Download Two Victims of the Euro - Causes and Escape Routes for Greece

Centre for Banking, Finance
& Sustainable Development
Business School
Two Victims of the Euro – Causes and Escape
Routes for Greece and Germany
Prof. Richard A. Werner, D.Phil. (Oxon)
Centre for Banking, Finance and Sustainable Development
University of Southampton Business School
17 May 2017
Symposium
Greece Out of the Crisis: Debt-End or Dead End?
Webster University, Business Management Dept., Vienna
Sofitel Stefansdom, Vienna
Richard A. Werner 2016
Centre for Banking, Finance
& Sustainable Development
Unresolved Major Puzzles in Modern Economics:
Business School
1. The Anomaly of Banks
2. The Anomaly of Bank Lending
3. The Anomaly of Recurring Banking Crises
4. The Anomaly of Fiscal Policy Ineffectiveness
5. The Anomaly of Interest Policy Ineffectiveness
6. The Anomaly of Interest Rates and Growth
7. The Anomaly of Ineffectiveness of ‘Quantitative Easing’
8. The Anomaly of the Velocity Decline
9. The Anomaly of Money
10. The Anomaly of Asset Prices
11. The Anomaly of Japanese Capital Flows
12. The Anomaly of Exchange Rates
13. The Anomaly of the Failure of Deregulation/Liberalisation (Supply Side Policy
Ineffectiveness)
14. The Anomaly of the Irrelevance of Central Bank Independence
Richard A. Werner 2016
1
Centre for Banking, Finance
& Sustainable Development
Business School
The Key Determinant of the Cycle
Official Story: Interest Rates
 Central bankers, market pundits, journalists have been repeating the
mantra that interest rates are the key variable driving the business
cycle.
 Lower rates are supposed to stimulate the economy and equity markets,
higher rates are supposed to slow the economy and depress markets.
 The story has been retold so many times over the past three decades,
we all assume that it has long been empirically tested and is well-proven
and established.
 What is the empirical evidence for the official story?
 Are there hundreds of empirical papers that have proven this?
2
Richard A. Werner 2016
Centre for Banking, Finance
& Sustainable Development
Business School
No.
There isn’t any empirical support for these
claims whatsoever.
Richard A. Werner 2016
Centre for Banking, Finance
& Sustainable Development
Business School
Fact: How interest rates and growth are actually related
Correlation
Statistical Causation
Nominal GDP and Call Rate
YoY %
15
Call Rate
% 10
8
Japan
10
6
0
2
0
Nominal GDP
-5
0
2
4
6
8
10
81 83 85 87 89 91 93 95 97 99 01 03
Nominal GDP YoY
%
US
Call Rate
5
4
-2
Nominal GDP and Call Rate
US Nominal GDP and Long-Term Interest
Rates
Rate %
US Nominal GDP and Long-Term Interest
Rates
Rate %
YoY %
20
15
15
US Interest Rates (R)
15
10
5
US Nominal GDP YoY%
0
0
5
10
15
10
10
5
5
US Nominal GDP (L)
0
80
84
88
92
0
96
00
04
4
Richard A. Werner 2016
Centre for Banking, Finance
& Sustainable Development
Business School
An empirical analysis of the relationship between interest rates and
economic growth in the UK, US, Germany and Japan over half a century
Lee and Werner (2016, forthcoming): Using diverse tests and estimation methods
(including DCC-GARCH* models and Granger causality test), we implemented
a comprehensive analysis of correlation and statistical causality in order to
describe the empirical relationships between the nominal GDP growth rate and
interest rates.
* Dynamic Conditional Correlation – Generalised AutoRegressive Conditional Heteroskedasticity
Richard A. Werner 2016
Centre for Banking, Finance
& Sustainable Development
Business School
The relationship between short-term interest rates and economic
growth in the UK, US, Germany and Japan (~1958-2008):
Richard A. Werner 2016
Centre for Banking, Finance
& Sustainable Development
Business School
The correlation between short-term interest rates and economic growth
in the UK, US, Germany and Japan (~1958-2008):
Richard A. Werner 2016
Centre for Banking, Finance
& Sustainable Development
Business School
Empirical analysis of the relationship between long-term interest rates
and economic growth in the UK, US, Germany and Japan:
Richard A. Werner 2016
Centre for Banking, Finance
& Sustainable Development
Business School
Correlation between long-term interest rates and economic growth in the
UK, US, Germany and Japan:
Richard A. Werner 2016
Centre for Banking, Finance
& Sustainable Development
Business School
Statistical causation (Granger causality) between long-term interest rates
and economic growth in the UK, US, Germany and Japan:
Concl.: Interest rates follow nom. GDP growth & are positively correlated.
