Guest Post: Curbing the Credit Cycle

By David Aikman, Andrew G Haldane, and Benjamin Nelson; cross posted from VoxEU

Credit booms sow the seeds of subsequent credit crunches. This column argues that these have their source in cross-bank externalities. To internalise these cross-sectional spillovers, policy should operate “across the system”. It adds that this is the essence of macro-prudential policy, which, for the first time is about to be undertaken internationally.

Credit lies at the heart of crises. Credit booms sow the seeds of subsequent credit crunches. This is a key lesson of past financial crashes, manias and panics (See e.g. Minsky 1986, Kindleberger 1978, and Reinhart and Rogoff 2009). It was a lesson painfully re-taught to policymakers during the most recent financial crisis.

In response, there have been widespread calls for remedial policy action. Evaluating the merits of these proposals requires a conceptual understanding of the causes of the credit cycle and an empirical quantification of its dynamic behaviour. What is the underlying friction generating credit booms and busts? Are credit cycles distinct from cycles in the real economy? And how have they evolved, both over time and across countries? Answers to these questions should help frame public policy choices for curbing the credit cycle.

One source of credit market friction arises from coordination failures among lenders (see for example Gorton and He 2008). In these models, banks are heterogeneous and their behaviour strategic. The individually rational actions of heterogeneous lenders can generate collectively sub-optimal credit provision in both the upswing (a credit boom) and the downswing (a credit crunch). This is a collective action, or co-ordination, problem among banks.

In credit markets, these co-ordination failures are far from new. Keynes memorably noted:

“A sound banker, alas, is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional and orthodox way with his fellows, so that no one can really blame him” (Keynes 1931).

Eighty years later, Chuck Prince, then-CEO of Citibank, captured the collective action problem thus:

“As long as the music is playing, you’ve got to get up and dance. We’re still dancing”

As Prince’s quote attests, these incentives were a key driver of risk-taking behaviour in the run-up to the crisis. In the face of stiffening competition, banks were increasingly required to keep pace with the returns on equity offered by their rivals – a case not so much of “keeping up with the Joneses” as “keeping up with the Goldmans”. To achieve these higher returns, it was individually rational for banks to increase their risk profiles in various ways (Alessandri and Haldane 2009).

Keeping up with the Goldmans

In recent research (Aikman et al. 2011), we develop a simple model, building on Rajan (1994) and Morris and Shin (2002), in which risk taking is driven by reputational concerns in a world of imperfect information. Bankers care about their future job prospects, which depend in part on their current reputations as assessed by the market. But the market has incomplete information about a banker’s underlying ability. Instead, ability is inferred by the market through announced returns.

As fundamentals improve, high-ability banks are more likely to achieve high returns than low-ability banks. So posting low returns in the boom is particularly damaging to reputation as this constitutes a clearer signal of low ability. This strongly incentivises excessive risk taking to boost short term returns as fundamentals improve. This dynamic sows the seeds for procyclical variation in risk taking and contributes to the generation of a credit cycle. The medium-term implications of short-term excessive risk taking are an eventual crystallisation of large scale losses together with widespread financial distress.

What are the empirical implications of our model?

  • First, strategic complementarities incentivise banks to adopt risky strategies in a coordinated fashion during the boom. So the dynamics of the model predict that we should observe cycles in financial activity at a macroeconomic level. Initial productivity improvements are amplified into lending booms, which are followed by credit busts and, potentially, crises.
  • Second, at a microeconomic level, the coordination of risky strategies during the boom should compress the dispersion of bank earnings, as low ability banks masquerade as high ability banks during good times. But during the bust, when the macro state turns bad, the dispersion of banks’ earnings should increase as low ability types crystallise losses while high ability types do not.

At the macro level, we document the existence of strong cyclical variation in real credit for a sample of 12 developed countries collected by Schularick and Taylor (2009). These cyclical fluctuations over the medium term (with a duration of 8-20 years) are not only statistically significant, but also strongly associated with the incidence of financial stress. The cycle we identify for the UK is shown in Figure 1. Not only is the duration of the cycle in real credit different from the business cycle, so too is its amplitude – around twice that of GDP in the medium term and roughly five times that of GDP at conventional business cycle frequencies. Cycles in asset prices are even greater in amplitude.

Figure 1. Medium-term fluctuations in real credit and real GDP, UK, 1880-2008.

Source: authors’ calculations

At the micro level, Figure 2 plots a time series of the cross-sectional dispersion of equity returns for major UK banks, alongside dispersion for the top 100 Private Non-Financial Companies (PNFCs). Measures of return dispersion are consistently and statistically significantly lower for banks than for non-banks. And dispersion tended to fall over the long credit boom during this century. Measures of equity return dispersion hit all-time lows at the height of the recent credit boom in 2006-2007, before exploding in 2008.

