Austrian School: Crap/Not Crap?

This is where I disagree with you. Keen says exactly the opposite in regards to the need for a central bank. Drastically so in fact. His proposal for the current crisis is a 'debt jubilee' funded from central bank created money - effectively creating money and giving it direct to debters instead of using QE. His opposition to neoclassical notions of exogenous money is that it leads to the belief that QE can solve the problem of liquidity, when his own models show this strategy to be inferior to direct giving of money to firms that are in debt.

Sorry, but you are simply wrong on this. Here's the written evidence to parliament on how the banks did it:

In theory it should have been impossible. Deregulation meant that, in practice, they did it.

In what way(s) are they similar?

Rules and the fact that their having done so will be fairly obvious to other parties rather quickly, so as well as being imposed external regulation, it's internalised self-regulation too.

i'm not wrong on this at all i'm afraid

this research only compares one part of a bank's funding streams (customer deposits) to its total extension of credit (loans)

it doesn't take into account, wholesale funding (which makes up a substantial part of a lot of bank's funding - and is really just commercial deposits but is not included in that analysis), central bank funding, equity capital, subordinated debt and all manner of other types of ways that banks fund their balance sheet. For the purposes of this discussion (to simplify terminology) i've lumped all of these into one category and called them deposits because in the wider sense they are all 'deposits' of money with the bank, they are just different in their nature - but what they all have in common is that they all form part of a bank's overall funding which allows it to lend money out. the research which you quote (which is based on an article that the bbc and times wrote) - purely looks at the relationship between bank lending and customer deposits, it excludes these other important components of bank funding)

The 322% figure quoted for Northern Rock shows exactly why it failed - because the bulk of it's lending was funded from wholesale markets and not from straightfoward more stable customer deposits - so when the wholesale market freezed up it was caught totally exposed. This research does not show that Northern Rock created money equivalent to 222% of the money it had lent out - it merely shows what proportion of it's customer lending was funded through wholesale borrowing (which is effectively the same as a deposit as it's a commercial bank 'depositing' money with another bank for a given time at a given rate)

(i'll quite happily walk through a bank's balance sheet with you and talk through the various categories/components and point out which parts are included in that analysis and which aren't - it will be dull as fuck mind, but it will prove the point)

my central point still remains, if a bank wants to lend out £110 but has only got £100 'deposited' with it (deposit in the wider sense, not the sense used in that report - i.e. if it only has funded itself to the tune of £100 through the variety of ways possible i.e., customer deposits, wholesale funding, equity capital, subordinated debt, etc..), the extra £10 can't be magiced into existence or created just because some regulations have changed - it has to be funded from somewhere before it can be circulated onwards - this is what i've been saying from post one on this thread

edit: and in fact looking back at my post you quoted, I didn't even talk about deposits in it, i referred to things like banks only being able to lend out what they got in - the parliament report doesn't contradict this in any way, as it only focuses on one part of what banks 'get in' to enable them to lend

I was referring to his models his models that LBJ points to which claim that there is no need for the central bank

his solutions that you refer to in relation to the current crisis do somewhat contradict his 'models' which show that the central bank is not required though i'll give you that - speak to keen on that one though, not me

The models are simplified models to demonstrate flows of money, but when keen modifies the model to replicate a credit crunch, he introduces a central bank injection of money to compare the effects of injecting that money into different parts of the system. In other words, the model containing no central bank is the one that generates crises, and a central bank is introduced to solve that crisis.

so is LBJ incorrect in his assertion that Keen:-

I'd be surprised if LBJ was wrong in relation to Keen on this as this is exactly the type of thing I would expect from someone coming from the perspective he comes from

YMU - here's a snapshot of Northern Rock's balance sheet prior to it's crash (this is a very summarised/condensed down version of it)



If you look at the 2006 year - you will see that loans to customers (the 87) is 322% of customer deposits (27) - this is what the parliament report refers to

All this shows is that the differences between customer lending and customer deposits, is funded by means other than customer deposits - i.e. other kind of funding that the bank has obtained, in this case mortgage securities which represented money that they had borrowed from the wholesale markets which was secured/collaterised on future income streams from their mortgage book and other borrowings plus a little bit of equity capital. It's nothing to do with the bank creating money out of thin air or lending out more than it has got in

While on the topic of this, balance sheets always balance, i.e. total assets equals total liabilities (something that was also discussed earlier on this thread) - anyone who claims that banks can create money out of the thin air would see a situation where the banks assets increase but not their liabilities. This is just absurd really - every asset on that balance sheet above, is funded by a liability for the exact same amount. So in 2006 northern rock had assets of 101bn which in turn were funded by liabiliites of 101bn - the component part of that 101bn that is made up of customer deposits is important from a point of view about how the bank funds it's operations (i.e. it's over reliance on a particular stream/type of funding), but just because customer deposits in this case doesn't equal 101bn, it doesn't mean the bank has created money out of nothing, or lent out more than it has 'got in'.

edit: also if you look at the end of year 2007 position - the reduction in customer deposits represents the run on the bank, meaning it's overall assets were even less funded from customer deposits and things like the state funding from the bank of england begin to take it's place - again this is just funding from different sources, it's not them creating money out of thin air or magicing it into existence

EDIT: didn't see your post before this one. Will come back to it.

