The Daily Mail reports Interest rates: How keeping them at a record low is a deliberate government ploy to pay off its debts:
A stealth raid by the Bank of England has stripped savers of more than £170billion, a Money Mail investigation can reveal.
By slashing the base rate to a record low of 0.5?per cent and allowing the cost of living to soar for more than four years, the Bank has whittled away the value of cash sitting in High Street accounts through a ‘secret tax’.
And it is not just savers who have effectively had their money pinched. Anyone who has a fixed monthly income, such as pensioners, or has had a tiny pay rise, has also lost out.
I campaign constantly against the injustice which is being manufactured by our centrally-planned system of money and bank credit so I am glad that the arguments are going mainstream.
We are in the midst of a great battle between debtors and creditors. Deeply indebted governments are on the side of those in debt. Too many claims on real goods have been created by bank lending so now the central banks are destroying those claims by stealth.
The implications for our society will be profound. I cannot help thinking that the whole enterprise would have already come crashing down if the public could see the tens and hundreds of billions of Pounds – and Dollars and Yen… – as paper in wheelbarrows going to governments’ favoured friends.
Given that the alternative is higher interest rates, sound money and a painful correction, governments and central banks think they are taking the easy way out. We’ll see.
This article was previously published at SteveBaker.info.
In light of recent events, we’re bringing forward this proposal from June 2010.
There’s two ways to view the financial meltdown that occurred in 2008. The first is that it was a rare and unfortunate blip that can be remedied with calm and enlightened improvements in the regulatory framework. The second is that it exposed a serious flaw in the entire monetary system, and is likely to be repeated unless a radical transition takes place.
It’s no surprise that politicians, bankers and regulators – the architects of the banking industry – favour the first idea. This is why their response has skirted around the edges instead of dealing with the core. Even supposedly extreme measures such as nationalising banks are in fact attempts to preserve the status quo.
For those of us who favour the second idea, 2008 provided a golden opportunity to join the public debate and present a credible alternative. Perhaps we missed it. But if indeed another crisis is coming, this article attempts to outline a 14-point plan that could be implemented quickly and genuinely reform the institutions that create financial instability.
The key aspects of this proposal have been made previously, notably by economists Kevin Dowd and Richard Salsman. It could be implemented in three phases:
Over 2 days the aim is to ensure that all operating banks are solvent
- Deposit insurance is removed – banks will not be able to rely on government support to gain the public’s confidence
- The Bank of England closes its discount window
- Any company can freely enter the UK banking industry
- Banks will be able to merge and consolidate as desired
- Bankruptcy proceedings will be undertaken on all insolvent banks
- Suspend withdrawals to prevent a run
- Ensure deposits up to £50,000 are ring fenced
- Write down bank’s assets
- Perform a debt-for-equity swap on remaining deposits
- Reopen with an exemption on capital gains tax
Over 2 weeks the aim is to monitor the emergence of free banking
- Permanently freeze the current monetary base
- Allow private banks to issue their own notes (similar to commercial paper)
- Mandate that banks allow depositors to opt into 100% reserve accounts free of charge
- Mandate that banks offering fractional-reserve accounts make public key information (these include: (i) reserve rates; (ii) asset classes being used to back deposits; (iii) compensation offered in the event of a suspension of payment)
- Government sells all gold reserves and allows banks to issue notes backed by gold (or any other commodity)
- Government rescinds all taxes on the use of gold as a medium of exchange
- Repeal legal tender laws so people can choose which currencies to accept as payment
Over 2 months the aim is the end of central banking
- The Bank of England ceases its open-market operations and no longer finances government debt
- The Bank of England is privatised (it may well remain as a central clearing house)
You can download a copy of the plan in pamphlet form here.
Over at ConservativeHome, I have promoted Douglas Carswell’s ten minute rule Bill on legal tender laws and currency choice:
People today have unprecedented choice. They can shop around online. They can tune into numerous television and radio channels. They can even decide between different hospitals for medical treatment.
But why are people not allowed to decide for themselves in which currency to transact their business and store their own wealth?
Today, Douglas Carswell introduces a Bill designed to make a range of different currencies legal tender in the UK. It would mean that, with the click of a mouse, people would be able to store wealth and pay taxes in a range of different currencies of their choice.
