Podcast: Philip Coggan's Paper Promises - Money, Debt and the New World Order

Below is the podcast of Coggan's book talk, and here is a good review of Paper Promises.

Speaker(s): Philip Coggan

Chair: Professor Christopher Polk

Recorded on 19 January 2012 in Sheikh Zayed Theatre, New Academic Building.

The world is drowning in debt. Greece is on the verge of default. In Britain, the coalition government is pushing through an austerity programme in the face of economic weakness. The US government almost shut down in August because of a dispute over the size of government debt.

Our latest crisis may seem to have started in 2007, with the collapse of the American housing market. But as Philip Coggan shows in this new book, Paper Promises: Money, Debt and the new World Order which he will talk about in this lecture, the crisis is part of an age-old battle between creditors and borrowers. And that battle has been fought over the nature of money. Creditors always want sound money to ensure that they are paid back in full; borrowers want easy money to reduce the burden of repaying their debts. Money was once linked to gold, a commodity in limited supply; now central banks can create it with the click of a computer mouse.

Time and again, this cycle has resulted in financial and economic crises. In the 1930s, countries abandoned the gold standard in the face of the Great Depression. In the 1970s, they abandoned the system of fixed exchange rates and ushered in a period of paper money. The results have been a long series of asset bubbles, from dotcom stocks to housing, and the elevation of the financial sector to economic dominance.

The current crisis not only pits creditors against debtors, but taxpayers against public sector workers, young against old and the western world against Asia. As in the 1930s and 1970s, a new monetary system will emerge; the rules for which will likely be set by the world's rising economic power, China.

Philip Coggan was a Financial Times journalist for over twenty years, including spells as a Lex columnist, personal finance editor and investment editor, and is now the Buttonwood columnist of The Economist. In 2009, he was awarded the title of Senior Financial Journalist in the Harold Wincott awards and was voted Best Communicator at the Business Journalist of the Year Awards. Philip Coggan is the author of the business classic, The Money Machine.

What is Money? (or How is Money Created?)

I just did a Google search on 'what is money?' and 'how is money created?', and many of the top results are probably confusing for someone looking for a simple explanation of the broader concept of money.

(Note: this post is not about physical cash or coin, which I trust most people correctly understand to be minted by the government. It is instead about a more complete measure of money in all its physical and non-physical forms: cash, coin, demand deposits, savings, etc.)

Courtesy of Dan Hind here's a simply explanation of how money is created:

Banks create money through the act of lending it. They don't have to limit themselves to lending out the money deposited with them. In fact, they can end up lending huge multiples of the money they hold in reserve. 

When they authorise a loan or extend credit in the form of an overdraft, the money is conjured out of nowhere.

So there you have it. Banks create the vast majority of the money supply out of thin air (electronic bits these days) when they make loans. Simple, right? Here's Dan again:

The economist and ironist JK Galbraith once wrote that "the process by which banks create money is so simple that the mind is repelled. When something so important is involved, a deeper mystery seems only decent". Offered the unadorned truth, stripped of any technocratic flim-flam, we can scarcely believe it. It seems preposterous that money should have such humble origins, as though it is beneath money's dignity that it should begin life at a banker's keystroke.  

The truth about money creation is a bit like the end of The Wonderful Wizard of Oz, when it turns out that there is no all-knowing wizard, only an old man behind a curtain, making things up as he goes along.

A perhaps more interesting question is why the subject of how money is created is not taught in secondary school? The reason can't be that it's too complicated. But as one of the commenters on Dan's article notes:

 "it is truly preposterous how little the public knows about arguably the single most influential conception humanity has ever created."

Education Site: Educate yourself on various aspects of the financial industry with classes from accredited online colleges.

Irish Banks Have Lost 40% Of Deposits, Why Have Greek Banks Only Lost 19%?

Irish banks have lost 40% of their deposits over the past 18 months, whereas Greek banks have lost 19%. (Without thinking I almost inserted a 'just' in front of the Greek figure, but 19% is still a significant number!)

Right now the risk is much greater for Greece than Ireland of either leaving or getting kicked out of the euro, followed by:

1. Declaring a bank holiday
2. Enacting capital controls
3. Restricting Shengen and imposing limitations on travel, reducing the amount of money which can be taken out of the country per visit, or both
4. And then devaluing the new currency by approximately 50%

Naturally, one would expect deposit withdrawals to be much higher in Greece than Ireland, but according to official statistics the opposite is the case.

