Money
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7. The discussion in which Wolf and Summers made these comments is available at: http://ineteconomics.org/net/video/playlist/conference/bretton-woods/V. Summers’ response referred to here is his answer to the first question in the interview, starting at 6:04.
8. Ibid. Summers also mentioned the 1981 Nobel Laureate James Tobin as an important influence, as well as alluding to the microeconomic literature on bank runs.
9. Ibid., second question starting at 10:58.
10. Ibid.
11. It was the short-lived but highly influential economic historian Arnold Toynbee who seems to have coined the name in lectures that he delivered at Oxford in the late 1870s which were published after his death in 1883 as The Industrial Revolution.
12. There were fewer than 70,000 Friends even at the height of Quakerism’s popularity in the late seventeenth century, and little more than 20,000 by the early nineteenth. See Rowntree, J.S., 1859, “Quakerism Past and Present: Being an Inquiry into the Causes of its Decline in Great Britain and Ireland,” cited in Walvin, 2005, pp. 71–4.
13. Anon., 1697, “The Snake in the Grass: or Satan Transformed into an Angel of Light,” quoted in Walvin, 2005, p. xvi.
14. Indeed, Barclays was assembled from the merger of three nineteenth-century Quaker banks, including the Gurney bank of Norwich, and as recently as the turn of the millennium a member of the Gurney family was reputed to be the largest private shareholder in the Barclays register. See Elliott, 2006.
15. The catalyst for this development in the role of the bill brokers seems to have been the financial crisis of 1825, in which the commercial banks were badly burned. The bill brokers stepped in to provide intermediation on their balance sheets where the banks would no longer do so. See Flandreau and Ugolini, 2011, pp. 8–9.
16. Exchange between Bank Directors and members of the 1858 Committee, quoted in Clapham, 1944, Vol. II, p. 237.
17. Capie, 2012, p. 16. The two largest banks at the time were the Midland Bank and the Westminster Bank. As Capie points out, the reason Overend, Gurney could support such an enormous balance sheet was that it ran a much lower ratio of capital to assets: at the time of its failure, Overend, Gurney’s ratio was 2 per cent, while most banks had capital–asset ratios of between 9 and 11 per cent.
18. Bagehot, 1999, p. 275.
19. Ibid., pp. 183 and 289.
20. Ibid., p. 164.
21. The famous claim of William Huskisson, the President of the Board of Trade, as quoted ibid., p. 200.
22. The Bank had advanced £9 million to bill brokers, and only £8 million to banks—see ibid., p. 298.
23. Xenos, 1869, p. 64.
24. Ibid., p. 84.
25. Stefanos Xenos, quoted in Elliott, 2006, p. 82. Elliott, however, argues that Edwards, who is held by most earlier scholarship to bear primary responsibility for many of the firm’s worst investments, was in fact essentially deployed as a troubleshooter after problems developed, and places most blame on the partners themselves.
26. Another pre-eminent securities-dealing partnership—Goldman Sachs—pulled off a similarly well-timed public offering in 1999. Despite the partners’ good fortune in selling out months before the bursting of the dotcom bubble in March 2000, there was however no suggestion on that occasion that the conversion to a public company had been done to escape bankruptcy.
27. The Economist, no. 1142, Saturday, 15 July 1865, p. 845.
28. King, W., 1936, p. 240.
29. Bankers’ Magazine, 1866, p. 639, quoted ibid., p. 243.
30. The Times, Saturday, 12 May 1866, p. 243, quoted ibid., p. 243.
31. The Times, Friday, 11 May 1866, p. 11.
32. Sir Launcelot Holland, in testimony to the 13 September 1866 meeting of the Court of Proprietors of the Bank of England, quoted in Bagehot, 1999, p. 165.
33. Clapham, 1944, p. 265.
34. Ibid., p. 270.
35. Quoted in Elliott, 2006, p. 188.
36. Bagehot, 1999, p. 273.
37. Quoted in Keynes, 1915b, p. 375. Bagehot believed this to be to his advantage—since he viewed Mill’s powerful influence on economic thought to have been essentially unproductive. “[T]here is little which is absolutely original in his great work,” he wrote (and in his obituary of Mill in The Economist, no less), “and much of that little is not, we think, of the highest value,” quoted in Keynes, 1915b, p. 374.
