One idea espoused by more rabid free-marketeers when discussing the banking system is the idea that banks should/should be able to issue their own currencies, e.g. as suggested by Financial Services Minister Lola in the comments to one of yesterday's posts:
Returning to commercial banks the right to issue their own currency would make them more 'prudent' and to switch from gaining deposits on 'rate' to gaining deposits on 'security'.
1. I always find it helpful, before we reinvent the wheel or propose something radical, to look at what actually happens. If you think about it, commercial banks can and do issue their own currencies when they raise money by issuing bonds (which historically are a far more important source of funding that issuing shares). The following does not really apply when a bank raises money by taking ordinary bank deposits.
2. The main practical difference between two different currencies are that they pay different interest rates (for a variety of reasons the relevant one, for the purposes of this discussion being the fact that some countries are better or worse credit risks); and that their relative values fluctuate, i.e. EUR 100 a year or two ago was worth GBP 60 and now it's worth GBP 90.
3. If a good bank like HSBC and a shit one like Lloyds Group both issue bonds for GBP 100 nominal value next week, the market value of each, on the date of issue will be close to GBP 100. But Lloyds Group's bonds will have to pay a much higher interest rate than HSBC's because they are, at present, a worse credit risk.
4. If Lloyds Group's credit rating tanks even further, the market value of all their bonds in issue will go down; if it recovers, the value will go up, and if the interest rate is high enough, the market value will go above nominal value. So you might pay GBP 100 for GBP 100 nominal next week and be able to sell them on for GBP 110 in a few months or a year's time.
5. So, somebody who invests in the bonds issued by a UK bank that are denominated in GBP, is to all intents and purposes investing in a (slightly) different currency to GBP. As and when the holder wants to convert his nominal GBP 100 of bonds back into hard cash, coins and notes, in the future, he will find that the market value could be anything between GBP 0 (if the bank has lost a lot of money and the bonds are 'junior' or unsecured debt) and a lot more than GBP 100* (if the banks credit rating is good/has improved and/or the interest rate is higher than future interest rates on similar quality bonds).
6. That's exactly the same as investing in bonds issued by a foreign government; if you invest GBP 100 today, the amount that you get back in hard cash in future will go up or down, depending on how that country's economy is doing, how high government debt is, how high their interest rates are in future and so on.
Just sayin', is all.
* For comparison, some building society 'Permanent interest bearing shares' that were issued when interest rates were very high, and which still pay 13% interest are worth about 150% of nominal value, even those issued by wrecks such as Halifax (now part of Lloyds Group)
Thursday, 12 November 2009
Economics Thought Experiment Of The Day
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Obviously, people will take a grand out of their HSBC acccounts in notes,exchange it at one of the money -changing emporia that will spring up ,or somebody who money changes on the side (taxi drivers give a good rate in some countries),getting no doubt a grand + 100 in Nat West notes that you will be free to spend (except that shopkepers will not accept Nat West/RSB notes).
Tell you the truth I am am beginning to lose faith in the upcoming Wadsworth administration and not just because of Lola's past indiscretions depicted in song
by Ray Davies ( people can do what they like in their spare time)but because of the prevailing opinion that banks just pass on Mr A's deposit as a loan to Mr B who eventually pays it back ( and when Mr A turns up at the bank in the meantime for his money is told its all out on loan-happens all the time,not)and makes no mention of the fact that B's money is given to C who sticks it in the bank as a new deposit.Do the maths in gold coins -it still comes out the same,as long as promissory notes are written on paper.
Also the Wadsworth policy on dividends /citizens incomes ,hopefully to be inaugurated next year when the electoral system collapses amid mass distaste and boredom, is horribly prudent by using existing government revenue.Meanwhile the tantalising possibility of using quantitative easing money to boost citizen's dividends and increase spending-power is left in abeyance (See letters by DBCR to Guardian & Observer and the works of Major Douglas and others bent on socialising credit)
I agree with your analysis Mr W and proffer this additional thought.
Money is, in essence, a means of measurement.
