Sunday, November 29, 2009

Maturity Transformation and Liquidity Crises

William Dudley's keynote address at a recent CEPS symposium on the financial system is worth reading in full. What I found especially interesting were the following remarks on structural sources of instability:
The risks of liquidity crises are also exacerbated by some structural sources of instability in the financial system. Some of these sources are endemic to the nature of the financial intermediation process and banking. Others are more specific to the idiosyncratic features of our particular system. Both types deserve attention because they tend to amplify the pressures that lead to liquidity runs.

Turning first to the more inherent sources of instability, there are at least two that are worthy of mention. The first instability stems from the fact that most financial firms engage in maturity transformation — the maturity of their assets is longer than the maturity of their liabilities. The need for maturity transformation arises from the fact that the preferred habitat of borrowers tends toward longer-term maturities used to finance long-lived assets such as a house or a manufacturing plant, compared with the preferred habitat of investors, who generally have a preference to be able to access their funds quickly. Financial intermediaries act to span these preferences, earning profits by engaging in maturity transformation — borrowing shorter-term in order to finance longer-term lending.
If a firm engages in maturity transformation so that its assets mature more slowly than its liabilities, it does not have the option of simply allowing its assets to mature when funding dries up. If the liabilities cannot be rolled over, liquidity buffers will soon be weakened. Maturity transformation means that if funding is not forthcoming, the firm will have to sell assets. Although this is easy if the assets are high-quality and liquid, it is hard if the assets are lower quality. In that case, the forced asset sales are likely to lead to losses, which deplete capital and raise concerns about insolvency.
The second inherent source of instability stems from the fact that firms are typically worth much more as going concerns than in liquidation. This loss of value in liquidation helps to explain why liquidity crises can happen so suddenly. Initially, no one is worried about liquidation. The firm is well understood to be solvent... But once counterparties start to worry about liquidation, the probability distribution can shift very quickly toward the insolvency line... because the liquidation value is lower than the firm’s value as a going concern...
These sources of instability create the risk of a cascade... Once the firm’s viability is in question and it is does not have access to an insured deposit funding base, the next stop is often a full-scale liquidity crisis that often cannot be stopped without massive government intervention.
As Dudley notes, maturity transformation is "endemic to the nature of the financial intermediation process and banking." But non-financial firms (and the United States Treasury) can also engage in maturity transformation by borrowing short relative to their expected revenue streams. This is what Hyman Minsky called speculative (as opposed to hedge) financing. One of Minsky's key insights was that over a period of stable growth with relatively tranquil financial markets, there is a progressive shift away from hedge and towards speculative financing:
The natural starting place for analyzing the relation between debt and income is to take an economy with a cyclical past that is now doing well. The inherited debt reflects the history of the economy, which includes a period in the not too distant past in which the economy did not do well. Acceptable liability structures are based upon some margin of safety, so that expected cash flows, even in periods when the economy is not doing well, will cover contractual debt payments. As the period over which the economy does well lengthens, two things become evident in board rooms. Existing debts are easily validated and units that were heavily in debt prospered; it paid to lever. After the event it becomes apparent that the margins of safety built into debt structures were too great. As a result, over a period in which the economy does well, views about acceptable debt structure change. In the deal making that goes on between banks, investment bankers, and businessmen, the acceptable amount of debt to use in financing various types of activity and positions increases. (Minsky 1982, p.65)
Short-term financing of long-lived capital assets is lucrative as long as debts can be rolled over easily at relatively stable interest rates. But this induces more firms to engage in speculative rather than hedge financing, making the demand for refinancing increasingly inelastic. The eventual result is a crisis of liquidity and a shift back towards hedge financing.
Many economists (myself included) have tried to construct formal models of the process described by Minsky, but with limited success to date. This may be a good time to give it another shot. 


  1. You should have a look at Maurice Allais's works, where he correctly identify maturity transformation by financial institutions with appropriation by the banking system of the sovereign benefit of issuing currency.

