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By Toby Baxendale, on 11 March 10
Why Even the Best Banks are Insolvent and Inherently Dishonest
We are told that Barclays is a good bank and it did well not to take the taxpayers shilling. We are told that it has recovered and is prospering and this indeed is a sign of the economic recovery.
Part of the mission of the Honest Money Movement is to explore and expose these fallacies.
Banks only exist with entrenched legal and accountancy privilege. Privilege for all sectors of the political spectrum is a bad thing. Trade Union privilege to operate a closed shop cuts back on employment and price gouges the customers who buy the goods that the closed shop workers produce. A group of countries who restrict the price of say oil will push up the price of oil and gouge their customers and so on and so forth. All privilege is bad.
Contrast Normal Commercial Activity…
Any business in this country from the plumber to BP will have current creditors, those people it owes money to such as suppliers and current debtors, those people who owe it money for the goods and services sold. It is a legal offense to not pay your assets and your liabilities as and when they fall due. Indeed as a company director you become personally liable should you trade in this position whilst you are insolvent.
…With That of a Bank
A bank has current creditors: on the whole, these are people like you and me who have our salaries or savings paid or deposited into our accounts on our behalf. We do not actually “own our money” that is deposited in the bank. The bank does.
This may come as a surprise to you. However this is a very well established point of law. Since 1811 in Carr v Carr, this has been the case. So you and I are the current creditors to the bank i.e. we are owed money by the bank. In fact your bank statement is just an IOU from the bank acknowledging that it owes you however much it says on the statement on demand.
The assets of the bank are those people to whom the bank has lent its (formerly your) money to i.e. all the borrowers of loans. As has been so clearly displayed during this crisis, they have lent their money out (formerly yours) over 33 times on average to borrowers. I explain the money credit creation multiplier here for a refresher on understanding this process. So when more than 1 of 33 of us wish to withdraw our money that is on demand, the bank can not pay it back as it does not have it.
I enclose a link to the balance sheet of the UK’s largest company, BP here here. Page 106 has the balance sheet.
| Non-current assets |
£161,854M |
| Current assets |
£66,384M |
| Total Assets |
£228,238M |
| Current liabilities |
£69,793M |
| Non Current liabilities |
£136,129M |
| Net Assets |
£92,109M |
This would suggest that BP has current liabilities marginally greater than their current assets. No doubt the timing of the payment to suppliers is carefully balanced off otherwise their auditors could not sign off the accounts if they thought the company could not pay off its assets as and when they fall due.
Contrast this with the Barclays Bank full year 2009 results shown on this spreadsheet.
See tab 4 where we have the consolidated balance sheet. There are just assets and liabilities and there is not a distinction in their accounts between current liabilities i.e. your and my money that has been deposited that is on demand now and a long term liability such as a mortgage to pay off a loan on some property they may occupy etc over a long period of time. There is £322 billion of money on deposit in current creditors that could be withdrawn “on demand” as that is what the bank tells you that you can do with it. Indeed you only deposit it that way because you need to make sure payments happen on demand. They have no requirement to provide you with the ability to make this happen despite the fact that you may have deposited money there!
So unlike BP and any commercial business from the lowest one man band plumber to the mighty BP, who have to account for keeping payments set aside to cover their current liabilities, a bank is not required to. Indeed, it is specifically allowed not to by accounting law and legal privilege under law. If the deposit base of Barclays wanted what it thought was “its” money back i.e. it wanted the £322 billion redeemed into cash or taken out of the bank and moved to another, then as there is no corresponding current asset to pay for this and only assets that have long term payment implications, it would have to suspend redemptions as North Rock did and hope people would wait until it could try to sell some of its long term assets or collect in its loans. In reality, this would be a run on a bank. Barclays by its very nature is inherently insolvent and can only exist by this accounting / legal privilege that does not apply to any other non bank business in the UK!
One of the first things you will ever learn in a law of contract course is that an agreement is reached between parties and a contract established when an offer is accepted with a mirror image of understanding , from the Latin “pacta sunt servanda” or agreements must be kept. So it would strike me that as the vast majority of people think that they deposit their money and it remains their money in a bank and that the law and accounting standards say otherwise, there is a very good argument that there is not a contract in place between any depositor and bank. Certainly as most depositors also want easy access.
I commissioned a survey for the Cobden Centre in Oct 2009 with ICM over 2,000 people. 74% of people think that they are the legal owner of the money in their current account rather than the bank. Paradoxically 61% know that their money is lent out even though 67% want convenient (now) on demand access. The full results of this survey will be published shortly in another paper.
Now we can understand how the banks have the biggest salaries, the biggest bonuses , the biggest offices, the most plush terms and conditions of employment and so on and so forth. If you do not have to provide for your creditors then you can use their money to do what you like with and this is what happens!
Just to give you an idea what this would mean for me in my company Seafood Holdings Ltd if I was allowed to do what the banks are allowed to do. As of December 2009, I had trade current creditors of £8.276m against trade debtors of £12.275m. If I was a bank, I could pick up the full £8.276m and pay a dividend or bonus and still be lawful. I could build a megalomaniac size corporate head office and stick a gold plated statue with me dressed in a Roman Caesar like uniform to please my demented ego! I could behave like the worst most vulgar of City bankers.
We must always remember their key service other than the safe keeping of our money is to act as an intermediary between saver and borrower. This is “Captain Mannering” style boring banking. Like and estate agent who mediates between buyer and seller of houses, he has a High Street presence like most providing a consumer service. Places like the City of London / Canary Wharf and Wall Street etc can only exist as they do today on this legal privilege and on the welfare state of credit whereby we allow them to exist at the tax payers’ expense.
By Toby Baxendale, on 10 March 10
Some of my City friends who work in banking have had a look at the 2009 Barclays balance sheet and made comment on how the profits are made up.
They report to me that the one off profit from the disposal of BGI to Blackrock was £6.3bn. Add that to the trading profit of £7bn and you get 130% of the total profit of this “bank.”
Accounting like this is like Manchester United selling top player Ronaldo in the last financial year for £80 million when the average sale of a player in the football world produces only £1 – £5 million and kidding themselves that this is a result of them trading profitably in a sustainable way. It seems unlikely that shareholders in this football club will be relying on a spectacular cash event occurring each year as a regular occurrence. Therefore, many analysts are inclined to deduct from the profits such one off events to get a better view of predictable stable cashflow. (see tab 18 of the spreadsheet previously mentioned in yesterdays article and downloaded from here, http://group.barclays.com/Investor-Relations/Financial-results-and-publications/Results-announcements ).
Further, I’m told that a brief review of the numbers indicates that £7bn of the £10.2bn profits are expressed as “trading income” (last year £1.3bn).
I would pose three questions:
a) What if the markets had gone the other way? Would we be told these are not real cash losses?
b) How many politicians that want Glass Steagall separation of retail banking from casino banking will criticise them?
The political class want both the cake and to eat it, or they are just ignorant.
They no doubt are content that 74% of the TOTAL ASSETS of Barclays sit in Barclays Capital – the investment banking or casino arm..
c) Let’s have a look at bonuses – having slashed cost income ratios from 76% q4 08 to 55% q1 09, ratio is now back up at 64% q4 09. Is this what the political class meant when they wanted to see a more equitable salary to profit ratio?
Let us also consider the consequences of mark to market accounting FOR P&L PROFITS. The wisdom of MTM for balance sheet and transparency is not in dispute, but in a government bailout environment, the profit and loss accounts of banks is boosted artificially by the very bailout itself. The effect of interest rates being forced down from 5% to 0.5% artificially boosts the mark to market value of any unhedged long term assets on trading book. I urge you to think about what imputed capital value you have on an income stream today with interest rates at 0.5% as against an interest rate of say 5%, they work in inverse proportion i.e. the lower the rate the higher the capital value. A property generating rent of £1,000 per week, should be multiplied by 200 times to get its capital value or the value of its income stream. A little bit Alice in Wonderland I am sure you will agree.