How much is FatBigot Towers worth compared to a Ford Focus? Well, FB Towers has bricks, wood, slates, glass and a plot of land whereas a Ford Focus has metal, plastic and a few other things. They are not comparable without a means of comparison that looks beyond the physical components. Neither has any value to anyone other than a human being, so we need something that measures what human beings think of the two items of property. That's where money comes in.
FB Towers will be evaluated by using pounds, dollars, Euros or whatever in one sum, it matters not what sum, and a Ford Focus will be given (I hope) a lower value. The value is measured by whatever currency is chosen for the exercise, but each currency is simply a unit used to measure relative value in the market as it stands at the moment of valuation.
Any number of further currencies will not alter the value of an item of property, they will simply provide additional measuring instruments.
DBC: "Mr A's deposit as a loan to Mr B who eventually pays it back ... and makes no mention of the fact that B's money is given to C who sticks it in the bank as a new deposit. Do the maths in gold coins -it still comes out the same, as long as promissory notes are written on paper."
I have done the maths a thousand times, it all nets off to nothing in the end. As to the A to B to C problem, that is what is known as a credit bubble, which sensible banking supervision (with the credible threat that banks will be allowed to fail, TM Lola) and a tax on land values (to prevent asset price bubbles) will prevent.
"the tantalising possibility of using quantitative easing money to boost citizen's dividends and increase spending-power is left in abeyance"
Because that just leads to inflation, i.e. redistribution from savers to borrowers, and so is ultimately pretty pointless.
TFB, exactly, that is a good way of putting it. The issue is that the value of a Ford Focus is pretty constant (as they can always build more new ones if demand increases) but the value of TFBT depends solely on the availability of easy credit (because land ownership is a quasi-monopoly in fixed supply and NIMBYism ensures we can't just build new ones).
Quantitative easing via the banks is not that inflationary at the moment so why should the same amount of created money suddenly become inflationary when it reaches the people? As Hitler said in Table Talk Schacht's monetary expansionism worked just fine while there was spare capacity in the German pre-war economy.
Also as Christine Lagarde elegant
French Finance Minister said recently in the Guardian you can also spend new money on infrastucture which will get the money down to the grass roots.(Of course ,as we know, any inflation from such new infrastructure would soon show up in raised land values and could immediately be scalped by LVT.)
As to loans A-B-C , you are missing out that banks don't close A's account while lending his money to B.The banks have created two spendable accounts out of one.And it not A-C you have to worry about: the original deposit can be re-capitulated eight or nine times, A-H in fact.This is not the exceptional case of a credit bubble,as you suggest,but standard procedure in fractional reserve banking.(And no harm in it whatsoever,especially if the banks were nationalised ,when interest rates could serve as a tax on money creation.Two single taxes!)
The Wadsworth administration though enlightened on LVT does look a tad conservative and of Calvin Coolidge like instincts when it comes to money.
DBC, you're still dabbling in one-sided economics.
"you can also spend new money on infrastucture"
Obviously, the private sector would never provide stuff like Crossrail, that requires the state to push it through, to be funded by LVT, of course (subject to democratic approval of those concerned). But the private sector is crying out to spend its own money on power stations, airports, docks, factories, houses (which would also get money down to the grass roots) but the NIMBYs won't let them (and we know which tax would sort out the NIMBYs).
"As to loans A-B-C , you are missing out that banks don't close A's account while lending his money to B..."
Well of course not, otherwise A would never deposit his money.
"The banks have created two spendable accounts out of one.And it not A-C you have to worry about: the original deposit can be re-capitulated eight or nine times, A-H in fact."
Yup, let's go with 8 or 9, I have never said anything else, that is how it works. But why would B borrow from Bank1 and deposit with Bank2? In normal conditions, he would be stupid to do so because the interest he earns is 2% less than what he pays.
It is only in credit bubble periods that this happens, and a highly dangerous practice it is too. Between 2004 and 2007, it was possible to remortgage at 4% and put money on deposit at 5%, which is madness of course.
