The Cobden Centre » Law

Timely call to open up UK legal tender laws

Dr Tim Evans — Tue, 06 Sep 2011 06:40:46 +0000

According to some media sources Douglas Carswell MP is today bringing a bill to the House of Commons that aims to demonopolise the UK’s legal tender laws. Very much a sign of the times, I believe you will hear a lot more about this idea in the days and weeks ahead. Already, the BBC has picked it up here.

A Conservative MP is to call for a basket of foreign currencies to be made legal tender in the UK.

Such a move would protect savers by allowing them to hold the currency least likely to be devalued, Douglas Carswell will argue in the Commons.

And it would allow consumers to shop around for the best currency deal – perhaps via a smart phone application – when buying goods in shops or online.

Read the whole article.

Stephan Kinsella goes from strength to strength

Dr Tim Evans — Fri, 12 Aug 2011 18:56:00 +0000

Back in 1995, I came across this fabulous journal article written by Stephan Kinsella called Legislation and the Discovery of Law in a Free Society. It made a huge impression on me and I will never forget its insights and teachings.

Sixteen years on, I am not only in contact with Stephan but I have just become aware of his latest book, Louisiana Civil Law Dictionary, described here. No doubt having an esoteric interest for Louisiana practitioners and lawyers, my understanding is that this work will also be of interest to anyone interested in the continental, Roman, civil, Spanish and French legal traditions.

Libertarian Legal Theory

Toby Baxendale — Wed, 19 Jan 2011 06:00:45 +0000

We are pleased to promote this upcoming course from the Mises Academy:

Stephan Kinsella, a libertarian attorney and writer, Senior Fellow with the Mises Institute and editor of Libertarian Papers, is teaching his second Mises Academy course later this month, entitled “Libertarian Legal Theory: Property, Conflict, and Society.”

This is a 6 week course to be held on Monday evenings, 9pm-1030pm EST (New York time) (Jan. 31-Mar. 11, 2011), with “office hours” later in the week for followup questions at an earlier time more suitable for students in Europe and elsewhere.

Kinsella describes the course in his article “Introduction to Libertarian Legal Theory,” Mises Daily (Jan. 3, 2011), and what the Mises Academy is like in “Teaching an Online Mises Academy Course,” Mises Daily (Jan. 10, 2011).

His previous Mises Academy course, Rethinking Intellectual Property: History, Theory, and Economics, was very popular with students, one noting:

Thank you so very much for all the excellent work — very few classes have really changed my life dramatically, actually only 3 have, and all 3 were classes I took at the Mises Academy, starting with Rethinking Intellectual Property (PP350) (the other two were EH476 (Bubbles), and PP900 (Private Defense)). …The IP class was a total blast — finally (finally) sound reasoning. All the (three) classes I took dramatically changed the way I see the world. I’m still digesting it all, to tell the truth. Very few events in my life have managed to make me feel like I wished I was 15 all over again. Thank you. …

Further description of the Mises Academy may be found in Daniel Sanchez’s Mises Daily article The Significance and Success of the Mises Academy.

More information on the Libertarian Legal Theory course may be found at http://academy.mises.org/courses/libertarian-legal-theory/.

What is the Legal Relationship Between the Banker and his Customer?

Toby Baxendale — Tue, 14 Sep 2010 06:30:10 +0000

In Parliament this Wednesday, there is a Ten Minute Rule Bill being introduced into Parliament by the inspirational and principled MP for Clacton, Douglas Carswell, with support from my co-Director at TCC, Steve Baker, the Member for Wycombe. Carswell described the proposal in a post on Friday entitled ‘How should we reform the banks?‘, and Steve promoted it earlier today on CentreRight.

This web site has had many articles on this matter and a survey, conducted on our behalf by ICM, showed great confusion on the part of the British public concerning the legal relationship between banker and customer.

The Current State of the Law

The key case is Carr v Carr 1811 (reported in Merivale (541 n) 1815 – 17). A testator in making his bequest said “whatever debts might be due to him…at the time of his death”, the key question in this case being whether “a cash balance due to him on his banker’s account” passed by this bequest. The Master of the Rolls, Sir William Grant held that it did. He reasoned that it was not a depositum; a sealed bag of money could be, but this generally deposited money could not possibly have an ‘earmark’. Grant concluded on this point, “when money is paid into a banker’s, he always opens a debtor and creditor account with the payor. The banker employs the money himself, and is liable merely to answer the drafts of his customers to that amount.” For the legal scholars among you, Vaisey v Reynolds 1828 and Parker v Merchant 1843 both affirmed this position.

In Davaynes v Noble 1816 it was argued in front of Grant that a banker is a bailee rather than a debtor. Rejecting that argument, Grant said “money paid into a banker’s becomes immediately a part of his general assets; and he is merely a debtor for the amount.”

In Sims v Bond 1833 the Chief Justice of the Queens Bench Division affirmed in judgement “sums which are paid to the credit of a customer with a banker, though usually called deposits, are, in truth, loans by the customer to the banker.”

The House of Lords, then the highest court in the land, had its say on the matter in Foley v Hill and Others 1848, duly reported in the Clerk’s Reports, House of Lords 1847-66 (pages 28 and 36-7). In summary, the appellant in 1829 opened a bank account with the respondent bankers. Two further deposits we added in 1830 and in 1831 interest was still added. In 1838 the appellant brought proceedings against the respondent bankers seeking recovery of both the principle and interest. The counsel cleverly tried to argue that it was the duty of the respondent bankers to keep all the accounts up to date at all times and thus there was more to this relationship than that of debtor and creditor.

The Lord Chancellor Cottenham said the following in judgement

Money, when paid into a bank, ceases altogether to be the money of the principal; it is by then the money of the banker, who is bound to return an equivalent by paying a similar sum to that deposited with him when he is asked for it. The money paid into a banker’s is money known by the principal to be placed there for the purpose of being under the control of the banker; it is then the banker’s money; he is known to deal with it as his own; he makes what profit of it he can, which profit he retains to himself, paying back only the principal, according to the custom of bankers in some places, or the principal and a small rate of interest, according to the custom of bankers in other places. The money placed in custody of a banker is, to all intents and purposes, the money of the banker, to do with it as he pleases; he is guilty of no breach of trust in employing it; he is not answerable to the principal if he puts it into jeopardy, if he engages in a hazardous speculation; he is not bound to keep it or deal with it as the property of his principal; but he is, of course, answerable for the amount, because he has contracted, having received that money, to repay to the principal, when demanded, a sum equivalent to that paid into his hands.

That has been the subject of discussion in various cases, and that has been established to be the relative situation of banker and customer. That being established to be the relative situations of banker and customer, the banker is not an agent or factor, but he is a debtor.

