Policy paralysis: Capital flows from China.

A lot of people spend a lot of time engaging in the reading of Chinese government tea leaves.

It is the modern equivalent of the Cold War exercise of Kreminology where platoons of pointy heads watched the Kremlin and tried to work out what the commies were up to.

When it comes to capital flows the “SinoSpooks” get very very excited on almost a daily basis as they try to work out whether the Chinese government has turned the capital flow tap on or off.

  • Are the Chinese tourists allowed to buy more than 10 tins of baby formula?
  • Can they buy investment properties in Australia, Canada and elsewhere?
  • Are the Chinese using bitcoin to get capital out of the reach of CCP minions.
  • Are Chinese developers pulling back or striding forth?
  • Is the Chinese government buying US treasuries via Belgium?

The list of potential capital flows are endless so it is a ripe field for observation.

Capital inflows are the issue

The point about capitals flows, that is almost always ignored, is that capital inflows are the problem not outflows from China and that is entirely within our control.

It is capital outflows that are hard to stop as they merely require someone outside China ageeing to sell them something and finding some way of settling the deal.

Thus why the Chinese government is having some difficulty.

Rather than clutching our knitting and wondering whether China will successfully stop or allow outflows we need to be talking about what Australia is doing about regulating capital inflows.

And not just from China. In fact China gets more attention in this department than it deserves.

Australia has a long and shabby history of allowing in capital from anywhere without any regard as to whether it is productive or unproductive. Much of our most unproductive capital comes from the US, UK, Europe and Japan.

In fact many of our economic commentators seem ignorant of the distinction. Scott Morrison certainly is clueless.

Unproductive capital inflows are easy to stop.

The basic point is that capital inflows cannot happen unless local law permits a foreigner to buy something.

  • Land
  • Assets
  • Government bonds
  • Bank Deposits
  • Etc

Would you buy any of those if the local government restricted or did not recognise your ownership?

Nope!

All of them are currently or could easily be made the subject of registered ownership.

Which means finding out if some foreigner has acquired ownership is easy.

Who would risk ownership of an asset in breach of local law?

Would you buy a Chinese asset if the Chinese government made that ownership illegal by a foreigner – they actually do this for many many classes of assets. They are not as stupid as we are and know the difference between productive and unproductive capital flows and do not fawn foreign ownership.

Restricting capital inflows that are clearly unproductive is not difficult and means that we are not hostage to what the Chinese government does or does not do.

At some point we need to take some responsibility for our own economy.

Hiding behind neoliberal mantras about “free capital flows” is not much of an excuse.

And let’s face it this is what the problem is all about.

Australia’s political and economic class are in the grip of a treacherous economic ideology that insists that capital should be allowed to slosh around the world regardless of whether it is productive or in the interests of the general Australian public.

To avoid giving a justification for their treachery they try to make out that unrestricted capital flows are some natural law discovered by Adam Smith and thus is self evident. Don’t buy this line it is complete nonsense.

The “free capital flows” crowd are ideological extremists pushing something close to a religious belief. They and their ticket clipping mates just happen to make profits rather than secure an express ticket to paradise.

The cost

The cost of unproductive capital inflows is that they do not involve any direct expansion of the productive capacity of the Australian economy but they do push up the AUD and that kills local jobs and local businesses.

If you want to know why Australian business struggles to compete look no further.

Bank “Junk Food” credit, macroprudential and the Australian Banking Royal Commission

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With all the excitement surrounding the announcement of a Royal Commission into Australian banks, a few have asked whether there are less drastic options than those recommended by the Glass Pyramid in the article “Real reform starts with a Banking Royal Commission”

One option that is often raised is that the Australian Prudential Regulatory Authority “APRA” could make more use of a regulatory tool that is commonly referred to as “macroprudential”. The argument goes that macroprudential action by APRA would ease the worst of the problems and allow the ‘hard’ issues about banking to be avoided or put off for another decade /generation – though most likely only until the next time the banking system explodes after too much greed and gouging.

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Certainly in many economic department tea rooms and “think tanks” macroprudential is the new black. A quick Google search will reveal a bunch of articles on the subject.  Here is one by our very own Reserve Bank of Australia.