From Bloomberg:

Deposits by financial institutions in Greek banks, which make up 21 percent of the total, have fallen by one-third since the beginning of 2010, while those by non-financial firms and residents dropped 9 percent, according to Bank of Greece data. 

People “are now afraid of the possibility of returning to the drachma,” said Giannoulis, referring to the Greek currency in circulation before the country adopted the euro in 2001. “Just a headline is enough to spook depositors.” 

Something doesn't smell right here. If Greek depositors were really afraid of returning to the drachma then they'd be pulling euros out en masse and stashing them under the mattress or opening bank accounts in other countries.

Greece has reported wildly inaccurate economic figures since the crisis began so one possibility here is that the 19% in withdrawals is another fraudulent Greek figure and massively understated. Recently Greece quietly activated the Emergency Liquidity Assistance (ELA) program in what was described as 'last stand' for Greek banks:

The ELA was designed under European rules to allow national central banks to provide liquidity for their own lenders when they run out of collateral of a quality that can be used to trade with the ECB. It is an obscure tool that is supposed to be temporary and one of the last resorts for indebted banks. So far it has only be used in Ireland. 

By accepting a lower level of collateral the debt in the ELA is, in theory, supposed to be the responsibility of Greece. However, since the Greek state is surviving on eurozone bailouts and Greek banks are reliant on ECB funding, in practice the loans are backed by the eurozone. The terms of lending and other details are not disclosed publicly. 

Mr Ruparel said: "Though the ELA is meant to be a temporary emergency solution, we know from Ireland, where the programme has been running for almost a year, that once banks get hooked on ELA they rarely get off it."

More about the slow motion European bank run here.

End Game: Greece to Default This Weekend?

While the Greek government is publicly denying it (I suppose they have to until the banks close) the game appears to be up (further confirmation from Spiegel here).

The timing of the default would come roughly in line with my prediction. We're also seeing a softening in the euro, now down to $1.36, also as predicted.

In terms of what happens next, the first step following default would likely be a bank holiday in Greece. This would then be followed by some type of devaluation (rumoured to be around 50%) of the reintroduced drachma.

As I posted yesterday, anyone in Greece who still has their euros in a Greek bank may want to move swiftly.

Here is Professor Eichengreen with some deeper perspective and why its likely the ECB is going to be doing a lot of Ctrl+P.

The Greatest Trick Lenders Ever Pulled?

A pretty good candidate in my mind was substituting the term 'credit' for 'debt'.

Not all too long ago, 'debt' was clearly understood as something that, simply put, was bad.

But 'credit'? Oh boy, give me some of that!

There is a lot more to the credit/debt bubble than rebranding. But it's interesting to observe the different terms used for the same or like things, and the effect such differences can have on adoption and/or support. Some other examples:

• 'Orderly resolutions' vs. 'bailouts'
• 'Quantitative easing' vs. 'printing money'
• 'Macroprudential regulation' vs. 'financial repression'
• 'Department of Defense' vs. 'Department of War'

The observation on swapping 'debt' for 'credit' and other interesting thoughts from this talk and Q&A with novelist (and non-economist) John Lanchester.

Has Federal Reserve Secrecy Become Untenable?

The most interesting aspect of the Fed's new 'quantitative easing' announcement (aka QE2 ) was not its $600,000,000,000 price tag.

Nor Fed Chairman Ben Bernanke's op-ed in the Washington Post which stated that a key benefit of QE2 is higher stock prices.

I believe the most interesting, and perhaps significant, questions relate to the impact on the Fed's ability to maintain secrecy in wake of the unprecedented media coverage of QE2.

A Well Telegraphed Event

Regular Fed watchers of course know that an oft used Fed strategy is to communicate upcoming policy shifts through speeches and leaks to the press well in advance of the actual vote and formal policy change announcement. The Fed's thinking here is that this strategy provides time for market participants to acclimate to an upcoming policy change, thereby avoiding a sudden (and perhaps unwelcome) monetary surprise.

Anyone following the general financial press was probably aware no later than September that QE2 was going to be announced at the November Fed meeting. Media coverage of QE2, including my first writeup, began appearing as early as June.