Sunday, May 05, 2019

Richard Werner is doing better than Benjamin Franklin

Do you like the idea of the prosperous life which the politicians promise? Last week in Leicester an economist showed an improved way of releasing prosperity. Point by point he showed that the 10 conditions generally deemed necessary for sustainable growth are misleading. He also showed that whilst  this conventional, western, economic set of rules has been  hopelessly unsuccessful, an alternative has been running for a long time and has proved a stunning success. 

Prof Dana Brown, Founding Principal and Dean of the Business School at De Montfort University Leicester introduced Richard Werner, Professor of Banking for his inaugural lecture. DMU supports the United Nations Sustainable  Development Goals, in particular  - G16 Justice and Strong Institutions. The economics and banking aspects of this is what Werner delivered as he took us comprehensively through basic economics and banking principles. 

His argument firstly demolished the assumption that in order to develop sound, sustainable economies governments must follow the 10 policies of the Washington Consensus. These include: austerity, fiscal deficit reduction, privatisation, the opening up of currency flows, free markets (deregulation, e.g. sell your assets to foreign buyers at knock-down prices) and several other items of accepted 'wisdom'. These ideas for promoting structural changes within developing countries in particular are repeated like religious mantras by chancellors of the exchequer, secretaries of the treasury, the IMF, the World Bank and the like. The terms were conditional to IMF 'help' to developing countries in 159 cases from 1973-1994. Werner exposed these conditions as unhelpful to good economic outcomes, and showing that the actual outcomes can include the transfer of power, advantage and control to external entities. His purpose was to show how the most spectacularly successful economy on the planet for the last 30 years tried quite different methods. The title of his lecture was:

Paradigm Shift. How to get sustainable, stable, equitable and high growth. Is everything wrong they ever told us about how economics works and did Deng Xiaoping get it right?  

The bedrock of his talk was how banking works by creating credit (money) out of nothing i.e. how they make the loans.  They don't wait for depositors to bring their money in and then lend it out, they just create the money themselves when asked for a loan and then lend it. As Werner has discovered in studies of Japan and now China, as long as general central direction is given that the loans should go into the productive economy (making things, invention, product improvement, et al) this is not inflationary, and the economy then runs sustainably for as long as the overall policy is followed. 

On the contrary what typically happens in western countries is that banks prefer to lend for speculative investment such as for land and built property (real estate), shares and other financial assets, all of which are outside the Gross Domestic Product (GDP) part of the economy. As he explained the power in such non-GDP lending lies with those who hold assets where there is a shortage; thus with more borrowed money funnelled into a market, prices rise, governed by the fundamental  principle: higher demand & short supply brings price rises. Thus for deals involving land assets (e.g.  existing houses) the land value component rises raising overall house prices; assets such as shares are in limited supply and again, prices rise.  This brings the familiar price boom and bust cycle of western economies - caused by unregulated credit creation for assets in short supply. Eventually the speculative side of the boom gets out of hand and then early speculators sell up and banks find they have too many non-performing loans as the asset prices ease and a crash develops, which brings recession and job losses.

However if investment into the productive side of the economy were encouraged GDP would grow, bringing jobs. Careful management of the financial side of the economy is needed or  inflation can occur as consumers raise easy credit. The sudden demand for limited goods and an inadequate supply can bring price rises. The typical western unrestricted, free-for-all method of the Washington Consensus does not bring sustainable economies, as we all know.       

Werner spoke of his findings on interest-rate-setting by central banks. With a colleague Kang-Soek Lee, he has proved that the western central bank assumption: that  interest rates cause growth is wrong. What happens is that growth drives interest rates, thus high growth brings high interest rates and low growth the reverse.  Thus whilst central bank committees  deliberate for hours over interest rate setting, thinking they will coax the economy into life or damp it down, what they should seek out is what really drives the economy - the  causes and not the effects. Will they heed what Deng Ziaoping  set in train in 1978 when he said China would 'seek truth from facts'. Deng was a pragmatist and gave a new direction to his  country and was prepared to try whatever worked. Werner said what is called in the west 'the Chinese Miracle' is a misnomer, it is nothing of the sort. What China has achieved is sustained growth through clear repeatable policies and actions. A miracle has no naturally observable cause.