Macroprudential is recommended as a clever solution to the problem of private banks recklessly creating too much credit, earning fat bonuses and aiding and abetting asset price speculators who drive up particular asset prices as they chase tax effective capital gains.

The “theory” is that if only APRA would do some more  “macroprudential” we could avoid talking about our systemic “banking” problems.

The problem is that macroprudential is a #fakesolution that offers no real answer to the problems created by the current role of private banks in our monetary system.

What is Macroprudential?

Macroprudential as the name suggests must have some ‘prudential’ element to it.

But it is not ‘prudential’ in the sense that people usually associate with APRA. When people talk about ‘prudential’ and APRA they generally mean that APRA monitors the banks to make sure they are at low risk of going broke.

In their mission statement APRA puts it this way

“….Our mission: to establish and enforce prudential standards and practices designed to ensure that, under all reasonable circumstances, financial promises made by institutions we supervise are met within a stable, efficient and competitive financial system….”

So what is meant by the word ‘prudential’ in macroprudential is a bit obscure, the RBA discussion of macroprudential does not exactly illuminate but it helps….. a bit 

“.While there is no universally accepted definition, most refer to macroprudential policy as the use of prudential actions to contain risks that, if realised, could have widespread implications for the financial system as a whole as well as the real economy; these risks are often referred to as systemic risks…”

It follows that the most likely meaning of ‘macroprudential’  is that if APRA uses macroprudential tools to regulate specifically how private banks create credit APRA might be able to reduce the risks that they will blow up themselves and the financial system along with them.    In doing so this will provide some ‘prudential’ benefit to the system as a whole.

In other words APRA should start directing how the banks make the decision to lend.

While it may sound like macroprudential is similar to what APRA currently does when it monitors ‘prudential’ standards and practices, it is actually very different.

Monitoring prudential standards and practices generally does NOT involve telling the private banks who, when and for what purposes they can create credit.   In theory it simply means telling banks they need more capital / funding source, different sources of funding and terms of various flavours, stress testing them and leaving the banks to ‘divine’ what that means for their credit creation operations.

Regulating how much credit the private banks create, who they create it for and for what purposes is very different.

Macroprudential is not just a tweak to the current regulatory model and this explains why APRA and the RBA have been very reluctant to embrace the concept that they should regulate how private banks create credit.

This should be self evident in the context of country where a highly concentrated banking system has managed to deliver, using hundreds of billions of external liabilities, nose-bleed residential asset prices in a continent sized country with only 23 million people.

Macroprudential – telling private banks how to create credit.

While macroprudential does involve regulating how the banks create credit it generally does not involve any fundamental change in the role of bank credit in the economy.

This is why the idea of macroprudential has become popular with those who recognise there is something profoundly wrong with our banking and monetary model but don’t really want to propose that we do anything substantial about it.

They acknowledge that a “deregulated free market” in private bank credit creation does not work and has a long record of failure but they hope that a bit of ‘regulatory’ intervention will be enough to keep the model from imploding or causing too much harm.

In other words they hope to fix the problems of “free market” private bank credit creation failure by having the regulator pick a few winners and ban the picking of a few duds. A bit of regulatory sticking tape and brown paper.

Macroprudential fans generally have few objections to private banks continuing to make fat profits from pumping asset prices.  All they want is for the banks to do so in a way that is less likely to result in an asset bubble popping.

For example there is nothing inherent in the ‘macroprudential’ approach that requires that credit creation by private banks should be productive and expand the productive capacity of the economy.

Simply stopping private bank credit from becoming bad debt and preventing the sagging of asset prices is the stunted objective of macroprudential theory.

Macroprudential:    Junk food is not the problem.

Using food as an analogy what this means is, that if private bank credit creation is considered food creation macroprudential would not object to the creation of junk food but it would object to banks producing “Junk” food and feeding it to fat people who might suffer a heart attack. It would just recommend that the banks find healthier customers for the junk credit.

Macroprudential generally sticks to the philosophy that private bank credit creation should remain central to our monetary system. It does not really seek to do more than make some minor ‘tweaks’.