Bonuses should not be paid on these numbers because the “profits” are unrealised, and will turn to huge losses if interest rates go up as they are still unhedged, remember! The bankers are making sure they can take a bonus on 30 years implied profits today in this low welfare state of credit environment with you and me, aka the taxpayer paying for it.
Let me explain in another way. MTM accounting takes a payment due in the future, say £100 after 1 year, and “discounts this by the interest rate to value the payment today taking into account the delay and the cost of money. So if rates are 5% in this simple example then the MTM value today is a shade over £95, since £95 invested at 5% for 1 year will produce about £100. If the interest rate is 0%, then the MTM value is £100. Therefore, the reduction in interest rates increases the MTM value of payments due in the future..
I question the long term value to profits of:
1) buying alphabet soup bombed out CLOs CDOs, CDO squared structures and funding them at 0.5% courtesy of the taxpayer via the Band of England Discount Window.
The Discount Window remember is being used as the lender of last resort in the banking system and has been very active since the October 2008 crash with us the taxpayer subsidizing all of this!
2) Present valuing (ie booking to p&l as if realised, earned income today) under synthetic (credit default swap) structures of say 30 year loan margins as day 1 profits.
For a more detailed explanation see Gordon Kerr’s presentation March 2nd at the European Parliament reported on this site as “Iceland and the Western Banking System”
http://www.cobdencentre.org/2010/03/iceland-and-the-western-banking-system/
Allister Heath (City AM) further notes that the accounts declare that cost of capital is 12% but return on capital employed is 8% – “shocking – makes no sense” is the comment.
Surely is not Barclays Bank effectively operating as a hedge fund with a modest high street retail bank attached?
I have only the following comment to make on this. If Barclays wants to list in the Caymans and invite me to invest in its shares, that is capitalism operating perfectly in a free market.
Where the Cobden Centre takes issue with this is the operation of the free market being distorted by taxpayer intervention. It is surely unacceptable for the taxpayer to be asked to:
a) underwrite the solvency of this hedge fund,
b) fund it through the Bank of England’s discount window, and
c) pay its employees bonuses based on asset valuations that not even a hedge fund at the racier end would attempt to classify as profits.
Any hedge fund with a cost of capital of 12% and a return on capital of 8% would be asking its “partners” (ie employees) to inject more money to evidence commitment or ’skin in the game’…as the hedgies in Mayfair term it.
So much for the new found stability of our banking system. Our money system continues to get more dishonest every day.
By Toby Baxendale, on 8 March 10
The current debate about bankers’ bonuses is often seen as one of fairness pitted against the greed of those nasty capitalists,.
To me, bankers are lawfully working within the system – one that is rotten to the core. The banking system is the greatest of all examples of State corporate capitalism. We have a central bank that is State owned, we have a legal tender law that prevents competition in the provision of the production of money, and we have private sectors banks which are licensed by the State to be its agent when it wants to monetise its very own debts and create inflation at the expense of its citizens: people who have been prudent and thrifty as well as those on fixed income.
The State has one important central intention: to hide its prolific over spending. We have private sector banks that have legal privilege granted to them so they can use their depositors’ money to lend out many times over to entrepreneurs. They are the only type of business in the whole country permitted do this. All other commercial enterprises at all points in time need to keep their current creditors whole, otherwise they are insolvent. There is no requirement at all in this country for any bank to keep even one penny in reserves against their depositors’ funds. In fact, it has been a stated fact of law since 1811 in Carr V Carr that “his” deposited funds are not his, but are in fact the banks’.
This fractional reserve banking system we have can only work with a lender of last resort i.e. the State owned central bank with legal tender laws. This means that in partnership with the State, the State can monetise its debts (at the expense of you and me) and the banks can keep as little reserves as they can get away with to make a return on capital that you and I in the real capitalist private sector could never do. This encourages risk. Indeed with the banks now able to borrow at the taxpayers’ expense via the discount window (heavily subsidised short term central bank funding) and know there is a guarantee of a bail out should their gambles go wrong makes the state and the bankers two equal partners in a very unjust process.
The resulting situation is what I call ‘corporate capitalism’ (thoroughly amoral) as opposed to ‘capitalism’, which is totally moral. This needs some explaining, as I suspect worthy people are shooting arrows at the wrong target.
We know that the free market capitalist system is without doubt the most efficient creator and allocator of resources. Adam Smith taught us that “It is not from the benevolence of the butcher, the brewer, or the baker, that we can expect our dinner, but from their regard to their own interest” in his Wealth of Nations. Self interest or the profit motive drives man to create and to provide all the multiplicity of goods and services we have enjoyed and will enjoy.
Mises in his famous book Socialism, http://mises.org/books/socialism.pdf showed us that if Society was run by planners, the price system which allows resources to flow to their most desired uses would not function. Indeed it would impoverish anyone nation that tried it. If, say. the planner could not correctly witness all the competing bids and resource allocations for metals that were capable of being used in the construction of railroad tracks (that involves many companies competing for scarce resources) he would never know which metal would be the most cost effective to build his railroad. No one planner would be able to economically calculate, or indeed, no army of planners would be able to calculate and allocate all the resources of Society in the socialist economy better than the many millions of participants in the economy allocating resources via the price mechanism. The experiment in the Soviet bloc with socialism impoverished at least three generations and lead to wide scale death and a general shortage of life, and misery.
Hayek, in his very famous essay “The Use of Knowledge in Society” http://www.econlib.org/library/Essays/hykKnw1.html added to the critique of Mises by pointing out that absenting the price system would mean that the central planning officials would need to absorb the entire knowledge of all the people in society to effectively plan their needs. This was absurd and impossible.
All State planned schemes, from the provision of money to the provision of health and education – even in our cosy mixed economy – could be done better by an unhampered market. We are thus weary of all bloated government departments and officials who say they can do something better for us – they can’t.
The efficiency case for an unhampered market, or free market capitalism is clear and unchallengeable. The subjective actions of freely consenting adults in a capitalist system produce the most amount of goods in the most efficient way. But is there an objectively moral case for the capitalist system? I attempt to answer it in the remaining part of this Insight article.
First Principles: Secular Argument
I Argue
One thing that distinguishes human beings from all other life forms is our ability to communicate with each other via talking. Only human beings can make a proposition. The question of what is just or unjust only arises because I can debate or argue this point with another person. To be able to argue my position I must be in control of my physical and mental self. I must own myself in order to be to be a human being. I have the total right to use all my physical and mental faculties to participate in life, otherwise I cannot even exist as a human being expressing an opinion. I do not know many people who would argue with this. If I did not own my own faculties I could not participate in life except under the command of who owned me. This also implies that just so much as I own myself, I do not own anyone else. It also follows that if I do something that violates another human being without their consent I violate their right to express their very humanness.
Thus, I deduce that by my very being , I own myself , I own my own property as me, I have a right not to be interfered with so long as I do not interfere with anyone else. It clearly follows that if I were to interfere with someone else’s property, they would not own it. This would deprive them of their own humanity, I suggest. This is a deduction from the axiom that to exist I need to argue. I come to this conclusion via the Haberrmasian axiom of interpersonal argument that has been so cleverly adapted by Hans Herman Hoppe in his book The Economics and Ethics of Private Property: full text, http://mises.org/books/economicsethics.pdf .
To argue against this you explicitly acknowledge control of your faculties, at the very least. Following Kant’s Golden Rule that a norm should be universal in its applicability should it be objectively valid, this proposition surely fulfils this requirement to be a totally objective axiomatic principle.
