Beyond fiat currencies

There's a new way to by-pass fiat currencies that governments can debase.  From Euro Pacific Bank come two new cards, one gold and one silver.  Instead of drawing from your cash reserves held in sterling or dollars or whatever, or of spending on credit and paying the bills in such currencies, these cards draw on bullion.  You own gold and silver in a vault, and what you spend is converted into bullion and drawn from your stock:

Now you can actually own precious metals and convert the amount you choose into cash at an instant. Spend cash from your metals backed card at more than 30 million locations and 1.4 million ATM’s worldwide.

With the gold card you spend gold, and with the silver one you draw from your stock of silver bullion.  This solves one of the problems of a commodity-backed currency, namely the ease with which it can be traded in small amounts.  These cards subtract coins and notes from the equation, replacing them by electronic transfers of bullion.

It's an intriguing idea.  If it catches on in a big way, it could give hard-pressed savers some respite from the ravages inflicted upon them by governments through inflation and artificially low interest rates.

Risky business

Those who think that responsibility for the financial crisis lies mainly at the door of governments and central banks might like to consider the following.  The policy of easy money and cheap credit, designed at the behest of politicians to smooth the down side of the business cycle, had one unexpected result.  by depressing interest rates it was made difficult for fund managers to gain decent returns on relatively low-risk investments such as bonds.

In search of decent returns in this low interest rate climate, they were forced to climb the risk ladder, investing in things that carried higher risk than they would otherwise have taken.  So while it is true that some investment groups were undertaking riskier investments, it was not because they had suddenly become greedy and reckless, but because government policies had denied them adequate returns on the safer things they would normally have gone in for.

The financial watchdog is barking

We are used to sabre rattling by financial regulators.  The last one told the industry to be very afraid of what the Financial Services Authority would do to them but, in the event, the only fearful thing was the FSA’s incompetence.  Martin Wheatley, CEO-to-be of the new watchdog, the Financial Conduct Authority, is barking similarly likewise.  According to the Independent on Sunday, he told the Association of British Insurers that he “will punish insurers and banks that make "excessive" profits”.

Quite how anyone, let alone a long-term financial bureaucrat, with little or no business experience, can determine what is or is not an “excessive” profit beats me and I’ve been teaching marketing for 40 years.  Perhaps RBS will be punished if it makes enough money for the government to sell off its stake.

But this is only one of the four all-seeing powers he expects to utilise.  The other three are “are making sure that firms develop new products, that they strive to offer better services than their rivals, and that the most successful banks or insurers are those that respond best to consumer demands.”

Wheatley should study the words of Adam Smith and seek greater understanding of how competitive markets work.  It would seem that he has little idea of brands or marketing or how consumers make choices and spend their money.  Wheatley’s apparent intention to tell suppliers how to do business would be ambitious if it were not ludicrous.

His insight that the most successful banks and insurers will be those that respond best to consumer demands runs the risk that they will thereby make excessive profits and need to be chastised by Headteacher Wheatley.  No doubt he will keep a cane for that purpose behind his door.

How exactly will he ensure firms develop new projects, especially when they are threatened with the cane if they succeed?

Wheatley’s reference to the payment protection insurance imbroglio is misleading.  Like so many disasters it was an unintended consequence of the government’s own policies.  The original concept was, and is, fine; the problems arose from the mis-selling.  The reason it became a disaster was that the regulator, then the General Insurance Standards Council, watched the mis-selling arise and did nothing about it.  Once again, the regulator either did not understand the industry or was too incompetent to move in promptly.  If the regulator had moved in swiftly, there would have been no disaster.  The FSA took over as the regulator in 1997 but 13 years passed by before, in December 2010, they addressed it with regulations for selling PPI.  The banks appealed the retrospective aspects of the new regulation to the courts.

Consumer complaints had been pouring in from 2007 so it was at least three years of FSA inattention.  In any case, there was no need to wait for the issue to be dragged into the courts as the FSA has quasi-judicial powers to discipline banks directly.

If Wheatley restricted himself to saying that the FCA would do their best to ensure fair trade in competitive financial markets, we would all cheer.  A regulator should seek to establish a culture which makes interventions unnecessary.  Consumers, if they are dissatisfied, can and do complain to the Financial Ombudsman Service.  If trends in such complaints indicate that external correction is needed, the Competition Commission and/or Office of Fair Trading (from April 2014 the Competition and Markets Authority) can wade in.

An ASI Briefing Paper to be released soon will show that we do not need the FCA at all and the unworldly barking by this new watchdog support that conclusion.

