Monday, 25 March 2013

Economic Myths: Capital controls

Today's City AM gleefully grabs the wrong end of the stick:

THERE is something truly terrifying about capital controls, the harsh restrictions that may soon be imposed on Cypriots. The freedom to take your money out of a country, and into another, at will and with no taxes, is an essential bulwark of a free society. It is also a central tool in a world of globalised commerce, multinational corporations, the internet and integrated supply chains.

The free movement of capital helps maximise an economy’s efficiency by allowing capital to be allocated where it is the most needed, regardless of country, and where it can generate the best risk-adjusted returns.

I am in principle against restrictions on people moving 'money' between bank accounts in different countries (provided governments are clued up enough to have a system of withholding taxes so this is not used for tax evasion), he is confusing 'money' with 'capital'.

1. To recap: 'money' doesn't really exist, it is a unit of measurement of indebtedness. Unless there is somebody somewhere prepared to run up debts (and thus create a financial liability) it is impossible for somebody somewhere else to have a financial asset. This does not apply to physical things which can be used as a convenient unit for barter transactions, like gold, but that is pretty much a red herring (you can still have debts denominated in units of gold). And if money does not exist it cannot be 'capital'.

2. 'Capital' on the other hand is real stuff, physical assets created by people; the value of your education; or the extra profits which arise (i.e. the extra capital creating capacity) when people specialise and trade with each other. So if you borrow €10,000 to buy a car, you have a real asset (a car) and a financial liability of €10,000. The hire purchase company has a financial asset of €10,000. You cannot simply add the real asset and the financial asset together to arrive at total assets of €20,000. It makes far more sense to count the car as a real asset of €10,000 and to net the financial liability and the financial asset off to nothing. Or let's imagine you borrowed the € 10,000 from an uncle who then dies and you inherit the financial asset, which you match off with your liability (you cannot owe yourself money). The total amount of real capital in the real world is unchanged when your uncle dies (depending on whether he could earn enough to pay for his own keep, it might actually be slightly reduced or increased).

3. So the only sensible starting point for looking at 'money' is the borrower himself and what the loan is secured on. In the context of Cyprus, let us assume that the government has issued bonds and wasted a lot of the money; the government has a nominal liability but no corresponding assets. Or the Cypriot banks have lent money secured on inflated land prices (they convert the rental value of land to a stream of interest payments), the loans are not secured on 'land' (which has no inherent value and does not generate cash or wealth) so the only source of income to pay the principal and interest is the borrower's real earnings (the extra amount he is willing or forced to pay to occupy if he wishes to occupy any particular site).

4. Some mortgage borrowers cannot or do not want to repay the full amount but the banks still have the nominal liability from taking in new savings or simply recycling the sales proceeds of the land as deposits again (splitting the zero). The bank's liabilities (deposits) are not some independent thing called 'money' which can be withdrawn or spent anywhere, they are a claim on the borrower's future income.

5. So while, in a perfect world, you can move your 'money' from one bank or one country to another, you cannot possibly move that borrower's source of income from one country to another, and you certainly cannot move the land value (ransom value) on which it is secured from one country to another. And if you own Cyprus government bonds, you can put them in a suitcase and move abroad, but you will still have to rely on the Cypriot government to actually pay up. Or taking the car example from 2. above, the hire purchase company can shift its head office to anywhere it likes, but the car owner is still (probably) in Cyprus.

6. So to sum up, what depositors in Cyprus banks and holders of Cypriot government bonds actually own are IOUs issued by people who can't or won't repay in full. The fact that the original nominal value of a deposit or bond was €100 is nigh on irrelevant. If the borrower (the person who issued the IOU) will only repay €80 then you do not have a deposit or bond of €100, you have a deposit or bond of €80.

7. If we accept that restrictions on moving 'money' are bad, then the corollary is that if you want to withdraw your entire deposit of €10,000 from a Cypriot bank and put it in a presumably safer German bank, you have to accept that the German bank will look at what they are really getting in exchange, which is an IOU issued by a Cypriot mortgage borrower or the Cypriot government, which is worth €8,000 and if they are acting rationally, they will offer you a deposit of €8,000 in exchange.

8. So you pays your money and you takes your choice. Do you prefer €10,000 in a Cypriot bank or €8,000 in a German bank? Or more realistically, do you prefer €10,000 nominal in a frozen Cypriot bank account which you can't access (and so it worth a lot less than €10,000, depending on how urgently you need it) or €8,000 in a German bank which is freely accessible?

9. If you take the common sense view, then the last sentence of the excerpt is complete gibberish. The real capital, in our example a car, will go to where it is most needed. So if you earn €20,000 from using the car in your window cleaning or delivery business in Cyprus but can earn €30,000 a year by taking it to Greece or Northern Cyprus or anywhere else, then that is what you will do .

