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Thomas Piketty Is Right
http://www.newrepublic.com/article/117429/capital-twenty-first-century-thomas-piketty-reviewed

Income inequality in the United States and elsewhere has been worsening since the 1970s. The most striking aspect has been the widening gap between the rich and the rest. This ominous anti-democratic trend has finally found its way into public consciousness and political rhetoric. A rational and effective policy for dealing with it—if there is to be one—will have to rest on an understanding of the causes of increasing inequality.

The discussion so far has turned up a number of causal factors:
the erosion of the real minimum wage;
the decay of labor unions and collective bargaining;
globalization and intensified competition from low-wage workers in poor countries;
technological changes and shifts in demand that eliminate mid-level jobs and leave the labor market polarized between the highly educated and skilled at the top and the mass of poorly educated and unskilled at the bottom.

Each of these candidate causes seems to capture a bit of the truth. But even taken together they do not seem to provide a thoroughly satisfactory picture.

They have at least two deficiencies.

First, they do not speak to the really dramatic issue: the tendency for the very top incomes—the “1 percent”—to pull away from the rest of society.

Second, they seem a little adventitious, accidental; whereas a forty-year trend common to the advanced economies of the United States, Europe, and Japan would be more likely to rest on some deeper forces within modern industrial capitalism.

Now along comes Thomas Piketty, a forty-two-year-old French economist, to fill those gaps and then some. I had a friend, a distinguished algebraist, whose preferred adjective of praise was “serious.” “Z is a serious mathematician,” he would say, or “Now that is a serious painting.” Well, this is a serious book.
 
IMF official says 'premature' to speak of Chinese crisis
http://www.reuters.com/article/2015/08/22/us-china-imf-idUSKCN0QR0JJ20150822
 
BREAKING: CSRC chair Xiao also urged 50 big brokerages to continue to contribute capital to state agency for margin finance to stabilize mkt https://twitter.com/george_chen/status/637928919916670976


Felix Zulauf Sees Markets Falling FurtherFelix Zulauf expects China’s yuan to lose up to 30% of its value, leading to more turmoil for stocks and a possible banking crisis in Asia.http://www.barrons.com/articles/felix-zulauf-sees-markets-falling-further-1440825824

Felix Zulauf has long trained his considerable wisdom on understanding and profiting from the investment implications of macroeconomic trends. As anyone with a pulse and a brokerage account now knows, the trends are pretty awful. Felix, a longtime member of the Barron’s Roundtable, is convinced the implications could be worse.

It is hard to argue with his track record of late as a prognosticator, since much of what he forecast in our midyear Roundtable, published on June 15, has come to pass. Major stock indexes around the world indeed have corrected by roughly 10% or more—and in China’s case, by 18%—since the Chinese government suddenly devalued the nation’s currency three weeks ago. The devaluation is another thing Felix predicted, although it happened a bit sooner than he expected.

Felix wears several hats these days: He’s president of Zulauf Asset Management and co-chief investment officer and partner at Vicenda Asset Management, both based in Zug, Switzerland. He thinks the world and the markets could be roiled further in coming months as China continues to adjust to decelerating growth, taking steps that will export deflation around the globe. He shared his bracing insights and current outlook in a conversation last week.

Barron’s: Is the recent selloff in stocks a so-called buying opportunity or the prologue to a bear market?

Zulauf: Technical indicators—of volume, breadth, volatility, and so forth—hit an extreme on Monday. After a selling climax like that, the market usually tries to recover. Such recoveries tend to last from a few days to a few weeks. Then the market retests its lows. My hunch is that U.S. stocks, and other stocks, will undercut this month’s lows in the next wave of selling.

On what do you base that hunch?

You have to look at the markets’ underlying fundamentals. Every market cycle has a dominant theme. The U.S. housing market was at the epicenter of the financial crisis of 2008-09. China is at the epicenter of the current crisis, and its problems will have an impact on the rest of the world. China experienced the biggest investment and credit-creation boom that mankind has ever seen, and the downturn probably will last for a few more years. China’s economic growth decelerated from more than 10% to about 2%, although the targeted figure is 7%, but that’s baloney. The industrial complex in China is in a recession. The currency is overvalued by 20%, at least, and the capital account has fallen into deficit.