What the macroprudential fan wants is for APRA to direct the banks to restrict the production and sale of junk food to fat people and instead direct as much as new credit as possible to healthy people who are not yet fat or at risk of sudden health failure (i.e. defaulting on their debts).

The macroprudential policy fan does not demand that the private banks henceforth produce, as far as possible, only healthy food (credit that expands the productive capacity of the economy).

Productive v Unproductive credit creation

The macroprudential approach does NOT demand that private bank credit creation be ‘productive’ and that is consistent with the way fans of macroprudential policy usually talk about what they consider are desirable macroprudential policies.

Many of those who argue for more “macroprudential” argue that credit be restricted by reference to particular classes of borrowers rather than the object or purpose of the credit.

They generally don’t argue that private bank credit creation be regulated with regard to whether the object of the credit creation is productive investment.

In other words the macroprudential approach argues that “Junk Food” credit creation for the purchase of existing property is fine provided the borrower is in an approved class of borrowers (healthy and less likely to keel over and default on their loans)

For example:

Macroprudential fans will generally argue that APRA should direct the banks to restrict credit to investors who have been gorging on “Junk” credit and instead now direct plenty of junk credit to first home buyers or owner occupiers who currently have lower levels of debt.

From the perspective of the “prudential” in Macroprudential this makes sense, as keeping the asset prices, that secure the private banking system, well pumped up with fresh credit is a fundamental ‘prudential’ objective and as First Home Buyers and owner occupiers are a lower risk of abandoning their credit obligations they are “healthier” or more ‘prudential’ targets for asset price pumping “Junk” credit.

Debt engorged investors are pragmatic and skittish people who will not hesitate to abandon their obligations if the need arises, so the macroprudential fan argues the banks just need to find debtors who can be ‘relied’ on to swallow a nice chunk of negative equity if the need arises.

Seen this way the philosophy of Macroprudential is fundamentally flawed as a real solution for reform of the current Australian banking and monetary system.

Macroprudential is simply seeking to keep a diseased and defective model working by having the regulator direct the banks to feed its “Junk Products” to healthier victims that are more likely to tolerate their ill effects.

Private bank credit creation must be clearly and demonstrably productive.

While the Glass Pyramid is of the view that the private banks should completely lose their privileges with regard to credit creation, if those privileges are to be maintained in any form at all it should only be on the explicit condition that they are used for productive purposes.

In other words credit creation regulation must require that private bank credit creation is restricted to expanding new productive economic capacity in infrastructure, goods and services.

This must be the core criterion of credit creation regulation.

This is not the macruprudential way.

While “new” housing is productive as new housing expands the productive capacity of the evonomy, credit creation to pump up or maintain the price of existing assets to reap capital gains tax benefits fails the criterion completely.

Credit creation to create new productive economic capacity in goods and services production and infrastructure is best of all.

See this article for the Glass Pyramid’s  discussion of the difference productive investment and unproductive #fakeinvestment.

How does credit creation regulation differ from Macroprudential?

The difference is that unlike the ‘macroprudential” approach which is concerned simply with maintaining the profitability and sustainability of the private banks,  credit creation regulation would be explicitly directed to ensuring that whatever private bank credit creation is allowed is restricted to the creation of NEW productive economic capacity.

The class (health) of the borrower is not the key issue though capacity to meet thecobligations of the loan are still important.

What matters is the purpose of the credit creation and that must be productive.

If people want to borrow money to have a speculative punt on asset prices they can still do that but they cannot borrow the money from a bank.

Banks are special and have a special privilege and ensuring it is not abused – i.e. By producing Junk Food credit – should be the central job of the regulators.

The fundamental flaw in the Macroprudential concept

The worst aspect of the “macroprudential” approach is that it is not even coherent or consistent with the overall philosophy of the current monetary model where in theory ALL credit creation decisions can be left “to the market”.   This ideology holds that monetary policy should be king and the banks can be left to “allocate capital / created money” to the most valuable purpose.

The role of a regulator like APRA in this ‘model’ is limited to a ‘prudential’ role. Just to keep an eye on things and make sure the banks don’t go mad and go broke.  But even that is not supposed to happen because ‘in theory’ it is not in the banks interests to destroy shareholder capital.