Richard A. Werner 2016
Centre for Banking, Finance
& Sustainable Development
Business School
Rule 2: Rates Follow the Cycle
Trade Secret 2: Central banks don’t use rates to run the economy
Official Story:
High interest leads to low growth;
Low interest leads to high growth
Cognitive Dissonance
Empirical Reality:
High growth leads to high interest;
Low growth leads to low interest.
• Interest rates are the result of economic growth.
• So they cannot at the same time be the cause of economic growth.
• The facts contradict the official story of monetary and banking policy.
• Questions:
Richard A. Werner 2016
If not rates, what then determines economic growth?
Why do central bankers keep repeating the mantra that they
use interest rates as policy tool?
11
Centre for Banking, Finance
& Sustainable Development
Business School
3. Markets
Official Story: Markets always clear and they are
efficient. Hence prices are key.
 Assume:
1. Perfect information; 2. Complete markets; 3. Perfect competition;
4. Instantaneous price adjustment; 5. Zero transaction costs;
6. No time constraints; 7. Profit maximisation of rational agents;
8. Nobody is influenced in any way by actions of the others.
 Then: It can be shown that markets clear, as prices adjust to deliver equilibrium.
 Hence prices
are key, incl.
the price of
money (interest)
Equilibrium
 Market ‘efficiency’ is a
more advanced condition,
requiring more assumptions
to hold.
12
Richard A. Werner 2016
Centre for Banking, Finance
& Sustainable Development
Business School
3. Markets
Fact: Markets almost never clear
 Assume:
1. Perfect information; 2. Complete markets; 3. Perfect competition;
4. Instantaneous price adjustment; 5. Zero transaction costs;
6. No time constraints; 7. Profit maximisation of rational agents;
8. Nobody is influenced in any way by actions of the others.
 If each assumption has a probability of 55% of being true, what is the probability of all
assumptions being jointly true?
 (55%)8 = 0.8%
Market Equilibrium
 But the individual probability is much lower.
 Result: Markets can never be expected to clear.
13
Richard A. Werner 2016
Centre for Banking, Finance
& Sustainable Development
3. Markets
Business School
Rule 3: Markets are rationed and determined by quantities.
Trade Secret 3: The short side has allocation power and
uses it to extract non-market benefits
 Since we cannot expect these assumptions to ever jointly hold true, we know that
there cannot possibly be market equilibrium.
 Thus all markets must be expected to be rationed.
 Rationed markets are determined by quantities, by the ‘short-side principle’:
Whichever quantity of demand or supply is smaller determines the outcome.
 The short side has the power to pick and choose who to do business with.
 This power is usually abused to extract non-market benefits.
 Think of how Hollywood starlets are selected.
14
Richard A. Werner 2016
Centre for Banking, Finance
& Sustainable Development
4. Money and Banking
Business School
Official Story: We don’t know what it is, and it doesn’t matter
 What is Money? Textbooks say they do not know. They talk about deposit aggregates
M1, M2, M3 or M4, are not sure which one it is, and admit that these are not very useful
measures of the money supply.
 Money and Banking textbook:
“Although there is widespread agreement among economists that money is
important, they have never agreed on how to define and how to measure it” (Miller and
VanHoose, p. 42)
 Even the Federal Reserve does not tell us just what money is:
“there is still no definitive answer in terms of all its final uses to the question:
What is money?”
 The leading textbook in advanced (Master-level) economics at leading British and US
universities is David Romer (2006), Advanced Macroeconomics, 3rd ed.:
“Incorporating money in models of [economic] growth
would only obscure the analysis” (p. 3).
Richard A. Werner 2016
15
Centre for Banking, Finance
& Sustainable Development
Business School
Could banks have anything to do with it? If so why?
Rule: Banks are the creators of the money supply.
 Unlike all other non-bank financial institutions, banks can create money out of nothing.
 They do this by what is called ‘bank lending’ – better: credit creation. This creates
bank credit and deposit money simultaneously.
 Through this process banks are the lynchpin of the economy.
 They decide who gets newly created money and for what purpose.
 This is why banks are unique and different from all other non-bank financial
institutions.
16
Richard A. Werner 2016
/
Centre for Banking, Finance
& Sustainable Development
Business School
Banks are Not Financial Intermediaries
RR = 1%
Saving
Banks
Investment
(Lenders,
Depositors)
(‘Financial
Intermediaries’)
=“indirect finance”
$99
$100
(Borrowers)
“direct finance”
They are the Creators of the Money Supply.
And they decide who gets the money and for which purpose it is used.
This decision shapes the economic landscape.
