tag:blogger.com,1999:blog-582368152716771238.post6044645600953308175..comments2024-03-28T14:41:03.793-05:00Comments on The Grumpy Economist: Toward a run-free financial systemJohn H. Cochranehttp://www.blogger.com/profile/04842601651429471525noreply@blogger.comBlogger48125tag:blogger.com,1999:blog-582368152716771238.post-64562764440549158712016-06-15T02:30:18.984-05:002016-06-15T02:30:18.984-05:00It's true!Learning how to manage and grow your...It's true!Learning how to manage and grow your money is the only way for getting rich.<br />market neutralhttp://www.rushtonfinancial.com.au/noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-22421769803685029252014-04-29T12:32:22.627-05:002014-04-29T12:32:22.627-05:00Ralph,
"but the temptation to organize pre-e...Ralph,<br /><br />"but the temptation to organize pre-election booms is just too big I think" <br /><br />Which is the reason the federal government either taxes to fund spending or sells securities to fund spending (as opposed to printing money). <br /><br />Taxing creates a relative demand change - I was going to spend money on a new car, government would rather spend that money on a new tank. Government taxes me - demand for cars goes down, demand for tanks goes up.<br /><br />When the federal government sells a security, it creates an incentive for the private individual to save while the government spends. For instance, I buy bond with a rate of return while government spends borrowed money. That works as long as the bond is accrual type (not coupon type) and the central bank does not try to monetize the government's debt.<br /><br />The only issue (that I see) is whether the government should sell securities with a guaranteed rate of return (bonds) or a non-guaranteed rate of return (equity).<br /><br />John prefers banks to issue equity when funding loans, but then digresses into perpetual bonds when addressing fiscal issues.<br /><br />Why not government equity? It eliminates the discretionary aspect of perpetual bonds (Congress suspending / re-instating interest payments) while still preserving the risk / reward profile of non-guaranteed securities. It also eliminates the possibility of monetary policy interference - central bank can't buy equity issued by federal government. It may be permitted to buy and sell perpetual bonds.<br /><br />Robert Shiller makes a similar case for "Trills" here:<br /><br />http://cowles.econ.yale.edu/P/cd/d17a/d1717.pdf<br /><br />"We make the case for the U.S. government to issue a new security with a coupon tied to the United States’ current dollar GDP. This security might pay, for example, a coupon of one-trillionth of the GDP, and we propose the name Trill be used to refer to this new security."<br /><br />"This security would be long term in maturity, ideally even perpetual."<br /><br />The only problems that I have with Trills are:<br /><br />1. Federal expenditures tied to Trills rise and fall with GDP when federal expenditures should be countercyclical, Trills tied to the output gap would make more sense - remember Trills are coupon securities and the coupon payments can be spent as soon as they are received. Shiller makes the mistake of assuming that only pension / retirement funds would be buyers.<br /><br />2. Trills do not change the incentives of the buyers of those securities - I think that is the crucial aspect that is missing from both perpetual bonds (recommended by JC) and from Trills (recommend by Shiller).<br /><br />Better would be a security where the return on investment can only be realized against a future tax liability. Potential return on investment is set by government / Treasury relative to the output gap. Higher output gap = higher potential return on investment. Realized return on investment is left to the owner of the security.FRestlyhttps://www.blogger.com/profile/09440916887619001941noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-4597857621554198192014-04-29T05:41:40.594-05:002014-04-29T05:41:40.594-05:00Frank,
You COULD have “economist / politicians” d...Frank,<br /><br />You COULD have “economist / politicians” deciding how much stimulus to implement, but the temptation to organise pre-election booms is just too big I think. <br />Ralph Musgravehttps://www.blogger.com/profile/09443857766263185665noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-91389786829788271492014-04-28T11:32:51.736-05:002014-04-28T11:32:51.736-05:00Thank you. It's a good article.Thank you. It's a good article.ahmedhttp://4long.netnoreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-62347907338846958032014-04-25T13:26:24.989-05:002014-04-25T13:26:24.989-05:00Ralph,
"while barring politicians access to ...Ralph,<br /><br />"while barring politicians access to the printing press"<br />"decided by a committee of economists"<br /><br />And there are no economist politicians?<br /><br />http://en.wikipedia.org/wiki/Paul_Douglas<br />http://en.wikipedia.org/wiki/Phil_Gramm<br /><br />Ever foresee the possibility that an economist is on both the finance committee of Congress AND the spending committee of Congress? Are economists precluded from running for office now?FRestlyhttps://www.blogger.com/profile/09440916887619001941noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-53235543029136967702014-04-25T11:49:46.820-05:002014-04-25T11:49:46.820-05:00Frank,