Figure 2. Cross sectional dispersion of equity returns of major UK banks and top 100 UK Private Non-Financial Companies (by market cap)

Source: CapitalIQ and authors’ calculations.

We also examined return patterns among the largest global banking and non-financial firms. The pattern is the same. We observe a compression of returns during credit booms and a dispersion in busts, with the cyclicality becoming more marked through time. This suggests an increase in the degree of coordination of global banks’ activities after the financial liberalisation of the 1980s, indicating that credit cycles may have become increasingly synchronous globally.

Pair-wise correlations between 12 advanced countries’ medium-term credit cycles for two post-war sub-samples, 1945-79 and 1980-2008, confirm that impression (Figure 3). A shift to the right of the cumulative distribution indicates an increase in the degree of cross-country correlation.

Figure 3. Cumulative distribution function of cross-country correlations of credit cycles

Source: authors’ calculations

Policy implications

Individual banks may fail to internalise the reputational externalities their lending actions impose on others. The result is a periodic tidal wave of credit during the boom followed by protracted credit drought during the crunch. Chuck Prince’s disco inferno causes murder on the dance floor. These credit cycle externalities provide justification for state intervention to help coordinate lending expectations and actions by banks.

One means of curbing credit cycle frictions might be through monetary policy – either by ensuring it moderates appropriately the business cycle (Taylor 2010) or, more ambitiously, by having it play a wider role in curtailing financial imbalances (Borio and White 2004). The evidence we present is not especially encouraging on that front. The frequency and amplitude of the business and credit cycles is quite different. Monetary policy may be an inefficient tool for calming the credit cycle, if at the same time it is to moderate the business cycle.

Micro-prudential policy, aimed at tackling financial imbalances in individual financial institutions, may also be ineffective for dealing with aggregate credit cycles. That is because bank-specific actions will not, by themselves, internalise the spillovers that arise across banks over the credit cycle. They may even worsen them if they allow individual banks to steal a reputational march over their competitors.

This coordination problem suggests systematic, across-the-system actions are needed to curtail effectively credit booms and busts. This is one dimension of macro-prudential policy. To be effective, these policies need to increase the long-term cost of credit extension to banks during booms and, as importantly, to lower these costs during busts. These actions would help smooth out credit supply over the cycle. There are a variety of macro-prudential tools which could have this effect, including pro-cyclical capital and liquidity requirements, or remuneration packages that tie individual earnings more closely to long term performance (Bank of England 2009, Kashyap et al. 2010, G30 2010).

Credit spillovers occur across borders as well as across banks. This suggests macro-prudential policies need also to have an international dimension if they are to tackle credit externalities. This is recognised in the macro-prudential policy framework currently being discussed by the international regulatory community (BIS 2010). For example, judgements on local credit conditions determine the amounts of capital to be held by international banks on their exposures in those countries. This reciprocity feature should help to reduce the arbitrage risks posed by the internationalisation of the credit cycle.

The state of macro-prudential policy today has many similarities with the state of monetary policy just after the Second World War. Data is incomplete, theory patchy, policy experience negligible. Monetary policy then was conducted by trial and error. The same will be true of macro-prudential policy now. Mistakes will be made. But as experience with the other arms of macroeconomic policy, as well as during the credit crunch, has taught us, the biggest mistake would be not to try.

The views expressed are the authors’; not necessarily those of the Bank of England.

References

Aikman, David, Andrew G Haldane, and Benjamin Nelson (2011), “Microfoundations for modern macroeconomics”, March.

Alessandri, P and AG Haldane (2009), “Banking on the State”, Bank of England.

Bank of England (2009), “The Role of Macroprudential Policy – A Discussion Paper”.

BIS (2010), “Countercyclical Capital Buffer Proposal – Consultative Document”, Basel Committee on Banking Supervision, Bank for International Settlements.

Borio, C and WR White (2004), “Whither Monetary and Financial Stability? The Implications of Evolving Policy Regimes”, Bank for International Settlements Working Papers 147.

Gorton, G and P He (2008), “Bank Credit Cycles”, Review of Economic Studies 75(4): 1181-1214.

Group of Thirty (2010), Enhancing Financial Stability and Resilience: Macroprudential Policy, Tools, and Systems for the Future.

Kashyap, AK, JC Stein, and S Hanson (2010), “A Macroprudential Approach to Financial Regulation”, Forthcoming in Journal of Economic Perspectives.

Keynes, JM (1931), “The Consequences to the Banks of the Collapse of Money Values”, Essays in Persuasion, Macmillan Publishers.

Kindleberger, CP (1978), Manias, Panics and Crashes: A History of Financial Crises, Palgrave Macmillan.

Minsky, HP (1986), Stabilizing an Unstable Economy, Yale University Press.

