James J. Morrison W.G. Dupree

This is a continuation of my October 2022 submissions in accordance with the review of the RBA announced by Treasurer Jim Chalmers in July. The continuation of my letter to the RBA addresses some of the public’s misperceptions concerning money, banking and the Reserve Bank of Australia. The first part of the letter appeared in the previous issue of Auswakeup, listed as part 1.

Misperceptions.

The issues of monetary approaches to affecting Unemployment and Fiat economies I have previously addressed are among many common public and media misrepresentations of the banking system. In these areas, it should be incumbent upon the government to educate the public through public broadcasting so that the expectations of the Reserve Bank are properly evaluated. These myths include:

• Banks can only lend out money they have from depositors.
• Credit is an extension of a money multiplier based on deposit reserves.
• Quantitative Easing is printing free finance into the money supply.
• Federal Treasury deficits are a liability to taxpayers.

At a Keystroke.

Money in Australia’s economy has two sources. First, that which the Government Treasury supplies through its fiscal agent, the Reserve Bank. In short, that money is spent into existence by the Federal Government. This money is called “Vertical” money, which exists within exchange settlement accounts between the Reserve Bank and the Private banks. As the public is not a joint holder of accounts of this type, such money is not available for lending to the public. Its only purpose is for interbank transactions, as well as the provision of hard currency (coins and banknotes) to banks for servicing the needs of their depositors. Secondly, a larger pool of credit via lending is generated “ex nihilo” in the economy through private banking, referred to as “horizontal” money. The Bank of England has explained this in detail. https://www.youtube.com/watch?v=CvRAqR2pAgw] When a bank lends, a deposit IOU is created within that bank using digital keystrokes. A customer’s deposit is both the bank’s liability and the customer’s asset. Deposits are fundamentally an IOUs from the bank. Similarly, when a bank makes a loan, the loan contract becomes a liability for the borrower and an asset for the bank. The banks create money for borrowers and also receive profit (in the form of interest) for themselves. There is a common banking franchise myth, that depositors provide deposits to participate in the funding of lending for which depositors receive interest payments for allowing the redirection of their funds.  In this misunderstood perspective, the “franchiser” is the Bank assigned the right to market and distribute money on behalf of the depositor. The perpetuation of this myth in public debate and political pronouncements does a disservice to the public good.

Deposits/Reserves relevancy

Credit creation is simply about a bank finding a credit-worthy customer with whom it can create a digital deposit as an account with that bank with the expectation of future interest payments. The loan to the borrower becomes a bank asset, with an accompanying liability created by a computer entry, which generates the deposit for the borrower. None of the aforementioned Bank reserves is touched, and neither are deposits. The exchange settlement Account reserves are used only when the borrower spends that deposit in another bank. The reserves of the lending bank held at the central bank are transferred to the account of the payee in the other bank. This is how all bank transfers work; by using the central bank’s reserve accounts. Instead of describing this process in high schools and economics courses more generally, educational institutions have failed to adequately explain how the monetary system works. The government and a properly educated Board of the Reserve Bank need to address these realities. In regard to my familiarity with this, I worked at the Reserve Bank between September 2001 and October 2002, where I was involved in operations and technical security teams.  I aided the reversal of the RITS system’s previous outsourcing of AlphaServers operating Open VMS previously managed by Austra Clear/SFE. At that time the money that churned between banks via their reserve accounts varied between $9b and $16b daily.

Quantitative Easing

In a financial crisis – such as what occurred during the pandemic – it became evident that excessive exchange settlement reserves were needed. The overused strategy of Central banks globally during the Pandemic was Quantitative Easing. The often-encountered talk of “printing money” is a red herring. Printing money depends on the demand for cash in the private sector – which is normally around 3% of the money supply – and never approaches more than a small portion of the digital money supply. Hard currency demand during the pandemic reached 17%. Digital money is the characteristic form of currency used in operations between the Reserve Bank and the private banking system. Quantitative Easing affects the money supply by increasing the banks’ ESA reserves at the Reserve Bank. This occurs when the Reserve Bank purchases Treasury bonds from the private non-bank sector (e.g. bond dealers, pension funds, asset managers) as well as from the private banks, and these purchases increase the volume of ESA reserves. This also means that more money is circulating in the private sector, which money may be used to pay off bank loans, thereby reducing the likelihood of further borrowings. Technically, increased reserves, while facilitating extensions of interbank transactions, have no direct impact on any credit creation expansion. Precisely what area of the economy Quantitative Easing serves is also of concern, as “employment growth” wasn’t one of them. The inequality of protecting financialised assets amongst the wealthy ruling class financial markets rather than the working class who lost jobs in the millions. As Adam Tooze, in his recent publication, “Shutdown”, observes:

“For the central bank, that meant holding interest rates down. Once again, it came down to financial markets. As far as anyone could figure out, QE worked by driving government bond prices up and yields down. Lower interest rates helped to encourage borrowing for investment and consumption. Lower yields also prompted asset managers to reallocate funds from Treasury markets, where prices were driven up by central bank buying, to riskier assets, like equity and corporate bonds. This boosted corporate borrowing and the stock market. It increased financial net worth and boosted demand. The supportive cooperation between central banks and treasuries in the common struggle against the coronavirus was thus, the central bankers adamantly insisted, no more than an incidental side effect of their frantic and clumsy efforts to manage the economy by way of financial markets. Despite the relentless accumulation of government debt on their balance sheets, the central bankers insisted that this had nothing to do with financing public spending. Their priorities were to manage interest rates and ensure financial stability, which in practice meant underwriting the high-risk investment strategies of hedge funds and other similar investment vehicles. Rather remarkably, they insisted that tending to financial markets was a more legitimate social mission than openly acknowledging the highly functional, indeed essential role they played in backstopping the government budget at a time of crisis.” [pg 149] [1]

When Financial markets become more important to the Reserve Bank than the well-being of the vast majority of Australians, then the bank’s philosophy is served and managed by too many businessmen/women who have a neo-liberal ideology to serve the interests of the few above that of the whole economy. As Curtin espoused, the Reserve bank’s original social mission is to “pursue a policy of low inflation, sustainable output and employment growth”. [2] This mission has evidently fallen away, as a consequence of the type of people chosen to run the Board of the Reserve Bank.

Taxpayer’s money?

Finally, It can be demonstrated simply by viewing the balance sheets (irrespective of the accuracy of dollar amounts) of the entities

• the Federal Treasury,
• Reserve Bank,
• the collective private banks and
• the collective non-bank private sector

that the deficit of the Federal Treasury is the combined surplus of the Australian economy’s private sector and foreign sector. Deficits are just the government’s way of provisioning the private sector. If a government wishes to pull the spending of an economy back and throttle the growth of an economy, it pursues a surplus for the Treasury, depriving the private sector of funds. John Howard, for example, achieved that when he throttled back the economy to provide the Treasury with a surplus. Consequently, the private sector, desperate for money, borrowed heavily from the Banks. Private debt expanded considerably under John Howard. [See here: The Howard impact or here: Debt, home repossessions portent for Australia poll]. But of course, Treasurer Jim Chalmers should already know this. Taxpayers are not on the hook for a federal government’s treasury deficit because that deficit just boosts taxpayers’ finances. The government’s debt is its problem, not ours, since the Treasury and Reserve Bank issue the dollar (which taxpayers don’t because that is a crime called “counterfeiting” for which it can prosecute us). The currency-issuing government can pay their debts at any time it chooses by simply issuing the appropriate quantity of currency to cover the debts. Admittedly, the wedging by political opponents and the Murdoch media would require of this government political courage, not financial inability.

Currency Issuing

Many members of the public believe that the issuance of Australian currency is the domain of the taxpayer. Aside from this being the description of the crime of counterfeiting (for which the Australian government would jail any offender), the Reserve Bank definitively sees the issuance of currency as its role. Despite the widely accepted myth about the existence of “taxpayer’s money“, the taxpayer is not an issuer of money, but rather is a user of it. The distinction between a money issuer and a money user is critical to the public understanding of monetary reality. The issuer of a sovereign currency is not operationally constrained and cannot be forced into default in its own currency. However, non-sovereign monetary currency issued or pegged to a foreign-issued currency such as we find within the Eurozone or for the example of Sri Lanka’s debts held in a foreign currency can, of course, lead to default. Australia, like Japan, the U.S., New Zealand and many others, are monetarily sovereign economies with no significant foreign debt and only face the constraints inherent in resource depletion and inflation. Users of Currency are everyone else, including taxpayers, municipalities, and the States and they certainly face monetary constraints. They must earn, budget and use the limited money they can acquire through business, taxation and exchange. Monetary issuers are not so constrained.

Knowledge is power

The problem is, if submissions for a public review of the functions of the Reserve Bank are to be effective, it is incumbent on the reviewers to have a realistic appreciation of how the banking system operates and the Reserve Bank’s role and function in Australia’s financial system. Holding to the public franchise myth, the NAIRU myth, and the Taxpayer funds myth, as many in the media (and possibly members of the Bank Board), will limit the usefulness of any submissions. Providing faulty recommendations to politicians who frequently use the analogy of a household budget to describe how fiat economies work is a recipe for disaster and subsequent legislative policies that will hamper the workings of the Reserve Bank to aid post-pandemic financial recovery. So we need governors and heads of departments within the RBA who know and understand inflationary causes, recognise the differences between supply vs demand causation and know that raising interest rates is an over-zealous intervention that cures symptoms by killing the patient.