All ethical propositions, such as socialism, that say that you owe a duty to the State to provide for others, are violations of the very distinguishing thing that makes you a human being and not a rock or a colony of ants. To advocate any form or socialism, be it of the democratic variety, the communist variety, or indeed the mixed economy is to violate your very essence of being a human.
John Locke in his “Two Treatises of Government” spells out that property or, if you like all resources exist prior to any government. Man mixes his labour with what he finds and it is by right his. Government cannot ‘dispose of the estates of the subjects arbitrarily’. Locke left us with a conundrum called “Locke’s proviso.” This is where if a man mixes his labour to own something that was not owned before; he must always leave a “sufficient” amount for other human beings.
Jesus Huerta de Soto, one of the greatest living polymath Austrian School teachers in his essay “The Ethics of Capitalism” http://www.acton.org/files/mm-v2n2-desoto.pdf , shows us how possibly the other living giant of the Austrian School, Israel Kirzner in “Discovery, Capitalism, and Distributive Justice” has solved this proviso of Locke. And allows us to build the objective moral ethic of capitalism.
Socialist, social democrats and a large body of modern day liberals and conservatives have a distributive conception of justice that is about a top down approach of redistribution of scarce resources from those who do have to those who that have less, or nothing , or whose lobby groups has succeeded in extracting something from those that have. Kirzner shows us how as all human being are creative actor: they are always engaging in entrepreneurial activity to generate new goods and services. All human beings are alert to opportunity, some to a greater degree than others. The fruits of this alertness arises via their actions. This is universally so. To not act would not create these things. So he proposes an axiom that all human beings have a natural right to the fruits of their own entrepreneurial creativity. As these things are created out of nothing, it implies that the acting person has an undoubted right to the quiet and peaceful enjoyment of the fruits of his or her labour. If it did not exist before, it cannot be a negative to anyone else. So Locke’s proviso is overcome by the understanding of society as dynamic and spontaneous constantly evolving process with alert actors constantly creating new goods and services that they must have an unquestionable right to own.
De Soto coins the term ‘Dynamic Efficiency’ to describe this process. He also points out that the free market capitalist system – that we know is the most efficient system – is also the most just and in fact, these two concepts are indeed two sides of the same one coin. Any form of intervention is immoral as it impedes the creative capacity of individuals to express their creativity and create all the wide range of goods and services we have. It should be pointed out that top down provision of health, education, transport, industry etc is inefficient and hence unjust as it suppresses the creative activity of human beings. Absent the profit motive and you will get sub optimal results.
Do Soto points out that the last Pope, Pope John Paul II in his Centesimus Annus http://www.vatican.va/holy_father/john_paul_ii/encyclicals/documents/hf_jp-ii_enc_01051991_centesimus-annus_en.html , which built on the earlier work of the Rerum Novarum http://www.vatican.va/holy_father/leo_xiii/encyclicals/documents/hf_l-xiii_enc_15051891_rerum-novarum_en.html of Pope Leo XIII, established the universal moral capitalist ethic by acknowledging the natural right (God given) to express your very creativity unhindered so long and you hinder no one else.
First Principle: Theological – God Endowed Rights
I Exist
Writing about the morality of capitalism in glowing positive terms as I have done above and setting it in the backdrop of universally applicable objective axioms is not as unfashionable as talking to any thinking person about God, but only just! Such is the secular society we live in; you are considered to be an ill informed mystic should you engage in “god bothering.” The See of Peter would naturally see this differently and I am very grateful for De Soto to direct me to the pro capitalist teachings of the Catholic Church.
Are the above self evident axioms that are universally applicable in all times and in all places to everybody there because we are human or are they there because they are God endowed?
I can ague both, but I favour self evident God endowed over self evident secular, although the latter can stand on its own legs. Why?
I wrote this article about the proof God three years ago: http://www.lewrockwell.com/orig4/baxendale2.html . In short, I take the Aristotelian inspired position that as I exist I know that other physical things exist. I know that each and every one of these physical things must have been caused by another physical thing. I know that nothing is infinite. If it was, I would not exist as for it to be infinite, it would occupy all time and space and I would not exist. As I exist, I know this cannot be the case. I know there is a beginning to the universe and that there are physical boundaries to the universe, therefore I know there cannot be an infinite series of physical causes and effects as there would be no boundary and no beginning. Therefore what caused the first physical thing must indeed be immaterial if it cannot be a physical cause. This immaterial thing is what I label as ‘God’. So I conclude God does exist and the only act I can attribute to God by a priori reasoning is that God created everything. As I like to exist I am very grateful for this and can only conclude that God has good intentions. If I do not like to exist, I can choose not to and commit suicide. God is therefore good for me and objectively good for all human beings. As God has created everything, he has endowed us with the ability to reason and engage in the formation of reasoned propositions, the latter which is undoubtedly a unique attribute to mankind the former quite possible unique to mankind, sets the foundation for the derivation of the rights of man and the very ethics of capitalism.
Further reading
By Toby Baxendale, on 1 March 10
 I founded the Cobden Centre inspired by the writing of F A Hayek, particularly his reference in “Denationalization of Money: the Argument Refined” (IEA, 1976) from which the following quote is taken.
Free Money Movement
What we now need is a Free Money Movement comparable to the Free Trade Movement of the 19th century, demonstrating not merely the harm caused by acute inflation, which could justifiably be argued to be avoidable even with present institutions, but the deeper effects of producing periods of stagnation that are indeed inherent in the present monetary arrangements.
Now of course that Free Trade Movement was the movement set up by the businessman and radical social reforming liberal, Richard Cobden. Hayek knew that the original founders of that movement attacked the import tariffs or “Corn Laws” that harmed ordinary people. The Corn Laws forced the price of basic food stuffs so high that the working man was almost paying what we would pay today on our mortgages.
The legal privilege that this gave landowners to price gouge the masses at the expense of the privileged few was an outrage and the courageous corn law reformers did away with this invidious protection by repealing the Importation Act of 1815 with the Importation Act of 1846.
In Bright, J. and Thorold Rogers, J.E. (eds.) [1870](1908) Speeches on Questions of Public Policy by Richard Cobden, M.P., Vol. 1, London: T. Fisher Unwin, republished as Cobden, R. (1995), London: Routledge/Thoemmes, they cite a quote from a working man who sums up the iniquities of the Corn Laws that Richard Cobden used:
When provisions are high, the people have so much to pay for them that they have little or nothing left to buy clothes with; and when they have little to buy clothes with, there are few clothes sold; and when there are few clothes sold, there are too many to sell, they are very cheap; and when they are very cheap, there cannot be much paid for making them: and that, consequently, the manufacturing working man’s wages are reduced, the mills are shut up, business is ruined, and general distress is spread through the country. But when, as now, the working man has the said 25s. left in his pocket, he buys more clothing with it (ay, and other articles of comfort too), and that increases the demand for them, and the greater the demand…makes them rise in price, and the rising price enables the working man to get higher wages and the masters better profits. This, therefore, is the way I prove that high provisions make lower wages, and cheap provisions make higher wages.
Sir Robert Peel, who was Prime Minster at the time, was very educated in the works of Hume, Ricardo and Smith: he understood the law of comparative advantage. With a massive starving Irish population (the “potato famine”) and pressure from the likes of Cobden at home, Peel powered through the repeal of the laws. In Morley, J. (1905) The Life of Richard Cobden, 12th ed., London: T. Fisher Unwin, 985 p., republished by London: Routledge/Thoemmes (1995), Peel said in his resignation speech after the repeal had been done for the UK:
In reference to our proposing these measures, I have no wish to rob any person of the credit which is justly due to him for them. But I may say that neither the gentlemen sitting on the benches opposite, nor myself, nor the gentlemen sitting round me—I say that neither of us are the parties who are strictly entitled to the merit. There has been a combination of parties, and that combination of parties together with the influence of the Government, has led to the ultimate success of the measures. But, Sir, there is a name which ought to be associated with the success of these measures: it is not the name of the noble Lord, the member for London, neither is it my name. Sir, the name which ought to be, and which will be associated with the success of these measures is the name of a man who, acting, I believe, from pure and disinterested motives, has advocated their cause with untiring energy, and by appeals to reason, expressed by an eloquence, the more to be admired because it was unaffected and unadorned—the name which ought to be and will be associated with the success of these measures is the name of Richard Cobden. Without scruple, Sir, I attribute the success of these measures to him.
