Economic Policies for an Incoming Labour Government

By Bryan Gould and George Tait Edwards

Part 7: The Community Interest Bank Key to Local SME Development

Despite the provision to the banks of huge sums by way of Quantitative

Easing, very little of that money has found its way into bank lending for

productive investment. The excuses trotted out for this failure include the

age-old claim by British banks that the comparatively low level of their

lending to business does not evidence any reluctance to do so, but merely a

shortage of demand – or, to put it another way, a shortage of suitable

projects on which to lend. But no sense of this can be made unless we

know the terms on which the banks are offering to lend.

And that is precisely, of course, what we are not usually allowed to know.

The banks have traditionally been very coy about the terms they offer. But

the Bank of England has recently required the British Banking system to

make returns showing the extent and the terms of lending to enterprises.

The information that is now available shows that, by comparison with other

and more successful economies, our banks lend over a shorter term – in

other words, the money has to be repaid faster. The average term loan is

now under two years, with a repayment rate of about 65%. This means

that the annual repayment costs of bank loans for British firms over the life

of the loan are much higher, the adverse impact on cash-flow is therefore

more severe, and the need to make an immediate return on investment

(and a quick boost to profitability) is much greater.

Annual repayment costs that are several multiples lower than British

equivalents are a large part of the reason for the greater amount and ease

of bank borrowing enjoyed by businesses in, for example, Germany and

Japan, and in the new powerhouses of China, Korea and Taiwan – and that

is, of course, why they are able to buy up and make a profit from our failing

assets.

This is the origin of the much-lamented British disease of short-termism.

Short-term cash-flow or liquidity is at least as important to British firms as

longer-term profitability; indeed, it is literally a matter of life and death.

It is a factor that both inhibits the willingness to borrow (and therefore the

access to essential investment capital) in the first place, and – if the loan is

made – greatly increases the chances that it cannot be repaid in accordance

with the loan period and terms insisted upon by the banks.

If, as is all too likely, a business borrowing on these terms runs into

difficulties before the return on the investment funded by the borrowing

becomes available, the news gets worse. British banks, unlike their

overseas counterparts, show little interest in the survival of their business

customers. Their sole concern often appears to be to recover the loan and

interest payments due to them over the short period specified in the loan

arrangement. If that means receivership or liquidation – even if the

business had a good chance of survival were the investment plans funded by

the loan allowed to proceed – so be it. The banks can congratulate

themselves not only on the return of the loan and other payments due to

them sooner than if the business had been allowed to survive but also on

the money to be made from the disposal of the assets (sometimes to foreign

buyers) through the receivership process.

Previous attempts to improve the investment funding of SMEs have failed in

the United Kingdom, in the face of well-funded bank opposition to any

changes to improve the existing situation. The current concentration of 84%

of UK bank savings in six banks and the absence of public local banks of the

Spakassen type is largely responsible for current failings.

Bank branches in the UK at present act as facilities for collecting local

savings and then channelling them almost entirely into London; there is little

direction of such savings into local SME investments. The

millions of VAT-paying SMEs in the UK receive virtually no support from

the branches of the UK banking system except for the standard retail

service of a money transfer system.

By contrast, the more successful German economy has seven regional

banks, 453 Sparkassen (or local savings banks) and a network of 12,600

branches to provide SME loans from German savings. Each Sparkassen – all

453 of them – concentrate on providing business loans to SMEs in the area

where it is located, and each has an interest in, and commitment to,

ensuring the economic success of its native village, city or region.

Britain has nothing remotely similar nowadays, but it had such a system

until the 1880 Bank Amalgamations were put into effect, so destroying

“country banking” and paving the way for the English Clearing Banks. As Professor

Glyn Davies said in his 1979 evidence to the Wilson Committee “If Britain

had had the financial arrangements it has now at the time of the industrial

revolution, that revolution would have been still-born.”

This situation is no longer tolerable. If we are to prosper so as to compete

with powerful overseas competitors, the banking system must be reformed.

Fresh legislation should be enacted to require British banks to operate

mainly in just one of four separate categories – as retail banks, mortgage and

consumer credit banks, merchant banks, and investment credit banks. At the level of the local

community, community interest credit banks,

having the function of supporting and developing all of the local SMEs,

should be created to fulfil that function.

The Creation of Community Interest Credit Banks in Britain

The continuation of the existing banking arrangements, in which the

merchant bank gambling function is a legally allowable integrated division

of Clearing Banks with the rest of their banking business, is not a safe way

forward for the British economy, as Mervyn King has regularly warned us all.