I'm still against money printing for the heck of it because it transfers wealth from savers to borrowers, although as you say, the fallback is The Sentinel Tax.
MW agreed with all that. The idea behind returning the freedom to us (not just the existing banks) to make and issue our own money is as much about driving responsibility into the population as it is about driving out the irresponsibility of central banks and their poltical masters. The basic basic economics you have laid out show this need. Somehow we have to re-couple banks (central and commercial) irresponsibility with fear of failure. If bad bank A has to offer / pay a higher interest rate it is by definition more risky than low rate paying bank B. Depositors can then choose where to store their wealth and whose money to use. The market is efficient and the differing risks of banks A and B will be known. Socially (yurgh) we may as society decide that small depositors that cannot easily diversify their deposits and money in hand need some form of insurance protection at a modest level. This will be provided commercially and again the price of the insurance (compulsorily disclosed) will add to the information available to the market - riskier banks will pay a higher price. Of course this information was, to a degree, already out there pre Crock failure in the share prices of the banks. But hey, once you nanny people they stop thinking.
Yes but you know the nature of interest bearing bonds and debt free notes. The latter would set the cat among the pigeons.
JH, what on earth is a 'debt free note'? There is no such thing. Even a bank note is not debt free - it's a kind of government borrowing.
Yes, well the bank is not going to stop people withdrawing money from their in fact emptied out/loaned on accounts because a) it would n't get many deposits as you correctly observe and b) the bank does n't have to when it can (and in fact customarily does)fill the emptied account with money created by the bank ex nihilo.
B does not ,as you suggest,take the money derived from A and immediately stick it on deposit in another bank,losing money on the comparative interest rates,he buys a van off C ,for instance,and C sticks the proceeds in the bank as a new deposit or as an enlarged deposit.
It is actually me in this discussion who is being orthodox ( See Kitty Ussher from Treasury last year 'When banks make loans ,they at the same time create a new deposit for those that have borrowed the money.As borrowers spend their new deposits-for example to pay a retailer for goods-this same money is returned back to the banking system as a new deposit in the bank account of the retailer.'
I have never come across any serious economist, or dabbler such as myself, who says that bank loans are matched by extant deposits.
DBC, she trying to say exactly what I am have always been saying, and which is a time-honoured fundamental point about banking.
"When banks make loans, they at the same time create a new deposit for those that have borrowed the money. As borrowers spend their new deposits - for example to pay a retailer for goods-this same money is returned back to the banking system as a new deposit in the bank account of the retailer."
Step 1. Bank makes new loan. The borrower now has two accounts - one account with money in it; one loan account with a liability. It nets off to nil. The borrower becomes neither richer nor poorer.
Step 2. Borrower withdraws money from current account and spends it. Retailer deposits money in his own account. So total 'cash' in both accounts still adds up to the same amount. Borrower's loan account already existed from Step 1 and is unchanged.
Or you can miss a step and imagine that somebody buys goods with a credit card. The buyer's loan is created in the same split second as the retailer's deposit balance goes up.
Either way (ignoring losses on reckless lending), total borrowing always = total savings (plus/minus fixed assets, share capital, bits and pieces).
I don't see how you can adduce Kitty Ussher in support of your argument since her letter was meant to demonstrate that "By far the biggest role in the creation of money is played by the banking system itself." She then goes through the steps I follow.
In the steps we've been enumerating ,the bloke who sold the van C has deposited money in the banking system in addition to the amount A still has available to spend.So two deposits from one; and the process of money creation is not finished yet.
DBC: "the bloke who sold the van C has deposited money in the banking system in addition to the amount A still has available to spend.
So two deposits from one; and the process of money creation is not finished yet."
Correct. The bank has created two deposit accounts. But to create the second deposit account it has to create a loan account. That's the bit you are missing.
And if the money goes round again, the bank creates another deposit account and another loan account.
And no matter what the actual reserve fraction or minimum capital ratio is, for every new deposit account there is a new loan account.
People who make deposits are savers. People who take out loans are borrowers.
So in the long run, total borrowings = total savings. (plus minus bits and pieces).