The pound Sterling has lost some 99% of its value since the suspension of commodity-backed money post World War I, as successive governments have chosen not to confront their electorates in an honest fashion and say how much all the activities they say they are doing for you to get your vote will cost you. Instead, tax receipts pick up the majority of the costs of government, but there is always a bit of debt they choose to monetize. This means printing it out of nothing or creating it electronically our of nothing, a term which today is now called QE or quantitive easing.
So, instead of a Free Money Movement, I have started what I call the “Honest Money Movement”.
Why do I use the word honest?
Well I simply use it to show that, like the iniquitous Corn Laws that our forefathers sought to destroy as they gave privilege and wealth to one minority party at the expense of the masses, governments can take everyone’s wealth to benefit them and the few who organize this wealth transfer for them, i.e. the Central Bank and its client banks in the private sector who organize bond sales and purchases. They get the new money wealth effect first, just like the aristocratic land owners of old got the excess price of corn at the expense of the masses of working people.
If honest money is demanded, a government can no longer monetize debt it has to live or fall by its tax receipts only. This means when a politician comes to you at election time with a menu saying “we are going to give you X and Y” they will now have to say, “we propose to take £A and £B from you and give £A and £B to Mr X and Mrs Y” and you can then decide the merits of this knowing what you are getting yourself involved with.
Sir Robert Peel plays another role in our story. He was the first Prime Minster to do something about the bad effects of private sector bankers issuing notes purporting to convert into gold on demand. The trouble being, just as the landed aristocrats kept corn high at the expense of the wealth of the people, so the goldsmiths issued promises to pay on demand on bits of paper that functioned as money, over the actual amount of gold in their safe keeping. This criminality was stopped by the Bank Charter Act of 1844: the original text can be seen here and the amended text, that is still in force today, can be seen here.
Unfortunately for us, there was no restriction on the creation of demand deposits. A demand deposit is where a bank creates an IOU or a bank deposit out of thin air which functions as money.
You as the deposit holder can make payments to anyone who will accept your transfer of this IOU to them. Whenever you write a cheque it is drawn on a bank deposit, whenever you make an electronic payment, you make it from a bank deposit. In Peel’s day, there were over 20 bits of paper, called promissory notes, issued by the goldsmiths of the day, to every unit of gold. When people tried to redeem in gold, there was a “panic” and bust followed the boom.
The rapid creation of bank demand deposits since then has had the same effect. I seek to encourage an amendment to the Bank Charter Act to include deposits and finish off the job that Peel so courageously started. This would stop credit-fuelled boom and bust. All booms and busts, even the South Sea Bubble and the Tulip Mania, can be traced back to credit-fuelled binges that have been created by governments. Remove this power from the governments and their proxies, the bankers, and we can have honest money, peaceful enjoyment of the fruits of our labours and the enrichment of only those who earn it.
 A starting point to advance this honest money movement is our banking reform proposal is available here. I hope you will help push for reform and end dishonest money and dishonest government.
More information
- Toby’s interview with Brian Micklethwait explores Toby’s philosophy in more detail: it can be found here.
- The staggering errors behind the policy of QE.
- In The Causes of the Economic Crisis, Mises forecasts and explains the breakdown of the German mark and the market crash of 1929: buy here or read online here (PDF).
By Toby Baxendale, on 26 February 10
A bank , building society that uses factional reserves, lends long and pays out short is only going to exist should confidence be kept in it. The “Run on the Rock” in the summer of 2007 saw people queuing to get their cash out of the Northern Rock which resulted in the first systematic run on a bank since the 1866 run on the Overend, Gurney & Company bank in the UK.
Readers of this site will know that a bank can only exist with the legal and accounting privilege that allows them to use current creditors – i.e. the depositors of the Presbyterian Mutual Society (PMS) – to lend out a multiple number of times to property loans and other entrepreneurial loans. Readers will also know that when they deposit money they in effect lend it to the bank and become a creditor to the bank. A deposit of cash into a bank/Mutual means you as the depositee lend money to the bank/Mutual That is, to be very clear, when you deposit, you cease to own the money – the bank does. This was established by law in 1811 in Carr V Carr and reaffirmed in Foley V Hill 1846.
The History
The Society’s audited accounts for the year ended 31st March 2008 showed £305m of loans and £5m of liquid assets to pay up to £310m on demand deposits. So one can deduce that there was only £5m of cash supporting £310m IOUs to its creditors, the depositors. This means that the PMS multiplied its credit creation to the tune of 62 times! This is nearly twice the average of all the banks licensed by the Bank of England. In fairness to the Society, they did pay out £21m before they were left with only £5m of cash, so £26m of cash was in their vaults when the run happened. Thus a more conservative 12 x credit was created out of thin air or a leverage ratio of 1 part cash to 12 parts credit existed in this Society.
A quick refresher on how the banking system allows this creation of credit out of thin air can be found here http://www.cobdencentre.org/2010/02/a-day-of-reckoning/ where I say, “ It is often forgotten but when you place £1m in a savings account (in cash) in say the Royal Bank of Scotland, which has no legal reserve requirement, they then lend £970k (in credit) , keeping on average 3% of cash back in reserves, to an entrepreneur in say HSBC, who then deposits that money in HSBC. We now have one claim to the original £1m and one claim to the £970k. The money supply has moved from £1m to £1.97m – just like magic! This is credit expansion.
The reality is that across all the banks in the United Kingdom licensed by the Bank of England, we have for every £1 of money (in cash), £34 in claims to money (credit)!”
The Administrators’ report tells the sorry story of events in summary which I list underneath, but one glaring fact is omitted. This is that the very Government of the UK actually triggered the loss of confidence in this Bank. When our Prime Minister in his own words was “saving the world” he ordered a full guarantee , government backed, on all deposits. The PMS, which had 10,000 members, went into administration following a rush by savers to withdraw their money at the height of the banking crisis in October 2008. People withdrew their money as they learned the Society was not covered by the government’s bank deposit guarantee scheme. Previously they were content to leave their money in the Society. For the purposes of this article, it is not needed to debate the point: was it or was it not a bank that should have been supported by this guarantee? The salient point being that not being guaranteed scared people into making withdrawals where little existed before.
From the Administrators’ report of the12th January 2009 that can be down loaded here http://www.presbyterianmutualsociety.co.uk/files/Administrator’s%20Proposals%2012.1.09.pdf the Society was placed into Administration by the Directors on 17th November 2008. The following are selected quotes from this report which speak for themselves:
“the demand for withdrawals by members of their investments exceeded its cash reserves;”
“the members’ investments were historically withdrawable on demand but the cash was invested by the Society in longer term investments such as property and loans.”
“For the Society to allow members to withdraw their investments on demand and invest members’ money in longer term investments, the Society required a high degree of confidence among its members that their investments were secure. However this confidence has been severely tested by the current economic climate and eventually the demand by members for withdrawals exceeded the Society’s cash reserves. …I believe it will be difficult for the Society in its current form to continue as a going concern.”
“loan capital will be treated as creditors and will therefore be paid in preference to members’ shares.”
“Government Guarantee
As you will be aware the Society does not benefit from the deposit guarantee scheme.