The BBC are covering it here. Read the full article.
Phase 1: Greenspan, the arch money crank
The Greenspan “put”, and the collective adoption by most central bankers of low interest rates after the dot-com bust and 9/11, caused one of the largest injections of bank credit in history. Since bank credit circulates as money, we can say public policy has created the largest amount of new money in history.
This should never be confused with creating new wealth. That is what entrepreneurs do when they use the existing factors of production — land, labour and capital — in better ways, to make new and better products. The money unit facilitates this exchange.
Now to a money crank. He will assume that new money will raise prices simultaneously and proportionately, so the net effect of the economy is that all the ships rise with the tide at the same rate. He’ll say that money is neutral and does not have any effect on the workings of the economy.
One of the great insights of the older classical economists, and in particular the Austrian School, is that new money has to enter the economy somewhere. Injected money causes a rise in the price levels associated with the industry, businesses, or people who are fortunate enough to be in receipt of the new money. Prices change and move relative to other prices. It is often quite easy to see where the new money enters into the economy by observing where the booms are.
Suppose a banker sells government bonds to another part of the government (as has been the case with UK QE policy). For selling, say, £30bn of government debt to the Bank of England, he gets a staggering, eye-popping bonus. With his newly minted money, he buys a new £10m house in Chelsea, a £5m yacht in Southampton, some diamonds for the wife to keep her happy, and lives a happy and rich life. The estate agent spends his commission on a luxury car, and some more humdrum items that mere mortals buy. At each point in time, the prices of the goods favoured by the recipients of new money are being bid up relative to what they are not spending on. Eventually these distortions ripple through the economy, and the people furthest from the injection of new money — those on fixed income, pensioners, welfare recipients — end up paying inflated prices on the basic goods and services they buy. A real transfer of wealth takes place, from the poorest members of society to the richest. You could not make this up. I am no fan of the “progressive” income tax, but I certainly can’t support a regressive wealth transfer from the poor to the rich!
Even when the government was not creating new money itself, it was setting the interest rate, or the costs of loanable funds, well underneath what would naturally be agreed between savers and borrowers. Bankers are exclusively endowed with the ability to loan money into existence, so they welcome the low rates and happily lend, charging massive fees to enrich themselves in the process.
After the dot-com bubble, it was property prices that went up and up. Not only do we have the richer first recipients of new money benefiting at the expense of the poor, we have a massive mis-allocation of capital to “boom” industries that can only be sustained so long as we keep the new money creation growing.
Our present monetary system is both unethical and wasteful of scarce resources. We do not let counterfeiters lower our purchasing power, and we should not let governments and bankers do it.
Phase 2: Bush & Brown – private debt nationalised by the Sovereign
This flood of new money brought more marginal lending possibilities onto the horizon of the bankers.
They devised a range of exotic products whose names are now familiar: CDO, MBS, CDO-squared, Synthetic CDO, and many more — all created to get lower quality risk off the issuing bank’s balance sheet, and onto anyone’s but theirs!
In 2007/2008, bankers started to wake up to the fact that everyone’s balance sheets were stuffed with candyfloss money, at which point they suddenly got the jitters and refused to lend to each other. As we know, bankers are the only people on the planet who do not have to provide for their current creditors; they can lend long and borrow short. Thus, the credit crunch happened when the demand for overnight money to pay short-term creditor obligations ran dry.
Our political masters then decided that we could not let our noble bankers go bust; we had instead to make them the largest welfare state recipients this world has ever known! Not the £60 per week and housing benefit kind for these characters, but billions of full-on state support to bail out their banks. They failed at their jobs and bankrupted many, but they kept their jobs with 6, 7, or 8 figure salaries!
Bush told us that massive state intervention was needed to save the free market. Brown said the same. We were told that there would be no cash in the ATMs and society would most certainly come to an end if heroic action was not taken to “save the world”, as Brown so memorably put it (though he seemed to think he had accomplished this feat singlehandedly). Thank God for Gordon!
Now in Iceland, a country I was trading with at the time, their banks did go bust; no one could bail them out. But within days the Krona had re-floated itself and payments continued; within weeks they had a functioning economy.
Within days the good assets of Lehman Bros had been re-allocated, sold to better capitalists than they.
