Central Bankers Want To Keep Economies Growing, But Politicians Hold The Keys (Demo)

On August 22, 2019, Jeanna Smialek writes in The New York Times:

As top economists from around the globe gather for their annual conference at Jackson Hole this week, they will have a collective hope in mind: that the world’s political leaders will work to help safeguard economic growth.

Economies from the United States to the European Union to China are slowing, presenting a challenge for central bankers, whose tools are limited at a time when interest rates remain historically low in much of the world.

In the United States and Britain, central bankers are hoping that trade uncertainty and political strife will not kill long economic expansions. And from Australia to Europe, economic policymakers have been urging politicians to step up their spending, hoping that a hand from the government will spur consumption and keep their economies from tipping into recession.

But there is a vast divide between technocrats trying to salvage waning global growth and politicians with an eye on their voting bases.

President Trump is locked in a trade war with China, with the latest round of tariffs scheduled to take hold on Sept. 1, and he shows no intention of backing down. American tariffs on European automobiles remain a possibility. Britain is negotiating its exit from the European Union and the likelihood of a no-deal departure, which could be economically punishing for the country and its major trading partners, has escalated with Boris Johnson’s ascendance to prime minister.

Complicating matters is Mr. Trump’s view that what is good economically for other countries is bad for the United States — a position that has led him to criticize efforts by central banks to keep their expansions on track. On Thursday, he once again needled the Federal Reserve Board over Germany’s low interest rates, suggesting that negative interest rates on German bonds were putting the United States at a disadvantage.

“Germany sells 30 year bonds offering negative yields,” Mr. Trump wrote on Twitter. “Germany competes with the USA. Our Federal Reserve does not allow us to do what we must do. They put us at a disadvantage against our competition. Strong Dollar, No Inflation! They move like quicksand. Fight or go home!”

Global political brinkmanship is adding to uncertainty just as factories around the world slow production and businesses hold off on investment, stoking fears of a more concerted slowdown.

“Important countries are not in good shape,” said Roberto Perli, head of global monetary policy research at Cornerstone Macro, who said there was a risk of a significant and protracted global slowdown with the potential for outright recessions in some nations, like Germany. “It started for largely cyclical reasons, but since then, other factors have intervened — trade, most importantly.”

While central bankers strive to be politically independent and avoid giving elected leaders advice, they have acknowledged that government policies are threatening growth.

The Fed cut interest rates for the first time since the Great Recession in July, a move driven in part by Mr. Trump’s trade policies and partly by the broader slowdown in global growth. Jerome H. Powell, chair of the Federal Reserve, speaks on Friday and is expected suggest that additional rate cuts are on the table without signaling how many or giving a specific timeline. Tariffs — and their likely escalation — are keeping the Fed and its global counterparts on edge.

But central bankers have begun warning that their ability to defend their economies is limited, especially because many never managed to sustainably lift interest rates back from rock bottom after cutting them during and after the global financial crisis.

Many are looking to their political leaders — who will gather in Biarritz, France, for the Group of 7 meeting this weekend — to help keep the world’s prosperity going.

“Policymakers around the world pulled the easiest lever, which is the monetary lever,” Mr. Perli said. “The more a central bank eases, the less powerful monetary policy becomes. We are at the point where, if we want to accomplish something — especially in countries like Europe — the ball is in the fiscal policy territory.”

But “that’s complicated,” he said, “by budget constraints in some countries and political constraints in other countries.”

While consumer spending is holding up in the United States and growth remains decent, manufacturing is slowing and consumer confidence sank in August. Businesses reported holding off on investment as they waited to see how the trade war plays out.

Mr. Trump has also begun mulling more tax cuts to lift the United States economy, though on Wednesday he insisted that it did not need one right now. And the Fed has room to cut rates, should a recession hit. The challenge is primarily one of intense policy uncertainty.

Europe, by contrast, has negative interest rates and a fraught economic backdrop — and while that owes more to fundamentals and global spillovers than domestic politics, growth is getting little help from national governments. In Germany, where China’s slowdown is hurting the manufacturing sector and the economy contracted in the second quarter, the government has been slow to spend more aggressively. Italy is also struggling, but it already has a heavy debt load, limiting its room to maneuver.

