Financial and Monetary Reform
Time after time, in market economies, we have seen the economic cycle follow the credit cycle (which has trended toward being a function of the property market cycle). Credit expands, consumers and the private sector go into debt, fuelling a boom.
If and when the debt becomes unsustainable, companies and consumers cut back on spending to repay their debts, and those who are unable to, go bankrupt. If this happens across the economy on a large enough scale, the economy can fall into recession, or worse. The policy response to mitigate recessions in these events, have been a combination of increased fiscal spending, and monetary stimulus (low interest rates, bond purchases, etc.). If governments have run a large enough fiscal surplus (if any) during the boom years, they may be able to fund the deficits without going into debt. However, since economies do not operate in a vacuum, and are sometimes exposed to surprises and external shocks, governments may sometimes decide they need to use debt to finance spending to fill gaps in aggregate demand. This creates an inverse relationship between private and public debt, which we see empirically. Additionally, central banks use a small toolset — mainly interest rates — to encourage lending over saving to further stimulate demand.Since the end of the Second World War, many developed nations have seen their private debt levels (as a percentage of GDP) balloon to new heights. Up to a certain point, this private debt increase was a positive; invested into new businesses, industries, and technologies that fuelled a post-war boom. The credit was invested very effectively, in businesses which paid off, and debt was still at a level manageable enough to be repaid. Debt can be a positive force; it’s just a matter of finding an ideal level. As time went on, private debt reached exceedingly high levels, with a rising share driven toward existing assets (as opposed to creating new assets), such as real estate.
In addition to driving up living costs (due to inflated real estate markets), this also created systemic risk in the economy beyond issues related to mortgage-backed securities. As a result of these rising private debt levels, at the end of each credit cycle, the amount of debt being repaid keeps rising; resulting in more demand being sucked out of the economy. Thus, deflationary pressures build up, and policymakers react with ever lower interest rates, and ever higher public debt. The overall debt levels have continued to expand, but have also been shifting between the public and private sector. Since the late-2000s recession, real economies have been unresponsive to the unprecedented levels of stimulus, while asset prices have soared. Governments then imposed budgetary austerity to attempt to control soaring public debt. The gap in demand was never completely closed, and governments and central banks proved incapable of closing it.It is arguable where exactly the gap in demand lies, considering many of the same countries with slack in their labor markets also face large trade and current account deficits (which sounds more like a gap in domestic supply). However, efforts to combat deflation or disinflation are best met with demand-side measures. For the US in particular, the most recent challenges involved a combination of overly low inflation, persistent current account deficits, slack in the labor market, high levels of public and private debt, and an unusually slow recovery. Tackling these issues with low interest rates and quantitative easing has been an extremely inefficient way of attempting to support demand. While it was (too) successful in boosting demand for assets, it proved to be ineffective in increasing investment and propping up demand where it was needed. In addition, these policies only encouraged taking on further debt, setting up the economy for more risk in the future. The fiscal policy options are also poor, between taking on excess government debt (purchasing growth from the future), or spending cuts (further decreasing demand and growth).
Raising inflation targets to cut debt can also cause serious harm. If done with the same policy tools as the central banks currently use, then in addition to reducing purchasing power, it would also worsen the already dangerous asset price bubbles.The only viable solution to the current crisis is to monetize some of the current public debt and enforcing spending within strict rules and limits. While it is a taboo topic, as long as it is done within a defined rule set, low inflation targets, and as a seldom-used emergency measure, it can be done safely and without creating perverse incentives. This contrasts with the dangers of negative interest rates, quantitative easing, and all other available options.
Some monetary reformists advocate full reserve banking, with a central bank that fully monetizes government expenses as a means to adjust the money supply. While a financial system completely reliant on oversized banks for monetary operations puts the economy in a precarious situation, so does a system entirely reliant on a centralized government authority, except in the latter case with even more perverse incentives, and a temptation to overinflate the economy. Others argue for the abolishment of central banks altogether, but this has the same effect, with power centralized in the hands of a few, and leaving the public without tools to handle crises. Money creation must instead be balanced between public and a diversity of private entities, with all of them paying fees to the citizens to compensate for the privilege.
To prevent the present-day monetary dilemmas in the future, central banks must also target ideal rates of private debt, and bank capital requirements should be kept at a range of 15-25%, as recommended by Lord Adair Turner (former chairman of the UK’s Financial Services Authority). Controlling debt levels in the economy combined with ensuring high capital requirements (allowing movement within the 15-25% range, for countercyclical rules) are a far simpler alternative to defeat the systemic risk in the financial system.
It can replace a whole host of complicated, expensive regulations, which anyway have holes torn in them by special interests. Similarly, minimum mortgage deposits should be around 25%, which would make property prices respond more accurately to demand, and encourage savings and investment. It also compensates for the disadvantages of housing ownership, such as anchoring the labor force to one location. Finding the ideal level of private debt in an economy is not so black and white; however somewhere within the extremes lies an ideal range that combines a sustainable rate of growth without an unacceptable level of risk. The tax benefits of debt (over equity) must also be removed, to discourage serious economic distortion. This may be done either through the taxation of debt, or by allowing deductions for the cost of equity; preferably through the latter. The regulatory costs of listing on an exchange and remaining there should also be considered as an artificial disincentive for raising money through equity, and tax credits should be issued for such expenses.A levy on private money creation would further reduce systemic risk (modelled on the UK bank levy, except at a higher rate). Meanwhile, it would automatically reduce debt and inflation while promoting growth if these new revenues are distributed evenly between the National Dividend (reducing consumer debt), Sectoral Banks (reducing corporate debt while lowering prices), and local/national governments (reducing government debt or tax burdens) as lending grows. This creates a unique scenario where lending growth and private seigniorage growth may actually translate into reduced rates of inflation, as it would convert into expanded production of Basic Essentials (via the Sectoral Bank mechanism). With high capital requirements and the new levy, central banks might also require extra tools to meet their targets; yet these tools would also provide more diverse streams of liquidity.
Typically, when lending fuels growth, it also fuels inflation, as the money supply and velocity increase, yet production of the basic essential goods we rely on, do not increase in supply with it.
Wages tend to chase prices, and it is difficult to get out of a price-wage inflationary (or deflationary) spiral. However, with the policy tools and automatic mechanisms in place to direct some of the flow of cash towards the production of Basic Essentials, and toward the National Dividend, the public is compensated for the externalities of increased lending (and monetary privileges), and ample funding for the production of Basic Essentials would keep price growth in check. A UK-style bank levy (on debts) at a rate of 0.3%, automatically distributed evenly three ways, between Sectoral Banks, the National Dividend, and general government revenues, would ensure that the benefits of peoples’ labor are properly rewarded, without their wages lagging behind inflation. By offering central banks the possibility to also engage with these programs such as Sectoral Banks and the Three Pillars (within strict rules), these positive effects can be multiplied, and central banks would better achieve their targets without resorting to dangerous measures such as ultra-low rates and quantitative easing (QE).On the consumer side, consumers need both protection against unethical behavior, and also to feel the consequences of their own banking decisions. An agency for consumer protection in the financial sector would be of benefit, especially in the realm of misleading behavior by lenders.
With regards to deposit insurance, the New Physiocrats recommend a regulation that ensures depositors must always have 10% of savings unprotected. This must be combined with rules enforcing extraordinarily transparent and visible advertising on the bank’s key metrics for risk, reserve ratios, and failure scenarios, so that consumers can make informed decisions, and so that rigorous market discipline is enforced on banks.