Wednesday, October 24, 2012

Canceling sovereign debt

Last summer I got into a depressing exchange.  The guy wanted to know what I would propose to deal with the massive national debt as he was certain this was the biggest problem facing the country.  He suggested cutting social security.

I explained that yes, we are certainly deep in debt.  We are in debt to the poisoned atmosphere, we are in debt to the depleted oil fields, we are debt to the soils that grow food, etc.  We have MANY real debts!  Then there are the "debts" we owe the electronic storage systems of banks.  Those are the debts the bankers and politicians talk about almost exclusively when they want to sound "responsible."  Yet these are the debts we could eliminate by pressing a few buttons.  Unfortunately, the debts caused by climate change or the end to the age of petroleum cannot be cancelled nearly so easily. But since those debts to storage systems are the only ones anyone can bring themselves to address, they get in the way of even addressing the real debts.  So the FIRST thing we need to do is push those damn buttons.

Because I have been thinking along these lines since at least the 1980s, I am not overly optimistic that we will see a global debt cancellation anytime soon.  But last week, we saw an "important" paper from the IMF (yes!) proposing just that.  The Greenback Party, the Non-Partisan League, The People's Party, etc. have been validated by an organization that has spent decades ruining the lives of billions of people with their austere structural adjustment dictates.


First this reaction from Business Insider.

Everyone's Talking About Just Taking All The Government Debt, And Lighting It On Fire

Joe Weisenthal | Oct. 22, 2012

Suddenly there's an avalanche of talk that central banks of some highly indebted countries should just rip up the sovereign debt they've acquired via quantitative easing. This is a topic we discussed heavily this weekend.

The latest contribution to this discussion is a quick comment from SocGen's Kit Juckes, in regards to Japan.

Of all the central banks, he says, it makes the most sense for the Bank of Japan, given the size of the Japanese debtload and the need to weaken the yen:

But the case for MOF/BOJ to be more aggressive in efforts to undermine their currency grows. S&P muttering abut downgrading Japan's ratings helps at the margin. The best thing they could do of course would be for the BOJ to steal a march on all others and simply cancel QE debt. I have been trying to figure out the pros and cons of cancelling bonds, as opposed to simply waiting for them to mature, and then giving the money back to the Govt (which is what may happen in the UK and US). The 'con' is that such barefaced debasement will spook investors but since that makes you currency go down, the BOJ may welcome such an outcome! The ECB ought to try it too, but the hurdles (or Hurden) may be insurmountable.

This line of thinking seems to be where more people are going: What exactly would be the big problem? Some inflation? Some currency weakening? That's exactly what everyone wants! more
 And then from the main economic thinker over at FireDogLake.

Talk Rises About Sovereign Debt Cancellation

By: David Dayen Monday October 22, 2012

It’s an intriguing question: why can’t central banks around the world, practically all of whom have bought up sovereign debt, just cancel it? Countries would get more headroom on their debts, inflation would rise but not necessarily at an unmanageable rate. It would have the effect of hitting the reset button.

And believe it or not, it has been a topic of discussion of late.

Gavyn Davies at the FT has been talking about this idea of central banks canceling debt.

The FT also discussed it in June.

The WSJ was on the topic this week as well, and apparently at least one member of the Bank of England was forced to deny that he favors such a radical solution.

So the bottom line is that this shocking move is being talked about by influential publications, Wall Street traders, and perhaps even officials, though they’re mum on something so radical.

Because very serious persons will continue to describe this step as radical (the screams of “monetizing the debt!” would accompany any action on this front), I wouldn’t bet the ranch on it. But why exactly would it hurt anyone? I suppose you could say that the expectation of what amounts to a bailout of sovereign debt would create a moral hazard. And I would argue that, in the line of countries who deserve a debt jubilee, industrial powers like the US and UK rank low on the list. Moreover, the US and UK don’t currently have a debt problem, and until they do it would be odd to see this step taken. It makes more sense for a country where debt has become an impediment to borrowing. Surely the conservative European Central Bank would recoil at such a solution, but there are others out there who might not.

But this gets into the elite perceptions of the national debt in the first place. It exists as not only an instrument of investment for those with large funds and seeking a yield, but as a forcing event to get governments to act “responsibly.” Canceling the debt would be about the most irresponsible thing you could do, in this telling, and so it’s unthinkable. But there’s no real reason for that.

