The Duran: Five Years of Sanctions, and Russia is still growing

The Duran’s Alex Christoforou and Editor-in-Chief Alexander Mercouris discuss the state of the Russian economy under Vladimir Putin, five years after the first sanctions were imposed on Russia for the accession of Crimea to the Russian Federation. Its monetary policy is discussed and contrasted with the negative rates in Western countries.

My comment: The Russian Central Bank is not immune from the same fallacious economic thinking we see in the West. Conventional wisdom says that high interest rates combat inflation, while low interest rates fuel it. Obviously, this mantra falls short when you apply it to our current reality. One country leader who gets it is Turkey’s president, who, like Trump, is pressing his own Central Bank head to relax borrowing costs. Higher interest rates are good for people who save in Treasury bonds, but what percentage of the population holds assets in the form of Russian Treasuries? Pension funds do require Government debt instruments in order to protect themselves against inflation; and Government debt is far safer than [private] commercial paper. Being cut off from foreign capital markets, there’s no reason to keep interest rates high, even with a banking sector left largely unregulated on the asset side.

As for the West, the fact investors are buying bonds which have negative yields means that the outlook on inflation is dismal and they still see this Government-issued instrument of saving as worthwhile. True, negative interest rates are a tax on the reserve accounts banks hold at the central bank. It’s a tax on bank liquidity. But there is no liquidity crisis in countries like Germany, the UK, and the US, and indeed there can’t be such a crisis, as long as their banking sectors meet their capital requirements. When bank assets shrink in value relative to bank liabilities, which are stable in value, this erodes their equity and makes it harder for them to borrow and can even lead to bankruptcy – unless the institutions in question are well-connected to the ruling class, in which case, the Central Bank and Treasury intervene with all sorts of bailout schemes. One reason as to why the Fed, the BoE, and the ECB adopted QE and near zero interest rate policy was in the logic that flooding the banks with reserves will revive lending. This move only makes sense in the fantasy world of mainstream economic thought – which preaches the fiction that banks lend out reserves to customers when they make loans. In reality, however, that doesn’t happen. Loans create deposits, while reserves are shuffled back and forth [as necessary] for legal accounting and settlement purposes only.

In July I wrote a piece on Russia’s macro picture, and pointed out why its budget surplus doesn’t put drag on the domestic private sector, due to the foreign sector’s large deficit against Russia [7 percent of Russia’s GDP in 2018]. With a budget surplus of 2.7 percent of GDP last year, that left Russia’s domestic private sector in a net financial surplus of 4.3 percent of GDP. The same situation is projected for this year.

On the question of affordable Government investment in public infrastructure and public services… it’s not about accruing financial savings before the Government can invest. After all, we’re talking about balance sheet statements [the Sovereign keeping a ledger in his own unit of account], not savings in actual physical materials. Russia has the technology, the skilled labor, and necessary materials to expand public services and physical infrastructure; and it doesn’t require foreign currency for any of this. For a country like Russia, a country with monetary sovereignty, there is never a “lack of its own money.” The challenge, or art of public finance, however, is to conduct fiscal policy in such a manner to accommodate investment, job creation, and income growth while keeping prices in check. So long as wages and profits are rising faster than prices, you achieve real growth, and that’s what matters.

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Erdogan is Right about Monetary Policy

by Serban V.C. Enache

Last month, Turkey’s president fired the head of the country’s Central Bank, Murat Cetinkaya. “We told him several times to cut interest rates at meetings on the economy […] We said that if rates fall, inflation will fall. He didn’t do what was necessary.” His view on monetary policy was mocked by mainstream economists, who are either incompetent or just playing dumb. Sure enough, the CB did what Erdogan desired. That being said, Turkey’s key lending rate and interbank rate remain in the double digits. Meanwhile, private debt to GDP has stabilized at around 170 percent and the public’s desire now is to slowly unwind.

Here’s why Erdogan’s unorthodox view on monetary policy is correct. The CB’s lending rate is the cost of borrowing reserves; reserves are used by banks for accounting and settlement purposes. Banks DO NOT lend out reserves to their debtor customers. The ability of banks to approve loans is contingent on their capital and the actual demand for loans: the presence of credit-worthy customers willing to borrow money. Banks first approve the loans, and later acquire the reserves if they need them. So long as a bank meets the capital requirement, it can always borrow reserves [in case it’s short on reserves] from the interbank market [from banks with a surplus of reserves] or from the Central Bank itself. The lending rate is a cost on liquidity. During a period of deleveraging, which the Turkish private sector wants to do, it’s not wise to increase this cost. At the same time, higher interest on reserves and on Government bonds translates into larger financial flows into the economy through the CB & Treasury interest payments channel.

A counter-argument can be made that, with a lower lending rate, speculators could borrow Liras more easily and use them to buy foreign currency. This is a legitimate concern, however, since Turkish private sector debt has peaked, fewer economic agents have a good balance sheet to engage in such activities, and at the same time, given the overall situation, banks are more prudent now, since their equity positions are shaky. This particular concern wouldn’t exist if the country’s laws ensured asset side discipline for the banking sector. Contrary to conventional beliefs, you don’t discipline banks on the liability side, but on the asset side. A bank’s liabilities are stable in value, but its assets [loans made] oscillate in value. The riskier the loans, the riskier the spread between assets and liabilities, endangering the bank’s equity position. Erdogan’s desire to have the Central Bank lower rates is beneficial in two ways for the Turkish economy. First, it allows for a smoother deleveraging phase. Second, it minimizes the volume of funds entering the economy via the CB & Treasury interest payments channel, easing inflationary pressures.