    For corporates, except the ones that are indeed "shadow banks" like GE, the issue is less sensitive because their leverage is usually lower and the maturity of financed asset is lower too. This being said, limitation of maturity transformation for corporates that issue commercial paper would be necessary as well

  2. Do you have a specific Allais reference in mind?

  3. I'd like to see that Allais reference too. He's right, or at least Charles' summary is.

    I explained the causal relationship between MT and financial crises last year on my blog. Briefly, you're right that MT is an essential aspect of the Anglo-American financial system, and wrong that MT is an essential aspect of all financial systems.

    Unfortunately, transitioning from an MT financial system to a non-MT financial system is politically almost impossible, because MT (basically a form of market manipulation) is concealing a natural yield curve that is much steeper than anyone wants it to be - and hence natural financial asset prices that are much lower than anyone wants them to be.

    There is a phrase for the removal from the market of the bogus demand for long-term securities that MT creates. The phrase is "bank run." Governments are generally focused on stopping bank runs, not ensuring that they run to completion. They thus find themselves involved in the banking business.

    Basically, by translating demand for present money into demand for future money, MT conceals the actual market for, say, 2039 dollars. The market for 2039 dollars, hence the price of 2039 dollars in 2009 dollars, hence the 30-year interest rate in 2009, should be dictated by the supply of 2039 dollars (ie, the set of investments profitable on this timescale), and the demand for 2039 dollars (ie, the set of people who want to save for 30 years). Instead, through the magic of MT, your checking account dollars are masquerading as demand for 2039 money.

    Result: lower long-term interest rates. But the structure is unstable if not insured by a currency issuer; and if it is insured by a currency issuer, the loan guarantees involved are merely government loans. Of course a currency issuer can drive down interest rates, short or long, to any level required by diluting the currency. Few economists would argue for an explicit role of the State as fiat moneylender, but few seem to see that it is doing just that implicitly by guaranteeing private loans (eg, bank "deposits.")

    There is nothing really new in this analysis. You want game theory? The work has basically been done. Diamond and Dybvig described the multiple equilibrium structure of a bank run 30 years ago. Somehow, this has failed to percolate into a collective realization that the Lombard Street banking model is broken by design. This is probably because there is simply no way our political system can act on a realization this awful...

  4. Also, while it's unfortunate that Minsky uses "speculative" as a pejorative, as though he were some kind of a Marxoid, you are correct (and indeed quite insightful) to associate the Dudley and Minsky quotes. Specifically, in the latter:

    Acceptable liability structures are based upon some margin of safety, so that expected cash flows, even in periods when the economy is not doing well, will cover contractual debt payments.

    What Minsky is saying here is: "maturity transformation considered harmful." Or at least, his definition of an "acceptable" financial structure is one in which all obligated payments are met by predicted cash flows. Ie: a structure that does not transform maturities.

    An "unacceptable" financial structure is therefore a structure which does transform maturities, ie, one in which obligated payments must be met through refinancing - new borrowing. (Just like "Bobby," the time-challenged pot dealer in my blogpost.)

    Now, you'll notice two things about these Minskian categories - "unacceptable" and "acceptable."

    First, since demand deposits are zero-term liabilities, all Bagehot-type banks operate under a regime of "unacceptable" finance.

    Second, the "acceptable" constraint is a much stronger constraint than the definition of solvency under which all businesses today, banks and non-banks, operate. "Unacceptable" finance is widespread, and has always been widespread.

    Third, we can without confusion or slander attach a more appropriate pejorative to these "unacceptable" systems of finance. For instance, we could call them "Bagehot schemes."

    Again: in recent Anglo-American history, Bagehot schemes have always been widespread. Then again, so have financial panics! Clean, hard-money finance is exceptionally rare in history modern or ancient.

    The difficult question with these "unacceptable" structures is not whether or not they should exist - they shouldn't. A Bagehot scheme is a Bagehot scheme, not a prudent public policy. The question is: since they exist, how can they be unwound? Sadly, there are no easy answers here, either.