In simple terms the current banking and monetary model which was hatched in the 1980s and given its full set of wings by John Howard and Costello is supposed to operate perfectly fine WITHOUT an active regulator.

Which is why APRAs act/charter does not explicitly provide for any regulation of credit creation or even macroprudential – lite or otherwise.   It is also why the RBA and APRA denied for years that there is any role for “macroprudential” regulation and have been dragged kicking and screaming to an acceptance that they might have a macroprudential role to direct the banks to sell more “junk” credit to healthier folk rather than manic speculators chasing tax freebies.

This is not an accident or oversight.

The whole premise of monetary policy / private bank credit creation at the core of the economy is that  ‘the market’ is the best way of determining credit creation and it should be independent from government regulators like APRA and RBA. Apart from some ‘prudential’ supervision.

When you keep in mind that bank credit is effectively public money the connection between the monetary policy as king and tight fiscal policy / small government / balanced budget mania is clear.  It is all just neoliberal wealth concentrating asset price pumping mumbo jumbo as public policy.

Unfortunately the theory proved to be wrong.

As 30 years of asset price bubbles has demonstrated.

So even if the macroprudential fans are right and it might be possible to ‘fix’ some of our banking problems by just making some tweaks, the current regulatory regime is not designed for even that level of regulation and will resist the ‘tweaking’.

In any event at the very least APRA should be announcing any and all of its tweaks to credit creation regulation in the same way as the RBA announces changes to the target interest rate each month.

No more APRA “secret business”.

Fixing the flaw

While abolishing the private bank credit creation privilege is the best option, if some people prefer to retain some private bank credit creation the following points are important.

  • The governing objective for private bank credit creation should be that the credit is created for productive purposes only
  • Macroprudential policy is not true credit creation regulation as it does not imply a criterion of only productive credit creation. Macroprudential only aims to keep private banks operational by making sure they sell their “Junk Food” credit products to people less likely to default.
  • The existing regulators APRA and the RBA are simply not designed to regulate private bank credit creation.
  • To change the role of the existing regulators APRA and RBA is not just a ‘tweak’ it involves a fundamental change to their philosophy and the legislation and regulations governing their operations.
  • Such a change requires public debate and a Royal Commission is a good way to start that debate.

Real economic reform starts with a Banking Royal Commission

What a week it has been.

The Prime Minister Malcolm Turnbull and the Treasurer Scott Morrison have been dragged kicking and screaming by the public, the opposition and even members of their own Liberal Party / National Party coalition into having a Royal Commission into their Australian Banking “mates”.

There has been an air of pandemonium as the Banking industry and their “special friends” in politics and the media have run multiple scare campaigns and threatened the end of life as we know it … unless we back off.

“..“Australia is capital hungry, and when the capital is gone our economy has a very good chance of going into some form of economic collapse.”.

If nothing else this attempt by the Bankers to create an atmosphere of panic and fear makes the point how insane the role of private banks in our monetary system has become.

A Royal Commission into Australian Banking is NOT an “inquisition into capitalism” or “Rank socialism“.

It should be nothing more than a thorough inquiry into why our banking system is so dysfunctional, bloated, greedy, powerful, sneaky, dodgy and incompetent and why the period of deregulation of Australian banking since the 1980s has produced record levels of household debt and an economy that is now hooked on using foreign debt and liabilities to speculate on the prices of houses and land rather than investing in productive industries.

What do private banks do anyway?

Listening to the Bankers this week and their political minions anyone might think that bankers hold up the sky, bring the rains, increase fertility of farm animals and sprinkle Australia with gold dust.

That is complete nonsense.

To the extent they are able to make threats and try to hold the Australian public and economy hostage it is only because they have been given an important role in our monetary system.

A role they have systematically abused time and time again.

And not for the first time either – the last time that the Bankers made a mess of things in the Great Depression there was a Royal Commission. (Click here to read about the last Royal Commission into Banking in 1937)

The obvious solution when someone has been given a privilege and abused that privilege is to take it away and that is exactly what the Royal Commission should recommend we do.