That was the major cause of the credit crunch, because that structure

enabled British Banks to gamble with the savings and the circulating credit

of the UK on the international money, stock and bond markets. The “clever”

re-packaging of poor quality US housing debt, with the mistaken sale of

these mortgages as good quality loans when they were not, was the main

factor in causing the credit crunch.

The six major UK Clearing Banks give no priority whatsoever to providing long-term capital in

relatively small amounts to the 4.85 million SMEs of the United Kingdom.

There is not a single financial organisation in the UK which has the

objective of collecting financial savings and providing it, as required, at

local level to those millions of inventive and innovative local SMEs.

This has been the major conclusion repeatedly found by a number of high-powered

reports, most recently from the Committee to Review the Functioning of Financial Institutions

(successfully renamed the “Wilson Committee” by the British Clearing Banks

so as to imply that report was just a socialist recommendation) which emphasised

the need for patient, major long-term funding for British industry.

The industrial revolution was born from the commitment of local and

“country” banks to the SMEs which then grew into major industries.

All successful economic developments in all countries – in the UK’s

industrial revolution, in the USA, in Germany and in Japan – have depended

not just on the major industries but on the millions of SMEs

which continually provide the wellspring of small-scale services and

manufacture without which major national industries could not flourish.

It is essential that hundreds of local CICs with thousands of branches are

established throughout the United Kingdom. These local CICs should have a

“local first” commitment to the success of local SMEs which should be

provided with the funds required to provide the liquidity, working capital

and plant and equipment investment to improve their commercial

operations.

These local banks could be quickly provided by the nationalisation

of the Trustee Savings Bank and its local branches, which could be

regrouped into quasi-independent local-first CICs committed to the success

of the SMEs and industries in their local area.

© Bryan Gould and George Tait Edwards 2015

Economic Policies for an Incoming Labour Government

By Bryan Gould and George Tait Edwards

Part 6: The No-Cost Keynesian Stimulation of Demand in the Economy

An incoming Labour government could and should stimulate the economy by

restoring all the benefits (worth about £20 bn a year) which the Coalition

Government has reduced or denied to the low-paid, the sick, the disabled,

the poor and the underprivileged. The case for doing so is based not only on

social justice and on restoring the integrity of our society but on making

good the deficiency of demand that has handicapped our economy as a

consequence of austerity.

This would be achieved by creating £20 bn of consumer credit at the Bank

of England to fund the policy during that first year. The costs of that credit

creation for Government expenditure would be nil and the benefits would

be immense. If we assume the average UK tax take of about 42%,

government income would rise by about £8.4 bn; but because much of the

extra purchasing power might be spent on food and other non-taxed

necessities, the tax take might be about half of that – say 21%. On the

other hand, the extra spending would have a multiplier effect of about 2, so

that the total effect on the UK economy would be a stimulus of about

£40bn. Even allowing for a lower than average tax take, the Government

would still gain revenue of £8.4 billion, the economy would receive a

stimulus of £40 billion (a likely addition to economic growth of about 2.6%)

and many of the dire effects of the Coalition’s austerity programme would

be negated. The financial condition of Britain’s poorest would be

ameliorated; the poor would be more able to afford to eat, heat their

homes, pay their bills, and live better lives without worrying where the

next penny was coming from.

That policy could be continued in the following years but, as the additional

government taxes came in from economic recovery, the credit required to

be created would reduce accordingly eventually becoming nil within the

lifetime of the parliament as economic growth increased due to investment

credit economics.

The Credit Restoration of the Royal Bank of Scotland

The bad debts of the Bank of Scotland should be immediately purchased in

their entirety by the Bank of England, using targeted quantitative easing.

Again, it would cost the Government nothing. The Government would have

bought assets worth (say) 50% of their book value for nil expenditure. The

total bad debts of the RBS are estimated at £38 billion, so the Government

would gain assets of about £19 billion in return for no appreciable cost

whatsoever. Furthermore, the RBS would cease rejecting loan applications

from SMEs, where they are urgently needed but where about three out of

four are currently being turned away. There is no good reason why the RBS

should continue to do this, when normal business could be resumed

immediately.

Through this means, which could be applied to stabilise other British banks

as necessary, one of the main and continuing consequences of the Global

Financial Crisis – the overhang of bad debts that inhibit the banks from

lending – can be negated. Interestingly, one of Richard Werner’s major

findings from his inquiry into the reasons for the Japanese stagnation over

recent decades was the inhibiting effect of bad debts on the willingness of

the Japanese banking system to maintain an adequate level of credit

creation and therefore of liquidity. In this instance, we have the chance to

learn from Japanese mistakes. We should be clear that the objection based

on moral hazard pales into insignificance by comparison with the huge

economic advantages from pursuing this course.