Analysts at the major banks report that canceling sovereign is among the leading questions they get from investors these days. So there’s at least some groundswell of support for it. The rule of thumb, I suppose, is that there are no simple solutions, or free lunches. But that also acts as a narrowing constraint, oftentimes. more
And, from the oh-so-Tory Telegraph.

IMF's epic plan to conjure away debt and dethrone bankers

So there is a magic wand after all. A revolutionary paper by the International Monetary Fund claims that one could eliminate the net public debt of the US at a stroke, and by implication do the same for Britain, Germany, Italy, or Japan.

By Ambrose Evans-Pritchard  21 Oct 2012

One could slash private debt by 100pc of GDP, boost growth, stabilize prices, and dethrone bankers all at the same time. It could be done cleanly and painlessly, by legislative command, far more quickly than anybody imagined.

The conjuring trick is to replace our system of private bank-created money -- roughly 97pc of the money supply -- with state-created money. We return to the historical norm, before Charles II placed control of the money supply in private hands with the English Free Coinage Act of 1666.

Specifically, it means an assault on "fractional reserve banking". If lenders are forced to put up 100pc reserve backing for deposits, they lose the exorbitant privilege of creating money out of thin air.

The nation regains sovereign control over the money supply. There are no more banks runs, and fewer boom-bust credit cycles. Accounting legerdemain will do the rest. That at least is the argument.

Some readers may already have seen the IMF study, by Jaromir Benes and Michael Kumhof, which came out in August and has begun to acquire a cult following around the world.

Entitled "The Chicago Plan Revisited", it revives the scheme first put forward by professors Henry Simons and Irving Fisher in 1936 during the ferment of creative thinking in the late Depression.

Irving Fisher thought credit cycles led to an unhealthy concentration of wealth. He saw it with his own eyes in the early 1930s as creditors foreclosed on destitute farmers, seizing their land or buying it for a pittance at the bottom of the cycle.

The farmers found a way of defending themselves in the end. They muscled together at "one dollar auctions", buying each other's property back for almost nothing. Any carpet-bagger who tried to bid higher was beaten to a pulp.

Benes and Kumhof argue that credit-cycle trauma - caused by private money creation - dates deep into history and lies at the root of debt jubilees in the ancient religions of Mesopotian and the Middle East.

Harvest cycles led to systemic defaults thousands of years ago, with forfeiture of collateral, and concentration of wealth in the hands of lenders. These episodes were not just caused by weather, as long thought. They were amplified by the effects of credit.

The Athenian leader Solon implemented the first known Chicago Plan/New Deal in 599 BC to relieve farmers in hock to oligarchs enjoying private coinage. He cancelled debts, restituted lands seized by creditors, set floor-prices for commodities (much like Franklin Roosevelt), and consciously flooded the money supply with state-issued "debt-free" coinage.

The Romans sent a delegation to study Solon's reforms 150 years later and copied the ideas, setting up their own fiat money system under Lex Aternia in 454 BC.

It is a myth - innocently propagated by the great Adam Smith - that money developed as a commodity-based or gold-linked means of exchange. Gold was always highly valued, but that is another story. Metal-lovers often conflate the two issues.

Anthropological studies show that social fiat currencies began with the dawn of time. The Spartans banned gold coins, replacing them with iron disks of little intrinsic value. The early Romans used bronze tablets. Their worth was entirely determined by law - a doctrine made explicit by Aristotle in his Ethics - like the dollar, the euro, or sterling today.

Some argue that Rome began to lose its solidarity spirit when it allowed an oligarchy to develop a private silver-based coinage during the Punic Wars. Money slipped control of the Senate. You could call it Rome's shadow banking system. Evidence suggests that it became a machine for elite wealth accumulation.

Unchallenged sovereign or Papal control over currencies persisted through the Middle Ages until England broke the mould in 1666. Benes and Kumhof say this was the start of the boom-bust era.

One might equally say that this opened the way to England's agricultural revolution in the early 18th Century, the industrial revolution soon after, and the greatest economic and technological leap ever seen. But let us not quibble.

The original authors of the Chicago Plan were responding to the Great Depression. They believed it was possible to prevent the social havoc caused by wild swings from boom to bust, and to do so without crimping economic dynamism. more
And finally we have comments from someone who has obviously been exposed to some of the old monetary theories I heard as a kid.