Now that we're getting a government owned investment bank what is the effect of government ownership of banks?

Vince Cable seems to have got his idea of a state owned business investment bank approved. Which seems like a reasonable time to ask what the effects of such state ownership of banks and the banking system is. Or if you prefer, what is the effect of allowing politicians to direct bank lending?

Which is interesting because there's a new paper out which looks at just that. There are two possible views here. One is that politicians are wiser than the accumulated wisdom of the markets (or perhaps their incentives lead them to make better decisions about capital allocation) and that therefore state owned banking will make everyone better off. Given that the part of the Spanish banking system, the cajas, that is bust and near to bankrupting the entire country is that part that was controlled by politicians makes this a tough argument to make. But perhaps that's just Spanish politicians. The other view, the "political" view, is that politicians will use state owned banks to reward their friends and buy votes. This will lead to even worse capital allocation than the market manages and make the future poorer than it needs to be. Having looked around the world the paper tells us that:

We assemble data on government ownership of banks around the world. The data show that such ownership is large and pervasive, and higher in countries with low levels of per capita income, backward financial systems, interventionist and inefficient governments, and poor protection of property rights. Higher government ownership of banks in 1970 is associated with slower subsequent financial development and lower growth of per capita income and productivity. This evidence supports “political” theories of the effects of government ownership of firms.

Ah, OK. So state owned banking is a very bad idea then. Something that should be clear to everyone a priori, even to the politicians rubbing their hands with glee at the idea of being able to buy support and votes. For while you, you near omniscient and incorruptible politician you, might indeed know better than everyone else how to allocate capital the same isn't true of your political opponents. Obviously it could not be for if it were you wouldn't be in the other party than them. But at some point the turns of political fortune are going to mean that they are going to get control of that lending and capital allocation.

This logic works whichever party you belong to: even if you do think that money should be allocated to cooperatives in order to stop the capitalists grinding the poor into the dust at some point the other lot will get in and allocate that same funding to the capitalists to grind the poor into the dust.

Or, as the paper says, we don't want state allocation of credit because it will lead to our children being poorer than they would be without it. For politicians make even worse decisions than bankers do if you could believe such a possibility.

Cable's business bank is a terrible idea

Business Secretary Vince Cable wants to establish a state business bank to lend to small and medium-sized enterprises. This idea will do business no good, will mess up the finance market, and saddle taxpayers with yet more cost.

There are three reasons why businesses are not borrowing. First, having found themselves overstretched when the crisis hit, they are now doing the right thing and – unlike Mr Cable's government – reducing their debt. The existence of a state business bank is not going to change that.

Second, times remain very uncertain and many firms cannot see many good projects to invest in, so are not actively seeking finance. A state business bank is not going to change that either – though a growth policy of major cuts in regulation and business taxes might.

Third, some SMEs that would like to borrow cannot get credit because the government has told their banks not to take so many risks – and SMEs are inherently risky enterprises. A business bank would simply pass these risks to the taxpayer. And taxpayers have already paid enough.

It is astonishing that Mr Cable believes that he and his civil servants know what SMEs have viable business plans that deserve finance better than professional lenders and investors who live by making these decisions every hour of every day. The only result will be the establishment of a vast new state organisation with all the efficiency of the Post Office, and more bureaucratic control and regulation of the capital markets on which economic growth depends.

Thankfully there's too few Bristol pounds to do any damage

The loons over at the nef (yes, this local town money comes from them) have managed to get another group of cultists to sign up and create the Bristol pound:

More than 300 businesses – including butchers, bakers, solicitors, plumbers, electricians, book stores, art galleries, a chimney sweep, supplier of firewood, even a pole dancing tutor – have signed up, making the Bristol pound the largest local currency in the UK.

The idea is simple: to encourage consumers to spend more of their money in the local independent shops that accept the one, five, 10 and 20 pound notes and stop money leaking out of the area to faceless multinationals, unknown shareholders or the discredited banking system.

They really are missing the point of this money thing, aren't they? It's so that one can in fact deal with faceless multinationals and unknown shareholders. If all you wanted was a small local economy that didn't trade with anyone outside a couple of miles all you need is some exercise books in which to keep a set of credits and debits. The whole and entire point of using "money" to trade with is to establish something that can facilitate trade with those you don't know and don't know whether you can trust. So I rather think they've missed the point.

What's worse of course is that by limiting trade to a specific area you've limited people to trading for what is produced in that limited area. Which agains isn't the point at all. Once we've accepted the very idea of the division and specialisation (and anyone who has seen a home made bookcase knows that's a good idea) of labour then the only logical boundary to the resultant trade is the entire world. And even that's only because of the absence of anyone anywhere else to trade with.

