BETWEEN DEBT AND THE DEVIL BETWEEN DEBT AND THE DEVIL MONEY, CREDIT, AND FIXING GLOBAL FINANCE ADAIR TURNER PRINCETON UNIVERSITY PRESS PRINCETON AND OXFORD Copyright © 2016 by Princeton University Press Published by Princeton University Press, 41 William Street, Princeton, New Jersey 08540 In the United Kingdom: Princeton University Press, Oxford Street, Woodstock, Oxfordshire OX20 1TW press.princeton.edu Jacket/frontispiece illustration: Faust and Mephisto, engraving by Tony Johannot, 1845–1847 From Johann Wolfgang von Goethe, Faust: Der Tragödie erster Teil, ed Hans Henning, 1982 All Rights Reserved Library of Congress Cataloging-in-Publication Data Turner, Adair, author Between debt and the devil : money, credit, and fixing global finance / Adair Turner pages cm Includes bibliographical references and index ISBN 978-0-691-16964-4 (hardback) — ISBN 0-691-16964-0 (hardcover) International finance Finance Financial institutions Credit Financial crises Monetary policy Economic policy I Title HG3881.T88 2015 332´.042—dc23 2015015015 British Library Cataloging-in-Publication Data is available This book has been composed in Minion Pro and Helvetica Neue Printed on acid-free paper ∞ Printed in the United States of America 10 To Orna CONTENTS Acknowledgments ix Preface: The Crisis I Didn’t See Coming xi Introduction: Too Important to Be Left to the Bankers PART I SWOLLEN FINANCE 17 The Utopia of Finance for All 19 Inefficient Financial Markets 34 PART II DANGEROUS DEBT 49 Debt, Banks, and the Money They Create 51 Too Much of the Wrong Sort of Debt 61 Caught in the Debt Overhang Trap 74 Liberalization, Innovation, and the Credit Cycle on Steroids 88 Speculation, Inequality, and Unnecessary Credit 108 PART III DEBT, DEVELOPMENT, AND CAPITAL FLOWS 131 Debt and Development: The Merits and Dangers of Financial Repression 133 Too Much of the Wrong Sort of Capital Flow: Global and Eurozone Delusions 149 PART IV FIXING THE SYSTEM 161 10 Irrelevant Bankers in an Unstable System 163 11 Fixing Fundamentals 175 12 Abolishing Banks, Taxing Debt Pollution, and Encouraging Equity 186 13 Managing the Quantity and Mix of Debt 195 PART V ESCAPING THE DEBT OVERHANG 211 14 Monetary Finance—Breaking the Taboo 213 15 Between Debt and the Devil—A Choice of Dangers 231 Epilogue: The Queen’s Question and the Fatal Conceit 241 Notes 253 Bibliography 277 Index 289 ACKNOWLEDGMENTS T without whom this book could not have been written, and my acknowledgements here are incomplete My rst thanks must go to the Institute for New Economic Thinking (INET), which has supported me throughout the past years, and to Robert Johnson, the executive director of INET, who has continually inspired me with the depth of his intellectual interests, encouraged me to think radically, and provided a never-ending stream of ideas for further research and reading In addition I must particularly thank two others The rst is George Soros, one of INET’s founders, with whom I have discussed my emerging ideas since we rst met in 2009, and whose own writing has posed a profound challenge to the simplicities of precrisis economic orthodoxy The second is Martin Wolf For several years Martin and I have been on a very similar intellectual journey, and his Financial Times columns and latest book, The Shifts and the Shocks, have played an important role in the development of my thinking My special thanks also go to friends who read and commented on early drafts of the book, including in particular Bill Janeway, Anatole Kaletsky, and Robert Skidelsky And I am indebted also to Mervyn King, who, in the depths of the nancial crisis of autumn 2008, first helped me understand the inherent instability of modern banking systems There are also many people with whom I have discussed my emerging ideas, or who have inspired me through their own writings They include Anat Admati, Olivier Blanchard, Claudio Borio, Marcus Brunnermeier, Jaime Caruana, Ulf Dahlsten, Brad DeLong, Barry Eichengreen, Roman Frydman, Charles Goodhart, Andrew Haldane, Will Hutton, Otmar Issing, Oscar Jorda, Richard Koo, Paul Krugman, Michael Kumhof, JeanPierre Landau, Richard Layard, Paul McCulley, Atif Mian, Liu Mingkang, Rakesh Mohan, John Muellbauer, Avinash Persaud, Michael Pettis, Thomas Piketty, Adam Posen, Zoltan Pozsar, Enrico Perotti, Raghuram Rajan, Hélène Rey, Kenneth Rogo , Moritz Schularick, Andrew Sheng, Joe Stiglitz, Larry Summers, Nassim Taleb, Gillian Tett, Jose Vinals, Paul Volcker, Richard Werner, and Bill White Some of them will almost certainly disagree strongly with some of my arguments, but all have played a role in making me think I also thank many colleagues at the UK Financial Services Authority, and in particular Hector Sants and Andrew Bailey, who had to put up with my musings on fundamental causes and theory even as we were struggling with day-to-day crises, or who provided vital research input to analysis of these issues And thanks also to the many members of the international Financial Stability Board with whom I worked closely for four years to redesign global nancial regulation There are far too many to mention them all, but in addition to Chairman Mark Carney, and Executive Director Svein Andresen (without whom we could never have made as much progress as we did), HERE ARE MANY PEOPLE I pay particular tribute to fellow hawks in our debates, such as Philipp Hildebrand from Switzerland, Dan Tarullo and Sheila Bair from the United States, and my fellow Brit, Paul Tucker We achieved a lot, even if I argue in this book that there is more to I am also greatly indebted to my two research assistants, Lisa Windsteiger and Yuan Yang, who have helped me identify and analyze key arguments in the academic literature, have challenged my emerging ideas, and have been tenacious fact finders My assistant Lina Morales has also played a vital role in the book’s production, working in particular on the bibliography No book can ever see the light of day without the hard work and encouragement of the publisher, and I am very grateful to Seth Ditchik at Princeton University Press for his excellent advice, which helped give the book a strong central focus, as well as to Cyd Westmoreland and Karen Fortgang for their vital role in editing and production And my thanks also to my excellent agent, Georgina Capel Finally and most importantly my deepest thanks go to my wife Orna, who has lived with this book not for the year that I thought it would take to write, but for the two it actually required Without her encouragement I would never have nished it And without her un agging support during ve demanding years at the Financial Services Authority, I would never have been able to start it This book is dedicated to her ——— (2010) Risk and Liquidity Clarendon Lectures in Finance Oxford: Oxford University Press Shleifer, A (2000) Inefficient Markets: An Introduction to Behavioural Finance Oxford: Oxford University Press Simons, H C (1936) “Rules versus Authorities in 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A Survey of Current Debates Geneva: International Labour Organisation, Conditions of Work and Employment Branch Weidmann, J (2012) “Money Creation and Responsibility.” Speech