MACRO-ECONOMIC DESIGN

The main home page is not long. Below that is some of the course content, as explained below.

Macro-Economic Design is replacing traditional macro-economics as taught at universities. It takes a new direction. Instead of allowing prices of every kind to be distorted by the financial framework in use today...instead of allowing financial instability to take hold and then intervening to try to reduce the damage, this new science shows how we can remove the sources of those financial instabilities. Across all related sites for Macro-economic Design there have been more than 100,000 Page Views says Google+

COPYRIGHT: Provided that you acknowledge the authors, that you fairly represent the views expressed and that you credit the Macro-economic Design Research Group (and where relevant any original source of the article in question) with due prominence, you may freely quote from articles on this website.

CONTACT
Edward C D Ingram travels a lot

Tel:+2639230487 at times but +27 12 547 5816 now

Cell: +263772900000 at times but +27 749660660 now
WhatsApp 0044749 713 8 287 now
Skype: edwarding2 any time. Free download www.skype4free.com
email: eingram@ingramsure.com

Available for seminar/workshop presentations

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LATEST NEWS
Click here to see the LATEST UPDATES
on this website and linked sites. Pages are subject to editing without notice.

Edward is now putting together an online course in macro-economic design in partnership with www.interfima.org. There will be exams, tutorials, and a certificate of competence will be issued as appropriate at the end of the course.

Pilot students are needed to help in developing the course. Apply to Edward Ingram: eingram@ingramsure.com

Membership of the exclusive MACRO-ECONOMIC DESIGN Discussion Group is well over 400 economists, finance people, and media. Apply to join Here

INTRODUCTION TO MACRO-ECONOMIC DESIGN
AND MANAGEMENT

The main sources of financial instability in the world's economies are as follows:

Fixed Interest Bonds
Housing and Commercial Finance
Currency pricing
Managed Interest Rates
And some problems with regulations and taxation.

Having instability caused by all of the above, basically means that there is little chance of being able to manage the economies of the world in any really meaningful way.

Here is an analogy:
If you design an aircraft which is highly unstable in flight, it will be difficult to fly and the passengers will not enjoy the ride. It is exactly the same with economies.

HERE IS THE PROBLEM:

Most economists have lost interest in the idea that free market forces operate or can be made operate in their economies. They have no real idea of what to look for. Yet when the above list is pointed out it becomes obvious - there are no free market pricing adjustments built into the key elements of the economic framework.

Furthermore, most faculties of economics are not combined with the faculty of finance nor the faculty of systems control and management. There is no academic structure in place which is capable of addressing the real instability problems.

Perhaps as much as a century of research and development in macro-economics and finance has been largely wasted by this oversight.

Fortunately Edward Ingram has a lifetime (over four decades) of in-depth knowledge and experience in all of these skills as well as in new financial services development and marketing. This means that practical solutions can be created. It is called Macro-economic Design and Management.

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THE KEY PROPOSITION

This proposition by J M Keynes explains the source of financial instability very nicely but despite almost immediately afterwards pointing to fixed interest debt as one of the sources of wealth re-distribution and hence financial instability, he failed to follow up on it:

Chapter 1 page 1 paragraph 1: In his 'A Tract on Monetary Policy', first published by Macmillan in 1923:

"If, by a change in the established standard of value [of money], a man received and owned twice as much money as he did before in payment for all rights and for all efforts, and if he also paid out twice as much money for all acquisitions and for all satisfactions, he would be wholly unaffected"

A more accurate statement would allow all prices to adjust to all market forces so that they would end up being that much higher than they would otherwise have been.

The outcome would be the same. People would then be spending on the same new things in the same new ways that they would otherwise have been doing had money not changed in value. They would be wholly unaffected.

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In fact, Keynes went on to say that in practice this is not what happens when the value of money halves. The distribution of effects on wealth is not uniform and the result is that it "affects different classes unequally, transfers wealth from one to another, bestows affluence here and embarrassment there, and redistributes Fortune's favours so as to frustrate design and disappoint expectations."

To address this issue we have to find a way to replace fixed interest money-back contracts with fixed interest value-back contracts. Because the risk premium to wealth / value is taken out, this will be a cheaper way to borrow and will provide valuable investment opportunities to pension funds and reserves of all kinds where preservation of value is of prime importance. Managed funds will be able to guarantee that some calibrated fraction of their fund will not be volatile, the older clients being put into the least volatile funds with the greatest proportion of such guaranteed assets.

It can be shown that keeping pace with National Average Earnings, NAE, is a reasonable but not completely accurate proxy to use for preserving value whereas preserving purchasing power is not. We can easily write contracts to lend value and to repay value once this is understood.

Market forces will adjust for the inaccuracy of this measure by altering the marginal rate of interest above the rate of growth of NAE, both for the ever-changing rate of devaluation of money at close to its unmeasureable actual rate, and for all other market forces which are operating. For fixed rate bonds the adjustment will be to the fixed rate at the time of issue - the market rate for the maturity date used.

Repaying the NAE which was borrowed plus interest is the way to arrange that with contracts written which are more easily understood than just saying this. It can be done. Examples are available.

What is more, debts are repaid out of earnings and pensions and savings seek to preserve NAE and so to keep pace with NAE. There is an earnings match between savings and repayments. This means that we can harmonise the entire savings and lending industry to adjust for something close to the rate at which money is falling in value.

