A tract on financial stability

I HAVE decided to release my book - A Tract of Financial Ability - in a number of volumes. Briefly this is what it says:

The role of central banks is to provide pull to the economy by creating money and credit at a sustainable rate and without unbalancing spending between sectors in the economy.

This is the dog.

The tail, which the central bank must not chase, is prices - these have to adjust.

But in order to adjust they have to be free to adjust.

This is where the big problems arise.

Keynes put it this way: "If the value of money halves in such a way that a person both earns twice as much and spends twice as much on the purchase of the same things, then he is basically unaffected."

But then Keynes went off in a different direction saying that this is not what happens, so we have to manage the rate of devaluation of money. I take the other route.

Keynes' statement is too simple. There are two price adjustments to be made - the core adjustment of which Keynes wrote, and the ongoing adjustments that take place every day resulting in real economic growth, or not. My treatise shows exactly how this state of affairs can be arrived at - well almost. There are still some small bits which readers of the book may be able to tidy up.

There is the complication of international trade where I have to create a separate market place for capital swops. Then each economy becomes a part of the world economy importing top business skills and resources, but it still has its own money supply and its own interest rates and now, its own free market trading exchange rates without currency wars or other distractions. The rand stabilises.

Interest rates are a price and a part of the tail. The dog must not touch them. Like price adjustments, interest rates have two parts which, added together, become the nominal rate of interest. The core part adjusts for money devaluation.  The real part keeps supply and demand close to a balance.

SOME TESTS FOR WHAT IS WRONG

Does the cost of fixed interest bonds adjust? Does it have a core part that adjusts? Does the maturity value adjust? Does the cost of housing finance rise and fall slowly like rentals and other prices do? Do house prices and bond values rise as the rate of devaluation of money rises? Does the tail follow the dog? Are interest rates free to adjust?

No. Some of these things even set off in the opposite direction. Chaos.

Every mistake in the design of these financial contracts has many knock-on effects. Combined, they make the economy unmanageable. Removing the mistakes, as one professor said, simplifies everything.

WRONG TARGETS

In the meantime, central banks continue to manage interest rates:

There are cycles in spending that are unavoidable. Credit cycles, for example. This cycle is what central banks are trying to kill off with QE and low interest rates. That is doomed to failure. Interest rates would have to go downwards forever. Repaying debt slows spending, just as increasing debt speeds spending. It is a cycle. The dog is following the wrong scent.

They target prices inflation - but prices find their own level. Wrong target.

They target unemployment. Wrong again. If they do their job, unemployment will reach its lowest possible level.

The rest is up to politicians - give incentives to employers to employ, add to people's pay to make them cheaper to hire.

This is what Prof Thomas Piketty and Ravi Batra are saying. Tax exceptionally high earnings and spread the wealth - but not the capital that provides the wealth. If the top 1% are taking too much income, it is better that this be taxed and used to subsidise employment and wages.

Lower the cost of hiring. This brings profits to businesses through more spending.

Help people to innovate and help them to get started in business.

Once the economy is stable all of that will be much easier.

* Edward Ingram is a leading thinker on the world stage of  macro-economic design and has written a series of essays for Fin24.

Do you have a comment? Write to Edward Ingram and you could be published.

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