  5. I'll add Lombard Street to the recommended books in the sidebar, this is definitely worth reading. I don't think that Minsky is using speculative as a pejorative (he uses the much more pejorative term Ponzi financing for maturity transformations that require refinancing just to meet interest payments). He is concerned with the scale of speculative financing rather than its existence, which he views as quite acceptable. What Minsky provides is a theory of changes over time in the extent of maturity transformation, and the manner in which this affects investment, output, employment, and eventually generates a liquidity crisis. Diamond and Dybvig offer a nice, clean model of bank runs (and I linked to their paper in a previous post) but they certainly do not provide a model that comes close to capturing Minsky's ideas. I stand by my comment that such a model is worth developing.

  6. I agree - if you find macroeconomic modeling a worthwhile pastime. Some of us do, others don't.

    I suppose I have a question here, so let me pose it more directly: what makes you think MT is a benign phenomenon? Besides, of course, the fact that it is widely practiced at present?

    In other words, do you agree with Minsky's implicit characterization of MT as categorically undesirable? Or do you believe MT has a Goldilocks nature - there can be too much MT, too little MT, or just the right amount of MT?

    If the former, you are basically getting the same results as the Austrians. You certainly can't have FRB without MT. If you do believe MT can ever be a benign phenomenon, I would be interested in hearing you explain why! Custom is certainly not an explanation...

    A good macroeconomic exercise is asking yourself what would happen to an economy if all MT schemes were rolled back tomorrow, and the practice made illegal. Most naive ways of unwinding MT structures, including the obvious approach of just letting them collapse, produce that deflationary effect so remarked on by Irving Fisher. However, this is by no means an argument that the structures are benign! Again, if you have a better argument, I and others would like to hear it.

  7. I actually wasn't aware that Minsky had discussed MT this directly - I thought of him as an animal-spirits man, ie a behavioralist. He is certainly often marketed as such. But I had also not read Minsky directly, so there.

    A Ponzi scheme and a Bagehot or maturity-transformation scheme are most certainly different things! If every business that depended on refinancing was a Ponzi scheme, all of Wall Street would be illegal. Contrary to certain over-enthusiastic Ron Paul fans, a bank is not a Ponzi scheme. Nor is a business that finances a 10-year project with a series of 1-year loans. If Minsky calls this class of operation a Ponzi, he is simply using the term incorrectly.

    The difference between a Bagehot scheme and a Ponzi scheme is that the latter is always insolvent by any conventional accounting definition. It needs to expand or die. Nothing like this is seen in fractional-reserve banking or any other MT scheme.

  8. It's a fair question: is MT categorically undesirable or (within limits) benign?

    To answer this we need to imagine how alternative systems would perform. It seems that you would prefer a system without no MT (100% reserve banking, no credit lines without collateral, no short lending backed by long assets, etc.) I grant you that such a system would not be subject to liquidity crises. But would it deliver better macroeconomic performance overall? There's a reason why the Anglo-American financial system is so widespread - societies that have adopted it have managed to out-compete those with alternative systems by delivering high and sustained rates of growth and innovation. You might argue that they would have done even better with an alternative system, but this claim does not seem to me to be empirically testable. So I guess my position is that liquidity crises are the price we pay for a system that works reasonably well most of the time.

    Regarding Minsky, his use of the term "Ponzi financing" is a bit tongue-in-cheek. He does not mean it to imply that these investments have negative present value, only that refinancing is necessary to make meet interest obligations in the short term. Of course this is different from the usual use of the term "Ponzi scheme".

    I'll post an overview of Minsky's financial instability hypothesis in a few days, and I hope to convince you that he is definitely not a behavioral economist or animal spirits man.

    Even though we disagree, I want to thank you for your comments, they have been thought-provoking. And I urge you to read Minsky.

  9. From a purely historical perspective, I have a much simpler explanation of why the Anglo-American financial system is so widespread. It's the same reason that the English language is so widespread: that England ruled the world in the 19th century, and America in the 20th! If you tried to explain the popularity of English as a function of its simple conjugations, you'd have Occam quite amused.

    The claim that MT is harmful is most certainly not "empirically testable." Economics is not generally susceptible to controlled experiment! History provides some events which look like natural experiments, but they are very "dirty" and seldom provide anything like unambiguous objective causality. Logic and common sense cannot be dispensed with.

