The beauty of balance

May 14 2014 07:45
*Edward Ingram
LAST week we looked at IMF Working paper WP/12/2014, which discussed what is known as The Chicago Plan in which the reserve ratios of the banks is placed at 100%.

The objective of this plan is to prevent the banking system from creating too much demand on an economy by constantly lending more money out of thin air.

That is what happens when interest rates are too low for too long.

The result is that the local economy where this is taking place fails to meet the demands placed upon it. The gap is filled by imports, then asset prices inflate, and finally when local investors see that there are no good investments left to invest in, they buy into the assets of other nations which creates more problems and greater imbalances, all over the world.

The question being addressed by the IMF/Chicago Plan is: “How can we prevent this from happening?”

I have almost always found that when I am seeking a solution to any such kind of structural problem - whereby things that we all know should not be happening, are happening - the guiding principles by which I work seem to lead to the best possible outcome.

That is to say, an outcome, or a solution that is better than any that others have been able to come up with. I think this is because the principles are not commonly applied or even thought of. Economists are usually taught to accept the existing economic framework, and even if they do not, they think there is little wrong with making an intervention.

In contrast I start by assuming that if all is well with the economic structure, no interventions should ever be needed with just one exception – if there is the wrong amount of money in circulation the economy will either slow down or it will overheat, meaning that we get into some, or all of the above problems.

Only people can create money, so people have to intervene to do that.

Eliminate trouble at its source

This means that I have to find structures that do not unbalance the economy as market forces take place whereas if that is not done, the only way to manage the economic machine is by intervening.

In this particular money creating intervention, it is important not to unbalance the spending or wealth patterns in the economy. It is well known that almost any other kind of intervention made takes something from ‘there’, where it was supposed to be, and moves it, or some of it, to ‘here’, where the trouble is.

It is well known that doing that (intervening), causes a distortion or an imbalance somewhere else. You help with one problem and you create another.

My solutions eliminate the source of the problem and so no intervention is needed.

A friend of mine says that the reason why my designs for the economic structure are so successful may be because I am NOT an economist by training.

This means I am the one looking in from the outside. I see the big picture, whereas the economists are deep in the ‘forest’ and unable to see the wood for the trees. This is another way of saying the same thing.

The secret is to apply the right principles. The principles that I apply are mostly simple common sense.

When I see something that is proposed, or is done to deal with a problem, something which either creates some other imbalance to spending patterns or wealth distribution, or which interferes with the pricing of something, I think: “This is wrong. There must be a better alternative.”

When I see a price being used as an instrument (interest rates to manage the level of spending), I see an abuse of that price because prices are supposed to be moved, not by people, but by market forces.

Keep it under control

The price of something is response; it is not ever supposed to be the instrument used as an intervention. And so it is with interest rates – interest rates are a price. They should find their own level.

In order for that to happen there should be a tightly controlled amount of spendable money (deposits) in the economy, and with the supply under control, the interest rate should be such that the demand for those deposits matches the supply.

And the supply should be just enough so that the demands placed upon the economy by the borrowing and the spending of that money does not exceed the capacity of the economy to satisfy that demand; except that a little extra may be needed so that the economy can grow.

Looking again at that IMF paper, it says of the advantages of the Chicago Plan for limiting the money in the economy:

“...allowing the government to issue money directly at zero interest, rather than borrowing that same money from banks at interest, would lead to a reduction in the interest burden on government finances and to a dramatic reduction of (net) government debt, given that irredeemable government-issued money represents equity in the commonwealth rather than debt.“

This ‘interest free’ idea is at variance with a number of principles of macro-economic design:

1. Borrowing cheaply is liable to result in wasted resources at national level.
2. It does not make government and the people equal partners, each bidding against the other for funds to borrow/access. There is an imbalance.
3. The option to stimulate the economy in a balanced way using newly created money to reduce sales taxes and to provide purchasing/spending subsidies over a limited and pre-stated period is overlooked.

My model as described in previous weeks has none of those major faults. Here is an index to my earlier essay.

 - Fin24

* Edward Ingram has a strong and growing support base. One American has started a petition asking President Barack Obama and/or his senate committees to look into these ideas. Ingram says: “Why not here in South Africa? The ideas are universal.” 

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edward ingram  |  money  |  investments



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