Here’s what Erdogan’s Government should do with regard to asset side regulations. Banks shouldn’t have subsidiaries of any kind, since keeping assets off balance sheet doesn’t serve public purpose and it makes it harder in real terms for Government regulators to monitor them. Banks shouldn’t be allowed to accept financial assets as collateral for loans, because leverage serves no public purpose. Banks shouldn’t be allowed to lend off-shore [for foreign purposes]; bilateral agreements between states should cover that type of activity. Banks shouldn’t be allowed to engage in proprietary trading or any profit making venture beyond basic lending. Banks would issue loans based on credit analysis, not market valuation; they would not be allowed to mark their assets to market prices. Banks shouldn’t be allowed to buy or sell credit default insurance. Banks shouldn’t be allowed to contract in an interest rate set in a foreign country. Banks would only be allowed to lend directly to customers, service and keep those loans on their own balance sheet. No public purpose is served by selling assets to third parties. The interbank market should be abolished as well, since it serves absolutely no public purpose. The CB should lend directly to its member banks. The reserve requirement should also be removed, since banks can provision themselves with enough liquidity [from the State] by simply looking at the behavior of their customers. And under all these rules in place, limited Government deposit insurance can be upgraded to full insurance. Last but not least, in order to improve the ability of banks to manage risk and lower overall speculation, a principle from the Islamic banking model should be adopted. It works as follows – when a customer comes in to get a loan to acquire a piece of property [a house, an apartment, a vehicle etc], the bank buys that property and gives it to the customer for use, but the bank retains ownership over it, until the debt is squared. This provision serves another great purpose… it facilitates an easy transition from mainstream taxation to the Single Tax [Georgist] framework. With this rule in place, the responsibility for paying the land-value tax [LVT] falls upon the bank, not the debtor. The debtor makes the debt payments to the bank, and the bank uses those funds to pay the LVT.

Here are two examples:

Phasing in Land-Value Taxation. I bought land through a bank loan, and now the Government has eliminated the property tax and instead introduced a 10 percent LVT. I’m stuck with paying the LVT and the debt I owe to the bank, which is not fair. Therefore, the Government introduces the Islamic banking rule retroactively, and the ownership of the land goes to my creditor, who can’t kick me out, as long as I honor my debt payments. With this change in ownership, the bank accepts a loss of 10 percent [the LVT]. It’s much easier for Government to deal with financial firms in an orderly, institutional manner, than directly with every household faced with this double-burden. The State can temporarily relax capital requirements, should it be necessary in the transition from the antiquated, regressive and perverse tax code to the new, fair and efficient one. The boys and girls at the Bank of International Settlements will, of course, grimace at such a bold and informed move.

Full Land-Value Taxation is in place. Banks won’t be happy to accept land as collateral, given the fact land has a 100 percent tax liability on it. And those that do will have to hope for a near zero profit at best. So gaining access to land will be possible in most cases without any upfront cost. A citizen will simply pledge to pay LVT to the State, and he or she gets the respective plot.

Going back to the issue at hand… mainstream commentators can mock Erdogan as much as they want, but they’re the ones who are wrong about interest rates. The ‘natural’ interest rate on fiat money is zero! Anything below zero is a tax. Anything above zero is a subsidy. Those who claim that higher interest rates lower the volume of ‘malinvestment’ are arguing for a regressive and inefficient way to combat it. According to their logic, all pharmaceuticals should be sold at a premium, to make it more expensive for those seeking to buy the drugs for recreational use, instead of treating illnesses. Why should everyone pay more because a few abuse these products? Why should the cost of money be higher, just because some use it for speculation, rather than wealth creation? The correct logic is to distinguish between productive and unproductive economic activity. Encourage the former and discourage the latter. Higher interest rates across the board [levied irrespective of the type of economic activity] is as regressive as it gets and it hardly does anything to contain malinvestment. Those who blame the real estate bubble on low interest rates [so-called artificially low rates] are wholly missing the root cause: privatized land rents – landlords and money lenders appropriating the value of location [value which they did not create]. Without this phenomenon, asset price inflation wouldn’t occur. Under full land-value capture, property prices would be kept stable. If Erdogan wants to escape the looming recession and secure his power, instead of engaging in damage control, his Administration should push in the Georgist direction, even if that means completely pissing off the vested interests within and without Turkey.

Monetary Policy Doesn’t Drive the Economy

by Derek McDaniel

To manage a currency, there are two primary tools: fiscal policy and monetary policy. Fiscal policy is all the spending done by the political authority (The Treasury), while monetary policy (setting the price for borrowing liquidity) is conducted by a so-called independent body (The Central Bank). Continue reading “Monetary Policy Doesn’t Drive the Economy”