A MAJOR COUP
This means that the financial instability connected with property prices and the (up to) one third of GDP which may be related to this whole sector, and up to $60trillions worth of bonds with unsafe bond prices which puts most financial institutions and businesses at risk, can be almost entirely eliminated.

NO MORE LOST DECADES
It means that unlike the dilemmas being faced by central banks currently, whereby they are scared to raise interest rates, we can release interest rates to rise without any major catastrophe. Those lost decades do not have to be lost - but more on that later. Read the pages on the LOW INFLATION TRAP and adjacent pages to the left of that on how to find the 'normal' rate of interest and why marginal rates of interest net of the falling value of money can be fairly stable.

HELPING ANOTHER HALF OF WORLD GDP
Above, it was shown that up to a third of GDP can be more financially stable and then there are bonds which must affect most of world GDP. Here is how to help another 50% of World GDP...

You cannot create a self-adjusting market price if there is no single market in which to operate. To deal with the price of currencies we need to reform the entire foreign exchange process so as to create one exchange market for trade and one for international capital. We need to have a good regulatory process to prevent large scale arbitrage without seeking perfection at the cost of slowing transactions. This will remove a lot of financial instability from around half of the world's business pricing - half of world GDP will benefit. It is worth making some effort to achieve that even if some arbitrage does get through.

This will prevent foreign money from entering our own money stock and influencing domestic interest rates in that way. It will end currency wars by removing the means. A level playing field will be established in the capital markets with foreign and domestic entrepreneurs competing to capture the national capital and human resources on level terms. The best use of these resources will be made. More on that in the course.

AND HERE IS HOW WE CAN HELP ANOTHER 100% OF WORLD GDP

To free domestic interest rates we need to follow some of the latest thinking being done by central banks. Better still, they need to follow the course in macro-economic design.

There are two kinds of liquidity:

Debt-free Money like notes and coins and the money created QE-style printing and
Debt-based money which is lent into existence and which goes out of circulation when repaid:

Until recently it was regarded as highly dangerous to issue a lot of debt-free money. This is nonsense. The truth is that it is highly dangerous not to have enough debt-free money in circulation because otherwise liquidity shortages cannot be avoided.

When the cycle of borrowing reaches a peak and debts start to be repaid, liquidity reduces and the economy slows anyway.

The idea that only more borrowing can restore spending levels and the idea that borrowing cycles should not ever slow spending, is completely wrong. But this is what appears to have brought interest rates down to currently low levels. These low interest rates waste huge amounts of capital and human resources as does any wrong pricing of anything.

It would be far better that the interest rate 'price of credit' should be set free and that the stock of money should be managed instead.

There is a whole section of macro-economic management theory based on control systems theory which deals with that. This will be presented in the course.

Creating debt-free money and distributing it across all sectors of the economy may not be enough to ensure that it gets spent. But it can be made to give a fairly balanced stimulus across most sectors. See below for more on that.

To create a truly balanced stimulus debt-based money also needs to be created. The balance between the two sets of money needs to be managed to avoid changing established spending patterns and to support all of the production which people have chosen to spend their money on. This should not be disturbed. Governments can change what they spend on freely but that should come from their own budget, not from a temporary stimulus because it is temporary. It will remove resources from elsewhere and then they will need to move back again. It will disrupt and therefore slow the economy.

The better way to distribute debt-free money is to reduce sales taxes like VAT and subsidise all spending which pays no sales tax. For example, regular savings, charitable donations, medical purchases if exempt, and so forth. People get an incentive to spend and everyone gets some free money left over in their accounts at the end of the month. So people give free goods and services in return for that new base money and they get free goods and services themselves when they spend that left over free money. The economy gets the added liquidity needed and there is no debt to repay afterwards.

The function of central banks will be to manage the ratio of debt-free money to debt-based money and to create new money at a fairly steady rate, not interfering with spending cycles which are natural and which rise and fall as people save more, borrow less, and import more, and then reverse those things.

Central banks should aim to steady the ship and not to target rates of prices inflation. They should create new money at a steady rate as Professor Milton Friedman suggested. They should not manage interest rates which, given a free market (more on that in the course), will find their own level. People naturally want to spend more than they earn and so the level of demand for loans will always exceed the supply unless the rate of interest is high enough to limits that demand.

This means that savings will be rewarded.

IF ALL OF THESE CHANGES ARE IMPLEMENTED
All prices including the price of hiring people (incomes) and paying rental and dividends (earnings), the cost of repaying home loans and servicing government and commercial debt, the value of properties, the price of the currency for trading purposes, will adjust as money falls in value without any interventions being needed. Adam Smith was right. We were wrong to ignore him.

Keynes was right, people would be wholly unaffected by te falling value of money. Creating too much will cause money to fall in value but it will also spur demand and make sure that no liquidity shortage slows things down.

There will still be spending cycles, more now and less latter, but a constant pull from excess money creation will ensure that no downwards spirals occur. Martin Fieldman was right.

In the event of a black swan or other impact distorting the economy, recovery will be much easier and much faster without all of the pricing distortions which destabilise the economy at present.

For more on how this can be done take the course when it is launched. To be notified of this event or to be a pilot student email:

eingram@ingramsure.com

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BELOW IS SOME COURSE WORK WHICH FORMED AN EARLIER hOME PAGE.