But with these notable exceptions, socialism was the order of the day. Bank’s inflated balance sheets were assumed by sovereign states. Like lager louts on a late night binge, after a Vindaloo as hot as hell itself, heads of government seemed to care little for the inevitable pain that would follow, as states tried to digest what they had so hastily ingested. Indeed, the failed organs of the nationalised banks survive only on life support, enjoying continuous subsidy through the overnight discount window.
But the sovereign governments, under various political colours, had a history of binging. In our case the Labour Party spent more than it could possibly ever raise off the people in open taxes, and the Tories offer “cuts” which in reality mean that the budgets of some departments will not increase as quickly as they were planned to.
Phase 3: King Canute, sovereign default
Default is the word that can’t be mentioned. In reality, we should embrace default. This debt is never going to be repaid. Never, that is, in purchasing power terms.
S&P ratings agency have hinted at this with the recent US rating downgrade. They know the American government can always mint up what it needs so long as it has a reserve currency. They also know that this is a soft default. In real terms, people seem likely to get back less than they put in.
Hard default should be embraced by the smaller nations like Greece and Ireland, so they can rid themselves of obligations they cant afford to pay. This will be good for taxpayers in the richer countries of Europe, as they will no longer be bailing out those who foolishly lent to these countries. It will be good, too, for the debtor nations, as they can remove themselves from the Euro and devalue until they are competitive again. They will, however, need to learn to live within their means. Honest politicians need to come to the fore to effect this.
Yes, this will be painful and the people who lent these profligate and feckless politicians the money will get burnt.
However, the FT has recently seen prominent advocates for a steady 4%-6% inflation target. This is the debtors’ choice and the creditors’ nightmare, with collateral damage for those on fixed or low incomes, for the reasons mentioned above. Should we let the Philosopher Kings have their way?
“Let all men know how empty and worthless is the power of kings. For there is none worthy of the name but God, whom heaven, earth and sea obey”.
So spoke King Canute the Great, the legend says, as waves lapped round his feet. Canute had learned that his flattering courtiers claimed he was “so great, he could command the tides of the sea to go back”. Now Canute was not only a religious man, but also a clever politician. He knew his limitations – even if his courtiers did not – so he had his throne carried to the seashore and sat on it as the tide came in, commanding the waves to advance no further. When they didn’t, he had made his point: though kings may appear ‘great’ in the minds of men, they are powerless against the fundamental laws of Nature.
King Canute, where are you today? We need honest politicians and brave men to step forward and point out the folly of trying paper over the cracks. Unless banks write off under-performing (or never-to-perform) securities from both the private sector and the public sector, we will progressively impoverish more and more people.
Let better business people buy the good assets of the bust banks, and let them provide essential banking services.
Let the sovereigns that can’t pay their way go bust and not impoverish us any further with on-going bailouts. In all my years in business, your first loss is always your best loss.
Yes, this will be painful. Politicians, fess up to the people: you do not have a magic bullet and you can’t offer sunshine today, tomorrow and forever.
I fear that if we do not do this, we approach the end game: the total destruction of paper money. Since August the 15th 1971, paper money has not been rooted in gold. It is the most extreme derivative product, entirely detatched from its underlying asset. Should the failure of this derivative come to pass, we will have to wait for the market to create something else. Will we be reduced to barter, as the German people were in the 20s?
A process of wipe out for all will be a hell of a lot harder than sensible action now. It is still not too late.
FT – Bullion bulls talk of $5000 gold
Historically, gold and silver were the money of choice, freely chosen by the people as the most marketable commodities. The value of your labour was measured in these precious metals.
Wicked Kings through the ages debased the people’s money for their own profit. The last English king to do this was Henry VIII. Our money was free from debasement for many years thereafter; the value of our work undebauched.
Today, governments around the world assume the powers of kings of old as they embark on the “monetisation” of their debt, minting new money from nowhere. They call it QE.
Since 1971, when Nixon severed the last link to gold (struggling to pay for the latest war), paper currencies have been the most extreme derivatives, resting on a mere memory of underlying value. CDO squared has nothing on paper fiat.
So the people are voting with their feet, and returning to ancient currency — to gold and silver.
How much does an ounce of gold buy you today? $1800 worth of goods and services. And a year ago? $1200 worth of goods and services. How much purchasing power been taken away from you?