The key to this crisis is a balance-of-payments problem, which many analysts and economists don’t seem to understand. China has experienced capital outflows for the past 12 months on the order of $500 billion or more. The country doesn’t have a completely open capital account, so you need to get the government’s permission to move money abroad, or find ways to cheat via fake billings and things like that. Under free-market circumstances, capital outflows would depress the value of the currency. But China was running down its foreign-exchange reserves to support its currency. The government concluded that a currency regime change was needed to prevent the loss of further foreign-exchange reserves.

China’s foreign-exchange reserves aren’t exactly puny.

According to the latest figures, China has $3.5 trillion in foreign-exchange reserves, of which about $1 trillion is illiquid. The authorities spent about $150 billion to support the currency, or smooth its decline, in the past two weeks. China was buying the currency with the country’s foreign-exchange reserves. In a sense, that meant it was withdrawing liquidity from the domestic credit market. It cut interest rates this week to try to calm the market, and reduced the bank reserve-requirement ratio, allowing Chinese banks to be more generous in lending.

Nice try. The Shanghai index has continued to fall.

In prior balance-of-payment crises, such as Latin America in the early 1980s, Mexico in 1994, Asia in 1997, and Russia in 1998, the currencies involved typically declined by 40% to 70%. I’m not saying the Chinese renminbi must decline by 40% to 70%, but it probably will decline against the dollar by 30%, in all. It is down 10% already.

What are the likely repercussions of a devaluation of that magnitude?

China is the world’s largest exporter, and has the world’s second-largest economy after the U.S. If the Chinese currency falls 30%, Chinese products will get 30% cheaper in the market. The price of all globally traded goods will come under pressure. That is terrible news for China’s direct competitors, and bad news for other producers. Price deflation would translate into declining sales, shrinking profit margins, and lower profits for the corporate sector worldwide. What do companies do when profits come under pressure?

That’s easy: They cut costs and fire employees.

Exactly. They cut the incomes of others. Consumers start saving more and spending less, which leads to a weaker world economy. The offset is that consumers get some relief from lower prices.

Today’s environment is deflationary because the indebtedness of too many economic subjects has reached capacity. The borrowing can’t continue. Central banks can’t solve the problem by providing more liquidity because liquidity isn’t the issue. We have plenty of liquidity; we don’t have enough borrowing capacity. Also, inventories are high around the world, in Asia and elsewhere. This virtually guarantees lower prices in the future. Inflation rates will be lower, and interest rates will stay low. The stock market will have to adjust to this new reality.

Among institutional investors and private households in the U.S., the asset allocation to equities is similar to the level in 2007. Liquidation pressure is building. It is going to be an extremely difficult environment.

How much lower, then, do you expect the Standard & Poor’s 500 index to fall?

I was targeting the low-1800s for the S&P, and 9000 for Germany’s DAX index. Both indexes fell to the vicinity of those levels on Monday and we closed our short positions. As the rebound unfolds, we will short them again as we think both markets will fall further. But the easiest bet is to short the Chinese currency, although that is a trade only for professional currency traders.

Is it time to buy gold?

Gold has begun a medium-term rally that could carry the price from a recent $1,125 an ounce to about $1,300. But I wouldn’t call it bullish for commodities in general; the commodity complex remains in a secular bear market.

The crisis in Asia will do a lot of harm to the banking systems in China, Hong Kong, and Singapore. The balance sheets of the region’s banks have more than doubled in the past six years relative to gross domestic product. Big and unexpected moves in currencies can hurt carry trades [borrowing at low interest rates to invest in potentially higher-earning assets], and nonperforming loans could jump dramatically at these institutions. It wouldn’t surprise me if one or another bank disclosed one of these days that nonperforming loans had climbed to 15% or 20% or 25% of its loan book. That might cause systemic risk, as the banks in these countries are linked to our banking system. People buying gold now are doing so for that reason.