LINKS GIVEN ARE NOT GUARANTEED TO WORK.

The study of Macro-economics has fallen into disrepute due to its failures. The BIG failures are Design Failures, not so much management failures, but that too. The financial framework demonstrably creates instability and the management systems do not function properly. In both cases, the design of the framework and the management systems, are demonstrably not designed in line with their respective text books. An exciting new page has been added on 12th August 2015 entitled INTRODUCTION TO MACRO-ECONOMIC DESIGN. This tries to explain why economics has got into such a mess. It goes back to basics.

Macro-economics without the Principles of Macro-economic Design is like Physics or Engineering without Newton's Laws of Motion and the laws of Magnetism, Electricity, etc. or like Mathematics without the strict rules of arithmetic. That is essentially what the PEER REVIEWS of these web pages are saying. Only now are we learning the basic principles behind the science of Macro-economic Design and Management and their APPLICATION. This is very much work-in-progress for everyone to take part in, in this discussion group.

THIS HOME PAGE HAS THESE PARTS -

MAIN CONCEPT
INDIVIDUAL PROBLEMS OUTLINED IN THREE SECTIONS
A NEW ILS RANGE OF SAVINGS AND LOANS
LINKS FOR FURTHER READING

1. MAIN CONCEPT

There are too many imbalances. The reason is simple: if the price is wrong, you get too much or too little supply. You get an imbalance.

Economists teach that economies are unstable and have to be managed.

This Research Group teaches that if the financial framework and management systems were not interfering with pricing, there would not be any imbalances in the world’s economies big enough for economists to worry about. That is basically what the early text books always said about the role of pricing. It is correct. The oversight is that the financial framework is the main cause of mis-pricing. See Section #1 below. But there are also problems with the selection of management targets and especially with management instruments. The aggregate level of demand should be managed, not the prices. And demand should be the target, not prices inflation. See Sections #2 and #3 below.

The issues are hidden in plain sight...

2. INDIVIDUAL PROBLEMS OUTLINED IN THREE SECTIONS

Section #1 This essay from the respected Project Syndicate website says a lot at least for the housing sector - a boom and bust in the property sector is the most damaging of all - by far. A quote: "I estimate that the total loss to production will eventually reach nearly $3 quadrillion. For each dollar of over investment in the housing market, the world economy will have suffered $6,000 in losses. Perhaps more credibly, the paper states that five years after such an event, national economic output is still 9% below what it would have been expected to be had that boom and bust not occurred. How can this be?

ONE SOURCE OF THE MIS-PRICING PROBLEM
We have interference in the pricing of debt, making housing finance and the entire sector unstable. By what measure? All prices including the overall cost of finance and the value of debt, should be able to adjust to balance the level of aggregate supply with the level of aggregate demand or demand per person in any economy. Otherwise there will be a mismatch between supply and demand in the relevant sector(s). Demand across the whole economy comes from spending that ultimately comes from National Average Earnings, NAE, but with undulations which come from changing levels of savings and borrowing to spend, together with some input from changing levels of imports and exports. But on average, spending rises or falls as NAE rises or falls. There ought to be a relationship between NAE and the cost of Loan Servicing payments, but that is not the case. Check this out:

Like rentals and most other prices, as demand rises slowly, the prices and debt servicing costs and property values should rise slowly and more or less proportionately to everything else, because supply rises much more slowly than demand - NAE. Here is why we have a problem - Table 1 above.

LP = Level Payments / Annuity mortgages.

EXAMPLE FROM TABLE 1
If the rate of growth of NAE, called the Average Earnings Growth rate, AEG% p.a., rises by 1% p.a. then by and large, interest rates should rise by 1% to restore order to the value of savings and debt. Every price, every cost, and every value should adjust likewise compared to what their values might otherwise have been, (before local or other impacts and influences are taken into account). But this table proves that that is impossible. You don't have to have the world's best definition of NAE or AEG% p.a. to see that there is something wrong because the cost response to a 1% raise in the interest rate is out of all proportion no matter what measure you use.

As this table shows, interest rate changes in response to a higher or lower level of AEG% p.a. send everything haywire. No matter what measure you use, repayment costs have no way to rise proportionately to everything else. Starting at 2% interest, a 1% increase in the rate of interest to accommodate a 1% increase in AEG% p.a. raises the cost of monthly payments by 12.8%. Starting at 8% interest, a 1% raise in interest rates causes the cost of repayments to rise by 9.2%. Market forces acting upon the level of monthly repayment costs are denied the right to adjust proportionately. Instead we have a positive feedback multiplier at work here. What is positive feedback? Positive feedback destabilises something as a general rule, but not always. It increases the speed of movement in the direction of the movement. When interest rates are raised to slow the level of demand, it raises the cost of mortgage repayments. That is expected. What is not expected is that it will raise the cost by multiple times, producing a positive feedback.

It is how we write the contracts. Why not repay the wealth (the number of NAE) borrowed at affordable and consistent rates? Why not start with a high level of repayments of the wealth borrowed and reduce that over time to prevent payments fatigue and a high level of arrears? It can be done. Otherwise, as we know, the consequence is mayhem:

The mayhem causes central banks to be afraid of raising interest rates so they also get mis-priced. What causes imbalances? Wrong prices do that. What else could?