How long will governments around the world, with no political will to tackle their dangerous debts and zombie banks, be able to maintain confidence in their paper systems? I do not know, but I feel that we’re fast approaching a day when the whole western monetary system will fundamentally change.
I hope the new paper will be redeemable in gold or silver. Governments can’t mint this stuff up like magic. They will be forced to raise money through taxation alone, according to what the public will bear. No longer will they be able to kick the can down the road, while stealthily confiscating the fruits of our labour.
I am delighted that even the FT, that stalwart of conventional economics, is now asking ‘how high could gold go?‘. Let us hope they consider the fundamentals, and recall our long, sorry history of debasement.
A view from America, previously published at Forbes.com on August 15th
Is it possible that the ghastly unemployment, stagnant growth (and possible double-dip recession), and financial market convulsions all can be traced back to one single decision? Perhaps.
Monetary policy is the most recondite yet most pervasive and powerful of economic forces. Keynes, in The Economic Consequences of the Peace, wrote, “There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”
The converse also is true. Restoring real monetary integrity engages all the hidden forces of economic law on the side of prosperity. And forces for monetary reform are very much in motion.
The dollar has fallen in value by more than 80% from the day when Richard Nixon took the world off the tattered remnants of the gold standard. Aug. 15 marks the 40th anniversary of the avowedly “temporary” abandonment of the gold standard by President Richard Nixon.
“Closing the gold window” was part of a series of dramatic but shocking and destructive tactics by Washington, including wage-price controls, a tariff barrier, and other measures, all leading to economic and financial markets hell. All such measures save one stand discredited. The only piece of the Nixon Shock still in force was the piece most ostentatiously designated as temporary. Nixon: “I have directed Secretary Connally to suspend temporarily the convertibility of the dollar into gold….”
Suspending convertibility was no trivial matter. Nixon speechwriter William Safire recalled: “On the helicopter headed for Camp David, I was seated between [Herb] Stein and a Treasury official. When the Treasury man asked me what was up, I said it struck me as no big deal, that we would probably close the gold window. He leaned forward, put his face in his hands, and whispered, ‘My God!’ Watching this reaction, it occurred to me that this could be a bigger deal than I thought….”
It proved to be a very big deal. How ironic that the most staunch defenders of a pure paper standard, the sole remnant of Nixonomics, are a few influential “progressives” such as Paul Krugman, Joseph Stiglitz and Thomas Frank. Call them “the Nixonians.” The poor jobs growth and stagnation of today’s “world dollar standard” are not, unsurprisingly, dissimilar to the results of the Nixon Shock.
There is ample evidence that restoring gold convertibility would put the world back on the path of jobs, growth, and a balanced federal budget. Politicians do not like messing around with monetary policy. But gold, recently rediscovered by the Tea Party, has an impressive technical, economic, and political pedigree. Gold convertibility has a very well established track record of job-creation, properly applied, during many eras.
The silver lining to the whipsawing Dow is that it makes politicians open to new ideas, even new old ideas. Monetary statesmen from Alexander Hamilton forward have faced circumstances far more dire than those of today and turned things around. Modern example? The German economic miracle, the Wirtschaftswunder.
That miracle was founded in currency reform. On the very day when Ludwig Erhard’s currency reform was put into place, the economic paralysis ended. The “rightest” economist of the 20th century, Jacques Rueff, wrote (with André Piettre) about the turnaround beginning on the very day of the reform:
Shop windows were full of goods; factory chimneys were smoking and the streets swarmed with lorries. Everywhere the noise of new buildings going up replaced the deathly silence of the ruins. If the state of recovery was a surprise, its swiftness was even more so. In all sectors of economic life it began as the clocks struck on the day of currency reform. Only an eye-witness can give an account of the sudden effect which currency reform had on the size of stocks and the wealth of goods on display. Shops filled with goods from one day to the next; the factories began to work. On the eve of currency reform the Germans were aimlessly wandering about their towns in search of a few additional items of food. A day later they thought of nothing but producing them. One day apathy was mirrored in their faces while on the next a whole nation looked hopefully into the future.