Many of those who call themselves economists and many politicians who

imagine themselves to be competent will be stunned by these proposals, if

the past is any guide. As Keynes commented, “the difficulty lies not so

much in developing new ideas as in escaping from the old ones, which

ramify, for most of us brought up as we have been, into every corner of our

minds.” And as John Kenneth Galbraith, who was a member of the FDR

administration when the investment credit creation policy was adopted by

the US Government, has said, “the creation of money is so simple that the

mind is repelled.”

We should remind ourselves that there is nothing new about the creation of

credit by the Bank of England. No less than £375 bn of credit was created

to stabilise the liquidity and preserve the operation of British Clearing

Banks and £80 bn of such credit was created to support Vince Cable’s

proposal to extend business loans to industry.

The novel aspect (in British terms at least) of our proposals is that the

proposed credit is to be focused on useful social and economic objectives –

on the establishment of more prosperity among the poor and

disadvantaged, upon the minimal cost fixing of the RBS and other banks and

upon the creation of the kind of bank support for industry and commerce

that has existed for centuries in Germany, for about a century in Japan and

for about a third of a century in China.

The Mechanisms

The primary objective of the incoming Labour Government’s reforms should

be the establishment of a United Kingdom of abundant capital resources

and the placement of Britain’s future industries on a sound economic

footing. Inseparable from that first objective is the reformation of the

British banking system to ensure its future stability and effectiveness.

Another objective would be the fulfilment of the Government’s duty of care

to the people – the relief of the groups disadvantaged by the actions of the

recent Coalition Government and the restoration of full employment as a

government objective. Finally, measures should be taken to ensure the

permanence and continuity of these reforms through major changes in the

machinery of Government. We set out now our proposals for achieving

these objectives.

The Re-nationalisation of the Bank of England

The Bank of England should be brought once again under Government

control. It is unwise for any government to allow any natural monopoly to

be fully independent, and the control of credit creation is such a central

aspect of government policy that direct control is required.

The operating objectives of the Bank of England, as a central departmental

agency of government policy, will be redefined as the promotion of

economic growth and the control of inflation within the guidelines of a

national industrial and social development plan.

Gordon Brown’s proclamation of the “independence” of the central bank

was widely applauded at the time and remains a cardinal – and

unchallenged – element in policy today. Yet handing monetary policy over

to the tender care of a central bank is simply a reinforcement of the

current and increasingly discredited orthodoxy that inflation is the only

concern and proper focus of monetary policy and that its treatment is

simply a technical matter that is properly the preserve of unaccountable

bankers, and is not to be trusted to politicians. Quite apart from the

undemocratic nature of this approach, we have paid a heavy economic

price for allowing the bankers’ interest to prevail over the interests of the

economy as a whole.

It is easy to see why the bankers – and the economists who work for them –

should support this. It is less easy to see why the politicians should so

readily have accepted it. Yet the answer is fairly clear. It has suited the

politicians well to be able to argue that the travails of the economy arise as

a consequence of inexorable economic forces which must kept in check and

marshalled by expert technicians. Our governments have thereby been able

to disclaim any responsibility for policies for which they should be

ultimately responsible.

As a matter of interest, this very issue was succinctly discussed by members

of the Japanese Committee on Financial System Research (Kinyu Seido

Chosa Kai) as it considered whether to revise the 1942 Japan Law that

established the Bank of Japan’s primary objective as the promotion of

economic growth. On that Committee, Dr Shimomura represented the

Ministry of Finance, while his opposite number was Mr Shigeo Matsumota,

representing the Bank of Japan.

Dr Shimomura is reported as having “stressed the inevitable subordination

of the central bank to the government from two standpoints – that the

policy of the central bank should be managed and operated in

full coordination with the general economic policy of the Government and

that the Government on its part is called upon to hold itself responsible to

the nation for the outcome of its financial policy.”

Mr Matsumoto on the other hand “emphasised the necessity of maintaining

the independence or neutrality of the central bank from the Government on

the ground that the central bank is first of all assigned with the task of

contributing to the stabilisation of the currency value….”1‑

What is clear is that an economic policy that breaks the shackles of current

orthodoxy would necessarily have to be removed from the exclusive and

self-interested control of bankers. It would need to be driven by politicians

who saw the need to ensure that the wider interest is carried into policy

and is an essential element in setting its direction and gaining for it the

necessary support.

© Bryan Gould and George Tait Edwards 2015

1. From “The Political Economy of Japanese Monetary Policy” by Thomas E Cargill, Michael M Hutchinson and Takatoshi Ito, The MIT Press, Cambridge Massachusetts and London, England, p24.