The Royal Commission should investigate the current role of the private banks in our monetary system, explain that role to the general public and show how it:

  • has been abused,
  • is dysfunctional,
  • is out of date
  • is unecessary

and then recommend that the banks lose that role and their privilege as soon as possible.

This is NOT an attack on capitalism or rank socialism it is nothing more than fixing a part of our free and democratic economic system that is BROKEN and needs reform.

This is about fixing our market economy so that it works better and is more productive and less infested with debt driven speculation. In a competitive world we simply cannot afford to stick with a model that is out of date.

There is nothing natural about the role of private banks in our monetary system.   It is defective and has been tolerated for too long.

Now is the time to fix the problem.

Do we need banks for investment or to buy a home?

If there was some practical need to have “banks” to ensure that business could obtain funds for investment or for home owners to buy a home then it might be necessary to tolerate their bad behaviour (when the regulators fail to stop them).

We certainly need smart and capable organisations who can evaluate productive investment projects and issue invitations to potential investors to subscribe to those opportunities.

We also need organisations that can connect people who wish to borrow to build or buy a home with people who wish to lend money to them.

These are vital services in our economy but we sure don’t need banks to provide those investment services.  Everyday private individuals, private and public companies, investment companies, insurance companies, superannuation funds are providing those services very effectively and they will continue to do so.

  • Companies raise funds by selling shares to shareholders or bonds to investors
  • Superannuation companies are making investments every day of the week to secure returns for their members retirements
  • Insurance companies are making investments to ensure they have enough funds available to pay when policy holders make claims
  • Investment companies are raising funds from investors to lend to home buyers

The banks are lazy, sloppy ineffective, greedy, incompetent mutant ‘pseudo’ investment companies that ONLY survive because of their totally inappropriate privileged role in the monetary system and their ability to ‘protect’ their income streams by pumping asset prices with an effective taxpayer guarantee.

Do we need banks to save or to spend money?

Not now.

Once upon a time, in the days before EFTPOS and Tap and Pay and electronic funds transfer it was critical to have a network of bank branches where people could go and withdraw money and manage their savings.

This was the key rationale for allowing private banks to have a role in our monetary system.   They were given a privilege and in return they provided a branch system, deposit/saving accounts and a payments system.

Most people now rarely enter a bank branch.  If they do they are likely to also have saving accounts with purely online banks that have no branches at all – for example – IngDirect, UBank, RaboDirect.

We certainly still need a saving/deposit account system and an electronic payments system but we don’t need “banks” to operate it.    We need companies that specialise in providing those services and ONLY those services.

What is the bankers “privilege”?

So what is the bankers privilege?

What is it that we gave them and should now be withdraw?

In very simple terms it is that we treat an IOU (promise to pay) issued by a banker as though it was issued by the public.   In effect this means that the private banks have a license (or franchise) to create something equivalent to public money.

No other company or individual has this privilege.

Needless to say if anyone today was to propose treating the promises to pay, of someone other than the government, as though they were money issued by the government they would be laughed out of the room.

Why would we do that when the government is perfectly capable of creating as much money as we could possibly need?

It is in effect a privatisation of the public power over public money.

Clearly this privilege to ‘create’ something that is effectively public money is a very powerful privilege and that is why we have APRA, ASIC and the RBA watching the private banks closely and require the banks meet capital adequacy rules and ‘stress tests’.

But regulating private organisations with this power is not easy.

The privilege, and the central role in the monetary system it gives the banks, makes it very easy for them to make very fat profits which they can then use to:

  • Offer jobs and well paid seats on boards to retired politicians. This helps to encourage politicians to ‘be nice’ to banks while they are still running the country.
  • Offer jobs and well paid seats on boards to retired regulators. This helps ensure that regulators still working as regulators think about their possible ‘career options’ when they retire from public service.
  • Pay armies of spin doctors and public relation people to promote their interests
  • Run expensive TV campaigns to create the impression that they are a fundamental part of the Australian cultural landscape
  • Sponsor lots of “feel good” things like spot and community organisations to build support
  • Pay for expensive ads in major newspapers that exert a subtle pressure on editors when considering how to “cover” bank industry issues.
  • Launch massive fear campaigns in newspapers when anyone suggests an Inquiry into the role of private banks in the Australian monetary system

You can buy a lot of propaganda and influence when you have been given a franchise to effectively create public money and operate the core machinery of the financial system.