Morris, S and HS Shin (2003), “Global Games: Theory and Applications”, Advances in Economics and Econometrics (Proceedings of the Eighth World Congress of the Econometric Society), Cambridge University Press.

Rajan, RG (1994), “Why Bank Credit Policies Fluctuate: A Theory and Some Evidence”, Quarterly Journal of Economics 109(2):399-441.

Reinhart, CM and KS Rogoff (2009), This Time is Different: Eight Centuries of Financial Folly, Princeton University Press.

Schularick, M and AM Taylor (2009), “Credit Booms Gone Bust: Monetary Policy, Levrage Cycles and Financial Crises, 1970-2008”, NBER Working Paper Series 15512.

Taylor, J (2010), “Commentary: Monetary Policy After the Fall”, Presentation at the Symposium “Macroeconomic Challenges: The Decade Ahead”, Jackson Hole.

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44 comments

  1. F. Beard

    Gee wiz guys. It has been 317 years since the BOE was founded and you still can’t make fictional reserve banking work properly? Could it be that a money model conceived in fraud (“Your money is available on demand even though we lent it out”) and based on theft of purchasing power via money creation from all money holders including and especially from the poor CANNOT be made stable?

    And quite apart from that is the problem of usury which requires exponential growth to pay the compound interest.

    Face it, conventional money is a dead end street. If we ever truly abolish the government enforced monopoly money supply for private debts then other money alternatives could be tried including those that do not require fractional reserves or even usury.

    The issue which has swept down the centuries and which will have to be fought sooner or later is the people versus the banks. Lord Acton

    1. Andrew Bissell

      Ready money is a most valuable thing; it cannot from its very essence bear interest — every one is therefore constantly endeavouring to make it profitable, and at the same time to make it retain its use as ready money, which is simply impossible. Turn it into whatever shape you please, it can never be made into more real capital than is due to its own intrinsic value, and it is the constant attempt to perform this miracle which leads to all sorts of confusion with respect to credit.

      The Bank of England has been long expected to assist in performing this miracle; and it is the attempt to force the Bank to do so which has led to the greater number of the difficulties which have occurred on every occasion of monetary panics during the last twenty years.

      *The Economist* newspaper [i.e. Walter Bagehot] has put forth what, in my opinion, is the most mischievous doctrine ever broached in the monetary or Banking world in this country; viz., that it is the proper functions of the Bank of England to keep money available at all times to supply the demands of Bankers who have rendered their own assets unavailable. Until such a doctrine is repudiated by the Banking interest, the difficulty of pursuing any sound principle of Banking in London will be always very great.

      -Thomson Hankey, The Principles of Banking, Its Utility and Economy, 1867

      1. Paul Repstock

        LOL: “Until such a doctrine is repudiated by the Banking interest,..”

        Why ever would they repudiate their best weapon?

    2. Eine Flugverbotszone


      usury which requires exponential growth to pay the compound interest.

      Face it, conventional money

      ~~F. Beard~

      Assuming a constant and strong rate of deflation, interest on savings accounts would be unnecessary. The depositor in such a situation would have nominal-break-even but a real return-on-savings equal to the rate of deflation. Such an incentive to save would motivate both the bank-depositor and the under-mattress-depositor to forgo consumption thus prevent bidding up of prices thus prevent pain of inflation. Is deflation the natural history of economics untampered by politicians who over-print legal tender? With constant shrinking of money supply frugal habits would be investment enough without the need for investment banks, financial analysts and a host of other parasitic operators. Do certain religions forbid charging interest? Forbid paying interest? No problem! Don’t deposit. Just keep the money in your pocket. It buys more every year with the magic of deflation.

      Who needs inflation? Ponzi Players and scam artists need inflation. Politicians need inflation so that they can increase tax revenues each year. Rent seekers need inflation. The economy works better on deflation. The saw-mills on Main Street want deflation. Only bankers and gamblers need inflation.

      You are my people, Populace.

      Start thinking, People
      !

          1. Paul Repstock

            Not, “actual money deflation ‘would be’ a nightmare.”

            Actual money deflation, “IS” a nightmare!
            I think the real supply of money is shrinking. As money concentrates in fewer and fewer hands, it is converted to fixedassets by the purchase of these assets at lower and lower prices (because there is more demand for money/less supply people are selling what they have just for taxes and subsistence). The tax portion is skimmed off the top continuously. When this is combined with the shrinking value of the dollar relative to other currencies, you are left with people who are captive to US goods, wherein supply is controlled, both by design and by global econonic forces.

          2. Paul Repstock

            This is compounded by the government’s rejection of real stimulus spending and by tendancies to cutting wages as seen in Wisconsin. And also seen in the recent threats to social security.