Banks thus decide over the economic destiny of a country.
Credit creation is the most important macroeconomic variable.
Richard A. Werner 2016
17
Centre for Banking, Finance
& Sustainable Development
Business School
Rule: Banks are the creators of the money supply, they follow the
central bank guidance
 Banks create money.
 One pound in net new ‘lending’ increases the money supply by one pound.
 Banks decide who gets the money and for which purpose it is used.
 This decision shapes the economic landscape.
 Banks thus decide over the economic destiny of a country.
 Credit creation is the most important macroeconomic variable.
 This is a simple message, but reflecting it in economics means discarding the
currently prevailing models – a veritable revolution. And about time.
18
Richard A. Werner 2016
Centre for Banking, Finance
& Sustainable Development
Business School
Recognition of Bank Credit Creation
is a Game Changer for…
 Economics, finance, banking research and forecasting
 Government policy (monetary policy, fiscal policy, regulatory policy)
 Recognition of the banks’ true role is the precondition for solving many of the
world’s problems, including
– the problem of the recurring banking crises,
– unemployment,
– business cycles
– underdevelopment and the
– depletion of finite resources.
19
Richard A. Werner 2016
Centre for Banking, Finance
& Sustainable Development
Business School
The Quantity Theory of Credit (Werner, 1992, 1997):
 Money is best measured by its credit counterpart (C) which created it.
 Financial transactions are not part of GDP.
 If we want a link to GDP, we must divide money/credit into two streams:
C
Credit used for GDP transactions, used for the ‘real economy’
(‘real circulation credit’ = CR)
Credit used for non-GDP transactions (‘financial circulation credit’ = CF)
Richard A. Werner 2016
20
Centre for Banking, Finance
& Sustainable Development
Business School
Quantity Theory of Credit (Werner, 1992, 1997):
Rule: The allocation of bank credit creation determines what
will happen to the economy – good or bad...
non-GDP credit
= unproductive credit
creation
Case 2: Financial credit
(= credit for transactions that do not
contribute to and are not part of GDP):
Result: Asset inflation, bubbles
and banking crises
GDP credit
Case 1: Consumption credit
Result: Inflation without growth
Case 3: Investment credit
(= credit for the creation of new
goods and services or productivity
gains)
Result: Growth without inflation,
even at full employment
= productive credit creation
Richard A. Werner 2016
21
Centre for Banking, Finance
& Sustainable Development
Business School
The Quantity Theory of Credit (Werner, 1992, 1997)
∆(PRY)
= VR ∆CR
nominal GDP
∆(PFQF)
real economy credit creation
YoY %
YoY %
12
12
10
10
8
8
6
nGDP (R)
4
= VF∆CF
asset markets
financial credit creation
YoY %
YoY %
80
40
70
35
60
30
25
50
6
40
4
30
Nationwide Residential
Land Price (R)
Real Estate
Credit (L)
20
15
10
20
2
5
2
0
0
83
85
87
89
91
93
95
97
0
0
-5
99
-2
-4
10
-2
CR (L)
-10
-10
71
-4
73
75
77
79
81
83
85
87
89
91
93
95
97
99
01
Latest: H1 2001
Latest: Q4 2000
Real circulation credit determines nominal
GDP growth
Richard A. Werner 2016
Financial circulation credit determines
asset prices – leads to asset cycles and
banking crises
Centre for Banking, Finance
& Sustainable Development
Business School
Rule: Credit for financial transactions explains boom/bust
cycles and banking crises
 A significant rise in credit creation for non-GDP transactions (financial credit CF) must lead to:
- asset bubbles and busts
- banking and economic crises
30%
 USA in 1920s: margin loans rose
from 23.8% of all loans in 1919
to over 35%
28%
 Case Study Japan in the 1980s:
CF/C rose from about 15% at the
beginning of the 1980s to almost
twice this share
22%
26%
24%
CF/C
20%
18%
16%
14%
12%
79
81
83
85
87
89
91
93
Source: Bank of Japan
CF/C = Share of loans to the real estate industry,
construction companies and non-bank financial
institutions
Richard A. Werner 2016
23
Centre for Banking, Finance
& Sustainable Development
Business School
Rule: Broad Bank Credit Growth > nGDP Growth = banking
crisis
This Created Japan's Bubble.