at the 18th Colloquium of the Institute for Bank Historical Research (IBF), Frankfurt, September 18 Werner, R (2003) Princes of the Yen: Japan’s Central Bankers and the Transformation of the Economy Armonk, NY: M E Sharpe ——— (2005) New Paradigm in Macroeconomics: Solving the Riddle of Japanese Macroeconomic Performance New York: Palgrave Macmillan White, W R (2012) “Ultra-easy Monetary Policy and the Law of Unintended Consequences.” Working Paper 126 Dallas: Federal Reserve Bank of Dallas, Globalization and Monetary Policy Institute Wicksell, K (1936) Interest and Prices London: Macmillan (for the Royal Economic Society) Wilkinson, R G., and K Pickett (2011) The Spirit Level Saybrook, CT: Tantor Media Wolf, M (2014) The Shifts and the Shocks: What We’ve Learned—and Have Still to Learn—from the Financial Crisis New York: Penguin Press Wolfe, T (1987) The Bonfire of the Vanities New York: Farrar, Straus and Giroux Woodford, M (2003) Interest and Prices: Foundations of a Theory of Monetary Policy Princeton, NJ: Princeton University Press ——— (2012) “Methods of Policy Accommodation at the Interest-Rate Lower Bound.” In The Changing Policy Landscape, Jackson Hole Symposium, Federal Reserve Bank of Kansas City Available at: www.kansascityfed.org/publications/research/escp/symposiums/escp-2012 Young, A (1995) “The Tyranny of Numbers: Confronting the Statistical Realities of the East Asian Growth Experience.” Quarterly Journal of Economics 110(3): 641–80 INDEX Admati, Anat, 173, 199–200 Ahamed, Liaquat, 164 Akerlof, George, 247 Alesina, A., 272n7 arbitrageurs, 38, 41, 45 Ardagna, S., 272n7 Aristotle, 5, 52 Arrow, Kenneth, 36, 56, 243 Asian financial crisis of 1997, 52, 141, 151, 183 asset management: dramatic growth in, 21–22, 23; value for money in, 44–45; in search for yield, 105 asset prices: debt overhang and, 56; quantitative easing and, 85 See also credit and asset price cycles Atkinson, Tony, 269n9 bad lending, 164–65 See also debt pollution Bagehot, Walter, 54 bailout of banks, 3, 82, 165, 173 bankers: anger at, 3, 163, 167; not the fundamental cause of crisis, 3, 163–68; remuneration reforms for, 9, 167–68, 172 Bank for International Settlements, banking crises, nineteenth-century, 113 See also financial crises banking regulations: capital requirements in, x, 7, 10–11, 74, 78, 176, 198–200, 201–2, 208, 270nn7–8; to constrain credit creation, 195, 198–202; historical development of, 114; ignoring the amount of credit before crisis, 254n9; insufficient to achieve stable economy, x, 9, 166; liberalization of 1970s–1990s in, 92–94; in U.S of 1920s and 1930s, 91 See also Basel II bank capital standard; Basel III bank capital standard; central banks Bank of England: debt overhang and, 85, 87, 227, 229; Funding for Lending Scheme of, 78, 217, 234; inflation targeting by, 118; minimal concern with banking system in, 245; monetary finance and, 233; postcrisis credit supply and, 78, 79; quantitative easing by, 85, 217, 227, 233–34 bankruptcy: debt contracts and, 56; on large scale, 225 banks: bailout of, 3, 82, 165, 173; beneficial roles of, 34–35, 52–54; capital flows and, 155, 156; categories of lending by, 62; conventional textbook description of, 57, 61, 66, 246, 257n13; dangers associated with, 54–57; desirable leverage levels of, x–xiii; dismantling of barriers between investment banks and commercial banks, 29, 91, 92, 93; empirical reality of role of, 246–47; eurozone sub-sovereign debt held by, 158, 159; financial innovation and, 94–99; fixed after the crisis, but with debt problem remaining, 74–75, 78–80, 172–74; ignored in modern macroeconomics, 31, 170, 245–46; increasing intrafinancial system activity of, 24–25, 96–97; instability caused by, 6, 9, 48, 186; interbank lending markets and, 59, 257n16; public recapitalization proposed for, 229–30; questioning the existence of, x, 185, 186–90, 208; real estate lending by, 61, 71–73, 104; reforms being implemented for, 172–74; reserve asset requirements proposed for, 200–201, 221–22, 270n10, 271n12, 271nn13–14, 273nn19–20; structural reforms proposed for, 205–7; in successful Asian development, 136; too-big-to-fail problem with, 3, 9, 164, 173, 199 See also central banks; Chicago plan (100% reserve banking); credit and money creation; debt contracts; fractional reserve banks; mortgage lending Basel II bank capital standard, 30, 100, 102, 270n8 Basel III bank capital standard, xii, 10, 11, 199–200, 229, 270n8 behavioral economics, 247 Benes, Jaromir, 188, 189 Bernanke, Ben, 56, 127, 213, 220, 227, 228, 230, 231–32, 233, 234 betting, 43, 46–47, 98–99, 170 Blanchard, Olivier, 170, 224 bonds: capital mobilization and, 53; corporate bond yields from 2002 to 2008, 101; danger associated with, 55, 57 See also government bonds booms and busts, 38–39; caused by excessive debt creation, 4; in credit before crisis of 2007–2008, 101; debt contracts and, 54–57; in Dutch tulip bulb mania, 39, 58, 66; five factors causing, 40–42; of Internet stocks, 5, 39, 48, 251; in Japanese real estate market of 1980s, 75–76; procyclical credit supply and, 51; uncertainty of identifying credit bubble in, 209 See also credit and asset price cycles Borio, Claudio, 197 Brazil, 135 Bretton Woods system, 90–91, 257n16 Brunnermeier, Marcus, 103, 248 Brynjolfsson, Eric, 69, 179, 180 bubbles See booms and busts Buiter, Willem, 220, 241, 248 Bundesbank: prohibition of money finance by, 275n5 See also Weidman, Jens Buttiglione, Luigi, 74 capital account liberalization, 149, 150, 154 capital allocation: argument for the euro and, 156; in Asian success stories, 136; facilitated by complete markets, 1, 46; facilitated by liquid markets, 1, 43; financial innovation and, 106; global capital flows and, 92, 124; inadequacy of free markets for, 130; increasing financial activity and, 1, 29, 44, 89; price of credit risk and, 101; value of financial markets for, 5, 34–35 capital controls, to buttress industrial investment, 139 capital flows: catch up in emerging economies and, 135; constraints on, proposed for short-term debt capital flows, 196; constraints on, under Bretton Woods, 90–92; as debt capital flows, 150, 196; desirable limits on, 11, 14–15, 159; emerging economies urged to open to, 150; empirical evidence vs faith in benefits of, 154–55; eurozone and, 150, 156–57; with gross value much higher than net, 151, 152–54; not limitlessly beneficial, 150; ring-fencing between countries and, 205–7; of UK before First World War, 150, 151; unmatched by useful capital investment, 1, 124–25, 150, 151–52 See also current-account imbalances capital investment: bank credit creation directed toward, 133–34, 137–38, 143; banks’ preference for real estate and, 71; banks’ role in mobilizing, 188–89; capital flows and, 124; as Chinese response to crisis of 2007–2008, 144; as creditfinanced overinvestment, 64–65; in credit-fueled development model, 133–34, 136–41; in East Asian development, 142–43; falling rates of, 128; for information technology, 69, 128, 176, 238, 258n16, 265n7, 266n8; policies to ensure needed credit for, 196; for public needs, 129–30, 207; real estate and urban infrastructure as increasing share of, 176; savings and, 124, 128–29; textbook description of banks and, 61, 