            Dr Koo’s analyis was very good.
            http://www.themonthly.com.au/world-economic-outlook-richard-koo-3085

            The fact is that the government does not “save money” by cutting costs, because it’s revenues shrink. Cutting costs only widens the wealth gap. Cutting costs has a “Negative Multiplier”, specially in a recessionary economy. Where stimulus spending in infrastructure is a one/two punch. Again specially in a ressesion. The economy gains from the strong positive multiplier, and tax revenues increase just as much. On top of that, good infrastructure positions the country for future growth.

            I say this, fully believing that it is no part of the agenda.

  2. Foppe

    But why do credit booms occur? One answer is of course because the banks are allowed to extend it. But what’s the other? The question I would like to have an answer to is how large of a role is played by the fact that there simply aren’t any safer investment/’growth’ opportunities available? And assuming this is a primary cause, how are we going to deal with that, given the fact that the total supply of money the world over hasn’t appreciably decreased, and is in fact still increasing?

    1. F. Beard

      The question I would like to have an answer to is how large of a role is played by the fact that there simply aren’t any safer investment/’growth’ opportunities available? Foppe

      Fictional reserve banking fouls its own nest. It cheats savers of honest interest rates (theft) and drives borrowers into speculation and debt that is non-serviceable during the bust.

      And assuming this is a primary cause, how are we going to deal with that, given the fact that the total supply of money the world over hasn’t appreciably decreased, and is in fact still increasing? Foppe

      Should we ever practice genuine capitalism in the US then we can expect that:

      1) We shall attract the best capital (talent) here.
      2) Labor relations would be peaceful.
      3) The need for socialism would “wither away”.
      4) many other good things?

      Furthermore, since large scale usury is probably untenable without governemnt support for it then we can expect the blessing in Deuteronomy 23:19-20 should we ever have true liberty wrt money creation.

      1. Mighty Booosh

        And a pony who poops gold nuggets?

        There is no magic stasis point, no magical equilibrium at which this fantasy can exist. Ever. Fractional reserve banking is part of a financial ecosystem that may stay in broad balance but can be easily perturbed through a variety of means. Currently we are in the corruption and denial phase of disequilibration of the economy. The reform movement will start soon or the collapse to lower organizational state will begin, but the fundamental definition of the universe described above cannot exist. Greenspan has already demonstrated the failure of Candyland (libertarian, Objectivist, Paulist) capitalism.
        Candyland Capitalism depends, like revolutionary communism’s New Socialist Man and the German NASDAP man, upon real people who are not perfect and do not match naive models of behavior. There is no perfect rational actor, no perfect free flow of information. Like Hayek, and Marx, and Engels, and Friedman, failure to take the real world on its own terms and accept it. Our system has evolved into this niche and it will either continue to evolve, perhaps into a dead end, or not continue.

        1. F. Beard

          Greenspan has already demonstrated the failure of Candyland (libertarian, Objectivist, Paulist) capitalism.Mighty Booosh

          Greenspan is at best a clown to imply that a government backed fractional reserve banking cartel using a government enforced monopoly money is libertarian. That is absurd on its face.

          But also it is possible that Greenspan, to bring about his beloved (and fascist) government enforced gold standard, deliberately wrecked the current system.

          1. F. Beard

            Not that it would not have wrecked itself anyway.

            So I’ll have to go with the clown hypothesis as more probable.

          2. Paul Repstock

            F.Beard wrote, “But also it is possible that Greenspan, to bring about his beloved (and fascist) government enforced gold standard, deliberately wrecked the current system.”

            This is an ugly possibility that some of us have considered for a while. But, do not think that Mr Greenspan acted alone.

            One other thing I think many of us implicitly understand, (even if we don’t necessarily like it), is that the economy cannot function in a stable mode for very long. And that the greater the effort to manage and contain it, the more extreme it’s eventual break out will be.

    1. Yves Smith

      The Bank of England has actually been extremely critical and is pushing hard to break up banks along commercial v. investment bank lines. That policy is on the table right now and this epic battle is getting NO coverage in the US media. It might as well be censored.

    2. Another Gordon

      The difficulty is, as Yves says, not with the BoE but the politicians (how surprising!!!). The Conservative party now gets more than half its funding from the City which makes it, if not a wholly-owned subsidiary, a controlled entity in terms of any Companies Act or HMRC rules.

      http://www.bbc.co.uk/news/uk-politics-12401049

      1. F. Beard

        The difficulty is, as Yves says, not with the BoE but the politicians (how surprising!!!). Another Gordon

        At least partially true, but the BoE is probably attempting to save itself with a PARTIAL repentance.

  3. Jim the Skeptic

    Of course the boom part of the cycle could not be caused by some borrowers being woefully ignorant of the consequences of taking out certain types of loans.

    Or that it could not be caused by bankers being so woefully stupid as to develop underwriting standards that are seriously flawed. Or so woefully stupid as to accept some assumption as holy writ when it it nothing but flawed logic. (Only tiny percentages of homeowners ever default on their mortgages, which is true with the correct underwriting standards but is not true otherwise.)

