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

Economic Policies for an Incoming Labour Government

By Bryan Gould and George Tait Edwards

Part 2 of 9: Stimulating Wealth Creation

If we are to find that better way, we must clearly understand the failures

and deficiencies of what has gone before. A major milestone in that quest

for understanding was reached earlier this year when the Bank of England,

in an article published in its first quarterly bulletin for the year1 became

the first significant central bank to acknowledge that the vast proportion of

money in our economy (calculated by the authors at 97% of the total money

supply) is created by the banks. This admission, which has been hotly

contested and denied by bankers and economists for decades, if not

centuries, casts a whole new light on the meaning of money and its

significance for economic policy, and is the key to a new approach – not

only as a response to recession – but as the foundation of a successful

economic policy.

We need not explore here the mechanisms by which the banks create

credit; suffice to say that they are well set out in the Bank of England

paper, and in the end amount to the simple fact that the banks are not

simply intermediaries, bringing savers and lenders together. They do not

lend money deposited with them but instead lend money that they

themselves create by making book entries unsupported by anything other

than their willingness to lend. But while the mechanisms may be simple,

the implications for policy are huge.

The facts that the quantity of money is almost entirely a function of bank

policy and that its continuing but regulated growth is the normal and

required condition for a well-functioning economy suggest strongly that the

conventional treatment of money as a neutral factor in economic policy is

completely mistaken. Current monetarist orthodoxy treats the money

supply as reflecting more or less automatically the needs of the real

economy, and impacting on it only in the sense that, if it is allowed to grow

too fast, it will generate inflation. The reality is, however, that the rate of

growth in the money supply is not just a function of the level of real

economic activity but is, as we shall see and according to the purposes to

which it is put, an important determinant of that level.

It is worth registering at this point that the banks’ remarkable monopoly

power to create (or “print”) money is exercised entirely in the interests of

profits for their own shareholders rather than of the economy as a whole.

It might be thought that this private exploitation of such an important

power would warrant the most careful public scrutiny, yet it attracts

virtually no attention from policymakers, other than in terms of countering

inflation; the Coalition government prefers to focus on reducing

government spending, as the supposedly essential feature of macroeconomic

policy.

They thereby totally overlook the fact that it is extraordinarily important

for the purposes of economic policy-making as a whole to understand the

impact of private money-creation on this scale and, in particular, to analyse

the purposes for which that credit is created.

A Labour government should no longer, in other words, accept that credit

creation by the banks is benign, and automatically serves – because it is

allegedly self-regulating – the public interest; a more effective economic

policy depends crucially on an acknowledgment that credit creation (and

therefore the whole of monetary policy) is hugely important and impacts

directly and substantially on the development of the real economy, and can

be made to serve a variety of wider economic interests rather than simply

those of private profit-seeking bank shareholders. A Labour government

that took this position would surely be encouraged to find that, on this

issue, public opinion had got there first.

Keynes was well aware of the fact, and of the almost unlimited potential,

of credit creation by the banks and recognised it as an important element in

macroeconomic policy. His pre-war contention that “there are no intrinsic

reasons for the scarcity of capital” is supported by compelling evidence, not

least now by the Bank of England’s recognition that money is created by the

banks from nothing. What should now be fully recognised, however, is that

the purposes of credit creation could and should extend well beyond the

funding of house purchase, which is currently its major feature.

Credit creation at the central bank, if properly directed and managed, can

be used to selectively increase the private investment level of the country,

as has previously occurred in all very high-growth economies, and as could

happen in Britain.

1Bank of England Quarterly Bulletin, 2014, Q1 “Money Creation in the Modern Economy” by

Michael McLeay, Amar Radia and Ryland Thomas of the Bank’s Monetary Analysis Directorate.

© Bryan Gould and George Tait Edwards 2015

Economic Policies for an Incoming Labour Government

By Bryan Gould and George Tait Edwards

Part 1 of 9: The Coalition Government’s Failed Austerity Programme

The outcome of the next general election cannot be confidently predicted but one thing is clear; the odds on both a Labour election victory and a successful term in office would be greatly increased if the Labour leadership had the confidence and courage to develop and deliver a convincing alternative economic policy.