AND THEN LOOK AT GOVERNMENT DEBT:

No matter what measure you choose to use, Government Fixed Interest Bonds are not permitted to adjust either in servicing cost, or in value, in a proportionate kind of way. This is due to the contract. The contract says that the MONEY capital will be returned.

Fixed v Variable: Fixed Interest cannot be used to counter ever changing rates of money devaluation. The value of the fixed interest bonds is impossible to estimate. The fixed money cost contract encourages governments to raise inflation to reduce their debt burden and the fixed money cost discourages them from reducing inflation. This fixed rate debt contract ensures that pension funds, annuities, and other offerings which use fixed interest bonds as an investment cannot offer safety to the public. It does not need to be like that. Bond values and loan servicing costs should, and can, also rise slowly with little volatility if the contract is written properly to keep pace with an index of NAE. This (Figure 2 above) is the consequence of not doing that. The chart shows annual changes in the true market value (in units of NAE) of USA Government bonds 1980 to 2005 in units of NAE. NAE is a suitable measure of value for use by pension funds when managing their funds. In an orderly economy, bond values should rise as NAE rises - just like most incomes rise and similar to how government revenues rise and just as a lot of other prices and values throughout the whole economy also rise. NAE is one loose but appropriate measure of the way that demand per person in an economy is changing, or will change in due course, when the earnings get spent. As already explained, there are undulations due to savings and borrowing undulations, and there are undulations coming from international trade, but eventually all the value that is spent comes from earnings. It does not come from God or any other external source. And it (earnings saved) does not accumulate indefinitely. In the end earnings are spent.

If this problem is fixed by using a different contract for government / sovereign debt, allowing, or ensuring, that bond values preserve the value or the wealth (NAE) borrowed, (see Key Concepts 3 below), the major part of the risk premium paid by governments on their fixed interest bonds could be eliminated and so save a borrowing government up to 2% in interest (risk premium) costs. In the above USA example, Figure 2, the interest cost saving in the early 1980's would have been around 8%. Needless to say, 8% of a huge national debt is a lot to pay for bringing inflation down. But that is what caused this extraordinary cost: it was caused by the use of fixed interest rates as the rate of inflation declined. Bill Gross made a fortune out of that - well done for him, but he was not to blame for making profits from tax payers. He did not have to be a genius to see that a huge profit could be made. Sorry Bill. It is the system.

Taken together with unstable house values and repayment costs, and unstable business finance and unstable reserve values based upon 'safe' fixed interest bonds (I did not say they are safe - that is what the text books say when they say government bonds are 'risk free'), these instability features prevent central banks from freely adjusting interest rates upwards as needed. This was confirmed in an essay jointly authored by myself and Keith Redhead, author of several books and now retired lecturer in economics as displayed here in Figs 15 and 15a. The contracts used for housing finance and much of government and business finance, make the related costs and asset prices too vulnerable to interest rate and/or inflation rate increases. There is a huge amount of gearing. The contracts can be changed to fixed interest payable on a bond whose capital is index-linked to NAE instead of being fixed interest on money. Problem solved. I call these contracts, WEALTH BONDS. Economists prefer to call them floating rate notes, but who wants to buy floating rate notes when they can buy wealth bonds?

IT IS ALL IN THE NAME:
It is all in the name. You can have good theory that is understood by economists and call them floating rate notes, or you can have good marketing and call them Wealth Bonds. I come from the real world as an ex financial adviser and creator of new financial services that sell.

Here, below in Figure 3, is an illustration of how difficult it is for central banks to raise interest rates against this HIGHLY GEARED RESPONSE background - the gearing of pricing and costing and value adjustments is far too big to handle:

Several attempts at raising interest rates have failed because, at first guess, the response of the market place is so highly geared that they arrive at a resulting response that they had needed to get a decade or more later. And it goes on rising. For more information on this check out the LOW INFLATION TRAP.

To make matters worse, Business Insider has just published this chart showing that the credit cycle has taken off again. It looks all too similar to the pre-crash one, and it is in housing. 8th July 2015.

Section # 2 We have prices (interest rates) trying to balance credit supply with credit demand, but we are not managing the amount of credit. We are managing the price of credit - the rate of interest. Prices are supposed to be passive, adjusting themselves to try to balance supply with demand. We are managing the wrong variable. The text books are clear about this. Why do we do it?

This management system leads to imbalances in the level of demand (spending) all the time. It overshoots the target in both directions - up and down. Management theory says it is a loose system. Like driving a car with loose steering (video link - 14 minute lecture to a University in 2008). You will never get the car to travel straight down the middle of the road. Credit is always too much or too little. It is never in balance. Not even nearly. The management system is loose so that we get booms and busts. The Bank of England just published a paper showing why lending booms during boom periods: it is because of the way banks are incentivized to create money at those times - positive feedback pushing everything in the direction of motion. Lending drops fast when the cycle goes the other way because of the way banks are incentivized to avoid risk. Same thing: positive feedback. Just like a vehicle, if the steering is loose, or maybe we should say it has too much positive feedback, it is unable to stay on the road. We can change this. We can manage the amount of credit and the stock of money exactly, allowing interest rates to find the balance. We can increase the stock of money and credit (the stock of money and the stock of credit money are two different things), as and when needed in an orderly fashion. Problem solved, Our IngramSure research group and the Positive Money Group are the two main proponents of the new order. Not everyone agrees - Anne Pettifer for example. See the page entitled ANNE PETTIFER ON EVERYTHING. But is is also worth reading about MONEY ISLAND. This is a fictional story about how money functions in various ways and how pure credit and savings are not exactly the same thing. These two pages explain a lot more on this subject than most readers can find elsewhere.