Do you foresee another crisis along the lines of 2008?

No, because the process is different. There most likely won’t be a waterfall decline in the value of financial assets, but a gradual erosion. The Chinese are trying to slow the process, which will make it even uglier over time. They aren’t letting market forces adjust to the economic situation. They are preserving the belief that the authorities have it under control. That is also baloney.

Speaking of the authorities, what are the odds that the Federal Reserve will lift its short-term interest-rate target in September?

If the Fed hikes rates next month, it will probably send the wrong signal to the market, and at the wrong time. I said in January that the Fed wouldn’t lift rates this year, and I still believe that. I simply don’t see how the financial authorities are going to prop up the world economy again. Look at the European Union: Its members knew Greece was bust but lent the country another 90 billion euros ($100 billion) to repay its old debt. They are the United Gang of Can-Kickers. As long as the authorities try to fix the global economy by increasing government control and manipulating markets, it can’t heal.

Europeans are proud of the recent uptick in their economy, but I expect Europe to disappoint again this year. The euro zone has benefited from the one-time effects of lower oil prices and a cheaper euro. Also, some economies, such as Spain, relaxed austerity measures in advance of national elections. But the recovery isn’t sustainable. Germany will eventually suffer on the export side as Japan eats into its markets. Developments in China and Russia are bad for the Europeans. That said, Greece isn’t an issue for the world. It is a symptom of the state of the world.

The recent selloff in global markets has hurt the portfolios of the superrich as well as the rest of us. Does this spell trouble for other highly valued assets, including luxury real estate and art?

Deflationary forces eventually bring prices down and lead to corrections. But the capital flowing out of China is being invested in the Western world, particularly in real estate in the U.S. and London. While things might look bleak in China, such investment creates the impression that everything is fine here.

The fact is, investors have no place to go. You can’t buy low-yielding bonds for a long-term investment, and the Chinese, by selling dollars to support their economy, are also selling U.S. Treasury bonds. That is a negative for the Treasury market.

Surely, there must be someplace to hide.

Stay defensive. The S&P 500 could bounce up to 1980 but then fall to 1800, or lower. Stick to quality in equities and bonds. Buy companies with low cyclicality and strong balance sheets. A U.S. investor should stick with the U.S. dollar and avoid trading other currencies. And, don’t try to bottom-fish emerging-market stocks, bonds, and currencies.


How Western Capitalism laid China low http://m.heraldscotland.com/opinion/13635156.How_Western_Capitalism_laid_China_low/


China’s banks face tightening bad loans squeezehttp://www.ft.com/intl/cms/s/0/3eace0ec-4d6d-11e5-9b5d-89a026fda5c9.html
 
Jason Zweig’s Rules for Investing

1. Take the Global View: Use a spreadsheet to track your total net worth — not day-to-day price fluctuations.

2. Hope for the best, but expect the worst: Brace for disaster via diversification and learning market history. Expect good investments to do poorly from time to time. Don’t allow temporary under-performance or disaster to cause you to panic.

3. Investigate, then invest: Study companies’ financial statement, mutual funds’ prospectus, and advisors’ background. Do your homework!

4. Never say always: Never put more than 10% of your net worth into any one investment.

5. Know what you don’t know: Don’t believe you know everything. Look across different time periods; ask what might make an investment go down.

6. The past is not prologue: Investors buy low sell high! They don’t buy something merely because it is trending higher.

7. Weigh what they say: Ask any forecaster for their complete track record of predictions. Before deploying a strategy, gather objective evidence of its performance.

8. If it sounds too good to be true, it probably is: High Return + Low Risk + Short Time = Fraud.

9. Costs are killers: Trading costs can equal 1%; Mutual fund fees are another 1-2%; If middlemen take 3-5% of your cash, its a huge drag on returns.

10. Eggs go splat: Never put all your eggs in one basket; diversify across U.S., Foreign stocks, bonds and cash. Never fill your 401(k) with employee company stock.
 