    No, mistakes are never a major factor in our economy! Sure.

    Some of you may know that John A Roebling designed the Brooklyn bridge. But did you know that earlier he had built a bridge across the Ohio river at Cincinnati. I think I will have a few shares for the that bridge printed up.

  4. Paul Tioxon

    http://www.clubforgrowth.org/aboutus/

    Why are there excessive demands for credit to begin with, before the credit goes boom from entering into high risk deals not considered at the beginning of the boom? Look no further than a representative of the demand for money, look at the Club for Growth, whose name says it all. Growth is unsustainable. Human beings who do not stop growing become obese, they level out at a high risk weight, which they frequently can maintain for years, after growth stops and then proceed to develop various maladies, non infectious diseases that kill us slowly over time, but usually before time would eventually take us to our final, non growth state. Increasing sales, increasing profits, increasing rates of return for all the well know categories of equity, capital, etc., ebita, ROI. All of this creates credit demand for growth, developing economic growth, smart growth and continued population growth.

    You would think by now, that all educated people know that there is a beginning, a middle and end to all things. When it comes to capitalism, such as it is today, there one and only one purpose, the endless accumulation of capital from profits. In a system that is totally devoted to the acquisition and control of money, in whatever cultural form money takes in the historical moment, credit drives growth, which drives the increase of profits, for accumulation of capital. The fact that bankers see the competition, or the benchmark for best practices for the purposes of profiting, the Goldman Sachs of the world, and emulate them in order to achieve success, is liking finding fault with a newborn who learns language by being culturally assimilated.

    Our business culture, like the larger culture that it is a part of, is learned. And, in banking, you learn the lessons of success, however it is measured, by the most successful. You do what they do. And while it is always refreshing to see complex economics reduced to dance metaphors, as in Mr Prince’s insightful quote, this is the truth of learned behavior. The banks of lesser ability, stand like awkward wallflowers, while the cool kids shake it with wild abandon. While our mothers would ask us why we feel the need to copy others, no matter how ridiculous the behavior, she would be considered part of a system wide culture of parenting that attempts to guide the young from childhood to adulthood. This would be the system wide regulation or co-ordination issue, that theoretically would keep excessive credit in check. But private enterprise, run by full grown adults, does not accept guidance outside of the corporate boardroom. The private company is not bound by the social order but by the mission of increasing shareholder value, and making a profit. The social order as a whole, even the sub-system of commerce as a whole, is not part of their concern, and when it is, only in the most diminutive of actions.

    But of course, there is no full formed ideological totality running capitalism and credit markets, such as they are. Many thousands of billionaires and corporate CEOs are at cross purposes, cross politics and are strongly competing citizens vis a vis, other nations and their business groupings. And still, we find an expressed, but not fully realized need for co-ordination. The United Nations deals with political sovereignty issues, in hope of preventing terrible military conflicts and another world war. Not much in the way of serious economic discussion for treaty negotiations goes on at the UN. There are other groups for private capital, the G_7_8 and now G_20 conferences. The WTO and of course, Davos, with the World Economic Forum, an avowed non political, meaning, non nation state outlet. The UN for the nation states and war and peace, The WEF and g20 for business and banking.

    If there were to be the kind of consequential co-ordination you seem to be requesting, your call for responsibility goes hand and hand with authority. This of course is at odds with the Club for Growth, which I use by way of example to represent the platform of demands of private capital. Authority is not contractual, but flows from the Leviathan police power of the state. It all comes down to power, on a scale of the global system of capitalism that we now live with. The nation state system and the world capitalist system are not co-extensive. In order to achieve the level of co-ordination, cross system, you have to specify which system. Only a uni-polar nation state hegemony, a world wide political empire that could enforce state police power over a global economic system, of whatever makeup, could co-ordinate such a far flung and complex economic system that we currently see. The world capitalist system runs back and forth among individual nation states, playing one against the other, in good times and war and no one has ever seriously considered creating a global empire any business on earth could escape regulation from.

    1. F. Beard

      There is nothing wrong with growth per se. However our system forces exponential growth to pay the compound interest due in the government enforced monopoly money supply. It is very much a forced game of musical chairs. One either borrows from the counterfeiting cartel or is outbid by those who do.

      This would be the system wide regulation or co-ordination issue, that theoretically would keep excessive credit in check. Paul Tioxon

      All credit creation in a government enforced monopoly money supply is THEFT. How much theft then is not excessive? The obvious answer is: None.

      1. Paul Tioxon

        Beard, are you 20 ft tall, are you 7,000 pounds, have you stopped growing? Our global population is going to continue to grow, because we are a self organizing system that has employed fossil fuels to expand the food supply, which is the basis for population and economic growth. We will stop growing when we run out the critical ingredients that allows for the growth, first and foremost, food.

