Category: Economy

Analysis of the global economy

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The Chicago Plan (1939)

The 1939 proposal — A PROGRAM FOR MONETARY REFORM — by a group of eminent economists, including Irving Fisher, became known as the “Chicago Plan” after its chief proponent, professor Henry Simons from the University of Chicago. The core proposal is to require banks to hold 100% reserves against demand deposits1, ending the fractional reserve banking system and making the monetary authority (the Fed) solely responsible for creation of new money. This extract describes major features of the plan:

Lending Under the 100% Reserve System
The 100% reserve requirement would, in effect, completely separate from banking the power to issue money. The two are now disastrously interdependent. Banking would become wholly a business of lending and investing pre-existing money. The banks would no longer be concerned with creating the money they lend or invest, though they would still continue to be the chief agencies for handling and clearing checking accounts.

Under the present fractional reserve system, if any actual money is deposited in a checking account, the bank has the right to lend it out as belonging to the bank and not to the depositor. The legal title to the money rests, indeed, in the bank. Under the 100% system, on the other hand, the depositor who had a checking account (i.e., a demand deposit) would own the money which he had on deposit in the bank; the bank would simply hold the money in trust for the depositor who had title to it. As regards time or savings deposits, on the other hand, the situation would, under the 100% system, remain essentially as it is today. Once a depositor had brought his money to the bank to be added to his time deposit or savings account, he could no longer use it as money. It would now belong to the bank, which could lend it out as its own money, while the depositor would hold a claim against the bank. The amount, in fact, ought no longer to be called a “deposit”. Actually it would be a loan to the bank.

Now let us see how, under the 100% system, the banks would be able to make loans, even though they could no longer use their customers’ demand deposits for that purpose.

There would be three sources of loanable funds. The first would be in the repayments to the banks of existing loans of circulating medium largely created by the banks in the past. Such repayments would release to the banks more cash than they would need to maintain 100% reserve behind demand deposits; and this “free” cash they would be able to lend out again. The banks would, therefore, suffer no contraction in their present volume of loans…..

The second sources of loans would be the banks own funds, capital, surplus, and undivided profits which might be increased from time to time by the sale of new bank stock.

The third source of loans would be new savings “deposited” in savings accounts or otherwise borrowed by the banks. That is, the banks would accept as time or savings deposits the savings of the community and lend such funds out again to those who could put them to advantageous use. In this manner, the banks might add without restraint to their savings, or time, deposits, but not to the total of their demand deposits and cash.

However, there would, of course, be a continuous moving of demand deposits from one bank to another, from one depositor to another and from demand deposits into cash and vice versa. To increase the total circulating medium would, nevertheless be the function of the Monetary Authority exclusively.

via A Program For Monetary Reform (pdf)

  1. Demand deposits are bank deposits, such as checking accounts, payable on demand. Savings or time deposits are payable on maturity. An easy way to separate demand from savings/time deposits is to class any deposit that matures within 30 days as a demand deposit.
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The Chicago Plan Revisited | IMF Working Paper

There is growing interest in this IMF Working Paper by Jaromir Benes and Michael Kumhof which discusses removing the role of monetary creation from fractional-reserve banks and assigning it to Treasury. Here is a brief abstract:

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. Furthermore, output gains approach 10 percent, and steady state inflation can drop to zero without posing problems for the conduct of monetary policy…..

I believe that Fisher is right in targeting fractional-reserve banks as a major cause of instability in capitalist systems, facilitating rapid expansion of credit during booms, inevitably followed by rapid contraction during the bust. To introduce a system such as the Chicago Plan would risk an abrupt shock to the monetary system, but gradual increase of bank capital, leverage and reserve ratios could achieve the same eventual end without any noticeable side-effects.

via The Chicago Plan Revisited (pdf)

Hat tip to Ambrose Evans-Pritchard at The Telegraph.

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Australia’s Future Fiscal Shock | Centre For Independent Studies

by Robert Carling

Long-term prospects for Australia’s public finances are not receiving the attention they deserve. It is one thing for Commonwealth and state governments to balance their budgets in the short term, as they are attempting to do, but spending commitments are being made as though nothing beyond the four-year horizon of the forward estimates matters. Under current policies, Australia is heading in the long term for a substantially larger share of government spending in the economy, which will bring pressures for higher taxation or borrowing or both. Spending by governments at all levels as a proportion of gross domestic product (GDP) (currently around 36%) could rise to well above 40% over the decades ahead, if not sooner…….

via Australia’s Future Fiscal Shock (pdf).