The global economy is in serious danger
https://www.washingtonpost.com/opin...d-11e5-b31c-d80d62b53e28_story.html?tid=sm_tw

As the world’s financial policymakers convene for their annual meeting Fridayin Peru, the dangers facing the global economy are more severe than at any time since the Lehman Brothers bankruptcy in 2008. The problem of secular stagnation — the inability of the industrial world to grow at satisfactory rates even with very loose monetary policies — is growing worse in the wake of problems in most big emerging markets, starting with China.

This raises the specter of a global vicious cycle in which slow growth in industrial countries hurts emerging markets, thereby slowing Western growth further. Industrialized economies that are barely running above stall speed can ill afford a negative global shock.

Policymakers badly underestimate the risks of both a return to recession in the West and of a period where global growth is unacceptably slow, a global growth recession. If a recession were to occur, monetary policymakers would lack the tools to respond. There is essentially no room left for easing in the industrial world. Interest rates are expected to remain very low almost permanently in Japan and Europe and to rise only very slowly in the United States. Today’s challenges call for a clear global commitment to the acceleration of growth as the main goal of macroeconomic policy. Action cannot be confined to monetary policy.

There is an old proverb: “You do not want to know the things you can get used to.” It is all too applicable to the global economy in recent years. While the talk has been of recovery and putting the economic crisis behind us, gross domestic product forecasts have been revised sharply downward almost everywhere. Relative to its 2012 forecasts, the International Monetary Fund has reduced its forecasts for U.S. GDP in 2020 by 6 percent, for Europe by 3 percent, for China by 14 percent, for emerging markets by 10 percent and for the world as a whole by 6 percent. These dismal figures assume there will be no recessions in the industrial world and an absence of systemic crises in the developing world. Neither can be taken for granted.

We are in a new macroeconomic epoch where the risk of deflation is higher than that of inflation, and we cannot rely on the self-restoring features of market economies. The effects of hysteresis — where recessions are not just costly but also stunt the growth of future output — appear far stronger than anyone imagined a few years ago. Western bond markets are sending a strong signal that there is too little, rather than too much, outstanding government debt. As always when things go badly, there is a great debate between those who believe in staying the course and those who urge a serious correction. I am convinced of the urgent need for substantial changes in the world’s economic strategy.

History tells us that markets are inefficient and often wrong in their judgments about economic fundamentals. It also teaches us that policymakers who ignore adverse market signals because they are inconsistent with their preconceptions risk serious error. This is one of the most important lessons of the onset of the financial crisis in 2008.Had policymakers heeded the pricing signal on the U.S. housing market from mortgage securities, or on the health of the financial system from bank stock prices, they would have reacted far more quickly to the gathering storm. There is also a lesson from Europe. Policymakers who dismissed market signals that Greek debt would not be repaid in full delayed necessary adjustments — at great cost.

Lessons from the bond market

It is instructive to consider what government bond markets in the industrialized world are implying today. These are the most liquid financial markets in the world and reflect the judgments of a large group of highly informed traders. Two conclusions stand out.

First, the risks tilt heavily toward inflation rates below official targets. Nowhere in the industrial world is there an expectation that central banks will hit their 2 percent targets in the foreseeable future. Inflation expectations are highest in the United States — and even here the market expects inflation of barely 1.5 percent for the five-year period starting in 2020. This is despite the fact that the market believes that monetary policy will remain much looser than the Fed expects, as the Fed funds futures market predicts a rate around 1 percent at the end of 2017 compared with the Fed’s most recent median forecast of 2.6 percent. If the market believed the Fed on monetary policy, it would expect even less inflation and a real risk of deflation.

Second, the prevailing expectation is of extraordinarily low real interest rates, which is the difference between interest rates and inflation. Real rates have been on a downward trend for nearly a quarter-century, and the average real rate in the industrialized world over the next 10 years is expected to be zero.Even this presumably reflects some probability that it will be artificially increased by nominal rates at a zero bound — the fact that central banks cannot reduce short-term interest rates below zero — and deflation. In the presence of such low real rates, there can be little chance that economies would overheat.

