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2011 06

In Defence of Fractional Reserve Banking

George Selgin defends fractional reserve banking against the fever swamp Austrians:

Free bankers have tried responding to this argument by noting how fractional reserve banking has prevailed under every sort of bank regulatory regime, from the earliest beginnings of banking, not excepting regimes that involved very little regulation, like those of Scotland, Canada, and Sweden, and that lacked even a trace of government guarantees or other sorts of artificial support.  But since some 100-percenters seem unmoved by this approach, I here take a different tack, which consists of pointing out that every significant 100-percent bank known to history was a government-sponsored enterprise, which depended for its existence on some combination of direct government subsidies, compulsory patronage, or laws suppressing rival (fractional reserve) institutions. Yet despite the special support they enjoyed, and their solemn commitments to refrain from lending coin deposited with them, they all eventually came a cropper. What’s more, it was these government-sponsored full-reserve banks, rather than their private-market fractional reserve counterparts, that were the progenitors of later central banks, starting with the Bank of England.

posted on 01 June 2011 by skirchner in Economics, Monetary Policy

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What Would Friedman Do IV?

Yes, Friedman would do QE. A new paper from Ed Nelson:

This paper views the policy response to the recent financial crisis from the perspective of Milton Friedman’s monetary economics. Five major aspects of the policy response are: 1) discount window lending has been provided broadly to the financial system, at rates low relative to the market rates prevailing pre-crisis; 2) the Federal Reserve’s holdings of government securities have been adjusted with the aim of putting downward pressure on the path of several important interest rates relative to the path of short-term rates; 3) deposit insurance has been extended, helping to insulate the money stock from credit market disruption; 4) the commercial banking system has received assistance via a recapitalization program, while existing equity holders have borne losses; and 5) an interest-on-reserves system has been introduced. These five elements of the policy response are in keeping with those that would arise from Friedman’s framework, while a number of the five depart appreciably from other prominent benchmarks (such as the Bagehot-Thornton prescription for discount rate policy, and New Keynesian approaches to stabilization policy). One notable part of the policy response, the TALF initiative, draws largely on frameworks other than Friedman’s. But, in important respects, the overall monetary and financial policy response to the crisis can be viewed as Friedman’s monetary economics in practice.

posted on 30 May 2011 by skirchner in Economics, Monetary Policy

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Anti-Dumping Actions as Protection Racket

American manufacturers extort protection money from Chinese firms:

The only Americans getting more work as a result of the tariffs are Washington lawyers, who have been hired by both U.S. and Chinese companies. Their work includes haggling each year over private “settlement” payments that Chinese manufacturers denounce as a “protection racket.”

Fearful of having their tariff rates jacked up, many Chinese furniture makers pay cash to their American competitors, who have the right to ask the Commerce Department to review the duties of individual companies. Those who cough up get dropped from the review list.

posted on 25 May 2011 by skirchner in Economics, Free Trade & Protectionism

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Budget Office Helps Pollies, Not Punters

I have a piece at the ABC’s Drum Unleashed on the proposed federal Parliamentary Budget Office. Here’s my conclusion:

Policy costings should be a low priority for the PBO or any other independent fiscal authority. Were we really any the wiser for the 128 policy costings released by Treasury and Finance for the 2010 federal election, the work of some 300 public servants? Hands-up if you can recall the conclusion of even one?

The new federal PBO’s focus should instead be on the analysis of overall fiscal strategy and long-term fiscal sustainability. The PBO will not end partisan disputes over competing policies. But it could serve a useful purpose if it injects some realism into debates over costings. To do this, it will need the independence to scrutinise and contradict, rather than just recycle, the work of Treasury and Finance. Whether the PBO is given the necessary freedom to do so remains to be seen.

posted on 19 May 2011 by skirchner in Economics, Fiscal Policy, Politics

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Guaranteed to Fail

My review of Guaranteed to Fail is available at The Conversation. Oddly enough, the book also gets an endorsement on its jacket from our old enemy Nouriel Roubini. Since the authors are colleagues of Roubini at Stern, this may just be a collegial courtesy. Roubini’s endorsement is ironic because the book demonstrates that the crisis looked nothing like any of Nouriel’s many and varied pre-crisis narratives. Nouriel managed to forecast every crisis except the one that actually occurred.

posted on 18 May 2011 by skirchner in Economics, Financial Markets

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Conservatives and Libertarians for Dumping the Gold Stock

We have previously noted the irony of those who worry about an over-supply of fiat money taking refuge in a commodity in which governments hold stocks that dwarf annual production. We also noted that the pro-free trade social democrats at the Petersen Institute had suggested liquidating the US gold stock to reduce US government debt and interest payments.

Now conservative and libertarian US think-tanks are saying it too. It is consistent with their long-standing support for the privatisation of government assets. Of course, it is a lazy approach to debt reduction, but a lazy debt reduction is better than none.

Dumping the gold stock without tanking the gold price is easier said than done, but the RBA was able to discretely offload 167 tonnes in 1997, yielding a handsome profit on the old Bretton Woods parity price and adding income producing assets to the RBA’s portfolio (contrary to Paul Cleary’s FOI beat-up).

In Australia, sales of public trading enterprises Qantas, Telstra, CBA and the airports yielded $61 billion during the 1990s and 2000s, making a large contribution to the reduction in net debt from $96 billion in 1996-97 to a negative net debt position in 2005-06 before the terms of trade boom really took off. Peter Costello knew a lazy policy option when he saw one. One of the problems facing the current government is that it has to do debt reduction the hard way. And the gold stock’s long gone.

