We have the third highest private sector debt to GDP ratio on the planet just now, and barely any other mechanism for driving new money through the economy.
That’s what makes recessions.
It’s the problem I described earlier where banks motivation is to push money supply up in boom times and down in bad. In both cases, pushing to extremes, creating boom/crash cycles.
This is probably a stupid idea because it just popped into my head reading this but…
What if the government (formally) acted as a insurer for consumer debt? Which is to say you take 2008’s scenario of the US government informally insuring the debt/derivative market (once it posed a threat to the entire economy) and make it formal, the government will buy any bad (and therefore cheap) debt assets owed from Australian consumers to take them off banks books and to prevent predatory asset retrieval.
Creditors have more confidence in loaning resulting in more consumer friendly loan agreements (less risk so less requirement for big rewards to offset). Investors can view debt derivative assets as a more secure investment, luring them away from interrupting the markets of real world assets.
@Ryan, I think the result of the position you are suggesting, would be the government acting as a backstop to bank risks, essentially allowing them to take greater risks with impunity.
Not sure that helps.
Investment is all about taking risks to make gains. No safety net to a bank just means a position with a high risk:reward ratio, where they need to be careful but go big when they go for it. For loans this means fewer loans with higher rates.
You lower the risk side of the equation and they will invariably lower their reward side because there will be more profits in increased volume… more loans with lower rates.
Also keep in mind this is only an idea proposing the government buy toxic debt at market price (extremely low-to-zero cost)… that’s still a loss to the bank just not as bad as them not being able to get rid of it. Think of it as a formal and continuous debt forgiveness program. The actual risk of “impunity” would be if the consumer side started thinking they can default all they want, incentive to prevent that is on the banks though.
The US federal reserve ended up doing what I’m saying but only AFTER things went to hell.
The banks were doing the toxic loans all on their own because they though debt bundling was some genius no-fail scheme…
Or more likely had the foresight to know they would get bailed out if they just kept making the shitball bigger. You don’t ever let the shitball get big and they don’t have the leverage to do whatever they want.
When these institutions full of ridiculously smart people act in obviously stupid ways (like giving out bonuses for making shit loans) it’s not proof they’re stupid, it’s proof they’ve found and are exploiting a structural flaw.
I think you need to read the book to get a handle on what the positive money people are advocating. Their aim is to create a more stable monetary system that does not lead to an ever-growing debt-to-GDP ratio with huge implicit subsidies for ‘too big to fail’ banks. There are also detailed proposals for transitioning from the current system.
A key ingredient of the proposals is to do away with the need for deposit guarantees, by creating two classes of bank accounts. The first kind, a ‘transaction account’, pays no interest and is risk-free because a bank must at all times maintain central bank reserves equal to total deposits. (This is basically Irving Fischer’s idea of 100% reserve banking.) Funds in a transaction account are available at call, and are the property of the depositor, not the bank. The bank simply manages payments (for a fee, of course) and cannot lend any of the deposits (hence no interest). If your bank fails, you just choose another one to manage your transaction account and the central bank transfers reserves equal to your account balance to your new bank.
The second kind of account is an ‘investment account’, which has no government guarantee but is still subject to consumer protection regulations. (Also, the bank still has to meet capital adequacy requirements.) To make a loan, the bank must first attract sufficient funds from transaction accounts into investment accounts. An investment account is illiquid, having either a fixed maturity date (like a term deposit) or a fixed notice period. In practice, a bank would offer a range of investment accounts with different risk-reward profiles, and longer or shorter maturities.
In this way, the payment system is protected against bank failures without any need for taxpayer-funded bailouts.
In the current system, the central bank attempts to influence the rate at which banks create credit by adjusting the interest rate it charges on their reserve accounts. In the positive money system, the central bank would not pay interest on these accounts. Instead, it would control the money supply directly, by creating or destroying central bank reserves (which basically amount to digital cash). There would be no change to the central bank charter of seeking to maintain low inflation and low unemployment.
However, the government would have to choose how any newly created money gets spent into the real economy. Importantly, the money supply would be able to grow in line with economic activity, without any corresponding growth in debt and the associated interest payments.
Yes, the Iceland report covers most points, but the book is more detailed (340 pages). There is also a shorter introduction (free download) of about 50 pages.
He seems to pretty much agree with the Positive Money folks on the basic problem.
Problem: Private debt in Australia is peaking (~123% of GDP). This is a huge problem, because around this level, the private sector stops borrowing because they are too concerned about their capacity to service the debt. This wouldn’t be a concern in and of itself, except that continued lending is the only current means by which new money enters the economy. If lending stops, money supply stops, and the economy crashes, and then we all have a problem.
Conclusion: Private debt needs to be reduced.
Caveat: Private debt reduction can’t happen via simply reduced lending and people (mostly property speculators) paying off that debt. Reducing that debt by those people repaying it themselves would also drastically reduce both economic activity and money supply … again … massive recession.
Short term bubble fix: Money has to be created by the government directly, and injected into the economy equally to all tax payers, with a caveat, that if you have a loan, it MUST go there first, thereby deflating the private debt bubble and commensurately increasing money supply to boost the economy while this gets sorted out. Probably couple this with a bit of a mea culpa, and a pleading for those without loans to spend it on local business - do house maintenance, get some education, invest in a local business - whatever.
Ongoing: Limit bank lending for mortgages (and get rid of negative gearing of course), and drive banks to lend to entrepreneurs on an equity basis rather than a secured loan basis. i.e. Ensure they have a hand in the game and have to be creative contributors to actual economic growth rather than leeches that charge interest on money they created out of nothing.
I get that it’s important. I just don’t understand it. Nor am I inclined to, even if I had the time. That doesn’t mean I dismiss it or not follow the “vibe” of the discussion. If I was to vote I’d probably follow @AndrewDowning (track record and all that). Just sayin’
TL;DR most people think the government is the one who creates fiat currency (true physically), in reality the overwhelming majority is made by banks (non-physically). There is inherent benefits to the creators of currency. Also massive repercussions to the economy dependent on the mindset driving creation or lack thereof.