The European Central Bank, which runs monetary policy for 19 European countries, is expected to cut interest rates deeper into negative territory and even consider asset purchases in a bid to protect growth — but it is low on ammunition.

“Monetary policy has done a lot to support the euro area and continues, as you can see today, to do a lot,” Mario Draghi, the outgoing head of the central bank, said at a news conference last month. “But if we continue with this deteriorating outlook, fiscal policy will become of the essence.”

German politicians do seem to be cracking open the door to more spending, with Finance Minister Olaf Scholz indicating that the government could make up to $55 billion available. For scope, that is equivalent to a little more than 1 percent of Germany’s economy. The United States’ crisis-era spending package amounted to more than 5 percent of its 2009 gross domestic product, albeit with spending that was spread out over several years.

“This is the best available countercyclical tool in Europe,” Krishna Guha, head of global policy and central bank strategy at Evercore ISI, wrote in a research note. But he cautioned against expecting too much. “Politics will slow and could jeopardize the move to fiscal stimulus in Germany.”

Mr. Draghi will not make an appearance at the Wyoming meeting this year, though other European Central Bank leaders will be in attendance.

Like Mr. Powell, Mark Carney, governor of the Bank of England, is paying attention to politically created risks. He warned in a recent BBC interview that a no-deal Brexit would create an “instant” shock. The bank had been setting up for potential rate increases, but investors increasingly expect cuts instead as global growth wanes and trade tensions loom large.

In Australia, the central bank has cut rates to record-low levels as the economy weakens and threats to the nation’s 28-year-old expansion loom large. The threats include precarious household consumption, the broader slowdown in Asia.

Politicians in the nation have passed a tax cut and engaged in infrastructure spending, but they are nevertheless headed for what may be their first budget surplus in more than a decade, underlining the limits to that support. Philip Lowe, the head of the Australian central bank, who speaks on Saturday in Jackson, suggested this month that it would be economically helpful if politicians raised unemployment benefit spending, Bloomberg reported — a policy change that the sitting government opposes.

Economic action might be needed sooner rather than later: Recession signals have been flashing in American bond markets, Japan and South Korea are engaging in their own trade war, and consumer and business confidence have taken a hit in many parts of the world. While recession far from guaranteed, it is looking increasingly likely across a number of economies, including the United States.

Gary Reber Comments:

The underlying problem throughout the world is economic growth is hindered because growth is predicated upon savings. The term “savings” means in the financial sense, money or credit diverted from immediate use for consumption. As binary economist and author Louis O. Kelso and philosopher Mortimer J. Adler wrote in their second book, The New Capitalists* published in 1961 “personal savings are normally invested in capital goods or in a bank, pension fund, insurance company or other financial intermediary which, in turn, perhaps through other financial intermediaries, ‘invests’ or uses the purchasing power thus represented to buy an interest in wealth-producing capital goods.” …”Personal savings are savings by individuals. Business or corporate savings are made up of the wealth produced by business or corporate capital [assets] that is retained as working capital [money], or is applied to the acquisition of further capital goods –– in the graphic term of the financial world, ‘new capital formation.'”

They go on to state “The act of using money or credit to acquire, either directly or indirectly, an interest in productive capital is called investment.”

Kelso and Adler defined a “capitalist” as “a member of a household which derives not less than half the amount the household spends on consumption from the ownership of capital, i.e., from interest, dividends, rents, royalties, and the like. Not over 1 percent of the households in the American economy would be capitalists households under this definition.”

Throughout the United States and the Western world, the acquisition of privately owned capital has been financed almost entirely throughout savings (the denial of consumption, which hinders demand).

Over numerous decades investment transaction trends have shifted away from personal savings to business savings to finance new capital formation. Note, the securities markets deal in second-hand securities that are sold and bought, and do not represent the formation of new productive capital. Unfortunately, within the Western world, corporation law has given management discretion to use corporate earnings to finance expansion rather than paying earnings out fully in dividends to shareholders. The sale of new issues of corporate stock has all but ceased to be an important source of capital funds. In the economy’s totality, both public, for-profit corporations, which account for the dominant portion of wealth production, and unincorporated businesses depend on savings to finance new capital formation.