You can walk us through the bank balance if you like, but I think the place to start is with the Morgan-Stanley research they cite. AFAIK the problem was that some of the things that they counted as equivalent to cash deposits for the purposes of lending were nothing like cash deposits in practice.

Am looking for more detail on that report now.

He actually made that model to show how disastrous it would be in practice.

The model that LBJ talks of is of a pure credit economy without central bank. Keen tries to show that this model, under very stringent conditions can be stable and self perpetuating, but that these conditions would not hold in the real world. This model is explicitly stated to be a heuristic device to simply demonstrate the circular flows. Keen does not use this simplified model to show that the economy is inherently stable, he uses it as a basic framework that when extended can produce instabilities and disequilibrium behaviour.

nope that's not what it was about i'm afraid - the problem was what i referred to above - that northern rock depended upon the wholesale funding markets far too much in relation to its customer lending - this got it into trouble then those markets froze up and as such a big component of its lending was funded in this way, along with the run on the bank which removed another slice of its funding in the shape of reduced customer deposits , leading first to emergency state funding and then it going down the pan

I got the impression in your previous post on his model that you were using that to back up your point that money could be created out of thin air (as long as it kept on happening) - at least that was the context you referred to it in

Yes - that it is a theoretically possible system. Keen makes the point that his simplified model in fact produces a better fit to reality than other models. But he doesn't think this is a good thing. The whole thrust of all his arguments is that the situation as it is now must be changed.

anything's possible in theory though if you artificially manipulate the conditions in which you model it to make it so!

what use do these things give us though?

we just need to look at what's going on around us in reality to realise the inherent instability of the current mode of production/social relations, and that they should be obliterated - we can see this by simply looking at and analysing reality and what actually happens

Not having much luck finding the Morgan Stanley report, but this bit from the Guardian's banking blog has some bearing, I think.

If there is a different risk associated with different ways of funding loans, then funding secured in this way cannot be regarded as equivalent to a cash deposit. How is it treated on the balance sheets?

The usefulness comes when this 'core' model is extended by coupling it with a model of the production economy. The model then is able to produce results that resemble some of the events of the past two decades.

Make of it what you will, I don't yet know if I accept what Keen says. But there it is. Here are the results of his model (on the right) compared to the actual numbers.

I don't really understand what you're getting at in your sentence above to be honest

all ways of funding loans have different risks, both within the same categories of funding (i.e. customer deposits) and between them (i.e. say between custoemr deposits and wholesale funding)

the question of the relative riskiness doesn't changes the fundamental fact (which you said this study proves I am wrong on) that if banks want to lend a £100, they have to get it first from somewhere (either by some combination of the different funding routes available or by just one of them)

I don't really understand what you're getting at in your sentence above to be honest - the different types of funding that funds a bank is shown separately on its balance sheet - one element of this funding is customer deposits, this isn't the only form of funding however, it merely forms part of the overall funding that a bank has in place - this funding is used to fund the bank's activities/lending

this is probably not a perfect analogy, but it's like if you say you have £1000 of outgoings in a month, and £800 of this is funded through your wage - with the other £200 being funded from say, the profit on renting out a flat. Just because you spend 125% of your wage income each month, doesn't mean that you spend 25% more than what you get in in total each month, or that it's impossible to spend 125% of your wage income each month. It just shows that you have income from other sources which when added together means that your incomings and outgoings match exactly. Clearly in this case there is risk to both income streams, the £800 could go if you lose your job and the £200 could go if your tenants move out - so there is risk inherent in both of them, however this in no way means that you are somehow able to spend more than you get in each month (if we exclude borrowing for the time being, ironic i know as this is what the topic is about..). So again i'm not quite sure why your sentence above about risk comes into what is a more fundamental issue about how something funds itself (whether it's a bank or you)

I think I can see what ymu's getting at. If you make a loan which will be repaid in 10 years' time, say, and fund that loan with a 'deposit' that you have to repay in 1 year's time, these are not equivalent. You have not funded your 10-year loan at the start of the process, merely a small part of it: ie the idea that the size of a loan is money plus time.

yes, but that's completely different from saying you can create money out of thin air or you can lend out more than you have already borrowed

you can only lend out that original loan for ten years, if you have the money in the first place to pass on to the borrower - so it has to be funded initially, and then over the course of the loan, refinanced if the borrowing to fund it didn't exactly match the maturity profile of the loan itself. This is exactly what got Northern Rock into trouble, it borrowed short term on the wholesale markets and lent long term in the mortgage markets - so when the wholesale markets froze up it was left with a huge financing gap when it's shorter term borrowing came up for payment and it wasn't able to renew it and it also wasn't able to liquidise its assets as they were tied up in long term mortgage deals

this is liquidity risk (and was the cause of a lot of the bank's failures), and it's important to bank's survivial - but it doesn't change the simple fact that if you want to lend something, you have to first fund it - this was the central point being contested earlier - and one which both of you suggested I was wrong about - i'm 100% right on this i'm afraid