Footnotes:

[1] Tooze, A. (2021). “Shutdown: How Covid Shook the World’s Economy.” Penguin Books Ltd. [pg 149]
[2] Edwards, J. K. (2011). Curtin’s Gift: Reinterpreting Australia’s greatest prime minister. Allen & Unwin [pg 142]

In September 2022, the Reserve Bank of Australia was opened to public assessment.  The submissions were to be part of a review announced by Treasurer Jim Chalmers in July. What follows is largely verbatim from my submission at the end of October.  This will be published along with other reviews on the RBA review website in the week of December 5th. The Review Panel – comprising Renée Fry‑McKibbin, Carolyn Wilkins and Gordon de Brouwer- assesses those submissions. Certain aspects of my original review used in-house vernacular, presuming a specific internal bank knowledge. I have added further explanations of those concepts to facilitate a better understanding of this two-part series. Beyond these additional explanations, this is essentially the content of my submission. There are more embedded links than initially provided to the RBA to aid your further exploration.

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Dear Minister Chalmers,

Thank you for the opportunity to contribute to this review of the Reserve Bank of Australia.

Themes

This submission covers Monetary policy frameworks such as adherence to the NAIRU and neoclassical “gold standard” mentality over that of monetary sovereign fiat economies. It covers RBA and Government communications about the Finance Franchise myths on Banking, in general. It is critical of the Board composition based on bias in inappropriate neoclassical education and the selection of business representatives instead of economists trained in the issues of fiat economies. Finally, it reviews the Interaction of monetary and fiscal policy with respect to RBA’s performance in applying monetary policy where fiscal policy is more appropriate. As a former employee of the Reserve Bank, I have some knowledge of the inner workings of the Reserve Bank. I understand the review of the Reserve Bank of Australia is underway to improve monetary policy and its success at realising its goals, governance by the Board, culture, leadership, and recruitment practices. Such a broad range of objectives has yet to be approached since the smaller incidental 1981 Campbell inquiry and before that, presumably at its inception in 1960.

Curtin

Over the last century, Australia’s Central Bank and economy have undergone many changes. In the previous World War, the Curtin Government asserted Commonwealth power over banking, which led to Ben Chifley’s later decision to legislate to nationalise the banks, effectively asserting Commonwealth control over money and credit as per the Commonwealth Bank Act of 1945. However, such nationalisation was later defeated in 1949, as the book “Curtin’s Gift” by John Edwards says on Pg 141. “Though the postwar Menzies Government amended Chifley’s central banking legislation to reintroduce a board, the Commonwealth’s last-resort power to direct the bank was retained in the legislation and remains today. The Commonwealth Treasurer has conferred on the bank an independent authority to make monetary policy, but it is a conditional independence to pursue a policy of low inflation, sustainable output and employment growth.” Curtin had also argued for two other changes,

1. Commit to a full employment policy to improve living standards and raise national development.
2. a floating exchange rate to free Australia from the fixed exchange rate with the British pound

Ben Chifley implemented the Full employment policy following Curtin’s full employment paper being submitted to Cabinet in March 1945. Until the rise of Neoliberalism in the 1970s, unemployment would remain dominantly at 2% (notably without substantial inflation).

Unemployment rate and NAIRU

This leads to the Reserve Bank’s first failure, which is its commitment to the Non-Accelerating Inflation Rate of Unemployment (NAIRU). The RBA’s adherence to the economic self-deception espoused by the Phillips Curve model falsely supposes a trade-offbetween inflation and unemployment exists. That trade-off was initially set at 6% unemployment, then later 5%, then for some 4% despite the evidence of Australian history. The NAIRU is a systematically flawed perspective on inflation generated by a nation’s economy approaching full employment that should have died in Australia in the 1950s. Specifically, after Ben Chifley’s success with the Full Employment policy in Australia demonstrated for 25 years, full employment did not accompany rampaging inflation. Menzies nearly lost an election when unemployment, rose to 53,000 people or 3% at the end of 1960. It did, although, settle back to 2%. Australia abandoned Full Employment policies in the early 1970s.  This led to increased unemployment and significantly growing inflation over the next decade. Supposedly this use of the Phillips curve fell out of favour after the great stagflation of the 1970s. Instead, this zombie economic perspective has been raised from the dead, evidenced in 2022 with the prospect of the RBA using that justification for raising interest rates. All purportedly to manage a disquiet of ABS’s unemployment measure at 3.5%. Notably for a working labour force over three times larger than that experienced by Menzies in 1961. Albanese’s claim in 2022 of the Job Summit was to seek a “Full Employment Summit” but baulked at the solution of the Curtin Government. Unfortunately, the neo-liberals of the political Party and the Bank adheres to the conservative myth of the NAIRU.