10. Or taking a wider view, capital does not exist in a vacuum and pays for itself anyway. If somebody works out that it would be profitable to build a dam or a factory in Country XYZ, you need architects, engineers and workers to be in that country on the ground to build it, and you need workers and managers to run the factory, you need there to be demand for the hydro electric power which the dam generates, you need customers who will buy your output, or a delivery chain and infrastructure to get your output to the market. All the finance providers do is oil the wheels a bit and speed things up; in theory, the architects and workers could club together and do the construction "for free" in exchange for getting a share in the future income from the electricity users or the manufacturer who owns the factory etc.

It cannot possibly be a pre-condition that 'money' exists first and this allows capital to come into existence, because 'capital' was there first (the first tool or shelter fashioned by hand was 'capital') and 'money' did not exist until somebody was prepared to run up a debt.


Robin Smith said...

Good one. Trouble is no one believes these observations. Key word being *belief* here. And if what people believe is different to reality, then that is the end of the matter. Its a purely religious experience , secular or not. Id say that anyone who believes that money is wealth is highly religious even if they claim not to believe in 'higher' things and that this kind of belief is even worse. We must get our heads around this and affirm to ourselves that most people are yes, living in a fundamentalist monetary world believing it to be wealth, contrary to all observation. Dont worry yourselves with secular Islam and Rome, they are puny in terms of belief.

One thing rarely seen is that when money is used to buy some goods with, that is only half the exchange. The buyer gives money because he wants capital more than the money.

And the seller wants money more than the sold goods, so that he can buy some other goods that he wants too.

Ignoring this simple observation, only seeing half the exchange, is why people believe that money is wealth. They cannot see that money is merely an extremely efficient means of exchange.

The worst examples of this are the gold bugs who think gold is the best kind of money, or the bitcoin or electronic money religious. They too confuse a commodity(gold) with a money token(gold). Living in a parallel universe means it can be both a commodity AND money at the same time. Clearly preposterous, yet believed.

Gold is a terrible form of money because it is extremely expensive to create as money. Debit money has almost zero cost of production so is extremely good money because it only has use in exchange and cannot be used as a commodity too.

Nevertheless, both are money only when used in exchange. I know so many high ranking money reformers and professors of economics who do not *believe* this. They know very little about the nature of money and are paid and funded very well to remain that way.

Mark Wadsworth said...

RS, yes, those are important further points, i.e. we actually live in a barter economy (always have done, always will), we just use a standardised unit to measure [one half of] each barter exchange for convenience.

Anonymous said...

Yes but... Euros ate iou's issued by the ECB. Euros are the EU currency, not just the Cypriot currency. If someone withdraws €10,000 from a Cypriot bank and moves it to Germany, the size of the Cypriot bank shrinks. They lose an asset and a liability. But crucially this movement does not affect whether the bank is solvent. It may affect its liquidity, necessitating support from the central bank, in this case the ECB. But its solvency is not affected.

So by moving Euros around the Eurozone you really are moving capital, because Euros are a claim on the output of the Eurozone, not a claim on the output of Cyprus.

Mark Wadsworth said...

AC, yes, Cyprus is in a wider currency zone, so what?

Euros are not IOUs issued by ECB, they are IOUs denominated in Euros.

The Cyprus banks own what they own, the same as XYZ regional building society in the GBP currency zone owns what it owns, assets in XYZ region.

A C bank cannot shift that "asset" anywhere, if it is secured on C land. And those C assets are claims on the future income of C borrowers, not primarily claims on Germany output or anything else.

The asset side of the C bank does not change if people withdraw money, as banking is a closed loop, all that happens is instead of owing C depositors money, they owe German banks money.

And there is no reason why a single real physical asset must move from one country to another because people move money between bank accounts.

Do you seriously believe that if I take £1 million cash from a UK bank and put it in a Cayman islands bank that £1 million's worth of goods have to be transported from a UK warehouse to a Cayman warehouse to balance it out?

Bayard said...

"which is worth €8,000 and if they are acting rationally, they will offer you a deposit of €8,000 in exchange."

Yes, but if they are acting by the rules of the Eurozone, they have to offer you €10,000.

Leftie said...

I guess this isn't a good moment to admit I'm a fully paid up gold bug (blame it on my Austrian School of Economics days).

1) Gold, and other similar commodities, are something that are tangible and have value in and of themselves, rather than State diktat.

2) Their expense and short supply are good things surely?

Mark Wadsworth said...

B, but under Eurozone rules, you get a frozen bank account, which is even less use to you than 8,000 in real exchangeable 'money'.

L, nothing wrong with gold. It looks nice in jewellery and it is an excellent conductor of electricity. It is a good commodity with infinite shelf life. But as RS points out, it is a very expensive and inefficient medium of exchange.

Bayard said...

L, gold, like paper money, is only worth what it's worth because everyone agrees it's worth that. Otherwise it wouldn't be worth much more than other useful metals like copper or lead.