Thus the settled position of the law is that when you deposit, the bank becomes the owner of the money deposited and you become a creditor to the bank.

The Carswell Bill

This seems to seeks to align the law to mirror what people actually think happens: that they deposit money and it is theirs. It also seeks to allow savers to save in a term deposit, by which they knowingly and indeed willingly allow the bank to lend their money to borrowers. This relationship will then be that of a depositor lending to the bank and the bank being the debtor to the lender.

The honesty of this approach is refreshing indeed. The economic consequences are that credit granted to borrowers is from real savings and the leveraging of loans (multiple on-lending of the same deposit) that has caused such financial destruction ceases to happen. Real savings lent to borrowers will produce goods and services, and once the loans are repaid, the lenders will be in a position to buy the goods and services. This will have the very positive effect of smoothing out the credit-induced boom and bust cycle, providing us with greater sustainable financing. Credit created out of nothing only supports activities that could not get funding out of real saved resources. Think of all those nutty Dot.com projects, and more recently the nutty finance projects embarked upon.

I hope this Bill gets a second reading so that Honest Money can become a major taking point in the banking reform debate.

Labour laws should be abolished

Jamie Whyte — Thu, 01 Apr 2010 05:00:50 +0000

In 2006, the European Court of Justice ruled that the Department of Trade and Industry has misinterpreted clauses 3 and 5 of the Working Time Directive. Clause 3 states: “Member states shall take the measures necessary to ensure that every worker is entitled to a minimum daily rest period of 11 consecutive hours per 24-hour period”. Clause 5 says that workers are additionally entitled to at least one uninterrupted rest period of 24 hours every week.

The tricky word here is “entitled”. The DTI interpreted it to mean entitled. They instructed employers that they must allow, but need not require, employees to take these rest periods. According to the ECJ, however, “entitled” actually means obliged. Employees may not choose to take shorter rest periods, and employers must not give them this option.

The European judges are surely correct on the matter of interpretation. If the words of European legislators are open to several interpretations, then deciding which was intended is simple; it must be the one that most restricts freedom of choice. And if you think that obliged is not a possible interpretation of “entitled”, then there is much you could learn from the judiciary about post-modern semiotics.

If not surprising, the ruling may still seem unfortunate. British employees already enjoyed the right to these rest periods. When it suited them, however, they were free to take shorter breaks – perhaps to earn overtime or to negotiate a longer break for another occasion. This option was surely valuable to them. Why should the manufacturing union Amicus have asked the ECJ to eliminate it? And why should the TUC have welcomed the ECJ’s ruling?

To see why, note that in the labour market employees are the suppliers and employers are the consumers. Employers buy the labour offered for sale by workers. The Working Time Directive, as now interpreted, is a regulation about the kind of service workers may offer for sale.

Product regulations usually impose minimum standards. When it comes to labour, however, we get maximum standards. The ECJ’s ruling means that, with respect to the flexibility of hours worked, employees may not offer a product exceeding a certain quality. And that is precisely why unions support this interpretation. Maximum standard regulations are required by suppliers attempting to fix their prices above the market price.

Consider a different example. Suppose you manufactured a basic type of bicycle. If the most efficient bike-maker could produce such a bike at a cost of £100, then this would soon be its market price. In a free market, price competition between suppliers drives the price of goods down to the cost of producing them. This is nice for consumers but not for suppliers. How might you avoid this unpleasant consequence of competition?

You could try collusion. Create the British Association of Bike-Makers and, at your annual conference, agree that no one will sell bikes for less than £200. Or lobby the government to set a minimum bicycle price of £200.

Alas, a minimum price will not work on its own, because it does not stop competition on quality. If everyone must sell bikes at £200, and my competitors’ bikes are worth £100, then I can get an advantage by producing better bikes at a cost of £110. My competitors will then retaliate with a yet better bike that costs £120 to make. This process will continue until we are all making bikes at a cost of £200, and none of us is better off than when they cost £100. To keep the benefits of our minimum price, we also need to restrict the quality of the bikes on sale: we need maximum standards.

Trade unionists and employment regulators are devoted to keeping the price of labour higher than its market value. So they must also stop the suppliers of labour from competing on quality. The endeavour is corrupt in principle – indeed, it would be illegal if the product were anything except labour – and futile in practice. The legislation they favour does not eliminate competition between workers; it simply benefits some at the expense of others.

I recently managed a team of two consultants. They were of roughly equal value. John was brighter but Don worked harder, often violating the Working Time Directive. If I had stopped him, who would have benefited? Not Don. He would have been robbed of his ability to compete with John, and his chance of promotion would have been reduced. A ban on hard work benefits not those who work “too hard” but those with other qualities to offer. It rigs the competition in their favour.

It is impossible to eliminate competition between the suppliers of labour. Rule it out in one respect, such as effort, and it will merely shift to something else, such as talent. Rule it out in all economically relevant respects – allow no price or quality competition – and it will shift onto irrelevant preferences of the employer. A bigot might employ foreigners if they came at a discount. But why would he otherwise? Immigrants do better in America than in France, not because Americans are less racist, but because their labour market is less regulated.

Labour laws are intended to protect employees from employers. But no such protection is needed. Feudalism ended long ago, and the labour market is not a monopsony (a market with only one buyer). No one is forced into any particular job. Indeed, unemployment benefits mean that no one need work at all. Labour laws merely distort the allocation of labour and arbitrarily bestow costs and benefits across the population. They should not be interpreted more stringently; they should be repealed.

Free Banking, the Balance Sheet and Contract Law Approach

Toby Baxendale — Mon, 15 Mar 2010 05:00:24 +0000

For new readers to this site who are not aware of the debate that exists within the Austrian School, there are those who are supporters of 100% Reserve Free Banking and those who are for Fractional Reserve Free Banking. The importance of this debate is that the School, whilst being the only School in economics to predict the crash, does not have a uniform policy prescription, or at least one policy prescription to fix our economy and put it on a sound and stable footing going forward.

There are a number of policy recommendations from varying branches of the School. We have given a platform to some of them on this site. To caricature: for the Keynesians, it is a matter of spending more via the government, for the monetarists it is print more and more money until the economy fixes itself. Until the differences are resolved within the Austrian School, there can’t be one coherent message to enable us to get out and engage with the political, academic and journalistic fraternities. This article is an attempt to resolve those differences that lie at the heart of our School, rendering it currently impotent in its forward-looking policy prescriptions.

So far, the only two point I see amounting to total agreement between both sides is that the Central Bank should be abolished. If there was a free choice in currency, people would almost certainly choose a commodity-backed currency, as always existed in history prior to the total move to money set by decree of the State. The flavour of what this would be is hotly debated though.