NOTE: The Money Island page will eventually provide a summary of all of the principles of macro-economic design and management covered by all of my researches and all of these researches will eventually become a book.

Section #3 We have currency pricing trying to create a balance in two different fields of operation at the same time. THAT IS AN IMPOSSIBLE TASK FOR ONE PRICE TO PERFORM. The balance of trade never balances because it cannot. One price cannot create a balance in two separate fields of activity. We can find another way. If we choose to do so, we can give the currency price just the one role: balance of trade. Problem Solved. But it is not that easy to think through how it can best be done.

Note in the above graph, from Business Insider how interest rates around the world are correlated. Is this helpful? Are all economies supposed to have similar rates of inflation and interest rates at all times? The dual pricing of currency problem gives rise to this problem by linking international capital flows to the price of currencies. This interferes with domestic interest rates and the stock of money as well. It creates a link to all of these things. The price of the currency is only loosely linked to the balance of trade, which is not right. Wrong currency pricing is responsible for major problems for the world economy. How big a problem is this? Read on...

One third of Global output is exported. See Chart:

Which means that one third is imported.

Which means that some part of two thirds of global pricing is unsafe. One third imports plus one third exports. Some imports are later exported to the total may be around a half of world output which has no safe price.

It was not always like this. As shown in Figure 4 at right a lot has changed over the past half-century. Now the problem has to be addressed.

Some people think that the answer is to have a single world currency but that is going to give rise to plenty of political problems. The assumption made is that the entire world will have one taxation system to cope with imbalances between various regions or nations, and one Federal Reserve Bank. And one set of powerful people will decide which region or nation will get assistance from the other nations and regions when needed. They will give terms and conditions for that assistance. Politically that system is unsafe.

Today, up to two thirds of businesses cannot plan far ahead because they do not know what the currency prices will be, they do not even know what the cost of credit will be, or how soon it will be before the economy changes to a better or worse mode of operation, recovery, boom, or bust. I estimate that the world is losing around 2% p.a. of its potential output growth. I say 'output growth' because all output growth may not be real economic growth. There is a viewpoint that real economic growth may not be sustainable for ever.

ONLY INSTABILITY IS PREDICTABLE
If we take into account all of those errors in pricing and management in all three areas mentioned above, no businesses and no families can make a safe financial plan.Why would economies not be unstable? What can be predictable? Only ongoing instability and political risks are predictable. Steady economic output is not possible. Why not? It should be possible with just minor undulations.

SUMMARY

Prices adjust to balance supply with demand – that is their function. So if we look at the pricing mechanisms (the financial contracts and the way things like regulations and taxation are done) we can find the faults. By correcting those faults we can end interference with those natural pricing and costing adjustments. We will get an end to imbalances, greatly reduced risk, reduced costs, lower capital reserve requirements, greater confidence, more investments that work, an end to very low interest rates, (people borrowing money will then have to contribute something of value to make a profit), a sustainable high-level employment economy, safer exchange rates, greatly reduced social turmoil and extreme political movements...the list goes on. And probably we will get 2% p.a. more economic output with less risk of war and social unrest.

WORLD'S LOSS

It is estimated that had these problems been addressed before the turn of this century, making these changes could have added 32% to annual world economic output by now. That is around 2% p.a. added to world economic output by the avoidance of losses - boom and bust, currency instability, property and debt value instability, lost confidence in savings and reserves, and the effects of those things on business planning and investment. The various Ingram Lending and Savings (ILS) models for savings and loan repayments can compete with equity investments significantly better, providing a better incentive to expand a business or to start a new one. These borrowing and savings structures / contracts make lenders more competitive, in need of less capital, and it is a significantly more sustainable business model for them.

TEXT BOOKS ARE WRONG

These Peer Reviews correctly say that the ideas will change everything financial. Text books will have to be re-written. Text books are making a number of mistakes. One is that they say that economies have to be unstable. Another is the measure used for the preservation of wealth. Read on:

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3. A NEW ILS RANGE OF SAVINGS AND LOANS

Here is a page about SECTION #1 - the new proposed range of Savings and lending / borrowing models named after the inventor as Ingram Lending and Savings (ILS) Models. They are basically new contracts aimed at taking out risk by aligning the ongoing cost and the new cost of borrowing for new loans, with the level of NAE and the rate of change of NAE. The rate of change of NAE, the rate at which Average EArnings are Growing is called Average EArnings Growth, AEG% p.a. If you write contacts that permit prices to do their proper job of adjusting it is natural to expect those contracts to be safer, cheaper, and more competitive and more sustainable with lower reserve ratios than what we have got now. It is natural to expect the central banks to have an easier time of managing the level of demand in the economy as a whole , and for the entire economy to perform much better.

KEY CONCEPTS

1. Economies are complex systems. This means that any one part of the system which is not behaving as it ought to behave has far reaching effects.