Wolf does not set out any specific role fo...Frank,<br /><br />Wolf does not set out any specific role for central banks. He just sets out the basics of full reserve banking (which comes to much the same as Grumpy’s system). Plus he quotes some advocates of full reserve, e.g. Laurence Kotlikoff. He might also have quoted Milton Friedman: see Friedman’s “Program for Monetary Stability” 2nd half of Ch3 if you’re interested.<br /><br />You’ll find a number of long quotes from Wolf’s article here which may be of some help:<br /><br />http://www.positivemoney.org/2014/04/strip-private-banks-power-create-money-financial-times-martin-wolf-endorses-positive-moneys-proposals-reform/<br /><br />“You seem to prefer the U. S. going back to the federal government printing money into existence (no central bank required)”. Quite right. Advocates of Modern Monetary Theory, of which I am one, tend to regard the distinction between central banks and governments as very artificial. Milton Friedman suggested scrubbing the distinction. See p.247, item No1 under the heading “The Proposal” here:<br /><br />http://nb.vse.cz/~BARTONP/mae911/friedman.pdf<br /><br />As to how to actually merge government and central bank, while barring politicians access to the printing press, Positive Money advocates that the AMOUNT of stimulus (or extra money created and spent into the economy) be decided by a committee of economists, while the split of that as between extra spending and tax cuts, and how the money is spent is left to the democratic process and politicians.<br /><br />Ralph Musgravehttps://www.blogger.com/profile/09443857766263185665noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-14915175988414315052014-04-25T07:18:50.543-05:002014-04-25T07:18:50.543-05:00Ralph,
The link is subscription only. Curious - ...Ralph,<br /><br />The link is subscription only. Curious - What role does Mr. Wolf envision for the central bank? Currently, private banks must create money for the government to be able to borrow money (the central bank may not directly loan money to the federal government). <br /><br />JC briefly touches on the fiscal angle at the end of his article, but does not elaborate on what changes would happen with the central bank under the arrangement he imagines.<br /><br />You seem to prefer the U. S. going back to the federal government printing money into existence (no central bank required) - See:<br /><br />http://en.wikipedia.org/wiki/United_States_Note<br /><br />Which would make the whole notion of government debt a mute point. The only question that remains would be whether the government would go back to some metallic standard - from the article on U. S. notes:<br /><br />"Soon after private ownership of gold was banned in 1933, all of the remaining types of circulating currency, National Bank Notes, Silver Certificates, Federal Reserve Notes, and United States Notes, were redeemable by individuals only for silver."FRestlyhttps://www.blogger.com/profile/09440916887619001941noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-6961237918983896972014-04-24T12:25:25.890-05:002014-04-24T12:25:25.890-05:00There's an article in today's Financial Ti...There's an article in today's Financial Times by Martin Wolf which is sympathetic towards the sort of system Grumpy wants. See:<br /><br />http://www.ft.com/cms/s/0/7f000b18-ca44-11e3-bb92-00144feabdc0.html?siteedition=uk#axzz2zoqbkZESRalph Musgravehttps://www.blogger.com/profile/09443857766263185665noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-52113033413658918352014-04-23T12:55:53.266-05:002014-04-23T12:55:53.266-05:00Anonymous,
"why not short circuit all this a...Anonymous,<br /><br />"why not short circuit all this and just require demand deposits to be fully backed by government bonds?"<br /><br />Why do you believe that treasury bonds are risk free?<br /><br />For that to work and for deposits to maintain their liquidity, all government bonds would need to be short term (probably six months or less). That puts huge interest rate rollover risk ($16 trillion and counting) on the federal government and its ability / willingness to collect tax revenue to make the payments on those bonds.<br /><br />Want to bet the federal government wouldn't suspend interest payments if they could not agree on other fiscal (tax / spending) policy?<br /><br />JC advocates just such a thing with his reference to perpetual debt:<br /><br />"If the government were to issue long-term, ideally perpetual, debt that comes with an option to temporarily lower or eliminate coupons, without triggering a legal or formal default, then government financial problems could be transferred to bondholders without crisis or inflation."