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China’s export growth accelerated in September

by Zarathustra

China’s trade data for September show some improvement in growth. Export growth picked up to 9.9% yoy in September, up from 2.7% yoy in August, and better than consensus estimate fo 5.5% yoy…….

via China’s export growth accelerated in September.

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5 Steps Obama or Romney Must Take to Fix Wall Street

By SUZANNE MCGEE

In [Sheila Bair’s] view ….. we haven’t yet come to grips with many of the problems that produced the crisis.

Too many regulators fall victim to one of several fatal flaws, Bair suggested in a speech to the National Association for Business Economics yesterday. Some of them over or under-regulate (usually at the wrong point in the cycle); they devise impossibly complex rules; they are “closet free-marketeers” proposing convoluted rules to prove it’s impossible to regulate financial institutions, or they are “captive” regulators who, without any corruption or malfeasance involved, have simply subordinated their judgment to those of the organizations they are charged with overseeing.

The former chair of the Federal Deposit Insurance Corporation suggests five steps that presidential candidates should take to fix Wall Street………

via 5 Steps Obama or Romney Must Take to Fix Wall Street.

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The United States Is Not Europe and Texas Ain't France

Extract from remarks by Richard W. Fisher, President of the Dallas Fed, before the Cato Institute:

….Under both Republican and Democratic leadership, we did what was economically sensible. The result was a long-lived expansion. But it ended in tears. Success led to complacency; complacency led to a tolerance and even encouragement of excess. We spent more than we could afford; our government—Republicans and Democrats alike—continued, at an accelerated pace, down the path of promising more in social programs and other spending programs than we could sustain. And on the regulatory front, we turned a collective blind eye to economic malpractice, resulting in the spectacular failure of Enron and culminating with the collapse of megabanks for which even a cursory glance at their balance sheets would have revealed, in the words of one of my colleagues, “nothing on the right was right and nothing on the left was left.”…….

via The United States Is Not Europe and Texas Ain’t France: America as the Thoroughbred Economy – Dallas Fed.

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Fed Governor Daniel Tarullo Calls for Cap on Bank Size – WSJ.com

By VICTORIA MCGRANE And ALAN ZIBEL:

“In a Philadelphia speech, Fed governor Daniel Tarullo recommended curbing banks’ growth by putting a limit on their nondeposit liabilities, which are sources of funding for operations that go beyond consumer deposits. The idea takes direct aim at the biggest U.S. banks, including J.P. Morgan Chase & Co., Bank of America Corp., Goldman Sachs and Citigroup Inc., all of which rely heavily on such funding. Firms outside of this tier make much greater use of regular deposits…..”

Comment:~ Rather than placing a fixed size limit on too-big-to-fail banks, it may be more effective to raise capital adequacy ratios and/or leverage ratios for banks above a certain size — to discourage further growth. There may well be advantages, such as economies of scale, that enable large banks to deliver better pricing to their customers — and justify their size — but we need to guard against systemic risks. Rather than setting a size limit, higher ratios would ensure that large banks are well capitalized to withstand systemic shocks.

via Fed Governor Daniel Tarullo Calls for Cap on Bank Size – WSJ.com.

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The unemployment surprise

Headline unemployment may be falling but this extract from John Mauldin summarises the US predicament:

We are employing almost 5% fewer people as a percentage of our population than we were at the beginning of 2008. That means our real unemployment-to-population level is well over 12%. So we’re not even close to where we were in 1999, during the last year of the Clinton administration. And that doesn’t take into account the 50% of college graduates who are underemployed. A significant part of the problem is simply the fact that we are trying to recover from a deleveraging recession. The data suggests that such recoveries may take 10 years. For Japan it is more than 20 years, and counting.

The unemployment surprise (pdf).

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IMF: Coping with high debt and sluggish growth [video]

The World Economic Outlook (WEO) presents the IMF staff’s analysis and projections of economic developments at the global level, in major country groups (classified by region, stage of development, etc.), and in many individual countries.

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[time: 38 minutes]

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IMF downgrades world outlook [video]

Chief economist Oliver Blanchard on the IMF’s latest forecast.

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  • IMF revises forecast down, global growth projected at 3.3 percent this year
  • World trade slumps, hurting emerging markets, developing countries
  • Prospects could improve if clouds over euro area, U.S. “fiscal cliff” are lifted

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