Many will argue that bond yields are artificially depressed by quantitative easing (QE) and so it is wrong to use them to draw inferences about future inflation and real rates. This possibility cannot be ruled out. But it is noteworthy that bond yields are now lower in the United States than their average during the period of quantitative easing and that forecasters have been confidently — but wrongly — expecting them to rise for years.

The strongest explanation for this combination of slow growth, expected low inflation and zero real rates is the secular stagnation hypothesis. It holds that a combination of higher saving propensities, lower investment propensities and increased risk aversion have operated to depress the real interest rates that go with full employment to the point where the zero lower bound on nominal rates is constraining.

There are four contributing factors that lead to much lower normal real rates:

●First, increases in inequality — the share of income going to capital and corporate retained earnings — raise the propensity to save.

●Second, an expectation that growth will slow due to a smaller labor force growth and slower productivity growth reduces investment and boosts the incentives to save.

●Third, increased friction in financial intermediation caused by more extensive regulation and increased uncertainty discourages investment.

●Fourth, reductions in the price of capital goods and in the quantity of physical capital needed to operate a business — think of Facebook having more than five times the market value of General Motors.

Emerging markets

Until recently, a major bright spot has been the strength of emerging markets. They have been substantial recipients of capital from developed countries that could not be invested productively at home. The result has been higher interest rates than would otherwise obtain, greater export demand for industrial countries’ products and more competitive exchange rates for developed economies. Gross flows of capital from industrial countries to developing countries rose from $240 billion in 2002 to $1.1 trillion in 2014. Of particular relevance for the discussion of interest rates is that foreign currency borrowing by the nonfinancial sector of developing countries rose from $1.7 trillion in 2008 to $4.3 trillion in 2015.

has now gone into reverse. According to the Institute of International Finance, developing country capital flows fell sharply this year — marking the first such decline in almost 30 years, as the amount of private capital leaving developing countries eclipsed $1 trillion.

What does all this mean for the world’s policymakers gathering in Lima? This is no time for complacency. The idea that slow growth is only a temporary consequence of the 2008 financial crisis is absurd. The latest data suggest growth is slowing in the United States, and it is already slow in Europe and Japan. A global economy near stall speed is one where the primary danger is recession. The most successful macroeconomic policy action of the past few years was European Central Bank President Mario Draghi’s famous vow that the ECB would do “whatever it takes” to preserve the euro, uttered at a moment when the single currency appeared to be on the brink. By making an unconditional commitment to providing liquidity and supporting growth, Draghi prevented an incipient panic and helped lift European growth rates — albeit not by enough.

Any discussion has to start with China, which poured more concrete between 2010 and 2013 than the United States did in the entire 20th century. A reading of the recent history of investment-driven economies — whether in Japan before the oil shock of the 1970s and 1980s or the Asian Tigers in the late 1990s — tells us that growth does not fall off gently.

China faces many other challenges, ranging from the most rapid population aging in the history of the planet to a slowdown in rural-to-urban migration. It also faces issues of political legitimacy and how to cope with hangovers of unproductive investment. Even taking an optimistic view — where China shifts smoothly to a consumption-led growth model led by services — its production mix will be much lighter. The days when it could sustain global commodity markets are over.

The problems are hardly confined to China. Russia struggles with low oil prices, a breakdown in the rule of law and harsh sanctions. Brazil has been hit by the decline in commodity prices but even more by political dysfunction. India is a rare exception. But from Central Europe to Mexico to Turkey to Southeast Asia, the combination of industrial growth declines and dysfunctional politics is slowing growth, discouraging capital inflows and encouraging capital outflows.

No time for complacency

What is needed now is something equivalent but on a global scale — a signal that the authorities recognize that secular stagnation, and its spread to the world, is the dominant risk we face. After last Friday’s dismal U.S. jobs report, the Fed must recognize what should already have been clear: that the risks to the U.S. economy are two-sided. Rates will be increased only if there are clear and direct signs of inflation or of financial euphoria breaking out. The Fed must also state its readiness to help prevent global financial fragility from leading to a global recession.