    This is why, from a methodological standpoint, I prefer what might be called narrative or "literary" economics, which is no more than the political economy of the 19th century. Frankly, I don't get the impression that the 20th has added a lot to the human understanding of how to manage a sovereign balance sheet. I am also not a believer in quantitative metrics such as GDP, at least not if they are taken as a measure of good government.

    In the methodology of narrative economics, it's easy to demonstrate that MT is harmful, or at least stupid: demonstrate its equivalence to some other practice that is obviously harmful, or at least stupid.

    To answer my question with my own methods, there are two cases of MT that need to be considered. One is unprotected MT, which is what the shadow banking system was doing when it blew up. Frankly, any argument that a policy whose impact includes these kinds of events is a good policy is an extraordinary claim demanding extraordinary evidence. There's creative destruction, and then there's just plain destruction.

    Moreover, UMT is actively dangerous for those who engage in it. Thus it is undesirable not just on a social level, but also an individual level. Message: avoid. (What happened to the shadow banking system is that everyone thought they were a lot more protected than they actually were.)


  10. What reasonable pundits are more likely to support is protected MT. In this case, a fiat-currency issuer (PMT cannot be 100% safe in a hard-currency economy) protects MT with a loan guarantee that is in practice risk-free.

    PMT of course is the normal state of the non-shadow banking system, via FDIC's guarantee of bank deposits - itself backed by the infinite checkbook of the Fed, which is why no one cares that FDIC is now broke!

    A "deposit" (the name itself being slightly Orwellian) is a zero-term, continuously-rolled loan from depositor ("D") to bank (B), the loan being guaranteed by the Fed or other currency issuer (A). B aggregates this zero-term money and uses it to buy a 30-year loan from a homeowner (H), or some similar security.

    Now, any loan guarantee can be replicated by an equivalent structure of simple loans. This generally clarifies the financial structure involved.

    So instead of D lending $1000 to B, guaranteed by A, we can say that D lends $1000 to A, who turns around and lends it to B. Risk structure: exactly the same. Funky contingent liabilities: none.

    But remember who D and A are: a depositor and the Fed. So really what we've done with this transformation is to flatten our two-tier banking system, and give ordinary Joe D an account at the Fed. You can still consider this a "loan," but really all it is is a number on a hard disk that says how many dollars D has.

    What does this number have to do with the relationship between A and B? Nothing. Or at least, it should be nothing. Note that in this model, the connection between the size of the deposit base and the quantity of loanable funds is entirely spurious. The trivial cosmetic question of whether D's dollars are in his account or folded in his pocket, for example, appears as it should be: irrelevant. A certainly can dispose of its entire loan portfolio if all Americans convert all their dollars from electronic to paper form, but it has no further need to do so.

    Since a zero-term loan of dollars to the Fed is not a meaningful transaction, the real relationship here is between A and B. D was just serving as a beard for this pleasant, lucrative relationship, which we now consider.

    The first thing we see is that we have eliminated the maturity transformation in our example. Because A does not intend to cause a maturity crisis, its loan to B is effectively of the same term as B's assets - they will be, in the lovely accounting phrase, "held to maturity." Thus A is lending money on a long-term basis to B. By no means a cosmetic transaction.

    So the real question - to which, if we consider only PMT and not the dangerous UMT, my earlier question is equivalent - is: is it socially valuable for the government to intervene in the loan market, by printing money and lending it to private parties? For example, to buy homes?

    H is certainly happy about the outcome - A, by intervening in the loan market, has driven up his home equity! But...


  11. In general I feel that a responsible economist should hold anyone who believes that printing money can make an economy more prosperous in very great suspicion. Frankly, this sort of inflationist logic is all over 20th-century economics, but it was also known to the 19th-century economists - who generally regarded it as quackery. From the perspective of the 19th-century economist, the 20th appears as the golden age of the monetary crank. (Look, for instance, at Gesell and Major Douglas - how different were their formulas from Keynes's - or Krugman's?)

    More logically, it is easy to show that printing money does not generate wealth, because we can redenominate any holding of fiat currency as a fraction of the whole. Just as we can with shares of stock - fiat currency is much like a sort of sovereign equity.

    Thus, when you print money, you are really just redistributing money, just as when you issue shares. A company cannot increase its market capitalization by issuing new shares.