Instead of NAIRU, we should consider NAIBER – as a better alternative perspective, especially as the Bank incorrectly suggests we are already “fully employed”. [See Prof Mitchell’s analysis: Never trust a NAIRU estimate] Beyond Prof Mitchell’s frequent analysis of the NAIBER, Prof Steven Hail’s book “Economics for Sustainable Prosperity” explains it on page 242.

“NAIBER stands for the ‘Non-Accelerating Inflation Buffer Employment Ratio’. The buffer employment ratio replaces the unemployment rate with the ratio of workers in the job guarantee scheme relative to the total available labour force. This is the replacement of our existing buffer stock of the involuntarily unemployed and underemployed with an employed buffer stock of workers within a public-sector job guarantee. The scheme would be a shock absorber for the economy— expanding to employ workers when they have been shed from the private sector during a downturn, and contracting automatically as the private sector absorbs labour from the job guarantee scheme in an upturn. Ecological modern monetary theorists have referred to an ecologically sustainable NAIBER, or ESNAIBER, in the context of a job guarantee as an element in a transition to an ecologically steady-state economy, given the ecological constraints referred to above.“

The goal of “full employment” has been achieved if you conclude ABS measures domestic unemployment, which, as you can see from the graphs and my articles covering what should have resulted from the Job Summit [my article and graphs: Stagnating Summit’s Shortfalls]. This is why “what gets measured” is essential. I will not go into detail about the shortcomings of the ABS statistics as they are probably already well known, and if not, the article aforementioned herein, should inform you. Raising interest rates as a strategy to deal with inflations is problematic at best. The link between spending and interest rates is unreliable and unpredictable. Interest rates affect both supply and demand. Economic modelling of “supply and demand” is only relevant to highly atomised markets with many participants, like the primary sector. Secondary and tertiary sectors of the economy follow different models. Changes in interest rates can have a reverse effect on inflation. Higher interest rates only affect people with variable interest rate debts. They don’t affect fixed interest rate debt and people with no immediate financial obligation. Higher interest rates increase the income of creditors and redistribute income to the wealthier, rentier class, exacerbating inequality. Fourth, higher interest rates reduce the incentive to undertake debt and may cause “distress borrowing” to service existing debt or keep businesses afloat. The resulting Ponzi balance sheets do a disservice to the economy, and all of the above, risk yet another recession. The government should be applying fiscal, not monetary, policy to these issues rather than letting the Reserve Bank’s adherence to a disproven NAIRU theory collapse the economy into greater inequality.

FIAT economy

Paul Keating’s floating of the Australian currency in 1983 meant Australia entered a new economic space. We became a monetarily sovereign, fiat economy no longer tied to another currency or a gold standard (which even America had abandoned with the collapse of the Brenton Wood decisions in 1971). The implications of which even the Bank of England acknowledges even if neither our government’s political rhetoric nor Reserve Bank acknowledge. [Bank of England video: Money in the modern economy: an introduction – Quarterly Bulletin] Instead of shifting into this new space and engaging with this new paradigm of fiat economies, the neoclassical economic conversation stayed with the decades-old “gold standard” economics model. Still, neoclassical economics guides the decisions of the Reserve Bank’s mission to “pursue a policy of low inflation, sustainable output and employment growth.” [“Curtin’s Gift” by John Edwards pg 142] Problematically, even Board members of the Reserve Bank need to understand the basics of a modern monetary system. [Prof William Mitchell: The RBA has no credibility and the governor and board should resign]. The Reserve Bank’s role as the currency issuer for the government has been misunderstood by business board appointees blinded by the tunnel vision of their experience as currency users in the business community. Most of the Board are business people (five in number), three are neoclassical economists (Dr Lowe, Michele Bullock, & Ian Harper), and Dr Steven Kennedy is economics adjacent given his Doctorate was in the Economic Determinants of Health, which is not precisely about the Banking systems. None of the Board has any formal training in the economics of fiat economies or Modern Monetary economies. However, that isn’t to say their experience on the Board has yet to give them insight. Some suggest the RBA is best served with Board members selected based on expertise in modern monetary fiat economics rather than as political appointees because of their relationships with former Prime ministers. To this day, neoclassical economics still guides the decisions of the Reserve Bank’s mission to pursue a policy of “low inflation, sustainable output and employment growth” but has universally failed to achieve what Curtin & Chifley (and even Menzies) did for nearly three decades. Banking is widely misunderstood as a heavily regulated franchise industry acting as an intermediary between scarce private capital and borrowers. Modern finance is relatively scarce, and depositors are the source of money supplied to borrowers. [Cornell Law School paper: “The Finance Franchise”].

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My letter to the RBA continued to explore more of the myths believed by the public about money and banking.   The letter reviewed the recent quantitative easing while serving the needs of the highly financed wealthy. It did sadly little for the well-being of the larger Australian public. All these are available in Rba Review part Two.