YoY %
20
Broad Bank Credit
15
10
Excess Credit Creation
Nominal GDP
5
0
-5
-10
81
83
85
87
89
91
93
95
97
99
01
03
05
07
09
11
Latest: Q3 2011
Richard A. Werner 2016
24
Centre for Banking, Finance
& Sustainable Development
Business School
Rule: Out-of-control CF creates bubbles and crises, e.g. in
Ireland & Spain
Broad Bank Credit and GDP (Ireland)
Broad Bank Credit and GDP (Spain)
30
100
90
25
80
20
70
60
15
50
10
40
30
5
20
10
0
nGDP
nGDP
0
-5
-10
-20
19
98
/
19 Q1
98
/
19 Q3
99
/
19 Q1
99
/
20 Q3
00
/
20 Q1
00
/
20 Q3
01
/
20 Q1
01
/
20 Q3
02
/
20 Q1
02
/
20 Q3
03
/
20 Q1
03
/
20 Q3
04
/
20 Q1
04
/
20 Q3
05
/
20 Q1
05
/
20 Q3
06
/
20 Q1
06
/
20 Q3
07
/
20 Q1
07
/
20 Q3
08
/
20 Q1
08
/
20 Q3
09
/
20 Q1
09
/Q
3
-10
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q
7/ 88/ 89/ 90/ 91/ 92/ 93/ 94/ 95/ 96/ 97/ 98/ 99/ 00/ 01/ 02/ 03/ 04/ 05/ 06/ 07/ 08/ 09/
8
19 19 19 19 19 19 19 19 19 19 19 19 19 20 20 20 20 20 20 20 20 20 20
Broad Bank Credit Growth > nGDP Growth
Richard A. Werner 2016
25
Centre for Banking, Finance
& Sustainable Development
Greece:
Business School
1993-2009: over 10% credit growth
1995-97: over 20% credit growth
2001-2: over 30% credit growth
Greece: Credit Creation
Index
YoY (%)
500
50
400
40
Bank Loans (R)
300
30
200
20
100
10
0
0
nGDP
-100
Central Bank LLI
(L)
-10
-200
-20
81
83
85
87
89
91
93
95
97
99
01
03
05
07
09
11
Latest: Oct 2012
RESEARCH CENTER LTD.
Broad Bank Credit Growth > nGDP Growth
Richard A. Werner 2016
26
Centre for Banking, Finance
& Sustainable Development
Business School
What happened in 1993/4? And in 2000/1?
• The Bank of Greece was established by League of Nations (Annex
to the Geneva Protocol of 1927) in 1928, as a Société Anonyme
• In 1994, the Bank of Greece was made more independent from
the government, and monetisation of government policy stopped.
“As of 1994 the Bank of Greece no longer provides finance in any form to
the public sector. …prohibition of monetary financing.” (Bank of Greece)
• In 2000, the Bank of Greece was made fully independent from
the government, without democratic accountability.
• In 2001, the Bank of Greece became an integral part of the ECB.
• Note: the ECB is independent of and unaccountable to any
government or democratically elected assembly in Europe
Richard A. Werner 2016
27
Centre for Banking, Finance
& Sustainable Development
Business School
The Great Greek Asset Bubble of 1994-2009
• was created by the policy of excessive credit creation by the
Greek central bank and the ECB.
• increased tax revenues and economic growth projections.
• encouraged the government to overspend and undersave significantly
• the bubble was unsustainable – as they always are – and thus would,
without fail, result in a banking crisis and a fiscal crisis
• what happened since 2009 has been predictable and was caused
by the monetary policy of the central bank and the ECB.
Richard A. Werner 2016
28
Centre for Banking, Finance
& Sustainable Development
Business School
Greece:
1995-97: over 20% credit growth
2001-2: over 30% credit growth
Greece: Credit Creation
Index
YoY (%)
500
50
ECB control
Independence
from govt
400
300
40
30
Bank Loans (R)
200
20
100
10
0
0
Central Bank LLI
(L)
-100
-10
-200
-20
81
83
85
87
89
91
93
95
97
99
01
03
05
07
09
11
Latest: Oct 2012
RESEARCH CENTER LTD.
Richard A. Werner 2016
29
Centre for Banking, Finance
& Sustainable Development
Business School
The Solution, as told by the ECB:
• Greece must increase its debts by borrowing more from the
IMF/EU/ECB.
• An exit from the euro or full default must not happen.
• Greece must implement deep fiscal and welfare cuts.
• All must tighten their belts.
• The ESM must be established and fiscal policy controlled
centrally by the EU/ECB (loss of national sovereignty).
BUT: No policies to stimulate growth and employment!
Richard A. Werner 2016
30
Centre for Banking, Finance
& Sustainable Development
Business School
What must happen with shrinking credit creation?
A deepening slump and higher unemployment
Greece: Credit Creation
Index
YoY (%)
500
50
400
40
300
30
Bank Loans (R)
200
20
100
10
Bank credit
creation:
-10
-7.2% YoY
0
0
Central Bank LLI
(L)
-100
-200
-20
81
83
85
87
89
91
93
95
97
99
01
03
05
07
09
11
Latest: Oct 2012
RESEARCH CENTER LTD.