<br /><br />Notice how John suddenly favors temporary government measures here, and yet favors rules based government policy here:<br /><br />http://johnhcochrane.blogspot.com/2014/03/hello-discretion.htmlFRestlyhttps://www.blogger.com/profile/09440916887619001941noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-86009391238379718532014-04-23T08:59:12.961-05:002014-04-23T08:59:12.961-05:00I've been thinking along similar lines. Prof. ...I've been thinking along similar lines. Prof. Cochrane seems willing to constrain the money stock to government debt, in the belief that $18 trillion is sufficient both for transactional needs as well as the demand for safe assets. He suggests that transactions can also be made by liquidating risky assets, when needed. But this allows HFT to tax such transactions, and why should we allow that?<br /><br />For liquidity enhancement, we need more money, and a safe way to generate it is for the government to issue more treasury securities. In addition to safe assets, they can produce an information insensitive risky asset, which would be usable as money without needing HFT for liquidity.<br /><br />Lately, we have seen the government buying risky assets in exchange for bonds, which does not enhance the government's portfolio. I advocate the reverse trade: the government should retire some debt in exchange for standardized equity that would act as macroeconomic insurance, and this does not need to decrease the money stock. Banks could do the same trade for the same portfolio benefits, while producing a second form of money.Anwerhttps://www.blogger.com/profile/08277173974258559733noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-91612142176335398342014-04-22T22:24:25.897-05:002014-04-22T22:24:25.897-05:00Benjamin,
"I am not sure I understand the so...Benjamin,<br /><br />"I am not sure I understand the somewhat oblique reference to downstream easy-to-fail intermediaries to tranche that equity to debt if needed. In fact, I don't understand what that means. "<br /><br />It means that an intermediate firm can exist between the firm that issues equity and the borrower that receives a loan. In essence, the "senior" firm issuing equity would turn around and buy equity in the "junior" intermediate firm. That intermediate firm would then originate a loan - hence the term "tranched" equity.<br /><br />Tranching debt involves create senior and junior levels of credit claims. Tranching equity involves the same thing. <br /><br />FRestlyhttps://www.blogger.com/profile/09440916887619001941noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-29731045516318727902014-04-22T13:06:00.881-05:002014-04-22T13:06:00.881-05:00You've already answered your question(s) when ...You've already answered your question(s) when you applied a 33% rate to the $6 theoretic income.<br /><br />As MM tell us, in many ways it's not so much that equity costs are higher, but rather that debt costs are lower (debt's privilege at the expense of equity). Further, debt payments are deducted from income. If dividends weren't discriminated against and a bank were 100% equity your sums above would add up just fine. (And JC clearly outlines in his vision that these distorting accounting / taxation policies need to go.)<br /><br />The core issue that JC is getting at is that we must purge, as far as possible, the notion that commercial entities (banks) can use demand deposits (or any other "fixed-value, pay-on-demand, and hence run-prone securities" to finance lending. Lending means risk and such inventions like demand deposits are (guaranteed) risk-free. At the moment the (sometimes very large) risk gap gets picked up by the government and where it's not is run-prone; why not short circuit all this and just require demand deposits to be fully backed by government bonds?<br /><br />In such a world, the saver/lender cannot live in blissful ignorance that his money is risk-free and will be paid back in full tomorrow - not if he wants to earn a return on it that is. Banks' lending funded by 100% equity may or may not look attractive to invest in depending on what they do with their funds. But if depositors want a return on their money, then they must accept risk. No more of this everybody-wins-all-the-time and the government will bail us (them) out if it all goes wrong. Prefer a completely risk-free deposit? Then you will de-facto be buying treasury bonds.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-87688978652422573282014-04-22T10:46:07.528-05:002014-04-22T10:46:07.528-05:00Professor Cochrane:
Allow me to make a tangential...Professor Cochrane:<br /><br />Allow me to make a tangential, possibly unrelated, but topical comment, away from the obvious financial theory/policy lines of inquiry. It occurs to me that an integral part of delivering in practice your vision would greatly benefit from further advances in an area that has now been declared "non-socially productive" by many "thought leaders" -- algorithmic-based HFT. We may or we may not be there yet in being able to liquify equities and a few government securities to the degree that your proposal may need, but clearly as this practice deepens, those miliseconds and micro cents people laught at will provide real areas for improved efficiencies on a much larger scale of trading. Moreover, as the practice broadens and more and more securities are brough into the liquification blender -- think the entire family of risky debt -- it will become obvious that what our securities markets need is more, not less, investment in liquidity enhancement technologies.<br /><br />So, perhaps those who are currently working in algorithmic and HFT, may soon have a greater incentive to broaden their software and hardware investments with aims not just to squezze out a micro bp off the S&P flow, but off the entire money supply!.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-38490887848345872872014-04-22T08:32:36.699-05:002014-04-22T08:32:36.699-05:00Ben,