UPDATE: Portugal is under pressure to sell its Nazi gold back to Germany.

posted on 16 May 2011 by skirchner in Commodity Prices, Economics, Financial Markets, Fiscal Policy, Gold

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Turnout Matters: Evidence from Compulsory Voting in Australia

A paper suggesting that compulsory voting in Australia has increased Labor’s vote share and spending on pensions (although the latter result is heavily qualified):

Despite extensive research on voting behavior, there is little evidence connecting turnout to tangible outcomes. Would election results and public policy be different if everyone voted? The adoption of compulsory voting in Australia provides a rare opportunity to address this question. The Commonwealth enacted compulsory voting for federal elections in 1924 and each state enacted similar policies at different times between 1914 and 1941. Within each state, the timing of compulsory voting was exogenous to other political events. Exploiting this variation, I estimate that compulsory voting increased voter turnout by 24% which in turn increased the vote shares and seat shares of the Labor Party by 7-9%. Then, employing synthetic control methods, I find that pension spending in Australia increased significantly after the adoption of compulsory voting. Results suggest that increased voter turnout can dramatically influence election outcomes and the resulting public policies.

Needless to say, we should not make a case for or against compulsory voting based simply on whether we like or dislike the political and distributional outcomes it supposedly produces, not least because these outcomes are unpredictable and could well change over time. The conservative politicians who originally backed the introduction of compulsory voting in Australia did so in part because they thought the labour movement was better at mobilising voters. Now the labour movement has the coercive power of the state to do it for them.

posted on 10 May 2011 by skirchner in Economics, Politics

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The Finite Resource Assumption: Tripling or Quadrupling Down with Jeremy Grantham

Malcolm Turnbull is not the only person to be led astray by the assumption that resources are finite. According to GMO’s Jeremy Grantham:

Scavenging refuse pits will no doubt be a feature of the next century if we are lucky enough to still be in one piece.

Here is Grantham’s strategy for trading commodities:

Given my growing confidence in the idea of resource limitation over the last four years, if commodities were to keep going up, never to fall back, and I owned none of them, then I would have to throw myself under a bus.  If prices continue to run away, then my small position will be a solace and I would then try to focus on the more reasonably priced – “left behind” – commodities.  If on the other hand, more likely, they come down a lot, perhaps a lot lot, then I will grit my teeth and triple or quadruple my stake and look to own them forever. 

Sounds like a good formula for losing ‘a lot lot’. Apparently, this is what passes for macro strategy at GMO.

posted on 06 May 2011 by skirchner in Commodity Prices, Economics, Financial Markets

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MNI-Deutsche Börse Economic Forecasting Competition

I came third in the first round of the MNI-Deutsche Börse economic forecasting competition:

NEW YORK, NY, May 5, 2011 – Market News International has announced the April winners of the MNI Forecast Competition, a free online contest in predicting US economic indicators.

April’s highest forecasters in descending order are:
•  Omair Sharif, RBS
•  Fernando Melro dos Santos, Private
•  Dr. Stephen Kirchner, UTS Business School

Until June 30, contestants are competing for the title of Best Overall Forecaster and a prize of $1,500 by forecasting ten economic data releases: Non-farm Payrolls, Retail Sales, CPI, PPI, Industrial Production, ISM Manufacturing Index, Housing Starts, Durable Goods Orders, International Trade Balance, and New Home Sales.

posted on 05 May 2011 by skirchner in Economics, Financial Markets

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20 Million Future Funds

I think it was my colleague Peter Saunders who first coined the phrase 20 million Future Funds in arguing that the Howard government should make one off contributions to individuals’ superannuation accounts rather than hoard revenue in the Future Fund.

The government has adopted the same tag line in arguing for an increase in the rate of compulsory superannuation contributions, although these contributions necessarily come at the expense of the supposed beneficiaries through lower take-home wages, fewer hours worked and reduced employment. Compulsory super promotes dissaving through other saving vehicles and only succeeds in raising net household wealth to the extent that some households are liquidity constrained and cannot dissave through other mechanisms to offset the compulsory contributions.

Bill Shorten is suggesting there is some kind of trade-off between an increase in the compulsory super contribution rate and a sovereign wealth fund. While this is absurd, it does provide Shorten with an opportunity to highlight the philosophical weakness of the federal opposition:

Turnbull’s sovereign wealth fund advocacy is inconsistent with his free market philosophy. A sovereign wealth fund would see the state play a role that Labor now sees being performed by the private sector. The importance of our superannuation savings during the GFC was evidence of how it acts as a bulwark. Since the last election, however, we have seen the Liberals move further away from their free-market credentials. It was evident in Joe Hockey’s overly regulatory approach to mortgage lending rates. And it’s evident in Tony Abbott’s Soviet style centrally controlled $10bn direct action policy on climate change. The philosophical contractions colliding within the Liberals may seem soft now, but watch it grow in the months ahead. Meanwhile, I’d rather trust thousands of trustees across thousands of super funds to invest and manage billions of dollars rather than government insiders in Canberra picking winners.

In this context, it is worth noting that the Future Fund has divested itself of two of its three biggest defence holdings, Lockheed Martin Corp. (LMT) and General Dynamics Corp. (GD) because they are supposedly engaged in mines and cluster munitions, even though Australia has yet to ratify the relevant convention and the Fund is notionally free from political direction from Canberra. Clearly the Fund is looking over its shoulder at what politicians are doing in making investment decisions.

posted on 03 May 2011 by skirchner in Economics, Financial Markets, Fiscal Policy, Politics

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