Rueff took a similar approach, including a dramatic currency reform, to reviving the French economy. As economist and Lehrman Institute senior advisor John Mueller summarizes:
Despite the unanimous opposition of his cabinet, de Gaulle adopted the entire Rueff plan, which required sweeping measures to balance the budget and make the franc convertible after 17.5% devaluation – though not without qualms. ‘All your recommendations are excellent,’ de Gaulle told Rueff. ‘But if I apply them all and nothing happens, have you considered how much real pain it will cause across this country?’ Rueff replied, “I give you my word, mon General, that the plan, if completely adopted, will re-establish equilibrium in our balance of payments within a few weeks. Of this I am absolutely sure; I accept that your opinion of me will depend entirely on the result.’ (It did: ten years later, de Gaulle awarded Rueff the medal of the Legion of Honor.)
Today, on this the 40th anniversary of the closing of the gold window, a group of Americans issued a statement reading, in its conclusion:
[W]e support a 21st century international gold standard. America should lead by unilateral resumption of the gold standard. The U.S. dollar should be defined by law as convertible into a weight unit of gold, and Americans should be free to use gold itself as money without restriction or taxation. The U.S. should make an official proposal at an international monetary conference that major nations should use gold rather than the dollar or other national currencies to settle payments imbalances between one another. A new international monetary system, based on gold, without official reserve currencies, should emerge from the deliberations of the conference.
Many of the signatories are associated with the American Principles Project, chaired by Sean Fieler, and the Lehrman Institute (with both of which this writer is professionally associated), chaired by Lewis E. Lehrman. Signatories also include such important thought leaders as Atlas Foundation’s Dr. Judy Shelton and Forbes Opinions editor John Tamny.
Politicians may have forgotten the power that real money, such as currency convertible into gold, has to reverse an economic crisis. But the people have not. Earlier this year, the government of Utah restored, to international attention, the recognition of gold and silver coins as legal money. Now news emerges that the largest and most respected political party in Switzerland is supporting the work of the Goldfranc Association, led by citizen Thomas Jacob, to introduce a gold-convertible Swiss franc as a parallel currency.
Proponents are using the Swiss political process to put the creation of a gold franc in the Swiss Constitution. Jacob finds himself in the very distinguished company of Rueff and Erhard.
While London burns Switzerland thrusts gold-based currency reform toward the center of the international debate on how to rescue the euro, end the debt crisis, and turbocharge economic growth and job creation with integrity, not Nixonian manipulation.
Will a world Wirtschaftswunder — an economic miracle — follow a restoration of gold convertibility? History shows how practical such a miracle can be.
A very old and well known story is told in Genesis 11. It is the story of the curse of Babel:
Now the whole world had one language and a common speech. As people moved eastward, they found a plain in Shinar and settled there.
They said to each other, “Come, let’s make bricks and bake them thoroughly.” They used brick instead of stone, and tar for mortar. Then they said, “Come, let us build ourselves a city, with a tower that reaches to the heavens, so that we may make a name for ourselves; otherwise we will be scattered over the face of the whole earth.”
But the LORD came down to see the city and the tower the people were building. The LORD said, “If as one people speaking the same language they have begun to do this, then nothing they plan to do will be impossible for them. Come, let us go down and confuse their language so they will not understand each other.”
So the LORD scattered them from there over all the earth, and they stopped building the city. That is why it was called Babel—because there the LORD confused the language of the whole world. From there the LORD scattered them over the face of the whole earth.
I retell this tale not for the sake of the theology but for the sake of our present debates. In what follows, the names have been omitted in the hope that I may be excused any hint of misrepresentation…
When I first approached a prominent worldwide leader of the Austrian School, in frustration at the pitiful state of economic debate, to ask who were the UK’s best Austrians, with a view to starting a UK-based Austrian-School think tank, things seemed ever so easy. I had mostly read Mises and a touch of Rothbard. I understood the Austrian school and the monetary theory of the trade cycle but I was not broadly read into the scholarly debate over money.
And then I discovered the curse of Babel amongst the monetary scholars of the free-market.
One eminent free-market British academic believes that central banking, fiat money and fractional reserve deposit taking are institutions which have evolved naturally in society and which should be preserved. He believes the Bank of England should be privatised.
Most Monetarists seem to think central banking and fiat money are just fine, together with the Keynesians, some of whom at least think they are free market, but some advocate various forms of full-reserve banking.