Recessions can be ended quickly by central banks. Ben Bernanke actually did this correctly after the credit crisis of 2007/8 as the US FED bought up US banks' non-performing loans at face value (not written down value)  and cleaned up their balance sheets, enabling them to lend.  This happened very rapidly as seen from a chart of the US Federal Reserve's balance sheet , with GDP growing within a year.
He examined the idea of equilibrium in markets. Assumptions are made: that markets being perfect, prices adjust instantly, and that markets clear automatically; that there is perfect competition; that all players are rational; that perfect information is available. These are all impossible and it is quite wrong to base policies on them. The Chinese way has been to accept the truth that markets never clear, rationing always taking place, so their government intervention is not a 'distortion', as believed in the west, but an essentially good thing to do, so that bad market outcomes are addressed. Markets are in pervasive disequilibrium Werner stated. He said that believers in equilibrium in markets (he listed 8 'features') were outdoing the Red Queen in the Alice in Wonderland fantasy novel, who sometimes believed '6 impossible things before breakfast'.

He challenged Washington Consensus believers to examine the outcomes of their conditions for sustainable growth. There is not a good track record compared with the Chinese case. One fundamental failing of western economics is the absence of textbook studies on money and clear statements that the creation of virtually a country's entire money supply, is through private banks, out-of-nothing. Until he carried out an empirical study no one had ever checked this money creation out-of-nothing theory. The result can be read here and became a most downloaded paper from Elsevier.    

A hopeful thing is that bank credit creation is a game changer for any country. With their own currency and banking system they have no need to borrow foreign currency. Their own local banks can create the credit needed in their own currency and lend it locally. Indeed, Werner demonstrated that even incoming 'foreign loans' remain in the jurisdiction of the issuing bank's country, and are merely matched by an accounting procedure in a local bank. When gold was shipped around the world in earlier times there were capital flows, but not now. All that flows is the control of the borrower's assets to the lender.  

China has thousand of local small banks so that credit is made available where the new jobs are going to arise, as the central policy of productive investment is encouraged. By contrast the UK has only 4 or 5 huge centralised banks which leaves a hopeless mismatch of the credit supply needed for the thousands of small businesses scattered over the country that will produce the new jobs needed for a sustainable economy. Werner said big banks naturally want big deals, small business need small loans which are proportionately too much trouble for big banks to bother with.   

Japan in 1945 followed the above methods and, hoping for a doubling in national income within 10 years after war, achieved that in 4 years and enjoyed  15% year-on-year growth for decades following. China adopted principles from Japan, of investment directed towards production in the late 1970s and had over 7% growth in GDP in most years for decades. By contrast Soviet Russia tried centralised direction of the economy but having only one main bank it failed to achieve a thriving economy at all.

Werner ended his lecture with a Q & A session and appealing for a local community bank in Leicester patterned on Hampshire Community Bank which is near to achieving its license.  No staff bonuses - just reasonable salaries, a charity is the ultimate owner giving towards local good causes. Such banks should follow the German local bank models which for more than 100 years: 

  • have never needed public money to bail them out
  • have never failed paying out customer deposits 
  • have under 3% non-performing-loans 
  • and provide 90% of SME loans in Germany.  

Local community-type banks have a great public appeal as they are based on relationships and trust - as was experienced in earlier times in UK banks. Werner showed that the prospect for new style local high street banks for the UK is good.

So, how do we consider startlingly different ideas that come from another culture such as  the economic success story of China? We are not fussed about buying their  goods, so why would a different way of doing economics from China be any different? UK politics is drifting to the left as Labour advocates more state intervention and as their poll ratings gain, perhaps the time is coming when economic lessons from Japan and China are becoming acceptable. Richard Werner wrote Princes of The Yen which details his findings as to how Japan ran its economy.      

A somewhat parallel story to this from 250 years ago is in The Times on 2nd May Paul Simons: 'Weather Eye.  American sailors discovered the powerful North Atlantic Gulf Stream flowing from America to England. British mail ships faced this as a counter-current on the journey to the America which slowed them. American ships found their voyages to Europe were up to two weeks shorter as they took advantage of the current. Benjamin Franklin, co-founder of the later American Constitution tried to publicise this navigation scenario.  Despite plotting the current on charts and delivering them to the Admiralty in London he was ignored. Franklin's cousin, a whaler who used the current, told him that the captains of the mail ships ''were too wise to be counselled by simple American fishermen''. It is thought that this blindspot disadvantaged the Brits in the following American War of Independence through delays to supplies and communications. The Brits lost that war. 

Werner's audience listened spellbound as his iconoclastic intellectual tornado swept through. Dean Dana Brown seemed impressed. But will there be a Bank of England governor and a Chancellor of the Exchequer who will grasp this economics nettle to reshape the economy with its banking system for the general good? Deng Xiaoping got something right about economics and decentralised banking.  With one community local bank nearly ready for the UK the hope of a more stable and sustainable prosperity might be coming, especially if the wider message from China is heeded. 
Posted by Charles Bazlinton. Author The Free Lunch - Fairness with Freedom
Director of Local First CIC - Promoting Local Banks.       

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