But fortunately this scheme, for all the column inches The Guardian will give it, is too small to actually damage very much.

The company (motto: Our City, Our Money) has made available £125,000 worth of the currency and thinks in excess of £500,000 will be in circulation by this time next year.

Looking at the Bank of England figures we seem to have £60 odd billion of notes and coins supporting our £1,400 billion economy (rough numbers you understand). So we seem to have around and about a 25 to 1 relationship between economic activity and the physical geld needed to grease it. £500k of this new money will thus support some £12.5 million of economic activity in Bristol over the year. The economy of Bristol is perhaps £9 billion a year at present. We're thus talking about an incredible 0.1% or so of the economy.

So, not really capable of doing much damage to anyone and at least it keeps the hippies happy, eh?

A little bit of inflation is still too much

Headline inflation in the UK has fallen to 2.5% (from a peak of 5.2% a year ago), so there is great rejoicing. The monetary hawks (such as Liam Halligan) have been proved wrong, we are told – all the Quantitative Easing didn't actually fuel inflation. Meanwhile, the Governor of the Bank of England, Mervyn King, is relieved that he doesn't have to keep writing to the Chancellor, as the law requires when the inflation target is widely missed.

But is everything so hunky-dory in reality? At the most basic level, there are some price-raising pressures in the pipeline. Oil keeps going up, the utility companies are raising their prices, and poor harvests around the world this year cannot help. But as every good monetarist knows, rises in some prices, however important, cannot raise prices overall. If there is a fixed amount of cash around, people can only spend more on one sector (like food and energy) if they cut back on others (luxury goods, say, or housing).

And the fact that prices are rising only moderately suggests that all the Bank's quantitative easing is not actually having much effect on the real economy. It certainly seems to be keeping up asset prices, which is why the stock market is looking so healthy. But maybe it is not seeping into the everyday economy. Maybe it just replaced the collapse in the money supply when the banks found themselves caught in the headlights and stopped giving out loans any more. Still, the monetary hawks would say that as and when the economy recovers, the Bank of England needs to be able to rein things in again or all this new money really will have an effect on prices – and reining people in is a lot harder than engineering a boom.

But as the deepest level, I still wonder why we should regard inflation of 2.5%, or the Bank's central inflation target of 2%, should be remotely acceptable. At that rate, the value of our money halves in 30 years. Which is great if you are a big creditor, like the government, because you are repaying your debts in devalued money. And indeed the government is charging us tax on the interest we get on our savings, even though these are negative in real terms. And as incomes struggle to keep pace with the inflation, more of us find ourselves drawn into the higher-rate income-tax brackets. And so on. It all favours the spendthrifts and punishes the savers.

Keynes figured that inflation is useful because of the downward inflexibility of wages. People don't like pay cuts, but pay in declining industries can be cut in real terms simply if it does not rise as much as prices. So people are gradually eased into more productive jobs without any nastiness. Keynes, though, did not realise just how damaging inflation is to signals in the economy. When all prices are rising, it is hard to separate the 'noise' of generally rising prices from the 'signal' of prices that rise because demand is not being met. For years, people invested in houses because they saw house prices going up and up, without realising that, after inflation, the rise was much less. So you get bubbles in some places, and underinvestment in others. None of which helps competitiveness and employment.

There is also an argument that a bit of inflation is fine because of the seignorage in the system. Put simply, as people get wealthier they keep more cash to hand, in their pockets, wallets and current accounts, without worrying about it so much. So you can have more money in circulation without it driving up prices, because there is more money lying dormant round the place. Maybe. But I still don't see why that is a reason to create so much money that prices, driven by the non-dormant bulk of the cash, rise beyond zero.

There is also an argument that it is wise to allow a bit of inflation because if by mistake we tipped into deflation things would be really terrible. With falling prices, why should anyone buy today what they could buy cheaper tomorrow? So business would grind to a halt, we're told. But in fact, inflation is equally destructive – killing the incentives for saving and investment, encouraging false booms, diverting resources into the wrong places. Should it not be a key duty of the government to preserve the value of our money – not to let it lose its value at 2.5% or indeed on any scale at all?

This is just too delicious for words

So, they've finally nailed one of the bankers, fined him and banned him from The City.

Peter Cummings, the HBOS banker whose division lent billions of pounds to property developers, has been given a lifetime ban by the Financial Services Authority for his role in the banking crisis. Cummings, who has also been fined £500,000, is the only former HBOS banker to be penalised by the City regulator as a result of the near-collapse of the bank which was rescued by Lloyds in September 2008 - and the highest profile banker to be punished since the financial crisis.

