Chris Dillow takes to bits the various aspects of Conservative economic philosophy evinced by John Redwood, which is all aimed at the same point: the idea that you can’t make the economy stronger by borrowing to spend.  Ever.  Because you either just defer pain, or drive up rates, or prevent the good ol’ private sector from spending, or something.

This, I suppose, is the Blue Toryism that Paul refers to, and which must be gaining ascendancy over the (minority interest) of Green Toryism, and (not really thought out yet) Red Toryism.

At a recent evening event hosted by a fine new economics outfit, I heard one right wing speaker dismiss government spending as “just taking a bucket of water out of one side of the pool and pouring it into the other side”.  The image of finite resources being artificially diverted (into presumeably corrupt and inefficient channels) is what all these right wing theses aim at.

This all reminds me of the massive fuss raised by Eugene Fama about a year ago, when criticising the very idea of stimulus working, with this home spun logic:

The problem is simple: bailouts and stimulus plans are funded by issuing more government debt…. The added debt absorbs savings that would otherwise go to private investment…. [G]overnment infrastructure investments must be financed — more government debt. The new government debt absorbs private and corporate savings, which means private investment goes down by the same amount.

This is so seductive, and so ‘micro’economically sound, that its failure to be TRUE is often beside the point: by then, the polemic is written, and the voter persuaded.  Brad DeLong is so infuriated by Fama’s Fallacy that he has tried to find it anywhere else, and failed.  Even in supposedly primitive economic history, they understood that a depressed economy can see its speed increased by government investment.  Here is Brad. It seems that even the famously Treasury View Hawtrey got it:

There is, however, one possibility which would in certain conditions make the Government operations the means of a real increase in rapidity of circulation. In a period of depression the rapidity of circulation is low, because people cannot find profitable outlets for their surplus funds and they accumulate idle balances. If the Government comes forward with an attractive gilt-edged loan, it may raise money, not merely by taking the place of other possible capital issues, but by securing money that would otherwise have remained idle in balances.

So perhaps it is just Eugene Fama.  And John Redwood MP.

I am not denying that there are certain, indeed many circumstances in which government spending depresses demand.  See last Thursday’s post.  But that is very different from saying that by sheer force of logic it is inevitable, because ‘the money must come from somewhere’.  Money has velocity.  It doesn’t GO anywhere – it circulates.

(this makes me all the more surprising the Dr Butler thinks deflation may happen)


10 thoughts on “John Redwood and Fama’s Fallacy

  1. I don’t think anybody has said government spending depresses demand. What it does do is soak it up & divert it. It need not be diverted into non-priductive spending but could be used to stimulate growth by, as i said on his blog, building nuclear power stations, roads, X-Prizes, cutting business taxes or other methods of investment. Indeed this is how Reagan’s “voodoo economics” worked. The difference is that what we see now is borrowing to finance running costs & subsidy of non-productive things like windmills & more regulators. That, obviously, does not generate growth.

    Certainly neither Labour nor the LibDems wish to borrow money for investment though they sometimes use the word where “current spending” would be the honest term.

  2. Fama’s position is based upon the ideological position that the credit which constitutes our currency is necessarily created by private banks, and that therefore it is finite because the bank capital underpinning it is finite.

    I will give a couple of counter-examples to disprove this.

    Firstly, the Swiss WIR credit clearing union has since 1934 enable tens of thousands of Swiss SMEs to exchange goods and services on credit terms not IN EXCHANGE FOR ‘fiat’ Swiss Francs (created either as notes or bank credit) but BY REFERENCE TO teh Swiss franc a a unit of measure or value standard. The necessary framework of trust or discipline in relation todebit balances comes from a requirment for members to give security over property.

    Currently I am advising a South American central bank in relation to a very interesting project where any VAT- registered business mwill be able to discount VAT invoices directly with the Central Bank, thereby obtaining working capital. In this case no ‘fiat’ currency changes hands, but obligations are used to settle other onbligations by reference to the dollar as a Value Standard. A similar project could be commenced here tomorrow….over the banks’ dead bodies…..

    The source of private credit in the above examples is the businesses, not the banks., and it is limited only in respect of the capacity of businesses to perform.

    Wherever a barter system includes credit or “time to pay” the result IS a monetary system, configured as a credit clearing union.

    Secondly, there is public = State credit and here there is the example of the Social Credit movement which came closest to implementation in Alberta, Canada in the 1930s. Indeed Alberta Treasury Branches nominally survive to this day, as a state owned bank.

    The driving intellect behind Social Credit was the very well respected engineer C H Douglas, and he identified – in his somewhat arcane A + B Theorem – the fact that credit – and hence purchasing power – is constantly draining out of the economy and must be replaced. He developed a technocratic and top down solution involving the managed creation and issue by government of ‘Social Credit’ ie QE in all but name.

    Douglas identified (ibut IMHO misdiagnosed) an important reality, which is that deficit-based credit=money actually – contrary to your last line – does indeed GO somewhere. It gets tied up in the conflicting legal claims over productive assets (particularly land) of shareholder equity and secured debt. Such credit is going precisely nowhere – it ceases to be dynamic credit = money and becomes static credit=capital) and if it is not replaced the economy comes to a halt.

    The heterodox economists Gunnar Tomasson and Dirk Bezemer (who are, like myself and Richard Werner, members of the Gang8 list) recently wrote an intriguing paper – “What is the Source of Profit and Interest? A classical conundrum reconsidered.”