ROYAL COMMISSION – DRAFT TERMS OF REFERENCE

It is no surprise that the Draft Terms of Reference issued by the reluctant Malcolm Turnbull and Scott Morrison specifically avoid any investigation of the role of the private banks in the Australian monetary system.

“..5.    The Commission is not required to inquire into, and may not make recommendations in relation to macro-prudential policy, regulation or oversight…

Macro-prudential policy and regulation means policy and regulation, including as to the structure, role  and purpose of financial regulators, that is concerned with containing systemic risk, which can have widespread implications for the financial system as a whole, beyond simply the banking system. “

They don’t want a proper inquiry into the role of the private banks.

They just want some window dressing inquiry that looks like they have done something. Something that may address a few of the symptoms but does NOTHING to cure the fundamental problem

A PROPER ROYAL COMMISSION

A proper Royal Commission that really looks at the problems with the Australian private banks should focus on the following:

Fundamental Issue

1.     What is the current role of private banks in our monetary system.

2.     What is the appropriate role, if any, of private banks in our monetary system.

3.     What are the reforms that are required to give effect to the appropriate role.

Symptoms of the problem.

The Royal Commission should also spend a considerable amount of time hearing from the victims, giving them a voice and investigating the many symptoms of the current broken and dysfunctional role of private banks in our monetary system including the following:

  • Financial planning scandals
  • Life insurance scandals
  • Sub-prime lending
  • Low doc lending
  • Rigging rates
  • Over charging fees
  • International money laundering
  • Control fraud
  • Asset price pumping
  • The legislation and regulations concerning the role of APRA
  • The legislation and regulations concerning the role of the RBA
  • The legislation and regulations concerning the role of ASIC
  • The failures, if any, of the regulators to discharge their responsibilities under the legislation and regulations.

The inquiry could be over in 12 months and the report could almost be written right now.

WHAT SHOULD THE ROYAL COMMISSION RECOMMEND?

The recommendations that the Royal Commissioners should make are straight forward:

Recommendation 1

The current role of the private banks in the Australian monetary system is a relic of the 19th and early 20th century and requires immediate reform.

Recommendation 2

The IOUs/credit issued by private banks should lose their privileged status and should be treated no different to the credit issued by any other private organisation or individual.

Recommendation 3

Each private bank will be required to create a deposit/savings subsidiary that will only offer deposit and savings accounts and access to the electronic payments and transfers system.

These subsidiaries will not offer any loans and will be completely independent of the banks that establish them.

Recommendation 4

Having regard to the importance of a low cost, fully guaranteed and secure system of deposit/savings accounts to all Australian citizens the government should give consideration to:

  • Subsidising some or all of the services offered by the specialist deposit/saving account companies
  • Encouraging the formation of “not for profit” organisations to enter the market for offering deposit/saving account and payment systems services to the public
  • Establishing a public organisation or extending the role of an existing public organisation (e.g. Australia Post) to offer deposit/saving account and payment system services to the public.

Recommendation 5

The remaining operations of the private banks will be conducted on the same basis as any other private investment company.

They will be required to raise the funds required for investment from investors and they will make investments on terms that are consistent with the terms on which the investors subscribed to the investment.

They will not be allowed to offer “at call” deposit accounts.

Recommendation 6

Having regard to the importance of investment in projects that expand the productive capacity of the Australian economy the Government should give consideration to making investments via the investment sector to projects that have been investigated and clearly demonstrate a high probability that they will result in an expansion of the productive capacity of the Australian economy.

Recommendation 7

The objectives of economic policy will continue to be low inflation and full employment.

It is time for the dawn of a new era for the Australian monetary system

Banker Panic ! Why a Royal Commission is so important.

What a week it has been.

The Prime Minister Malcolm Turnbull and the Treasurer Scott Morrison have been dragged kicking and screaming by the public, the opposition and even members of their own Liberal Party / National Party coalition into having a Royal Commission into their Australian Banking “mates”. Continue reading