This article is not written to scholarly Journal standards, indeed it is written on a Saturday afternoon and my working life is entrepreneurship and not academia. I aim to stimulate debate within the wider Austrian academic community and beyond, to thoroughly flesh out some of the research areas I recommend and, hopefully, provide grounds for moving forward on a unified, or as near as damn it unified, basis.

A Quick and Dirty Recap on the Differences

The Fractional Reserve Free Banking School

They say all bank deposits are loans. This is the correct position in law since Carr v Carr 1811 in this country.

Therefore in a free banking world, if bank A issues promissory notes (this is a throw back to when the promissory note was redeemable in gold, but the word credit could just as easily be inserted in the place of promissory notes and is more applicable to our day and age) and if bank A lends to its customers in excess of its inherent worth, then Bank B, a more conservative bank and a competitor, may present Bank A’s notes for redemption (or create rumors in the market place to encourage Bank A’s notes to be redeemed) in the knowledge that it has been over inflating its issue. This will cause a run on their competitor’s bank.

This is a good free-market self correcting mechanism that will make sure all parties behave honestly, as large credit-induced booms that will go bust would not happen under this system. Therefore, by removing the ability of banks to go to a Central Bank to be bailed out over night via the discount window, in a Fractional Reserve Free Banking system with a multiplicity of credit / promissory note issuers, never could an over issuing bank go to the Lender of Last Resort, the Central Bank, and get overnight funds to pay its depositors’ redemption requests. The fear of imminent bankruptcy keeps the over issue of credit / promissory notes in a very stable position.

If we think about what has happened since the “Big Bang” in the mid 80s under Lawson when lots of restrictive practices in the City of London were abolished and the legal reserve ratio was abolished (it is now a voluntary system and sits at around 3%), we saw an explosion of credit that has created at least the late 80s / early 90s boom and bust, the late 90s /early 2000 boom and bust and the mother of all booms and busts in the late 2000s. So the free market has certainly been allowed to work as much as possible. As it over extends and under extends it produces catastrophic and distorting results, as we have seen.

This system is not, in fact, free market capitalism, but corporate capitalism. This is because the whole system is underpinned by the Central bank, which lends overnight to the banking systems so they can match their lending with their redemption demands. On the plus side for the State, they can run this system whereby debt is sold via the banking system i.e. their client banks, as all require some kind of liquidity support at some point in time be it explicit or implicit. They can, more importantly, monetize the debt – or, in modern parlance, do QE, which is nothing more than putting more money into circulation than existed before, thus devaluing the pound in our pocket.

This self correcting mechanism of the market is compatible with liberty and does indeed free money from state control. What is more, if you allow people to choose their own money, then the state becomes totally uninvolved with banking and money, and just as we do not have an apple or jam boom and bust, we shall not have a money or credit boom and bust.

The 100% Reserve Free Banking School

Turning to supporters of 100% reserves, the participants in this debate would agree that there should be no Central Bank and free choice in currency with a strong disposition that people, if left to their own devices, would choose gold or silver or a combination as they have overwhelmingly done in history in most places of the world.

Their problem and, indeed, mine is with the very nature of the demand deposit: the relationship between the bank and its depositing customer. Unlike the Fractional Reserve Free Bankers, the 100% Reserve Free Bankers say that when the vast majority of people deposit money in their bank account, such as their salary and their savings, they think that it is “theirs” and indeed it is safe. Of course we all know that banks own “your money” and indeed they owe you “your” money. A bank statement is the bank saying they owe you want you think is “yours.”

The loan you make to the bank is used by the bank (one loans to the bank in ignorance, I suggest). Indeed, once in the banking system, with its ability to multiply on average in the UK up to 33 times the level of credit, with only 3% of your money ever kept in reserves, it is clear that you only have 3% of “your” money in the banking system at any one point in time. As long as no more than one in 33 people walk into the bank to withdraw that which they think is theirs at the same time, then the claim or “their” money is still safe.

This rapid expansion of credit is the start of the Austrian Theory of the Business Cycle. I struggle to see how anyone can doubt the causes of the Business Cycle and both parts of the Austrian School are united on this. Now, the 100% Reserve advocates say that even under a free banking system with no Central Bank, there will still be boom and bust. This is because as the economy grows and there are more participants in the economy, transacting the sale of more goods and services (it is said by all economists except the 100% Reserve Free Banking advocates) the need for the services of more money grows. A series of fractional reserve free banks can issue extra money in the form of credit or promissory notes and you can thus accommodate the needs of trade.

This will cause a boom and bust, just as the current set up with a Central Bank under pinning the system does. This will be the case as every bit of credit issued not backed by prior real savings will cause a lengthening of the structure of production that will set in motion the capital misallocation of resourses that will look like a boom. But as there are no real savings to support the outcome of this new investment activity backed by bank created credit, that will indeed lead to a bust. If you are not happy with why this will cause boom and bust, I suggest cribbing up on the Austrian Theory of the Business Cycle, in particular Hayek in Prices and Production (PDF).

100% Reserve Free Banking advocates will say that to accommodate the growing population and the needs of trade, we should be happy at the spontaneous increase in our purchasing power of our monetary unit (i.e. falling prices). This is wholly beneficial to us all and is not in any way ever going to cause boom and bust.

Jesus Huerta de Soto in his brilliant book Money, Bank Credit, and Economic Cycles (PDF) in Chapter 9 adds a very seductive and interesting twist to the debate when he outlines a reform program that would lead to the total paying off of the National Debt (a very topical issue now!) and a very sound, solid banking system going forward. I have summarized these thought here: A Day of Reckoning .

A Way Forward, the Balance Sheet and Contract Law Approach to Free Banking

On the Nature of a Bank Deposit

I outlined the start of my case in this article last week: Why All Banks Are Insolvent. It does seem to me that it is critical to decide: should current bank deposit contracts be loans, as they lawfully are, or safe keeping / custodian deposits? If they are loans, the Fractional Reserve Free Bankers have the day, if they are custodian accounts or safe keeping accounts the 100% Reserve Free Bankers have the day.

As mentioned in that article:

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.

This would overwhelmingly suggest that people want safety, they think their money is theirs, even though it is the banks’. They would also like it lent out as long as they can have it back when they want it. I conclude people want safety and easy access, but really they are confused!

It is worth while understanding how a legally binding contract is determined and pondering the glaring confusion that exists with a bank deposit contract.

Law of Contract

Traditionally the formation of contracts has been analysed in terms of offer, acceptance, consideration (and later, intention to create legal relations).