At present, Ed Miliband and Ed Balls seem inhibited from attacking the

failed policies of austerity (to which George Osborne claims there is no

alternative) and are content to focus on policy in other areas as a means of avoiding any real debate on economic policy. Yet there is, as both

experience and reason demand, a growing consensus that austerity has

failed and, as a consequence, an urgent need for Labour to describe clearly what an alternative and better policy should be and how it would operate.

The purpose of these articles is to identify one of the basic and central

issues on which that successful alternative policy should be developed. A full understanding and adoption of the proposals advanced here would allow the Labour leadership, in the run-up to the election, to attack the

Coalition’s economic record with greater conviction and confidence, and

would provide the launching-pad in government for a long-delayed and

hence urgently needed restoration of Britain’s economic fortunes.

Not A Moment Too Soon

The new direction that an incoming Labour government must adopt will

come not a moment too soon. The damage done by the Coalition

government is cumulative and fundamental, and extends beyond purely

economic failure to social dislocation and political disintegration.

In economic terms George Osborne’s record is appalling. The so-called

recovery has been delayed unnecessarily for more than half a decade and means that a return to pre-2008 living standards is still many years away.

Median GDP is still 3% below 2007 levels, and since the population has

increased by3%, that means an average fall in individual incomes of 6%.

The decline of the productive sector and particularly of manufacturing has meant that only 10% of our GDP is now accounted for by manufacturing -the lowest proportion of any major developed economy – and our share of world trade has fallen to just 2.7%.

Coalition polices have resulted in the sharpest fall in living standards in

more than 60 years. According to data from the Institute of Fiscal Studies, average wages have fallen by over £1,600 since 2010, at an average rate of over £530 a year. The pre-Coalition reduction in median income (not the same as average wages, but an acceptable proxy), can be calculated at about £5,400 over thirty years (1980 to 2010) – about £180 a year – so that the Coalition has produced a reduction in worker incomes of almost three times the previous trend.

But these figures relate only to the working population, and take no

account of the reduction in unemployment and disability benefits, the

denial of benefits to mothers seeking work because they have not been

employed during the previous two years, and the exclusion from the data

for both the employed and unemployed of the growing practice of zero hours contracts, all of which mean that the real extent of income cuts is

much larger than official figures indicate.

The burden imposed on working people has not of course been shared by the wealthiest people in our society. According to an Oxfam report1, the richest 5 families in Britain have more wealth than the poorest 20% of the population. That level of inequality is unprecedented since records began in the UK.

In an even more recent report2, Oxfam also reports that the Coalition’s

welfare cuts have pushed 1.75 million of the UK’s poorest households

deeper into poverty, suffering an absolute cut in their income in the past

three years and leaving them struggling to cover food and energy bills.

The national scandal that millions of children in the UK are going to bed hungry is not some accidental by-product of Coalition policy. It is the inevitable and deliberate consequence of policies pursued by a government that is “of the privileged, by the privileged, for the privileged”.

The disadvantaged poor – the disabled, the sick and the unemployed – have suffered, through cuts in their benefits, the greatest burdens in dealing with the recession. SCOPE, the charity supporting disabled people, have shown, for example, that 600,000 people in the UK lost a total of £2.62 billion pounds a year from Monday 8 April 2013 as a result of the Coalition Government abolishing the Disability Living Allowance (DLA) and introducing the new Personal Independence Payment (PIP), with tighter eligibility criteria and a controversial new assessment. The purpose of that change is not to improve service or to make things more fair but simply to save money. The lack of concern for the most disadvantaged in our society was compounded by the amazingly (and deliberately) inaccurate statements about incapacity benefit made by Ian Duncan Smith.