One of the key concepts which Edward Ingram likes to put forward as an analogy is this:

“If all of the passengers in the bus are sick, dizzy, have headaches and back ache, do not administer medicines. Do not spend vast resources on a better stability system. Just change the wheels from square or oval ones (as in Figure 1 above) to round ones as in ILS loans and Wealth Bonds. Dozens of symptoms will disappear." If we use oval wheels, spending patterns will have to change as the wheels turn. People will not have the money that they used to have to spend on what they really want. Instead they will be forced to pay much more on loan servicing costs, or much less, depending upon what part of the wheels are touching the ground. - as in Table 1. As these costs rise and the tip of the oval wheels is reached, raising repayment costs, the suppliers of some of those goods and services will lose their jobs. That will start a chain reaction of lost confidence, reduced spending, lower property values, and even a recession which is self perpetuating. The trend has a momentum of its own.

And so it is with the world’s financial sector. The finance sector, including housing, government, commercial finance, and related savings and pensions plans, are easy examples to chose as a starting place for reform because if the loans are made right so the savings contracts become safe: people will not HAVE to default.

Whereas rentals and other prices and costs tend to rise slowly over time, the cost of housing and the value of investment bonds behave as if they are on board that bus. Nothing feels safe. Nothing is safe. The proposal is to change the wheels from oval to round with dozens of significant benefits for everyone in the savings, pensions, borrowing, and business sectors.

Every economics text book explains how, in a free market, prices are expected to adjust to balance supply with demand. If that were the case in the savings and borrowing sectors, prices and costs would rise steadily as National Average Earnings, NAE, (a reasonable proxy for average long term spending demand), increases faster than supply. The supply of everything in the world does not rise much every year, but spending from income can rise very fast because incomes / earnings can rise very fast. If priced correctly to adjust to this, the value of savings and investments in property and bonds would be significantly less variable and chancy. Businesses would be more easily planned and cheaper to finance, as would pensions and home ownership. Family homes would not be repossessed in a boom and bust cycle creating millions of worried people, fearful of loss of employment, family, and home. Even if the supply of credit is better managed and interest rates somewhat stabilise, the rate of change of demand will still vary, and interest rates will still have to make adjustments. The currency pricing system also needs to be reformed.

CONCEPT: If people feel safe, and if they are able to make plans that are safe from financial instability, the economy will perform.

2. Protecting purchasing power is not enough. A natural and undistorted economy will protect National Average Earnings, NAE, not purchasing power. Here, in outline, is why:

Again, market forces have to balance the supply with the demand in the global / national economy. In order to do this the total demand, mostly coming from earnings, borrowing, and spending of the nation, has to be in at least somewhat balance with the total productive capacity of the nation. To the extent that there may be an excess demand, (faster rising earnings), prices will rise.

ALL IN HARMONY

Without going into too much detail at this stage, as NAE rises, so all prices should tend to rise including investments, company turnover, costs, profits, dividends, share prices, rentals etc. To keep a sustainable balance (something which has never been achieved but which nations strive to achieve by manipulation of interest rates), interest should add to savings and loans at a rate which keeps that balance. They should add 1% to the money value of accounts for every 1% rise in NAE. It is not possible to make National Average Earnings (NAE) rise at a constant Average Earnings Growth, (AEG% p.a.), rate. Therefore, in a sustainable and well balanced economy, the AEG% p.a. rate should be a guide as to how interest rates should change; and, given freedom to do so, that will happen. If all prices, costs, and values can be free to adjust, spending patterns will not change. Employment patterns will remain the same.

GRANDPA'S FUND

Edward Ingram likes to give this example: Imagine this: a fund valued at 20 National Average Earnings, 20 NAE, (around half a life-time’s earnings for an average person), was invested by your grandpa to keep pace with a prices index. A century later, when you were expecting to inherit this fortune, and to be able to spend half a lifetime spending it all, you are told that it might be worth just one year’s National Average Earnings, 1 NAE. That is a 95% loss of NAE over the century. You are shocked. It will be worth, not a half life-time’s earnings as intended, (the original 20 NAE), but closer to 1 NAE – just a single year’s average earnings. Other people got the main benefit, not you.

That is because it is usual for earnings to rise faster than prices. Here, the difference in the rate of increase between rising earnings and rising prices was assumed to have averaged 3% p.a. for 100 years. That is, about 3% p.a. real economic growth, which broadly, is accepted to mean the difference between the rate of average earnings growth (AEG% p.a.), and the rate of prices growth, (inflation). As earnings rise faster than prices we all, savers included, GRANDPA'S FUND INCLUDED, should become better off.

CONCLUSION

AEG% p.a. is the growth rate (or interest rate) needed by a pension fund in order to offer a pension which reflects the amount of NAE paid into the fund. If a total of 6 NAE is paid in during the course of say, 30 years, then there needs to be around 6 NAE in the fund at the end of the 30 year contract - when the fund is needed to provide a pension. So the fund must earn AEG% p.a. just in order to preserve those NAE. Any more NAE earned is a profit. Any less is a loss. AEG% p.a. is a neutral rate of interest.

Here is a table showing how much a small variation in the marginal interest rate relative to AEG% p.a. can affect the cost of borrowing and the return on lending.

The true rate of interest is the name given to this marginal rate of interest. At AEG% interest the true interest rate is zero. Above AEG% the true return, the true interest rate, is positive (upper part of the table), and below AEG% the true rate is negative, (lower part of the table).