Meeting of the Minds

Horrocks v Foray [1976]:

In order to establish a contract, whether it be an express contract or a contract implied by law, there has to be shown a meeting of the minds of the parties, with a definition of the contractual terms reasonably clearly made out, with an intention to affect the legal relationship: that is that the agreement that is made is one which is properly to be regarded as being enforced by the court if one or the other fails to comply with it; and it still remains a part of the law of this country, though many people think that it is time that it was changed to some other criterion, that there must be consideration moving in order to establish a contract.

Clearly, the depositor does not think he is making a loan to the bank, and the bank knows it is not safe-keeping but on-lending. There is no “meeting of minds.”

The standard which is adopted in deciding whether or not a contract has been concluded is objective rather than subjective. Smith v Hughes (1871):

If, whatever a man’s real intention may be, he so conducts himself that a reasonable man would believe that he was assenting to the terms proposed by the other party, and that other party upon that belief enters into the contract with him, the man thus conducting himself would be equally bound as if he had intended to agree to the other party’s terms.

It would seem that there is confusion at best about the real intentions of the depositor.

Acceptance

Acceptance must be communicated to the offeror – Entores v Miles Far East Corp [1955].

The general rule is that acceptance of an offer will not be implied from mere silence on the part of the offeree and that an offeror cannot impose a contractual obligation upon the offeree by stating that, unless the latter expressly rejects the offer, he will be held to have accepted it – Felthouse v Bindley (1862) 11 CB (NS) 869.

In Order to Create a Binding Contract, the Contract Must be Certain

Scammell and Nephew Ltd v Ouston [1941] – Viscount Maugham – “in order to constitute a valid contract the parties must so express themselves that their meaning can be determined with a reasonable degree of certainty. It is plain that unless this can be done…consensus ad idem would be a matter of mere conjecture.”

Confusion does not constitute a lawful contract.

Previous Course of Dealing Does not Mean Binding Contract Exists

University of Plymouth v European Language Center Ltd [2009] – one party could not rely on an exchange of e-mails and telephone calls as establishing a binding contract with another party, even though the parties had worked together for some years.

It would be very interesting to test that if over the course of a lifetime of banking you always thought that you were depositing for safekeeping if the law courts would give the above interpretation when there has in the vast majority of cases, never been a meeting of the minds.

Consideration

Tweedle v Atkinson (1861) – consideration must move from the promise.

The classic definition of consideration was expressed in Currie v Misa (1875) LR 10 Ex 153:

a valuable consideration, in the sense of the law, may consist either in some right, interest, profit or benefit accruing to the one party, or some forbearance, detriment, loss or responsibility given, suffered or undertaken by the other.

Your banking in some way shape or form , even your “free” bank account, does invariably have some charge somewhere down the line, they get you somewhere, so I would be happy that there is consideration in the current bank arrangements.

Intention to Create Legal Relations

Meritt v Meritt [1970] – In determining the intention of the parties an objective test is used by asking if reasonable people would regard the agreement as legally binding.

With two parties so at odds, I cannot see how we have any intention to create legal relations in the vast majority of deposit contracts.

I would even go as far to say that the vast majority of deposit contracts are unlawful under the Law of Contract.

A sensible policy prescription should be to align the banks to the account holders’ wishes and make the deposit contract one where the bank holds the depositors’ money as custodian / safe keeper and not as borrower. Make this contract explicit. Charge a fee for custodianship / safe keeping.

When a depositor wants to earn some interest on his money, allow an explicit lending contract to be put in place so that the depositor understands that his money has been loaned out, and that it is his no more. He now has a right to his lent money back some agreed time in the future, with a coupon paid.

This allows banks to go back and do what their time honoured role has been, to mediate between the saver and the borrower and to act as custodian and safe keep money for their clients. This is unashamedly boring, and steady as you go banking.

Should a bank be allowed to offer explicitly a fractional reserve account, when you as the depositor know right from the off that they are going to lend your money out a number of times over so there are many claims to this original money that you have deposited? I would say yes under contract law so long as it was explicit and conformed to all the case law listed above, but fundamentally no as this would require the bank to exist under legal and accounting privilege. I work from the assumption that all state sanctioned privilege is a bad as one party is exploiting another lawfully at the expense of the other party. This is antithetical to liberty. I would also add that there could be a similar type of fractional contract but this would be within the realm of hedge funds which operate under the normal commercial law that we all work under – except banks. This will be explored later.

The Balance Sheet Approach

In an article I wrote last week, I outline what I term the Balance Sheet approach to banking. I compare the balance sheet of the UK’s largest company BP, with that of one of our largest banks, Barclays. In a separate article, I look at the accounting treatment of its record profits for 2009 and some remarkable accounting trickery , all perfectly lawful - except that I would not be able to do and such trickery in my business. The link is here More on Banking and the Barclays 2009 Results. The important thing to note is that BP has current creditors and long term or non current creditors. Barclays has only creditors. Why does BP split out its current creditors from its long term ones?

As far as I am aware, in the UK Under International Financial Reporting Standards and UK Generally Accepted Accounting Principles, you have to report your creditors as current, under one year and over one year. This shows the outside world what your ability is to pay your debts, as and when they fall due. Most companies will always aim to match their current creditors with their current debtors, their less than one year creditors, but over current creditors, with the equivalent matching on the debtors’ side and with the long term debt being matched with long term creditors.

Most companies in this sense in the commercial world, other than banks, would indeed be 100% reserve companies and not companies that only keep a small fraction of money aside to pay their creditors. A very good research project for a graduate would be to map out all the FTSE 100 companies and see what percentage were 100% reserved and what were not. With those that were not, what were above 95% , 90%, 85% etc. In reality, if they are not very highly reserved their auditors will not sign off their accounts and they run the risk of insolvency. There is a grey area between a 99%, 95% reserved company as to if it is solvent and at the extreme end, the banks, where they are 3% reserved to current creditors!

Banks need another set of laws that only apply to themselves to operate. Thus they have a privilege accorded only to them. This allows them, like Barclays, to have creditors and debtors only. So all the current money on demand is lumped in with a catch-all lump of all creditors. This implies to the outside world that they perfectly balance their short term creditor needs, i.e. withdrawals with their long term debtors’ repayment profiles such that they never prejudice the current creditor losing his/her shirt. I do not know what specific accounting laws that the banks are allowed to audit to, but they sure are not GAAP that applies to all other commercial organizations. I do intend to find out when I have time, and again, this could be a rich source of research work for a graduate. Notwithstanding, it is clear there is one law for all commercial companies and one law for banks.

It should be clear that a lending and custodian bank where a deposit contract of either type conforms to the Law of Contract, at all points in time will conform to the normal commercial law.