Most, perhaps all, Austrians think the central banks are a plain instrument of statism which should be abolished, together with deposit insurance, legal tender laws and various other privileges. They reject fiat money outright, more often than not, as a creature of interventionism and a tool of the enemies of liberty.
But one faction believes that fractional reserve deposit taking is a breach of sound property rights — a thoroughly libertarian concept — and that it emerged out of fraud to be legitimised by the state.
The other faction pay little heed to the theory of property rights in demand deposits, emphasising freedom of contract. They believe fractional reserve deposit taking is a natural and honest phenomenon which enjoys the consent of depositors. They argue that full-reserve deposit taking is only ever a product of the state and deride the full-reservers willingness to restrict freedom.
Amongst all this, the protagonists accuse one another variously of economic or legal ignorance or a misinterpretation of history. All sides have their scholars and their literature. Both factions claim the term “free banking” as a rejection of central banking. Sometimes they claim the support of the same scholars…
It seems once we go beyond money as the means of exchange, universal agreement stops. Truly, when it comes to the institutional arrangements for money, we are under the curse of Babel.
It is a pity then that money is dying.
Right across the western world and perhaps shortly in China, we see state-supplied money running out of control, with all the distortions and maladjustments that implies, across sectors, regions and time. It seems the state’s response to every setback is more borrowing and more debasement. Unable to sensibly measure the money supply and unsure whether circumstances are inflationary or deflationary, the authorities wrestle to prop up a system damned by its own inadvertent design, a design which emerged out of the failure of Bretton Woods, itself a system condemned to a youthful death.
Five years ago, I would have wondered how the monetary authorities of the Weimar Republic could be so stupid…
At The Cobden Centre, we are agreed that honest money is a product of the market subject to the laws of property and contract, not the will of authority. With Richard Cobden, we agree that the very terms of regulating and managing the currency are an absurdity: the currency should regulate itself. Unfortunately and despite endless study, we seem to be able to agree neither what the proper institutions of such a system would be nor how to get there.
We have previously published an admittedly incomplete list of ten plans for reform. Since I agree with Sir Mervyn King (PDF) in that “of all the many ways of organising banking, the worst is the one we have today”, I could happily accept most of them as a step forward. Perhaps Bagus’ “button-pushing” withdrawal of the state would have disruptive consequences beyond our imagination but it seems mere perseverance with our present system is little more predictable, except in as much as it shall fail.
The original curse of Babel was cast, it seems, to prevent a people speaking as one: for speaking as one, nothing they planned to do would be impossible for them. Perhaps we shall not aspire so high, but we must change if we are to rise above the level of The People’s Front of Judea and win a battle which, it seems, must be won in our lifetimes.
I do not doubt that the Government is sincere in its wish to make Britain “open for business” and to deliver greater life chances through reform of the welfare state. I gave some time to the Centre for Social Justice and now I see many of their ideas filtering through to public policy. I support those reforms from both a practical perspective and in view of their moral necessity.
The Prime Minister is correct to talk of the culture we have lost, particularly in respect of private shame. I am put in mind of C S Lewis’ book The Abolition of Man: there is, after all, such a thing as right and wrong. Lewis predicted humanity’s ultimate destiny on the path which embraces subjective morality: a dystopian society in which “we find the whole human race subjected to some individual men, and those individuals subjected to that in themselves which is purely ‘natural’ — to their irrational impulses.”
Some readers will recognise the problem and the dangers but reject the state’s role in finding a solution. However, we do not live in that world where the state is comprehensively rejected. There is a welfare state and it needs reform. The Government is getting on with it, and in the right direction too.
However, what the Government is not addressing is the de-civilising effects of inflation, that is, increasing the money supply.
What is commonly called “inflation” – a rise in the general price level – is an automatic consequence of debasing the currency. And currency debasement has been fierce in our lifetimes: the consequences have been and remain profound.
There is a presentation which, in one form or another, I have given many times. It shows, in a few charts:
- How the state has grown inexorably since 1900,
- How taxation reached an apparent limit at rather less than the scale of state spending, remaining there since 1971 or thereabouts.
- Where our debt projections are heading,
- How our money has been debased, particularly since 1971.