Richard A. Werner 2016
31
Centre for Banking, Finance
& Sustainable Development
Business School
The same is happening in Ireland, Portugal, Spain & Italy
Ireland Liquidity
YoY(%)
Index
1200
1100
1000
900
800
700
600
500
400
300
200
100
0
-100
-200
110
100
90
80
70
60
50
40
30
20
10
0
-10
-20
Bank credit: -17% YoY
Bank Loans (R)
LLI (L)
81
83
85
87
89
91
93
95
97
99
01
03
05
07
09
11
Portugal Liquidity
YoY(%)
Index
800
750
700
650
600
550
500
450
400
350
300
250
200
150
100
50
0
-50
-100
-150
Bank credit: -6.6% YoY
Bank Loans (R)
LLI (L)
81
83
85
87
89
91
93
95
97
99
01
03
05
07
09
11
Latest: Aug 2012
RESEARCH CENTER LTD.
300
250
Latest: Oct 2012
RESEARCH CENTER LTD.
Spain Liquidity
Index
55
50
45
40
35
30
25
20
15
10
5
0
-5
-10
Italy Liquidity
YoY(%)
Bank credit: -1% YoY
200
30
500
25
400
20
Bank Loans (R)
10
5
100
5
0
0
0
10
0
-5
LLI (L)
-100
20
Bank Loans (R)
200
100
-50
25
15
15
C
Bank credit: -0.3% YoY
300
150
50
YoY %
Index
-100
-5
-10
-150
-15
87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12
Latest: Oct 2012
CENTER L .
RichardRESEARCH
A. Werner
2016
LLI (L)
-200
81
83
85
87
89
91
93
95
97
99
01
03
05
07
09
-10
11
Latest: Oct 2012
RESEARCH CENTER LTD.
TD
32
Centre for Banking, Finance
& Sustainable Development
Business School
But there is a solution – without costs and fiscal pain,
producing a recovery and lower unemployment
• the policy proposal would have reduced government debt and deficits
• it would solve the funding problem in the bond markets
• it would help the banks and increase credit creation without extra
costs
• no need for centralisation of fiscal policy or issuance of European gov’t
bonds
Richard A. Werner 2016
33
Centre for Banking, Finance
& Sustainable Development
Business School
How to Create A Recovery After a Banking Crisis:
Werner-Proposal of 1994:
A new policy called “Quantitative Easing” = Expansion in Credit
Creation = Total Effective Purchasing Power
Richard A. Werner, Create a Recovery Through Quantitative Easing,
2 September 1995, Nihon Keizai Shinbun (Nikkei)
Richard A. Werner 2016
34
Centre for Banking, Finance
& Sustainable Development
Business School
Applying this Framework to Solving the
European Sovereign Debt Crisis
Werner-Proposal of 2011
 Greece, Ireland, Portugal, Spain and Italy need to stimulate economic growth.
This means stimulation of credit creation.
 Their governments need to save money and reduce borrowing costs.
 Bank credit growth needs to expand and banks need a safe way to expand
their business and their returns
 Here is how all of this can be achieved:
 Governments need to stop the issuance of government bonds
 Instead of borrowing from the bond markets – who do not create money
– governments should fund their borrowing requirements entirely by
borrowing from all the banks in their country.
35
Richard A. Werner 2016
Centre for Banking, Finance
& Sustainable Development
Business School
Werner-Proposal: The solution that maintains the euro and avoids
default
 Governments should enter into 3-year loan contracts at the much lower prime
borrowing rate.
 Eurozone governments remain zero risk borrowers according to the Basel
capital adequacy framework (banks are thus happy to lend).
 The prime rate is close to the banks’ refinancing costs of 1% - say 3.5%.
 Instead of governments injecting money into banks, banks create new
money and give it to the governments.