    Of course, if you redistribute purchasing power from rich people to poor people, you will stimulate spending and raise GDP. This does not constitute a demonstration that Robin Hood economics is good national stewardship, although it may be in some cases. But I think it accounts for most of the obvious "positive" effect of inflationist policies - including MT protection.

    The takeaway for me is that, if inflationist policies were not hidden under these layers of accounting camouflage, they would strike the average voter's common sense as imprudent.

    This, for me, is sufficient explanation for the ubiquity of MT. MT is a good way to camouflage unsavory ties between State and Bank. The loan guarantee in PMT is a sweetheart loan, but it doesn't look like one.

    As for "Ponzi," this slightly-careless use of terminology is what has turned me off Minsky, I think. One can be both economist and polemicist without the two getting in each other's way. Calling a bad practice "Ponzi" when it is not in fact a Ponzi scheme is the kind of thing too-angry finance bloggers do. Precision is damning enough.

    Anyway. I am curious as to whether your defense of MT is a defence of UMT, PMT, or both. Clearly, if your Minsky model takes the Goldilocks interpretation of MT, it must assign social value in some way to the practice...

  12. I have my hands full at the moment so have to respond briefly.

    Regarding methodology, I probably value the narrative/literary approach of the 19th century political economists much more than the average contemporary economist. But when thinking about the logical implications of a set of assumptions, I usually find it useful to have a mathematical model at hand. The manner in which the financial system affects long run economic growth is complicated, and given the lack of historical variation in financial systems in industrialized economies, I can't make confident statements about the consequences of abandoning fractional reserve banking, etc.

    The English language is widespread because of British and American power, yes, but the source of this power is an economic infrastructure built on a particular financial system. So I would say that the widespread use of English supports rather than refutes my argument.

    I consider certain aspects of PMT (such as deposit insurance) to be socially valuable for reasons discussed by Diamond and Dybvig: they can help select among multiple equilibria and solve a coordination problem. Yes, there are moral hazard issues that arise (excessive risk-taking by S&L firms in the 1980's for example) but if one is to have fractional reserve banking then it is better to have it with deposit insurance than without. Would it be even better to have 100% reserve banking? Maybe, but I am skeptical. Show me a successful economy with this institution and I'll reconsider.

    UMT is of course the root of the current crisis. If you read the Dudley speech in full, he has some suggestions for improving matters. Perhaps this is just tinkering with a deeply flawed system when a complete overhaul is required; I haven't made up my mind on this. What I'd like is a model to help me think through the consequences of different counterfactuals. That's why I ended my post the way I did.

  13. Professor Sethi,

    Yes, the macroeconomy is complicated! It is not so complicated you have to model it, however. It is so complicated as to be quite beyond modeling. It shares this quality with Earth's atmosphere, I'm afraid.

    BTW, as a computer guy, I am entirely puzzled that macroeconomists still prefer to build their "models" in terms of exotic mathematical tools, rather than just writing world simulations - as they would if they had started on their bleak career of mathemolatry in the 1990s, not the 1890s. The result of a simulation rather than a system of equations, or whatever, would not be any more scientific. Neither has any predictive power at all. It seems to me that the former would be more fun to do, however, and produce more and flashier graphs.

    As for hard-money examples: Professor Sethi, no offense, but your historical window is just way too short. Most of classical Europe was on a hard-money standard, and flourished on that standard, for many centuries before the Anglo-American era. FRB was generally a localized exception. Fiat currency was even rarer. The general presumption was that when any such paper structure failed, it served both the promoters and the investors exactly right.

    Centuries of European writers on political economy would have been absolutely shocked by the doctrines that became the conventional wisdom in 20th-century economics. They would not have been shocked by the results, which have been exactly as they would have predicted.

    Mill in the 19th century gave a celebrated answer to the question of how regions devastated by warfare automatically recovered, in a few years. In the 20th century, entire cities - such as Detroit - were devastated not by war, but by 20th-century economics. They have not recovered. They will not recover - at least, not if the matter is left in the hands of 20th-century economists!

    The classical example of a successful hard-money economy, given in all the Austrian literature, is the Bank of Amsterdam system in the Dutch Golden Age. Hard money financed multiyear trading voyages to the Indies.