Economic Policies for an Incoming Labour Government

By Bryan Gould and George Tait Edwards

Part 5 of 9 – The Two Great Traditions in Western Economic Thinking

In studying what actually happened to the Japanese economy and then testing various explanations

for consistency with the observed data, Professor Richard Werner of

Southampton University has placed himself firmly in the first of the two great traditions in

Western economic thought. That first tradition, dating from the time of

Adam Smith, derives economic conclusions from detailed observation and

inductive reasoning based upon the observed facts and data analysis. The

second tradition, most highly developed in the 20th century with the

development of mathematical economic models and more lately computers,

develops a body of deductive reasoning based upon stated theoretical

propositions.

The “bottom up” tradition of observing what is happening, building

economic understanding on the foundation of the observed circumstances

or measured data, and arguing from the observations or the data to the

economic theory is exemplified by Adam Smith’s, The Wealth of Nations.

An example of his technique is his reference to the productive power of

specialisation, which he illustrates by referring to the workers in a pin

factory, and demonstrating how, by breaking down the elements of

production into their constituent parts, a few specialised workers can

create thousands of pins a day when one man could hardly produce one pin

per day on his own. Smith’s book is a major illustration of the major

scientific principle – revived in the Renaissance – of learning by observation,

extracting the particular principle from the general, and basing theory upon

precise, real-world, observation.

The one common factor in the work of Adam Smith, and of John Maynard

Keynes, Osamu Shimomura, Kenneth Kurihara and Richard Werner is that

they all belong to the first tradition in economics, the derivation of valid

theory from detailed observation. Smith in the pin factory; Keynes in his

observation that labour markets, left to market forces, do not produce full

employment; Shimomura deriving the economic model for Japan from his

observation of the productive force of credit creation in the USA from

1938-44; the Japanese-American Kurihara – examining and discussing the

Japanese economic miracle in close-up while acting as the Fulbright

Professor to Tokyo University in 1965; the German-born and Japanese-fluent

Werner in Tokyo, working from the Bank of Japan financial data about

credit creation in Japan, and analysing it into its three key functions of

investment credit, financial credit and the presence (or lack of)

consumption credit, and then proving the predictive linkages using Granger

causative analysis – the work of all these economists is located in the great

inductive tradition of economics.

The second and more recent tradition in Western economics is the “topdown”

approach. This starts from explicitly stated but theoretical

assumptions and then proceeds logically from these to policy

recommendations, using deductive reasoning and highly developed

mathematics. A number of assumptions are made – that consumers and

investors act within perfect markets, with access to perfect information, in

a world in which perfect information has levelled out local differences. On

this basis, deductive logic arrives at economic models which appear to have

great logical validity but which – as Keynes asserted – may bear little

relation to reality. In view of the imperfect outcomes of this second

approach, as evidenced by the declining fortunes of many western

economies, there is much to be said for a return to the methods used by

Adam Smith and his great successors.

Three Practical Illustrations of the Use of Credit Creation

As we have seen, if credit creation is left to the tender mercies of self-interested

commercial banks, credit will be largely devoted to gambling on

property creating a housing and other asset bubbles so as to maximize

profits for private shareholders while the real economy languishes for want

of adequate liquidity and investment capital, and the economy as a whole is

handicapped by a shortfall in effective demand.

An incoming Labour government, however, fully understanding the use of

credit creation in the public interest, could resolve many outstanding

problems. We provide three examples of the way in which this would work

to achieve quite different kinds of objectives.

The Acceleration of British Economic Growth Through Higher Investment

This aspect of central bank credit creation is by far the most potent policy

within a government’s control. It would allow the government to create

earmarked investment credits, cost-free, for use by SMEs and other private

companies to ensure the fulfilment of the Government’s economic, social

and environmental policies.

The provision of these funds would be directed by the Bank of England,

reflecting advice from the Treasury – a technique described as “Window

Guidance” when used by the Bank of Japan in using similar mechanisms in

the 1960s and 1970s. There would need to be a bank which was, or ideally a

number of banks which were, prepared to use its local branches as taps for

local investment (as the Sparkassen in Germany are) and not just – as

currently occurs – as drains to collect local saving, taking it away for

whatever fashionable policy use the London HQ decides.