36
Richard A. Werner 2016
Centre for Banking, Finance
& Sustainable Development
Business School
Why fiscal spending programmes alone are ineffective
Fiscal stimulation funded by bond issuance
(e.g. : ¥20trn government spending package)
Non-bank private sector
(no credit creation）
-¥20trn
Funding
via
bond
issuance
+¥20trn
Fiscal
stimulus
Ministry of Finance
(no credit creation)
Net Effect = Zero
Richard A. Werner 2016
37
Centre for Banking, Finance
& Sustainable Development
Business School
How to Make Fiscal Policy Effective
Fiscal stimulation funded by bank
borrowing
(e.g. : ¥20trn government spending package)
Bank sector
deposit Non-bank private
(credit creation power)
sector
Assets　Liabilities
(no credit creation)
¥20 trn
¥20 trn
+¥ 20 trn
Funding
via bank
Loans
MoF
(No credit
creation)
Fiscal
stimulus
Net Effect = ¥ 20 trn
Richard A. Werner 2016
38
Centre for Banking, Finance
& Sustainable Development
Business School
Rule: Concentrated banking systems are prone to recurring
crises and instability
 Banks and bankers maximise their benefits by growing quickly
 The easiest way to grow is to create credit for non-GDP (speculative)
transactions
 This is why we have had hundreds of banking crises since the 17th
century (when modern banking started)
39
Richard A. Werner 2016
Centre for Banking, Finance
& Sustainable Development
Business School
Central Banks
Official Story: They aim at stability of prices, growth, currencies
 What is the empirical evidence for this assertion?
 There isn’t any: Stability of prices, growth and currencies is not what we
observe.
 Central banks also claim that they pursue these goals by manipulating interest
rates.
 But interest rates follow growth, and hence are useless as monetary policy tool
40
Richard A. Werner 2016
Centre for Banking, Finance
& Sustainable Development
Business School
Central Banks
Fact: Central banks often cause, exacerbate cycles
 Prediction in 2003 (Princes of the Yen): The ECB will create massive credit bubbles,
banking crises and recessions in the eurozone.
 Between 2004 and 2008 the ECB oversaw between 20% and 40% broad credit growth in
Ireland, Spain, Portugal and Greece.
 This could not fail to create massive asset bubbles, banking crises and recessions.
 The ECB has said that the recessions in these countries are ‘opportunities’ to implement
structural changes and increase EU control over national budgets.
 The Bank of Japan has said that the long recession was ‘doing good’, by imposing the
pressure for deregulation, liberalisation and privatisation.
 The World Bank has said that the central bank-created Asian crisis was a ‘window of
opportunity’ for structural changes and the ‘transfer of ownership’.
41
Richard A. Werner 2016
Centre for Banking, Finance
& Sustainable Development
Business School
Central Banks
Rule: The job of central banks is to create cycles
 Legal independence of central banks has increased significantly in the past 30 years
world-wide.
 Central banks are more powerful than ever before in history.
 They can choose their tools, instruments and often also their policy goals.
 After each crisis, they demand greater powers still, which is always granted.
 The principle of Revealed Preference (Samuelson, 1939) indicates that central banks
are choosing to create massive cycles.
 Theory of Bureaucracy: Policies are taken by bureaucracies to perpetuate their power.
Central banks increase their power through business cycles.
42
Richard A. Werner 2016
Centre for Banking, Finance
& Sustainable Development
Business School
What determined bank lending in Japan in the 1980s?
 Bank credit is the key variable in the economy
 That’s why central banks have always attempted to control bank credit creation
directly through ’informal’, unofficial control of bank credit called:
- ‘credit control’, ‘lending ceilings’, ‘corset’ (US, UK)
- ‘l’encadrement du credit’ (France)
- ‘Kreditlenkung/Kreditplafondierung’ (Germany, Austria)
- ‘credit planning scheme’ (Thailand, India)
- ‘window guidance’ (Japan, Korea, China)
 Japan: Officially discontinued in 1982. Empirical research, using primary eyewitness accounts, and econometric tests, showed:
43
Richard A. Werner 2016
Centre for Banking, Finance
& Sustainable Development
Business School
Official policy tools:
Unofficial policy tool:
1. Price Tool (ODR, call rate):
not relevant
2. Quantity Tool (operations, lending):
not relevant
Direct credit controls: no. 1 policy tool
3. Regulatory Tool (reserve ratio): not relevant
Bank Lending and "Window Guidance"
YoY %
18
16
14
12
10
8
6
4
Window Guidance
Bank Lending
74
76
78
80
82
84
86
88
90
44
Richard A. Werner 2016
Centre for Banking, Finance
& Sustainable Development
Business School
How to Avoid Asset Bubbles & Home-Grown Banking Crises
– and ensure ample funding for small firms
Broad Bank Credit and GDP Growth (Germany)
15
10
5
0
nGDP
-5
19
9
19 7/Q
9 2
19 7/Q
9 4
19 8/Q
9 2
19 8/Q
9 4
19 9/Q
9 2
20 9/Q
0 4
20 0/Q
0 2
20 0/Q
0 4
20 1/Q
0 2
20 1/Q
0 4
20 2/Q
0 2
20 2/Q
0 4
20 3/Q
0 2
20 3/Q
0 4
20 4/Q
0 2
20 4/Q
0 4
20 5/Q
0 2
20 5/Q
0 4
20 6/Q
0 2
20 6/Q
0 4
20 7/Q
0 2
20 7/Q
0 4
20 8/Q
0 2
20 8/Q
0 4
20 9/Q
09 2
/Q
4
-10
Richard A. Werner 2016
45
Centre for Banking, Finance
& Sustainable Development
Business School
Rule: A banking sector dominated by local, not-for-profit
banks avoids asset bubbles and banking crises
German banking
sector
Regional,
foreign,
other banks
17.8%
Large, nationwide banks
12.5%
Local gov’t-owned
Savings Banks
42.9%
Local cooperative
banks (credit unions)
26.6%
70% of banking sector
accounted for by hundreds
of locally-controlled,
small banks, lending mostly
to productive SMEs
46
Richard A. Werner 2016
Centre for Banking, Finance
& Sustainable Development
Business School
Mario Draghi, EZB-Chef, 21 Sept 2016: “Overcapacities in the
banking sector in some countries” – The ECB has been
aiming to decrease the number of banks. QUIZ: Which
countries could Draghi have been talking about?