66; unsustainable debt and, 62, 64, 65, 258n9, 258n11 capital requirements See banking regulations carry trade activities, 153 CDOs See collateralized debt obligations (CDOs) CDS See credit default swaps (CDS) Cecchetti, Stephen, 209 central banks: in Chicago plan, 187; after crisis of 2007–2008, 74, 78; discretionary decisions required for reform and, 208–9; forbidding fiat money finance, 113, 231, 233; funding private-sector loans for development, 139–40; independence of, 233–34; inflation goals of, 2, 9, 31, 59–60, 93, 108–9, 114, 170–71, 196–98; interest rates as instrument of, 9, 93, 196, 209, 233, 248; liquid bank reserves held at, 59; liquidity provision and, 262n16; neutral view of financial system in, 30–31; option of fiat money creation by, 12, 111–12, 233–34, 262n6 (see also fiat money); pre-crisis approval of increasing financial activity by, 1; public recapitalization proposal and, 230; rapid credit growth before the crisis and, 116; reserve asset requirements and, 200–201, 221–22, 271n12, 271nn13–14, 273nn19–20 See also banking regulations; Bank of England; Bundesbank; Chicago plan (100% reserve banking); European Central Bank; Federal Reserve; interest rates Chang, Ho-Joon, 264n5 Chicago plan (100% reserve banking), 10, 13, 111, 174, 187–90, 201, 220–21 China: bank credit creation in, 134, 144, 239; debt overhang in, 239; debt shifted to, 12, 83, 215; downturn of 2015 in, 12, 146; excessive real estate and infrastructure investment in, 145–46, 239; foreign direct investment in, 151; global financial stability in future and, 134; high growth rate of, 135, 147; high savings rate in, 127; leverage increase in, 6, 52, 144, 215, 257n3, 266n19; prospects for transition without crisis, 143–48; trade surpluses of, 180–82 Citicorp, 168 climate change, investment needs and, 129 Cochrane, John, 191 Coggan, Philip, 260n7 collateral, 101–2, 103, 105, 167, 203 collateralized debt obligations (CDOs), xiv, 26, 94, 99 collateralized loan obligations (CLOs), 26 compensation See remuneration competitive equilibrium theory, 36–37, 99 complete markets See market completion Consumer Financial Protection Bureau, 165 consumption: capital flows for, 151, 156; changing pattern of, 69–70; Chinese need for transition to, 144, 181; creditfinanced, 62–64, 104, 120–21, 258n6; cut when house prices fall, 77, 78; fiat money used to stimulate, 130; German taxation of, 182–83; sacrificed for increase in investment, 137–38, 266n11; smoothing of, 120–21, 123; in transitioning from credit-fueled development model, 141–42 See also demand costly state verification, 53, 257n6 countercyclical capital buffers, 200, 208, 209 credit: categories of, 62–67, 197–98, 201–2, 271n14; constraints on borrower access to, 196, 204–5; to finance existing assets, 66–67, 116–17, 118, 171, 258n11; securitized provision of, 97–99 (see also securitization); treated as product like any other, 93 See also debt credit allocation: case for depoliticizing, 140–41, 143; in China, 145; harmful potential of free markets for, 208; in Japanese and Korean development, 139–40; using public policy for, 11, 208 See also credit direction credit and asset price cycles: capital flows and, 154, 206; existence of debt contracts and, 184–85; inequality and, 205; interest rates and, 196–98; in real estate, 6, 71–73, 117–18, 119, 121, 143, 146, 156, 175, 185; risk management and, 101–2, 167, 203; shadow banking and, 203; uncertainty about identifying bubbles and, 209 See also booms and busts; credit cycle, and financial innovation credit and money creation, 5, 6, 10, 33, 57–60, 113–14, 253n8; by acceptance of promissory note, 58; dangerous but without producing high inflation, 171; dangers associated with, 250; demand for urban land and, 247; directed to investment rather than consumption, 133–34; fiscal stimulus and, 116; interbank lending markets and, 59, 257n16; macroeconomic implications of, 33; problems of free market approach to, 11, 130, 190, 208, 239; proposals to abolish private money creation, 187–90 See also debt contracts; fiat money credit creation: active management of, 159, 172–74, 251; by banks, missing from central bank models, 170; by banks in economic development, 134, 137–38; biases of, 104; in Chinese stimulus following 2007–2008 crisis, 144; end of Bretton Woods system and, 91–92; private, inherent instability of, 209 See also credit and money creation credit cycle, and financial innovation, 6, 89–90 See also credit and asset price cycles credit default swaps (CDS), 26, 30, 37, 47, 96, 99, 101, 203 credit demand, lacking due to debt overhang, 79–80 credit derivatives, 25–26, 29, 30; IMF approval toward, 100 credit direction, 131, 134, 136–40; Chinese exposure to dangers of, 146; Japanese model moving away from, 142; structural changes in financial system and, 207; waste associated with, 140–41, 145 See also credit allocation credit growth: to achieve nominal demand growth, 13; in decade before 2007–2008 crisis, 51–52; dramatic, in advanced economies, 21–23; drivers of rapid increase in, 8; economic growth and, 7–8, 11, 30, 32, 52, 108–9, 116, 119–20, 208, 237–38; excessive despite stable inflation, 9, 114, 171; expansion of financial activity and, 21–22; faster than GDP growth, 7, 12, 22–23, 51–52, 74; fundamental drivers of, 106–7, 109, 175–85 (see also current-account imbalances; inequality; real estate); inequality and, 119–23, 263n28; inflation and, 109, 116, 125; instability caused by, 3–4, 6–10, 13–14; key questions about, 116; monetary policies and, 9, 12; nominal GDP growth and, 116; policies to prevent excess of, 4, 8–11, 199–202; procyclical, 51; restimulated by low interest rates, 86; secular stagnation and, 125; shadow banking and, 104; sudden stop to, after 2007–2008 crisis, 74, 78; unnecessary but potentially harmful, 171–72 See also credit supply; finance, growth of credit securities, 6, 25–27, 94–96, 97–99; mistaken beliefs about, 168, 243; risk management and, 100 See also derivatives credit structuring, 25–26, 29, 89, 94, 97, 99 credit supply: fixing the banks after 2007–2008 crisis and, 78–80; higher bank capital requirements and, 199; monetary policy and, 247–48; objections to constraints on, 203–4; pre-crisis assumptions and, 104; procyclical, 51; restricted immediately after 2007–2008 crisis, 207, 214 See also credit growth crises See financial crises crowding out, 115, 215, 220 current-account imbalances, 124–25, 150; asymmetric debtor-creditor responses to, 266n6; Bretton Woods system and, 91; Chinese surplus in, 127; in eurozone, 266n12; policy implications of, 180–84; of United States, 152; unsustainable debt associated with, 8, 10 See also capital flows Darling, Alistair, xi Debreu, Gerard, 36, 56, 243 debt: enough of the right sort of, 207; policies to constrain quantity and mix of, 195–96; shifted from advanced to emerging economies, 12; shifted to public sector after a crisis, 12, 80–83, 217, 226, 266n12; too much of the wrong sort of, 195 See also credit entries; leverage; public debt debt contracts: under Chicago plan, 187; deflation and, 56–57; inequalities exacerbated by, 123–24; inherent risks of, x, 5–6, 10, 48, 54–57, 60, 190–91, 193; moral and religious objections to, 5, 52, 124; positive