The central banks of Europe and Japan need to be clear that their biggest risk is a further slowdown. They must indicate a willingness to be creative in the use of the tools at their disposal. With bond yields well below 1 percent, it is doubtful that traditional quantitative easing will have much stimulative effect.They must be prepared to consider support for assets such as corporate securities that carry risk premiums that can be meaningfully reduced and even to recognize that by absorbing bonds used to finance fiscal expansion they can achieve more.

Long-term low interest rates radically alter how we should think about fiscal policy. Just as homeowners can afford larger mortgages when rates are low, government can also sustain higher deficits. If a debt-to-GDP ratio of 60 percent was appropriate when governments faced real borrowing costs of 5 percent, then a far higher figure is surely appropriate today when real borrowing costs are negative.

The case for more expansionary fiscal policy is especially strong when it is spent on investment or maintenance. Wherever countries print their own currency and interest rates are constrained by the zero bound, there is a compelling case for fiscal expansion until demand accelerates to the point where interest rates can be raised. While the problem before 2008 was too much lending, many more of today’s problems have to do with too little lending for productive investment.

Inevitably, there will be discussion of the need for structural reform at the Lima meetings — there always is. But to emphasize this now would be to embrace the macroeconomic status quo. The world’s largest markets are telling us with ever-increasing force that we are in a different world than we have been accustomed to. Traditional approaches of focusing on sound government finance, increased supply potential and avoidance of inflation court disaster. Moreover, the world’s principal tool for dealing with contraction — monetary policy — is largely played out and will be less effective if contraction comes. It follows that policies aimed at lifting global demand are imperative.

If I am wrong about expansionary fiscal policy and such measures are pursued, the risks are that inflation will accelerate too rapidly, economies will overheat and too much capital will flow to developing countries. These outcomes seem remote. But if they materialize, standard approaches can be used to combat them.

If I am right and policy proceeds along the current path, the risk is that the global economy will fall into a trap not unlike the one Japan has been in for 25 years, where growth stagnates but little can be done to fix it. It is an irony of today’s secular stagnation that what is conventionally regarded as imprudent offers the only prudent way forward.
 
Werner RA. How do banks create money, and why can other firms not do the same? An explanation for the coexistence of lending and deposit-taking. International Review of Financial Analysis 2014;36:71-7. https://www.sciencedirect.com/science/article/pii/S1057521914001434

Thanks to the recent banking crises interest has grown in banks and how they operate. In the past, the empirical and institutional market micro-structure of the operation of banks had not been a primary focus for investigations by researchers, which is why they are not well covered in the literature. One neglected detail is the banks' function as the creators and allocators of about 97% of the money supply (Werner, 1997 and Werner, 2005), which has recently attracted attention (Bank of England, 2014a, Bank of England, 2014b, Werner, 2014b and Werner, 2014c). It is the purpose of this paper to investigate precisely how banks create money, and why or whether companies cannot do the same. Since the implementation of banking operations takes place within a corporate accounting framework, this paper is based upon a comparative accounting analysis perspective. By breaking the accounting treatment of lending into two steps, the difference in the accounting operation by bank and non-bank corporations can be isolated. As a result, it can be established precisely why banks are different and what it is that makes them different: They are exempted from the Client Money Rules and thus, unlike other firms, do not have to segregate client money. This enables banks to classify their accounts payable liabilities arising from bank loan contracts as a different type of liability called ‘customer deposits’. The finding is important for many reasons, including for modelling the banking sector accurately in economic models, bank regulation and also for monetary reform proposals that aim at taking away the privilege of money creation from banks. The paper thus adds to the growing literature on the institutional details and market micro-structure of our financial and monetary system, and in particular offers a new contribution to the literature on ‘what makes banks different’, from an accounting and regulatory perspective, solving the puzzle of why banks combine lending and deposit-taking operations under one roof.
 