The initial creation of credit could be at the level of about 10% of GDP, that

is about £150 bn a year; multiplier effects might create an eventual new

level of commercial and industrial funding of about £300 billion. We would

expect these funds to be initially used to provide an improvement of about

£100 billion in business liquidity, about £100 billion in early new plant and

equipment investment and about £100 billion in funding higher levels of raw

materials, working capital and work in progress. If the usual level of tax

take of 42% applies to the new investment and to work in progress,

government revenue receipts could increase by about £84 billion – an

excellent return to government in addition to the overall benefit to the

economy as a whole. Furthermore, that new investment would produce a

permanent increase in output of about an extra £100 billion a year, equal to

a permanent increase in GDP of about 6.7%, and a permanent rise in

government revenue of about £42 billion a year. We think these changes

would occur within about two years.

Some economists have traditionally argued that, because an extra job in

manufacturing industry has historically created another job in the service

industries, the final effect could be twice the initial stimulus. It is indeed

likely that placing the economy on a higher growth path will enable the

under-performing assets and spare capacity in our industries to respond to

the higher levels of demand created by this stimulus.

The experience of other countries shows that investment credit economics

works by creating wealth in the productive sector of the economy. The

loans made are almost completely repaid (the failure rate is typically about

2.5%) out of the growth of the economy resulting from the additional

investment. The failure rate of these loans matters little in any case

because the loans cost nothing to create; their consequences matter,

however, because they produce their targeted effect in reducing poverty,

stabilising the banking system, and creating widespread prosperity through

many flourishing private industries in all the areas of the country.

The increase in output would obviously negate the risk that a substantial

increase in the money supply could be inflationary, as Keynes recognized

and as the Japanese experience in particular demonstrates. The

consequence of the increased money supply could well be a fall in the

international value of the pound, which could only be helpful in

ameliorating the competitiveness problem of British industry and in

ensuring readily available markets for increased British production.

Unemployment will fall to a low level. Social security payments will

automatically reduce as fuller employment becomes the norm and

Government income will cease to be disappointing, ending the need for

austerity in government expenditure and bringing to an end all of its ill

effects for our people.

© Bryan Gould and George Tait Edwards 2015

Economic Policies for an Incoming Labour Government

By Bryan Gould and George Tait Edwards

Part 4 of 9 – Shimomuran Economics

The body of developed policy that underpins Asian industrial and economic

success is not understood in the West, yet it was clearly foreshadowed in

the work of the greatest western economist of the twentieth century, John

Maynard Keynes. It is a sad reflection on western economists that the

Keynesian insights were most fully developed by the great Japanese

economist, Dr Osama Shimomura 1910-89, whose work has only recently

come to the attention of western economists by virtue of the sustained

efforts over four decades by the second author of this paper.

An indication of the extent to which Shimomura has been overlooked in the

West is the fact that his works have never been translated Into English

except by the Indian Statistical Institute1, (and even in that work the

Development Bank of Japan has edited out Shimomura’s key formulae).

Shimomura enjoys, however, a towering reputation in his own country. The

Development Bank of Japan offers a “Shimomura Fellowship” to

commemorate his life on the basis that “during his long career as an

economic scholar and critic, Dr Shimomura rose to become Japan’s most

influential post-war economist, founding a school of thought based on the

“Shimomura Theory,” which attracted numerous followers.”2

He was acknowledged, within Japan and during his lifetime, as the “brains

behind the Japanese economic miracle” – the most successful national

economic growth plan of the 20th century. Five of his published works

became available in the British Library last year but there seems to be little

interest in how Japan, in the course of a few decades, progressed from the

war-damaged, impoverished country of 1945 to become one of the most

highly developed and powerful industrial economies in the world.

Shimomura’s major contribution to macro-economics is his economic growth

model, the basis of which was that the total level of Japanese investment is

equal to the natural investment level (that is, investment financed by

savings) plus the additional investment financed by credit creation

originating at the Bank of Japan. The model illustrated the range of that

additional credit-created investment as no less than 10% to 15% of national

income a year.

It is generally agreed by most economists, following Keynes, that

investment is the major key to economic development and growth.

Shimomura’s economic model applied an extension of the Keynesian

analysis and showed that an economy could selectively increase its

investment level through an increase in investment credit at the central

bank, if that credit was earmarked for commercial and industrial

investment. The rapidity of Japanese industrial development in the 1960s

and 1970s, in apparent response to the stimulus provided by investment

credit-creation by the Bank of Japan under instructions from the

government, is widely seen in Asian economies as a vindication of

Shimomuran policies.

