other advocates of full reserve banking, far as I know, that says (as per your item “ii”) that banks “can only make this loan by lending him some bonds”.

The loan making process is described on p.9 of this submission to the Vickers commission (though preceding pages are relevant if you want the full picture).

Submission URL is:

Under a Positive Money / full reserve system a bank can only make loans using money that depositors have told the bank they’re happy to see loaned on or invested. Thus when making a loan, the law would state that a bank cannot make a loan unless it has a sufficient stock of money which depositors have said they’re happy to see used in this way.

Of course, a naughty bank could always just ignore the law, and lend in the way that banks currently do: creating the relevant money out of thin air. And the only way of preventing this would be to include in bank audits a check on whether banks are actually abiding by the above law.

Mark Wadsworth said...

RM: " a bank can only make loans using money that depositors have told the bank they’re happy to see loaned on or invested."

Sure yes. My first draft assumed that WB asks a depositor to kindly waive his transaction account (freeing up the bonds) and convert it into an investment account.

But it all comes to the same thing - banks can still split the zero into a mortgage and an investment/deposit account. The fact that the total value of transaction/deposit accounts is fixed and frozen would not affect this.

James Higham said...

Positive Money believes that the root cause of many of our current social, economic and environmental problems lies in the way that we allow money to be created. We campaign for fundamental reform of a system that is fueling debt, poverty and our economic and environmental crises.

The basic error with all these theorists is they say "we allow". "We" haven't done anything - it is foisted upon us from above.

Mark Wadsworth said...

JH, to paraphrase: "We allow them to foist it upon us..."

We, collectively, allow this to happen by celebrating high house prices and believing their crap about super-profitable banks being vital to the economy, we put up with the endless bail outs of banks etc.

And we, collectively, keep voting for one or other of the two wings of the Home-Owner-Ist Party, red or blue wing, makes no difference. You have seen for yourself the grief I get when I suggest sorting it all out at a stroke with LVT.

QP said...

I think I need to do a bit more reading on this, would +ve money like all banks to be like the old building society model?

Another alternative proposed in other quarters would be to link mortgage lending not to incomes but to local rents. One benefit of this could be the development of a formal system of rent assessments outside of government which could then be used as the basis for an annual tax(!)

Mark Wadsworth said...

QP, I think their idea is more fundamental than that.

Now, as it happens, the building societies 'worked' because of additional restrictions placed on them and not because they were prevented from 'splitting the zero'. If you allow a building society to accept deposits from a vendor who is depositing the proceeds of the sale of a house, then you have split the zero, end of discussion.

Some sort of cap on mortgage lending is always good, but the simplest is to simply tax privately collected land rents out of existence so that no mortgage ever needs to be for more than the bricks and mortar value.

Graham Hodgson said...

Needless to say, we at Positive Money don't agree with this depiction of our proposals, nor with the conclusions regarding "splitting the zero" but we welcome the attention given and we have had a fruitful debate with Mark over the last few days.

Briefly, we go beyond the old Chicago Plan requirements for banks to hold bonds or central bank deposits to back their deposit liabilities to their customers. We remove transactions accounts entirely from banks' balance sheets.

All transactions accounts will be central bank money, not commercial bank liabilities. Banks will not therefore be able to split the zero by creating new deposits for borrowers.

Banks will lend by transferring money from an existing investment fund to the transaction account of the borrower, or of the person with which the loan is to be spent.

The money in the investment fund will come from the transactions accounts of customers who wish the banks to invest their money. Once the fund is spent, no more loans can be extended until existing loan repayments are received or new investors provide further funds from their transactions accounts.

Simulations of mortgage lending suggest that, depending on assumptions concerning interest rates and securitisations, there will be a reduction in the growth of mortgage debt of between 72% and 92% under our proposals.

Mark Wadsworth said...

GH, OK, let's take the simplest possible model, all "money" is replaced with coins and notes, of which there is a precisely rationed amount.

WB starts off with £100 cash from shareholders (me). Total assets/liabilities £100.

WB lends £100 coins and notes to mortgage borrower who gives them the vendor of land (or shares).

Vendor pays the coins and notes back into WB, and I persuade him to open an investment account.

Total assets/liabilities now £200.

Because those coins and notes are not in an earmarked transaction account, WB does not need to keep them in the safe in case vendor comes back - WB is free to lend them out again.

WB then lends the same coins and notes to the next mortgage borrower who walks in the door, he gives them to another vendor who returns them to WB and opens another investment account.

Total assets/liabilities now £300.

Rinse and repeat. The fact that there is only a limited amount of coins and notes, or a limit to total balances held with the BoE or a limited amount of gold coins or anything else does not stop WB from splitting the zero.

Graham Hodgson said...

