Banking as Fraud
I’ve got involved with one or two on-line debates recently in which the issue of money in commercial banking is seen as a fraudulent process by which value is stolen from citizens. Usually the central bank is seen as the government’s enabler in this process, and so to blame for the resultant misallocation of credit or ‘malinvestment’. This is a view to be found among adherents of the ‘Austrian’ school of economics, and ties in nicely with their extreme views of the efficacy of markets and the villainy of governments. Even if they do not believe the only money used should be gold, they believe that its value should be tied to gold and that central banks consistently devalue the currency by setting too low the interest rates at which commercial banks borrow from them.
While the Austrians’ views are so dogmatic as to be fairly easily ignored, there has also been a recent tendency among some campaigners, such as Positive Money or GolemXIV, to blame the current discrepancy between rewards to the rich and punishment for nearly everyone else on the banking’s ability to ‘create money out of thin air’. According to this view the banks then profit from this costless activity by lending it to us at interest, either directly or indirectly via government.
In fact the truth is that the banks have being doing too little lending to us, and too much to each other, and for the wrong things. To start with understanding what is going wrong with banking we have to understand what banks are really supposed to do, why it’s not fraud, and why the central bank should not be blamed for everything.
What Banks are (Supposed to) Do
Money is a tangible (or semi-tangible in the case of a bank deposit entry) representation of an abstract entity. The abstract entity behind the representation of money is a credit contract. A credit contract is a promise to provide something in the future in exchange for something now. So as long as such a promise is offered and accepted in good faith, the representation of that is no counterfeit.
And that is what banking is (supposed to) do – for a fee (interest) banks monitor and guarantee credit contracts so that the representation of the promise is widely accepted. Socially speaking, the fee for banking is in exchange for enabling the acceptance of as many viable promises as possible, by allowing them to be made in the form of goods and services that those accepting the promise do not themselves desire, but which have value on the market.
This sort of thing was going on long before the existence of central banks, and would continue to go on without them. The banks willingly provide the guarantee for their fee; the promisers voluntarily make their promises and pay the banker’s fee; the promisees willingly accept these promises; and crucially, those accepting the guaranteed representations of this contract (money) also do so voluntarily. Credit banking is therefore a classic free arrangement of individuals, and any objection could only arise collectively – and so should certainly be anathematic to (economic) Austrians and all that value personal freedom.
If central banks play a malign role in this, it is because their guarantee to those accepting the representations of contracts enabled by multiple banks is provided at too low (or possibly too high) a cost, particularly given the moral hazard implications of such a guarantee. Of course it’s possible to argue that such guarantees are worthless, and so any cost is too high, but if some want it, should it not be available?
2 replies on “Is Banking Government-sponsored Counterfeiting?”
As I understand your concluding paragraph, you are saying that all that is wrong with the role played by central banks is that the price they charge for standing behind commercial banks is too high or too low.
I suggest there is something wrong with a banking system that needs support of any sort from the taxpayer.
Also I’m not sure about the argument in your penultimate paragraph. This seems to be that what banks and their customers do involves agreements entered into voluntarily, thus “all those that value personal freedom” should approve. I think the flaw in that argument is that there are hundreds of types of “voluntary” agreements and arrangements that are clearly against the common interest. For example we don’t allow anyone total freedom to make and sell alcoholic drinks without paying a hefty tax. Or for another example, the agreement between a coal producer to sell coal to an electricity generator who in turn sells electricity to customers is all entirely voluntary. But for environmental reasons it should arguably be curtailed or banned.
Hi Ralph. Thanks for your comment.
The support from the tax-payer, with all its moral hazard problems, is a trade-off with the ability of banks to respond flexibly to opportunities to increase welfare while at the same time providing efficient transaction services. Any risky project may fail; any bundle of risky projects may all fail and with it the bank holding them. The role of deposits and the interlinking of banks mean that a bank failure has wide repercussions that may not be politically tolerable.
I don’t see how an absence of deposit insurance (implicit or explicit) is sustainable in the modern environment. What’s your view on that?
As to the interlinking – if banks don’t get loans from each other (with resultant balance sheet exposure) to match flow discrepancies then they have to get them from the central bank anyway. Without the interlinking, every bank basically issues its own currency, with all the problems that entails.
To some extent the Vickers Report is addressing the trade-off referred to above by trying to separate some of the more risky activities from transaction services, but lending is itself risky and lending cannot be separated from transaction services.
Sorry, yes, in general terms you are quite correct. This paragraph was originally written in response to a fundamentalist free-market position, so this was emphasised. It also refers to stand-alone credit banking, with no central bank – for which I think the externalities are minimal.