The banks are just middlemen. They may be wily, cunning, greedy or reckless middlemen, but middlemen nonetheless.
The real debts are as between borrowers and savers. Which conveniently usually net off to nil.
You 'll have to explain how this self balancing process ends up being the principal cause of monetary expansion according to the Treasury's then Economic Secretary and authoritative works of reference e.g."In the course of issuing money the commercial banks actually create it by expanding their deposits ,but they are not at liberty to create all they may wish ,for the total is limited by the volume of bank reserves and by the prevailing ratio between these reserves and bank deposits- a ratio set by law,regulation or
custom. "Encyclopaedia Britannica vol 12 p.357 1981 edition.
DBC, because 'monetary expansion' just measures one side of the equation!
That EB quote might as well say "In the course of issuing money the commercial banks actually create it by expanding their loans" and it would mean the same thing.
So the money supply can either measure all deposits or all loans. If it measured both and netted off the positive deposits and negative loans the answer would always be zero.
Compare and contrast:
a) I supply you goods on credit for payment in x weeks, and you then have a liability (you have to pay me money) and I have a receivable (I am fairly certain to receive money from you). Whether we have thereby expanded the money supply is open to debate.
b) You pay for the goods in my shop with your credit card, you still have a liability (you have to pay the bank some money) and I have a receivable (I am almost certain that I will be able to withdraw money from the newly created deposit account at the bank). It is widely accepted (by everybody except me) that you, me and the bank between us have increased the money supply.
You have the liability either way.
But in example a) I have to make a proper risk assessment of whether you will actually pay. In example b), I rely (possibly wrongly) on the bank's ability to be able to collect the money from you.
And that's where it always goes wrong - I overestimate the bank's ability to collect money from you, and you overestimate your ability to repay the bank (not you personally, but people who take on huge mortgages etc), so the banks busily create more and more loans and more and more deposits until one day the credit bubble bursts.
I cannot see how the factors you describe above explain the consistent monetary expansion of the banking system which governments and officials try to regulate by monetary and fiscal measures.
It would help if you would cite a few outside sources for your opinions as I have done with The UK Treasury and the Britannica ,from which my accounts of money creation do not deviate very far.At the moment there is a lack of objective correlatives your side of the debate.
Congratulations on your storming letter for the FT.As you know they often delay publishing for days after receipt,so hope is not lost.
DBC: "I cannot see how the factors you describe above explain the consistent monetary expansion of the banking system"
I explained that in my previous comment!
It's because the retailer will always overestimate the credit-worthiness of banks and banks will always overestimate the credit-worthiness of personal borrowers (in my previous comment). If the retailer had to sell the goods on credit to the customer with no bank as intermediary, this would be far less likely to happen.
More to the point, banks appear to believe that 'house prices can only go up' so will lend ever larger amounts against the same old assets, so people who have sold houses and the Chinese end up with huge deposits, and recent purchasers end up with huge loans.
And the monetary expansion only goes so far. Sooner or later there is a credit crunch and the whole bubble disappears and then we start again.
"And the monetary expansion only goes so far. Sooner or later there is a credit crunch and the whole bubble disappears and then we start again."
Or the central banks resort to QE to keep the bubbles going. In other words they try and frustrate the necessary destruction of money that must occur to correct the over-inflated asset bubble. Of course this just leads to an even bigger bust when QE has to stop plus catastrophic rises in the general price level driven by the monetary inflation of QE. The consequential and necessary destruction of money - deflation - has now to be so much greater than it would have been if the Central Bank and the Government has left well alone in the first place.
Monetary expansionism can go on long term ,while fiscal and monetary checks and balances are in place,triggered by signs of inflation.The Credit Crunch was less to do with banks lending too much money as it was to do with banks discovering that their reserves were disintergrating in front of their eyes by consisting of mortgage based derivatives which demonetised when people stopped paying their mortgages on sub-prime real estate in the US.
I take it from your lack of citations that yours is a home-made
explanation of the system.Fair enough but I am surprised you have come over all Fotherington Thomas on this one: "Hello trees! Hello flowers!The banks are the friend of man!"