38. Keynes, 1915b, p. 269.
39. Ibid., p. 371.
40. Bagehot, 1999, p. 1.
41. Ibid., p. 189.
42. Ibid., pp. 158–9.
43. Ibid., p. 22.
44. Ibid., p. 323.
45. Ibid., pp. 68–9.
46. Ibid., p. 35.
47. Ibid., p. 20.
48. Ibid., p. 35.
49. Ibid., p. 42.
50. Ibid., p. 196.
51. Ibid., pp. 197–8.
52. Ibid., p. 197.
53. Ibid.
13 … and Why It Is a Problem
1. Say, 2001, I.XXI.32.
2. Mill, 1848, III.7.9.
3. Bagehot, 1999, pp. 66 and 190.
4. Say, 2001, I.XV.3.
5. Joplin, 1832, p. 219. Say himself also observed the results of the British crisis of 1825 and revised substantially his earlier teachings, as pointed out by DeLong, 2012, pp. 7–9. The argument of this section is heavily indebted to DeLong’s brilliant ongoing research into the lessons of the macroeconomic debates of the nineteenth century for today’s theoretical and policy morass.
6. Smith, A., 1981, II.4.4., p. 351.
7. Say, 2001, I.XV.7.
8. Mill, 1848, Preliminary Remarks 9.
9. Ibid., III.7.8.
10. Keynes, J.M., Letter to Lydia Lopokova, 18 January 1924, cited in Skidelsky, 1992, p. 175. Evidently, Keynes had forgotten the maxim attributed to Gladstone that “not even love has made so many fools of men as pondering the nature of money.”
11. Keynes, 1936. He also wrote his A Treatise on Money, 1930, along the way.
12. See chapter 12, n. 9.
13. In today’s monetary regimes, the two are linked. Whereas in Bagehot’s day, the Bank of England was only able to issue sovereign money against either gold (in the normal course of things) or private debt (in a crisis), modern central banks have typically been licensed to issue money only against government debt—at least until the crisis of 2008–9 forced many of them to start issuing money against various types of private debt (notably mortgage-backed securities in the case of the U.S. Federal Reserve; corporate bonds in the case of the Bank of England; and a very wide range of private debt in the case of the European Central Bank).
14. Walras, 1874.
15. Hicks, 1937.
16. Arrow and Debreu, 1954.
17. Hahn, F., “On Some Problems of Proving the Existence of a General Equilibrium in a Monetary Economy,” in Hahn and Brechling, 1965, pp. 126–35. In fact, Arrow and Debreu’s pioneering 1954 paper had been quite explicit in proving the existence of general equilibrium in an economy without any money—some might say a strange thing to do, but what they did nonetheless. The target of Hahn’s critique was really a second generation of “monetary general equilibrium” models (specifically, in Hahn and Brechling, 1965, the model set out in Patinkin, 1956), which aimed to prove the Arrow–Debreu result for an economy that did include money. The basic challenge these models had to overcome was to show why one commodity would be chosen and valued as a medium of exchange in a general equilibrium. Hahn’s famous critique demonstrated that these models had not succeeded in this. The class of general equilibrium models pioneered by Arrow and Debreu, 1954, are intrinsically models of a non-monetary economy: solutions that include money always encompassed by simpler solutions that do not.
18. McCallum, 2012, p. 2.
19. The way was to allow the assumption that some nominal prices are “sticky”—that is, they take time to adjust. This generates both a rationale for proactive monetary policy—since sticky prices
will cause inefficient relative price changes in the presence of inflation—and the means for it to be effective—since by changing the nominal interest rate, the central bank can manipulate the real interest rate. Since money itself does not exist in the model, credit and liquidity risk—and other factors emphasised by the unconventional view of money—do not appear, and hence are not considered either as factors of instability or objects of policy.
20. King, M., 2012, p. 5. Outside of the orthodoxy, there remained independent-minded scholars who nevertheless persevered with the project of understanding the economy as a system in which money and banks play an irreducible role, as, for example, Smithin, 2000; Wray, 2004; Werner, 2005; and Werner, 2011, demonstrate. There were also attempts within the mainstream to establish a more realistic theory of the microeconomic foundations of money: Kiyotaki and Moore, 2001; Kiyotaki and Moore, 2002a; and Kiyotaki and Moore, 2002b, jointly constitute an important example. It took the crisis of 2008, however, to alert orthodox macroeconomics to the urgency of what such scholars had been doing.