The table is sourced from Edward Ingram's spreadsheets for home loans - mortgages. AEG% p.a. was set at 4% p.a. so a true interest rate of 1% was a nominal rate of 5%. The entry cost is the initial cost of the repayments using the current LP Model for mortgage repayments. The amount lent is set at 3.5 years' NAE or 42 moths' income. The total excess months (above 42 months) of repayment costs in months of NAE is shown in the third column, and the benefits to the lender who finds new borrowers all the time so as to remain fully invested in lending for 25 years is shown in the right hand side column.

HOW MARKET FORCES WORK
If interest rates are equal to AEG% p.a. then borrowing to invest in assets which tend to keep pace with AEG% p.a. such as property and shares is automatically profitable and the demand for new loans will exceed the supply unless the supply is not fixed. That excess demand arises because these assets also provide income. The cost of the borrowing is less than the return on the investment - at least on average across all such investments. True interest rates will rise to limit the demand. If the central bank fails to raise the true rate, then demand will continue and the amount of credit thrown into the economy and the amount of transaction money created will constantly rise until the central bank wakes up and gets ahead of the curve, as they say. By that time all prices, wages, and asset values will have risen, which means that more transaction money is needed so that Paul can pay Bill without having to be paid first himself. For that, there must be enough money circulating. The money in circulation was created by banks when they created all that borrowing. Now the borrowing has peaked and is going into reverse, that transaction money is disappearing. QE steps in. But QE is not balanced. It is spending in just one or two sectors. A golden rule of macro-economic design and management is that all balances need to be maintained. Of course, the world's economies are not balanced because of the pricing imbalances. So QE tries to re-balance some of those.

If true interest rates are too high then the return from lending, (see the above table), without the volatility that other assets have, will mop up all of the investment monies out of those other areas; but at the higher level of true interest rates, borrowers will be unable to afford the repayments. Interest rates will fall. So there is a stability mechanism here. Stability happens when there is negative feedback: negative feedback opposes a strong movement away from target in either direction. In this case, the target is to create a balance between the supply of credit and the demand for credit.

If the supply of credit was limited, then the scenario of the central banks allowing interest rates to be too low for too long as just outlined above, would be impossible. The system would be self-stabilising. The true interest rate would target at a level where supply of credit matched the demand for credit with undulations around that level. The negative feedback of too great a cost of borrowing as the true rate rose and of a big incentive to borrow when the true rate was below that level would create a basically stable model for the economy on that front.

I just wrote that. The previous text is also worth keeping. It said: This partly assumes that the stock of money and credit is limited - which will be a great help in stabilising the system - see Section #2 on that - management of money creation. But it already happens because central banks target the rate of inflation as well as creating a stimulus when needed by adjusting interest rates.

Here is a graph showing how that marginal rate of interest above AEG% p.a. (called the true rate of interest) behaved prior to the new era of super-low, unsustainable interest rates of the current century.

Here is the South African version:

Clearly the management systems are awful. Look at how rates swing around. But market forces still prevail in the end. The 20 year moving average gives the same result as the UK average - true rates are around 3% meaning nominal rates 3% above AEG% p.a. for prime lending with collateral security.

In Japan it was not possible for the writer to get good data. But it was stated that housing finance was subsidised at 2.5% p.a. At the time, AEG% p.a. was stuck at close to zero.

3. The proposed Ingram Lending and Savings (ILS) Models for savings and debt all recognise, and easily adjust costs and prices in the savings and lending and property investment sector to market forces; they clear the way for market forces to operate with less distortion in an imperfect world.

I apologise for some repetition of what has already been written.

The ILS Model for government debt can simply index-link the debt, (the capital value of the bonds), to an index of NAE. The capital will then grow at AEG% p.a. A pension fund or any managed fund wanting to take out the risk to the fund can simply buy into these Wealth Bonds (as they have been named). No risk premium will be added,[1] saving governments up to 2% p.a. in interest costs. In the above graphical example for USA Treasuries 1980 - 2005 the saving could have been up to 8% in true interest. No wonder bond portfolios did exceptionally well over that period. The price paid by the USA government for cooling inflation was very high. Use of Fixed Interest Bonds was the reason why.

EUROPE The same thing happens in Europe when revenues are falling but bond servicing costs are not falling during austerity. Fixed interest loans may look a bit like this:

And the chances of default rise taking the risk premium up (interest rates rise for new fixed rate loans). As the risk premium rises, for a government which must keep on replacing their old fixed rate bonds with new fixed rate bonds as the old ones mature and get repaid, this is a major source of instability. As the new bonds rise in risk premium, the interest rates rise and the risk of government default rises. The risk premium can become the major source of risk. It can create a government default.

With Wealth Bonds this would not happen because the risk premium would be around zero. It may rise above zero if the government does not show any sign of balancing its budget. As long as people believe that there will be no government default the cost of the risk premium paid by a borrowing government or by a home buyer with enough collateral security will be close to zero. Home buyers have a greater risk of arrears and administrative costs so their borrowing does cost more.