By the end of the presentation, I have explained our banking, fiscal and economic crisis. Given that what it shows is a monetary and fiscal catastrophe, people receive it surprisingly well. As far as I can tell, people can handle the truth and they want it.
One of the key slides is a price index from 1750-2003:
The grotesque debasement since 1971 – when Bretton Woods finally collapsed – hides the detail of the nineteenth century on a linear scale, so I include the same chart on a log scale. The log chart shows that, despite a number of crises and fluctuations, a pound in 1900 bought about the same basket of goods as a pound in 1800.
In contrast, money has lost almost all its value since the Second World War.
The Ethics of Money Production by Jörg Guido Hülsmann is particularly relevant at this point. Hülsmann writes:
To appreciate the disruptive nature of inflation in its full extent we must keep in mind that it springs from a violation of the fundamental rules of society. Inflation is what happens when people increase the money supply by fraud, imposition, and breach of contract. Invariably it produces three characteristic consequences: (1) it benefits the perpetrators at the expense of all other money users; (2) it allows the accumulation of debt beyond the level debts could reach on the free market; and (3) it reduces the [purchasing power of money] below the level it would have reached on the free market.
While these three consequences are bad enough, things get much worse once inflation is encouraged and promoted by the state. The government’s fiat makes inflation perennial, and as a result we observe the formation of inflation-specific institutions and habits. Thus fiat inflation leaves a characteristic cultural and spiritual stain on human society
He goes on to write of inflation’s tendency to centralise government, to extend the length of wars, to enable the arbitrary confiscation of property, to institutionalise moral hazard and irresponsibility, to produce a race to the bottom in monetary organisation, to encourage excess credit in corporations and to yoke the population to debt. He explains how “The consequence [of inflation] is despair and the eradication of moral and social standards.”
That all sounds familiar.
Hülsmann’s work is not scripture of course, but neither are his ideas isolated. Consider Ayn Rand:
Whenever destroyers appear among men, they start by destroying money, for money is men’s protection and the base of a moral existence.
It is my firm view that inflation – the debasement of money – was the primary cause of the banking crisis. That inflation was a deliberate policy choice of welfare states. You may recall Eddie George’s remarks in 2007 and now Mervyn King has said, “Of all the many ways of organising banking, the worst is the one we have today.”
Moreover, if Hülsmann, Rand and other scholars including Mises and Hayek are to be believed, then inflation is also a major contributor to the moral and spiritual decline of our country. No amount of welfare reform alone will solve that.
All is not lost however. To return to that log-scale price index, money’s value was substantially more volatile in the first half of the nineteenth century than in the second. In 1844, the Bank Charter Act, Peel’s Act, took from the banks the privilege of extending bank notes in excess of specie (coins of inherent worth). It was recognized that this extension of candy-floss credit un-backed by prior production of real value was a systemic cause of economic and banking crises.
Unfortunately, that Act left the banks unmolested in their ability to create deposits. As our system of money and bank credit has evolved, that loophole, combined with central banking and the socialisation of risk, has delivered us into our present predicament.
It falls to our generation to solve this problem and that is why we established The Cobden Centre.
As Martin Wolf wrote in the Financial Times on 9th November 2010, “The essence of the contemporary monetary system is creation of money, out of nothing, by private banks’ often foolish lending.” And then we wonder why house prices have raced out of reach. We wonder why the basement garages in Canary Wharf are full of supercars while what was once our industrial heartland languishes in state dependency.
I admire the Prime Minister and the coming welfare reforms. I will back them gladly. But, until we end inflation as a way to fund the promises of the welfare state, we shall not have done the decent thing. We shall not have established objective morality in banking and in that lifeblood of society: money. Honest money is a prerequisite for social progress and it must be delivered if reform is to succeed.
The Interim Report on our banking system by Sir John Vickers was released on Monday. There is no mention in all of the report that a banker is a fiduciary to his client first and foremost. Call me old fashioned, but the casino banking of “lets place our bets” (of course with other people’s money) is now the vogue.
I submit that on the strong foundations of the fiduciary relationship sits a solid and sound banking system. Until we understand this, we are just tinkering around the edges.
Professors Kevin Dowd and his co-author Martin Hutchinson remind us of the partnership roots of banking and how this kept bankers from being too risky, and focused them on the long term needs of their clients, to whom they had open ended liability. Fiduciary or not, this forced honesty in the system.