21. The classic references for these innovations are Markowitz, 1952, Sharpe, 1964, and Black and Scholes, 1973.
22. Mehrling, 2011, p. 85.
23. Tobin, 1969.
24. Black, F., 1995, “Hedging, Speculation, and Systemic Risk,” Journal of Derivatives, 2(4), pp. 6–8, quoted in Mehrling, 2005, p. 10. Mehrling cites this as an example of how diametrically opposed the worldviews of academic macroeconomics and academic finance had become by the mid-1990s, calling it “[f]or a macroeconomist … a shocking statement.”
25. High and volatile inflation is a macroeconomic ill in New Keynesian models essentially because in the presence of sticky prices, it generates inefficient relative price changes which reduce output to below its potential.
26. The idea of central-bank independence, unlike inflation targeting, is not associated specifically with New Keynesian theory—its origins lie in an earlier literature, notably Rogoff, 1985—though it was only once the New Keynesian approach had become the most widely used framework for policy-making that it achieved a concrete institutional impact.
27. Turner, 2012.
28. Minsky, H., “The Financial Instability Hypothesis: Capitalist Processes and the Behaviour of the Economy,” in Kindleberger and Laffargue, 1982.
29. King, M., 2002, pp. 162 and 173.
30. Ibid.
14 How to Turn the Locusts into Bees
1. See http://en.wikipedia.org/wiki/Locust_(finance). The term became widely used in political debate in the run-up to the September 2005 federal elections in Germany.
2. See chapter 8.
3. The title of Novi, E., 2012, La dittatura dei banchieri: l’economia usuraia, l’eclissi della democrazia, la ribellione populista.
4. “Banksters: How Britain’s Rate-fixing Scandal Might Spread—and What to Do About It,” The Economist, 7 July 2012.
5. “How to Tame Global Finance,” interview with Adair Turner in Prospect magazine, 27 August 2009.
6. “The Only Useful Thing Banks Have Invented in 20 Years Is the ATM,” New York Post, 13 December 2009.
7. In the U.S. there are the 849 pages of the Dodd-Frank Wall Street Reform and Consumer Protection Act, incorporating the Volcker Rule and establishing the Financial Stability Oversight Committee. In the U.K. there was the 2009 Turner Review of what went wrong with the supervision of the banking sector, which has led to the wholesale rearrangement of the U.K.’s regulatory institutions, and the 2011 report of the Independent Commission on Banking, on which the Draft Financial Services (Banking Reform) Bill is based. Even in the Eurozone—where even more existential challenges have dominated policy-makers’ attention—serious structural reforms were proposed in October 2012 by the High-level Expert Group on Reforming the Structure of the EU Banking Sector.
8. In November, 2008. The remark was reported and subjected to sceptical ridicule in the Wall Street Journal on 28 January 2009: http://online.wsj.com/article/SB123310466514522309.html.
9. U.K. Financial Services Authority, 2007.
10. This was the title of the U.K. House of Commons Treasury Committee’s 2008 report on the episode and the authorities’ response to it: U.K. House of Commons Treasury Committee, 2008.
11. See chapter 6.
12. U.K. Financial Services Authority, 2007.
13. The nationalisation of Northern Rock was done under special legislation, and no consideration was paid for the existing shareholders’ equity. On 1 January 2010, the Treasury—by then the sole shareholder—injected £1.4 billion of capital into the bank. See UKFI, 2012, p. 26.
14. U.K. House of Commons Treasury Committee, 2008, Vol. I, p. 74.
15. In a debate in the U.K. House of Commons on 10 December 2008, the then prime minister Gordon Brown made what became an infamous slip of the tongue. He claimed that the policies of his government in the heat of the crisis had “saved the world” before correcting this claim to the more modest one that they had only “saved the banks.”
16. Laeven and Valencia, 2012, Table 1, p. 6, and passim for details. In addition to liquidity and capital support, all but three of these countries ramped up the guarantees provided by the sovereign on bank deposits and other liabilities—a further form of sovereign support.
17. In fiscal year 2011, federal outlays on defence were 4.7 per cent of GDP. See Congressional Budget Office, 2012, Table F.4, p. 139.