It is clear that a Fractional Reserve Free Bank violates the law of contract and the normal commercial law for every company, thus they have accounting and legal privilege. A custodian / lending bank, conforming to the law of contract and normal commercial accounting law, could not compete with a fractional reserve free bank as the latter would be able to fully use all of its clients’ deposited money to do whatever it pleases, including the creation, on average, of 33 times more deposits. If we take the example of Barclays with some £300 billion of current creditors, the ability to fully use this would place it at a distinct unfair advantage with all other commercial enterprises. Indeed, under the current law, if would be very difficult indeed for a custody / safe keeping bank to get off the ground, the odds are so stacked in favour of the current arrangement.

The Case for Free Banking Under the Normal Commercial Law

Hence I conclude that the current system of making sure companies disclose and match timed liabilities to keep solvent is good and fair to all parties. The anomaly that is fractional reserve banking, be it in its Central Bank sponsored format or in its hypothetical format with no Central Bank, can only work with this legal and accounting privilege in place. This sets one party (the banks/bankers) at a distinct and unfair advantage to another parties (ie all other people / enterprises).

As the Fractional Reserve Free Banking system ex the central bank can only work with the positive intervention of legal privilege and a setting aside of all the principles of contract law, it would seem the case for it is negligible indeed. Added to the fact that there is still the possibility of business cycle inducing properties as they could automatically grow to the needs of trade, we need to map out an alternative that allows people to keep safe, save, invest and speculate.

In the above, I outlined the two forms of deposit that would accord with the normal commercial law that would exist without legal and accounting privilege, i.e. a straight forward safe keeping or custodian contract and a straight forward loan contract.

I would also propose the possibility of a third, called a “High Risk” deposit. This is a deposit contract that again is explicit, that allows one party to deposit in the full knowledge that the institution may or may not engage an over issue of credit, or even promissory notes that may take the form of money if they can become a generally accepted medium of exchange, provided that like in any other company, they are subject to audit and a market valuation up or down of underlying assets at least once per year. As in a normal company’s balance sheet, each year, your properties or other chattels are re valued up, or impaired down, so you can and should do this with the “High Risk” deposit account. This way, there is no extension or contraction of credit over the audit year that does not have real wealth behind it. The boom and bust implications of functioning this way are that of any normal commercial activity.

Conclusion

Any deposit can be made between freely consenting adults provided it is enforceable under the Law of Contract and does not rely on the grant of a state sanction / privilege under commercial law and accounting standards to operate. This would be supporting something that was antithetical to liberty.

Personally, I would prefer to keep these kind of “High Risk” deposits in Hedge Funds and the like – clearly away from banks so as not to confuse. It would be quite possible for somebody with a higher risk profile to place all his money at the disposal of a hedge fund and the hedge fund to offer normal banking services, such as transacting cheques, direct debits, standing orders, issuing debit cards that the hedge fund would subcontract back to the regular standard custodian / safe keeping lending bank. This would give the appearance in almost every respect of the current fractional reserve banking.

To all intents and purposes the overwhelmingly vast majority of non bank companies are 100% reserve companies i.e. they square up with their creditors as and when they fall due or could fall due, unlike fractional reserve banks who make very little provision and rely on state sanction to exist like this.

The balance sheet and contract law approach to free banking allows a solid safe and traditional approach to banking to be the banking system’s default position, but then allows freely consenting adults all other options to enter into whatever deposit contracts they like so long as they are truly lawful.

If this is accepted, I would think it is clear that the proposal of De Soto mentioned above, concerning banking reform, becomes a real possibility in order to be the key policy solution and recommendation of the Austrian School.

It would be right and proper that the School that was the only School to predict the Great Credit Crunch / Meltdown, could provide a series of solutions for a lasting and sustainable recovery.

Afterthought

I have laid out my case that there is such a discrepancy between what the overwhelming majority think happens with their deposited money that under contract law, I doubt very much that an enforceable contract exists as currently offered by the banking system. I propose a reform that would very clearly demarcate what is a custodian / safe keeping contract and what is a lending contract. I agree that freely consenting adults who do no harm to others should be allowed to do as they please which means contract as they please, but entering into a fractional reserve free banking contract would violate very solid good balance sheet accounting and financial reporting standards that have been developed over many years to make sure trade happens without violation of people’s property rights. After that I propose a third contract that could have similar characteristics to a fractional reserve free bank account, called a High Risk account that would allow more speculative activities. The market would evolve in time, and new ways of doing things would no doubt emerge. As long as these new ways of doing things conform to commercial law and do not exist on privilege, then there would be no reason to get het up about this type of innovation.

Some of the debates existing in the wider free banking school need to be addressed.

What is the Difference Between a Fractional Reserve Contract and a House Insurance Contract?

With my house insurance, I pay, not loan, money to an insurance company in exchange for the right to a policy, my consumable item if you like, with the explicit knowledge that they are hoping to charge me and all the other policy holders more than they would pay out in the eventuality of a disaster that I am trying to insure against. There is a small risk that the insurance company will get its sums wrong and not be able to pay me out in full or at all. The policy tells me this.

With a deposit contract, I think I am depositing for custody and safe keeping and only the enlightened few know they are loaning their forgone purchasing power i.e. money to the bank.

So insurance is paying for a product that you consume by virtue of holding the policy for its life time. You know that there is a small risk that you may not get 100% of what you have bought.

With banking, you loan your purchasing power with the overwhelming people doing this in ignorance of what they have committed to. The vast majority expect to have the quiet and peaceful enjoyment of their purchasing power at their convenience and do not deposit in the knowledge that there may be wholesale default.

If we Accept the Legal Position that a Demand Deposit is a Bank Loan, can you Ever Have a Loan with no Fixed Term i.e. an Indefinite Loan?

This is an impossibility.

The loan under these circumstances should properly be called a gift. Fractional Reserve Free Banking relies on the fact that the legal position says all deposits are loans. In 22 years in business I have never borrowed money without a term implied. Even in the most friendly of loans where I have borrowed from a family member and they have said “pay me back when you can,” there is an implied term, when I can, and that it is not a gift.

You can vary terms then reset the period, re cut it, re dice it , re jig it, re price it, etc, but there are still implied terms. At some point in time, a lender always wants to get paid back, otherwise he/she would not be a lender, but someone giving a gift. Depositors are not giving a gift!

In the three banks that I use, representing a very large chunk of the UK banking business, I see nothing whatsoever in any documentation that leads me to believe that when I deposit I am making a loan. What is more, it does not fit my understanding of what a loan is unless we accept it is a callable loan on demand. If it is on demand, it needs to be provisioned for. Prudent management would dictate 100% reserves against my loan. General accounting principles that apply to all commercial activities bar the banks do not have to.