        The money supply as control over the populace is only oppressive not because the government prints or enforces the use of money. It is because we are forced to turn over our total personal economic output in exchange for money, in the form of wages. It is not the government that is the problem, it is the capture of state power by a ruling elite, even in a democratically controlled republic. I do not own anything that can keep me fed, warm, healthy, safe, and cared for in my old age, other than money, which I must gain possession of by trading whatever my skillset produces to sell in an open market, to an employer or client.

        There is more money printed and now through check 21 digitally distributed, because there are more and more people. I am not sure that the concept of money as a medium is getting across to the people that want sound money, or real money or gold or whatever. What ever material cultural expression money may take is irrelevant as long as it is used to control labor in the current cash for work exchange. Money does not have to backed by anything. It is a intermediary artifact, of not much worth all by itself. Its value is the role it plays in larger system of which it is a critical component, but not the determining component.
        Whatever you propose to substantiate the legitimacy of money would then become the next target of questioning legitimacy, and so on, ad infinitum. This is what logic calls a reductio to absurdity. An infinite regression. If money is backed by gold, what backs gold? Money is a medium, not a commodity in itself. Politically, the state needs to control money to establish egalitarian social relations, not servitude in the form of wage slavery. By turning money into a commodity, it creates an internal contradiction in the form and function it plays in our economy. Since money itself is not supposed to be either a good or service, the transformation of money into a commodity called a profit, creates the expansion of money over and above actual economic output. Hence, the money that is created out of money, by declaring a profit making transaction that people have been systematically introduced into for the last several hundred years. The actual economic output has been valued as the cost of input. But how does the total cost of input increase so that someone will give you more of the actual input than they could buy from the exact same place, as the business owner? The answer is to create a system of money exchange, for everything and to ask for more money than want you spent for inputs. The profits are the theft not the government printing of money.

        1. F. Beard

          The profits are the theft not the government printing of money. Paul Tixon

          The problem is that governemnt money is de facto legal tender for private debts instead of its proper role as just legal tender for government debts. It is called the “stealth inflation tax” ( http://en.wikipedia.org/wiki/Stealth_tax ).

          As for the rest of your comment, you presume too much about my views. For instance I agree with you that commodity monies are silly.

          1. F. Beard

            As for profits being the problem, without the government backed counterfeiting cartel to borrow from, corporations would likely be forced to issue their common stock as money. Thus all money recipients would share in the profits and control of the corporation.

            The Bible hints at this too. While taking profits is condemned, profit itself is praised. Common stock companies without dividends but which used their common stock as money is apparently the ideal solution to the private money problem.

  5. Dean Sayers

    This not only closely parallels the problems in the mortgage securitization bust – but also shows that the underlying problem with these banks in the unregulated competitive process of valorization.

  6. John Doe

    F. Beard is dead on. Tweaking credit is rearranging the deck chairs of the Titanic. If we want to eliminate recessions and depressions then control of the money supply must be taken away from the private banks. Fractional reserve banking is a centuries old experiment which has failed. But the banks will react like Muammar so changing the system will not be pretty. But it is required.

    1. F. Beard

      If we want to eliminate recessions and depressions then control of the money supply must be taken away from the private banks. John Doe

      I hate to disagree with a rare supporter but the solution is actually separate government and private sector money supplies per Matthew 22:16-22. The government is force and the private sector is voluntary cooperation. The government is a blunt tool and the private sector is exquisitely adaptable. How then can they share a single money supply without distorting the private sector? They can’t seems to be the lesson of Scripture, logic, and history.

      Government money should only be legal tender for government debts (taxes and fees) else we allow government counterfeiting (the stealth inflation tax) of private money. Private monies (including PMs) should only be good for private debts else we allow private counterfeiting of government money.

      1. Paul Repstock

        Like John Doe said, “It ain’t gonna be pretty”.
        F. many of your posts and ideas have merit inspite of Christian connections which are not valid for many of us.

        However, you always tend to overlook that the present system is so entrenched and so large a part of the population is dependant upon the ‘government fiat money credit bubble’, that they will not give it up. Certainly neither the banks nor the government will peacefully allow the changes you suggest.

        1. F. Beard

          Certainly neither the banks nor the government will peacefully allow the changes you suggest. Paul Repstock

          I reckon genuine reform would demonstrate that conventional money and banks are obsolete. As for the government, assuming a parasite model, what is good for the private sector economy would be good for it too.

          As for the Biblical references, I point out that many bankers are Jewish and Christian. Call it psychological warfare if you like; others might call it “spiritual warfare”.

          But in any case, I won’t pretend that the ideas I present did not come from the Bible.