During the month of October 2008 the Society experienced an unprecedented increase in the number of requests for repayment of members’ investments. It was common practice for the Society to repay investments on receipt of a request, and payments of £21 million were made up to Friday 24th October 2008, leaving £4 million in the Society’s bank account.
An emergency meeting of the Society’s Board of Directors was convened on 25th October 2008 and it was resolved that:
…the 21 day notice period for the repayment of members’ investments be invoked in respect of requests received from members as at that date and any new requests received from members.
On 6th November 2008 the Society’s Board of Directors met again and it was reported that the demand among the Society’s members to withdraw their investments had increased which further exacerbated the Society’s liquidity. It was also reported at this meeting that legal proceedings had been commenced by three members seeking repayment of their investments. It was resolved by the Society’s Board of Directors on 6th November 2008 that the Society should be placed into Administration so that its assets could be protected, subject to enabling legislation being passed to permit the Society to go into administration.
During the period 27th October 2008 to 17th November 2008, the Society had received requests for withdrawals in excess of £50 million but the Society had cash reserves of only £4 million to meet such requests.”
Now this would have been the story of every bank in the UK if the government had not acted as it did as we were ‘panicking’ as a nation. We should also note that all banks are in the same precarious situation as the PMS was with regard to lending long and paying out short still, to this day. Do we need to live like this?
The Future Safe Way to Run Banks and Provide Interest for Savers and Lending to the needs of Trade.
If banks were mandated to hold 100% reserves of cash in their vaults, they could issue their bank statements saying what they owe you each month and you would know that you actually had cash in the vault to support your deposit that is represented by your bank statement. The bank statement after all is only a thing that would more accurately be called a “bank IOU statement.” Should you want interest you could ask for the cash you have deposited to be placed in a highly liquid government bond that could be converted into cash when you need it, paying you a rate of interest. Should you want a higher rate of interest, you can lend your money i.e. cease ownership and place in a bond that has in turn been lent to an entrepreneur for 6 months, 1 year, 2 years, 3 years, 5 years etc with the highest rate of interest being given for the longer term locked away and lent to somebody.
The Solution for Paying Out 100% of the PMS Depositors’ Lost Money- £310m – Now, Today
Following the work of 5 Nobel Prize winners and the founder of the American Chicago School, I would suggest the following written about in the Day of Reckoning article;
The Bank of England immediately issues notes to cover all the deposits i.e. redeem all the depositors for 100% cash notes and coins to be placed in their accounts. Please note, this costs the Bank of England the price of paper and the ink and nothing else and IS NOT INFLATIONARY and generates no liability to the UK taxpayer – see next point.
At the same time, get the administrator of the PMS to delete all current creditors (the depositors) as these have now been redeemed from the bank’s books by the Bank of England. The deleting of these bank obligations means that the money the depositors did lend on deposit to the PSM no longer exists, so for the sake of argument, if there was £310m of deposits, these have been redeemed in cash by the Bank of England and the equivalent amount of deposits have been removed from the money supply. Cost to the Bank of England = zero and cost to the UK tax payer = zero. Money supply stays the same.
The PMS in administration now has only assets i.e. loans from entrepreneurs /people who are repaying the loans or mortgages. These can now continue to get repaid, but instead of paying the creditors of the PMS, there are now none, so these loans can go into paying off the National Debt.
This way all parties win.
A courageous politician in Northern Ireland or in mainland GB could well put forward a Private Members’ bill which could be the first legislative move to establishing Honest Money.
The Day of Reckoning article linked to above provides the start of the legislative solution to the whole UK wide banking system whose model is sadly no different to that of the little PMS.
By Toby Baxendale, on 24 February 10
FOX Business Network’s Brian Sullivan speaks in this interview with famed economist and fmr. Chilean Labor and Social Security Minister Jose Pinera about the Social Security problem in the United States. See the video link at the bottom for the audio version. Thank you to Sean Corrigan for pointing this out.
This does beg the question as to what would the number for the UK be?
BRIAN SULLIVAN, FBN ANCHOR: We are very honored to be joined by Jose Pinera. He is the founder of the International Center for Pension Reform. He is the former labor and social security minister of Chile and a distinguished senior fellow at the Cato Institute. Up from Santiago into D.C., which is where we are. Jose, it’s a pleasure. Thank you very much.
JOSE PINERA, FOUNDER, INTERNATIONAL CENTER FOR PENSION REFORM: Good morning. Thank you very much, Brian.
SULLIVAN: Last week, we hit hard on the program the latest Pew Center study showing that states have about a trillion dollars gap in their — just state — pension plans. How do we solve that?
PINERA: Well, that is a very serious problem and I’m extremely worried about all the debt America has.
But you have a much bigger problem, Brian. You have a 100 trillion-dollar problem. Look, this is something published by the American government, saying that the present value of the obligations on health and Social Security amount to a 100 trillion dollars…
SULLIVAN: OK, wait a minute. We were talking about 3-point-something trillion, 1 trillion underfunded. You are saying we have 100 trillion dollars. Where is that number coming from? How do we get to 100 trillion?
PINERA: This comes from the government. This is not recognizing the public debate, but this is the real debt of America. This amounts to 700 percent of GDP. This is a gigantic liability that basically you are legislating and will be paid by your children and your grandchildren.
SULLIVAN: Let’s walk through what that is, OK? Because these are new numbers. These are big numbers. These are coming from the CBO, correct?
PINERA: These are coming from government, from the U.S. government. These are net, liabilities of the health, Medicar,e and Social Security system. This is the present value of what Americans will have, one way or another, to pay, unless they default on their obligation to the citizens.
And that is the future. And I’m extremely worried because it is like you are passengers in the Titanic. The Titanic is going towards the iceberg of aging populations. The populations that feel entitled to all the huge benefits that the politicians have promised the people. But they have not funded the benefits for the future. So how are you going to pay them? That is the big issue. The big domestic problem facing America.
SULLIVAN: One of the big stories today is the president unveiling his own healthcare plan. On this piece of paper, again from the CBO, $35 trillion in hospital insurance for current and future. $34 trillion for Medicare Part B, about $18 trillion for drug benefits and Social Security.
So, actually Social Security, which we’re going to talk about later on — that is actually a big hole, but it’s smaller than health care. How are we going to pay for this? How does the U.S. cover a 100 trillion dollars, Jose?
PINERA: Brian, the problem is what I call the entitlement state. The problem is that there is gigantic disconnect between what people want the government to pay them in the future, in health pensions, and what the people want to pay in tax. And because the entitlement state is based on promises for the future, you don’t have to pay it today.
This is growing, because to win elections, politicians offer benefits to people that will be paid in the future. So, this big hole is not only a problem in America. It’s exactly the same problem in Greece today, in southern Europe, eventually in France, in Germany. The West will go bankrupt until and unless you reform deeply the entitlement state. This was created by Prince Bismarck (ph) in the 19th century. You are all prisoners of Prince Bismarck (ph). Prisoners of a system…
SULLIVAN: Otto von Bismarck?
PINERA: Yes.
SULLIVAN: Because he created…
PINERA: He created the unfunded tax-and-expense system. You said, he simply said if you tax workers a little, we can pay the pensions. But then the unintended consequences has been with the aging of population and the extended life, you have been accumulating this huge liabilities that eventually be bankrupt the government. A huge fiscal crisis is coming to the West unless you face it and confront it directly by completely changing the entitlement estate. That’s the root of the problem.
SULLIVAN: I want to get more on Social Security in just a bit. But for pensions — OK. State and federal pensions. The gap between retirement ages between private and public is growing wider. The gap between the amount of money being given in pensions is growing wider.
How do we just solve the pension crisis on government workers, federal and state? And is it unsustainable as it is?
PINERA: It is totally unsustainable. You either will have to raise taxes big-time in America, or you will have to cut benefits. But it’s extremely difficult to do that in a system in which you have people entitled to all these things.