Everything I have ever seen in banking when I have deposited leads me to believe I am depositing money for custody / safe keeping and not as a loan. The language is always that of custody / safe keeping. Free banking going forward needs to be very explicit in nailing in contract what is custody / safe keeping and what is loaning and what is speculating.

Do Fractional Reserve Banks in a Free Market Environment, i.e. one with no Central Bank, Create Inflation?

I touched upon this point in the main body of the article. The price of money is determined, like all things, by demand and supply. Mises called this the money relation. If there is an increase in both, then there will be no inflation. To be clear, Fractional Reserve Free Banking people who advocate this are correct, there will be no price inflation. However, the number of money units has now gone up, so there has been a money inflation. Do we care? Yes, as Austrians we do. Why? Whoever is in receipt of the new money, in a Fractional Reserve Free Banking world with no Central Bank, the first recipients are the new demanders of money. They will get the wealth effect of having new purchasing power first. Where there should have been an increase in purchasing power (falling prices) for all the existing money holders, there is no increase, thus impoverishing those who are holding the existing monetary unit. Again, this gives special privilege to a certain class of person over another class of person. That is antithetical to liberty. The only way this can be avoided is to have Free Banking that sits within commercial law, accounting rules that apply to everyone, and framed within the time-honoured principles of the law of contract.

Do Grain Store Examples Shed any Useful Light into this Debate?

I am often told by advocates of Fractional Reserve Free Banking that banking is like a grain store. That if ten tons were to be deposited by one man who took a certificate from the store holder explicitly stating that the store will be lending 9 ton of the grain out to bread makers in exchange for the original depositor not having to pay for the storage, or even being paid to store there – what would be wrong with this? Also, it would tell me under what time period my grain would be being used by others, and when I could get my grain back. Well, the answer is nothing at all as the contract is explicit – except that I will never get my grain back at all as it is being consumed by someone else. I will never get it back!

Grain examples should be avoided, for they certainly do not stack up.

The Ethics of Capitalism: A Secular and a Theological Justification

Toby Baxendale — Mon, 08 Mar 2010 05:00:12 +0000

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, 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” 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.

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” , 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, which built on the earlier work of the Rerum Novarum 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 an article about the proof God three years ago for LewRockwell.com. 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.

Do it for the money

Jamie Whyte — Wed, 10 Feb 2010 05:00:05 +0000

Last year two police women (WPCs) were discovered to have a reciprocal child-minding arrangement. It was initially declared unlawful. Child minders who receive payment for their services must be registered with Ofsted. And receiving payment is not restricted to receiving money. Anything of value counts, including “free” minding of your own child. These unregistered WPCs were wrongdoers.

Public outrage at the absurdity of preventing friends from looking after each other’s children caused Ed Balls, the Secretary of State for Children, Schools and Families, to intervene. He declared that reciprocal childminding was not a kind of payment after all. The WPCs congratulated him on this small victory for common sense.

Which just goes to show that the common sense of WPCs cannot be relied upon. For, despite Mr Balls’ great powers, he cannot by mere proclamation stop reciprocal childminding from being a kind of payment. His decision simply exempts this barter payment from the tax that Ofsted’s rules and registration fees impose on childminding when other forms of payment are used.

If one of those WPCs quit her police job but offered to continue minding her friend’s child for £50 a day, Ofsted’s requirements would reimpose themselves. The child may be cared for by the same person in the same place, but the introduction of money to the deal would bring with it the state’s administrative and financial burdens. Mr Balls’ “common sense” intervention thus encourages a barter economy in childcare.

This is a silly thing to do. Because money is a better method of payment than barter. While the WPCs barter, they can consume the value of the childminding work they do only in the form of childminding for themselves. This means that they will restrict the amount of childminding they supply to the amount they want to consume. If they paid each other in cash, this restriction would disappear.

As all economists know, money increases the opportunities for trade. Limit its use and many potential transactions will not take place; valuable goods and services will not be produced. And, when they are, they will often be produced by the wrong people.

For where money-based exchange is restricted, people must produce a wider range of goods, either for their own consumption or to increase the chance of having something they can swap for something they want. This is unfortunate, because the more things you do, the worse you will be at them.

In short, discouraging the use of money constrains trade, which limits the division of labour, which leads to inefficiency. Politicians ought not do it. Yet they do it all the time. They impose burdens on activities when done in exchange for money that they otherwise leave alone.

Consider the minimum wage. I am not allowed to pay someone £4 to spend an hour shopping for me. According to our government, that would be unfair, even if my employee agreed to it. Yet I am free to add an hour to my own shopping by walking to a distant supermarket in search of a £4 saving.

I am also allowed to spend an hour cooking my dinner, even if I would be unwilling to pay someone more than £3 to do it for me. Contrary to what you may have read on the Directgov website, working for less than £5.80 an hour is not illegal in Britain. It is illegal only if the payment is made in money.

Taxes have the same effect. Since most are levied on money-based transactions (with the notable exceptions of poll and property taxes), they inhibit trade and, hence, the division of labour. And the greater the rate of tax, the greater this malign effect.

Suppose, for example, that you are willing to pay up to £10 an hour to have some work done, and that the cheapest qualified labourers are willing to work for anything over £9 an hour. Then you should find someone to do the job. But if incomes are taxed at 20 per cent, the most the labourers can earn from you is £8 an hour and they will be unwilling to take on your job. You will have to do it yourself or go without.

Britain’s enormous regulatory and tax burdens on trade lead to an excess of do-it-yourself. People with neither talent nor inclination cook, garden, teach, drive and shop, to name but a few of the more common amateur activities. They are thereby drawn away from doing things they are better at and enjoy more.

What is the cost of such restrictions on the division of labour? Terry Arthur of the Institute of Economic Affairs has estimated that, at current tax levels, the cost is two thirds of every pound of tax collected. In other words, the marginal cost of transferring a pound from private hands into the coffers of Her Majesty’s Revenue is 67 pence.

Mr Arthur may be wrong, of course; estimating such “invisible”, deadweight costs is notoriously difficult. But even if his estimate is three times the real cost, the implications are profound. Taxes, minimum wages and the other regulatory burdens the government places on money-based commerce are far more costly than politicians and voters seem to realise.

Indeed, most do not recognise this cost at all. Some lament the futility of a system in which people are taxed only to receive their money back in the form of government provided services, such as education and healthcare. But they fail to see that the spinning of this money-go-round creates a terrible economic drag.

Alas, there is no prospect of an end to this waste, even if politicians understood it. When invisible costs are incurred for the sake of visible benefits, a politician will never consider them too great.