18. Thomas Jefferson to John Taylor, Monticello, 28 May 1816, in Ford, 1892–99, Vol. 2, p. 533.
19. The total spending of the U.K. Department of Health was 7.6 per cent of GDP in 2011–12. See HM Treasury, 2012, Table 5.1, p. 73, and Table F.2, p. 206.
20. Alessandri and Haldane, 2009, p. 2 and Table 1.
21. EUR 870 million. See Whelan, K., 2011, “Anglo’s January 31st Bond,” available at http://www.irisheconomy.ie/index.php/2011/01/. A lively and expertly informed debate on the merits of the particularly extreme strategy of liquidity and capital support undertaken by the Irish sovereign is available on the excellent joint blog The Irish Economy (www.irisheconomy.ie) in which this post appears.
22. The multinational origins of the Apple iPhone mentioned in chapter 2 are a contemporary example of the kind of industrial organisation that resulted in the consumer electronics industry.
23. The share of corporate bonds in total corporate debt financing (excluding mortgages) averaged 51 per cent between 1980 and 1984. These and the related data in this paragraph are calculated from Table B.102 of Board of Governors of the Federal Reserve System, 2012.
24. Martin, 2011, 1. Data from Citibank Credit Investment Research.
25. Homer, 1968, pp. 27–29.
26. What is described here is the illustrative, generic, credit intermediation process of the international shadow banking sector as set out in Pozsar, Adrian, Ashcraft, and Boesky, 2010, pp. 10–12 and Exhibits 2 and 3.
27. International Monetary Fund, 2006, p. 51.
28. Ibid.
29. In the IMF’s defence, it did warn on the same page as the infamous quotation above that “while these markets increasingly facilitate the ‘primary’ transfer of credit risk, secondary market liquidity is still lacking within some segments, creating the potential for market disruptions”—a statement which at least intimated that the new system of credit market intermediation was being expected to manage liquidity as well as credit risk, but that its ability to do so remained untested.
30. Poszar and Singh, 2011, p. 5. This estimate is for the end of 2007.
31. Bouveret, 2011, p. 18. Note that this estimate is as of the end of 2010, and so not strictly comparable with Poszar and Singh’s estimate for the U.S. above (but instead with their end-2010 estimate of the size of the U.S. shadow banking system at U.S. $18 trillion).
32. The details of how central-bank assistance found its way to the shadow banking sector—as well as a superlative history of the evolution of the U.S. financial sect
or and its relationship to the evolution of economic and financial theory—can be found in Mehrling, 2011, a brilliant and profound book to which I am much indebted in this chapter.
33. Total assets of the U.S. Federal Reserve rose from U.S.$927 billion to U.S.$1.8 trillion. See Board of Governors of the Federal Reserve System, Credit and Liquidity Programs and the Balance Sheet website: http://www.federalreserve.gov/monetarypolicy/bst_recenttrends.htm. Total assets of the Bank of England rose from £93 billion to £292 billion. See Bank of England Bank Return, available at www.bankofengland.co.uk.
34. It took until the beginning of 2012 for the total assets of the European Central Bank to double from their level of approximately EUR 1.5 trillion in October 2008.
15 The Boldest Measures Are the Safest
1. In Basel Committee on Banking Supervision, 2006, commonly called the Basel II Framework. The Basel Committee is simply an international forum, and until the crisis its main focus was on harmonising the measurement of bank capital (rather than liquidity) and standards of its adequacy. Most of the definition and all of the implementation of prudential regulatory standards remains in the hands of national regulators, however—and after the crisis, many national regulators too proposed more stringent capital or liquidity requirements in addition to those agreed on in the Basel III accords (see n. 4 below).
2. Alessandri and Haldane, 2009, p. 3 and Chart 2.
3. Ibid., p. 3 and Chart 3.
4. Basel Committee on Banking Supervision, 2010, commonly called the Basel III Framework. As its name suggests, the Basel III Framework incorporated a more explicit focus on internationally co-ordinated measurement and standards of bank liquidity as well as capital.
5. This analogy is drawn from Haldane, 2010.
6. Ibid.
7. Haldane, 2010, presented illustrative estimates of the present value of the total economic cost of the global financial crisis, depending on how much of the output loss proved permanent. They ranged between 90 per cent and 350 per cent of the world’s output in 2009.