I note an interesting little discussion between Tim Worstall and Ralph Musgrave on money creation in the context of the Northern Rock bank crisis of 2007. Essentially Tim was claiming, against the PositiveMoney view, that the failure of the bank was evidence that it was not possible for banks to create money. Ralph’s point was that it is possible for banks to create money if they move ‘in step’, but since Northern Rock was creating money (by lending) faster than other banks this led to its problems.
In fact both Tim and Ralph are ignoring the role a crucial player here: the Central Bank – in this context the Bank of England (BofE).
The basis of our monetary system is money created by the BofE in the form of notes, coins and accounts held by commercial banks with the Bank of England. Let’s imagine a single commercial bank operating in the UK that holds a certain amount of this BofE money. This bank could certainly create additional money by lending up to the point that it could still cope with demands of depositors for banknotes and coin, or to pay taxes etc. to the government. Most transactions, however, would be between account-holders. All the bank need do for these is adjust its deposit records; no reserves would be required.
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. Continue reading Is Banking Government-sponsored Counterfeiting?→
Long piece today by the Guardian’s economics leader writer, Aditya Chakrabortty, on the cost of the banking crisis, bank misconduct and what should be done about it. I agree wholeheartedly with the thrust of this piece, and indeed said much the same two and half years ago in my piece on the Guardian Cif site. Aditya’s piece concludes that
any investigation needs to understand how to reform the finance sector so that crises like these don’t recur; and so that banks actually work in the public interest rather than hire propagandists to pretend they do. Because in the end, financial reform is not about technicalities, but about politics: deciding what role banks should play in an economy, and what kind of economy we want.
However, he says also that:
According to the IMF, the British stuck £1.2 trillion behind the finance sector. Read that again: well over a trillion pounds in bailouts, and loans and state guarantees on bankers’ trading. In just a few months, and with barely any public debate, every household subbed £46,774 to the City. A sliver of that money eventually went unused; as for the remaining hundreds of billions, we have no idea just how much we’ll get back – or when.
David Malone, a documentary film maker, perhaps better known these days as blogger on the financial crisis and its causes – operating under the name GolemXIV – gave a talk in Edinburgh on the 6th of December.
He’s quite a charismatic guy and gave an effective talk in a church with no aids other than a radio microphone. I hope that he will continue to campaign against the current acceptance of continuing economic policies that will undoubtedly make the majority of us worse off. I have offered him this commentary in the hope of improving our mutual understanding of the problems faced and how we might deal with them.
I was at your talk in St John’s in Edinburgh last Tuesday night and was impressed by the eloquence and passion with which you make the case that the current economic situation is a travesty of democracy and fairness. With that view I am in complete agreement, and I think you have the qualities needed to get the required message across. Continue reading Commentary on GolemXIV in Edinburgh→
Varley accepts on the behalf of ‘the banking system’ the existence of ‘failings’, but is vague on specifics. He characterises critics of banks as accusing them of ‘irresponsible lending’ while also complaining that they must provide more credit, but since these criticisms are ‘irreconcilable’ he presumably believes them both to be nonsense. Investment banks are not casinos, he says; those that think many of their activities to be ‘gambling’ are the victims of ignorance. In his conclusion he implies that it is the banks, rather than the public or its representatives, that will do ‘what is necessary to restore confidence, to secure economic recovery and to create a more stable and resilient financial system.’ Continue reading Varley versus Volcker→
The 2001 winner of the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, Professor Joseph Stiglitz, was in Edinburgh last week to give two talks as part of the Edinburgh International Book Festival. He is a pioneer of the economics of information, showing how markets can produce unexpected outcomes because information is unequally available to parties to a contract. These outcomes can include bankruptcies that transmit further failures. So he was one of the few economists to whom collapse of the financial system did not come as a complete surprise. He noted the irony of his appearance in a large tent sponsored by the Royal Bank of Scotland, an institution that perceptively backed a large tranche of mortgage-backed securities, and ended up mainly owned by the UK government as a result!
Professor Stiglitz is also famous for turning on his previous employers, the World Bank, and criticising the policy of ‘structural adjustment’ imposed by this institution and the IMF on developing world borrowers. These arguments appear in his book Globalisation and its Discontents.
I attended the first of his Edinburgh talks, in which Professor Stiglitz started by pointing out that the three decades of crisis-free rapid growth that followed the Great Depression were primarily a result of the financial regulation introduced following it. As that regulation has been removed crises have become more frequent and more damaging. Continue reading Joe Stiglitz in the RBS tent→
Well, if I ever doubted the wisdom of my Guardian on-line piece about bankers and their remuneration, here’s a bit more evidence from Prof Randall Wray in Kansas City!
When a firm approaches an investment bank to arrange for finance, the modern investment bank immediately puts together two teams. The first team arranges finance on the most favorable terms for the bank that they can manage to push onto their client—maximizing fees and penalties. The second team puts together bets that the client will not be able to service its debt. Since the debt cannot be serviced, it will not be serviced. Heads and tails, the investment bank wins.
Read the full article here. There’s lots more interesting stuff on their site as well! Have a look round (after you’ve read all the good stuff here of course!)
In fact, I had avoided answering the points in his previous post partly because I wanted to see the ‘daylight’ of a consensus on reform of the monetary system, with a view to action of some sort – if possibly not ‘imminent’, since it depends on a lot of changed minds first! Secondly I believed I had addressed all of his ‘points’ before. But maybe the argument got scattered across a lot of posts, and so I present a detailed response here to that last substantive post. I hope, also, that this will stand on its own as an explanation of why we need to work with our current system, rather than expecting it to collapse under its own weight or tearing it down to replace it with some new and untried (or failed elsewhere) system.
He accused me of not addressing his points. I don’t accept that, but I do intend to respond in detail to his last substantive post in due course. Since I respect virtual property rights, I shall post that response here!
In a modern state, the government has a monopoly on physical force and so it is natural that the government should provide the final backing to contracts through the legal system. Moreover, the government can use physical force on its own account to enforce its own purchasing and debt-collecting activity, in which State or Central Bank Deposit Money (SBDM) is created and spent, circulates and is destroyed. By imposing liabilities in the form of taxes that must be paid in the money it has created, the state can control the quantity of this money in the economy. This also serves to establish this money as a unit of account and gives it the status of a means of payment. (1)
By insisting on credit payments of taxes taking place in central bank money, the central bank also forces the other banks to hold deposits with the central bank, these deposits being increased when the government makes a credit payment to one of their deposit-holders and decreased when a deposit-holder makes a tax payment in credit money. Transfers of credit money between banks can then occur via their deposits at the central bank, allowing them to settle asset-liability discrepancies that arise as deposit-holders transfer Commercial Bank Deposit Money (CBDM) between each other. Continue reading The Role of a Central Bank→