"Because those coins and notes are not in an earmarked transaction account, WB does not need to keep them in the safe in case vendor comes back - WB is free to lend them out again."

This isn't an issue anyway. WB never has to keep customers' coins and notes in the safe. Any money a customer pays over to WB, that's WB's property. What a customer retains in his transaction account doesn't even feature on WB's books.

WB does not split the zero when a vendor recipient of borrowed money chooses to open an investment account with the proceeds, since WB has not created the investment account liability in the course of acquiring the loan asset. The liability follows only if the vendor separately makes the decision to entrust to the bank the sales proceeds arising from the spending of the loan. The chain of causality is broken with the loan. The money leaves the bank's books as soon as it is lent. The notes and coins lent out had belonged to the bank, since its investing customers had paid them into the bank's fund, but the bank has spent them in acquiring the borrower's loan obligation. The vendor recipient of the borrowed money, being in the happy situation of not needing to spend the money, is free to give it to any fund manager it chooses to invest on his behalf. Every fund manager acquires new liabilities when investors pay over their subscriptions and every fund manager uses those subscriptions to buy existing loan and equity assets or create new ones by subscribing to new issues. The Positive Money bank has no special status in this regard: the bank can only buy existing assets, or create new ones by subscribing to new issues or lending directly, using the money already existing in its fund. It cannot create new deposits in the course of making loans so it can't split the zero.

Graham Hodgson said...

To clarify my earlier comment, I'm not claiming that if the recipient of borrowed money chooses to hand it to a bank to invest then the bank's liabilities will not increase. What I am saying is that this is not the exponential process of money/debt creation characterised as splitting the zero.

Derek said...

Mark, thank you for making that clear and simple to understand.

I am constantly amazed by the number of people who think that our current problems are down to Fractional Reserve Banking or the "impossibility" of paying back Principal+Interest when the banks only lent Principal in the first place or whatever when it's so easy to demonstrate that they're not.

The fact is that while it's obvious that something is "wrong" with our current monetary system, it is not at all obvious what that something is. And people tend to jump on the first thing they see that looks "iffy".

I've been looking at this issue since the 1980s and while it quickly became obvious to me how the physical side of the economy works, I'm still groping my way to a full understanding of the financial side.

My main conclusion after all this time is that barter economies are easy to understand; money/debt economies are hard.

Mark Wadsworth said...

GH: It cannot create new deposits in the course of making loans so it can't split the zero.

Yes it can. I just explained it.

I'll number the steps this time so that you can tell me exactly which of these steps is no longer possible under the Positive Money proposals.

Please assume in ALL cases that the accounts which vendors open are 'investment accounts'

Please note, I am using "coins and notes" just to make it really simple. Exactly the same principle applies to "earmarked balances held by commercial banks with the bank of england".

1. WB starts off with £100 of its own cash obtained from shareholders. Total assets/liabilities £100. That's WB's money in every sense of the word so WB is free to lend it out.

2. WB lends £100 coins and notes to mortgage borrower who gives them the vendor of land. WB records the loan as an asset.

3. Vendor pays the coins and notes back into WB, and I persuade him to open an investment account, which WB records as a liability. Total assets/liabilities now £200.

4. WB does not need to keep the coins and notes n the safe (analogous to earmarked funds held with BoE) because I have the permission of the vendor/depositor to use them to make loans in case vendor comes back - WB is free to lend them out again.

5. WB then lends the same coins and notes to the next mortgage borrower who walks in the door, he gives them to another vendor.

6. The vendor from 5 returns the notes and coins to WB and opens another investment account. Total assets/liabilities now £300.

That's all I need you to tell me - which one of these six steps will no longer be possible under your proposals.

And then tell me why. You will note in this example that the total amount of cash in circulation does not change and cannot change. But the bank's assets/liabilities can go up.

Mark Wadsworth said...

D: "barter economies are easy to understand; money/debt economies are hard"

That's the beauty of it, you can do economics perfectly well while completely ignoring the concept of "money" and assuming it's all done in barter.

Let's assume you can buy or rent a particular farm, and the rent is one cow per month, or the landowner is prepared to swap it for one hundred cows in full and final.

Maybe that's a fair deal. But what if the vendor says that he will sell you it on a mortgage for two cows a month for ten years, after which it's yours? And if you ever miss a 'payment' then there's a penalty of an extra cow in the next month?

Assuming you're reasonably trustworthy, the farmer can take that written promise from you and exchange it for something else etc.

Perhaps there is a cow disease so the value of a cow goes up but you still owes the vendor two cows per month, that vendor has now become 'richer' (albeit you are a worse credit risk - maybe you start giving the vendor cows out of your 'stock' and running down your herd?).

And so on and so forth. You can make it up as you go along, but you can have interest and speculation and 'credit bubbles' even in a barter economy.