A day of reckoning: how to end the banking crisis now

Toby Baxendale — Thu, 04 Feb 2010 05:00:56 +0000

Drawing on the work of Nobel Laureates in economics from three traditions, plus numerous other distinguished scholars, Cobden Centre Chairman, economist and successful entrepreneur Toby Baxendale presents an informal introduction to our proposal for honest money and the benefits consequent on the reform. See also our precis of Irving Fisher’s 100% Money.

Fact

The average overhang of credit to money of all banks in the United Kingdom is 34 x to its reserves i.e. its actual money base¹.
If more than one person in 34 walks into all banks simultaneously to withdraw their deposits, there will be a system wide bank run and a mass liquidity event with systematic default and insolvency.
We saw the start of this with Northern Rock in the summer of 2007.
We attempt to paper over the cracks and restore confidence in the banking system still today – with little success².

Sterling Liquid Assets (BoE FSR, Jun 2009)

A practical, politically-acceptable proposal

Our proposal is, as Irving Fisher wrote, “The opposite of radical”:

Require 100% cash reserves to be held against all demand deposits; there can never be a crisis if a bank always holds 100% cash against all its demand deposits.
Parliament can do this with one Act.

A similar Act took place in 1844. The Bank Charter Act or “Peel’s Act” established a 100% reserve requirement for bank notes that were issued claiming to be redeemable in gold. The reality was that there were 23 notes in issue for every one unit of gold at the time, creating instability, “panic” and general economic chaos. Not a too dissimilar situation from today where we have 34 claims on money to one unit of money. Politicians in the 19th century did not see the creation of unbacked credit through accounting entries as a problem, since it was only done on a very small scale. The problem then was rampant note issue (claims to real money) well over and above the monetary base, as this was the preferred method the bankers used at the time.

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)!

Peel’s problem was the over issue of notes to gold: our problem is the over issue of credit to money.

The really clever move

One would have to print in excess of a trillion pounds Sterling to place in the banks to run against the money that has been created already through credit expansion and which now sits as deposits.

This one off act would not be inflationary, as the money (strictly speaking the money substitute or “credit”) already exists on deposit. Our proposal merely provides real cash to stand behind existing accounting entries.

Before this Act, the banks would have a particular net worth on their balance sheets; after the act, they would have in excess of £1 trillion pounds of new net worth³.

The banks’ current assets, which they balance against their current deposits, would no longer be necessary to balance their books.

Those current assets (loans to entrepreneurs, companies, people etc) could then be parcelled up into Mutual Companies.
Parliament could compel these Mutual Companies to swap all the existing outstanding government debt for shares in these institutions. Government debt would then be paid down via the assets of the new mutuals.

This would end the burden on the tax payer of funding the enormous debt that has been created over the last 200 years, including the phenomenal sums that need to be raised in this Parliament and the next one. Let us pause on the fact that this government, arguably the most incompetent government in our history needs to raise some £700 billion next year alone to fund its expenditure programs. This is greater than all governments in our entire history have ever had to raise.

This would enable the government to deliver a massive tax cut as it would not have to fund the National Debt anymore. The Treasury forecasts that paying the interest on the national debt will cost taxpayers £42.9 billion in 2010/11, more than the annual budget of the Ministry of Defence. Grant Thornton, an accountancy firm, estimates that by 2013, debt interest will cost £58 billion. The income tax is forecast to generate approximately £142 billion in 2010/11. This could mean an incoming Conservative Government could give everyone a 30% tax cut, or substantially take many people out of having to pay income tax at all by raising the tax free allowance levels!

Any surplus funds could be used to fund the pension and social security deficits by issuing bonds to cover those deficits which could be swapped for ownership in the new Mutual Companies.

We have a project in progress to formalise the relevant figures and stimulate debate.

Consider then how the consolidated balance sheet of the entire banking system would look post reform.

Consolidated Balance Sheet of All Banks Post Reform

Assets	Liabilities
Assets corresponding to owner’s equity =	Owner’s Equity prior to the reform
Newly minted bank notes backing the deposits and supplied to banks to maintain 100% reserves =	The sum of demand deposits not exchanged for shares in the fund – the largest sum of all bank liabilities prior to the reform
Total of all other banking assets transferred to mutual funds managed by banks ex treasury bills held by banks as they can all be cancelled =	The sum of the new fund shares which replace outstanding government debt and the partial or total liquidation of other state liabilities, social security, pension etc.
Total Assets =	Total Liabilities

The money supply is the same before and after demand deposits are backed 100% by new bills.

Government from hence forth could be rule based. Rule 1: government must live within its means.

Government could only spend what it had taken in tax receipts: a transparent system.

Under a system of honest money, no deleveraging can now take place. Another way of saying this is that no monetary deflation brought about by the private banking system itself can now take place.

Sterling could now be considered sound.

The Great Depression saw a 30% contraction in the money supply of the USA, with 100% reserve, this could not happen and more importantly we would stop what is happening today.
Also observe the very simple fact that the magnitude of the loans made by banks can only go up if there has been a prior increase in society’s voluntary savings. This means the economy would be built on save and invest. The amount of debt in the economy would be automatically set at a sustainable level.
Remember, savings is the non consumption of present goods for the future consumption of goods that will be produced with the loans from the banking system: that is lent to entrepreneurs who will marshal the factors of production, land, labour and capital, to make these future goods.

The primary source of imbalances in the economy would have been removed.

No longer would banks be able to manufacture profits out of nothing by lending money created out of nothing:

A “day of reckoning” would have been struck against the banks.

Some objections considered

Banks could not lend money like they have now to promote industry.

Yes they could. They would be able to take deposits on a timed basis i.e. the depositor would deposit their savings and relinquish control over those savings, by lending to the bank for X number of months/years, so that the bank could lend to the entrepreneur / company for the same period. This is true old style and effective bank intermediation between a bank and its customer.

More importantly, when the level of savings goes up (that is when the consumer is putting more away for consumption later), the bank intermediates between the funds that are being set aside for future consumption and the entrepreneurs / companies that are seeking to provide those goods and services.

This proposal will reduce the available credit and push up interest rates causing economic doom.

With 100% reserves, that which has been saved will be lent. This ensures the on-going co-ordination of present goods and future goods. This will stop credit created booms and busts. The marginal entrepreneur, who could have got credit in lax times, will not get it. It is those projects that are allowed to come into fruition that are the essence of boom and bust. Credit will only go where the money is most needed to satisfy future consumption needs.

Another way to say this is voluntary savings is always equal to investment, therefore bank created money (a large part of the 34x leverage to the capital base) can only bring forth projects that will never be able to be sustained as the voluntary savings are not there to buy the made goods and services. This is commonly called a bust.