role of, 5, 34, 52–54, 133, 189; pre-crisis orthodoxy and, 33; questioning the role of, 185, 186; secured, 29 See also credit and money creation debt overhang: capital flows and, 125, 152; causing weak recovery from 2007–2008 crisis, 4, 7, 56, 74–75, 174, 213–14; Chinese problem of, 146, 147–48; continuing to grow globally, 11–12; credit-financed consumption and, 64; creditfinanced investment and, 64, 65–66; dealing with, 9, 12–13, 84–87, 224–30; deflationary consequences of, 146; in eurozone, 157, 158, 266n12; Japanese experience and, 75–76, 142; private-sector leverage determining severity of, 195; public debt increase and, 82; from real estate lending, 73, 76; shadow banking and, 104; shared-risk mortgages and, 193; unpayable magnitude of, 222–24; U.S economy harmed by, 76–78 See also deleveraging debt pollution, 4, 6, 9, 190–91 See also bad lending default on public debt, 224–26 deflation: arguments against, 109–10; money-financed fiscal deficits in times of, 188; public investment to avoid, 130 deflationary effects: of Chinese slowdown, 146; debt contracts and, 56–57; of debt overhang, 152; inequality and, 179 deleveraging, 222–27, 229; attempted after crisis of 2007–2008, 215; contractionary effects of, 272n7; in eurozone, 234–35; negative impact on demand arising from, 77, 259n10; after Second World War, 222–23 See also debt overhang DeLong, Brad, 216 demand: cause of Great Depression and, 108; credit direction and, 134; inequality and, 120; negative impact of deleveraging on, 77, 259n10 See also consumption; credit demand, lacking due to debt overhang; nominal demand growth demand for money, 171, 268n14 deregulation, favored by policymakers before the crisis, 29 derivatives: central clearing for, 172; collapse of Long Term Capital Management and, 94; dramatic growth in, 1, 25–26, 89, 95–96; generating risk, 98–99; pre-crisis presumption in favor of, 29, 89, 94, 97, 100, 169, 243 development See economic development devil, 13, 231, 250 Draghi, Mario, 228 Drehmann, Mathias, 197 Dudley, Bill, 29, 30, 89, 97, 104 Dutch tulip bulb mania, 39, 58, 66 Dynamic Stochastic General Equilibrium models, 170, 246 Dyson, Ben, 188 Eccles, Mariner, 108, 121 economic development: credit-fueled model of, 14–15, 133–34, 136–42, 143; by direct state expenditure, 142–43; financial liberalization and, 11, 29, 134, 150; financial systems in early stages of, 32, 33; fractional reserve banks and, 53–54; transition to consumption-intensive economy and, 141–42, 143 See also emerging economies; industrialization economic growth: bank money creation and, 58; benign pre-crisis assessment and, 30; catch up after Industrial Revolution, 134–36; chronic deficiency of nominal demand and, 128; credit growth and, 7–8, 11, 30, 32, 52, 108–9, 116, 119–20, 208, 237–38; credit supply insufficient to restore, 79; crucial role of debt contracts for, 5, 34, 52; deleveraging enabled by, 270n2; depressed by attempted deleveraging, 215; eurozone export-led model of, 183; financial deepening and, 32, 54, 172; financial innovations and, 1; financial intensity and, 35; fiscal policy and, 216–17; instability risks as price of, 189; investment and, 137, 266nn8–10; investment banks and, 54; with printed money, 13; proposed constraints on credit and, 196; slowed or stopped after crisis of 2007–2008, 214 See also economic development economics, mainstream: defense of, 247–48; failure to anticipate crisis, xiii, 4, 15, 241–42; ignoring irreducible uncertainty, 41, 250; ignoring role of banks, 31, 170, 245–46; mathematical precision in, 242, 243–44, 246, 249–50; methodological and philosophical bias of, 242, 248; neoclassical, 136, 138, 248; new approach needed in, 242; simplistic assumption about banks in, 246–47 efficiency, economic, 36–38; complete markets and, 169, 248; financial deepening and, 1, 35, 36; mistaken assumptions about, 242; pre-crisis financial activity and, 23 Efficient Market Hypothesis (EMH), 30, 37–38, 243; irrational exuberance and, xii, 45; real-world evidence against, 38–42, 45, 106, 247; risk management and, 100–101; valid applications of, 42 Eichengreen, Barry, 223 Elizabeth, Queen, 241 emerging economies: capital flow volatility and, 154–55; with central banks using reserve asset requirements, 201; debt overhang effects on, 152; debt shifted from advanced economies to, 12; financial liberalization and, 11, 93, 150; privatesector leverage increase in, 7, 52; removing controls on capital flows, 92, 150; wealth attributed to urban land in, 69 See also economic development equity contracts, tax regimes favoring debt over, 191, 192 equity markets: with beneficial side-effects though irrational, 47–48, 251; capital flows associated with, 155; compared to debt markets, 34–35, 52–53, 55–56; contradicting efficient market theory, 39; growth of value as percent of GDP, 23; liquidity in, 35, 46 See also stock market European Central Bank: fiscal stimulus and, 228; forbidding fiat money finance, 113, 231, 275n5; postcrisis credit supply and, 78, 79; quantitative easing by, 234–35, 236; Targeted Long-term Repo Operation of, 217 eurozone: consequences of breakup of, 236, 276n10; continuing consequences of 2007–2008 crisis, 12, 158, 213, 216; fiscal austerity in, 12, 84, 182; money finance needed to deal with debt in, 157, 159, 227–28, 235–36; quantitative easing used in, 217; radical reform needed for, xiii, 15, 159, 235–36; trade surpluses in, 181, 182–83; unmanageable public debt in, 223–24 eurozone crisis, xii, 150, 155–59 exchange rates: capital flows and, 90–92, 153, 154, 156; Chinese policy and, 181, 184; globalization and, 90–92 See also foreign exchange trading Facebook, 69, 128 Faust (Goethe), 13, 231 Federal Reserve: post facto examples of money finance and, 275n9; shadow banking and, 26, 105 fiat money, 111–13; to achieve nominal demand growth, 12–14, 214, 218–22, 232; appropriate constraints on, 232, 233–34, 239, 275n5; in Chicago plan, 187–88; continuous role for, 237–39; to deal with debt overhang, 227–30; to deal with public debt following fiscal stimulus, 116; as desirable policy tool, 232; eurozone and, 157, 159, 227–28, 234–36; fiscal discipline and, 233–34; fractional reserve banks and, 220–22; future reversal of, as possibility, 273n18; as helicopter money, 218–19, 220, 227–28, 230, 233; historical examples of, 13, 112–13, 219; to increase investment, 137; inflation and, 13, 112–13, 214, 219, 231, 232, 234, 250, 266n11, 273n17; Korean investment effectively described as, 139–40; modern electronic forms of, 111–12, 219–21, 272n15; one-off use of, 237; with reserve requirements imposed by central banks, 221–22, 273nn19–20; risks of, 189, 230, 232, 237, 239; safer than private credit and money creation, 187, 239–40; to stimulate additional consumption, 130; to stimulate by financing fiscal deficits, xiii, 14, 129–30; structurally deficient nominal demand and, 239; taboo against, 230, 231–32, 250–51; U.S post facto examples of, 275n9 finance, growth of: belief in benefits of, 1, 2, 4, 19; crisis of 2007–2008 and, 21, 32–33; increasing earnings at the top and, 119; rapid growth in recent decades, 1, 19–21, 89, 254n3; specific activities contributing to, 21–23; variations over time, 20 See also credit