Friday, March 19, 2010

Keynes: Where did credit creation go? Werner asks Skidelsky & Hayes

It's spring in England and we've had a very hard winter. Because the roads are badly potholed and local elections are coming, the hole-detectorists are out in force. Election leaflets usually feature a photo-opportunity with the candidate squatting down and pointing at a pothole: 'a vote for me will sort this lot out'. 

At the Centre for Banking, Finance and Sustainable Development in Southampton University (18 March)  hole-detection was also at work, and with a national election coming also, it was a case of examining holes in economic policies . The seminar panel comprised Lord Skidelsky (Warwick University), Dr Mark Hayes (Cambridge U.),  Professors Richard Werner and Maozu Lu (both Southampton U.). Professor Skidelsky has been Labour, Social Democrat, Tory and is now a cross-bencher. He is an economic historian who was described yesterday as the world's No: 1 expert in John Maynard Keynes - who was the towering presence in world economics for his entire adult life, and who is still influential. Lord Skidelsky's lecture was titled: 'The Relevance of Keynes'.

National elections bring out the grandest hole-detectorists and Robert Skidelsky gave us the state of play in a national series of articles and letters to the press, where  we are getting, pantomime-like: 'Your policy's more dangerous than mine'... 'Oh, no its not'... 'Oh, yes it is'.   The national bantering started off with a Sunday Telegraph article by his Lordship in September '09 and has run on a bit since. The article, and some subsequent writings feature George Osborne (GO) the shadow chancellor who may be in government shortly.   GO's article with Jeffrey Sachs in the Financial Times on Monday  really spurred Lord S into action with a  letter in the FT the day before the seminar. He accused GO and JS of trying to spook us all by saying that unless the GO/JS view of cutting the government stimulus is taken quickly, financial panic will ensue.

So what's it all about?  Lord S says that because the UK economy is 6%-10% under-performing from its trend growth, the government must fill this 'output gap' by fiscal stimulus. In doing this, an offset to the fall-off in private and business demand will occur and further recession averted. Once the economy starts to recover, the stimulus should be withdrawn - but if you withdraw too early, the recession will intensify. Keynes' model for the economy (following such as this recent huge economic shock) is that it is not self-regulating or auto-correcting. One problem for budding hole-detectorists is that in the view of the 'withdraw early' people -  there is actually only a very small 'output gap' - maybe only 3% - and if so, and the government stimulus is  kept up too long, roaring inflation will ensue. Another hole recognition problem is that the hands-off / let the economy self-heal people think that it was the government that caused the problem (the crisis)  in the first place by excessive monetary expansion - so keep your hands off now!  
Lord S took a massive swipe at some universities' economics education - where you might get a degree without even having read a single word of Adam Smith or Keynes. He pointed out the  student-inspired PAE (origin in Paris) which attempts to bring reality to economics education. Much of what goes for current economics theory attempts to explain it without incorporating social and inter-relational behaviours, so that the mathematical modelling is an inadequate one and 'The tail of mathematics wags the dog'. One assumption is of 'perfect foresight' - which cannot exist. On a downbeat note, he said wrongheaded economic notions are likely to prevail, due to academic tenure and the prevalence of existing textbooks, closing his talk with: ' Economics is too serious to be left to economists'

Richard Werner exposed a hole in economic thinking around Keynes work. The title to his lecture was: Keynes - Linking Fiscal and Monetary Policy. Keynes said in 1932 that whilst fiscal stimulus (e.g: tax cuts, building roads) might be needed at times, it was  possible for a central bank to negate the growth-promoting effect of it by not creating new money. If this happened government spending would 'crowd out' business activity.  It seems that Keynes did not pick up this point in his later writings. Did he change his view? If so why? Joseph Schumpeter, as revealed in a 1970 book, noted this change by Keynes, and also noted the key role of banks in creating credit: 'You don't need savings to grow the economy, only that you create money...without any previous savings'. Werner gave us an economist's view of money/credit creation. See his book: New Paradigm In Macroeconomics. Macmillan

His findings, from his experience in Japan from 1992 to 2000 and subsequently, show that Japan has hit the record for its length of deflation (now -4%). There has been lots of fiscal stimulus and interest rates have been zero since the late 1990's. It didn't work! The problem? Credit creation policy by the central bank. He is haunted by deja vu as he sees the current UK situation developing in the same way. He displayed copies of currency notes from: Japan 1868; Germany 1874-1918; UK 1914-1928 (the Bradbury note) ; USA 1963, to illustrate that governments in the past have issued money - literally 'printed money' - to promote safe economic growth. Nowadays the government only produces about 2% of the money supply (notes and coins) the remainder is created by the banks on their screens.  He suggested some of the ways to create money: by Central Bank; by borrowing from commercial banks rather than issuing government bonds and by a government creating money itself. In this latter case, three advantages arise: No increase in the national debt; no interest payable - because no debt; no compounding interest.  
Mark Hayes, a newcomer to Werner's work, seemed intrigued. He said the ideas fly in the face of the policy of the supposed benefits of an independent central bank. Lord Skidelsky recalled Keynes' remark about burying newly-printed pound notes and creating employment by digging them up. He said that Keynes knew of the highly successful credit creation scheme of Silvio Gesell. This was run in an Austrian town in 1932 using newly minted but date-limited notes. He found the ideas of both Werner and Hayes extremely interesting. 
Maozu Lu spoke of the current Chinese stimulus with predicted growth of 9% this year - some are saying: Withdraw! Others: Why stop it now?  He said the government stimulus has produced many new high buildings and new motorways (hey! no potholes). Recently he drove for 1/2 hour on one and his was the only car using it!

Still confused?  All fledgling, economics theory hole-detectorists should repair rapidly to this website QFinance for their very useful dictionary of terms and a Viewpoint article by one: R A Werner.

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