Professor Kenneth K Kurihara (1910-1972) – the Distinguished Professor of

Economic Theory at the State University of New York in Binghampton,

teacher of macro-economics at Princeton and Rutgers, the State University

of New Jersey, guest lecturer at the universities of Oxford and Cambridge,

and author of “The Growth Potential of the Japanese Economy” – was one

of the most influential interpreters of Shimomuran economics; he also had

the great advantage of being able to write in English. He concluded that

“if, therefore, greater investment can be financed partly by credits, there

is no need for that ‘abstinence’ which the classical economists considered

necessary for economic progress, any more than there is for that ‘austerity’

which some present day underdeveloped countries impose on already

under-consuming populations at the constant peril of social unrest. Nor is it

difficult, in such credit-creating circumstances, to agree with Keynes’

observation that investment and consumption should be regarded as

complementary rather than competitive.”3

After more than two decades of persistent stagnation, during which

Shimomuran policies were lost sight of, and supplanted by policies urged on

the Japanese by the IMF and western economists, Shimomura is now back in

favour in Japan. The Prime Minister of Japan, Shinzo Abe, announced on 19

April 2013 in a speech to the Japan National Press Club that Japan is once

again implementing Shimomuran economics – he explicitly made two

references to Dr Shimomura – in order to end the Japanese depression and

restore high growth to create once again what he described as “a Japan of

abundant capital.”4

Western economists, however, seem to be unaware of this revival of

Shimomuran economics. On the rare occasions that they have been invited

to consider the issue, they have maintained that correlation is not

causation, and that there is no evidence that the new credit created by the

Bank of Japan “caused” the observed growth in the 1960s and 1970s, or

that the cessation of that growth was the consequence of abandoning credit

creation. And there the argument might have rested except for two recent

developments.

First, the British economist Sir Clive Granger produced, in a 1969 paper in

Econometrica, a new statistical technique called Granger Predictive

Causation Analysis – an achievement that led in 2003 to his award, along

with his colleague Robert Engle, of a Nobel Prize for contributions to

economics. The Granger Causality Analysis tests the validity of predictive

causative links between two economic factors; using Granger predictive

analysis, it can be shown whether there is a predictive link between two

items of economic time series.

Second, and more recently, detailed and expert work on the course of the

Japanese economy – both its period of sustained and almost unprecedented

growth, and its subsequent period of stubborn stagnation – was undertaken

by Professor Richard Werner, professor of economics at the University of

Southampton. Professor Werner originated the term “quantitative easing”

and in 1991 predicted the imminent ‘collapse’ of the Japanese banking

system and the threat of the “greatest recession since the Great

Depression”. He is a specialist in the Japanese economy and became the

first Shimomura Fellow at the Research Institute for Capital Formation at

the Development Bank of Japan where he spent ten years in the 1990s.

Professor Werner has applied Granger Predictive Causation Analysis to the

Japanese data over a long period and has shown in his book “New Paradigm

in Macroeconomics” – that there is a clear Granger causation predictive link

between investment credit creation at the Bank of Japan and subsequent

rates of Japanese economic growth, both positive and negative. He also

found that the causative link that is so clear in the case of investment

credit creation does not hold good in respect of any other of the

candidates, such as interest rates, structural changes, and so on, that are

often advanced as potential explanations for the vagaries of the Japanese

economy over five decades. Significantly, Werner also found that excessive

credit creation where that credit is not earmarked for use in new

investment in productive capacity will finds its outlet in speculation and the

creation of asset bubbles, as occurred in Japan from 1986-91.

Werner’s use of the Granger technique and the conclusions he is able to

draw allow us to say with certainty that the use of investment credit

creation has been the essential element in determining the rate of growth

for the Japanese economy. Empirical observation and the analysis of the

observed data allow for no other explanation. It is on that basis that we can

extrapolate from the Japanese experience, as identified by Werner, to

western economies, and say that – since advanced economies function very

similarly, whether in Japan or elsewhere – the solution to the poor

performance and lagging development of western economies is the adoption

of investment credit economics, which is fully capable of reversing the ill effects,

including the damage to personal incomes and the social fabric, of

austerity.

1 A reference to that inadequate translation of what is perhaps Shimomura’s most significant

books, Seicho Seisaku No Kihon Mondai (Basic Problems in Growth Policy, 1961) can be found

http://books.google.co.uk/books/about/Basic_Problems_of_Economic_Growth_Policy.html?

id=DyNjHQAACAAJ&redir_esc=y

2 See http://www.dbj.jp/ricf/en/fellowship/

3 See “The Growth Potential of the Japanese Economy” (John Hopkins Press Maryland 1971), pp.

137-138

4 http://www.kantei.go.jp/foreign/96_abe/statement/201304/19speech_e.html

Economic Policies for an Incoming Labour Government

By Bryan Gould and George Tait Edwards

Part 3 of 9 – The Different Uses of Credit Creation

Credit creation when properly deployed can serve five main purposes, each

having major and differential effects on the real economy. We cannot

expect, and nor can an incoming Labour government, to produce better

economic outcomes unless we understand the differences between them.