          1. Paul Repstock

            F.Beard; that was not a personal attack…Not for you either, God…:)
            There is a lot of good sense in The Good Book.

            What I meant, was that there will be such resistance to change, I don’t think it can be “reformed”. Both the Singularity and it’s enabling government, are based upon growth and aquisition. Both will like Gaddafi resist to the death. The creation of debt is their weapon, their income source, and their control mechanism.

            Only by disarming them of the ability to create and impose debt, can we ever achieve any freedom. They dare not allow that as they would loose all control and relevance.

  7. Schofield

    Well if the issue is protecting the poor bankers from Price Point then taking the money activation process away from them to place it in the hands of an institution that doesn’t have to worry about Price Point sounds to me like it will result in the old adage “As safe as the Bank of England” actually being worth something !

  8. Birch

    What a useless article. How can a thinking being talk about curbing the credit cycle without even mentioning the term “fractional reserve”? Great, lets try to patch an exploding steam boiler with duct tape! “Mistakes will be made.” Of course – because you want to make them, and make yourselves richer by them.

    Destructive credit cycles exist becaue the monetary system is a ponzi scheme: creating money from nothing, then charging interest on that which you never had in the first place – but, money was never created to cover that interest, so more is lent so we can fight amongst ourselves for the interest paymenst. After a little while, the scam grows so big that the fraud is too obvious. Then you withdraw credit and crash the system so those of us who may question must instead scramble for survival. Then the people on top buy everything up cheap and start over with even more of an upper hand.

    Destructive credit cycles have been built into the system on purpose. In fact, they are the key attribute of our monetary system. To write an article without even articulating this fact means you wish to perpetuate this criminal system.

  9. joebhed

    This IS the basic issue that SHOULD be debated among monetary system analysts, and I certainly agree with the bearded one here.

    The fundamental mechanical and mathematic problem of debt-based money – a.k.a. fractional reserve banking – was so eloquently laid out for the first time in English by German(Berlin School of Economics) Prof. Dr. Bernd Senf recently in his lecture, available here:
    blip.tv/file/4111596

    Clue, yeah, it’s the immorality of cumulative interest on all money in existence.

    We curb the credit (boom-bust) cycle with a permanent debt-free money system.
    Like we owned it.
    The Money System Common

    1. F. Beard

      We curb the credit (boom-bust) cycle with a permanent debt-free money system.
      Like we owned it.
      joebhed

      That is certainly 1/2 of the solution but it would be best to allow genuine private money alternatives also because:

      1) The gold bugs will not rest till the stealth inflation tax is abolished. If they are not allowed to escape it via genuine private money alternatives then they will insist that all money be PM based.
      2) Optimum sustainable economic growth will require them.

      1. joebhed

        Interesting.
        To me, the private role doesn’t include the creation of any money that can in any way threaten the stability of the public money system.
        The goldies can do what they want with their trinkets, and that includes selling multiple receipts of their “goldies” to trade among themselves (like they’re doing now), even internationally, but it can have no REAL relationship to our own United States Money.

        1. F. Beard

          To me, the private role doesn’t include the creation of any money that can in any way threaten the stability of the public money system. joebhed

          I agree. Private money including gold and silver should be completely unacceptable for government debts. Government should recognize only its own fiat as money.

    2. Birch

      joebhed: “The fundamental mechanical and mathematic problem of debt-based money – a.k.a. fractional reserve banking – was so eloquently laid out for the first time in English”

      The first time? Was that a grammatical slip?

      Edward Kellog and Henry George well over a hundred years ago, Frederick Soddy and Gertrude Coogan around 80 years ago, very accurately detailed the “fundamental mechanical and mathematic” problems of debt-based money. Karl Polanyi was well aware too.

      Soddy, as a sub-atomic genius, was particularly good at applying the laws of thermodynamics to economics. The sad, sad part is how hopeful he was that people were on the brink of an awakening to the fraud scam of private debt-money. Then someone dreamed up WWII and put an end to that before it started.

      We’ve known exactly what the problems are for a very long time, and many solutions have been proposed – and even successfully implemented – only to be destroyed and burried by selective history. These issues were hotly debated over a hundred years ago. The tragic workings of fractional reserve banking used to be household knowledge, before the creation of the public indoctrination system- oops, I mean ‘education’. Hell, The Wizrd of Oz is about the fight against fractional reserve banking! It used to be mainstream.

      1. joebhed

        Yes, of course, you’re right.
        George to Soddy, etc.
        I was saying that Prof. Senf has for the first time presented his work in an English-language presentation for we linguistically challenged, obviously including myself.
        I find Dr. Senf’s work picks up the fundamental, and to me unchallengeable, points of the mathematical impossibilities of debt money. I haven’t seen ANY other such work out there.
        And so we paddle around in a mess of discussion about credit-cycle problems. It’s one of those forests-for-the-trees types of mega-economic situations.
        One of its greatest points Dr. Senf makes is his personal admission that despite almost fifty years of being a prof. of economics and passing on Masters and Doctoral Thesis of the “science”, he found he has only NOW discovered how the real science of monetary economics works, or DOESN’T work to be more accurate, which was Soddy’s basic gift to us all.
        Thanks.