growth; financial innovation financial activity See finance, growth of; financial intensity; intrafinancial system activity; market completion; socially useless financial activity; trading activity financial crises: Asian crisis of 1997, 52, 141, 151, 183; bad apple theory of, 163, 267n3; credit and asset price cycles and, 73; debt shifted to public sector following, 12, 80–83, 217, 226, 266n12; growing frequency of, 88–89; nineteenthcentury banking crises, 113 See also booms and busts; financial crisis of 2007–2008; instability financial crisis of 2007–2008, xi–xiv; benign pre-crisis assessments and, 28–33, 241–42; Chinese government stimulus responding to, 144, 266n19; credit crunch following, 74; debt shifted to public sector following, 12, 80–83, 266n12; dramatic increase in private-sector leverage and, 23, 51–52, 76; fatal conceit that produced, 15, 251; huge increase in financial intensity and, 21; innovations implicated in, 99; lack of foresight about, xi–xii, 241–42; low mortgage losses following, 165–66; most important causes of, 5–7, 164; slow recovery from, 4, 7, 56, 74–75, 174, 213–14; theoretical foundations of orthodoxy prior to, 36–38 See also post-crisis recession financial deepening: defined, 1; economic efficiency and, 1, 35; economic growth and, 32, 54, 172; market imperfections and, 38; pre-crisis consensus on benefit of, 32–33, 61, 104, 248 financial innovation: belief in benefits of, 1, 2, 242, 248; conflicting evidence on benefit of, 45, 46–47, 170; to create more stable system, 193–94; credit securities and, 25–27; disastrous impact of, 6, 104; low interest rates as incentive for, 86, 129; market imperfections and, 38; theoretical underpinning for, 37; top math and physics graduates working on, 28; zero-sum game associated with, 106 See also derivatives; market completion; securitization financial integration, international, 15, 149, 150–55, 156, 159 financial intensity: benign view of, 28–31; competitive equilibrium theory and, 37; economic growth and, 35, 89; factors that unleashed, 90–97; positive and negative effects of, 42–46 See also trading activity financial liberalization: apparently supported by theory, 248; contributing to Asian financial crisis of 1997, 141, 142, 143; domestic, 92–94; emerging economies and, 11, 29, 134, 150 financial markets: active, case for benefits of, 47–48; difference from other markets, 23, 33; domestic liberalization of, 92–94; imperfections of, 4–5, 11, 14, 36–37, 38; inefficient and irrational, 38–42; irrational exuberance in, xii, See also equity markets financial repression: in dealing with debt overhang, 224; successful development and, 131, 134, 136 Financial Services Authority, UK, xi, 29, 165, 166, 169 Financial Stability Board, international, 105, 203, 267n9 financial system: benefits of fragmentation for global system, 11, 15, 155, 170, 206–7; essential for advanced market economy, 35; essential to nineteenth-century economic development, 32; increasing complexity in, 24–27, 33, 87, 97, 106 (see also financial intensity); unnecessary cost in, 42–45 See also reform of financial system financial transaction taxes, 5, 45–46 fiscal deficits: in Chicago plan, 187–88, 189; funded by public debt issue, 114–16, 262n20; increasing after crisis of 2007– 2008, 215; printing money to finance, xiii, 13–14, 113, 129–30, 214; to stimulate economy, 12, 84, 215–17 See also public debt Fisher, Irving, xiii, 10, 11, 31, 56–57, 170, 188, 190, 220–21, 225, 245, 269n3 fixed-income financial assets: defined, 255n8; growth of debt liabilities as, 23 forced savings, 138–39, 266nn12–13 foreign direct investment: benefits of, 155, 206; capital flows growing more rapidly than, 89; in China, 151 foreign-exchange reserves, 183–84 foreign exchange trading, 1, 25, 89, 206 fractional reserve banks: Chicago plan compared to, 188; credit and purchasing power creation by, 58–59; historical origin of, 53–54, 113; instability associated with, 185; money-financed fiscal deficits and, 220–22; proposals for abolition of, 10, 174 France, housing wealth in, 68 free markets: competitive equilibrium theory and, 36; in credit creation, instability of, 208; misallocation of capital by, 207; overconfidence in power of, 28, 242, 249, 251 Friedman, Benjamin, 253n8, 263n22, 268n14 Friedman, Milton, 10, 112, 188, 218–19, 220, 221, 222, 230, 231, 237, 273n18 Frydman, Roman, 41, 243–44, 249 Fuld, Dick, 168 full-reserve banking See Chicago plan (100% reserve banking) “funding for lending” schemes, 85; of Bank of England, 78, 217, 234; of European Central Bank, 79 Galí, J., 273n17 GDP growth See economic growth Geithner, Tim, 184 George, Henry, 178 Germany: credit growth in export markets of, 83; ordo-liberal tradition of, 275n5; post-crisis deleveraging in, 215; trade surpluses of, 182–83, 184; Weimar hyperinflation in, 13, 113, 232, 262n13 Gerschenkron, Alexander, 54 Gertler, Mark, 245, 257n13 Giavazzi, Francesco, 228, 235 Glass-Steagall act, 91, 92 global imbalances See current-account imbalances globalization, 90–92; inequality in advanced economies and, 119, 179 Goethe’s Faust, 13, 231 Goldberg, Michael, 41, 249 Goldman Sachs, 89 gold standard, 90, 110–11, 250 Goodhart, Charles, 157 good lending with bad effects, 165–66, 202, 225–26 Goodwin, Fred, 168 government bonds: dramatic fall in yields of, 126–27, 238; GDP-linked, 193; Greek, 46, 156; liquidity and, 46; stimulative effects and, 85, 115 See also public debt issue; quantitative easing Graeber, David, 52, 123 Great Depression, 56–57, 113, 121, 164, 174, 187 Great Moderation, 2, 9, 31, 114 Great Recession See post-crisis recession Greece: cost of bank rescue in, 82; excessive public spending in, 82; public debt of, 46, 156, 223; write-down of public debt of, 226, 274n30 Green Investment Bank, 207 Greenspan, Alan, 97, 100, 103, 169 Greenwald, Bruce, 247 Greenwood, Robin, 21, 22 growth See economic growth Gurley, John, 245 haircuts, 100, 102, 103, 203 Haldane, Andrew, 20, 35, 40, 245, 254n3 Hansen, Alvin, 264n36 Hayek, Friedrich, xiii, 31, 64, 66, 133, 138, 145, 163, 170, 209, 245, 248–49, 266n12 hedge funds: collapse of Long Term Capital Management, 94; in complex financial system, 25, 26, 97, 105; earnings of managers of, 19; efficient markets and, 37; fees of, 21, 44; illusory benefits among, 261n26 hedging of risk, 26, 37, 41, 46, 98–99, 169–70, 194 helicopter money, 218–19, 220, 227–28, 230, 233 Hellwig, Martin, 173, 199–200 herd effects, 40, 45 Hicks, John, 276n7 high-frequency trading, 44 high-interest consumer lending, 123, 205 Hubbard, Glenn, 29, 30, 89, 97, 104 ICT See information and communications technology (ICT) IMF See International Monetary Fund (IMF) imputed rent, 191, 269n9 India, 13, 54, 135, 172 Indonesia, 135, 140–41, 151 industrialization: in China, 145; of Germany, 264n5; supported by financial systems, 32, 35 See also economic development industrial policy, in Asian success stories, 136 Industrial Revolution: capital mobilization in, 53; catch up of other regions following, 134–36; debt contracts and, 133, 193; economic growth in, 134 inequality: continuing to increase, 213; credit and, 8, 10, 64, 119–24, 263n28; high-interest consumer lending and, 123, 205; increased across advanced