090711 Gardiner to Gang8

EU Article 101

It looks as though the change in the EU to a Swiss Style central banking system which forbids the central bank from lending to its government is quite recent as I can find no mention of repos in the table 4.2A of the British Financial Statistics until recently. I shall need to investigate more deeply but I wonder if it is one of the results of the Lisbon Treaty. That is just a guess at this stage. If it is I can think of no better reason for voting against the treaty.

My second thought is, 'Is this the cause of the chaos over banking liquidity which started the current crisis?' Change always causes disruption. In my 2006 book I suggested, following Randy Wray's example, that the central bank MUST provide all the liquidity the banks need, and not try to muck around. 'Fractional Reserve Banking' is pretty much nonsense. It is a relief to know that at the time I wrote the book the new rules had not come into force and my chapter analysing the bookkeeping of bank reserves was then valid, though I must admit it needs rewriting even so.

There is an excellent discussion of the question of bank liquidity in Chapter Five of Randall Wray's book, 'Understanding Modern Money', Edward Elgar, 1998. For those who are new to Gang8, Randy Wray was a founder member but does not have the time to participate now. I commend all his work to you all. Besides this book and 'The Credit and State Theories on Money', Edward Elgar, 2004, one should also read papers he has written which can be found at Levy.org

The thought that governments should never be trusted in any financial area has its appeal, but changing to the Swiss rule seems to be driven not by pragmatism but by monetarist ideology of a rather old-fashioned kind. Milton Friedman got a big following in the 1960s by asserting, I understand, that government borrowing is the root of all inflation. A little knowledge of history would cast doubt on that assertion. The huge borrowing which the British Government indulged in in the 18th century and which resulted in half the budget being interest on the National Debt caused some inflation, about 30 per cent, but nothing like the level we have seen since Friedman's theories were made the basis of practice. I still agree with Chris Meakin that present domestic inflation is to a considerable extent the knock-on effect of asset price inflation which itself has been caused by new credit creation by banks for the purchase of assets. New credit creation was at least £800bn in the period 2004 to 2009. The exact figure is not clear as I do not know how much more credit creation there was which has disappeared from the money supply figures by disintermediation. A quick look at the stats suggests it may be huge.

The Swiss system may even intend that the government should be required to put its spending plans to the test of making an application for loans from private sector banks, a nice thought! One can imagine Neville Chamberlain in 1935 going to Lloyds Bank and asking for a loan for £400mn for rearmament. Would bankers care whether the government was proposing sensible spending? Hardly likely. Loans to the government are zero-weighted for Basel purposes and so long as interest is paid, who should worry? 2½% Consolidated Stock arose from George II's wars in the 1740s.

If all the liabilities of the central bank, note issue and accounts of banks, are matched by government loans, then the government saves the interest on those loans and no more. Backing them with repos gives the government the chance to make something more by charging penalty rates, the assumption being that a bank short of liquidity has been naughty whereas all it may mean is that a customer, like BP, has paid its excise duties, or an issue of gilts has been successful.

Geoffrey