First, credit creation may be undertaken (and usually is) for purely

speculative purposes. Its principal purpose and effect is to fund housing

purchase and speculative financial transactions; it is often the main factor

in the development of housing, land and asset bubbles. It is this aspect of

credit creation that attracts most attention in today’s economy and which is

the main focus of the banks’ activities, since it is the easiest business to

attract, the most secure (since mortgages guarantee the value of the credit

in most cases) and the most profitable.

It is also the principal factor in stimulating inflation; housing values, in

particular, rise sharply as large volumes of credit-created money flow into

the housing market, and the consequent asset inflation is inevitably

followed by consumer led inflation as home-owners use the increased value

of their equity to increase consumption. This is, of course, of great

significance, given that the control of inflation is the prime and virtually

only focus of macro-economic policy; it suggests that the use of interest

rates to tighten monetary conditions, impacting as it does on the whole

economy, fails to address effectively and accurately the real cause of

inflationary pressures and is an unnecessarily broad and badly focused

instrument that does great damage to the wider economy at the same time.

The overwhelming dominance of credit creation for speculative purposes –

for both housing and other financial transactions – has other adverse

features. It distorts the desired operation of the economy by diverting

investment capital away from productive purposes, and by creating asset

bubbles in both residential housing and financial assets, not least in western

stock exchanges; and the resultant constant inflationary impetus then has

to be restrained by measures such as higher interest rates, so that the

chances of greater innovation and productivity are further prejudiced.

Despite all of these downsides, credit creation for speculative purposes as a

major economic factor impacting on the real economy is virtually ignored

by our policy-makers, except to the extent that it is seen as perfectly

normal and relatively benign.

The second kind of credit creation operates as an important element in

demand management. It is used to raise purchasing power by putting more

money in people’s pockets, and thereby can help to resolve the problem of

deficient demand that Keynes identified as the key element in the Great

Depression and that continues to characterise recessionary conditions today.

It would normally be undertaken by the banks, under direction from the

central bank or the Treasury, though it could also be undertaken directly by

the central bank or the government. It is little used in today’s Britain, not

surprisingly, when the Coalition government does not recognise a deficiency

of demand as the feature of a recessionary situation that needs correction.

It has, however, returned to favour as a counter-recessionary instrument in

the thinking of some of our leading monetary economists. Keynes had

suggested in the 1930s – half-jokingly but so as to make a serious point –

that a valuable counter-recessionary outcome could be obtained by burying

money in the ground and then paying firms to employ people to dig it up.

Their increased income would represent a significant increase in purchasing

power and therefore demand.

Such a policy today is often pejoratively characterised as “helicopter

money” – the notion that demand could be raised if pound notes were

scattered from the air – but has been seriously analysed by economists such

as Adair Turner and Michael Woodford who have reached the point of

debating whether it would best be delivered by fiscal measures (such as tax

cuts) or by monetary policy (essentially printing money).1

Credit creation undertaken to raise demand does not mean that it cannot

serve other purposes at the same time; or, to put it in another way, credit

creation undertake for other purposes, such as funding the purchase of

assets or providing capital for investment, may well also have the additional

effect of lifting the level of demand. As we shall see, the crucial question

is then as to whether the increased demand is merely inflationary or is

matched by increased output.

Thirdly, credit creation can also be undertaken for the purpose of stabilising

the financial system; this technique, which has been called Quantitative

Easing over recent times, has been implemented by governments in both

the UK and the US, and was meant to remedy – in the wake of the Global

Financial Crisis – the precarious situation of an otherwise bankrupt financial

system. In the case of the UK, the policy took the form of the Bank of

England’s £375bn of financial credit to stabilise the UK Clearing Banks but it

did nothing to benefit the wider economy. The greater proportion of that

sum was used by the banks to strengthen their balance sheets (and to

resume paying large bonuses); very little found its way into lending to the

Small and Medium-Sized Enterprises that desperately needed help in

maintaining adequate liquidity (and for plant and equipment investment).

Credit creation for the purpose of funding major innovative programmes –

sometimes called Government Credit Creation (GCC) – is the fourth kind of

credit creation and is designed to enable major innovative structural

economic change, such as the invention of the atomic bomb, the mass production

of synthetic rubber in the US in 1940-44, and President Obama’s

Energy Initiative; it is often resorted to in wartime. The intention is to

stimulate innovation in the public sector or infrastructure area of the

economy and to undertake large-scale projects that are vitally important to

the economy but are too large or not commercially rewarding enough to

attract private capital.