economies, xii, 27, 119–20; increase in desired savings and, 127; magnified by debt contracts, 52; monetary policies exacerbating, 12; policy implications of, 178–80; quantitative easing and, 85, 218, 260n23; rising urban land prices and, 177–78 inflation: central bank policies and, 2, 9, 31, 59–60, 93, 108–9, 114, 170–71, 196–98; consensus on desirable level of, 110; excessive credit growth not resulting in, 116; fiat money and, 13, 112–13, 214, 219, 231, 232, 234, 250, 266n11, 273n17; forced savings and, 138, 266n12; Korean growth along with, 140; raising target to facilitate deleveraging, 224, 274n28; as sole policy objective, 196, 242 information and communications technology (ICT): capital investment for, 69, 128, 176, 238, 258n16, 265n7, 266n8; driving down investment costs, 128, 176, 238, 266n8; inequality and, 179–80, 268n7; rising importance of land and, 69, 70 See also technology infrastructure investment: in Chinese stimulus effort, 144, 145–46, 239; needed, 129; proposed European program for, 236 innovation: in financial system (see financial innovation); irrational equity markets and, 47–48 instability: banks and the inevitability of, 6, 9, 48, 113–14, 186; caused by excessive credit creation, 3–4, 6–10, 13–14, 60; China as future determinant of, 134; debt contracts and, 48, 56, 185, 186; demand for land and, 247; denied in pre-crisis assessments, 29, 89; fiat money leading to, 250; financial system complexity and, 27; of free markets in credit creation, 208; global capital flows and, 153–54; increased financial activity and, 42, 45–47, 48; of inefficient and irrational markets, 38, 41; as inevitable price of economic growth, 189; inevitably generated by free financial markets, 251; inherent in monetary economies, 85, 138; inherent in private credit creation, 209; inherent in the financial system, 9–10, 185; mainstream economics’ lack of understanding of, 242, 248; Minsky on, 108; pre-crisis orthodoxy and, 60, 170; real estate lending and, 61–62, 73, 175–78; recent excellent work on, 248; risk management contributing to, 100–104, 164, 166–67, 203, 206; very low interest rates leading to, 12, 129, 130; wealth-to-income ratios and, 176 See also booms and busts; financial crises interbank lending markets, 59, 257n16 interest rates: to deal with debt overhang, 85–87; different categories of credit and, 197–98; dramatic fall in real yields, 126–30, 264n38; to influence nominal demand growth, 109; instability generated by low levels of, 12, 129, 130; natural level of, 59, 196, 197, 198; negative, 218, 272n10; policy proposal of sustaining close to zero, 224; public investment and, 129; vs quantitative controls on credit, 197, 198; raised to slow down credit booms, 9–10, 196–98; remaining close to zero, xi, 12, 78, 79, 86, 216, 217; reserve asset requirements and, 201, 221–22; as sole instrument of central banks, 9, 93, 196, 209, 248; zero lower bound for, 110, 115, 128, 261n3, 262n19 See also monetary policy International Monetary Fund (IMF): ignoring details of financial system, 170; market prices for credit and, 100; recent reform plan in paper issued by, 188; recent statements on monetary policy from, 218; supporting capital account liberalization, 150; supporting financial innovation, xi, 29, 88, 168, 242; supporting financial liberalization, 141, 150 Internet boom and bust, 5, 39, 48, 251 intrafinancial system activity, 24–25; banks’ involvement in, 24–25, 96–97; dangers of innovations in, 99; global capital flows and, 92, 153; growth of, in recent decades, 89; search for yield and, 105 investment: cut by overleveraged households, 7; savings and, 124, 126–29, 238 See also capital investment Ireland: credit supply in, 55; current-account deficits of, 156; public debt of, 82, 223; real estate investment in, 65, 72, 73, 124, 151, 156, 165, 239 irrational exuberance, xii, 5, 34, 38, 41, 51, 101 irrational human decisionmaking, 40 irrational markets, 38–42 Islamic prohibition against debt contracts, 5, 52, 193, 194, 270n12 ISLM model, 244, 276n7 Italy, 156, 223 Jackson, Andrew, 188 Janeway, Bill, 48 Japan: balance sheet recession of two decades in, 75–76, 79, 118, 141, 142, 165–66; banking liberalization in, 93, 94; capital flow constraints of, 91; catch up to advanced economy living standard, 136, 264n5; challenge of transitioning from credit-fueled model, 141–42; credit policies to increase investment in, 138–39, 140, 143; economic development of 1950s in, 134, 135; fiat money creation of 1931–1936, 112, 232; government debt increase in, 12, 80, 213, 216, 223, 228, 259n13, 262n20; lack of demand growth in, 214; land prices in, 175; options to deal with government debt, 227, 228–29; printed money used in 1930s in, 13; real estate bubble of 1980s in, 75, 259n7; trade surpluses of, 181 Jensen, Michael, 38 Jordà, Òscar, 61, 66, 76, 78, 246–47, 272n7 Kahneman, Daniel, 247 Keynes, John Maynard: banking system and, 31, 170; on excessive growth of credit, 116–17; in favor of global central bank, 266n6; funded fiscal deficits and, 114, 262n17; on mathematics applied to human decisions, 250; on money, 231, 263n22; post-war macroeconomics and, 244, 245, 276n7; on professional investment, 41; secular stagnation and, 120; on speculation, 117, 118 KfW banking group, 207 Khan, Kublai, 112 Kindleberger, Charles, 38–39, 51, 58, 88–89, 195 King, Mervyn, xi, 31, 241, 269n9 Knight, Frank, 250, 269n3 Koo, Richard, 75, 77, 78, 79, 166, 216 Korea, 134, 135, 136, 138–40, 141, 142, 143, 181 Krugman, Paul, 129 Kumhof, Michael, 121–22, 188, 189, 263n31 land, urban: changing pattern of consumption and, 69–70; inelastic supply of, 70, 77, 175, 177, 247; Japanese boom of 1980s and, 75; need for three-factor model including, 276n11; taxation of, 177–78; wealth residing in, 68–69, 117; wealth-to-income ratios and, 176, 247 land reform, 136 Lane, Philip R., 74 Lange, Oscar, 249 Latin America, 135 Lehman Brothers, xi, 168 Leijonhufvud, Axel, 276n7 leverage: continuing to grow after crisis of 2007–2008, 74, 215; predicted to rise in UK, 86; reforms focusing on level of, 208; shifted between countries, 83, 215; shifted from private to public sector, 80–83, 215 See also deleveraging; privatesector leverage Levine, Ross, 32, 35, 172 Lewis, Michael, 44 liberalization See capital account liberalization; financial liberalization LIBOR rate, manipulation of, 3, 253n5 Liikanen Group proposals, 205 liquidity See market liquidity liquidity transformation, 53, 256n2 List, Friedrich, 265n5 Lloyds Bank Group, xi, 253n6 loan-to-income (LTI) ratio, 11, 123, 176, 178; placing limits on, 204–5, 271n17 loan-to-value (LTV) ratio, 11, 72, 123, 176, 178, 179; placing limits on, 204–5, 271nn17–18 local thinking, 55 Long Term Capital Management, 94 Lucas, Robert, 2, 241, 242, 249 MacKay, Charles, 39 macroeconomics, ignoring financial system details, 31, 170, 242, 245–46, 248 See also economics, mainstream Mandelbrot, Benoit, 102 manufacturing, in Asian success stories, 136 margin calls, 100, 103, 167 market completion: delusion of, 99; positive and negative effects of, 42, 45, 46–47; presumption in favor of, 1, 28, 29, 36–37, 243, 248; rejecting axiomatic arguments in favor of, 48; rejecting pre-crisis beliefs about, 169–70, 241 See