Zahl der Banken in der EU – nach Land
In Deutschland gibt es zehn mal so viele Banken, die KMU Kredite vergeben als im
Vereinigten Königreich.
Richard A. Werner 2016
47
Centre for Banking, Finance
& Sustainable Development
Business School
‘Informal guidance’ of bank credit by central banks

This practice is known world-wide, for instance, in
– the UK as ‘Corset’
– Germany as ‘Kreditplafondierung’
– the US as ‘credit controls’
– France as ‘encadrement du crédit’
– Korea, Taiwan, China as ‘window guidance’
– Thailand as ‘credit planning scheme’

Central banks can require banks to primarily create productive credit,
delivering stable, non-inflationary economic growth without banking crises
(Japan 1937-1982; Taiwan, Korea, China) and with less inequality than when
most of credit creation is used for financial purposes (UK).
48
Richard A. Werner 2016
Centre for Banking, Finance
& Sustainable Development
Business School
Secrets of Japan’s Success
 The central bank operated a credit guidance mechanism, banning harmful credit
creation for financial speculation and for consumption.
 Thanks to productive credit creation, sustainable, non-inflationary growth was
possible.
 In addition, incentive-structures at companies were changed, to align them with the
national interest and ensure a growth-orientation.
 Thus the influence of shareholders was reduced. Managers were empowered.
 Competition for market-share (not profits) became so fierce, that the introduction of
cartels became necessary, further enhancing efficiency
 Dividend payments were reduced, funds were re-invested to grow the firms
 Corporate finance was shifted away from capital markets to bank finance.
 The labour market was changed from US-style hiring and firing to long-term
employment, job security, seniority pay and loyalty to the company.
49
Richard A. Werner 2016
Centre for Banking, Finance
& Sustainable Development
Business School
The True Impact of Deregulation and Liberalisation
 Neoclassical economics argues that deregulation, liberalisation and
privatisation will have a positive effect on economic growth
 Under pressure from the USA, Japan introduced such policies in the 1970s and
has deregulated, liberalised, privatised ever since.
 The Bank of Japan stopped guiding bank credit for productive purposes in 1985.
 Today, Japan’s economy is more liberalised than the US economy.
 Has this been beneficial for growth?
 Since these “needed structural reforms” have been implemented, Japanese
growth has collapsed.
50
Richard A. Werner 2016
Centre for Banking, Finance
& Sustainable Development
Business School
New Monetary Policy: Recognising the Importance of Credit Creation
 In 1991, the Quantity Theory of Credit was presented, disaggregating credit into
– productive investment credit
– unproductive consumer credit and
– unproductive and unsustainable financial credit.
 I also argued that the emerging crisis could be ended at any time by the right
policies, by expanding credit creation for GDP transactions - which I called
‘quantitative easing’ (Nikkei, 2 September 1995).
51
Richard A. Werner 2016
Centre for Banking, Finance
& Sustainable Development
Business School
Werner-proposal of 1994: A monetary policy called ‘Quantitative
Easing’ = Expansion of broad credit creation
Richard A. Werner, ‘Create a Recovery Through Quantitative Easing’,
2 September 1995, Nihon Keizai Shinbun (Nikkei)
What I said would
not work:
• reducing interest
rates – even to
zero
• fiscal stimulation
• expanding bank
reserves/high
powered money
Richard A. Werner 2016
52
Centre for Banking, Finance
& Sustainable Development
Business School
How to Reflate after a Banking Crisis:
Re-ignite bank credit creation for GDP transactions
to avoid credit crunch & deflation
 1. Central bank purchases all banks’ non-performing assets at face value.
 2. Central bank purchases assets from non-banks as short-term liquidity
measure, ensuring stability of the financial system.