The 100% reserve system would not allow the money supply to grow to suit the growing needs of the economy.

It is argued that as economic productivity increases — i.e. every given unit of capital employed in production is producing more units than before — unless more money is created, the purchasing power of the given monetary units will go up and thus prices will fall and people will stop buying things as they will wait until the goods and services fall further. This will cause economic catastrophe.

This is the straw man of price deflation, or an increase in the purchasing power of money. So much nonsense has been expended upon this fallacy of economics. In 1989 in my first business venture I bought an Apple Mac for £3,000. It was my first PC, used to help me drive efficiencies in the business. Would I have waited until 2009 to buy one for £500 in the full knowledge that they would become cheaper as Apple would become more productive at producing more of them? Hell no! Would my grandfather have waited 80 years to by a cheaper car in real purchasing power terms and forego all the advantages of owning a car for 80 years? Hell no!

As with all price deflation, I am delighted that the purchasing power of my money has gone up: which allows me to buy more things!

As the governments have systematically allowed the purchasing power of money to fall by over 99% in the last 80 odd years because they have allowed the practice of money creation via the banking system to take place and have printed money themselves (“Open Market Transactions” or “Quantitive Easing”) via their Central Bank, a period of raising purchasing power of money would be most overdue!

Does not the implied government guarantee behind all deposits actually create the same effects as the 100% reserve system?

No. This is because the bankers’ can still create money out of thin air and lend it to whoever they like with the knowledge that the State will bail them out should the loan go bad. The moral hazard created in this process is enormous. What we need is bankers who respond only to the lodging of voluntary savings, who then lend them out to entrepreneurs / companies for their activities as these will be more sustainable than lending with an implied guarantee from the taxpayer.

The banks often claim that they do only use deposits to fund loans so they are in effect very solvent and only illiquid for timing purposes (site the Select Committee Comments by the notorious RBS and HBOS Bankers) so what is the problem?

You have to have your current assets (loans to entrepreneurs / corporations, mom and pop individuals etc) backed by demand deposits, this is true. The point being if I deposit £100 of real cash in notes and coins into a bank, then the bank that has got this deposit, then lends all but 2.94% of it (1/34th of 100) out again. This is the average Reserve Ratio of all licensed banks licensed by the Bank of England. In effect, £97 pounds of the original £100 gets lent to an entrepreneur.

So now we have the original £100 and £97 lent to the entrepreneur and £3 kept back in reserves. The bank’s asset, the loan, is equal to the current liability, the deposit. Therefore the bank’s balance sheet balances.

The trouble comes when the entrepreneur deposits his new £97 borrowed in a new bank, and the same process starts again until the last penny over 2.94% of a whole series of transactions is completed. So on the face of it, they all seem to have deposits that are lent to good security. In reality, if I wanted my £100 back, along with every one else, we would only get 2.94% of it. Thus, by any normal definition, all of the banks are insolvent.

By law, banks are allowed to run on an insolvent basis by any normal commercial standards and the law allows them to describe themselves as solvent. In truth, they are legally solvent until people want their money back, then even under any understanding they become at least illiquid or to the common man: insolvent! So without a “lender of last resort” — and the Bank of England ceased to be this in its failure to lend to Northern Rock in August 2007 — we are in a very precarious situation.

If the Peel Act was so effective why was there bank runs and booms and busts after that?

Up until the total link with Gold was abolished in 1971, Bank of England Notes were backed with gold. From the Peel Act of 1844, no one has ever had any trouble redeeming in gold as far as I am aware. So the Act was effective.

What it did not do, was seek to regulate the growth of demand deposits. It was this oversight that has caused a significant growth in the money supply that can be directly correlated with National Income. Broadly speaking, when deposits are growing, we “boom,” when they are shrinking, we have a “bust.”

Tim Congdon in “Central Banking in a Free Society” 2009 and “Money and Asset Price in Boom and Bust” of 2005, both published by the Institute of Economic Affairs, very ably demonstrates this, although the author does not agree with 100% reserve systems we propose. He would prefer the reestablishment of the pre 1946 Bank of England owned not by private individuals, but by all banks like the Federal Reserve in the USA, which for sure would be a better arrangement than we have today, but not the ultimate solution, which I propose in this paper.

Would not financial innovation just create another method whereby the Banks could lawfully re create the same effect as the over issuing of notes over specie or the uncontrolled growth of demand deposits and render your whole 100% Reserve project ineffective?

Yes, that may well be the case and it should be the job of law makers to not wait 165 years to stop it!

Afterthought

At present, a saver thinks they own their demand deposit. Since Carr v Carr 1811, it is clear in English Law that the bank in fact owns the deposit and can do with it what it likes. You as a saver think you own this money. Two people cannot own one bit of property.

In this country, 34 people think they own the same one bit of property in the banking system. This system is rooted in a flagrant abuse of private property. Addressing this single issue – the sole cause of the Boom Bust environment we occupy, will prevent all the effects that have happened in this current boom and bust. By this, I mean the claim that sub prime , credit default swaps, various derivatives, too much saving in China etc are effects of the uncontrolled credit creation by banks. None of these events could have happened without the credit to support them.

As legal tender in this country is Sterling and can only be created by the Bank of England and in effect its branch network (the private banks that it licenses), the only cause for this boom / bust is lack of control by Gordon Brown and his Government. The cause, that no one mentions, or possibly understands is the other half of the problem that Peel dealt with 165 years ago. Resolve this omission and we will have a very stable financial system and a much more prosperous and fair economy.

This shows thank our leading bankers either were disingenuous to the Select Committee, or they were genuinely ignorant as to the whole process of credit creation in the — their! — banking system, or just plain fibbers.

Remove the systemic risk, don’t levy against it

Steven Baker MP — Mon, 25 Jan 2010 13:43:44 +0000

Via The Guardian, City minister campaigns to protect taxpayer from bank failures:

City minister Lord Myners today stepped up the government’s campaign to ensure taxpayers will never again need to bail out banks by urging delegates to a Downing Street seminar to hammer out ways to transfer the risk of bank failures away from the public sector.

At the start of the meeting with academics, country officials from the G7, international and UK policymakers, Myners said: “There is clearly a strong rationale to charge for the externality caused by the financial sector and financial institutions should shoulder the responsibilities for losses they may face”.

“Numerous innovative ideas including contingent capital and systemic risk levies have recently emerged to increase the resilience of the financial system globally and to ensure that the costs of any future failures primarily fall to banks and bank investors rather than taxpayers,” Myners said.

Well, yes indeed: businesses should certainly shoulder their own risks.

However, rather than raising a levy on the systemic risk, the law should remove it: bank deposits should be subject to sound property rights and contract law.