  10. scraping_by

    “Not only is the duration of the cycle in real credit different from the business cycle, so too is its amplitude – around twice that of GDP in the medium term and roughly five times that of GDP at conventional business cycle frequencies. Cycles in asset prices are even greater in amplitude.”

    In everyday language, there’s absolutely no connection between the level of credit and real economic activity. This is a direct contradiction to the Reagan/Bush/Clinton/Bush/Obama cover story for enrich the rich tax policy. This undercuts the justification of the bully bark of the hate radio shouters. It also wipes away fifty years of academics.

    While a certain amount of credit’s necessary, it’s only useful as much as it’s useful. This was a pretty easy insight for most people before now. However, it’s nice to have statistical evidence and passive-voice reasoning so even more of the people to conclude they’re blowing smoke up our ass.

  11. readerOfTeaLeaves

    This coordination problem suggests systematic, across-the-system actions are needed to curtail effectively credit booms and busts. This is one dimension of macro-prudential policy. To be effective, these policies need to increase the long-term cost of credit extension to banks during booms and, as importantly, to lower these costs during busts. These actions would help smooth out credit supply over the cycle. There are a variety of macro-prudential tools which could have this effect, including pro-cyclical capital and liquidity requirements, or remuneration packages that tie individual earnings more closely to long term performance (Bank of England 2009, Kashyap et al. 2010, G30 2010).

    Credit spillovers occur across borders as well as across banks.

    I listened to this post repeatedly, but I’m still not convinced that the problem originates in ‘cross bank externalities’. I can understand making a case that credit is an externality, and one way to rein it in is to bring everyone into one (international) system that can better track credit, in order to ensure that there cannot any longer be ‘cross bank externalities’.

    I think that I grasp the basic argument, but I’m apprehensive.

    For one thing, the correlations offered don’t convince me there’s causation involved. There does appear to be a relationship, and it appears to be significant. But I don’t see a trigger mechanism; obviously, the business cycle and the credit cycle are linked. But as I read this information, the two become farther and farther apart. If there was some kind of ‘boundary’ that could be identified, then that might provide more insight about a trigger that would explain causation. Perhaps I misread, but the actual cause-effect relationships are not completely clear to me.

    Even claiming that cross-bank externalities lie at the core of the ‘friction’ that leads to problems with credit cycles, I fail to see how that specifically addresses problems identified in earlier posts —
    – for instance, Fred Goodwin was busy selecting wallpaper and micromanaging a construction project while his bank was sinking due in part to credit problems; but that problem lies in the realm of social psychology rather than bank externalities (or at least, the way that I read it). Perhaps if he’d had to show how his bank’s loans were more viable than other banks, that might have reined in the mess that happened, but the proposed measures certainly don’t appear to have a whole lot of control over a rogue actor like Goodwin, nor his feckless corporate board.

    — for instance, how does the issue of ‘cross bank externalities’ really, actually work in addressing ridiculous leverage rates? Would the system say: ‘the global system has X amount of assets (fluctuating, depending on outputs, earthquakes, etc) and the **total** amount of credit available to **all** banks well be X*4, and each bank has to justify its claims on a portion of that total amount of credit’. I can see how that could work (and the sooner, the better…).

    However, this claim of ‘cross bank externalities’ does not appear, at least to this reader, to address the problem of more and more money chasing less and less value. At some point, the credit is actually fraud; but even limiting total global credit doesn’t solve that problem, necessarily.

    Also, it seems to be the term ‘bank’ gets squishy in this post. What is a bank, really? If the ‘banks’ were unable to compete with GS, yet GS offers itself as a ‘bank’, then what IS a bank? Who decides?

    As we’ve all seen in the US, one way that traders avoided having to be accountable to a larger, trackable system was to claim that ‘swaps’ were ‘not insurance’ and therefore did not have to be regulated. And IIRC, AIG or some other monster bought a little bitty savings and loan somewhere so that it could choose its regulator and be ‘regulated’ (an ironic term if one ever was used) by the OCC as a ‘thrift’. So if the objective is to bring all banks within some system by which total global credit can be tracked and divied up among ‘banks’, then it seems mighty critical to nail down anything that walks, talks, smokes, or prattles like a bank and call it a bank in order to ensure that it gets roped into this system.

    There are surely externalities involved, but I’m still not persuaded of the argument made in the post. Then again, I’m not an economist and not in finance, so there may be terms of art that got right past me. Wouldn’t be the first time…

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