 If bank credit creation remains weak:
3. Government stops the issuance of government bonds, borrows from banks:
Enhanced Debt Management
53
Richard A. Werner 2016
Centre for Banking, Finance
& Sustainable Development
Business School
No Surprise: The creation of the ECB & introduction of the
Euro produced the predicted outcomes
1.
Creation of diverging business cycles in the eurozone
2.
Exacerbation of the trade imbalances within Europe
3.
Bank credit-driven asset bubbles, banking crises and deep recessions
with large-scale unemployment
4.
Imposition of an excessive number of EU-regulations that kills entire
industries
5.
Increased concentration of the banking systems and industries – greater
profits for the oligopolies
6.
Complete lack of accountability and democratic checks and balances
concerning these disastrous policies
54
Richard A. Werner 2016
Centre for Banking, Finance
& Sustainable Development
Business School
EU Plans for Europe
 Creation of a ‘United States of Europe’
 Creation of a European finance ministry with budgetary powers
 Abolition of nation states (Schäuble, speech November 2011)
 Jean Claude Trichet, Co-author of the Maastricht Treaty (1993), said in 2011:
It is ‘necessary’ to introduce a European finance ministry’
“a ministry of finance that would exert direct responsibilities…” (translation: direct powers of control)
 In this Aachen speech, Trichet admitted his goal as head of the ECB had not
been to run sensible monetary policy, but to introduce the United States of
Europe.
55
Richard A. Werner 2016
Centre for Banking, Finance
& Sustainable Development
Business School
EU Plans for Europe
 Fiscal Union was effectively introduced thanks to the crisis of Spain,
Portugal, Ireland, Greece
 Now all member states must receive approval for their budget plans from the
Politbureau of the Highest Soviet Commission every October (the unelected
commissars in Moscow Brussels)
 The ESM (2012) is de facto the EU proto-finance ministry
56
Richard A. Werner 2016
Centre for Banking, Finance
& Sustainable Development
Business School
Bankenunion
Das Prinzip der bisherigen Bankenrettungsaktionen in Großbritannien:
Steuergelder werden für Großbanken verwendet; Kleinbanken wird nicht geholfen.
Wahrscheinliches Resultat der EZB-Bankenunion:
 Der ESM wird Großbanken stützen.
 Die aufsichtsrechtlichen Auflagen werden für Kleinbanken immer teurer und schwieriger
zu bewältigen. Dies ist kein Zufall.
 Die Zinspolitik der EZB zwingt kleinere Banken zu Fusionen
 Der gute Einlagenschutz und die Finanzmittel der deutschen Kleinbanken sind ein
besonderes Augenmerk der Zentralplaner.
57
Richard A. Werner 2016
Centre for Banking, Finance
& Sustainable Development
Business School
The ECB’s policies are not designed to end the crisis
 Zero or negative interest rate policy and mass purchase of gov’t bonds: Flat
yield curve around zero
kills the thousands of community banks in Germany, Italy, Austria etc., as lending
to the real economy is hardly viable
 Drastic increase in regulatory requirements: Small banks have to hire many
new staff for regulatory reporting – bankrupting the small banks
 Result: In the coming 5 years, many of the good community banks in Germany
will disappear due to mergers
 The ECB is creating a property bubble in Germany, as the interest & asset
purchase policy encourages speculative lending The bursting of the property
bubble in a few years will finish off the community banks, consolidate banking in
Germany to a handful of banks
 We currently are witnessing how the foundation of German economic success
for the past 200 years (community banks lending to SMEs)
58
Richard A. Werner 2016
Centre for Banking, Finance
& Sustainable Development
Business School
The ECB’s policies looking ahead:
 The ECB is fair: Having crushed Greece, Ireland, Portugal and Spain, it has
been moving to do the same to Germany
Confluence of six policies creates major threat to mankind:
 Negative interest rates – a tax on banks and savers
 War on cash – digitalisation of transactions, “financial inclusion”: helps
with confiscation policies via negative interest rates: no escape
 Monetary reform – abolition of bank credit creation. Centralisation of money
 Introduction of central bank digital currency
 Contactless payment systems NFC/RFID
 Universal Basic Income – why now? The bribe to accept the chip implant
59
Richard A. Werner 2016
Centre for Banking, Finance
& Sustainable Development
Business School
Further Reading:
M. E. Sharpe, 2003
Richard A. Werner 2016
Palgrave Macmillan, 2005
New Economics Foundation, 2012