also financial innovation market liquidity: adequacy of credit and, 10; capital allocation and, 1, 28–29, 35, 43; dangers of increase in, 99; economic growth and, 32; in equity markets, 35, 46; excess of, 43, 44, 46; objections to constraints on, 203–4; rejecting pre-crisis beliefs about, 169–70 market-making, 43, 97 markets See financial markets; free markets mark-to-market accounting, 9, 29, 100, 101–2, 103, 104, 166–67 Martin, Felix, 111 maturity transformation, 35, 58, 97, 98, 188–89, 191, 203, 256n2 McAfee, Andrew, 69, 179, 180 Mellon, Andrew, 225 metallic money system, 110–11, 261n4; gold and, 90, 110–11, 250 Mian, Atif, 74, 76–78, 79–80, 118, 122–23, 166, 174, 186, 193, 205, 225 Miles, David, 264n38 minimum wage, 161, 180 Minsky, Hyman, xiii, 64, 65, 66, 108, 145, 163, 164, 185, 209, 245, 258n9, 258n11 Mirrlees, James, 247 monetary finance See fiat money monetary policy: credit growth and, 9, 12; credit supply and, 247–48; to deal with large accumulated debts, 85–87; ultraloose, 217–18, 224, 227, 228 See also interest rates money: created by banks, 58, 257n14; declining velocity of, 171; as subset of bank liabilities, 171, 268n14; unique features of, 190 See also credit and money creation; fiat money; metallic money system money finance See fiat money money market mutual funds, 26, 95, 96, 98 mortgage debt: not sufficiently restructured in US after 2008, 225; written off under Kumhof-Benes plan, 189–90 mortgage lending: bad practices in, 164–65; capital inflows for, 151; credit securities and, 94–95, 96, 104; inequality and, 122–23, 178; innovation of shared-risk mortgages in, 193–94; liberalization of financial markets and, 92; losses in 2007– 2008 crisis, 71; proposed constraints on, 11, 178–79, 204–5; recessions associated with, 76; social value of, 71, 118–19, 176; squeezing out commercial lending, 271n20 See also real estate; subprime mortgage loans Muellbauer, John, 268n3, 269n9 NASDAQ boom and bust See Internet boom and bust neoclassical economics, 136, 138, 248 See also economics, mainstream nominal demand: chronically deficient, 128, 130, 214, 228; inadequacy of free markets for, 130; Keynes on disconnect between speculation and, 117; possible structural deficiency of, 238–39; stimulated by post-crisis fiscal deficits, 215 nominal demand growth, 12–13, 14; bank credit creation and, 134, 137–38, 171–72, 187; bank money creation and, 58, 187; fiat money and, 12–14, 214, 218–22, 232; interest rates used to influence, 109; need for, 109–10, 214; potential sources of, 110–16; stimulating without excessive credit growth, 109; ultra-loose monetary policies and, 217–18 Office of Budget Responsibility, UK, 86 oil futures, 25, 46 Organisation for Economic Cooperation and Development (OECD), 268n16, 272n21 paper money, proposed abolition of, 261n3 Pareto efficiency, 36 Park Chung Hee, 139, 140 payday lending market, 123, 205 Persaud, Avinash, 267n3 Pettis, Michael, 264n35 Phelps, Edmund, 243–44 Philippines, 134, 140–41, 143 Philippon, Thomas, 27 Piketty, Thomas, 67–68, 73, 127, 176, 177–78, 179, 180, 238, 247 Polo, Marco, 112 position taking, 43, 97, 170 post-crisis recession: cuts in U.S consumption and, 166; debt overhang in, 74–75; economic harm caused by, 2, 3; Fisher’s debt deflation dynamics and, 57; with GDP 10–15% below what would have been, 45; most important causes of, 5–7; produced by excessive private credit creation, 82; underestimated extent of, xi, xii Pozsar, Zoltan, 261n24 price discovery, 35, 37, 44, 46, 47, 169, 170, 203 Prince, Chuck, 168 printing money See fiat money private equity funds, 35, 44, 66, 191 private-sector leverage: capital inflows and, 151; debt overhang determined by level of, 195; in decade before 2007–2008 crisis, 51–52; defined, 7; excessive growth of, before the crisis, 82; harmful effects of 2007–2008 crisis and, 23, 76; plan for radical reduction in, 188; predicted to rise in UK, 86, 218; rapid growth for 50 years in, 1, 7, 22, 24, 254n5; shadow banking and, 104; shifted to public sector, 80–83, 215; trust in free markets and, 93; uncertainty about harmful level of, 209 See also debt overhang procyclical financial system, 103 productivity: declining growth of, 214; increasing financial activity and, 1; investment for increase in, 137 public debt: estimates of, 254n5; of eurozone countries, 156, 157–59; fiscal policy and, 85, 216–17; Greek, 46, 156, 223; post-crisis increase in, 2, 3, 12, 80–83 See also fiscal deficits public debt issue: to fund fiscal deficits, 114–16, 262n20; for unmet investment needs, 129 See also government bonds public debt write-off, 12, 224–26, 228–29, 233 public investment, 129–30 See also infrastructure investment purchasing power: Chicago plan and, 187, 188; created by banks, 58–59, 113–14, 137–38; created by governments, 111–12; economic development and, 140 quantitative easing, 12, 78, 79, 85, 217–18; by Bank of England, 217, 227, 233–34; by Bank of Japan, 217, 228–29, 234; by European Central Bank, 234–35, 236 Rajan, Raghuram, 19, 97, 121, 169, 255n25 Rancière, Roman, 121–22, 263n31 Rational Expectations Hypothesis (REH), 37, 38–42, 243–44, 249 rationality, and behavioral economics, 247 real estate: as asset class for investment, 70; bank lending for, 61, 71–73, 104; capital flows for excessive investment in, 124, 151, 156; Chinese investment in after 2007–2008 crisis, 144, 145–46; credit and asset price cycles of, 71–73; developing economies shifting toward lending for, 141–42; excessive debt created for purchase of, 4, 6; financial crisis of 2007–2008 and, 207; financial market liberalization and, 93, 94, 141; history of crises involving, 51; increasing importance in modern economies, xii, 8, 67–70; instability and, 61–62, 73, 175–78; Irish investment in, 65, 72, 73, 124, 151, 156, 165, 239; Japanese boom of 1980s in, 75–76, 142; lending against existing assets of, 66–67; as majority of bank lending in advanced economies, 66–67, 116; as majority of wealth in advanced economies, 61, 67–70, 71, 73, 117; natural rate of interest and, 198; policy reforms needed in relation to, 11, 176–78; risk weights of loans for, 202; Spanish investment in, 65, 67, 72, 124, 151, 156, 165; tax policy in regard to, 10, 177–78, 191 See also land, urban; mortgage lending recessions: debt contracts as driver of, 56; in eurozone periphery, 158; in United Kingdom of early 1990s, 76; worse when preceded by mortgage debt build-ups, 76 See also Great Depression; post-crisis recession recovery from crisis of 2007–2008, 4, 7, 56, 74–75, 174, 213–14 See also debt overhang redistribution of income and wealth, 180 reform of financial system, 10–11; limitations of current proposals for, xii; mistaken ideas to reject and, 169–72; now being implemented, 172–73; rejecting pre-crisis orthodoxy, 208, 209, 239–40, 242; structural, 186–94, 205–7 REH See Rational Expectations Hypothesis (REH) Reichlin, Lucrezia, 74 Reinhart, Carmen, 88, 213, 216–17 Reinhart, Vincent, 74 remuneration: of bankers, 9, 167–68, 172; of top executives, 179 repo markets, 103, 203 reserve asset requirements, 200–201, 270n10, 271n12, 271nn13–14; money finance and, 221–22, 273nn19–20 Reshef, Ariel, 27 Rey, Hélène, 149, 155 Ricardian equivalence, 115, 215, 220 ring-fencing