That’s why what we did in Chile was to completely change the logic. In Chile, you save for old age. In Chile, we have sort of a Benjamin Franklin system, you see. You remember Benjamin Franklin, the thirteen virtues? You should save for the future, you should be self-reliant. We have instilled a culture of personal responsibility and saving.
Of course, we also have a safety net for the very poor. But 80, 85 percent of the population will finance their old age, health and pension with their own personal savings.
SULLIVAN: We are going to take a quick break, Jose. We will come back and talk about what you did in Chile, and what we might have to do here. Look at some of the pretty scary numbers around Social Security. And also what we can do about it.
Will the Chilean plan work here? How does it work? We are going to learn as we continue part two of our exclusive interview with Jose Pinera, right after this.
(COMMERCIAL BREAK)
SULLIVAN: Welcome back. I’m Brian Sullivan in Washington, D.C. today, and I am here because we are being very privileged to speak to Jose Pinera. He’s the architect of Chile’s Social Security reform. He’s the former labor and Social Security minister and the founder of the International Center for Pension Reform. It is an exclusive interview.
Jose, we’re very happy to have you. Listen, although some of the numbers you are throwing around are pretty frightening, there have been — there’s a lot of debate in this country about whether or not our Social Security plan, our system is going to be there for people that are if their 20s and 30s. There’s a big debate about whether or not we will be solvent by 2040. Do you believe that the U.S. system as it is now can be solvent decades from now?
PINERA: Clearly not.
SULLIVAN: Clearly not.
PINERA: Clearly not. In only seven years, the Social Security system will begin to have a deficit. That is more money will have to be spent than money coming in.
And then you will face the very hard choices. You will probably have to increase the retirement age. You will probably have to increase payroll tax. You may have to cut benefits, unless you change the paradigm and you go to a system of personal accounts.
Personal accounts is very simple. You save for old age. And that saving gets accumulated rate of return, so you benefit from that extraordinary force of compound interest. When you reach 65, you are going to look whether the government is deficit or in surplus, you look at the balance of your account, and with that, you buy annuity for your life.
It is a system we had all over the world before Otto von Bismarck, a Prussian chancellor created this monster of the unfunded welfare estate that is bankrupting Europe and eventually the U.S.
SULLIVAN: That’s the problem with Social Security, right? Is that we are using money now. Instead of me saving for myself, the money that is taken out of my paycheck, out of everybody in this room’s paycheck, is being paid to current beneficiaries. You have described that as a Ponzi scheme.
PINERA: That is a Ponzi scheme. You could even call it a Madoff scheme.
SULLIVAN: Hopefully, the money is real somewhere.
PINERA: No, there is no money being saved for the future. There is no funding. There’s no trust fund. You are paying the money immediately to the retirees, and the problem is that with Baby Boom generation retiring, with the expectancy of life increasing every single year because of your great doctors and researchers, you will not be able to pay the promises.
So, the system will eventually default. Technically default in the sense that you will have to break the promises to the people, and that may create a lot of pain and a lot of anguish. That’s why you have to look into the future, do the responsible thing and begin moving towards a system of personal accounts. It’s the only long-term solution.
SULLIVAN: Seventy-one million people will be 65 in this country by 2030. 330 people turn 60 years old every hour right now. But they are expecting benefits. How would we implement a system like yours with everybody already expecting the current system to be there for them?
PINERA: The first decision that I took as secretary of labor and Social Security of Chile was to guarantee the benefits of the elderly. I call it we are not going to take your grandmother check away. We will find a way to protect the elderly.
So, the system has to be changed for the young people, for the future that are coming into the labor force or are already in the first years of the labor force. And the moment you change the dynamic and people begin to know that if they save more, they work more, they will get a better pension out of their own saving, then the whole system begins to…
SULLIVAN: Here’s the criticism will be that we are at 11-year flat line for the stock market. That if you have your money in the stock market for 11 years, you are basically flat. That’s what people will say. That the stock market has proven that it is not a wealth creator. At least in the short-term.
PINERA: The stock market is today the Dow Jones is around 10,000.
SULLIVAN: 10,300.
PINERA: Do you know how much it was when we began our system in Chile 30 years ago?
SULLIVAN: Thirty years ago. 1980 — 2 grand. Dow 2000.
PINERA: 900. The Dow Jones was 900. So — if you had began your system at the same moment that Chile began, you would have benefited enormously from the stock market.
SULLIVAN: Tenfold gain.
PINERA: OK. And you don’t have to put all the money in the stock market at all. We don’t put it all. You can have a very diversified portfolio of corporate bonds, of mortgages, of government bills (ph), of stocks international — you have to be very prudent with long-term management. That’s how we have been in Chile, and that’s why we have been able to give workers a rate of return of 9 percent above inflation for 30 years compounded.
So, the system works because in the long run, you see your economy is so strong. I do believe in America. And you must believe that workers by saving for old age would be much better than the government promise.
SULLIVAN: Instead of the 12.4 percent tax that we pay, like in Chile, they take 10 percent out, automatically put that into a private account that’s not for use for current beneficiaries it is our money; correct?
PINERA: Yes, correct. Your money is protected constitutionally. That money grows in your account exponentially compounded 45 years, so forget the…
SULLIVAN: Can the government tap into it?
PINERA: No, no…
SULLIVAN: If Chile if the government gets into — in Chile if the government gets into financial difficulty, can they go raid that money?
PINERA: No way. It is protected by property rights. This is your money, we have accumulated already seventy percent of GDP in that money. The capital markets in Chile have boomed, have increased. We are financing the new infrastructure, the new growth of the industrial, the forest, with this money.
Instead of Chile having a huge trillion-dollars debt, as you have, we have a huge funded system of retirement.
SULLIVAN: Jose Pinera, we are going to leave that here. But I know later on we will be speaking about European problems. Thank you very much for joining us, at least in this hour. And we’re going to see you more in a couple of hours. Jose Pinera of Chile. Thank you, Jose
PINERA: Thank you very much, Brian.
http://wallstreetpit.com/17422-jose-pinera-social-security-in-the-u-s-to-face-deficit-in-7-years
By Toby Baxendale, on 24 February 10
Our Corporate Affairs Director Steve Baker has posed this question to some of his fellow board members, “Would be great to nail this phenomenon on the system of money – that is to demonstrate clearly that it is credit expansion which redistributes wealth to the wealthy:
In other words, the trickle-down effect that is meant to spring from wealth accumulation has not worked as it should have. Flexible labour markets have delivered big time for bankers and shareholders, but failed to improve the lot of ordinary workers in the same way. In Britain, growth in consumption was funded not by real economic advancement, but by the fool’s paradise of ever-increasing debt.
http://www.telegraph.co.uk/finance/comment/jeremy-warner/7105004/Capitalism-has-forgotten-to-share-the-wealth.html
The essence of a credit expansion starts with the policy of the Treasury / Bank of England aka “the State”. The aim is to make money cheaper so that more money / credit is granted to borrowers, more economic activity is then meant to take place.
How is this done?
If you wanted to make jam cheaper, you would need to produce more of it for the same level of demand. The only way the jam market would clear is for the jam to sell at that demand for a lower price.
The State has the monopoly issue of money under its control. If the whole history of man was displayed in the form of a 12 hour clock, with today being the 12th hour, the State has only had this monopoly of the production of money since the end of the Gold Standard at the outbreak of the 1st World War. Attempts to get back on the Standard took place in the 20’s but were abandoned in the 30’s. Post World War II until 1971 there was a weak form of Gold Standard under the Bretton Woods system. Since that date, there has only been paper standards in different countries. So from the dawn of civilization until about the 11th hour and the 59th minute of human existence, Gold was money. It was a commodity for which all things exchanged for, it was produced by private individuals and no one person controlled the production of gold. Like language, it was a spontaneous invention of human beings to facilitate working together. It is thus one of the greatest inventions of man.