This kind of credit creation for public purpose is being supplanted

increasingly in Britain today by Public/Private Partnerships, on the specious

ground that they offer better value to the taxpayer; the reality is that they

are much more expensive than publicly funded projects, but they have the

great merit in the eyes of right-wing governments of offering fat profits to

their friends in private industry.

The fifth and, for our purposes, most interesting and important form of

credit creation is usually called Investment Credit Creation (ICC). This form

of credit is targeted at increasing investment in the plant and equipment

level in private industry, with the goal of encouraging productivity

improvement, accelerating the rate of economic growth and providing full

employment. Investment Credit Creation is usually delivered through the

local banks (if you have any) at the behest of the central bank and the

government. It is this aspect of credit creation that has been virtually

ignored in western economies over recent decades but which offers by far

the best prospect of breaking out of our seemingly irreversible economic

decline.

There is today virtually no understanding in Britain and other western

countries of how Investment Credit Creation functions and of the benefits it

can bring to economic development. The provision of credit – that is, bank

lending – is seen almost exclusively in terms of its capacity to stimulate

inflation and is seen therefore as a potential threat rather than as an

essential element in producing a better economic performance.

This is notwithstanding Keynes’ perceptive assertion that there is no reason

why the provision of credit for the purpose of productive investment should

not precede the increase in output that it is intended to produce, provided

that the increase occurs over an appropriate time frame. Other economies

have understood and benefited from this insight and have used Investment

Credit Creation to stimulate growth, without being inhibited by the

conviction that any increase in the money supply must necessarily be

inflationary.

There are, in fact, many persuasive instances from both recent history and

from other countries of the successful deployment of Investment Credit

Creation. One of the most striking examples of the use of credit creation,

not to inflate the property market for private profit as is done in the West

at present, but to stimulate rapid industrial growth, was provided by the

United States at the outbreak of the Second World War, when Roosevelt

used the two years before Pearl Harbour to provide virtually unlimited

capital to American industry – simply by printing money – so that the

country could rapidly increase its military capability.

Roosevelt encountered the usual objections from conventional economists

but the exigencies of war and his own political strength and will prevailed.

The results were spectacular and hugely significant. American industrial

output grew on average by an unprecedented 12.2% per annum from 1938

to 1944 – an outcome that went a long way towards enabling the US, and

the Allies more generally, to win the Second World War.

An equally impressive instance is provided by Japan in the 1960s and 1970s,

when Japanese industry was enabled by similar means to grow at a rapid

rate so as to dominate the world market for mass-produced manufactured

goods. Western economists have typically shown no interest in how this was

done and are almost totally ignorant of the work of leading growth expert

economists such as the Japanese Osamu Shimomura and the American-

Japanese Kenneth Kurihara. We shall look in more detail 2 later at exactly

how Investment Credit Creation was specifically implemented by the Bank

of Japan, at the behest of the government and following the advice of

Shimomura and his colleagues, and accordingly brought about the Japanese

economic miracle.

More recently, China has used similar techniques to finance the rapid

expansion of Chinese manufacturing. The Chinese central bank, and their

provincial counterparts, under instructions from the government, makes

credit available to Chinese enterprises that can demonstrate their ability to

comply with the government’s economic priorities. Enterprises that wish to

build or buy new capacity in compliance with the overall industrial strategy

are provided with the required investment capital, obtained through cost-free

credit creation; Chinese manufacturing capacity in particular has

largely been funded by such government-authorised new credit, as has the

huge purchasing programme of strategic assets from around the world that

is currently being undertaken by Chinese enterprises. This is admittedly, in

principle at least, easier to bring about in a totalitarian regime than in the

UK, but in practice there is nothing to stop a British government from

requiring the central bank, as the Chinese have done, to create cost-free

credit for specific (and productive) purposes.

Other Asian countries, such as Korea and Taiwan, have applied similar

policies in order to produce rapid industrial growth. Typically, however,

Western economists have arrogantly assumed that these successful

economies have nothing to teach us, and are easily dismissed as

undeveloped economies relying for competitive advantage on cheap labour;

the reality is, of course, that these economies are, as a consequence of the

rapid economic growth and industrial development made possible by

Investment Credit Creation, delivering incomes and living standards to their

populations that are approaching and in some cases surpassing those in the

West.

1 See www.voxeu.org/article/helicopter-money-policy-option

2   http://londonprogressivejournal.com/article/view/1565/the-key-relevance-of-the-writings-of-professor-kenneth-kenkichi-kurihara

© Bryan Gould and George Tait Edwards 2015