What If We Adopted A System Where The Banks Did Not Create Our Money?

By Michael, October 22nd, 2012

What if there was a financial system that would eliminate the need for the federal government to go into debt, that would eliminate the need for the Federal Reserve, that would end the practice of fractional reserve banking and that would dethrone the big banks? Would you be in favor of such a system? A surprising new IMF research paper entitled "The Chicago Plan Revisited" by Jaromir Benes and Michael Kumhof is making waves in economic circles all over the globe. The paper suggests that the world would be much better off if we adopted a system where the banks did not create our money. So instead of a system where more money is only created when more debt is created, we would have a system of debt-free money that is created directly by national governments. There have been others that have suggested such a system before, but to have an IMF research paper actually recommend that such a system be adopted is a very big deal. At the moment, the world is experiencing the biggest debt crisis in human history, and this proposal is being described as a "radical solution" that could potentially remedy some of our largest financial problems. Unfortunately, apologists for the current system are already viciously attacking this new IMF paper, and of course the big banks would throw a major fit if such a system was ever to be seriously contemplated. That is why it is imperative that we educate people about how money really works. Our current system is in the process of collapsing and we desperately need to transition to a new one.

One of the fundamental problems with our current financial system is that it is based on debt. Just take a look at the United States. The way our system works today, the vast majority of all money is "created" either when we borrow money or the government borrows money. Therefore, the creation of more money creates more debt. Under such a system, it should not be surprising that the total amount of debt in the United States is more than 30 times larger than it was just 40 years ago.

We don't have to do things this way. There is a better alternative. National governments can directly issue debt-free currency into circulation. The following is a brief excerpt from the IMF report...

At the height of the Great Depression a number of leading U.S. economists advanced a proposal for monetary reform that became known as the Chicago Plan. It envisaged the separation of the monetary and credit functions of the banking system, by requiring 100% reserve backing for deposits. Irving Fisher (1936) claimed the following advantages for this plan: (1) Much better control of a major source of business cycle fluctuations, sudden increases and contractions of bank credit and of the supply of bank-created money. (2) Complete elimination of bank runs. (3) Dramatic reduction of the (net) public debt. (4) Dramatic reduction of private debt, as money creation no longer requires simultaneous debt creation. We study these claims by embedding a comprehensive and carefully calibrated model of the banking system in a DSGE model of the U.S. economy. We find support for all four of Fisher's claims.Why should banks be allowed to create money?

That is a very good question.

Why should sovereign governments ever have to borrow money from anyone?

That is another very good question.

Our current system is designed to enrich the bankers and get everyone else into debt.

And is that not exactly what has happened?

Taking the creation of money away from the bankers would have some tremendous advantages. A recent article by renowned financial journalist Ambrose Evans-Pritchard described some of these benefits...

One could slash private debt by 100pc of GDP, boost growth, stabilize prices, and dethrone bankers all at the same time. It could be done cleanly and painlessly, by legislative command, far more quickly than anybody imagined.

The conjuring trick is to replace our system of private bank-created money -- roughly 97pc of the money supply -- with state-created money. We return to the historical norm, before Charles II placed control of the money supply in private hands with the English Free Coinage Act of 1666.

Specifically, it means an assault on "fractional reserve banking". If lenders are forced to put up 100pc reserve backing for deposits, they lose the exorbitant privilege of creating money out of thin air.

The nation regains sovereign control over the money supply. There are no more banks runs, and fewer boom-bust credit cycles. So why don't we go to such a system immediately?

Well, the transition to such a system would undoubtedly be a major shock to the global financial system, and most people try to avoid significant short-term pain even if there are tremendous long-term benefits.

More importantly, however, is that the bankers have a tremendous amount of power in our society today, and they would move heaven and earth to keep a debt-free monetary system from ever being implemented.

You see, the influence of the bankers is not just limited to the big banks. Our largest financial institutions (and the people who own them) also have large ownership stakes in the vast majority of the big Fortune 500 corporations. In essence, the big banks are at the very pinnacle of "the establishment" in the United States and in almost every other major country in the western world.

And the vast majority of all political campaigns are funded by "the establishment". It takes an enormous amount of money to win campaigns these days, and most politicians are extremely hesitant to bite the hands of those that feed them. more

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