Coalition policies have disproportionately affected women, who are

more often found in lower-paid occupations and in the caring

professions. An analysis of Treasury data by House of Commons Library

researchers in 2012 showed that £11.1bn of the £14.9bn raised from the

five spending reviews since 2010 comes from women even though they earn less than men on average. Planned changes to tax credits, child benefits and public sector pensions were largely to blame. They came shortly after the government announced plans to cut the 50p top rate of tax for all those earning over £150,000.

A Failed Banking System

The failures of the Coalition government have extended into other areas of policy. One of the principal reasons for both the excesses that led to the Global Financial Crisis and the difficulty we have had in recovering from recession has been the absence of a responsible and supportive financial-industrial banking system in the United Kingdom. The Coalition Government acknowledged as much in “The Coalition: our programme for government”3 where they promised that, “We will reform the banking system to avoid a repeat of the financial crisis, to promote a competitive economy, to protect and sustain jobs”.

None of this has been done. There has been no reform of the banking

system with the result that, as Mervyn King has regularly warned, a repeat of the financial crisis is still a major risk.

They further promised that “We will introduce a banking levy and seek a

detailed agreement on implementation.” The banking levy was introduced in 2010 and was intended to raise £2.5 bn, but has raised nothing like that sum. In the 2014 Budget, George Osborne restructured the levy to provide maximum limits for individual banks and five bands, which meant a cut that is disproportionally beneficial to the very largest banks.

They also undertook to “bring forward detailed proposals for robust action to tackle unacceptable bonuses in the financial services sector; in

developing these proposals, we will ensure they are effective in reducing

risk.” Less than six months after the Coalition came into Government, the proposal to deal with bonuses was abandoned. Bonuses are back with a vengeance.

A fourth promise to “bring forward detailed proposals to foster diversity in

financial services, promote mutuals and create a more competitive banking industry” produced no action whatsoever, while a fifth to “develop effective proposals to ensure the flow of credit to viable SMEs … which will include consideration of both a major loan guarantee scheme and the use of net lending targets for the nationalised banks” produced an extra £80 bn of re-discounting of loans by banks, part of which may have proved useful to some banks who wished to reduce the bank levy, but which nevertheless produced a fall in loans to SMEs of about £56bn.

The failure to take effective action on any of these issues has been, as we shall see later, hugely detrimental to any attempt to correct one of the main deficiencies in the management of the British economy. The failures were compounded by the fate of the Parliamentary Commission on Banking Standards which was established in July 2012, following the LIBOR-rigging crisis. The Commission’s report was set aside by politicians who showed themselves anxious to find reasons to shy away from the necessary reforms. It was claimed that such reforms had been rendered unnecessary by reforms already being implemented, that they would damage the competitiveness of the City and cost jobs, and that they would harm the banks’ ability to support the rest of the economy.

The UK’s competitiveness will be threatened in the long-term by this

indifference to the dangers associated with poor banking standards and

culture. If the arguments against complacency and inaction have not been heeded now, when the crisis in banking standards has been laid bare, they are yet more certain to be ignored in the future when memories have faded.

It should be understood, however, that the real problem with British

banking is not about dubious ethics but that it does not, unlike foreign

banks, see the funding of investment in productive capacity as its main

function. The right ethics with the wrong agenda is no recipe for British

economic recovery.

The list of failures demonstrates one central theme; because the Coalition Government does not understand the process of wealth creation at all, their focus is on the side-issue of making economies in the budgeted cost of government. Their obsession with the objective of achieving a balanced budget blinds them to the fact that there is a much better way to govern Britain – a way that increases the wealth and welfare of all, as we will illustrate in the following articles in this series.

1 www.theguardian.com/business/2014/mar/17/oxfam-report-scale-britain-growing-financial-inequality?

CMP=EMCNEWEML6619I2

2 www.theguardian.com/politics/2014/apr/22/welfare-cuts-drive-uk-poorest-poverty-oxfam

3 www.gov.uk/government/uploads/system/uploads/attachment_data/file/78977/ _programme_for_government.pdf

© Bryan Gould and George Tait Edwards 2015