    For a more recent primary-source description, try this passage from Condy Raguet's treatise on currency and banking from the 1830s:

    Such being the theory of this branch of my subject, I have the satisfaction to state in regard to the practice under it, upon the testimony of a respectable American merchant, who resided and carried on extensive operations for near twenty years at Gibraltar, where there has never been any but a metallic currency, that he never knew during that whole period, such a thing as a general pressure for money. He has known individuals fail from incautious speculations, or indiscreet advances, or expensive living; but he never saw a time that money was not readily obtainable, at the ordinary rate of interest, by any merchant in good credit. He assured me, that no such thing as a general rise or fall in the prices of commodities, or property was known there; and that so satisfied were the inhabitants of the advantages they enjoyed from a metallic currency, although attended by the inconvenience of keeping in iron chests, and of counting large sums in Spanish dollars and doubloons, that several attempts to establish a bank there were put down by almost common consent.

    Page 37. More examples are given there. In general, Raguet observes that in a hard-money economy prices and interest rates are stable. Again, if there are not larger and more recent examples, this is entirely the result of military activity.

  14. You simply can't use military or even cultural conquest as a proof of institutional superiority. Alaric sacked Rome - did that make Gothic institutions superior to Roman institutions? This means of reasoning will lead you into the most absurd Panglossian paradoxes.

    We live in an Anglo-American world because Nelson tacked left instead of right at Trafalgar, or whatever. History is contingent - it is not a matter of destiny. (It's actually no accident that your American-leadership line is reminiscent of the old Manifest Destiny movement; it is more or less the modern successor of that movement, I believe.)

    I find an excellent cure for this particular disorder - American and/or democratic triumphalism - is Henry Maine's Essays on Popular Government (1893). The accuracy of Maine's predictions will shock you. Even the features he praises in the US Constitution were to be removed in a generation, with the exact results he would have predicted.

  15. Anyway, Diamond and Dybvig are completely confused about PMT. There is no multiple equilibrium in PMT. It is straight-out government lending. Any argument for a fiat lender is an argument for PMT, and vice versa.

    What your model of UMT needs to capture is, above all, the effect on the yield curve when demand for current or near-term money is maturity-transformed into the market for long bonds. And, of course, the reverse effect when it leaves.

    In particular, your model should show how this yield-curve whiplash drives the Austrian theory of the business cycle. Investments which appear profitable under the depressed long-term interest rate appear unprofitable when the artificial demand is withdrawn and the long rate spikes. The Austrian term is "malinvestment."

    Another compelling analogy is the problem of "burying the corpse" in a commodities-market manipulation. UMT is essentially a market manipulation - it introduces phony demand into the long-term money market, driving up the price of long-term bonds and capital assets, just as phony demand in the FCOJ market would drive up the price of FCOJ.

    The reason that Bagehot schemes often last a very long time, unlike market corners which tend to fall apart very quickly, is just that many people are too lazy to judge the term of their loans, and wind up rolling over where they should have selected a higher maturity. If no one ever rolled over, these schemes could not exist. They are held up by duct tape - they depend on inefficiency, opacity, or both.

    Of course, when the tape snaps, the State often steps in. This, not any conscious plan, is the origin of PMT. Rational explanations of historically evolved institutions can be produced, but they often sound more like rationalizations than rationales.

    Anyway. I will let you get to your important modeling. I just wanted to make sure you understand the problem, which you seem to...

  16. Thanks (again) for your comments and also for promising to let me get on with my modeling. Actually what I really want to do is to complete a post on Cormac McCarthy's typewriter... maybe I can get to this tonight.

    On one thing we agree: MT flattens the yield curve, and changes the set of investments that are considered profitable. You think this is necessarily harmful, and I think it may actually be beneficial. For instance, a set of investments that would each be relatively worthless if adopted in isolation may be extremely productive if adopted simultaneously. A flatter yield curve counteracts the effect of this externality and could therefore result in better long run growth. Just a possibility worth considering.

    This has been fun but I really must stop now...