A lost century in economics: Three theories of banking and the conclusive evidence.
https://www.sciencedirect.com/science/article/pii/S1057521915001477?np=y

Highlights
• The three theories of how banks function and whether they create money are reviewed
• A new empirical test of the three theories is presented
• The test allows to control for all transactions, delivering clear-cut results.
• The fractional reserve and financial intermediation theories of banking are rejected
• Capital adequacy based bank regulation is ineffective, credit guidance preferable
• This is shown with the case study of Barclays Bank creating its own capital
• Questions are raised concerning the lack of progress in economics in the past century
• Policy implications: borrowing from abroad is unnecessary for growth

How do banks operate and where does the money supply come from?

The financial crisis has heightened awareness that these questions have been unduly neglected by many researchers.

During the past century, three different theories of banking were dominant at different times:
(1) The currently prevalent financial intermediation theory of banking says that banks collect deposits and then lend these out, just like other non-bank financial intermediaries.
(2) The older fractional reserve theory of banking says that each individual bank is a financial intermediary without the power to create money, but the banking system collectively is able to create money through the process of ‘multiple deposit expansion’ (the ‘money multiplier’).
(3) The credit creation theory of banking, predominant a century ago, does not consider banks as financial intermediaries that gather deposits to lend out, but instead argues that each individual bank creates credit and money newly when granting a bank loan.

The theories differ in their accounting treatment of bank lending as well as in their policy implications.

Since according to the dominant financial intermediation theory banks are virtually identical with other non-bank financial intermediaries, they are not usually included in the economic models used in economics or by central bankers.

Moreover, the theory of banks as intermediaries provides the rationale for capital adequacy-based bank regulation.

Should this theory not be correct, currently prevailing economics modelling and policy-making would be without empirical foundation.

Despite the importance of this question, so far only one empirical test of the three theories has been reported in learned journals.

This paper presents a second empirical test, using an alternative methodology, which allows control for all other factors. The financial intermediation and the fractional reserve theories of banking are rejected by the evidence.

This finding throws doubt on the rationale for regulating bank capital adequacy to avoid banking crises, as the case study of Barclays Bank during the crisis illustrates.

The finding indicates that advice to encourage developing countries to borrow from abroad is misguided.

The question is considered why the economics profession has failed over most of the past century to make any progress concerning knowledge of the monetary system, and why it instead moved ever further away from the truth as already recognised by the credit creation theory well over a century ago.

The role of conflicts of interest and interested parties in shaping the current bank-free academic consensus is discussed.

A number of avenues for needed further research are indicated.
 
That Yellen may go down in central banking history as “The Great Tightener” appears to pose more than a little irony, perhaps to the coming surprise and irritation of Senate Democrats who signed a letter to the president endorsing her Fed-chair candidacy in 2013. Yet, the shift in policy does not reflect a transformation of her beliefs, but rather their pursuit by different means.

Tightening now follows logically from Yellen’s understanding of the economic outlook and the dynamics of the Fed’s policymaking group, the Federal Open Market Committee (FOMC). Hiking the funds rate, even as economic growth disappoints and inflation remains subdued, buys Yellen the credibility with her colleagues and market participants to subsequently tighten slowly.

That is, Yellen positions herself now as a conservative central banker to ensure that she can be a compassionate one later by allowing Fed policy to remain considerably accommodative for a considerable time.

Central bankers sometimes argue that a rate increase will give them more “ammunition” to cut rates in the future. That’s actually a moronic argument, as it does exactly the opposite. Fed funds target rate increases tend to reduce the Wicksellian equilibrium interest rate, and hence give them less ammunition for the future. The ECB in 2011 is now the classic example, but you can cite Sweden, or Japan (2000 and 2006) or the US (1937) as well.

In contrast, Reinhart has provided what seems to me to be the most plausible explanation for Yellen’s oddly hawkish views. She’s storing up reputational ammunition, which can be used in the future.