I just don't follow DBCReed's 'logic'.
It's not my logic: this is the orthodox explanation. I have sourced my references to a Treasury official and the Britannica, than which you cannot get more mainstream.
I cannot follow the logic of allowing banks to go down pour encourager les autres.Read up on the Pennsylvania Rail Strike in 1873(?): the consequences were horrendous in respect of loss of life in rioting and the destruction of property.This happened before the American Central Bank was set up in the early 20th century.There was another American bank panic in the early 1890's.There is a cost to letting banks crash.Once bank runs start,there is not much to stop them because their reserves are fractional.
I don't suppose you'd be so sanguine if your bank had gone down and taken your savings or capital with it.
Ahh right.
Letting banks, or any business, go bust is fundamental to the success of wealth creation. Bad businesses and people and investors are punished and resources they would have consumed are available to other better businesses.
Banks are not exempt from this discipline, fractionally reserved or not. In fact the moral hazard implicit in the perenniel rescue by the taxpayer of failed banks just makes them more profligate.
It is perfectly reasonable for the State to stand behind the indiginous depositors (unsecured lenders to) the banks, whether corporate of private. Preferably this will done on a commercial basis by commercial insurance companies whose premiums will be avery good price indicator of the level of risk of any particular bank.
When the bank goes bust the small depositors are compensated but the equity and bond holders lose the lot, or whatever fraction cannot be realised. Pension funds are big holders of bank bonds, so they would suffer, once. Once everyone knew that banks were not going to be supported such funds as pension funds would diversify away from banks and the problem created by moral hazard would go away.
The risk in our current system is only systemic because all banks are as bad as each other and they all work on the basis that they can take on as much risk as they like because they will be rescued by the taxpayer. Once it is made very clear that this will not be the case the levels of acceptable risk, and the price of that risk, will be adjusted upwards and you will find, for example, that banks fractional reserve ratios will automtically become more prudent.
@ Lola
Its difficult to see that rescues of banks are "perennial" and that they will "automatically" be rescued by the taxpayer:Lehman Bros was allowed to go belly up when its giant property speculation outside Bakersfield hit the usual trouble; Barings ,which should have served as a warning, went out of existence.There were some fringe banks BCCI etc that were put in the BoE lifeboat after a mortgage lending catastrophe in the 1973 fiasco.
I would have thought that the banking reform that recommends itself from the above instances is that banks get out of mortgages and the bubble real estate market that is a recipe for disaster for institutions that borrow money short,often on the wholesale spot markets and lend for lifetimes.If people sourced mortgages from old-fashioned small savers in building societies (mortgages from commercial banks are comparatively recent in the post-war era)then this would be a useful, essentially conservative
step.Never mind the Glass Steagall split: in the present circumstances a split between old fashioned mutualised building societies (which lend money more the way Mark thinks banks do) and popular savings banks is more what is required . I agree casino banks should take their commercial chances,as not affecting many people and those pretty rich: the sinking of Barings caused barely a ripple,except of laughter.
I do not think banks for ordinary people's savings should be thrown to the wolves of the market:deposit insurance would be expensive,would require a capitalisation equal to an actuarial computation of the fractional reserves sufficient for regular bank crashes and runs (see previous American examples i.e. 1873,1893); would point the finger at banks like Northern Rock that did ,in fact ,offer high interest rates to depositors,leading to a run followed by a clean out of the insurers' capital reserves,and a "competitive" banking system henceforth where all banks nervously stayed in line on (low ) interest rates to savers and high interest rates to borrowers.And there's the one-off near certainty of people losing all their pension funding which you mention in passing.
Can't see whats in it for ordinary
hardworking families (snortle ,snortle). (They would in fact stick all the more money into real estate, this being what OHF's do).
DBC, where on earth did I say that banks are the "friend of man"? I wasn't putting a value judgement, I'm saying how it works, which is pretty much the same as your explanation, I'm just fleshing it out.