The ILS Model for Home Loans
For home loans, using the ILS Model at low interest rates not too much wealth would be lent (as happens now). That is because the mathematics of lending shows an increased risk as as the amount of wealth lent rises, and lower entry costs (the initial cost of repayments) does not justify lending much more. This means that the entry cost will not be allowed to fall when interest rates fall, at least not by much. It also means that the repayments will be able to fall every year. As incomes stopped rising and the interest rate drops, to 3% in this illustration, the repayments over 25 years would look like this:

See table at right. Source Edward C D Ingram
Spreadsheet for 3.5 years' income loan repaid at 3% nominal (and fixed true) interest and zero AEG% p.a. This is an ILS Model.

It is dangerous to lend more when nominal rates of interest fall significantly. Using the ILS Models the entry cost (first year cost) and loan size and property prices are all stable across interest rate changes but can vary somewhat as the true rate of interest changes, making borrowing cheaper or more costly as tabulated above. The reason for that is risk management science as illuminated in these various web pages - but re-enforced by regulations. In every case, with the ILS Model, the cost-to-income (or more precisely, the NAE rate of repayment), falls at a similar rate to that illustrated in this table.

As incomes rise, the value of money falls because supplies from national output do not rise that fast, and if they did, then the value of money would still fall. With the ILS models, the money cost of repayments rises correspondingly but there is still more NAE to pay in the early years than in the later years. So there is a kind of race: will money fall in value faster than the payments are supposed to fall? In that case payments will rise but less quickly than NAE - average earnings.

And so all ILS models which use fixed true rate loans look very similar, with the '% of income' needed to repay falling from 30% to around 11% over the total 25 year period. This is not based upon individual incomes but upon units of NAE - the number of NAE repaid is defined in the contract without actually using the terminology. Sales documents are simpler than that! In sketch form ILS Home Loans with fixed true rate (funded by wealth bonds) might look like this:

The 21% of income line is included to show how much rental payments might cost if they grow at AEG% p.a. For variable rates the repayment slope varies and there are a lot of technical things to understand. That is covered in the General Equations for Lending.

Managed funds can calibrate the amount of wealth risk (NAE risk) which they wish to expose the fund to by specifying how much must be invested in wealth bonds which can be issued both by governments and the private sector for housing and for commerce. A subscriber to the fund can potentially save 6 NAE over a lifetime and exit with a guaranteed 6 NAE, paying very little in administration costs, most, or all of which could be covered by the interest paid by the government or other borrower issuing wealth bonds. Given widespread use of wealth bond funding by the various ILS models, and a generally better-adjusted economy overall, actively managed fund managers, when selecting their investments, will devote more time and resources to assessing how well a company is managed and the potential market for its products, and less time on pondering how well the economy is likely to perform and affect a particular sector, or the whole market.. This will help to allocate capital to the greatest benefit and it will help the economy to provide more effective employment.

As a further consequence, variable interest rates should become less variable. On average interest rates should be high enough above AEG% p.a. to limit borrowing to the level needed by the economy as a whole in the credit-driven economic structure that we have today. If the interest rate goes a little higher, investors will crowd into the lending sector, forcing rates down again. If the interest rate is too close to AEG% p.a., demand in the economy will exceed supply forcing interest rates to rise. This assumes the economy has returned to normal mode.

This explains why this marginal rate of interest above AEG% p.a. has averaged a small percentage above AEG% p.a. for prime lending in the developed economies studied.[2] Higher rates can be found, reflecting greater risk, or monopoly lending, or other unusual difficulties, it is assumed.

[1] This assumes that the government is unlikely to default on its debt. It also makes it less likely that the government will default on its debt. The risk premium is the rate of interest added to protect lenders.

[2] The studies were done prior to the low interest rate era which central banks are struggling to end.

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4. LINKS FOR FURTHER READING

WHERE TO FIND MORE INFORMATION

For now, just read through all of the pages on this website and follow the links to see anything else that you wish to read. Alternatively:

Here are links to pages which cover most of the topics that will appear in the book. These words come from a guide given on the General Equations for Lending web page which is the best way for mathematicians to learn how the new proposed lending models work and why they will out-perform all other models yet devised. All lending models can be fitted onto the Risk Management Charts and compared directly.

The basic economics and this group's theory of the origins of financial instability is being written more fully as a book of which this mathematics will be a key part for Section #1 of the overall book.

There is this page on NEW FINANCIAL PRODUCTS RESULTING which is based upon the maths.

Some of the research done on past true rates of interest can be found on the three pages starting with this one. The third page, named THE LOW INFLATION TRAP explains why interest rates are distorted and currently low.

Sections #2 and #3 of the book are covered quite well in outline on www.fin24.com in the later essays. There is a guide to those essays here.

Section #2 deals with problems of money creation, including the cause of unstable interest rates, booms and busts resulting, and a suggested remedy.

Section #3 deals with currency price instability, and a suggested remedy.

Various attempts have been made to write the opening pages of the book on this website - that particular page is NOT the book, but is a CV of sorts, so see the following various pages if you are interested. Check the three pages headed BOOK etc and the one headed IMBALANCES Edn 2 which is no longer Edition 2 but to change the name cuts the links from other pages. So the name stays.

GROUPS AND OTHER LINKS

LINKED GROUPS THAT HAVE COMMON OBJECTIVES

MACRO-ECONOMIC DESIGN DISCUSSION GROUP

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Introduce yourself in the Tea and Chatter Forum.

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Firstsource Money - http://firstsourcemoney.org/