If the the State, as the monopoly issuer of paper money decided that the economy needs more liquidity (we have done this with our £200bn QE program), the bank will buy its governments outstanding debt obligations , or IOU’s, commonly called Gilts or Bonds, with newly minted money (to monetize). Thus the new money, like the new jam, or the jam over supply illustrated in the above example , enters the economy via the recipients of the new money.
Dear reader, I would like you to pause for a minute and ask yourself how comfortable would you feel about the government setting the price of jam and issuing all of its supply? Is this not what they tried to do in the Soviet Union? Absenting the price mechanism, that coordinates the choices of many millions of people, to allow suppliers of jam to know how much to produce to satisfy the demand for jam, and we have shortages for jam leaving shops empty for sometimes many months on end. Why do we trust the State to do this?
We seem to accept that the government, in its wisdom, that must be greater than that of all its citizens , can plan the production and supply of money as the old Soviet system did for a whole host of goods and services, for its subjects.
Experience will tell us, that like the Soviet production of jam, our State production of money will cause shortages and surpluses of varying degrees. Worst still, constructivist policy activism by the State via its agents at the Bank of England attempt each time they set the interest rate, to produce just enough money to keep the economy on an even keel. The evidence that they get this wrong is called “Boom and Bust.”
If you got jam production wrong, your surplus jam goes to waste or you can not feed your demand.
An over supply of money is called a “boom.” An undersupply is called “bust.” Every single boom from the Soutth Sea Bubble onwards can be traced back to some artificial expansion of money / credit not brought about by the free interplay of market forces determining the production of money. As money permeates every aspect of the economy, an over or under supply of it has far more consequences than an over or under supply of money. In this current “bust” I would submit that virtually all people in the world wide system of capitalistic production have been effected in their personal lives to some degree of negativity as they have had to adjust to the new world order.
The effects of this over supply are so little understood, it is worth while explaining once more by looking Richard Cantillon in his Essai sur la Nature du Commerce en Général (1755). This showed us that if money supply doubled, prices do not necessarily double. Money is not neutral in terms of consumption and production. Money goes into the system when created by the government to the bond holders whose bonds are redeemed. With this new money they have the first wealth effect of this new money. Like a counterfeiter he exchanges his new bits of paper for real goods and services, bidding up the prices of these goods and services. The producers of these initial goods and services then do the same with the goods and services that they buy and so on and so forth until the prices for the last people, those who spend less in the economy, the poor, those on fixed income (pensioners, the thrifty saver) etc, spend on goods and services that now have a higher money price. Thus, the insidious effect is a transfer of wealth away from the poorest in society to the richest in society: those banksters who buy / sell the bonds and the bond holders who have received the newly minted money.
We must remember, the bankster in all of this is often the agent of the State when he sells and buys the government debt either creating over supply or under supply of money. He takes his commission right at the well spring or the fountain of this money making process. He gets the first ability to benefit from the wealth effect as he can spend his money on goods and services at the same time as the bond investor. He is a direct recipient of the first order of the wealth transferred from the poorest to the richest members of society. The bankster is on the welfare state of credit. The government is totally in control of this process yet does not seem to realize it.
This is why Jeremy Warner in his well argued Telegraph article wonders how so much wealth has been created for so few and why his the trickle down did not have a positive effect on the poorest members of our society. I hope I have demonstrated that as the production of paper money in itself does not create wealth , as if it did, world poverty could be ended tomorrow, like a counterfeiter, new money allows its first recipients to exchange nothing (bits of paper) for real things such as Mayfair town houses etc. The sad salient point, is as the “wealth effect” works its way through society bidding up prices, the poorest people pay more for their goods and services. They have what little wealth they have confiscated to the benefit of the likes of the banksters who are knee deep on the welfare state of credit. Real wealth creation happens when entrepreneurs start coming up with better methods of production to make better goods and services more efficiently then before. There has been too much of the former providing the illusion of wealth and too little of the latter.
By Toby Baxendale, on 22 February 10
I went to this event today.
“22/02/2010 – Ideas Space
Quantitative Easing: Friend or Future Foe?
The Bank of England entered unchartered territory in January last year when the Treasury authorised it to begin a radical monetary policy experiment that we now know as “Quantitative Easing”. Given the unprecedented monetary conditions resulting from the liquidity crisis, the Asset Purchase Facility has been welcomed with open arms, and now stands at almost £200bn invested in UK gilts and corporate debt. But has QE had an economic impact to match its political use? Will the cure prove as dangerous as the disease? How and when should the Bank close the lid on this potential Pandora’s Box?”
Several leading economic figures including Roger Bootle, Tim Congdon and Allister Heath, chaired by Policy Exchange’s Chief Economist, Andrew Lilico, will debate and discuss the merits of quantitative easing, the exit strategies for the Bank of England, the main challenges the UK’s economy will face as a result of the program in 2010 and beyond, and how policymakers should face them.”
These are my notes:
Tim Congdon spoke first , this basic message was that unless money supply, primarily bank deposits, is kept very tight and only moderately growing, there will be trouble ahead with boom or bust. QE has kept the economy on the road and the money supply has not fallen. He acknowledges that there were some problems in measuring this.
Roger Bootle second, he opened by accusing one of our columnist, Liam Halligan of being intellectually devoid of any understanding of economics as he viewed Liam’s world to be predicated on massive inflation and a bond strike and this would never happen. He also said that QE could happen an infinitum. I tell no lie, this is what he said. In fact he was of the view that this should go on and on for whatever amount of time until we were out of trouble. People needed to believe that this policy was going to be the policy that would sort out the economy and indeed he agreed with Krugman, that crude of all the crude Keynesians, that Japan had actually done too little to stop the ongoing deflation. The UK’s risk was never going to be inflation but deflation.
Allister Heath opened with saying he reluctantly supported QE as the key thing was to stop a monetary deflation but questioned why we were having a debate in the first place about the merits of QE and should we do more etc when we should be questioning why do we inflation targeting ? As this has given us the biggest boom and bust in living memory should we not dispense with this independent Bank of England , FSA and other so called control bodies and centralise further into one overall controlling body that controls the broad money supply?
I was utterly bemused by all this tosh spoken in the name of economics with glimmers of hope only coming from Allister Heath.
The chairman asked three questions and the audience were asked three questions with one follow up.
I asked “in business I create wealth by making my factors of production work more efficiently to produce more goods and services. I invariably have to lengthen the structure of my production by saving and investing this money in new and more efficient kit to produce more of my goods and services for better prices and service level for my customers. With those goods I can exchange them with other entrepreneurs, shop keepers etc for my basic food, rent for my roof over my head etc via the medium of money. Money is bits of paper in this country and an electronic bank deposit, so having more of the bits of paper and banks deposits to exchange for the same goods and services would only mean my purchasing power had been debased, so no wealth would have been created. I thought this question go to the heart of the matter.
The second was about bond yields – had they or had they not moved up or down.
The third as about what the panel thought about the questioner’s view that we could only get out of this mess via and export related recovery.
Peter Bottomley asked a question that I cannot remember.
The Chairman then had another round of questions.
Mine was relegated to the bottom by the Chairman. Roger Bootle thought it should be answered by Tim Congdon and in the end Allister Heath did give an answer which acknowledged that no wealth could be created by paper alone and that there was a large body of work in Mises and Hayek showing that the creation of credit causes boom and bust . He was reluctant to support QE as it at least kept money supply near static as opposed to imploding, but saw no ability for it to create wealth . I was not allowed time to debate this with Allister , but did mention afterwards that as he said to me, the Austrian School was divided between those who would support a printing of money to offset a fall in V and those who would just advocate a deflation to allow the market to clear at new lower prices. Having to go I should have added, there is a third camp based around the Cobden Centre who would advocate 100% reserves as this would fix the money supply and you can never have a run on the bank with 100% reserves in place. This is explained here http://www.cobdencentre.org/2010/02/a-day-of-reckoning/ .