I seconded Lola's eminently sensible suggestion that banks be allowed to fail (i.e. via debt-for-equity swaps).
Just because I blame the Home-Owner-Ists far more than the banks, doesn't mean that the banks are entirely innocent in all this.
Look, Mr DBCReed, you only have to remember one thing to understand that the banks are just a cartelised tool for the State to fleece us. "Banks merely allocate capital. Where the State has the monopoly of money it controls the supply [and price]."
All of the problems of asset bubbles would go away if the state stopped messing about with things it doesn't and can never understand. Consider, at any one time you and I know just at what price we will lend money to anyone taking into account the underwriting and market risks, despite what the State sets as an arbitrary rate. The very fact that all politicians, and I mean all of them left and right, persist in maintaining the fiction that the central Bank (that means they, the politicians) need this rate setting/money supply power to 'successfully run the economy'. It's just total bollocks. The economy runs itself very well without any of their interference. All we set the State up for is to provide, with our democratic consent if you like, a few basics, viz; the rule of law, to guarantee our right to enjoy our property, low and certain taxes, security and defence, and to act as umpire not player.
You may decide that we could add to that insurer of last resort, for example for health care (I confess this is self interest as I am uninsureable for private health care) and to provide for education funded from general taxation. And possibly lender of last resort for the commercial banks - if we persist in wanting to hang on to Sterling as the only currency avaialble to UK citizens to ease the conduct of business.
You can be sure that returning to us our freedoms and responsibilities would ensure a more stable economy with booms and busts of much smaller magnitude. I have not bothered to check the examples you have cited but my own general reading has indicated that the magnitude of booms and busts has been made much greater by the State monopoly of money and the creation of nationalised central banks. This present boom and bust being a good example of such an issue in that the policy decisons taken in the wake of the much smaller bust of the tech boom precipated the much larger bust of the credit boom. And what is more, the QE program and such ludicrous 'stimulus' measures will result in a much bigger, or even catastrophic, bust sometime in the near future.
We either have to recognise now the extreme limitations of politicians and central banks to do anything meaningful to make our commercial lives better and wealth creation possible and pursue a properly liberal (dare I say libertarian) free, democratically accountable, small state, low tax future, or to slip ever further into the social bureaucratic state with our lives in general, and our commercial lives in particular, governed by endless rules entirely incompatible with freedom and wealth creation, but given public consent as long as Dancing Strictly X Box and football and Big Macs are available on demand.
The arguments we are having here are about small parts of this bigger picture. To understand this start from freedom, the fundamental human value, and work forwards from Magna Carta. If you love freedom, guaranteed by full democratic accountability you'll end up with a referendum on staying in or getting out of the EU. You cannot end up anywhere else.
@ Lola & our genial host
I have no wish to further lose friends and alienate people so will pack (cycling term) in the certain knowledge that none of the quotes and instances I flourish will change entrenched opinion.
Two observations: when the EB states definitively that "In the course of issuing money the commercial banks actually create it by expanding their deposits" the corollary is that by charging interest on sums of money that they create the banks are permanently in moral hazard,to put it mildly.(This is the cornerstone of the old Social Credit belief system) So this very Anglophone opinion that the in fact,ineffectual State restraints on banking privilege should be further lessened is wide of the mark.
Secondly,the present readily observable situation is that the U.K. banking system crashed through ingesting too many toxic derivatives from American sub-prime mortgages.The Government did not force them to do so.Once the banks were down and out the Guv stepped in and sorted things out without the OHWF's losing any deposits.The Guv did n't have to do this either: it could have let the banks dangle in the wind pour encourager les autres as urged at some length by Lola.
Since these UK banks have been re-capitalised with public sector money,many of their private sector derivatives having dematerialised,far from suffering under the lash of the New Labour/New World Order the banks have hoarded the money,paid themselves huge bonuses and taken not a blind bit of notice of anything Brown and the Brownites have said.So much for the over-mighty State!
PS "The banks are just middlemen"In the context of this quite fierce argument ,this does have shades of Molesworth's
hippy-before-his-time school companion.
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