I could be wrong, but I think that John allo...Ben,<br /><br />I could be wrong, but I think that John allows for bank debt to handle brick and mortar financing - for instance a bank opens a new office in Toledo.<br /><br />Normally fixed construction is financed with debt. The holders of that debt have a recovery mechanism (liquidation of fixed assets) that is not available to share holders.<br /><br />A bank floats a loan for $100 million and says it will use this money to build a new building. At the same time a bank sells $100 million in equity and says it will use it to fund lending operations. How does a government regulator who is enforcing the 100% equity rule decipher which funds are being used where?FRestlyhttps://www.blogger.com/profile/09440916887619001941noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-65340130330761476882014-04-22T02:32:48.545-05:002014-04-22T02:32:48.545-05:00Frank-
I was thinking the same thing, the interna...Frank-<br /><br />I was thinking the same thing, the international angle. The USA would would become dependent on foreign capital/lending.<br /><br />Okay, it is getting murkier and murkier.<br /><br />Dr. Cochrane:<br /><br />1. You say banks should be 100 percent funded by equity, but then we have the mystery sentence, "For banks, that means mostly common equity, though some long-term or other non-runnable debt can exist as well."<br /><br />Okay, is this is just a flub, or do I have a deeper misunderstanding? Are we conflating commercial banks with investment banks? <br /><br />2. "I argue that Pigouvian taxes provide a better structure for controlling debt than capital ratios or intensive discretionary supervision, as in stress tests. For each dollar of run-prone short-term debt issued, the bank or other intermediary must pay, say, five cents tax."<br /><br />Okay, I like the above idea, but I thought we had settled on 100 percent equity-financed banks. Now we seem to be saying banks can borrow money, but pay taxes based on the flightiness of borrowed money. The flightier a bank's source of funds, the higher the taxes.<br /><br />I am not sure I understand the somewhat oblique reference to "downstream easy-to-fail intermediaries to tranche that equity to debt if needed." In fact, I don't understand what that means. <br /><br />But all that said, I like the idea that financial intermediaries have a lot more skin in the game----much larger equity-to-loans ratios----and that they be taxed based on the flightiness of their sources of money to be lent out. <br /><br />These ideas are simple enough to fit under my KISS rubric, but also strike me as effective. <br /><br />Maybe banks should be required to have 15 percent equity to loans, and pay sliding scale of taxes on the days duration of their borrowed funds. <br /><br /><br />Benjamin Colehttps://www.blogger.com/profile/14001038338873263877noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-49631837100481353062014-04-21T17:36:07.923-05:002014-04-21T17:36:07.923-05:00Benjamin,
You are welcome.
The presumption is th...Benjamin,<br /><br />You are welcome.<br /><br />The presumption is that without a central bank to provide short term funding (overnight discount window) and without a deposit base, interest rate arbitrage (borrow short / lend long) cannot be realistically achieved. <br /><br />Of course, this type of banking arrangement would need to happen on a global scale to be truly effective. Can't get short term funding because there is no U. S. Central Bank? Go the the Central Bank of Europe or Japan.<br /><br />Less clear is whether central bank open market operations would continue. I presume that they would not (but that is just my presumption). A central bank that conducts only open market operations, but buys bonds at a premium and sells them at a discount, provides an interest spread (or rather a bond price spread). <br /><br />That spread is useless unless the central bank is permitted to buy and sell debt obligations other than U. S. Treasuries.FRestlyhttps://www.blogger.com/profile/09440916887619001941noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-63996338058606763412014-04-21T15:34:55.889-05:002014-04-21T15:34:55.889-05:00Thanks for your reply. But it strikes me that larg...Thanks for your reply. But it strikes me that large lending organizations could evolve that borrow and re-lend but don't call themselves banks...Benjamin Colehttps://www.blogger.com/profile/14001038338873263877noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-10112404846285219812014-04-20T22:09:13.088-05:002014-04-20T22:09:13.088-05:00Benjamin,