Isn’t It Ironic? The Outlook for Federal Reserve Policy [By Vincent R. Reinhart]
http://www.aei.org/wp-content/uploads/2015/12/Isnt-it-ironic.pdf

Fed Chair Janet Yellen is widely viewed as a dovish central banker, but she is about to lead her institution into a prolonged campaign of raising the policy interest rate. Starting now is a tactical decision on Yellen’s part to achieve her longer-run strategic aim. Hiking the funds rate, even as economic growth disappoints and inflation remains subdued, buys Yellen the credibility with her colleagues and market participants to subsequently tighten slowly. Thus, US monetary policy will remain accommodative for a considerable period.
 
Quintessential Tanta: Reflections on Alt-A (with a Donald Trump mention)
Calculated Risk: Quintessential Tanta: Reflections on Alt-A (with a Donald Trump mention)

Subprime will eventually come back, too. The difference is that it will come back--in some modified form--called "subprime." That term is too old, too familiar, too, well, plain to ever go away, I suspect. "Subprime" is a term invented by wonky credit analysts, not marketing departments. It is not catchy. It is not flattering nor is it euphemistic. You may console yourself if your children "have special needs" rather than "are academically below average." If you get a subprime loan, you may console yourself that you got some money from some lender, but you can't avoid the discomfort of having been labelled below-grade.

Actually, the term "B&C Lending" used to be quite popular for what we now universally refer to as "subprime." (It was also called "subprime" in those days, too. We didn't have to pick one term because nobody in the media was paying any attention to us back then and there were no blogs and even if there had been blogs if you had suggested that a blog would generate advertising revenue by talking about the nitty-gritty of the mortgage business you would have been involuntarily institutionalized.) In mortgages as in meat, "prime" meant a letter grade of A. These were the pre-FICO days, when "credit quality" was determined by fitting loans into a matrix involving a host of factors--whether you paid your bills on time, how much you owed, whether you had ever experienced a bankruptcy or a foreclosure or a collection or charge-off, etc. "B&C lending" encompassed the then-allowable range of sub-prime loans that could be made in the respectable or marginally respectable mortgage business. It was always possible to find a "D" borrower, but that was strictly in the "hard money" business: private rather than institutional lenders, interest rates that would make Vinny the Loan Shark green with envy. "F" was simply a borrower no one--not even the hard-money lenders--would lend to.
Read more at Calculated Risk: Quintessential Tanta: Reflections on Alt-A (with a Donald Trump mention)
 
In a recent post Positive Money showed that there is a strong intellectual body of history behind the various alternative proposals for QE. Both John Maynard Keynes and Milton Friedman proposed a style of Quantitative Easing (QE) that was aimed at the real economy. Today, these types of proposals are commonly referred to as “QE for People”, “Sovereign Money Creation”, “Strategic QE” and “Helicopter Money” amongst others.

In effect, both Friedman and Keynes advocated a different form of QE than that which we are experiencing today: one that would be relayed away from the banking sector and speculators and towards consumers, non-financial businesses and low income earners – and one that could directly back investment projects, rather than create risky asset price bubbles.

At Positive Money we have been trying to keep track of Keynes’s and Friedman’s contemporaries and share them with the public. Accordingly, we will be releasing a series of posts that illustrate the various influential people who advocate a different type of QE. Each post will address a separate category of influencers. In our previous post, we highlighted some of the quotes made by prominent Policy Makers and Public Advisors and people working in the financial sector in favour of a different type of QE. Today’s post will highlight quotes made by prominent Academics. Subsequent posts will highlight quotes made by: Politicians, Journalists and Media Commentators, Activists and Special Advisors.

Who Are The Prominent Academics Who Advocate A Different Type of QE? - Positive Money
 
Roche, Cullen O., Understanding the Modern Monetary System (August 5, 2011). Available at SSRN: Understanding the Modern Monetary System by Cullen O. Roche :: SSRN or Understanding the Modern Monetary System by Cullen O. Roche :: SSRN

This paper provides a general understanding of the workings of the modern fiat monetary system in the United States within the context of the global economy. The work is primarily descriptive in nature and takes an operational perspective of the monetary system using the understandings of Monetary Realism.
 
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