Allister framed his discussion in the mainstream language of the Quantity Theory of Money, more I suspect to engage with his fellow economists rather than he having any belief in it being more than a tautology. For a refutation of the Quantity Theory see here http://www.cobdencentre.org/2009/09/qe-errors/ . I did point out at the end after the event had finished that if V went down, how could me selling a house to someone, real bricks and mortar exchanging for money and having it sold back to me for the same 10 times create any wealth? Yes we can increase the velocity of the circulation of money by doing daft things like I describe, but Allister accepted nothing like wealth creation will come of it.
The medium of exchange will not create wealth on its own. It is not wealth. If you hold these bits of paper you hold claims to wealth. The retained goods and the savings we have are wealth. The whole capital infrastructure of our companies and private balance sheets are wealth . This infrastructure drives wealth creation via the dynamic entrepreneurial spirit of men of action who mix the factors of production into the most efficient combinations to satisfy the most amounts of needs. No small matter of printing paper that facilitates exchange or adding electronic reserves to banks will make that wealth creation process any easier. The second part of this article explains how wealth is created http://www.cobdencentre.org/2009/09/can-the-manipulation-of-interest-rates-create-wealth/ .
A poor day for economics!
By Toby Baxendale, on 21 February 10
Via Darius Guppy: our world balances on a sea of debt
What is needed is a root and branch re-evaluation of that most curious of cultural inventions – money, argues Darius Guppy.
See the enclosed article above, it could be written for this site.
I am delighted by the comments that show more and more people are questioning the madness of fractional reserve banking.
Soddy was our first Nobel price winner to suggest 100% reserves as a solution and I am delighted that Guppy is aware of this academic and his work.
By Toby Baxendale, on 16 February 10
The answer is that the US dollar has lost 98.17% of its purchasing power and the pound sterling 99.42% of its purchasing power. Well done then, I suppose, for surpassing even the great tyrants of old who plagued the citizenry of both nations!
Some History
Gold was money for a large part of mankind’s history.
It was discovered by early man to be the most marketable of commodities. As such, the free interaction of people led to this commodity being adopted as the final thing for which all goods and services were traded. This discovery allowed man to lift himself from direct exchange, or barter, of his goods and services to indirect exchange. This indirect exchange allowed the universal application of the division and specialization of labour that has, in turn, given us all the material prosperity we have today. The discovery of money, then, must rank along with language as arguably the most important invention or discovery in the whole course of human history.
Note that, like language, money was not created by the State but by the private and spontaneous interaction of free individuals.
There are many stories in history of wicked monarchs who, to fund their various despotic regimes or lifestyles, would call in the coinage of the realm, extract a small percentage of gold — a “clip” — and then add an impurity before giving them back to the public; this is debasing of the monetary unit. This embezzlement was unlawful for the minter in the private sector and many people over the ages have been executed for stealing from money owners in this way but the monarch usually got away with it. One of the most notable examples in history was when Emperor Nero reduced the value of the denarius from being pure silver weighing 4 grams to 3.8 grams. His financial gain was enormous.
Another great example of history is our very own tyrant per excellence, Henry the VIII. He reduced the weight of sliver in the silver penny to 1/3rd of its purity from 0.925 to 0.250. By the reign of Elizabeth I, the Tudor financier Sir Thomas Gresham had to negotiate a loan from the Antwerp traders to provide more money for her nation. Sir Thomas came back and said
It may please your majesty to understand, that the first occasion of the fall of exchange did grow by the King majesty, your late father, in abasing his coin … which was the occasion that all your fine gold was conveyed out of this your realm.
What became know as Gresham’s law is that “Bad money drives out good under legal tender laws”. In Europe this is know as the Copernicus Law, as he was saying the same thing on the continent. The great medieval philosopher and theologian Nicole d’Oresme was the inspiration of Copernicus on this matter.
Economics of the Matter
A debasement always meant an inflation. Why? As there was more coinage in circulation chasing a similar amount of goods and services for sale, prices rose.
No less a figure than John Maynard Keynes in Economic Consequences of the Peace (1920), said:
By a continuous process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method, they not only confiscate, but they confiscate arbitrarily; and while the process impoverishes many, it actually enriches some.
This is from a man whose current disciples are inflating the western world’s money supply to a point that can only lead to rampant inflation.
We should remember the names which we have used to label money historically. In the UK “sterling” and in the USA “dollar” each described a fixed weight of gold . Gold was the money unit, not sterling or dollar in itself.
Before World War I the pound sterling was worth $4.86856 and a dollar was worth 1/20th of an ounce of gold. For the sake of simplicity I will say that the pound sterling was defined as ¼ of an ounce of gold and the USA dollar 1/20th of an ounce.
So How Much is my Pound Sterling Worth Today?
The Maths
One ounce of gold today is worth $1,093.40 and 1/20 oz therefore $54.67 but the dollar pre World War I was just a name in the USA for 1/20 of an ounce of gold: what would have cost $1 before World War I would cost $54.67 today. The dollar has lost its purchasing power. In fact it has lost 98.17% of its purchasing power in 100 years. One dollar today should buy something like a single person’s weekly food shop, not a single daily newspaper.
The fate of the pound sterling has been even worse than that of the dollar. One ounce of gold today is £692.26. So if a pound sterling pre World War I was just a name in the UK for 1/4 of an ounce of gold, it would imply that the pre World War I purchasing price was 1/4 of £692.26 or £173.06. In fact the pound sterling has lost 99.42% of its purchasing power in 100 years. One pound should buy something like a good week’s food shop for a familiy of four and not just one daily newspaper like it would today.
Conclusion
Our modern day Neros and Henry VIIIs are those we call our Prime Ministers and our Presidents. We are told they are all well meaning men and women. That may well be the case. They have however, since World War I, sat on the single greatest debasement of our wealth in human history.
They do this via the monetization of their nations’ debt. A politician in power might have promised to give X, Y or Z group of people £X, £Y and £Z in exchange for voting for them. If the tax revenue is not enough, then they simply, out of thin air, either create more money — old style monetizing the debt to pay off the debt obligation — or, with a computer key, they open up a new bank deposit for themselves to pay or buy back some of their debt. This is called “QE” or Quantitive easing and we discuss the errors associated with it here.
Last year the UK raised over £200 billion by one part of the government issuing debt and the other part buying it. So £200 billion of new money is now in circulation. Nero and Henry VIII would blush at the brashness of this debasement. This is done wholly at the expense of yours and my very own purchasing power.
The Cobden Centre exists to promote honest money and social progress. Honest money is money that cannot be debased by governments to pay off liabilities they have incurred over and above their tax revenue. I outlined a banking reform proposal which advocated 100% reserve money here. Staying within the existing paper money regime, one would need a bill to prevent the new issuance of either paper money or computer generated new bank deposits by the government. Ultimately, we must look at fully re rooting our paper money back into solid commodities that the government cannot destroy or create at will.
Further Reading
- Huerta de Soto, Money, Bank Credit and Economic Cycles
- Baxendale, A day of reckoning: how to end the banking crisis now
- What is wrong with banking, part 1: the legal nature of banking contracts
- Frank Whitson Fetter, Development of British Monetary Orthodoxy 1797 – 1875
- F. A. Hayek, Denationalisation of Money: The Argument Refined
- Gordon Kerr, How To Destroy the British Banking System and Bailing out the Banks – Glaring Evidence of Moral Hazard
- James Tyler, My Journey to Austrianism via the City, Money is not working and How to avoid future encounters with financial meltdown
- Irving Fisher, 100% Money, 1935
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