of banking structures, 205–7 risk: bank losses in 2007–2008 and, 98; financial system complexity and, 97; hedging of, 26, 37, 41, 46, 98–99, 169–70, 194; mathematical modeling of, 41; neglected in regard to debt contracts, 54–55 risk management: confidence in new techniques of, 94, 99–104; instability associated with, 100–104, 164, 166–67, 203, 206; market completion and, 46, 243; need for improvement in, 173; pre-crisis, 1, 9, 29, 41 risk weights, in banking regulations, 201–2, 271n15 Rogoff, Kenneth, 88, 213, 216–17, 218, 224, 261n3 Royal Bank of Scotland, xi, 166, 168, 253n6 Russian oligarchs, 122 savings and loan crisis of 1980s, 94 savings rates, 124, 125, 126–28, 130; global imbalances and, 180, 181–82; inequality and, 178, 179, 180; structurally deficient nominal demand and, 238 Scandinavian countries: financial liberalization in, 93, 94; interest rate tool in Sweden, 197 Scharfstein, David, 21, 22 Schularick, Moritz, 61, 66, 76, 78, 88, 246–47 Schumpeter, Joseph, 138 secular stagnation, 14, 109, 120, 125–30, 264n36; continuous money finance and, 237–39 secured debt contracts, 29 securitization, 1, 25–26, 29, 88, 89, 94, 97–98, 99, 104, 107, 243 See also credit securities shadow banking: benign assessment of, 30; Chinese investment using, 144; complexity of, 105; credit and money created by, 5, 10, 58, 98, 104, 175, 203; credit securities and, 25, 26; defined, 6; essential features of, 98; Federal Reserve map of, 26, 105; instability caused by, 6, 47; macroeconomic implications of, 33; rare pre-crisis warnings about, 255n25; regulations to curtail, xii, 195, 202–4; risk management and, 29; tightly controlled banking systems leading to, 142 shared-risk mortgages, 193–94 Shaw, Edward, 245 Shiller, Robert, 34, 39, 193, 247 Shin, Hyun, 103, 167, 248 Shleifer, Andrei, 41, 55, 247 Simons, Henry, 10, 11, 113–14, 186, 187, 188, 190, 208, 209, 221, 245, 269n3 Smith, Adam, 36, 112 socialist planning, 248–49 socially useful financial activity, 32, 43, 61, 118 socially useless financial activity, xiii–xiv, 36, 42–43, 47, 106 Soros, George, 41 Spain: banking liberalization in, 93; collapse of credit growth in, 78; current-account deficits of, 156; growth of private debt in, 22; public debt of, 216, 223; real estate investment in, 65, 67, 72, 124, 151, 156, 165; shifting distribution of debt in, 80 speculation, credit-financed, 39, 58, 86, 116–19, 128 stable economy, building, 8–11 Stein, Jeremy, 197 Stiglitz, Joseph, 43, 46, 247, 276n11 stock market: crash of October, 1987, 39; Efficient Market Hypothesis and, 37; high-frequency trading in, 44; irrational valuations in, 34; turnover in, 1, 35 See also equity markets stress tests, 74, 78, 230, 235 student loans, 94, 261n23 Studwell, Joe, 133, 136 subprime mortgage loans, 26, 71, 98, 164–65; German bank losses due to, 183; large losses of wealth due to, 205; market liquidity and, 203–4 sudden stops: in credit supply, international, 154; in debt markets, 55–56, 79; after financial crisis of 2007–2008, 74, 78 Sufi, Amir, 74, 76–78, 79–80, 118, 122–23, 166, 174, 186, 193, 205, 225 Summers, Lawrence, 129, 216, 238, 264n36 Sweden, 197 Tabellini, Guido, 228, 235 Taiwan, 136 Takahashi Korekiyo, 13, 112, 232 tariffs, 136, 264n5 tax cuts, eurozone proposal for, 235–36 tax policy: current bias in favor of debt finance, 10, 191–92; financial transaction taxes, 5, 45–46; German, 182–83; real estate and, 10, 177–78, 191; taxing credit intermediation, 191–92, 201, 270n10 tax revenues, falling after crisis of 2007–2008, 215 Taylor, Alan, 61, 66, 76, 78, 88, 246–47, 272n7 technology: catch up in emerging economies and, 135; foreign direct investment and, 151, 155, 206; inequality in advanced economies and, 119; role of land and, 276n11 See also information and communications technology (ICT) Thailand, 135, 140, 141, 151 Tilford, Simon, 182, 183 Tobin, James, 42 too-big-to-fail problem, 3, 9, 164, 173, 199 trade deficits and surpluses See current-account imbalances trading activity: banking industry changes and, 96–97; outpacing real economic activity, 1, 19–20, 25; price discovery and, 44; questionable benefit of increases in, 45–46, 47, 169–70; search for yield and, 105–6; valuable up to a point, 43, 44 See also financial intensity; intrafinancial system activity tulip bulb mania, 39, 58, 66 unemployment, post-crisis: debt overhang in U.S and, 77; overinvestment and, 65 United Kingdom: banking reforms in, 205; capital flows and, 150–51, 181; categories of bank lending in, 62; credit growth in, 51–52, 86; deleveraging after Second World War, 222–23; falling capital investment in, 128; Financial Services Authority, xi, 29, 165, 166, 169; fiscal deficits in, 215, 216; Green Investment Bank in, 207; housing wealth in, 68, 70; inequality in, 123, 125; liberalization of financial markets in, 92–93; mortgage lending losses in, 71, 165; mortgage lending standards in, 204–5; nominal demand growth in, 214; shifting debt and, 81, 83; ultra-loose monetary policy in, 217–18; very low interest rates in, 126, 238 See also Bank of England United States: capital flows and, 151, 152, 181, 183; Consumer Financial Protection Bureau, 165; debt liabilities in, 24; debt overhang and, 76–78; deleveraging after Second World War, 223; Federal Reserve, 26, 105, 275n9; fiat money in history of, 112, 275n9; fiscal deficits in, 215, 216; growth of finance in, 20, 27, 35, 89; inequality in, 119, 121, 122–23, 125; liberalization of financial markets in, 92, 94, 95, 96; mortgage credit in, 72; mortgage lending losses in, 71; nominal demand growth in, 214; post-crisis collapse of credit growth in, 78; private credit in, 51–52, 62–63; private sector deleveraging in, 225; shifting debt and, 80–83; ultra-loose monetary policy in, 217–18; very low interest rates in, 126, 238; Volcker rule in, 205 See also Great Depression; subprime mortgage loans urban development, 10, 176–78 usury, 52, 124 Value at Risk models, 9, 29, 41, 100, 167; flaws of, 102–3 venture capital industry, 21, 48 Vickers commission, 205 Volcker rule, 205 Washington consensus, 136, 141, 143, 150, 264n5 wealth: concentrated in real estate in advanced economies, 61, 67–70, 71, 73, 117; created by information and communications technology, 69 wealth tax, globally agreed, 180 wealth-to-income ratios, 67–68, 176, 247, 276n11; in Japan of 1980s, 75 Weidman, Jens, 13, 231, 232 Wen Jiabao, 144 Werner, Richard, 118, 259n7, 261n4 White, William, 197 Wicksell, Knut, xiii, 58–59, 114, 170, 188, 196, 197, 245, 257n16 Wolf, Martin, 128 Wolfe, Tom, 43 Woodford, Michael, 59, 232, 274n4 yield, search for, 105–7, 126 Young, Alwyn, 137, 266n10 Zimbabwe, 13, 113, 232 Zingales, Luigi, 19, 97 .. .BETWEEN DEBT AND THE DEVIL BETWEEN DEBT AND THE DEVIL MONEY, CREDIT, AND FIXING GLOBAL FINANCE ADAIR TURNER PRINCETON UNIVERSITY PRESS PRINCETON AND OXFORD Copyright ©... creation.11 Their belief sprang from deep re ection on the nature of credit and money, and on possible sources of nominal demand growth Between Debt and the Devil—A Choice of Dangers There are... to the Bankers PART I SWOLLEN FINANCE 17 The Utopia of Finance for All 19 Inefficient Financial Markets 34 PART II DANGEROUS DEBT 49 Debt, Banks, and the Money They Create 51 Too Much of the