    This paper makes that same distinction (between credit used in productive assets and credit used for consumption) which I arrived at independently and have been making for years, and they identify an early, and long suppressed, publication by Bentham as the earliest source.

    The bottom line is that the assumptions underpinning economics are complete nonsense, and bear zero relationship to reality.

    But then I think you know that.

    The challenge is a new set of assumptions and fwiw mine are here

    1. I am not sure that the belief in banks creating credit is so much an ideological or theoretical position, as an empirical fact.

      We all know that if I say to my mate “you can owe me”, I am creating credit. Anyone can do it. But Banks do it on an industrial scale, and weaning the economy off it in a structural way is very difficult. The skills to do it and willingness are not always there. See this from young mr Hilton in the Standard:

      I use Zopa myself, and am all in favour of more forms of credit. But they need massive structural change.

      1. That banks create credit is an empirical fact.

        My point is that the fact that they do so, and thereby benefit from seigniorage, has been systematically obscured for as long as banks have been doing it, and they have fiercely defended and enhanced their de facto monopoly by fair means or foul.

        The canard that public credit is necessarily and de facto inflationary I have seen stated as fact in a Treasury letter. It is in fact LESS inflationary ceteris paribus to the tune of the excess management rents collected in the private sector, and the dividends to private capital supporting private credit creation.

        The key for credit intermediaries to avoid inflation is professional credit management – whoever issues it, and competent oversight by a monetary authority. There is no structural need for a Central Bank, as Hong Kong demonstrates empirically.

        But my case is that all credit intermediaries – including Treasuries, Central banks and private banks – are unnecessary in a networked economy of instatntaneous direct ‘Peer to Peer’ connections.

        Zopa is the Peer to Peer equivalent of a Credit Union. It moves credit around: it does not create it. The Peer to Peer Finance

        mechanisms I have developed with Norwegian government seed funding, on the other hand, do create credit, both based upon individuals capacity to produce (the Guarantee Society) and ‘unitisation’ of the use value of land and energy (Capital Partnership).

        To this day you will not find the financial pornography of private vs public credit creation published in any decent newspaper.

  3. The problem with John Redwood is he is a moralist and it taints his analysis. It simply offends his sense of morality that the government can borrow so cheaply. It was possible to get a glimpse of his morality last week when he complained that the private sector was paying more to borrow than the government. This annoys him and his bizarre solution was to put up interest rates.

    His logic is all over the place. He complains that government borrowing could force up nominal long-term interest rates. However, if the government was not borrowing and the the central bank had not conducted QE, we would be in deflation. Therefore, real interest rates would be rising.

    The old fallacy of ‘ the money has to come from somewhere ‘ gets trotted out. It is just nonsense for him to suggest that if the banks are lending to the government then they can’t lend to the private sector. When the banks lend to the government they receive a liquid capital security, it was the lack of liquid assets on the balance sheets that caused the liquidity seizure 2008. Although if they do buy a lot of gilts now when prices are high they will suffer capital losses if prices fall and yields rise. If the banks are not supplying the funds to meet demand in the economy, it is not because they are liquidity constrained. They either do not have enough capital or they can’t find enough credit worthy demand.

    In more normal times it is possible to think of government deficits competing with the banking sector i.e. if the government was not running a deficit that money would be borrowed from the banks. However, we are far from in normal times. It is the government deficit that is supporting demand and allowing the private sector to deleverage and repair their balance sheets. John Redwood either does not understand that or it offends his morality and ideology.

    1. In fact, government spending should be right up any Free marketer’s street right now. There is a high demand for government debt. By running a big deficit, the government is only giving the market what it wants.

    2. I had no idea he complained about the private sector paying more! That is classic!

      My favourite was a week or so ago, his complaining about the government losing discipline just as the private sector gained thrift again. It makes you want to sit down with a bunch of national accounts equations and go through them slowly ….

      The normal times point is exactly right in my view. One of my (longer term) concerns is that when we DO hit normal times again, the keynesian habits will be hard to break. But I am happy to cross that bridge when we come to it. In the meantime, we have a job preventing the Redwoods there preventing us ever getting back to normal

  4. I’ve just been listening to an edition of File on Four about the enormous waste of public money in misguided and mismanaged government IT projects. The beneficiaries of these projects appear to be IT companies who are either very incompetent and/or extremely cynical in the way they absorb this money to provide grotesquely substandard services. I notice that the arguments put forward by you and Chris Dillow on the merits of public spending rarely if ever contain any discussion or analysis about how efficiently public money is actually spent. If these terrible IT failures are anything to go by not only are large amounts of public money being spent without achieving any tangible results in terms of improving infrastructure or making government work better, they are also distorting the market in IT services by allowing companies with access to public funds to achieve large profits without being efficient or effective. Thus, carelessly spent public money may also have the effect of clogging up the arteries of the private sector by conferring unjust benefits on inefficient companies. If a private company made the kind of cock-ups made by government on IT projects, it would probably go bust. At the very least heads would roll and lessons would be learnt. This, though, rarely if ever happens when government departments make these cock-ups. But there must be and is a price for all this incompetence and needless waste, and that price is the crippling deficit and the higher taxes and poorer public services that we will have to endure in the not-too-distant future.

    1. I by no means intend to question the structure inefficiencies that can occur should we rest on govt spending for a very long time. I favour private provision over state in all possible circumstances. I think your points are mostly highly relevant for that.

      But this post is a cyclical point about demand, mostly, not supply. The sooner we get demand up to scratch the sooner we can get the govt out of where it should not be.

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