A fiduciary duty is a legal relationship between one party, the principal, who is dependent on the better knowledge and judgement of the person he trusts, the fiduciary. This relationship exists between the doctor and the patient, the teacher and the student, the lawyer and his client, the accountant and his client and yes, the banker and the client. A fiduciary duty is the highest form of duty for you to dispense advice, offer services and do business. Your clients’ interests are above your own. You must avoid conflicts of interest, and you must only profit from your transactions so long as your client is aware of this. This is contrasted with the ordinary tort duty of care required when individual parties act only to avoid harm to others.
When you deposit your life savings with another party such as a bank, you are not requiring just reasonable tort standards of care, but absolute standards of car, i.e. fiduciary standards. Nothing can replace lost savings set aside for retirement. The banker has an enduring obligation of fiduciary care.
Now, in a modern bank from the very outset we have confusion. Its raison d’être, after providing safety for your money, is to offer to intermediate deposits to pass them through to where they are demanded, to willing borrowers of the bank. We are told by the majority of our bankers that the money in those deposits is ours. In reality, as recognised by law, a deposit is a debt from the bank to the depositor. This comes as a surprise to most, as evidenced by our Cobden Centre survey on banking. Some would say that this is fraud. I would say this is negligent misrepresentation. The latter requires only a false statement of fact being made to induce a party into a contract, which I submit is what actually happens when you go to open a bank account. Most offers of opening a bank account make no reference to the fact that you are becoming an unsecured creditor to the bank. This is a critical point, as most people are very shocked at this revelation. I am amazed that even after the total collapse of the banking system, the majority of people still think that their money is in their bank (and safe!). We have discussed on this web site before how there never is any mention of what you are actually legally getting involved with when you enter into an act of depositing or savings with a bank.
A group of us have tried to make matters very simple and clear up this confusion by supporting this Bill in Parliament. By requiring a distinction between deposits for safe custody and deposits for lending, we have cleared up some confusion in the banking system and laid the foundations for a solid system to grow and flourish.
The banker as fiduciary can then act in your best interest with your money kept aside for safe keeping and instant access, and investing the money you have allocated for lending, thus earning you interest. An honest fiduciary would then advise you according to the time-frame you choose for the investment, and your appetite for risk. You could invest in different parts of the bank to reflect this time and risk profile. At all points in time the bank could pay its safe-keeping deposits out, as they sit in the vaults as cash. Should some of the assets of the banks (the loans) turn bad, it is the liability of the partners, not the current account depositors, still less the taxpayers.
A fractional reserve bank, be it state-supported as they are today, or even a free one as some readers of this site advocate, could never guarantee this all the time. Thus they are immoral and thoroughly dishonest if tested under the fiduciary standard. A fractional reserve free bank could well exist with full disclosure as to the nature of the arrangement, but I would suggest this is not a fiduciary relationship. It implies reasonable standards of care, not absolute standards. This must be the case as the fractional reserve free banker can never say to you with certainty, “you can have all your money back when you demand it”. Only the fiduciary 100% reserve banker can. A fractional reserve free banker can say “with the law of large numbers, I am pretty sure I can guarantee you your money back, but never all of my deposits at the same time”.
That may well be fine for large numbers of people. Not for me. A humorous look at the mislabelled “Fidelity Fiduciary Bank” in Mary Poppins reveals the inherent contradictions. A boy does not want to deposit his tuppence, preferring to spend it on feeding the birds. The bankers attempt to persuade him to part with the money, eventually grabbing it from the boy. Other customers are concerned, and demand their own money back, with a chain reaction leading to a run on the bank.
To found a system of money and banking on such fragile foundations does seem insane to me. As I have said, the first step is to clarify the law with regards to the legal status of the banker and the client.
The establishment of the banker as a fiduciary is the next step in the reform process. This does not mean a banker can never earn anything other than a wage, like a law firm or an accountancy firm. They can always run their business in the most efficient manner, and thus profitably. They would only be forbidden from profiting at the expense of their clients.
Address these issues and we may well move towards an unregulated and honest money-orientated banking system that is wonderfully boring and fit for purpose. I see nothing in this Report that addresses those issues.