An individual, who engages in saving to invest or “speculate” with regards to the securities exchanges, uses part of his or her income to purchase new corporate stocks, or bonds, or notes, and the corporation, using the funds thus acquired, purchases land, manufactory plant, equipment, or uses the money as working capital. Individual proprietors or partners in small businesses use part of their income to invest in capital goods but on a smaller scaler compared to a large corporation. Thus, the totality is that both large public for-profit corporations and small businesses use earnings withheld from stockholders or personal savings, respectively, to purchase capital assets, whose use is to produce wealth that can be consumed by the populous –– goods, products, and services.

Capital acquisition takes place on the logic of self-financing and asset-backed credit for productive uses. People invest in capital ownership on the basis that the investment will pay for itself by producing sufficient wealth, in addition to its own costs of production.  The basis for the extension of capital credit and commitment of loan guarantees is the fact that nobody who knows what he or she is doing buys a physical capital asset or an interest in one (existing or to be formed) unless he or she is first assured, on the basis of the best advice one can get, that the asset in operation will pay for itself within a reasonable period of time — five to seven or, in a worst case scenario, 10 years (given the current depressive state of the economy). And after it pays for itself within a reasonable capital cost recovery period, it is expected to go on producing income indefinitely with proper maintenance and with restoration in the technical sense through research and development.

Still, there is at least a theoretical chance, and sometimes a very real chance, that the investment might not pay for itself, or it might not pay for itself in the projected time period. So, there is a business risk. Thus, there is the risk of entrepreneurial error, or risk of error in determining economic feasibility. In the case of securing capital credit, in addition to determining that the investment is viable and that the business corporation is creditworthy and reliably expected to make loan repayments, there needs to be security against default. Thus, for the lender to make the loan the corporation must provide the security.

There is a path to solve the security issue, that is, the risk can be absorbed by capital credit insurance or commercial risk insurance. Thus, in order to achieve a national economic democracy, we need a way to handle risk management in finance by broadly insuring the risks. Such capital credit insurance would substitute for the security demanded by lenders to cover the risk of non-payment, thus enabling the poor and others with no or few assets (the 99 percent) to overcome the collateralization barrier that excludes the non-halves from access to and the means to finance their ownership wealth-creating, income-generating productive capital.

As Kelso and Adler stated in The New Capitalists, “the most obvious, and certainly the most distressing, consequence of a system which rigidly links the formation and ownership of new capital to the ownership of existing capital is the progressive concentration of the ownership of capital” in the stationary ranks of the 1 percent of the populous, despite that some capital is owned by more than 1 percent of the households of the economy, the great bulk of capital is owned by less than 10 percent of the households.

Note, though millions of Americans own diluted stock value through the “stock market exchanges,” purchased with their earnings as labor workers, their stock holdings are relatively minuscule, as are their dividend payments, if any, compared to the top 10 percent of capital owners. Statistically, stock market wealth is held by a relatively small number of the most affluent. In reality, most Americans don’t have any stocks to their name. In fact, many Americans don’t even have any savings to their name.Pew Research found that 53 percent of Americans own no stock at all, nor have any retirement accounts, and out of the 47 percent who do, the richest 5 percent own two-thirds of that stock. And only 10 percent of Americans have pensions, so stock market gains or losses don’t affect the incomes of most retirees.

So it comes down to how do we free economic growth from the slavery of savings? As Kelso and Adler state, if one must be an owner of capital to become the owner of newly formed capital, and if the more capital one owns today, the more newly formed capital one can and probably will own tomorrow, then conventional finance is designed to accomplish precisely the opposite of the capitalist dream –– a constantly growing number and proportion of households owning viable capital estates. As the burden of production is shifted through technological change from labor to capital, the amount of wealth produced by an almost stationary class of capital owners will continuously increase. In consequence, the maintenance of prosperity and a widely diffused standard of economic well-being will depend upon ever more intensive efforts by government and government-supported power blocs to divert the wealth produced by capital to those who do not own capital.”

The solutions require adopting new financing tools, using the existing powers of the central bank, and economic proposals, while devising other practical ways designed to correct the imbalance between production and consumption at its source, and broaden ownership of productive capital in conformance with private-property free-market principles, simultaneously with the responsible growth of the economy.

As Kelso would say, today’s techniques of finance are designed to make the rich richer. None are designed to make the poor richer. That’s why the poor are poor. The reason they are poor is because they do not have viable capital ownership. Thus, we need to focus on revising today’s techniques of finance to broaden capital ownership.