"Okay, but does Ccchrane's mea...Benjamin,<br /><br />"Okay, but does Ccchrane's mean, in the entire country, and in every state, no group of people can pool their capital and lend it out, unless they are 100 percent equity funded?"<br /><br />No, I don't think that is what Cochrane means. What it means is that a bank cannot borrow money to turn around and lend it. <br /><br />Sure, a group of people who already have money could pool it together to form a firm that lends that money. This group of people could not go to a "bank" in John's world to borrow money and turn around and lend it (no credit intermediation).<br /><br />"We would substitute a prohibitive federal regulation for free markets?"<br /><br />No, the only thing that would be eliminated is the central bank as lender of last resort and open market operations by the central bank (in essence no central bank to speak of). <br /><br />Prior to the Federal Reserve Act of 1913 and Banking Act of 1933, the United States went through several banking panics:<br /><br />http://en.wikipedia.org/wiki/Panic_of_1907<br />http://en.wikipedia.org/wiki/Panic_of_1893<br />http://en.wikipedia.org/wiki/Panic_of_1873<br />http://en.wikipedia.org/wiki/Panic_of_1857<br />http://en.wikipedia.org/wiki/Panic_of_1837<br /><br />Those panics began about the same time as the expiration of the charter for the Second Bank of the United States:<br /><br />http://en.wikipedia.org/wiki/Second_Bank_of_the_United_States<br /><br />One final tidbit of interest that John makes mention of is the Chicago Plan for banking reform:<br /><br />http://en.wikipedia.org/wiki/Chicago_plan<br /><br />Mind you this plan for banking reform was put forth in 1933, 20 years after the establishment of the federal reserve.<br /><br />This was amended and represented as:<br /><br />http://home.comcast.net/~zthustra/pdf/a_program_for_monetary_reform.pdf<br /><br /><br />FRestlyhttps://www.blogger.com/profile/09440916887619001941noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-33753624772002120062014-04-20T18:19:47.785-05:002014-04-20T18:19:47.785-05:00Ralph,
Simple question - once a banks assets (loa...Ralph,<br /><br />Simple question - once a banks assets (loans) fall below the value of its equity, should the bank be permitted by the federal government to continue to lend?<br /><br />I would argue - no it should not, for the same reason that a company that makes faulty goods should not be able to continue to make those faulty goods even if shareholders are willing to fund the production of those faulty goods.<br /><br />It would be different if a bank was forced to retain all the loans that it makes (no faulty goods are sold) - equity holders bear current and future risk.<br /><br />FRestlyhttps://www.blogger.com/profile/09440916887619001941noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-57083989715862500382014-04-20T17:42:54.463-05:002014-04-20T17:42:54.463-05:00Ralph,
"There are thousands of businesses al...Ralph,<br /><br />"There are thousands of businesses all over the country whose shares have fallen below book value. That does not, repeat not equal bankruptcy, insolvency or anything of that nature."<br /><br />I never said it did. What I was describing was a banking system that had to maintain 100% equity financing in real time. JC doesn't make that distinction in his paper.<br /><br />And the question becomes should a bank whose shares have fallen below a certain threshold be permitted to continue to lend? Companies are routinely delisted from the equity indices once their share values fall below a certain value. You might say leave that decision up to the shareholders, and I would say as long as all shareholders hold voting equity, there is no problem with that solution.<br /><br />But neither you nor John will specify what type of equity should be sold to fund lending operations (preferred / common, voting / nonvoting).FRestlyhttps://www.blogger.com/profile/09440916887619001941noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-90565307935777846002014-04-20T11:45:37.811-05:002014-04-20T11:45:37.811-05:00Mr. Musgrave
Several things:
1) Let us allow Mr....Mr. Musgrave<br /><br />Several things:<br /><br />1) Let us allow Mr. Cochrane to respond instead of engaging in dialog on "his" blog<br /><br />2) There is no inconsistency at all. Equity does have a higher cost and if companies are not generating returns in excess of this cost of equity i.e. they are not making sufficient economic profit, stockholder returns are bound to be anemic. So there is no inconsistency between your "claim" that equity returns have lagged returns on bonds.<br /><br />3) You contradict yourself. First you say that the "REALITY" is that return on equity is just ain't too impressive. OK. If that is the case, then why do you say in the very next sentence that "casts doubt on the idea that equity holders demand a particularly large return on their investment". Well if they didn't demand a high return on their investment, why has their performance lagged vs. bonds? Can't have your cake and eat it too you know. You have to choose what it is that your proposition is.