I find this all just too delicious for words.

Let's just potter through the standard critique of The City and banking shall we?

Everyone was too committed to trading and products rather than relationships. Too much investment banking and not enough commercial banking. Exotic products and derivatives rather than proper loans to real businesses. Even, not enough real investment, only loans.

We're told that the answer to all of these problems is to divorce investment from commercial banking. To tax, with the Robin Hood Tax, that socially useless trading. To reduce the productisation of things and to go back to relationship banking. To encourage banks to provide real capital, equity, not just debt and loans.

I'm not being unfair here, am I? This is generally the current received wisdom, yes?

So, which banker do we actually fine and ban from The City? The one who used no derivatives. Did not do any trading. Was a straight commercial banker, nothing to do with the socially useless stuff at all. Who invested in real companies making real product. Who was willing to invest equity as well as just provide debt finance. Whose activities would not have been affected for one moment by a Robin Hood Tax.

One of these three things has to be wrong. The initial analysis of the basic problem, the solution to that perceived problem or the bloke we've dumped the blame upon.

Unless, that is, we English are even better at irony than our global reputation already suggests. Punishing the guy who did what everyone says all bankers should now just do is irony, isn't it?

The QE3 fantasy

The monetary authorities are at it again – trying to defy reality. In Europe, the ECB has thought up a new wheeze, called Outright Monetary Transactions, by which they can buy up the debts of bankrupt eurozone countries without (they hope) causing too much grumbling among the Germans who will ultimately pay for it. In the US, the Fed has just announced a new quantitative easing (QE3) plan to buy up mortgage debts in order to keep long-term interest rates down and make homeowners happy – well, as happy as they could be after a 20%-30% slide in the value of their properties.

Lots of economists are popping up on TV screens in Europe and America to say how wise these new moves are. Well they would, wouldn't they? Most economists work for banks and big companies or big financial firms. All this new government money is very welcome in such quarters. It goes directly into bidding up the price of financial assets, mortgages and shares, including the shares of the banks themselves.

I supported the early rounds of QE on good monetarist grounds. It is one of the oddities of fractional reserve banking that banks can actually create money. At the stroke of a pen, they can create loans that their customers then deposit in other banks, allowing those banks to create more loans...and so on. During the financial crash, the banks were caught like rabbits in the headlights, and clamped down on their lending. The politicians and regulatory authorities added to the contraction, telling the banks not to make so many risky bets. As a result the amount of money around fell sharply. But money affects everything in the exchange economy: it is critically important, and you do not want to see it falling sharply like that. So the Bank of England needed to fill the gap. As long as the Bank is prepared to cut back sharply again, should the economy start booming once more (though the chance of a rapid bounce-back seems to be receding somewhat).

The Fed's latest $40bn-a-month boost to the mortgage market is just a fraction of its earlier monetary boost, of course. So whatever good or harm it will do might be limited. But what exactly is it intended to do? The effect, of course, will be to keep down long-term interest rates, which  one might hope makes life easier for businesses that want to invest and grow. But the immediate and strongest effect will be to shore up the US housing market, and making it easier for people to get housing loans and buy houses. Wait a minute, though...is that not exactly the thing – or at least, a large part of the thing – that got us into this mess in the first place? Cheap credit that encouraged people to borrow more than they could afford and boost house prices beyond any commonsense level? When are our authorities actually going to face reality?

Nobody would (willingly) invest in a government-run bank

I am in City AM this morning, debating with Keynes's biographer Lord Skidelsky about whether we should have a government-run investment bank, as Nick Clegg has proposed. Skidelsky says yes:

Showing the government is willing to invest in the right project would lift business expectations, and the contracts from large projects would flow down to small and medium-sized enterprise.

I'm not convinced. If a project is so risky that the private sector won't invest in it without some kind of taxpayer guarantee, it is far too risky to spend taxpayer money on. And government has different priorities to private investors, whose main aim is to make a return — bailing out 'national' industries is a political priority, which a state investment bank would only :

Four out of five start-ups end in failure – if the private sector can’t get it right, how will the government? Inevitably, a state-run bank would be used to bail out politically sensitive projects, as was Leyland Motors in the 1970s, at a cost of £12bn to the taxpayer (inflation adjusted).

Read the whole debate. For me, the bottom line is that a project that's too risky to attract voluntary investment is the last thing that taxpayers' money should be spent on. Governments aren't very good at what they do as it is — I shudder to imagine how badly they'd do at playing the market with other people's money.