  17. MT does flatten the yield curve! Unstably, in the case of UMT. (The "multiple equilibrium" of Diamond and Dybvig is really one equilibrium, and one somewhat-stable disequilibrium.)

    PMT is stable. But - as I said, any argument for PMT is an argument for government loans. Your argument above is in exactly this class! So you can make it without even mentioning MT. This I would recommend doing.

    BTW, if you're interested in interventionist and protectionist economics, the German Historical School (bane of the Austrians) is a goldmine. Take a whack at Friedrich List sometime. His point about "cosmopolitical economy" is excellent.

  18. Interesting discussion above. The arguments for MT strike me as weak and for the following reasons.

    1. MT allegedly enables those wanting to borrow in order to make long term investments to do so at a lower rate of interest. Given that investments can bring returns of anything between plus and minus 100% p.a., a change of average interest rates from say 4% to say 2% (about what MT delivers?) is a total irrelevance.

    2. Investment involves diminishing returns. Thus the advantage for a country of say of 10% increase in the total amount it invests is small.

    3. Most investments just replace existing or worn out investments. Thus while a proportion the INITIAL investment in a given plant or office block doubtless comes from short term depositors, the cost of REPLACING the investment is charged to those who consume the product made in the plant or office block. I.e. if MT brings any advantages from investments, such advantages come only from ADDITIONS to the aggregate or total investments made by a country.

    4. In that MT DOES result in more investment, it does not get round the brute and inescapable physical fact that investment involves pretty well the entire community (including small depositors) sacrificing current consumption. Thus the advantages for small depositors who get higher interest rates are doubtful. I’ll explain.

    Assume a closed economy and that MT is not allowed. Assume full employment. Assume that MT is then allowed. Interest rates for long term investors will drop and interest rates for short term depositors rise, all of which sounds nice.

    But additional investment is an injection, as pointed out in the basic economics text books. That is the additional investment is an addition to aggregate demand, which is not permissible given full employment (else inflation ensues). Thus demand from consumers has to be paired back to make room for the demand stemming from the additional investment.

    This is just a reflection of the brute physical fact that investment involves a sacrifice of current consumption.

    Thus while households and others making up the ranks of small depositors gain more interest, they (and others) have to take a standard of living cut to enable the relevant investments. Indeed, the ADVANTAGES of MT are obvious to depositors and long term investors, while the DISADVANTAGE is BEYOND THEIR COMPREHENSION! That is, they’ve been CONNED.

    Depositors and the population at large would probably be better off the advantages and disadvantages, the costs and rewards of short and long term deposits were completely open and above board.

    Abolishing MT in all its shapes and forms is doubtless not possible. But clamping down on it would certainly help prevent another credit crunch and precious little is lost by making MT more difficult, far as I can see.

  19. The arguments for MT strike me as weak and for the following reasons.

    1. MT allegedly enables those wanting to borrow in order to make long term investments to do so at a lower rate of interest. Given that investments can bring returns of anything between plus and minus 100% p.a., a change of average interest rates from say 4% to say 2% (about what MT delivers?) is a total irrelevance.

    2. Investment involves diminishing returns. Thus the advantage for a country of say of 10% increase in the total amount it invests is small.

    3. MT makes it look as though the resources required to make investments somehow come out of thin air. This is a delusion. I’ll explain.

    Assume a closed economy and that MT is not allowed. Assume full employment. Assume that MT is then allowed. Interest rates for long term investors will drop and interest rates for short term depositors rise, all of which sounds nice.

    But additional investment is an injection, as pointed out in the basic economics text books. That is the additional investment is an addition to aggregate demand, which is not permissible given full employment (else inflation ensues). Thus demand from consumers (i.e. current consumption) has to be paired back to make room for the demand stemming from the additional investment.

    Indeed, the ADVANTAGES of MT are obvious to depositors, while the DISADVANTAGE is HIDDEN! That is, they’ve been CONNED.

    Depositors and the population at large would probably be better off the advantages and disadvantages, the costs and rewards of short and long term deposits were completely open and above board.

    Abolishing MT in all its shapes and forms is doubtless not possible. But clamping down on it would certainly help prevent another credit crunch and precious little is lost by making MT more difficult, far as I can see.

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