One feasible way to significantly broaden capital ownership simultaneously with the responsible growth of the economy is to lift ownership-concentrating Federal Reserve System credit barriers and other institutional barriers that have historically separated owners from non-owners and link tax and monetary reforms to the goal of expanded capital ownership. Removing barriers that inhibit or prevent ordinary people from purchasing capital that pays for itself out of its own future earnings is paramount as an actionable policy. This can be done under the existing legal powers of each of the 12 Federal Reserve regional banks, and will not add to the already unsustainable debt of the federal government or raise taxes on ordinary taxpayers. We need to free the system of dependency on Wall Street and the accumulated savings and money power of the rich and super-rich who control Wall Street. The Federal Reserve System has stifled the growth of America’s productive capacity through its monetary policy by monetizing public-sector growth and mounting federal deficits and “Wall Street” bailouts; by favoring speculation over investment; by shortchanging the capital credit needs of entrepreneurs, inventors, farmers, and workers; by increasing the dependency with usurious consumer credit; and by perpetuating unjust capital credit and ownership barriers between rich Americans and those without savings.

The Federal Reserve Bank should be used to provide interest-free capital credit (including only transaction and risk premiums) and monetize each capital formation transaction, determined by the same expertise that determines it today — management and banks — that each transaction is viably feasible so that there is virtually no risk in the Federal Reserve. The first layer of risk would be taken by the commercial credit insurers, backed by a new government corporation –– the Capital Diffusion Reinsurance Corporation (CDRC) –– through which the loans could be guaranteed. The CDRC would reinsure any portion of any financing risk assessed as reasonable and insurable but not already insured by the commercial capital credit insurance underwriters. In establishing the CDRC, the federal government would not be undertaking a new responsibility but merely simplifying and rationalizing an existing one. This entity would fulfill the government’s responsibility for the health and prosperity of the American economy. 

The Capital Diffusion Reinsurance Corporation would function similar to the Federal Housing Administration, generally known as “FHA”, which provides mortgage insurance on loans made by FHA-approved lenders throughout the United States and its territories. The FHA insures mortgages on single family and multifamily homes including manufactured homes. FHA borrowers pay for mortgage insurance, which protects the lender from a loss if the borrower defaults on the loan. While pay-downs on home mortgages require a separate source of income, capital credit for productive capital formation is self-liquidating, with the earnings from the investment the source of the pay-down.

The fact is money power rules. When money power is broadly distributed in the hands of the citizens, not the politicians or bankers, the people shall rule. Ensuring that money power is broadly distributed should be the primary role of the Federal Reserve.

The Federal Reserve Board is already empowered under Section 13 of the Federal Reserve Act to reform monetary policy to discourage non-productive uses of credit, to encourage accelerated rates of private sector growth, and to promote widespread individual access to productive credit as a fundamental right of citizenship. The Federal Reserve Board needs to re-activate its discount mechanism to encourage private sector growth linked to universal capital ownership opportunities for all Americans.

The Federal Reserve, which has been largely responsible for the powerlessness of most American citizens, should set an example for all the central banks in the world. Members of the Federal Reserve need to wake-up and implement Section 13 paragraph 2, which directs the Federal Reserve to create credit for local banks to make loans to finance economic growth. We should not destroy the Federal Reserve or make it a political extension of the Treasury Department, but instead reform it so that the American citizens in each of the 12 Federal Reserve Regions become the owners. The result will be that money power will flow from the bottom up, not from the top down, not for consumer credit, not for credit that doesn’t pay for itself or non-productive uses of credit, but for credit for productive uses to expand the economy’s rate of responsible and environmentally enhanced growth.

One may ask but these ideas require creating new money. How is money created?

A commercial bank serves this purpose. A commercial bank is in the business of creating general promises (“money”) that people in the community will recognize out of individual promises made by borrowers from the bank. And how does a bank do that? –– By making loans. But doesn’t making loans increase the money supply by depositing the proceeds, and then loaning them out again? No. All that happens is that the original amount of new money gets passed around from hand to hand. No new money can be created by making deposits or by re-depositing existing deposits; only by making new loans.