Except that lending money you've only got for a year for ten years could be functionally equivalent to lending more than you have borrowed. After that first year, you have to repay your initial borrowing and borrow again - in other words, you are borrowing to finance a loan that's already been made after it has been made.

no it's not lending more than you have borrowed - as at the outset you have to have funding in place to fund the proposed loan - yes you have to then refinance that borrowing during the term of the loan, but this is different from what you were proposing earlier that money is created out of thin air to lend out - it's nothing like that

and if you are unable to refinance the borrowing after the first year - you go under and tits up, just like northern rock, you are no longer in that game and instead are funded through central bank funding and wound down/liquidated - whereas again you were asserting that this model of creating money out of thin air was not only possible but sustainable

edit: at the point of the original loan being made out to the customer for ten years, this is the point when the money supply is expanded , and to do this, you have to be in a position to fund that loan - i.e. you can't expand the money supply through circulation if you can't fund your lending - your earlier assertions suggest that the money supply can be increased through the creation of money from thin air - this is simply not possible

and the subsequent refinancing of a loan/deposit that a bank may have taken out to fund a ten year loan has absolutely no impact on the money supply, it's just a straight replacement of funding, leaving the original expansion of the money supply (the ten year loan) completely unchanged

I'm saying that if you use a risky asset to fund loans, it is not the same as a cash deposit and cannot be treated in the same way on the balance sheet. Especially if some of those assets are fake AAA financial instruments which are worth a fraction of their stated value.

Still need that Morgan Stanley report - I want to know exactly what they said about these ratios, and about the other assets used to fund loans. You're saying it has been widely misreported. I don't disbelieve you, I just want to know exactly what they said.

Here are a few quotes from a paper by Basil Moore that Keen references in support of his endogenous money theory. What flaws do you see in this, ld? (Sorry if I seem like I'm pestering you with questions, but you seem pretty clued up so I'd be silly not to)

How is that not functionally equivalent to creating money out of thin air, though?

If you borrow for a year and lend for ten years, that is not funding your loan, is it: it is not matching promises, in other words, as you've promised your borrower money for ten years, but your creditor has only promised you money for a year.

It is taking a gamble at the start of the process that you will be able to fund it for the nine unfunded years by relying on there being future investments - a point Minsky makes. If short-term borrowing by banks is cheaper than long-term borrowing, and long-term lending is more profitable than short-term lending, then it's easy to see where their margin comes from - but it relies at the start of the process on there being nine years' worth of funding in the future that does not yet exist.

Pretty sure no one is claiming it was sustainable?

Keen uses his model to show how, in the long term, it produces exponentially spiralling debt, unemployment and deflation. It isn't sustainable! But the point of his model is to show how well it matches up to our current unsustainable system, which, according to Keen, operates in a very similar way to his model.

first of all it's not a risky asset used to fund loans, it's a risky liability (liabilities on a bank's balance sheet relate to its funding)

a cash deposit could be as risky as any other type of funding for a bank so i'm not sure why you're so wedded to this idea of cash deposits - for example when Northern Rock got into trouble, loads of people withdrew their cash deposits - this compounded the situation for Northern Rock as it gave them an even bigger funding gap at a time when all routes to funding for it (other than state help) was closing up

the point about AAA financial instruments in this case is pretty irrelevant to the point being made also - if Northern Rock issued a AAA rated instrument then at the time of it selling it, it would get say the £100 on day 1, the buyer would then own an instrument that in theory was worth £100 and would give it an income stream. Norther Rock gets the £100 on day 1 (i.e it secures the money at that point) and can then do what it wants with this money (lend it on as a mortgage for example) - the risk in this case is not with Northern Rock the issuer of the security, but the buyer who has already given Norther Rock £100 for it. If it goes tits up it's the buyer who loses out not the issuer.

I'm saying you are using the information in it in a way that is not correct for the purposes of your argument/discussion with me - you are conflating narrow categories that are used within it with the wider categories which I have been talking about

I've already went though one of the examples in that report, i.e. Norther Rock and showed you where the figure of 322% derives from, what it's constituent parts relate to and most importantly what is not included in that ratio (and again it's not about assets that are used to fund loans, it's liabilities that are used to fund loans/assets)

By all means look into it more yourself, I don't expect anyone to take my word on it without doing their own investigations - but I am 100% confident of being correct about this, and the only reason I can say this is because it's a straightforward technical matter, there's no ambiguity involved (although the interpretation of these kind of studies does provide a lot of money cranks with erection material for conspiracy theory type analysis of the system)

I need to go and get my tea now

Because they're not. They're gambling that money - actual money - will be available in the future, at a price they can afford.