<br /><br />4) What I see in all your responses to other comments is a lot of words a very little data to support anything. Can we have some data next time you say something please?<br /><br />5) Let me reiterate again, this is Mr. Cochrane's blog and after this I don't wish to engage in any further dialog with commenters. Let us allow Mr. Cochrane to respond - assuming he wants to.<br />Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-37992882715943275412014-04-20T11:08:47.506-05:002014-04-20T11:08:47.506-05:00This comment has been removed by the author.FRestlyhttps://www.blogger.com/profile/09440916887619001941noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-4048998399505808182014-04-20T10:54:34.865-05:002014-04-20T10:54:34.865-05:00Ralph,
Milton Friedman lived in a time when there...Ralph,<br /><br />Milton Friedman lived in a time when there were two forms of U. S. currency:<br /><br />1. Federal Reserve notes (lent into existence by the central bank)<br />2. United States notes (printed into existence by the U. S. Treasury)<br />See: http://en.wikipedia.org/wiki/United_States_Note<br /><br />Are you advocating the return of US Notes?<br /><br />"Certainly if the cost of loans rises, then all else equal, the effect is deflationary." <br /><br />If all else is equal (supply of goods is unchanged, demand for goods is unchanged) then why would raising the nominal cost of loans be deflationary?FRestlyhttps://www.blogger.com/profile/09440916887619001941noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-3268353657894474752014-04-20T09:06:43.465-05:002014-04-20T09:06:43.465-05:00Absalon:
Okay, but does Ccchrane's mean, in t...Absalon:<br /><br />Okay, but does Ccchrane's mean, in the entire country, and in every state, no group of people can pool their capital and lend it out, unless they are 100 percent equity funded? <br /><br />In other words, non-bank banks would be outlawed? We would substitute a prohibitive federal regulation for free markets?<br /><br />Why 100 percent? Why not 80 percent? Is there a chance that 80 percent of a bank's loans would fail? <br /><br />Then Cochrane also has this conflicting sentence: "For banks, that means mostly common equity, though some long-term or other non-runnable debt can exist as well."<br /><br />Well, then, banks are not lending out only backed b 100 percent equity, but using some sort are sticky borrowed money too. <br /><br />That's the part I do not understand. <br />Benjamin Colehttps://www.blogger.com/profile/14001038338873263877noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-2238426079552973142014-04-20T05:39:42.488-05:002014-04-20T05:39:42.488-05:00Anonymous,
If you think “equity capital has a muc...Anonymous,<br /><br />If you think “equity capital has a much higher cost” perhaps you can explain the reverse yield gap. I.e. the REALITY (contrary to what you or I might expect) is that the return on equity just ain’t too impressive compared to the return on bonds. Of course bonds are not EXACTLY THE SAME as bank deposits, nevertheless, and quite apart from Modigliani Miller, the reverse yield gap casts doubt on the idea that equity holders demand a particularly large return on their investment.<br /><br />Second, even if funding loans just from equity did raise the cost of loans (and I think it would to a finite extent), that increased cost comes about as a result of the removal of bank subsidies. Remember that banks enjoy HUGE SUBSIDIES under the existing system: that’s because the existing and chronic banking system (fractional reserve) needs periodic injections of trillions from the taxpayer to stop it collapsing. In contrast, JC’s system (i.e. full reserve banking) cannot suddenly collapse, ergo it needs no subsidy.<br /><br />And it’s a cardinal rule in economics that subsidies do not make sense (unless there are very good social reasons for a subsidy).<br /><br />Next, you claim the switch to JC’s system would bring a “sharp economic downturn”. Certainly if the cost of loans rises, then all else equal, the effect is deflationary. But loans are only as cheap as they currently are because banks are subsidised. And subsidies, to repeat, do not make sense. And as to how to deal with that downturn, that’s easily done: just have the central bank and government do a bit of stimulus. My preferred form of stimulus (also favored by Milton Friedman) is simply to create and spend new money into the economy: up to the point that brings full employment without exacerbating inflation too much.<br /><br />The net result would be less lending based economic activity and more non-lending based activity. Given that private debts are at record levels relative to GDP, I fail to see the problem there. Also in the UK, the banking industry is now TEN TIMES AS LARGE relative to GDP as compared to the 1960s. If you can think of any benefits we’ve derived from that, I can’t. Certainly economic growth is no better now than in the 60s.<br /><br /><br />Ralph Musgravehttps://www.blogger.com/profile/09443857766263185665noreply@blogger.com