There are three basic types of banks, each filling a particular social and financial need — banks of deposit, banks of issue/circulation and banks of discount. A bank of deposit is what most people think of as a “bank” –– a bank that takes deposits and makes loans out of those deposits and its capitalization, but does not create money. A bank of issue/circulation does not create money, either, but functions to change one form of money into another form of money more easily used to carry out financial transactions. A bank of discount is the only type of bank that actually creates money. It only makes loans and accepts bills of exchange/commercial paper at a discount from the face value, and issues a promissory note to “buy” the bill or paper. A modern commercial, merchant, or mercantile bank (confusingly different names for the same thing) is a combination of all three types of bank. It takes deposits and makes loans out of those deposits, thus acting as a bank of deposit. It also changes one form of money — accepted bills of exchange and commercial paper — into a form more convenient for transacting business, usually by issuing a promissory note used to back a new demand deposit. It also accepts bills of exchange and commercial paper, “buying” (accepting) them by issuing a promissory note that it uses to back new demand deposits.

I am on the board of directors of the Center for Economic and Social Justice (www.cesj.org). CESJ subscribes to the Banking Principle, as opposed to the so-called “multiplier theory” — disproved by Dr. Harold G. Moulton, author of The Formation Of Capital — promulgated as the Currency Principle. That’s the belief that banks create money out of nothing by double counting reserves. Under the Banking Principle there are two types of money, past savings money and future savings money. In technical terms, these are mortgages (contracts on existing assets) and bills of exchange (contracts on future assets). All money is a contract, just as all contracts are, in a legal sense, money. Any promise consisting of offer, acceptance, and consideration is a contract and thus money.

How does a mortgage differ from a bill of exchange? A mortgage is a contract conveying an ownership interest in past savings, that is, existing wealth owned by the issuer of the mortgage. A bill of exchange is a contract conveying an ownership interest in future savings, that is, wealth that the issuer doesn’t have now, but reasonably expects to have when the bill comes due.

The role of a commercial bank and a central bank (broadly speaking, a central bank is a commercial bank for commercial banks) is to “accept” money in the form of a personal contract, and issue its own general contract to “buy” it. Strictly speaking, a bank can only “create” money by accepting something of value and issuing a promissory note that obliges the bank to deliver value once the original borrower has redeemed the contract he, she or a non-person legal entity “sold” to the bank. A bank’s promissory notes, whether in the form of banknotes or to back a new demand deposit, are negotiable, and can be used as currency, a general medium of exchange with a uniform and (presumably) stable value.

Paradoxically, although many people think that commercial banks create money out of thin air by creating demand deposits, it is easily seen that when a commercial bank accepts a bill of exchange or commercial paper that it is really creating asset-backed money. In contrast, when the government emits “bills of credit” and the central bank “buys” the bills of credit (misleadingly usually called government bonds) by creating a demand deposit or printing currency for the government, it really is creating money out of thin air — or (more accurately) future taxes that might never be collected.

So, if everybody who consumes, produces, and everybody who produces, consumes, things would work a lot better in the world. When people cannot produce, something must be done to meet their consumption needs, or what was a simple economic problem (how people can consume) turns into a major political problem (how to keep order in society when people are deprived and starving). Thus, what should be the major, if not sole focus of government — how to assist people in becoming and remaining productive is ignored. Instead, government implements policies seeking to guarantee that most if not all people have sufficient effective demand to enable them to consume when they do not or cannot produce. This in turn requires ever-increasing levels of government interference, not only in the economy, but in every aspect of life.

The conclusion is that, given financially feasible investments, i.e., investments that pay for themselves out of future profits and thereafter provide consumption income for the investor, there should never be a question of whether there’s enough savings accumulated in the economy to finance all the necessary new capital. Using future savings, there can always be enough money in the economy — and past savings can effectively be spent on consumption, which is their purpose, as they represent unconsumed production from the past.

This is the solutions’ path that needs to be taken if central banks want to keep economies growing.

For an in-depth overview of solutions, see my article Economic Democracy And Binary Economics: Solutions For A Troubled Nation and Economy at http://www.foreconomicjustice.org/?p=11 and utilize the tremendous resources available on the CESJ.org Web site.

*For a free download of the book, The New Capitalists, download the pdf at http://www.kelsoinstitute.org/pdf/nc-entire.pdf. You can also download Kelso’s and Adler’s first book, The Capitalist Manifesto at http://www.kelsoinstitute.org/pdf/cm-entire.pdf.